**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

**FORM 10-KSB**

**x**                              ANNUALREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934 FOR THE FISCAL YEAR ENDED APRIL 30, 2006

**o**                                 TRANSITIONREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**CommissionFile Number 000-33295**

**MedicalCV, Inc.**

(Name of Small BusinessIssuer in Its Charter)

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

 

**(651) 452-3000**

(Issuer’s TelephoneNumber, Including Area Code)

Securities registered under Section 12(b) ofthe Exchange Act:

**None**

Securities registered under Section 12(g) ofthe Exchange Act:

**CommonStock ($0.01 par value)**

(Title of Class)

Check whether the issuer is not required to filereports pursuant to Section 13 or 15(d) of the Exchange Act. o

Check whether the issuer:  (1) filed all reports required to befiled by Section 13 or 15(d) of the Exchange Act during the past 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x   No o

Check if there is no disclosure of delinquent filersin response to Item 405 of Regulation S-B contained in this form, and nodisclosure will be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part IIIof this Form 10-KSB or any amendment to this Form 10-KSB. o

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). o Yes   x No

The issuer’s revenues for its most recent fiscal yearwere $338,333.

The aggregate market value of the common equity heldby non-affiliates of the issuer as of June 26, 2006, was $14,427,119,based upon the last sale price of one share on such date.

As of June 26, 2006, the issuer had outstanding9,122,938 shares of common stock.

**DOCUMENTSINCORPORATED BY REFERENCE**

None.

 

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**TABLE OF CONTENTS**

|                                                                                                                                                | ** ** | PAGE | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|------|------------|
| PART I                                                                                                                                    |       | 1    |       |   |
| ITEM 1   DESCRIPTION OF  BUSINESS                                                                                                    |       | 1    |       |   |
| ITEM 2   DESCRIPTION OF  PROPERTY                                                                                                    |       | 13   |       |   |
| ITEM 3   LEGAL  PROCEEDINGS                                                                                                          |       | 13   |       |   |
| ITEM 4   SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                        |       | 13   |       |   |
| PART II                                                                                                                                   |       | 14   |       |   |
| ITEM 5   MARKET  FOR COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND SMALL BUSINESS ISSUER  PURCHASES OF EQUITY SECURITIES            |       | 14   |       |   |
| ITEM 6   MANAGEMENT’S  DISCUSSION AND ANALYSIS OR PLAN OF  OPERATION                                                            |       | 15   |       |   |
| ITEM 7   FINANCIAL  STATEMENTS                                                                                                       |       | 39   |       |   |
| ITEM 8   CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                                       |       | 39   |       |   |
| ITEM 8A   CONTROLS  AND PROCEDURES                                                                                                   |       | 40   |       |   |
| ITEM 8B   OTHER  INFORMATION                                                                                                         |       | 41   |       |   |
| PART III                                                                                                                                  |       | 42   |       |   |
| ITEM 9   DIRECTORS,  EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF  THE EXCHANGE ACT |       | 42   |       |   |
| ITEM 10   EXECUTIVE  COMPENSATION                                                                                                    |       | 47   |       |   |
| ITEM 11   SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER  MATTERS                           |       | 54   |       |   |
| ITEM 12   CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS                                                                            |       | 57   |       |   |
| ITEM 13   EXHIBITS                                                                                                                   |       | 62   |       |   |
| ITEM 14   PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                                                    |       | 63   |       |   |
| SIGNATURES                                                                                                                                     |       | 64   |       |   |
| INDEX TO FINANCIAL STATEMENTS                                                                                                                  |       | F-1  |       |   |
| INDEX TO EXHIBITS                                                                                                                              |       | E-1  |       |   |

 

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**PART I**

**ITEM 1**                   DESCRIPTIONOF BUSINESS

*The followingdiscussion contains various forward-looking statements within the meaning of Section 21Eof the Exchange Act. Although we believe that, in making any such statement,our expectations are based on reasonable assumptions, any such statement may beinfluenced by factors that could cause actual outcomes and results to bematerially different from those projected. When used in the followingdiscussion, the words “anticipates,” “believes,” “expects,” “intends,” “plans,”“estimates” and similar expressions, as they relate to us or our management,are intended to identify such forward-looking statements. These forward-lookingstatements are subject to numerous risks and uncertainties that could causeactual results to differ materially from those anticipated. Factors that couldcause actual results to differ materially from those anticipated, certain ofwhich are beyond our control, include those discussed in our CautionaryStatement as well as those discussed elsewhere in this document.*

*Our actual results, performance or achievements coulddiffer materially from those expressed in, or implied by, forward-lookingstatements. Accordingly, we cannot be certain that any of the eventsanticipated by forward-looking statements will occur or, if any of them dooccur, what impact they will have on us. We caution you to keep in mind thecautions and risks described in our Cautionary Statement and to refrain fromattributing undue certainty to any forward-looking statements, which speak onlyas of the date of the document in which they appear.*

**Overview**

Our ATRILAZE system utilizes laser energy in cardiactissue ablation procedures in open-heart surgery. We acquired the initialtechnology in August 2003 and we have developed several generations ofproducts beyond the initial technology purchase. We received FDA 510(k) clearancesfor the first generation product in November 2004 and the secondgeneration product in October 2005. In addition, we received a third 510(k) clearancein April 2006 which covered an additional laser wavelength.

The ATRILAZE system with its laser technology platformis currently being utilized to ablate cardiac tissue concomitantly, or inconjunction, with open-heart surgical procedures. Our strategy is to leverageour laser technology to develop a stand-alone, minimally invasive treatment foratrial fibrillation, or AF. We define a minimally invasive treatment as beingone in which the procedure is performed on a beating heart in a closed-chestsetting. We submitted an application for FDA 510(k) clearance of ourminimally invasive system in May 2006 and expect to introduce this systemfor commercial use in the second half of 2006.

AF is the most commonly occurring cardiac arrhythmia.AF is an erratic heartbeat that causes the atria to contract rapidly andineffectively and is associated with abnormal electrical impulses that alter apatient’s normal cardiac function. AF reduces cardiac output, is a majorprecursor to congestive heart failure, and is associated with an increasedincidence of stroke. Patients afflicted with AF are five times more likely tosuffer a stroke and are more likely to suffer increased mortality at an earlierage. According to the Framingham Study published in 2004, one in four people over40 years of age in United States has a lifetime risk of developing AF and theincidence of AF increases with age. More than 5.0 million people worldwide areafflicted with AF. Of the approximately 5.0 million, approximately 2.5 millionAmericans are afflicted with AF, with more than 200,000 new diagnoses eachyear. The annual market for open-chest surgical AF procedures is expected toreach $190 million to $250 million. The projected annual market forstand-alone, minimally invasive AF surgical procedures is expected to reach$2.1 billion.

We have begun supplying our current product, theATRILAZE system, a hand-held wand, to select centers for surgical ablation inconcomitant open-heart procedures to increase surgeon exposure to our products.We do not expect significant revenue until we introduce our ATRILAZE minimallyinvasive system.

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MedicalCV, Inc. wasincorporated in Minnesota on March 30, 1992, under the name CV Dynamics, Inc.

**AF TreatmentOptions**

There are currentlyfour primary treatment modalities for AF with a wide range of success andmorbidity rates.

·       *Drugs*—As a first line of treatment, patients typicallyreceive drug therapy to prevent blood clots, control heart rate and restore theheart rhythm. These drugs are often ineffective, not well tolerated and may beassociated with significant side effects. For these reasons, drug therapy forAF fails for up to 50% of patients within one year and 60% of patients withintwo years.

·       *Implantable Devices*—Implantable devices, such asdefibrillators and pacemakers, can be effective in reducing the symptoms andnumber of AF episodes, but neither device is intended to treat AF. Patients maycontinue to experience the adverse effects of AF as well as some of thesymptoms, including dizziness and fatigue, because the AF continues.

·       *Catheter-Based Treatment*—Catheter-based AF treatments aretechnically challenging, can be associated with serious complications and yieldinconsistent results. In proportion to the prevalence of AF, only a smallnumber of catheter-based AF treatments are performed each year in theUnited States.

·       *Surgery*—There are two types of surgical approaches totreating AF. These procedures are frequently done concomitantly with mitralvalve or coronary artery bypass surgery:

·        *Classic Maze Procedure—*The standard for curative treatmentof atrial fibrillation is known as the classic Maze procedure. This is amaximally invasive procedure that is routinely done concomitantly and requirescracking the sternum, opening the patient’s chest, placing the patient on theheart-lung machine, stopping the heart, disassembling, and finally reassemblingthe atrial chambers of the heart. This is done to create lesion lines using thesurgeon’s scalpel to interrupt the erratic electrical impulses that cause AF. Thisprocedure has a success rate of approximately 90 percent, but is a technicallydifficult and time-consuming procedure. The postoperative recovery times arelong, and the morbidity and mortality risks of this procedure are significant*.*

·        *ModifiedMaze Procedure—*Because of the significant technical challengesassociated with the classic Maze procedure, modifications were developed. Theseinvolved using ablation techniques rather than a scalpel to achieve lesiontransmurality, or full-thickness necrosis, in the target tissue. Thesetechnologies, however, have been designed to facilitate ablation mainly in theopen-chest setting*.*

**Minimally InvasiveCardiovascular Surgery—Stand-Alone Procedure**

During the last several years, newer minimallyinvasive cardiac surgery techniques have gained momentum as they have beenproven to lower costs, reduce patient trauma and provide better outcomes. Webelieve that these techniques are being used more frequently and represent oneof the fastest growing segments within the cardiovascular surgery market.Closed-chest procedures are done utilizing thoracoscopic and/or robotictechniques that allow the cardiovascular surgeon access through ports. Thistechnology allows the cardiovascular surgeon’s hands to be placed inside the patient’sclosed chest cavity through instrumentation and to view the cardiac anatomy asin an open-chest setting. Because of cardiac surgeons’ growing familiarity withthese techniques outside of the AF space, we believe there are significantopportunities in minimally invasive AF treatments. We believe MedicalCV’stechnology is ideal 

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for the minimally invasivesetting because of the size and flexibility of the optical fiber and itsdelivery system.

We began providing theATRILAZE system, which includes a hand-held wand, to surgeons in January 2005to help validate the use of laser in ablation. We intend to compete in themarket by leveraging laser technology in developing a stand-alone, minimallyinvasive system for ablating cardiac tissue.

**Alternative EnergySources for Surgical Ablation**

A number of energysources are currently used to ablate cardiac tissue in an open-chest, modifiedMaze procedure. These energy sources are used to create transmural lesionswhich prevent the abnormal electrical impulses that cause AF.

·       *Cryothermy*—also referred to as cryoenergy or “cryo.” Thistype of energy uses either a catheter or hand-held probe to ablate cardiactissue by freezing at extreme temperatures of up to negative 60°C.

·       *Radiofrequency*—Monopolar—also referred to as RF. This typeof energy uses either a catheter or hand-held probe or pen to ablate cardiactissue by using heat from radio waves.

·       *Radiofrequency*—Bipolar—also referred to as Bipolar RF. Thistype of energy uses a hand-held clamp device with two poles to ablate cardiactissue by using heat from radio waves.

·       *Microwave*—This type of energy uses either a catheter orhand-held probe to ablate cardiac tissue by using heat from microwave.

·       *Ultrasound*—sometimes referred to as high-intensity focusedultrasound, or HIFU. This type of energy uses either a catheter or hand-heldprobe to ablate cardiac tissue by using heat from ultrasonic energy.

·       *Laser*—also referred to as light energy or photocoagulation.This type of energy functions at varying wavelengths and uses either a catheteror hand-held device to ablate cardiac tissue by using absorptive heating.

There is currently an interest among both hospitalsand physicians to use minimally invasive procedures. While the systems thatutilize these energy sources have achieved some acceptance in open-chestconcomitant procedures, we believe current systems do not address the needs ofthe minimally invasive market because of either design or performancelimitations. In part, this is because most of these systems were notspecifically designed for minimally invasive applications, but rather modifiedin an attempt to adapt them for that application.

Laser technology has a long history of use in numeroussurgical procedures. Laser devices are valued for their coherent energy sourcewhich can create precise tissue ablations. Different wavelength lasers can beselected depending on the desired depth of penetration and absorptioncharacteristics of the target and surrounding tissues. Many cardiovascularsurgeons are already comfortable with laser devices, using them to bore smallholes in the heart to achieve transmyocardial revascularization for patientswith persistent angina. The small diameter and flexibility of the laser fibermake it possible to design a low-profile device that can be introduced into thebody through a minimally invasive access port.

In contrast, other devices, because they were designedfor open-chest procedures, require large incisions or use energy sources thatare not ideal for the creation of transmural lesions in a closed-chest, beatingheart setting.

Expenses related toresearch and development services were $3,471,241 for the fiscal year ended April 30,2006, compared to $1,581,016 for the fiscal year ended April 30, 2005.Research and development 

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servicesinclude expenses we previously referred to as research and development expensesand engineering and regulatory expenses.

**MedicalCV’sATRILAZE Minimally Invasive Solution**

MedicalCV’s ATRILAZEminimally invasive system is specifically designed to enable access to andablation of cardiac tissue for the potential treatment of AF in a closed-chestbeating heart. We expect that the ablation procedure would be completed in oneto two hours under general anesthesia. The surgeon would access the patient’sheart through three approximately 1 cm incisions, thread a unidirectional laserguide through the incisions and position it around the pulmonary veins. Asshown in the figure below, once the guide is in place, the surgeon initiatesthe ablation sequence, which lasts no more than 15 minutes. MedicalCV’s systemis pre-programmed and automatically navigates the laser energy around the heartdelivering precise ablation—minimizing the potential for surgeon error. Oncethe ablation is complete, the guide is removed and the approximately 1 cmincisions are closed. Because this treatment will be minimally invasive, weanticipate patients should experience significantly less pain and shorterrecovery time than they would in open-chest procedures.

ATRILAZE Minimally Invasive Application

Thereare three main components of our minimally invasive system including the laser,the controller, and the disposable kit that contains the delivery system withunidirectional laser guide.

|                |                     |
|----------------|---------------------|
| ATRILAZE Laser | ATRILAZE Controller |

 

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ATRILAZE DeliverySystem withunidirectional laser guide

We believe MedicalCV’s minimally invasive surgicalablation system has significant clinical advantages:

| **Feature**                | ** ** | ** **                                                         | ** ** | **Benefit**                                                              | ** ** | **Advantage** |
|----------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|---------------|
| Submillimeter Fiber  Optic |       | Allows for  miniaturization of delivery device                     |       | Facilitates closed-chest  treatment                                      |
| Coherent Energy            |       | Allows for  surgical precision and provides transmurality          |       | Limits collateral  damage and delivers effective lesion on beating heart |
| Ideal Wavelength           |       | Provides deep  tissue penetration and scatters when contacts blood |       | Increases  efficacy and safety                                           |
| Smart Automated Ablation   |       | Delivers rapid and  consistent ablation to tissue                  |       | Minimizes the potential  for surgeon error                               |

 

**The MedicalCVStrategy**

MedicalCV intendsto compete in the cardiac tissue ablation market by introducing products whichit believes are ideally designed for stand-alone, minimally invasive surgicalprocedures. The key elements of this strategy are:

·       **Capitalize on the potentially large atrial fibrillation market.****  **The AF marketis one of the fastest growing segments in cardiovascular surgery andinterventional cardiology. MedicalCV’s minimally invasive system allows thesurgeon to achieve a high quality transmural lesion by mimicking the classicMaze procedure. The similarity of the laser to the surgical scalpel providesprecise, transmural lesions. We believe that this will lead to rapid acceptanceof our system as providing stand-alone, minimally invasive cardiac tissueablation.

·       **Focus on leading surgeons to drive initial market acceptance.****  **We will firstfocus our efforts on surgeons who have active open-heart practices and who areconsidered to be opinion leaders in minimally invasive cardiovascular surgicaltechniques. As these leading surgeons incorporate our minimally invasive systeminto their standard practices, we believe they will help accelerate broaderawareness within the medical community through peer communication, thepresentation of results at surgical conferences and the publication of resultsin leading surgical and medical journals. We plan to educate, inform andheighten awareness as we further develop the market for a stand-alone,minimally invasive system.

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·       **Continue to penetrate the cardiac tissue ablation and atrialfibrillation markets using a dedicated sales team.****  **We intend toleverage the extensive cardiac experience of our dedicated sales team toleverage key cardiovascular relationships and provide effective customerassistance to accelerate market definition and adoption, thereby increasing thepenetration of our cardiac tissue ablation systems.

·       **Educate physicians and patients about our minimally invasive system.****  **We believeeducation of physicians and patients regarding the benefits of laser ablationis critical to the successful adoption of our minimally invasive system. Weintend to develop cardiovascular surgeon and electrophysiologist training andeducation programs which will emphasize the clinical efficacy and ease of useof our minimally invasive system. We also intend to develop patient-orientedmarketing materials for cardiovascular surgeons and hospitals to use to informpatients of the availability and potential benefits of our minimally invasivesystem.

·       **Conductclinical studies to support our market initiatives.  **We intendto create a clinical registry in our initial centers. We will also beconducting additional studies to support the efficacy of our ablation systems.We intend to initiate a pre-clinical study after the clearance by the FDA ofour minimally invasive system. This study will be designed to pursue expandedlabeling for the specific indication of AF. We expect to initiate the study infiscal year 2008. We believe the results of this and other studies, ifsuccessful, will allow us to expand our marketing and clinical sales efforts.

**RegulatoryClearance**

Our ATRILAZE systemhas received three 510(k) clearances:

·       InNovember 2004, our hand-held wand received 510(k) clearance for deliveryof laser light to soft tissue, including cardiac tissue, during surgicalprocedures. Indications include the incision, excision, dissection,vaporization, ablation, or coagulation of soft tissue.

·       InOctober 2005, our malleable hand-held wand received 510(k) clearancefor delivery of laser light to soft tissue, including cardiac tissue, duringsurgical procedures with the same indications, including the incision,excision, dissection, vaporization, ablation, or coagulation of soft tissue.

·       InApril 2006, both hand-held devices were the subject of a third 510(k) clearanceallowing for the expansion of our laser base platform by the addition of asecond wavelength.

In May 2006, we filedan application for 510(k) clearance for our minimally invasive system. Weexpect to introduce this system for commercial use in the second half of 2006.

**Sales and Marketing**

In the United States, weplan to market the ATRILAZE minimally invasive system through a specialized,direct sales organization. In expectation of a commercial launch of ourminimally invasive system during the second half of 2006, we have hired a VicePresident of Sales, a Vice President of Marketing, and a Clinical Specialist.In addition to supporting our current efforts, this team will be responsiblefor the hiring and training of our sales organization. We expect to initiallyfocus on cardiovascular surgeons who have active open heart practices and areconsidered to be opinion leaders in minimally invasive surgical techniques, andon hospitals with well-established cardiovascular programs. Over time, weexpect to expand our sales and marketing organizations to service a broadergroup of potential customers. In addition, we intend to build patient awarenessthrough partnerships with cardiovascular surgeons, their cardiac servicespartners, and hospitals. Outside the United States, we intend to develop anetwork of distributors to assist in our international sales and marketingefforts.

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**Manufacturing**

The minimally invasivesystem has been designed internally. We expect that the assembly of thedisposable system components and quality control will also take placeinternally. The manufacture of the hardware system components will beoutsourced to qualified vendors. Product sterilization and related testing willalso be outsourced to qualified vendors.

**IntellectualProperty**

We intend to aggressively document and protect ourintellectual property by obtaining U.S. and foreign patents to protecttechnology important to the development of our business. We have filed 14 U.S.non-provisional patent applications, one provisional U.S. patent application,one international patent application and one European patent application,relating to products we have designed for use in treating AF. Obtaining patentprotection for our products will be critical to our commercial success. Weregularly conduct searches of third party patents. This includes a review ofpatents owned by third parties and patent applications pending known to us asattempting to address treatment of atrial fibrillation using a laser to ablatecardiac tissue. We regularly search publicly available records for relevantpatents assigned to other companies. During the course of these searches, weidentified two issued patents in our field relating to the use of lasertechnology for which we deemed it advisable to seek the advice of patentcounsel. Based upon advice from our patent counsel, we believe that the saleand use of our cardiac tissue ablation systems using infrared laser energywould not infringe any valid claim of these patents.

We cannot assure you that any patents issued to uswill be valid, enforceable or otherwise be of value to us in relation toproducts of our competitors or the market in general, or that any patent forwhich we have applied or may apply will issue.

In April 2005, we received a letter from EdwardsLifesciences, LLC (“Edwards”) concerning our ATRILAZE system, which is thesubject of some of our patent applications. Edwards did not claim that ourproducts infringe any of its patents. Edwards’ letter called to our attentionsix of its patents and requested us to comment on how our products differ fromthe claimed methods and apparatus of the six specified Edwards patents. Wereviewed the specified Edwards’ patents and discussed them with our patentcounsel, and believe that our cardiac ablation systems do not infringe any ofthese patents. In response to a further inquiry from Edwards on May 25,2006, we responded through patent counsel outlining our position on at leastone of the Edwards’ patents. While Edwards did not claim in its letter that ourproducts infringe its patents, it is likely that in the future, Edwards orothers will continue to inquire regarding our products and patents and possiblymake intellectual property claims relating to our tissue ablation devices. Ourdefense of any claims made by Edwards, or of any other intellectual propertyclaims made in the future, regardless of the merits of such claims, coulddivert the attention of our technical and management personnel away fromdeveloping and marketing our products for significant periods of time. Further,the cost incurred to defend such claims could be substantial and adverselyaffect us, even if we are ultimately successful in defending such claims. Anadverse determination in connection with any of such claims in the future couldaffect our ability to sell our products, subject us to significant liabilitiesto third parties, or require us to modify our products to be non-infringing orseek licenses from third parties. There can be no assurance that we could beable to so modify our products or obtain licenses on satisfactory terms.

We also rely upon trade secrets and proprietaryknow-how. We require our technical employees and consultants to agree inwriting to keep our proprietary information confidential and, with certainlimitations, to assign all inventions relating to our business to us.

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

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**Competition**

Our industry is highly competitive, subject to change,and significantly affected by new product introductions and other activities ofindustry participants. Many of our competitors have significantly greaterfinancial and human resources than we do and have established reputations withour target customers, as well as worldwide distribution channels that are moreestablished and developed than ours. Our primary competitors include AtriCure, Inc.,Boston Scientific Corp., CryoCath Technologies, Inc., Edwards LifesciencesCorp., ESTECH, Inc., Medtronic, Inc., and St. Jude Medical, Inc.As of May 2006, no company had received FDA approval or clearance tomarket an ablation system for use as a treatment for AF in the United States.However, our competitors provide products that have been adopted by physiciansfor the off-label treatment of AF.

We and many of our competitors have developed surgicalablation devices that have been used to treat AF concomitant with an open-heartsurgical procedure. We and these competitors utilize different technologies asenergy sources for their ablation devices, including cryothermy,radiofrequency, microwave, high-intensity focused ultrasound, and laser. Eachof these companies is also currently working with its core technology todevelop devices that can be used as a stand-alone therapy minimally invasive AFtreatment.

Some of our competitors offer catheter-basedtreatments, including Boston Scientific Corp., Cardima, Inc., CryoCathTechnologies, Inc., CryoCor, Inc., Johnson and Johnson, Inc.,Medtronic, Inc., and St. Jude Medical, Inc. These companies sell productsthat are used by physicians to treat the population of patients that have AF,but are not candidates for open-heart surgery, which is the same group ofpatients that we believe would most benefit from stand-alone AF treatmentsusing our minimally invasive system. Some of these catheter-based treatmentsalready have FDA clearance or approval for cardiac use, including the treatmentof certain arrhythmias, although none has approval for the treatment of AF.

We believe that once ourATRILAZE minimally invasive system is cleared pursuant to the FDA 510(k) process,we will compete favorably in the minimally invasive cardiac ablation market.Because of the size of the AF market and the unmet need for an AF cure,competitors have and will continue to dedicate significant resources toaggressively market their products. New products that could compete with usmore effectively are likely because the surgical AF treatment market ischaracterized by extensive research efforts and technological progress.

**GovernmentRegulation**

The medical devices we manufacture and market aresubject to regulation by the FDA and, in most instances, by state and foreignauthorities or their designated representatives. Under the U.S. FederalFood, Drug and Cosmetic Act and the regulations promulgated thereunder, as amanufacturer of medical devices, we must comply with policies and proceduresthat regulate the manufacturing, composition, labeling, testing, packaging anddistribution of medical devices. In addition, medical devices are subject todifferent levels of government approval requirements, the most comprehensive ofwhich requires the completion of an FDA approved clinical evaluation programand submission, and approval of a premarket approval application before adevice may be commercially marketed. The FDA also conducts inspections beforeapproving a premarket approval application to determine compliance with thequality system regulations which cover manufacturing and design.

After premarketapproval is received, the FDA may require testing and surveillance programs tomonitor the effectiveness of approved products which have been commercialized.It has the power to prevent or limit further marketing of a product based onthe results of such post-marketing programs. In addition, the FDA may, at anytime after the approval of a premarket approval application, conduct periodicinspections to determine compliance with good manufacturing practiceregulations and current 

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medicaldevice reporting regulations. If the FDA concludes that we are not incompliance with applicable laws or regulations, it can institute proceedingsto:

·       Seizeour products;

·       Requirea product recall;

·       Withdrawpreviously granted market clearances;

·       Implementprocedures to stop future violations; and/or

·       Seekcivil and criminal penalties against us.

The FDA also regulates recordkeeping for medicaldevices and reviews hospital and manufacturers’ required reports of adverseexperiences to identify potential problems with FDA-authorized devices.

Some of the products that we market, including ourATRILAZE system, can be cleared under Section 510(k) of the FederalFood, Drug and Cosmetic Act. Under Section 510(k) a new orsignificantly modified device must be shown to be “substantially equivalent”(SE) to an existing legally marketed device. The new/modified device can becommercially introduced after the filing of a 510(k) premarket applicationwith the FDA and the subsequent issuance by FDA of a SE determination. The FDAhas provided guidance documents to manufactures of devices governed by Section 510(k) wherebychanges made to previously cleared devices can be evaluated by the manufacturerand a determination can be made as to the need to file an additional premarketapplication. We received Section 510(k) clearance for the firstgeneration of our ATRILAZE system in November 2004 and the secondgeneration product in October 2005. A third 510(k) clearance wasreceived in April 2006. The process of obtaining Section 510(k) clearancetypically requires less time and expense than the premarket approval process. Section 510(k) clearancenormally takes from three to twelve months, but can take years, and generallyrequires the submission of supporting data, which in some cases can beextensive. In addition, the FDA may require review by an advisory panel as acondition for Section 510(k) clearance. We intend to rely on the Section 510(k) processwith regard to future products that add to or enhance our current cardiactissue ablation technology. However, we may develop or acquire technology thatwill require clearance under the FDA’s lengthier and expensive premarketapproval process, which can take a number of years and can require extensivesupporting documentation. If we encounter difficulties in the premarketapproval process, the commercial marketing of a product could be substantiallydelayed or prevented.

International sales of medical devices are alsosubject to extensive regulation. Foreign regulatory bodies have establishedvarying regulations governing product standards, packaging requirements,labeling requirements, import restrictions, tariff regulations, duties and taxrequirements. Generally, the extent and complexity of the regulation of medicaldevices is increasing worldwide, with regulations in some countries alreadynearly as extensive as those in the U.S. This trend may continue, and the costand time required to obtain marketing approval in any given country thus mayincrease. We cannot assure you that any foreign approvals will be allowed on atimely basis, or at all.

To market our products incountries of the European Union, we are required to obtain CE markcertification. CE mark certification is the international symbol of adherenceto certain quality assurance standards and compliance with European medicaldevice directives. We intend to apply for CE mark certification for ourminimally invasive system product in fiscal year 2007.

**Product Liabilityand Insurance**

The development and sale of medical devices entailssignificant risk of product liability claims and, sometimes, product failureclaims. We face an inherent business risk of financial exposure to productliability claims if the use of our products results in personal injury ordeath. We also face the possibility that defects in the design or themanufacturing of our products could necessitate a product recall. We have 

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not, to date, experiencedsignificant product liability claims, and we have never had a product recall.We cannot assure you, however, that we will not experience losses in the futuredue to product liability claims or recalls.

If patients allege that the use of our cardiovascularsurgery devices injured them, we may face substantial product liability claims.Substantial product liability litigation exists within the medical device industry.Our products are used in cardiovascular surgery, and their failure may resultin patient injury or death. We have had product liability claims assertedagainst us in the past, which were resolved under our insurance coveragewithout significant financial cost to us. We cannot assure you, however, thatfuture product liability claims will not exceed the limits of our insurancecoverage or that such insurance will continue to be available to us oncommercially reasonable terms, or at all. Consequently, a product liabilityclaim or other claim with respect to uninsured liabilities, or in excess ofinsured liabilities, could have a material adverse effect on our business,financial condition, operating results and cash flows. In addition, adverse publicityresulting from product liability litigation may materially adversely affect usregardless of whether the claims are valid or whether we are liable.Furthermore, these claims would likely divert our financial and managementresources that would otherwise be used to benefit the future performance of ouroperations.

We sold more than 50,000 mechanical heart valvesbetween 1992 and 2005. We assume that a majority of the patients who receivedour heart valves are still alive. If any of these patients were to have aproblem with a heart valve, they could assert claims for damages against us. InApril 2005, we placed our product liability insurance with a new insurancecarrier. Our new policy provides us with potential coverage for claims of up to$5,000,000 per occurrence and in the aggregate per policy year. Concurrently,we purchased a three-year extended reporting coverage endorsement from ourformer carrier, which was unwilling to renew our coverage on the previousterms. The extended reporting period coverage will allow us to seek coverageunder the prior policy for products claims arising from occurrences which tookplace during such policy period but which were not asserted against us duringthe previous policy period.

In March 2005, webecame aware that a patient who had been implanted with our heart valve haddied. We have not received any claims related to this matter but believe thatany such claim would be covered by our existing liability insurance. Based uponthe expectation that insurance would cover the cost of any claims after ourpayment of the deductible, we do not expect the ultimate resolution of thismatter to have a material effect on our business, financial condition,operating results or cash flows.

**Employees**

As of June 26, 2006,we had 23 full-time employees, including 12 who support or were in research anddevelopment, and the remainder of whom were in administration, regulatory andclinical, and sales and marketing. We are not a party to any collectivebargaining agreement and believe that our relations with employees are good.

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**Executive Officersof the Registrant**

Thefollowing table provides information with respect to our executive officers asof June 26, 2006. Each executive officer has been appointed to serve untilhis successor is duly appointed by the board or his earlier removal orresignation from office. Each executive officer’s position with MedicalCVrepresents such person’s principal occupation. 

| **Name**           | ** ** | ** ** | ** ** | **Age**                                                       | ** ** | **Position with MedicalCV** | ** ** | **Director  Since** |
|--------------------|------------|------------|------------|---------------------------------------------------------------|------------|---------------------------------------|------------|---------------------|
| Marc P. Flores     |       | 41         |       | President, Chief  Executive Officer and Director              |       | 2004                                  |
| Adam L. Berman     |       | 31         |       | Vice President, Research  and Development                     |       | N/A                                   |
| Eapen Chacko*      |       | 58         |       | Vice President, Finance  and Chief Financial Officer          |       | N/A                                   |
| Robert W. Clapp    |       | 56         |       | Vice President,  Operations                                   |       | N/A                                   |
| James E. Jeter     |       | 43         |       | Vice President, Sales                                         |       | N/A                                   |
| John H. Jungbauer* |       | 57         |       | Principal Financial  Officer and Principal Accounting Officer |       | N/A                                   |
| Dennis E. Steger   |       | 59         |       | Vice President,  Regulatory Affairs and Quality Assurance     |       | N/A                                   |
| Gary O. Tegan      |       | 39         |       | Vice President, Marketing                                     |       | N/A                                   |

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*                    Mr. Chackois expected to assume the roles of principal financial officer and principalaccounting officer upon Mr. Jungbauer’s resignation.

*Marc P. Flores*became our President, Chief Executive Officer and one of our directors in August 2004.Mr. Flores served as Vice President of Sales & Marketing ofCoalescent Surgical, Inc., a company focused on developing advancedtechnology for blood vessel anastomoses, from March 2000 to August 2004.Prior to joining Coalescent, Mr. Flores was Western Regional Manager ofSales for CardioThoracic Systems, Inc. from June 1997 to March 2000.Before joining CardioThoracic Systems, he held a variety of management andsales positions with Boston Scientific Corporation, GE Medical Systems andXerox Corporation.

*Adam L.Berman* joinedMedicalCV in September 2004 as Vice President, Research andDevelopment. Mr. Berman has extensive experience and relationships withinthe cardiac surgery industry. From July 2001 to August 2004, he was aregional sales manager for Coalescent Surgical, Inc. From August 1998to June 2001, he was a regional development manager for Computer Motion, acompany focused on robotic-assisted, minimally invasive approaches for surgery.Before joining Computer Motion, Mr. Berman held various clinical researchpositions within the field of cardiac surgery.

*EapenChacko* joined MedicalCV effective June 21, 2006, as VicePresident, Finance and Chief Financial Officer. Mr. Chacko will assume theroles of principal financial officer and principal accounting officer upon theresignation of John H. Jungbauer. Mr. Chacko has over 30 years ofexperience in strategic planning, investor relations, equity research andeconomics. From September 2000 to May 2005, he was Chief FinancialOfficer of Possis Medical, Inc., a developer, marketer and manufacturer ofmedical devices for the endovascular treatment market. Mr. Chacko was VicePresident for Investor and Public Relations, Corporate Communication at Possisfrom September 1999 to August 2000. From 1995 to 1999, he wasDirector of Investor Relations at Fingerhut Companies, a direct marketer andfinancial services company. Mr. Chacko is a director of Hawkins, Inc.,a company that formulates, blends and distributes bulk and specialty chemicals.Mr. Chacko has been named, along with his former employer Possis Medical, Inc.and another officer of that company, as a defendant in a securities classaction case entitled Crowell, et al. v. Possis Medical, Inc. et al., No. 05-CV-01084-JMR-FLN,originally filed on June 3, 2005 in the United States District Court forthe District of Minnesota. The consolidated amended class action complaintalleges violations of Section 10(b) and Rule 10b-5 of theExchange Act against all defendants and claims under Section 20(a) againstthe officer defendants, all arising out of alleged misstatements and omissionsabout that company’s AngioJet product and clinical trials for that product.

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*Robert W. Clapp*****joined MedicalCV in August 2004as Vice President, Operations. From March 1993 to August 2004,Mr. Clapp was Vice President of Manufacturing, Quality, andResearch/Development for EMPI, where he developed and introduced many newproducts, improved manufacturing efficiencies and lowered manufacturing costs.From February 1987 to March 1993, he was Vice President ofManufacturing for Dacomed Corporation, where he helped introduce five newproducts into the marketplace in 18 months. Prior to that, Mr. Clapp heldengineering and operations positions at Xerxes Corporation, Medtronic, Inc.,Control Data Corporation and AMF Paragon Electric.

*James E. Jeter* joined MedicalCVin November 2005 as Vice President, Sales. Mr. Jeter most recentlyserved as a Central States Region Manager for Medtronic, Inc. from August 2004to November 2005, where he led a team charged with revenue growth acrossthree product platforms: cardiac revascularization, atrial fibrillation andCoalescent anastomotic devices. From January 2001 to August 2004, Mr. Jeterwas a Regional Sales Manager, then a Divisional Sales Manager, with CoalescentSurgical, Inc. tasked with starting and building the anastomotic devicebusiness for cardiac and vascular surgeons in the company’s Central StatesDivision. From July 1999 to January 2001, Mr. Jeter was a co-managingpartner of Innovative Surgical Products. Previously, he held a series ofpositions, including Director of Sales, Cardiac Division, with the GenzymeCorporation.

*John H. Jungbauer* joinedMedicalCV in February 2004 as Vice President, Finance and Chief FinancialOfficer. Mr. Jungbauer came to our company with more than 26 years ofexperience in financial management and long-range planning, internationalfinancial/treasury operations, information technology systems. From 1990 to2002, Mr. Jungbauer was Vice President of Finance and Chief FinancialOfficer with ATS Medical, Inc. During 1988 and 1989, he was Executive VicePresident of Titan Medical, Inc. From 1977 to 1987, he held severalfinancial management positions at St. Jude Medical, Inc., including VicePresident of Finance and Chief Financial Officer from 1981 to 1987. On April 6,2006, Mr. Jungbauer announced his intention to resign from his executiveofficer position at our company. On June 21, 2006, Mr. Jungbauer’sroles transitioned from Vice President, Finance and Chief Financial Officer toprincipal financial officer and principal accounting officer. Mr. Chackowill assume the roles of principal financial officer and principal accountingofficer upon the resignation of Mr. Jungbauer. Further details regardingthe anticipated effective date of Mr. Jungbauer’s resignation are setforth below under “Executive Compensation—Employment Contracts and Terminationof Employment, and Change-in-Control Arrangements.”

*Dennis E. Steger*,****Vice President, Regulatory Affairs and Quality Assurance,joined MedicalCV in September 2001 as Vice President, Quality Assurance.From August 1998 to August 2001, Mr. Steger was Director DesignQuality Assurance for Medtronic Perfusion Systems, where he was responsible forcontrolling the development and transfer of new/modified products from researchand development to manufacturing. He also held the position of DirectorRegulatory Affairs/Quality Assurance & Clinical for AVECORCardiovascular, Inc. from July 1991 to August 1998, where he wasresponsible for quality systems, technical support, risk analysis,documentation, and regulatory affairs. He has also held senior level managementpositions with Johnson & Johnson Cardiovascular, ExtracorporealMedical Specialties and Tompkins Rubber Company.

*Gary O.Tegan*, Vice President, Marketing, joined MedicalCV in April 2006.Most recently, Mr. Tegan served as the Vice President of Sales &Marketing for PneumRx, Inc. from September 2005 through April 2006,where he developed and implemented the company’s sales and marketing strategyfor its initial product launch. From June 2004 to September 2005, heserved as Vice President of Marketing at Curon Medical, Inc., aradiofrequency energy based company focused on the treatment ofgastrointestinal disorders. Prior to that, Mr. Tegan was the Director ofMarketing for Coalescent Surgical, Inc. from June 2001 to June 2004,where he helped develop its anastomotic device business using technology-basedmarketing techniques. Previously, Mr. Tegan held a series of senior salesand marketing positions at United States Surgical and Starion Instruments.

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**ITEM 2**                   DESCRIPTIONOF PROPERTY

We lease a 55,000 squarefoot production and administrative facility located in Inver Grove Heights, asuburb of Saint Paul, Minnesota. Our facility has approximately 8,000 squarefeet of general office space and more than 41,000 square feet of manufacturingspace. Our facility is subject to inspection by the FDA and foreign regulatoryagencies as part of their product marketing clearance and surveillanceprograms. In April 2003, we sold and leased back this facility in arefinancing transaction with PKM Properties, LLC (“PKM”), an entity controlledby Paul K. Miller, one of our directors and one of the largest beneficialowners of our securities. We simultaneously leased back our facility pursuantto a ten-year lease, with options to renew and an option to repurchase thefacility. We continue to utilize the facility as we did prior to the financingtransaction. See “Management’s Discussion and Analysis or Plan of Operation”and the notes to our financial statements for the fiscal year ended April 30,2006, for more information regarding such lease.

**ITEM 3**                   LEGALPROCEEDINGS

On March 9, 2006, JGiordano Securities LLC (d/b/a J Giordano Securities Group) (“JGSG”) filed suitagainst our company in U.S. District Court, District of Connecticut. JGSGclaims that it is entitled to damages due to an alleged breach of theengagement agreement, as amended, between us and JGSG. In particular, JGSGclaims that the exercise of outstanding warrants for the purchase of commonstock by certain JGSG-identified investors and our purchase of outstandingshares of 5% Series A Redeemable Convertible Preferred Stock from certainJGSG-identified investors in December 2005 and January 2006 entitleJGSG to damages no less than $1,431,769. In particular, JGSG seeks (a) $279,191in cash commissions, (b) warrants for the purchase of 85,905 shares at$3.25 per share, (c) lost profits of $751,669 on the argument thatJGSG would have exercised the foregoing warrant and sold 85,905 shares on December 30,2005, at a price of $12.00 per share, and (d) the $400,909 in cashcommissions we paid C.E. Unterberg, Towbin, LLC. JGSG also seeks reimbursementfor reasonable expenses, interest, costs and attorneys’ fees. In addition, JGSGnotified us by letter dated May 26, 2006 that, pursuant to the agreement,it may claim compensation arising out of alleged rights to serve as aco-managing underwriter or member of the underwriting group of a proposedpublic offering set forth in the registration statement on Form SB-2we filed with the Securities and Exchange Commission on May 19, 2006. Webelieve that this lawsuit is without merit and intend to vigorously defendourselves against the lawsuit and any additional claims brought by JGSG.

**ITEM 4**                   SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

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**PARTII**

**ITEM5**                   MARKET FORCOMMON EQUITY, RELATED SHAREHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASESOF EQUITY SECURITIES

Previously, units of oursecurities, consisting of common stock and Class A Warrants, traded on theOTC Bulletin Board, until the expiration of the Class A Warrant componentof such units on November 20, 2004. Due to lack of market makers, ourcommon stock did not trade between November 19, 2004 and December 20,2004. Our common stock resumed trading on the OTC Bulletin Board under thesymbol “MDCV” on December 21, 2004. Our common stock currently trades onthe OTC Bulletin Board under the symbol “MCVI.”

Thefollowing table sets forth the high and low bid prices as reported by the OTCBulletin Board for our units and common stock, as applicable, for the periodsindicated. Such quotations reflect inter-dealer prices, without retail mark-up,markdown or commission, and may not represent actual transactions.

| **Period**       | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------|------------|------------|------------|----------|------------|---------|------------|
| Fiscal Year 2005 |       |       |       |     |       |
| First Quarter    |       | $          | 20.50      |     | $          | 13.00   |       |
| Second Quarter   |       | $          | 25.00      |     | $          | 7.50    |       |
| Third Quarter    |       | $          | 15.10      |     | $          | 5.00    |       |
| Fourth Quarter   |       | $          | 12.50      |     | $          | 5.70    |       |
| Fiscal Year 2006 |       |       |       |     |       |
| First Quarter    |       | $          | 11.90      |     | $          | 6.50    |       |
| Second Quarter   |       | $          | 10.00      |     | $          | 6.00    |       |
| Third Quarter    |       | $          | 12.30      |     | $          | 5.30    |       |
| Fourth Quarter   |       | $          | 13.60      |     | $          | 7.00    |       |

 

As of June 26, 2006,we had 241 shareholders of record and approximately 648 beneficial owners.

We have never declared orpaid cash dividends on our common stock. 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. Anypayment of cash dividends in the future will be at the discretion of our boardof directors and will depend upon our results of operations, earnings, capitalrequirements, contractual restrictions and other factors deemed relevant by ourboard.

See “Security Ownership ofCertain Beneficial Owners and Management and Related Shareholder Matters” inItem 11 for information regarding securities authorized for issuance under ourequity compensation plans.

**Sales of Unregistered Securities during the FourthQuarter of Fiscal Year 2006**

On March 22, 2006,Tower Finance, Ltd. (“Tower”) exercised a portion of its warrant to purchase37,214 units on a net exercise basis, resulting in the issuance of (a) 11,270shares of our common stock and (b) a warrant to purchase 11,270 shares ofour common stock, at an exercise price of $18.375 per share, which expires on April 30,2009. Following this partial exercise, Tower retained a unit warrant topurchase 14,989 units, at an exercise price of $4.70 per unit, which alsoexpires on April 30, 2009. Each unit consists of one share of common stockand one warrant to purchase one share of common stock at an exercise price of$18.375 per share.

On April 19, 2006,Tower exercised its warrant to purchase 14,989 units on a net exercise basis,resulting in the issuance of (a) 8,738 shares of our common stock and (b) awarrant to purchase 8,738 shares of our common stock, at an exercise price of$18.375 per share, which expires on April 30, 2009.

Theforegoing issuances were made in reliance upon the exemption provided in Section 4(2) ofthe Securities Act. Certificates representing such securities containrestrictive legends preventing sale, transfer or other disposition, unlessregistered under the Securities Act. Except as set forth above, no discount orcommission was paid in connection with the foregoing issuances.

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**ITEM 6**                   MANAGEMENT’SDISCUSSION AND ANALYSIS OR PLAN OF OPERATION

*The following discussion of our financial conditionand results of operations should be read in conjunction with our historicalfinancial statements and related notes appearing elsewhere in this document.This discussion contains forward-looking statements that involve significantrisks and uncertainties. As a result of many factors, such as those set forthin our Cautionary Statement and elsewhere in this document, our actual resultsmay differ materially from those anticipated in these forward-looking statements.Also, see our Cautionary Statement for a discussion of the material risks anduncertainties applicable to our business.*

**Overview**

Our ATRILAZE system utilizes laser energy in cardiactissue ablation procedures in open-heart surgery. We acquired the initialtechnology in August 2003 and we have developed several generations ofproducts beyond the initial technology purchase. We received FDA 510(k) clearancesfor the first generation product in November 2004 and the secondgeneration product in October 2005. In addition, we received a third 510(k) clearancein April 2006 which covered an additional laser wavelength.

The ATRILAZE system with its laser technology platformis currently being utilized to ablate cardiac tissue concomitantly, or inconjunction, with open-heart surgical procedures. Our strategy is to leverageour laser technology to develop a stand-alone, minimally invasive treatment foratrial fibrillation, or AF. We define a minimally invasive treatment as beingone in which the procedure is performed on a beating heart in a closed-chestsetting. We submitted an application for FDA 510(k) clearance of ourminimally invasive system in May 2006 and expect to introduce this systemfor commercial use in the second half of 2006.

We have begun supplying our current product, theATRILAZE system, a hand-held wand, to select centers for surgical ablation inconcomitant open-heart procedures to increase surgeon exposure to our products.We do not expect significant revenue until we introduce our ATRILAZE minimallyinvasive system.

Our company was incorporated in Minnesota on March 30,1992, under the name CV Dynamics, Inc. In April 1992, we acquired allof the tangible and intangible assets of Omnicor, Inc. Omnicor resultedfrom the corporate and financial restructuring of a predecessor company calledMedical Incorporated, which was organized in 1971 to develop and market theLillehei-Kaster heart valve, licensed from the University of Minnesota.

Until November 2004,we developed and marketed mechanical heart valves known as the Omnicarbon® 3000 and 4000 heart valves. In November 2004,after an exhaustive evaluation of the heart valve business, we discontinued allheart valve related production. In April 2005, we announced that ourefforts to find a buyer for the heart valve business had been unsuccessful andthat we would stop selling heart valves and were exiting the heart valvebusiness. At that time, we also determined to direct all of our resources tothe development and introduction of products targeting the treatment of AF.

**Reverse Split**

On May 31, 2006, weeffected a reverse stock split pursuant to which every ten shares of our commonstock and every ten shares of our preferred stock were combined into one shareof common stock and one share of preferred stock, respectively, without anychange in the par value of the shares. Our authorized capital stock was reducedin like manner. No fractional shares were issued as a result of the reversesplit, and any fractional share interests will be paid in cash. The reversesplit was approved by our board of directors without shareholder approval inaccordance with the requirements of Minnesota law. Historical share datapresented herein gives retroactive effect to this reverse stock split.

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**Critical AccountingPolicies**

*The preparation ofour financial statements in conformity with U.S. generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe amounts reported in the financial statements and accompanying notes. We believeour estimates and assumptions are reasonable; however, actual results and thetiming of the recognition of such amounts could differ from those estimates. Wehave identified the following critical accounting policies and estimatesutilized by management in the preparation of our financial statements: revenuerecognition, inventory obsolescence, accounting for income taxes, andaccounting for stock-based compensation. Actual amounts could differsignificantly from management’s estimates.*

**RevenueRecognition.**   Werecognize revenue using guidance from SEC Staff Accounting Bulletin No. 104“Revenue Recognition in Financial Statements.” Revenue from the sale of ourproducts is recognized provided that we have received a written order, theprice is fixed, title has transferred, collection of the resulting receivableis probable and there are no remaining obligations. We did not generate anyrevenues related to our ATRILAZE system through the fiscal year ended April 30,2006. All revenues for fiscal year 2006 and prior pertain only to ourdiscontinued heart valve business and are reported as part of discontinuedoperations.

**InventoryObsolescence.**   In determining the appropriate carrying value of ourinventories, management considers a number of factors, including the aging ofour inventory, recent sales trends, industry market conditions and economicconditions. Although adjustments to the carrying value of our inventoriesreflect our best estimates, the estimates require a large degree of judgment.At April 30, 2005, the carrying value of our heart valve inventoriesreflected the cost of only the heart valves that we subsequently sold in May 2005.These inventories are reported as a component of our current assets ofdiscontinued operations. All other inventories of the discontinued heart valvebusiness have been reduced to a carrying value of zero.

**DeferredIncome Tax Assets.**   In assessing the realizability of our deferred taxassets, management considers whether it is more likely than not that ourdeferred income tax assets will be realized. The ultimate realization ofdeferred income tax assets is dependent on the generation of future taxableincome, which must occur prior to the expiration of our net operating loss andcredit carryforwards, which comprise the majority of the deferred tax assets.As of April 30, 2006, we had established a valuation allowance of$13,565,631 to fully offset our deferred tax assets due to uncertainty aboutgenerating sufficient future taxable income necessary to realize these deferredtax assets, particularly in light of our history of significant operatinglosses. In addition, future utilization of available net operating losscarryforwards may be limited under Internal Revenue Code Section 382 as aresult of changes in ownership.

**Stock-Based Compensation.**   We account forstock-based employee compensation arrangements in accordance with the provisionsof Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees,” and its interpretations whereby the difference betweenthe exercise price and the fair value on the date of grant is recognized ascompensation expense. Under the intrinsic value method of accounting, nocompensation expense is recognized in our statement of operations when theexercise price of our employee/director stock option grants equals or isgreater than the market price of the underlying common stock at the date ofgrant, and the measurement date of the option grant is certain. The measurementdate is certain when the date of grant is fixed and determinable. Compensationcost for employee stock options is measured as the excess, if any, of thequoted market price of our stock at the date of grant over the amount that theemployee is required to pay for the stock. Options issued tonon-employees/non-directors are accounted for as required by Statement ofFinancial Accounting Standards No. 123, “Accounting for Stock-BasedCompensation.”

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**Recent AccountingDevelopments**

In December 2004, the FASB issued SFAS No. 123R,“Share-Based Payment—an amendment of SFAS No. 123,” which requirescompanies to recognize in the statement of operations the grant-date fair valueof stock options and other equity-based compensation issued to employees. SFAS No. 123Ris effective for companies filing under SEC Regulation S-B as of the beginningof the first interim or annual reporting period of the first fiscal year thatbegins after December 15, 2005, which for us will be the first quarter ofour fiscal year ending April 30, 2007. We will use the modifiedprospective application method. Under the modified prospective applicationmethod, awards that are granted, modified or settled after the date of adoptionwill be measured and accounted for in accordance with SFAS No. 123R.Compensation costs for awards granted prior to, but not vested, as of the dateSFAS No. 123R is adopted would be based on grant date attributes similarto those originally used to value those awards for the proforma purposes underSFAS No. 123. We are in the process of evaluating the impact of theadoption of SFAS No. 123R.

In March 2005, theSEC released SAB No. 107, “Share-Based Payments.” The interpretations inSAB No. 107 express views of the SEC staff regarding the interactionbetween SFAS No. 123R and certain SEC rules and regulations, andprovide the staff’s views regarding the valuation of share-based paymentarrangements for public companies. In particular, SAB No. 107 providesguidance related to share-based payment transactions with non-employees,valuation methods (included assumptions such as expected volatility andexpected term), the classification of compensation expense, non-GAAP financialmeasures, first-time adoption of SFAS No. 123R in an interim period,capitalization of compensation costs related to share-based paymentarrangements, accounting for income tax effects of share-based paymentarrangements upon adoption of SFAS No. 123R, modification of employeeshare options prior to adoption of SFAS No. 123R and disclosures inManagement’s Discussion and Analysis subsequent to the adoption of SFAS No. 123R.SAB No. 107 requires stock-based compensation to be classified in the sameexpense lines as cash compensation is reported for the same employees. We willapply the interpretations of SAB No. 107 in conjunction with our adoptionof SFAS No. 123R.

**Results ofOperations for the Fiscal Years Ended April 30, 2006 and 2005**

*Salesand Marketing, Continuing Operations.**  *Salesand marketing expenses for the fiscal year ended April 30, 2006 were$525,384 compared to $317,386 in the prior fiscal year. Sales and marketingexpenses for both periods were comprised of expenses related to the marketingof our ATRILAZE system. The major components in the increase in sales andmarketing expense were an increase in salaries and related costs of $108,256and an increase in travel and related costs of $46,088.

*Generaland Administrative, Continuing Operations.*   General andadministrative expenses for the fiscal year ended April 30, 2006, were$3,459,916 compared to $4,012,506 for the fiscal year ended April 30,2005. The major components of the decrease in general and administrativeexpense were a reduction in consulting fees of $1,027,470, offset in part byincreases in personnel cost of $136,424 and professional fees of $266,256.

*Researchand Development Services, Continuing Operations.*   Research anddevelopment services include expenses we previously referred to as research anddevelopment expenses and engineering and regulatory expenses. Expenses relatedto research and development services were $3,471,241 for the fiscal year ended April 30,2006 compared to $1,581,016 in the prior fiscal year. The increase in researchand development services expense was primarily attributable to increasedconsulting and advisory board fees and expenses of $899,812, increasedpersonnel costs of $405,783, increased material costs of $159,132, a milestonepayment of $125,000, and increased travel expenses of $97,109.

*OtherIncome (Expense).*   Net other income was $16,770,731 for the fiscal year ended April 30,2006 compared to net other expense of $11,310,583 for the fiscal year ended April 30,2005. During the fiscal year ended April 30, 2006, we amended theterms related to the exercise price and expiration date of the 

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putable warrants we issuedin April 2005. The changes resulted in the recording of other income inthe amount of $6,744,930 in the fiscal year ended April 30, 2006. Inaddition, due to the decrease in our stock price between April 30, 2005and the date the putable warrants were exercised, we recorded the reduction tothe fair value of the putable warrants of $9,804,527 in other income in thestatement of operations during the fiscal year ended April 30, 2006. Thefair value of these warrants upon the closing of our preferred stock sale on April 1,2005 was $22,271,047. Because the fair value of these warrants at April 1,2005 exceeded the proceeds received in the redeemable convertible preferredstock and warrant issuances, the excess of the fair value of the warrants overthe proceeds received of $4,266,047 was recognized as other expense uponclosing in fiscal year 2005. In addition, during the period between closing andApril 30, 2005, the fair value of the warrants increased by $5,721,562which amount was included in other expense in the statement of operations forthe fiscal year ended April 30, 2005. See “Liquidity and Capital Resources”below for a more detailed discussion of our accounting for these warrants.Interest expense totaled $177,401 in the fiscal year ended April 30, 2006,compared to $1,352,183 in the prior fiscal year. The decrease in interestexpense was due to the decreased amount of borrowings outstanding. Interestincome totaled $384,773 for the fiscal year ended April 30, 2006 comparedto $22,994 in the prior fiscal year. The increase was due to a greater amountof cash available in fiscal year 2006.

*Income(Loss) from Continuing Operations.*   For fiscalyear 2006, our income from continuing operations totaled $9,314,190. For fiscalyear 2005, our loss from continuing operations totaled $17,221,491. Theincrease in income from continuing operations resulted from the other incomediscussed above.

*DiscontinuedOperations.*   Discontinuedoperations relate to the heart valve business. The loss from discontinuedoperations of $81,800 for the fiscal year ended April 30, 2006 resultedfrom costs and expenses of $557,780 being partially offset by sales of $338,333and a gain on disposition of assets of $137,647. The loss of $1,873,381 in thefiscal year ended April 30, 2005 related to costs and expenses of$4,178,278, being, partially offset by sales of $2,304,897.

*Dividendson Preferred Stock.  *During the fiscal year endedApril 30, 2006, we offered to repurchase certain outstanding shares ofredeemable convertible preferred stock pursuant to our preferred stockacquisition plan. Our acquisition of the redeemable convertible preferred stockin consideration of the issuance of 3,077 shares of common stock per share ofredeemable convertible preferred stock resulted in a non-cash dividend on theredeemable convertible preferred stock of $13,579,979. In addition, cashdividends of $588,542 were paid during the fiscal year ended April 30,2006.

*Income Tax Provision.  *Inlight of our history of operating losses, we have historically recorded avaluation allowance to fully offset our deferred tax assets. We have continuedto provide a full valuation allowance throughout fiscal year 2006 due to theinherent uncertainty about our ability to generate sufficient taxable income torealize these deferred tax assets. We have recorded no tax provision in fiscalyears 2006 and 2005 due to net operating losses generated for income taxreporting purposes.

**Liquidity andCapital Resources**

Cashand cash equivalents were $10,351,570 at April 30, 2006 compared to$10,637,796 at April 30, 2005. The decrease in cash and cash equivalentswas due to the following:

| Net cash used by  operating activities     |   | $         | (5,859,025 | ) |
|--------------------------------------------|--------|-----------|------------|---|
| Net cash used by  investing activities     |   | (3,611    | )          |
| Net cash provided  by financing activities |   | 5,576,410 |       |
| Net decrease                               |   | $         | (286,226   | ) |

 

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Net cash used by operating activities totaled$5,859,025 and $5,538,337 in fiscal years 2006 and 2005, respectively. Netincome of $9,232,390 in fiscal year 2006 was offset by net non-cash adjustmentsof $16,095,655, relating primarily to the decrease in the fair value of putablewarrants and gain from the sale of property, plant and equipment. The netchange in operating assets and liabilities of $1,004,240 related primarily tothe decrease in accounts receivable.

Net cash used by investing activities totaled $3,611and $195,543 in fiscal years 2006 and 2005, respectively. Purchases ofproperty, plant and equipment of $350,418 and $218,666 in fiscal years 2006 and2005, respectively, were offset by proceeds from sales of property, plant andequipment of $346,807 and $23,123 in fiscal years 2006 and 2005, respectively.

Net cash provided byfinancing activities totaled $5,576,410 and $15,711,820 in fiscal years 2006and 2005, respectively. In fiscal year 2006, the cash provided by financingactivities resulted primarily from net proceeds received from the exercise ofwarrants partially offset by preferred stock cash dividends and principalpayments under related party lease obligations. In fiscal year 2005, the cashprovided by financing activities resulted from net proceeds from the issuanceof redeemable convertible preferred stock and warrants, common stock andwarrants and from borrowings on long-term debt partially offset by payments ofterm debt and related party lease obligations.

*FinancingActivities*

Throughout fiscalyears 2006 and 2005, we entered into a number of transactions to provide fundsnecessary to meet our working capital and capital expenditure needs and to meetother obligations. Details of these activities are set forth below.

·       *2004 Private Placement.  *During February, April andMay, 2004, we conducted a private placement to accredited investors of units,with each unit consisting of one share of common stock and one common stockpurchase warrant. In this placement, we sold 273,076 units for aggregate grossproceeds of $4,014,222. During fiscal year 2005, we received gross proceedsfrom this placement of $2,265,123. The five-year warrants sold with the commonstock are exercisable to purchase an aggregate of 273,076 shares of commonstock at an exercise price of $16.00 per share. In connection with theplacement, we issued our placement agent a five-year warrant to purchase 12,327units at an exercise price of $18.375 per unit, paid our placement agent cashcommissions of $181,210 and paid our placement agent a non-accountableexpense allowance of $67,954. In addition, we issued a finder a five-yearwarrant to purchase 9,518 units at an exercise price of $18.375 per unit, paida finder’s fee of $140,928 and reimbursed a finder for expenses of $4,163. Thewarrants underlying the unit warrants issued to the placement agent and thefinder are exercisable for a period of five-years at an exercise price of$18.375 per share. As a result of anti-dilution adjustments through April 30,2006, these unit warrants became exercisable in the aggregate for 85,401 unitsat $4.70 per unit, with each unit consisting of one share of common stock andone warrant exercisable for one share of common stock. In March and April 2006,warrants to purchase 37,214 units were exercised on a net exercise basis. At April 30,2006, warrants to purchase 48,187 units at $4.70 per unit remained exercisable.

·       *Credit Agreements with PKM and Hauser.  *On November 17,2004, we entered into a discretionary credit agreement with PKM Properties, LLC(“PKM”), an entity controlled by Paul K. Miller, one of our directors and oneof the largest beneficial owners of our securities, pursuant to which we borrowed$500,000. This discretionary credit agreement had a maturity date of February 28,2005, that was extended to June 30, 2005. It required the payment ofinterest at a rate of 10 percent per year. It also contained variousrepresentations and loan covenants as are customary in banking and financetransactions. We issued a credit note to PKM to evidence such indebtedness. Inconnection with this discretionary credit agreement, we entered into anintellectual property security agreement 

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with PKM, pursuant to whichwe granted PKM a security interest in all of our intellectual property. We alsoacknowledged and accepted a third amendment to the first amended and restatedsubordination and intercreditor agreement by and between PKM and Peter L.Hauser, a beneficial owner of our securities. Pursuant to this agreement,proceeds borrowed under this discretionary credit agreement were deemed “seniordebt.” Further, PKM, pursuant to a waiver agreement, waived past defaults underthe discretionary credit agreements from January 2003 and November 2003.As additional consideration for the discretionary credit agreement we enteredinto in November 2004, we issued to PKM a warrant with a ten-year term topurchase 3,401 shares of our common stock at $14.70 per share. As a result ofanti-dilution adjustments through April 30, 2006, this warrant isexercisable for 11,363 shares at $4.40 per share. This debt was converted intoconvertible preferred stock and warrants in April 2005, as describedbelow.

·       *Bridge Financing.  *On December 31, 2004, we issued$225,000 principal amount of convertible bridge notes due May 31, 2005, tocertain accredited investors. On January 13, 2005, we issued $200,000principal amount of convertible bridge notes due May 31, 2005, to anaccredited investor. The notes bore interest at the rate of 10 percent per yearand were convertible into securities to be issued in our next equity financing.In April 2005, these notes were converted in connection with the preferredstock financing described below, at 100 percent of the issuance price of suchsecurities. In consideration of converting at 100 percent rather than 80percent of the issuance price of the preferred stock, the note holders werepermitted to retain the warrants issued to them in connection with theconvertible bridge financing.

In connection with theissuance of these notes, we issued five-year warrants to the investors for thepurchase of an aggregate of 8,500 shares of common stock. Such warrants areexercisable to purchase common stock at a price per share of $5.00. Theallocated fair value of the warrants was $79,030 and was accounted for as adiscount on the borrowings. This discount, which was initially presented as areduction of the carrying value of the debt, was amortized as interest expensethrough the April 2005 conversion date of the notes.

In connection with these issuances, we paid Tower, afinder, a cash commission equal to 8 percent of the gross proceeds raised frominvestors introduced to us by Tower and we agreed to issue a five-year commonstock purchase warrant to Tower for the purchase of a number of shares equal to8 percent of the total possible shares issuable to Tower-introduced investorsin this financing at an exercise price of $6.25 per share.

These bridge notes were converted into preferred stockand warrants in April 2005 at 100 percent of the issuance price of suchsecurities, as described below. Because the convertible bridge notes provided acontingent conversion option to the note holders which resulted in a beneficialconversion price when converted, we recorded an interest charge of $68,000 uponconversion of these notes in April 2005.

·       *Sale of Preferred Stock and Warrants.  *On April 1,2005, under the terms of a Securities Purchase Agreement with accreditedinvestors, we issued 1,803 shares of 5% Series A Redeemable ConvertiblePreferred Stock (“preferred stock”) to such investors, five-year warrants forthe purchase of 2,705,250 shares of common stock to such investors exercisableat $5.00 per share, and five-year warrants for the purchase in the aggregate of163,596 shares of common stock to the placement agent and finder exercisable at$5.00 per share. Each share of preferred stock, which was non-voting, had astated value of $10,000 per share and accrued dividends at a rate of 5% of thestated value annually, was convertible into the number of shares of commonstock equal to the $10,000 stated value divided by $5.00, subject toanti-dilution adjustments. We obtained gross cash proceeds of $13,603,000 atthe closing (net of $30,000 in legal fees which were withheld by the leadinvestor). We also converted $4,402,000 of indebtedness into theabove-referenced securities. We 

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incurred cash offeringcosts of $817,980, including agent commissions, a finder’s fee andout-of-pocket expense reimbursements. We also paid legal and administrativeexpenses of $18,086 incurred by PKM in this transaction.

In certain circumstances, we could have required thepreferred shareholders to convert their shares into common stock. In the eventof a fundamental transaction, as defined, the preferred shareholders had theright to require us to redeem the preferred shares at their stated value,including any accrued but unpaid dividends. In the event of certain defaults,the preferred shareholders had the right to require us to redeem the preferredshares at 110 percent their stated value, including any accrued but unpaiddividends. As a result of these redemption provisions, the carrying value ofthese preferred shares was considered to be redeemable and was reported as a “mezzanine”instrument on our balance sheet beginning on April 30, 2005. The aggregateliquidation value of these redeemable preferred shares at April 30, 2005,was $18,109,116. However, the carrying value of this redeemable preferred stockat April 30, 2005, was zero, net of a discount associated with thewarrants issued to the shareholders, the placement agent and the finder, asdescribed below. No redeemable convertible preferred stock was outstanding at April 30,2006.

We were required to register the common sharesunderlying the preferred stock and the common shares underlying the warrants.If we did not meet certain registration deadlines, the holders of preferredstock were entitled to liquidated damages, as defined. In the event of afundamental transaction, as defined, the warrants issued to the preferredshareholders, the placement agent and the finder, all provided the warrant holderswith the right to put the warrants to us for cash in an amount equal to thefair value of the warrants, as determined using the Black Scholes optionpricing model. As a result of this put right, the warrants were reported attheir fair value as a liability on our balance sheet and changes in the fairvalue of the warrant resulted in charges or benefits to our results ofoperations. The fair value of these warrants upon closing of the preferredstock sale was $22,271,047. Because the fair value of these warrants at April 1,2005 exceeded the proceeds received in the preferred stock and warrantissuances, the excess of the fair value of the warrants over the proceedsreceived (including the converted debt) was recognized as other expense of$4,266,047 upon closing. During the period between closing and April 30,2005, the fair value of these warrants increased to $27,992,609. We reportedthe $5,721,562 increase in fair value of putable warrants in other expense inthe statement of operations for the fiscal year ended April 30, 2005. Thefair value of the warrants, after the changes in terms noted below, was$11,443,152 at the date the warrants were exercised or the put option wasremoved. We reported the $16,549,457 decrease in fair value of putable warrantsin other income in the statement of operations for the year ended April 30,2006.

·       *Purchase of Preferred Stock and Exercise of Warrants.  *Holdersof a majority of the outstanding shares of preferred stock authorized us toproceed with a preferred stock acquisition plan. Pursuant to such plan, on December 21,2005, we entered into preferred stock acquisition agreements with the holdersof an aggregate of 1,499 shares of preferred stock. Under the agreements, weacquired the preferred stock of each such holder in consideration of theissuance 3,077 shares of common stock for each share of preferred stock beingacquired. On January 6, 2006, under the same form of preferred stockacquisition agreements, we acquired an additional 271 shares of preferredstock, representing all of the remaining then-outstanding shares of ourpreferred stock, for the same per share consideration. In the aggregate, weissued 5,447,814 shares of common stock in consideration of the acquisition of1,770 shares of preferred stock. We originally sold 1,803 shares of preferredstock. The 33 shares of preferred stock not purchased in December 2005 or January 2006were converted between June 2005 and October 2005 into shares ofcommon stock at a conversion ratio of 2,000 shares of common stock for eachshare of preferred stock.

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Also on December 21, 2005, we and holders of amajority of the outstanding shares of preferred stock and related common stockpurchase warrants entered into an amendment to the securities purchaseagreement as of April 1, 2005, to revise certain definitions containedtherein. Following such amendment, on December 21, 2005, we and each ofthe holders who originally agreed to sell preferred stock to our companyentered into amendments to such holders’ warrants issued under the securitiespurchase agreement. Pursuant to these amendments, we (1) reduced theexercise price on outstanding warrants for the purchase of an aggregate of2,296,950 shares of common stock held by such persons from $5.00 per share to$3.25 per share, and (2) accelerated the expiration date of such warrantsfrom April 1, 2010, to January 6, 2006. Concurrent with such warrantamendments, investors delivered warrant exercise notices to our company. Weauthorized one of such warrants, namely the warrant for the purchase of 445,200shares held by PKM, to be exercised on a net exercise basis (using a marketprice of $6.60 per share).

On January 6, 2006, under the same form ofamended warrant agreements, investors exercised warrants for the purchase of423,050 shares of common stock. We authorized one of such warrants, namely thewarrant for the purchase of 151,200 shares held by Mr. Hauser, to beexercised on a net exercise basis (using a market price of $6.60 per share).

In the aggregate, we issued 2,411,567 shares of commonstock in connection with the exercises by investors of investor warrants issuedin our April 2005 private placement. We also issued an additional 14,750shares of common stock in connection with exercises of warrants originallyissued to our agent and finder in our April 2005 private placement.

Also on January 6, 2006, pursuant to exercisenotices dated January 5, 2006, we issued shares of common stock upon theexercise of certain other warrants. In particular, holders of warrants for thepurchase of an aggregate of 107,850 shares of common stock, which wereoriginally issued to our placement agent in our April 2005 financing, wereexercised. Of such number, warrants for the purchase of 1,500 shares wereexercised for cash and warrants for the purchase of 106,350 shares wereexercised on a net exercise basis, resulting in the issuance of 75,974 sharesof common stock. Also effective January 6, 2006, we amended theoutstanding finder warrant for the purchase of 40,996 shares of common stock toadjust the exercise price to $3.25 per share and eliminate the right to put thewarrant to us for cash in an amount equal to the fair value of the warrants inthe event of a fundamental transaction.

The net effect of the December 2005 and January 2006transactions was to increase cash by $6,435,140 (net of expenses of $471,435),decrease the warrant liability associated with the warrants containing a putfeature by $18,188,082, increase common stock and additional paid-in capital by$31,458,271, increase non-cash dividends on preferred stock by $13,579,979because of the change in the number of common shares issued upon acquisition ofthe preferred stock and increase other income by $6,744,930. The outstandingshares of common stock were increased by 7,951,605 shares.

·       *Filing ofRegistration Statement for Public Offering.  *On May 19,2006, we filed a registration statement on Form SB-2 with theSecurities and Exchange Commission related to a proposed public offering ofcommon stock. Recent market conditions have delayed such proposed publicoffering. We cannot assure you that we will complete such offering on favorableterms, or at all.

*Analysis*

We anticipate that our sales and marketing, generaland administrative and research and development services expenses will continueto constitute a material use of our cash resources. The actual amounts andtiming of our expenses will vary significantly depending upon progress on ourproduct development projects and the availability of financing. Given our cashbalance of $10,351,570 at April 30, 2006, we 

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anticipate that we will requireadditional financing to enable us to build inventory, launch and market ourATRILAZE minimally invasive system and provide working capital to support ouroperations.

Our capitalrequirements may vary depending upon the timing and the success of the implementationof our business plan, regulatory, technological and competitive developments,or if:

·       Salesof our products are not achieved;

·       Operatinglosses exceed our projections;

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

·       Wedetermine to acquire, license or develop additional technologies.

We cannot, however, assure you that our efforts toenter the market for treating atrial fibrillation through laser ablation will:

·       Beattainable;

·       Beprofitable;

·       Reduceour reliance upon financing transactions; or

·       Enableus to continue operations.

**Commitments andContingent Liabilities at April 30, 2006**

*ProductLiability Contingency.*   In March 2005, we became aware that a patientwho had been implanted with our heart valve had died. We have not received anyclaims related to this matter but believe that any such claim would be coveredby our existing liability insurance. Based upon the expectation that insurancewould cover the cost of any claims after our payment of the deductible, we donot expect the ultimate resolution of this matter to have a material effect onour business, financial condition, operating results and cash flows.

*RelatedParty Lease Obligation.*   On April 4, 2003, we sold our corporateheadquarters, manufacturing facility and surrounding land in Inver GroveHeights, Minnesota, to PKM. In connection with the transaction, we receivedtotal consideration of $3.84 million consisting of (1) $1.0 million incash, (2) PKM’s assumption of our $2.5 million outstanding indebtedness toAssociated Bank which eliminated our indebtedness to Associated Bank, and (3) PKM’sassumption of our promissory note with Dakota Electric Association and landspecial assessments payable to Dakota County aggregating $336,105.

We simultaneously leased back our facility pursuant toa ten-year lease, with options to renew and an option to repurchase thefacility. We continue to utilize the facility as we did prior to the financingtransaction.

*SeveranceContingencies.*   At April 30, 2006, employment agreements withseven executive officers contained a provision for lump sum payments of up totwelve months severance if the employment of the officer is terminated withoutcause by us or for good reason by the officer as defined in the contracts.

On April 6, 2006, we entered into an amendment tothe executive employment agreement with John H. Jungbauer, our principalfinancial officer and principal accounting officer, to reflect the mutualdecision reached concerning his departure from our company. Pursuant to theamendment, Mr. Jungbauer’s employment will terminate on the date we advisehim that we have engaged a new chief financial officer and/or principalaccounting officer. The actual termination date will be no earlier than July 31,2006. We also have the right, at our option, to extend Mr. Jungbauer’semployment (as a non-officer) for a transition period. Such transition periodwill not, without Mr. Jungbauer’s consent, continue beyond December 31,2006. Mr. Jungbauer’s compensation and benefits will continue to be paidunder the 

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employment agreement attheir current rates through the termination date and any transition period.Under terms of the employment agreement, Mr. Jungbauer has the right toterminate his employment upon 60 days’ prior notice and is entitled to aseverance payment equal to six months of base compensation. Under theemployment agreement, Mr. Jungbauer will receive a severance payment of$100,000 on his termination date. To facilitate a smooth transition, we havealso agreed to make an additional severance payment to Mr. Jungbauer.Under the amendment, Mr. Jungbauer will receive an additional severancepayment of $100,000 on January 2, 2007. In addition to these severancepayments, we have agreed to pay or reimburse Mr. Jungbauer for medical(COBRA) benefits for the periods covered by the severance payments. A liabilityof $131,793 for the severance payments, related payroll taxes, and medicalbenefits is included in accrued expenses on our balance sheet at April 30,2006 and the expense is included in general and administrative expenses in thestatement of operations for the fiscal year then ended. Mr. Jungbauerholds stock options for the purchase of 144,012 shares of our common stock. Mr. Jungbauer’sstock option agreements provide that he has three months following terminationof employment to exercise the vested portions thereof. Options to purchase44,065 shares of our common stock will be vested on July 1, 2006. Pursuantto the amendment, we agreed to amend Mr. Jungbauer’s stock optionagreements to provide that his options, to the extent vested on the terminationdate, will be exercisable for a period of twelve months following thetermination of Mr. Jungbauer’s employment. In July 2006, we agreed toretroactively rescind the provision in the amendment that provided Mr.Jungbauer twelve months following termination of employment to exercise thevested portions thereof and revert to the original terms of the stock optionagreements that provide Mr. Jungbauer three months following termination ofemployment to exercise the vested portions thereof.

*TechnologyPurchase Agreement.*   In August 2003, we entered into a technologypurchase agreement with LightWave Ablation Systems, Inc. (“LightWave”) andits principals, one of whom became a current employee of our company, relatingto the acquisition of LightWave’s interests in technology consisting of acatheter/probe containing elements of optical fiber, coolant passages and otherfeatures for the purpose of delivering laser energy to the epicardial surfaceof the heart for treatment of atrial fibrillation. We paid LightWave an initialstandstill payment consisting of 1,500 shares of our common stock, $10,000 uponclosing and an additional $30,000 to LightWave in installments in 2004 and2005. In addition, at closing, during fiscal year 2004, we issued to LightWavea warrant for the purchase of 2,500 shares of common stock at $14.60 per shareand, during fiscal year 2005, a warrant for the purchase of 2,500 shares ofcommon stock at $14.60 per share upon receiving FDA 510(k) clearance. Inaddition, we are obligated to issue a warrant for the purchase of2,500 shares of common stock upon receipt of a U.S. utility patentcovering the product and a warrant for the purchase of 2,500 shares of commonstock upon the first commercial sale of our product.

A milestone payment of $125,000 was made to LightWavein January 2006. We will be obligated to pay an additional $385,000 within45 days following our achievement of $1,500,000 of cumulative gross sales ofdisposable products.

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Inaddition, following the first commercial sale, we have agreed to pay LightWavepayments equal to 6 percent of net sales of the LightWave product incountries in which we obtain patent protection and 4 percent of net salesof the LightWave product in territories in which there is no patent protection.Commencing with the second year following our first commercial sale, we haveagreed to pay minimum annual payments as follows:

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

 

We are obligated to makepayments for a period of ten years following the first commercial sale. Ourtechnology purchase agreement with LightWave contains other customaryconditions, including mutual indemnification obligations. LightWave and two ofits principals have agreed to certain noncompetition obligations, nondisclosureobligations, and certain obligations to assign new developments or inventionsrelating to the acquired technology to our company. We have agreed to use ourreasonable commercial efforts to commercialize the technology within threeyears following the acquisition of the technology from LightWave. If we fail inany year to pay minimum annual payments, we may be obligated to grant LightWavea nonexclusive right to use the technology acquired from LightWave, or payLightWave the difference between payments actually made and minimum paymentsdue for a given year.

The following tablesummarizes our contractual obligations as of April 30, 2006, excludingproduct liability contingencies, severance contingencies, and payments that arecontingent upon achievement of future development and sales milestones, asdescribed above:

| ** **                                        | ** ** | **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)                |       | $                                         | 2,914,034  |   | $ | 432,344 |   | $ | 877,468 |   | $ | 1,604,222 |   |
| Accrued Severance                                 |       | 131,793                                   |       | 131,793 |   | — |   | — |   |
| Operating Lease                                   |       | 22,580                                    |       | 5,530 |   | 11,060 |   | 5,990 |   |
| Total Contractual  Obligations                    |       | $                                         | 3,068,407  |   | $ | 569,667 |   | $ | 888,528 |   | $ | 1,610,212 |   |
|                                                   |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Includesinterest

**Qualitative and Quantitative Disclosures about MarketRisk**

We have discontinued sales of heart valves and arefocusing all of our resources on the development and introduction of ourATRILAZE system. Sales in fiscal year 2007 are not expected to be material, andwe expect that any sales will be in the United States denominated in U.S.dollars. Our interest income and expenses are sensitive to changes in thegeneral level of U.S. interest rates, particularly since our investments are inshort-term instruments. At April 30, 2006, we held a majority of our cashin a money market account. Based on the current nature and levels of ourinvestments we believe that we currently have no material market risk exposure.

Ourgeneral investing policy is to limit market and credit risk and the risk ofprincipal loss. All liquid investments with maturities of three months or lessare considered to be cash equivalents.

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**CautionaryStatement**

*Investing in ourcommon stock involves a high degree of risk. You should consider carefully therisks described below and the other information in this document, including ourfinancial statements and the related notes included elsewhere in this document,before deciding to invest in our common stock. If any of the following risksactually occur, they may materially harm our business and our financialcondition and results of operations. In this event, the market price of ourcommon stock could decline, and you could lose part or all of your investment.*

**Thedevelopment and commercialization of our ATRILAZE minimally invasive system,which has not yet been cleared by the FDA, is critical for our success.**   InMay 2006, we filed an application with the FDA to obtain FDA 510(k) clearancefor our ATRILAZE minimally invasive system. We cannot assure you that we willreceive such clearance in a timely manner, if at all. Failure to receiveclearance would have a material adverse effect on our business, financialcondition, operating results and cash flows. Even if we do receive FDA 510(k) clearance,we will not initially be able to market the system as an effective means oftreating AF until we can demonstrate its clinical efficacy to the FDA.

If we do receive FDA 510(k) clearance on ourATRILAZE minimally invasive system, we intend to initiate a human clinicalstudy in fiscal year 2008. This study will be designed to pursue expandedlabeling for the specific indication of AF. We cannot assure you that thesystem will prove to be a safe and effective treatment option or that the FDAwill expand the labeling for the specific indication of AF. If the labeling isnot expanded, it would have a material adverse effect on our business,financial condition, operating results and cash flows.

**Evenif our ATRILAZE minimally invasive system receives FDA 510(k) clearance,we can give no assurance the system will be equal to or superior to othersystems for the ablation of cardiac tissue.**   Althoughlaser energy has been used widely in various cardiac procedures, the use isrelatively novel in minimally invasive procedures to ablate cardiac tissue andpotentially treat AF. While our ATRILAZE minimally invasive system hasdemonstrated success in ablating cardiac tissue in animals, we have not yetconducted studies in a human clinical setting. Accordingly, there can be noassurance that this system will be clinically effective. In addition, ourcompetitors have developed alternative surgical treatments to ablate cardiactissue and potentially treat AF. Furthermore, our competitors may be in theprocess of creating similar or superior treatments or procedures to ourATRILAZE minimally invasive system of which we are not aware. If our ATRILAZEminimally invasive system does not prove to be equal to or superior to othersystems for the ablation of cardiac tissue, it would have a material adverseeffect on our business, financial condition, operating results and cash flows.

**Even if we obtainregulatory clearance, we cannot assure you that our ATRILAZE minimally invasivesystem will gain physician acceptance.**   A limitednumber of cardiovascular surgeons and cardiologists can influence medicaldevice selection and purchase decisions for a large portion of the targetcardiovascular surgery patient population. Even if we obtain FDA 510(k) clearancefor our ATRILAZE minimally invasive system, we cannot assure you that it willgain any significant degree of physician acceptance, or that users will acceptour minimally invasive system as preferable to alternative products or methodsof treatment of AF. Physician acceptance of this system depends upon a numberof additional factors, many of which are beyond our control, including:

·       Oursuccess in extending our labeling to the treatment of AF;

·       Theperceived safety and effectiveness of the system;

·       Educationand training of physicians of the system;

·       Theprevalence and severity of any side effects;

·       Theprocedure time associated with the use of the system;

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·       Potentialadvantages over alternative treatments;

·       Thestrength of marketing and distribution support; and

·       Thirdparty coverage of reimbursement.

If our minimally invasive system does not achieve anadequate level of acceptance by physicians, patients or healthcare payers, wemay not generate significant revenue and we may not become profitable.

**If weare unable to manage our expected growth, our future revenue and operatingresults may be adversely affected.**   If we receiveFDA clearance for our ATRILAZE minimally invasive system, we will need torapidly expand our sales and marketing operations and grow our research anddevelopment, product development and administrative operations. This expansionis expected to place a significant strain on our management and operational andfinancial resources. Our current and planned personnel, systems, procedures andcontrols may not be adequate to support our anticipated growth. To manage ourgrowth, to commercialize our ATRILAZE minimally invasive system and to fundclinical studies, we will be required to improve existing and implement newoperational and financial systems, procedures and controls and expand, trainand manage our growing employee base. If we are unable to manage our growtheffectively, our business, financial condition, operating results and cashflows could be harmed.

**Ourefforts to develop and commercialize new products beyond our ATRILAZE systemand accessory products are at an early stage and are subject to a high risk offailure.**   A key element of our strategy is todevelop and commercialize new products for the treatment of AF as extensionsof, or in addition to, our ATRILAZE system. We are seeking to do so through ourinternal research programs and we may explore strategic collaborations for thedevelopment of new products utilizing our core technology. Research programs todevelop and commercialize new products require substantial technical, financialand human resources, whether or not any products are ultimately developed. If wefail to develop and commercialize new products, including our ATRILAZEminimally invasive system, our business will suffer.

**Wemay need to fund ongoing clinical studies throughout the lifecycle of each ofour products, providing statistically significant scientific data to regulatoryagencies and cost effectiveness data to third party healthcare payers.**   TheFDA, foreign regulatory agencies and third party health care payers may requirescientific clinical outcomes data and cost effectiveness data. We will need toprovide this data throughout our products’ lifecycles. Payers and governmentalagencies may change the frequency and breadth of clinical research required,potentially significantly increasing our costs. Without adequate positiveoutcomes data that demonstrate advantages from the use of our ATRILAZEminimally invasive system, we may not achieve any significant marketpenetration. We cannot assure you that our outcomes data will be adequate tomeet present or future medical device utility requirements. If our outcomesdata does not meet such requirements, we may be unable to sell our products orobtain third party reimbursement for the costs of our products.

**Substantialgovernment regulation abroad may restrict our ability to sell our ATRILAZEminimally invasive system or other products.**   Ifwe choose to market our products in foreign countries, they must also complywith laws and regulations of foreign countries in which we market suchproducts. In general, the extent and complexity of medical device regulation isincreasing worldwide. This trend may continue, and the cost and time requiredto obtain marketing clearance in any given country may increase as a result. Wecannot assure you that our products will obtain any necessary foreignclearances on a timely basis, or at all.

**Ourproducts face competition from those of well established companies with greaterfinancial and marketing resources, as well as alternative therapies ortreatment options.**   Our industry is highlycompetitive, subject to change, and significantly affected by new productintroductions and other activities of industry participants. Many of ourcompetitors have significantly greater financial and human resources than we doand have established reputations with our target customers, as well asworldwide distribution 

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channels that are moreestablished and developed than ours. Our primary competitors include AtriCure, Inc.,Boston Scientific Corp., CryoCath Technologies, Inc., Edwards LifesciencesCorp., ESTECH, Inc., Medtronic, Inc. and St. Jude Medical, Inc.As of May 2006, no company had received FDA approval or clearance tomarket an ablation system for use as a treatment of AF in the United States.However, our competitors provide products that have been adopted by physiciansfor the off-label treatment of AF.

We and many of our competitors have developed surgicalablation devices that have been used to treat AF concomitant with an open-heartsurgical procedure. We and our competitors utilize different technologies asenergy sources for ablation devices, including cryothermy, radiofrequency,microwave, high-intensity focused ultrasound and laser. Each of these companiesis also currently working with its core technology to develop devices that canbe used as a stand-alone, minimally invasive AF treatment.

Some of our competitors, including Boston ScientificCorp., Cardima, Inc., CryoCath Technologies, Inc., CryoCor, Inc.,Johnson and Johnson, Inc., Medtronic, Inc., and St. Jude Medical, Inc.,offer catheter-based treatments. These companies sell products that are used byphysicians to treat the population of patients that have AF, but are notcandidates for open-heart surgery, which is the same group of patients that webelieve would most benefit from stand-alone, minimally invasive AF treatmentsusing our minimally invasive system. Some of these catheter-based treatmentsalready have FDA clearance or approval for cardiac use, including the treatmentof certain arrhythmias, although none has approval for the treatment of AF.

Because of the large number of competitors andtreatment options in the AF market, we cannot assure you that even if weintroduce our ATRILAZE minimally invasive system that we will be able tocompete effectively.

**Wehave a history of losses and no assurance of future profitability.****  **We have incurred losses in each of the last ninefiscal years. We had a net loss to common shareholders of $4,936,131 for thefiscal year ended April 30, 2006 and a net loss to common shareholders of$19,094,872 for the fiscal year ended April 30, 2005. We expect tocontinue to incur substantial losses through fiscal year 2007 and into fiscalyear 2008 as we continue development of new products. As of April 30,2006, we had an accumulated deficit of $47,343,088. We will incur additionallosses until we are able to successfully introduce new products and generatesubstantial revenues. Due to our recent entry into the cardiac tissue ablationmarket, we do not expect to generate material revenue until fiscal year 2008,at the earliest. Even if we begin to recognize revenues from our ATRILAZEminimally invasive system, it may be several years, if ever, before we achieveprofitability and positive cash flow. If we do achieve profitability, we cannotassure you that we would be able to sustain or increase profitability on aquarterly or annual basis in the future. In addition, the report of ourindependent registered public accounting firm for each of fiscal years 2006 and2005 includes an explanatory paragraph expressing doubt about our ability tocontinue as a going concern.

**Wewill require additional financing in the future, which may be difficult toobtain.****  **Weanticipate that we will require additional financing to enable us to launch andmarket our ATRILAZE minimally invasive system and provide working capital tosupport our operations. Our failure to obtain necessary financing by January 2007,or doing so on unfavorable terms, could adversely affect our productdevelopment program and marketing efforts. Our future capital requirements willdepend on a number of factors, many of which are beyond our control, including:

·       Thecost of development or enhancement of existing or new products, includingoutsourced design and engineering services, and product prototyping;

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

·       Thecost of enhancing and protecting our intellectual property portfolio;

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·       Thecost of internal and outsourced manufacturing services;

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

·       Theneed to upgrade corporate systems and hardware;

·       Thecost of building inventory to support sales;

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

·       Ourability to establish and maintain collaborative arrangements;

·       Ouradvancement of other product candidates into development;

·       Thecost of maintaining MedicalCV as a public company; and

·       Potentialacquisition or licensing of other products or technologies.

Additional financing may not be available to us whenwe need it or it may not be available to us on favorable terms. If we areunable to obtain adequate financing on a timely basis, we may be required to significantlycurtail or cease product development. We could be required to seek fundsthrough arrangements with collaborators or others that may require us torelinquish rights to some of our technologies, product candidates or productswhich we would otherwise pursue on our own. If we raise additional funds byissuing equity securities, our then-existing shareholders will experienceownership and/or share price dilution and the terms of any new equitysecurities may have preferences over our common stock.

**We may be unable toestablish and protect our proprietary rights which are critical to our successin developing products for cardiac tissue ablation and the potential treatmentof AF.**   We have no patents issued to us coveringour soft tissue ablation products. We have filed 14 U.S. non-provisional patentapplications, one provisional U.S. patent application, one international patentapplication and one European patent application, relating to products we havedesigned for use in treating AF. We expect to seek patent protection foradditional products that we may develop in the future. Our success will depend,in part, on our ability to protect our products and to manufacture and sellthem without infringing the rights of third parties. The validity and breadthof claims covered in medical technology patents involve complex legal andfactual questions and, therefore, are highly uncertain. In addition, the lawsof many countries may not afford protection for our proprietary rights to thesame extent as U.S. laws. We cannot assure you that:

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

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

·       Wewill be able to commercially exploit any issued patents before they expire;

·       Anyof our patents will be held valid if subsequently challenged;

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

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

·       Wewill be able to protect meaningful rights in proprietary technology over whichwe do not hold patents.

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Furthermore, we cannot assure you that others have notdeveloped or will not develop products that may duplicate our products ormanufacturing processes, or that others will not design around our patents.Other parties may independently develop or otherwise acquire substantiallyequivalent techniques, gain access to our proprietary technology or disclosesuch technology. In addition, whether or not we obtain additional patents,others may hold or receive patents covering components of products weindependently develop in the future.

**Wemay be subject to claims that we infringe the intellectual property rights ofthird parties, which could adversely affect the sale of our products and ourfinancial condition.**   The medical device industryhas been characterized by extensive litigation regarding patents and otherintellectual property rights. Litigation, which would likely result insubstantial cost to us, may be necessary to enforce any patents issued orlicensed to us and/or to determine the scope and validity of others’proprietary rights. Our competitors hold issued patents which may result inclaims of infringement against us or other patent litigation. We also may haveto participate in interference proceedings declared by the United States Patentand Trademark Office, which could result in substantial cost to determine thepriority of inventions.

We are aware of patents issued to our competitors andare aware that these competitors have patent applications pending. Thesepatents and applications could become the basis for infringement claims againstus. In April 2005, we received a letter from Edwards Lifesciences, LLC (“Edwards”)concerning our ATRILAZE system, which is the subject of some of our patentapplications. Edwards did not claim that our products infringe any of itspatents. Edwards’ letter called to our attention six of its patents andrequested us to comment on how our products differ from the claimed methods andapparatus of the six specified Edwards patents. Edwards did not claim in itsletter that our products infringe its patents. We reviewed the specifiedEdwards’ patents and discussed them with our patent counsel, and believe thatour cardiac ablation systems do not infringe any of these patents. In responseto a further inquiry from Edwards on May 25, 2006, we responded throughpatent counsel outlining our position on at least one of the Edwards’ patents.While Edwards did not claim in its letter that our products infringe itspatents, it is likely that in the future, Edwards or others will continue toinquire regarding our products and patents and possibly make intellectualproperty claims relating to our tissue ablation devices. Legal proceedingsbrought against us alleging that our products infringe existing patents,whether with or without merit, could be time-consuming for our management andemployees, result in costly litigation, cause product shipment delays, requireus to pay damages or settlement amounts, or require us to:

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

·       Enterinto royalty-bearing licensing agreements; or

·       Designcommercially acceptable non-infringing alternative products.

We cannot assure you thatwe would be able to obtain licensing agreements, if required, on termsacceptable to us or at all, or that we would be able to develop commerciallyacceptable non-infringing alternative products. Our failure to do so could havea material adverse effect upon our business, financial condition, operatingresults and cash flows.

**Wedepend upon single and limited source third-party suppliers, making usvulnerable to supply problems and price fluctuations, which could harm ourbusiness.  ****We expect to rely on single and limited sourcethird-party vendors for the manufacture of many of the components used in ourATRILAZE minimally invasive system. For example, we expect to rely on onevendor to manufacture our ATRILAZE laser and one vendor to manufacture ourATRILAZE controller. In addition, in some cases there are relatively fewalternative sources of supply for certain other components that are critical toour ATRILAZE minimally invasive system.**

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**Our reliance on these outside manufacturers and suppliersalso subjects us to risks that could harm our business, including:**

**·****      ****we may not be able to obtain adequatesupply in a timely manner or on commercially reasonable terms;**

**·****      ****we may have difficulty locating andqualifying alternative suppliers;**

**·****      ****switching****components may require productredesign;**

**·****      ****our suppliers manufacture products fora range of customers, and fluctuations in demand for the products thosesuppliers manufacture for others may affect their ability to deliver componentsto us in a timely manner; and**

**·****      ****our suppliers may encounter financialhardships unrelated to our demand for components, which could inhibit theirability to fulfill our orders and meet our requirements.**

**Any interruption or delay in the supply of components ormaterials, or our inability to obtain components or materials from alternatesources at acceptable prices in a timely manner, could impair our ability tomeet the demand of our customers and cause them to cancel orders or switch tocompetitive products, and could therefore have a material adverse effect on ourbusiness, financial condition, operating results and cash flows.**

**Ifpatients allege that the use of our cardiovascular devices injured them, we mayface substantial product liability claims.**   Substantialproduct liability litigation exists within the medical device industry. Ourproducts are used in cardiovascular surgery, and their failure may result inpatient injury or death. We have had product liability claims asserted againstus in the past, which were resolved under our insurance coverage withoutsignificant financial cost to us. We cannot assure you, however, that futureproduct liability claims will not exceed the limits of our insurance coverageor that such insurance will continue to be available to us on commerciallyreasonable terms, or at all. Consequently, a product liability claim or otherclaim with respect to uninsured liabilities, or in excess of insuredliabilities, could have a material adverse effect on our business, financialcondition, operating results and cash flows. In addition, adverse publicityresulting from product liability litigation may materially adversely affect usregardless of whether the claims are valid or whether we are liable.Furthermore, these claims would likely divert our financial and managementresources that would otherwise be used to benefit the future performance of ouroperations.

We sold more than 50,000 mechanical heart valvesbetween 1992 and 2005. We assume that a majority of the patients who receivedour heart valves are still alive. If any of these patients were to have aproblem with a heart valve, they could assert claims for damages against us. InApril 2005, we placed our product liability insurance with a new insurancecarrier. Our new policy provides us with potential coverage for claims of up to$5,000,000 per occurrence and in the aggregate per policy year. Concurrently,we purchased a three-year extended reporting coverage endorsement from ourformer carrier which was unwilling to renew our coverage on the previous terms.The extended reporting period coverage, which expires in 2008, will allow us toseek coverage under the prior policy for products claims arising fromoccurrences which took place during such policy period but which were notasserted against us during the previous policy period.

In March 2005, webecame aware that a patient who had been implanted with our heart valve haddied. We have not received any claims related to this matter but believe thatany such claim would be covered by our existing liability insurance. Based uponthe expectation that insurance would cover the cost of any claims after ourpayment of the deductible, we do not expect the ultimate resolution of thismatter to have a material effect on our business, financial condition,operating results and cash flows.

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**Key employees could leaveour company at any time, thereby adversely affecting our product developmentand profitability.****  **Wedepend heavily on the technical knowledge and industry expertise of ourmanagement team. The development and execution of our business plan dependsupon these individuals. The departure of key people could materially andadversely affect our business, financial condition, operating results and cashflows.

**We may be unable torecruit, motivate and retain qualified employees.****  **Our success depends in part 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. Eventhough we have not experienced shortages of qualified people to date, qualifiedindividuals needed to fill these positions could be in short supply in ourmarket. Our inability to recruit, motivate and retain such individuals maydelay the planned launch of new products, or result in high employee turnover;either of which could have a material adverse effect on our business, financialcondition, operating results and cash flows. Additionally, competition forqualified employees could require us to pay higher wages and provide additionalbenefits to attract sufficient employees.

**Oncemedical devices are cleared for sale, regulatory authorities may still limitthe use of such products, prevent the sale or manufacture of such products orrequire a recall or withdrawal of such products from the marketplace.**   Followinginitial clearance from regulatory authorities, we continue to be subject toextensive regulatory requirements. Government authorities can withdrawmarketing clearance due to our failure to comply with regulatory standards ordue to the occurrence of unforeseen problems following initial clearance.Ongoing regulatory requirements are wide-ranging and govern, among otherthings:

·       Productmanufacturing;

·       Suppliersubstitution;

·       Productchanges;

·       Processmodifications;

·       Medicaldevice reporting;

·       Productsales and distribution; and

·       Annualinspections to retain CE mark for sale of products in the European Union.

The FDA and various government agencies inspect ourfacilities from time to time to determine whether we are in compliance withapplicable laws and regulations. If we fail to comply or maintain compliancewith medical device laws or regulations, regulatory authorities may fine us andbar us from selling our products. If the FDA or comparable foreign authoritiesbelieves we are not in compliance with such laws or regulations, it can:

·       Seizeour products;

·       Requirea recall;

·       Withdrawpreviously granted market clearances;

·       Implementprocedures to stop future violations; and/or

·       Seekcivil and criminal penalties against us.

In addition, suppliers ofcomponents of, and products used to manufacture, our products must also complywith the FDA and foreign regulatory requirements, which often requiresignificant resources and subject us and our suppliers to potential regulatoryinspections and stoppages. If our suppliers do not 

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achieveand maintain required regulatory approval, our commercialization efforts couldbe delayed, which would impair our business, financial condition, operatingresults and cash flows.

**We may be subject tofines, penalties or injunctions if we are determined to be promoting ourproducts for unapproved, “off-label,” or new uses, or making false, misleadingor unsubstantiated claims, which would harm our operating results and reducethe value of your investment.**   Our promotionalmaterials and training methods for physicians must be in compliance with FDAand other applicable regulations. FDA regulations prohibit us from promoting oradvertising our products for uses not within the scope of our clearances andfrom making unsupported safety or effectiveness claims. These determinationscan be subjective and the FDA may disagree with our promotional claims. If theFDA determines that our promotional materials or training constitutes promotionof an unapproved use, or makes false or misleading claims or claims notsupported by adequate scientific data, the agency could subject us to seriousenforcement sanctions and/or limit the promotional claims that we are permittedto make for our products. The FDA typically does not permit promotional claimsfor a device based upon physician reports and other anecdotal data. There canbe no assurance, therefore, that the FDA would agree that any independentpeer-reviewed studies are scientifically adequate to support the claims we makefor our products. The FDA also may limit or prohibit claims based on comparisonof our products with other surgical cardiac tissue ablation technologies anddevices in the absence of a scientifically valid head-to-head clinical trial orother adequate supporting data. Any legal limitations on the promotional claimswe may make for our products could adversely affect our sales.

**As amedical device manufacturer, we are subject to federal and state lawsprohibiting “kickbacks” and false or fraudulent claims which, if violated,could subject us to substantial penalties.**   Afederal law commonly known as the Medicare/Medicaid anti-kickback law, andseveral similar state laws, prohibit payments that are intended to inducephysicians or others either to refer patients or to acquire or arrange for orrecommend the acquisition of healthcare products or services. These laws limitthe kinds of financial arrangements, including sales programs, we are allowedto have with physicians, surgery centers, hospitals or other potential purchasersof our products. Other federal and state laws generally prohibit individuals orentities from knowingly presenting, or causing to be presented, claims forpayment from Medicare, Medicaid or other third-party payers that are false orfraudulent, or for items or services that were not provided as claimed.Anti-kickback and false claims laws prescribe potentially substantial civil andcriminal penalties for noncompliance. A challenge to or investigation into ourpractices under these laws could cause adverse publicity, be costly to respondto, and harm our business, financial condition, operating results and cashflows. Even an unsuccessful challenge or investigation into our practices couldcause adverse publicity and be costly to respond to, and thus could harm ourbusiness, financial condition, operating results and cash flows.

**Compliance withenvironmental laws and regulations may be expensive. Failure to comply withenvironmental laws and regulations could subject us to significant liability.**   Ourmanufacturing operations and research and development activities involve theuse of biological materials and hazardous substances and are subject to avariety of federal, state and local environmental laws and regulations relatingto the storage, use, discharge, disposal, remediation of, and human exposureto, hazardous substances. Our research and development and manufacturingoperations may produce biological waste materials, such as animal tissues, andcertain chemical waste. These operations are permitted by regulatoryauthorities, and the resultant waste materials are disposed of in materialcompliance with environmental laws and regulations. Compliance with these lawsand regulations may be expensive and non-compliance could result in substantialliabilities. In addition, we cannot completely eliminate the risk of accidentalcontamination or injury to third parties from the use, storage, handling ordisposal of these materials. In the event of contamination or injury, we couldbe held liable for any resulting damages, and any liability could exceed anyapplicable insurance coverage we may have. In addition, our manufacturingoperations may result in the release, discharge, emission or disposal ofhazardous substances that could cause us to incur substantial liabilities,including costs for investigation and remediation.

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**Theuncertainty of third party reimbursements and possible healthcare reforms mayadversely affect us.****  **Ourability to market products successfully in the U.S. depends in part on theextent to which reimbursement for the cost of such products and relatedtreatment will be available from government health administration authorities,private health insurers, health maintenance organizations and other third partypayers. Payers may challenge the need for, and prices of, medical products andservices. Third party payers may deny reimbursement for procedures that theydeem experimental or for devices used in ways other than as cleared by the FDAor stated in their indications for use. With respect to our products, somepayers could deny coverage until the medical profession generally acceptsdevices and new procedures. The inability of hospitals and other providers toobtain reimbursement from third party payers for our products would have amaterial adverse impact on our business, financial condition, operating resultsand cash flows. Healthcare reform may also impact sales of new products. In theU.S. reforms may include:

·       Mandatedbasic health care benefits;

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

·       Fundamentalchanges to the health care delivery system.

We anticipate that theU.S. Congress and state legislatures will continue to review and assessalternative health care delivery systems and payment methodologies, and thatpublic debate of these issues will likely continue in the future. Due touncertainties regarding the ultimate features of reform initiatives and theirenactment and implementation, we cannot predict which, if any, of such reformproposals will be adopted, when they may be adopted or what impact they mayhave on our ability to market our products. Laws resulting from such reforminitiatives could adversely impact our business, financial condition, operatingresults and cash flows.

**If we are unable tosuccessfully address the material weakness in our internal controls, ourability to report our financial results on a timely and accurate basis may beadversely affected.**   As of April 30, 2006and 2005, we did not maintain effective controls over the preparation, review,presentation and disclosure of our statement of operations. Specifically, weincorrectly reported certain expenses as part of continuing operations rather thanas part of discontinued operations in accordance with U.S. generally acceptedaccounting principles. This control deficiency resulted in the restatement ofour financial statements for the fiscal year ended April 30, 2005 and thethree and six-month periods ended October 31, 2004. Accordingly,management determined that this control deficiency constitutes a materialweakness in our internal control over financial reporting.

A material weakness is acontrol deficiency or a combination of control deficiencies that results inmore than a remote likelihood that a material misstatement of the annual orinterim consolidated financial statements will not be prevented or detected. Wehave taken steps to remediate the material weakness that include a thorough reviewof the classification requirements of each component line item and theindividual elements that comprise each line item of the statement ofoperations, in accordance with generally accepted accounting principles.Although we have taken these steps, we cannot assure you that this or othercontrol deficiencies will not result in a misstatement in the future.

We have developed a planto address this material weakness that includes adding additional professionalaccounting personnel. We engaged a senior financial consultant in March 2006as an interim controller to provide an immediate expansion in our technicalfinance and accounting resources. In April 2006, we hired a full-timecontroller with national public accounting firm experience. We will continue toassess the adequacy and appropriateness of our financial staff and adjustaccordingly as changes in our business warrant. Management believes that ourplan to address this material weakness, when fully implemented, will remediateit. Although we are not certain when the material weakness will be 

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remediated, we will need aperiod of time over which to demonstrate that these controls are functioningappropriately to conclude that we have adequately remediated it.

We cannot be certain thatadditional material weaknesses in our internal control over financial reportingwill not be discovered in the future. Any failure to remediate the unremediatedmaterial weakness described above or any future material weaknesses or toimplement required new or improved controls, or difficulties encountered intheir implementation, could harm our operating results, cause us to fail tomeet our reporting obligations or result in material misstatements in ourfinancial statements.

**We may be exposed topotential risks relating to our internal controls over financial reporting andour ability to have those controls attested to by our independent registeredpublic accounting firm.**   As directed by Section 404of the Sarbanes-Oxley Act, the SEC adopted rules requiring publiccompanies to include a report of management on internal control over financialreporting in their annual reports, including Annual Reports on Form 10-KSB,which we file. In addition, the independent registered public accounting firmauditing a public company’s financial statements must attest to and report onmanagement’s assessment of the effectiveness of the company’s internal controlover financial reporting as well as the operating effectiveness of the company’sinternal controls over financial reporting. We expect to be subject to theserequirements for the fiscal year ending April 30, 2008.

While we expect to expendsignificant resources in developing the necessary documentation and testingprocedures required by Section 404 of the Sarbanes-Oxley Act, there is arisk that we will not comply with all of the requirements imposed thereby. Atpresent, there is no precedent available with which to measure complianceadequacy. Accordingly, there can be no assurance that we will not receive anadverse report on our assessment of our internal controls over financialreporting and/or the operating effectiveness of our internal controls overfinancial reporting from our independent registered public accounting firm.

In the event we fail toremediate the material weakness described above, we identify significantdeficiencies or other material weaknesses in our internal controls overfinancial reporting that we cannot remediate in a timely manner or we receivean adverse report from our independent registered public accounting firm withrespect to our internal controls over financial reporting, investors and othersmay lose confidence in the reliability of our financial statements and ourability to obtain equity or debt financing could be adversely affected.

In addition to the above,in the event that our independent registered public accounting firm is unableto rely on our internal controls over financial reporting in connection withtheir audit of our financial statements, and in the further event that they areunable to devise alternative procedures in order to satisfy themselves as tothe material accuracy of our financial statements and related disclosures, itis possible that we could receive a qualified or adverse audit opinion on thosefinancial statements. In that event, the market for our common stock could beadversely affected. In addition, investors and others may lose confidence inthe reliability of our financial statements and our ability to obtain equity ordebt financing could be adversely affected.

**We will be required torecord compensation expense related to employee compensation awards in ourfinancial statements beginning in our fiscal year 2007, which could harm ourfuture reported operating results and cause unexpected fluctuations in ourexpenses.**   Our ability to attract and retain ourmanagement team, research, development, clinical, medical device salespersonnel and others depends to some extent on our continued ability to issuestock options or other forms of equity compensation awards. Among other optionissuances we have made, in April 2005 we issued options to key members ofour management team for the purchase of an aggregate of 666,565 shares ofcommon stock. These options will vest over a four-year period commencing April 1,2006 (to the extent of 25 percent on such date and 6.25 percent quarterlythereafter). We have granted and expect to grant additional stock options tocurrent and future management personnel and other key employees to provideadditional incentives to join or 

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remain with us. TheFinancial Accounting Standards Board has issued Statement of FinancialAccounting Standards (“SFAS”) No. 123R, “Share-Based Payment.” We arerequired to adopt the provisions of this standard effective May 1, 2006.We will adopt this standard using the modified prospective method. We expectadoption to result in an increase in our operating expenses. SFAS No. 123Reliminates the ability to account for share-based compensation transactionsusing Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees,” and requires such transactions be accounted for using afair-value-based method and the resulting cost to be recognized in thefinancial statements over the option vesting periods. Recording compensationexpense in the statement of operations for employee stock options using thefair value method could have a significant negative effect on our reportedfinancial results, particularly if we grant a significant number of options toour employees in future periods.

**We cannot predict theoutcome of legal proceedings and an adverse determination could negativelyimpact our financial results.**   In March 2006,J Giordano Securities LLC (d/b/a J Giordano Securities Group) (“JGSG”) filedsuit against our company claiming that it is entitled to damages due to analleged breach of the engagement agreement, as amended, between us and JGSG. Inparticular, JGSG claims that the exercise of outstanding warrants for thepurchase of common stock by certain JGSG-identified investors and our purchaseof outstanding shares of 5% Series A Redeemable Convertible PreferredStock from certain JGSG-identified investors in December 2005 and January 2006entitle JGSG to damages no less than $1,431,769. In addition, JGSG notified usby letter dated May 26, 2006 that, pursuant to the agreement, it may claimcompensation arising out of alleged rights to serve as a co-managingunderwriter or member of the underwriting group of a proposed public offeringset forth in the registration statement on Form SB-2 we filed withthe Securities and Exchange Commission on May 19, 2006. Although we intendto vigorously defend ourselves against the lawsuit and any additional claimsbrought by JGSG, an adverse resolution of this claim could negatively impactour financial condition.

**Our stock price isvolatile; purchasers of our common stock could sustain substantial losses.****  **The stock market in general and the market for small medical devicecompanies in particular have experienced extreme volatility that has often beenunrelated to the operating performance of particular companies. As a result ofthis volatility, investors may not be able to sell their common stock at orabove the price paid for the stock. The price of our common stock will bedetermined in the marketplace and may be influenced by many factors, including:

·  Physicianand patient acceptance of our products;

·  Developments, disputes or litigationconcerning patents or other proprietary rights and our ability to obtain patentprotection for our technologies;

·  Regulatory restrictions in the United Statesand foreign countries;

·  The ability to manufacture our products tocommercial standards;

·  Public concern over our products;

·  The loss of key personnel;

·  Additional future sales of our common stock;

·  Comparisons of our financial results withthose of companies that are perceived to be similar to us;

·  The pricing of our products;

·  Changes in the structure of healthcare paymentsystems;

·  Investors’ perceptions of us; and

·  General economic, industry and marketconditions.

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A decline in the market price of our common stockcould cause you to lose some or all of your investment and may adversely impactour ability to attract and retain employees and raise capital. In addition,shareholders may initiate securities class action lawsuits if the market priceof our stock drops significantly, which may cause us to incur substantial costsand could divert the time and attention of our management.

**Fluctuationsin our operating results may result in decreases in the price of our securities.**   Weexpect our operating results to fluctuate significantly because of severalfactors, including the timing of FDA clearance, government policies regardingpayment for our products and the development of new technologies. Consequently,our operating results may fall below the expectations of public market analystsand investors. In that event, the price of our securities would likelydecrease.

**Ifthere are substantial sales of our common stock by existing shareholders, theprice of our common stock may decline.**   If ourexisting common shareholders sell substantial amounts of common stock in thepublic market, or the market perceives that such sales may occur, the marketprice of our common stock could fall. Existing shareholders may sell 8,563,929shares in the public market pursuant to SB registration statements filed withthe Securities and Exchange Commission. In addition, we anticipate that we willneed to raise additional capital in the future to fund operations or forcapital expenditures. If we raise additional funds by issuing equitysecurities, our stock price may decline and our existing shareholders mayexperience significant dilution. Furthermore, we may enter into financingtransactions at prices that represent a substantial discount to market price. Anegative reaction by investors and securities analysts to any sale of ourequity securities could result in a decline in the trading price of our commonstock.

**Youmay have difficulty reselling our common stock.****  **We cannot assure you of an active public market forour common stock. Selling our securities also may be difficult because of thequantity of securities that may be bought and sold, the possibility thattransactions may be delayed, and a low level of security analyst and news mediacoverage. These factors could contribute to lower prices and larger spreads inthe bid and ask prices for our securities.

**If wefail to maintain the registration statements for the common stock issued uponconversion of preferred stock and the related warrant exercises, we could facesubstantial monetary charges.**   In connection withour April 2005 private placement and our December 2005 and January 2006preferred stock purchases, we entered into registration rights agreements inwhich we agreed to prepare and file with the SEC by certain filing dates,registration statements to register certain shares of common stock, whichregistration statements must be maintained effective throughout a period of upto five years. If we fail to file any registration statement by a requiredfiling date, or a registration statement is not declared effective by aspecified effectiveness date, or after an effective date, the registrationstatement ceases to be effective and available to the holders of the securitiesthat were registered for more than an aggregate of 40 trading days in anyconsecutive 12 month period, then in addition to other rights which suchholders may have against us under applicable law, we are obligated to pay asliquidated damages to such holders for each calendar month or portion thereofan amount equal to 1.5 percent of the aggregate amount invested by theinvestors until we satisfy the requirements of the registration rightsagreement. If we are required to pay such liquidated damages or other amountsto these holders, our business, financial condition, operating results and cashflows would be materially adversely affected.

**Theissuance of additional equity securities in a future financing could triggerthe anti-dilution provisions of our outstanding warrants.**   Ifwe were to issue additional equity securities at a per share price lower thanthe exercise price of our outstanding warrants, then the exercise price of suchwarrants would automatically adjust downward on either a weighted-average orfull-ratchet basis. While we have no plans to issue securities in a manner thatwould trigger these anti-dilution provisions, we could elect to do so in thefuture or be required to do so in order to finance the company. Suchadjustments would dilute the holdings of existing common shareholders.

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**Ouraffiliated shareholders have significant control over our company, which couldreduce your ability to receive a premium for your securities through a changein control.**   As of June 26, 2006, officersand directors of our company beneficially owned approximately 21.4 percent ofour outstanding common stock. As a result, they may be able to control ourcompany and direct our affairs, including the election of directors andapproval of significant corporate transactions. This concentration of ownershipcould also delay, defer or prevent a change in control of our company, and makesome transactions more difficult or impossible without their support. Thesetransactions might include proxy contests, tender offers, open market purchaseprograms or other share purchases that could give our shareholders theopportunity to realize a premium over the then prevailing market price of oursecurities. As a result, this concentration of ownership could depress theprice of our securities.

**Ouracquisition of preferred stock and related warrant exercises have resulted in aconcentration of ownership.****  **InDecember 2005 and January 2006, investors who purchased preferredstock and warrants in our April 2005 private placement sold back theirpreferred stock to our company and exercised their related warrants. The commonstock issued in connection with such transaction represented over 85 percentof our outstanding common stock at the completion of the transaction. A majorportion of such securities were acquired by PKM Properties, LLC (“PKM”), anentity controlled by Paul K. Miller, one of our directors, and, with 18.3percent beneficial ownership, one of the largest beneficial owners of oursecurities. Should a few of these investors agree to vote in concert, theywould control our company. To our knowledge, these investors have not acted asa group in seeking, negotiating or making their investments in our company andconsider themselves independent investors.

**Minnesotalaw and our ability to issue preferred stock could deter a take-over oracquisition of our company.**   Our articles ofincorporation authorize the issuance of shares of preferred stock. Our board ofdirectors, without any action by our shareholders, is authorized to designateand issue preferred stock in such classes or series, as it deems appropriateand establish the rights and privileges of such shares, including liquidationand voting rights. Our ability to designate and issue preferred stock havingpreferential rights over our common stock could adversely affect the votingpower and other rights of holders of common stock. We are also subject to 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 “businesscombinations” between issuing public corporations and specified personsacquiring their securities. Our ability to issue preferred stock and theapplication of the provisions of Minnesota law discussed above could impede ordeter another party from making a tender offer or other proposal to acquire ourcompany.

**We do not intend to paycash dividends on our common stock in the foreseeable future.****  **We have not paid dividends on our common stock and donot anticipate paying any cash dividends in the foreseeable future.

**Cautionary NoteRegarding Forward-Looking Statements**

This document contains forward-looking statements,which generally include the plans and objectives of management for futureoperations, including plans and objectives relating to our future economicperformance and our current beliefs regarding revenues we might earn if we aresuccessful in implementing our business strategies.

The forward-lookingstatements and associated risks may include, relate to or be qualified by otherimportant factors. You can identify forward-looking statements generally by theuse of forward-looking terminology such as “believes,” “expects,” “may,” “will,”“intends,” “plans,” “should,” “could,” “seeks,” “pro forma,” “anticipates,” “estimates,”“continues,” or other variations of those terms, including their use in thenegative, or by discussions of strategies, opportunities, plans or intentions.You may find these 

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forward-lookingstatements under the captions “Business” and “Management’s Discussion andAnalysis or Plan of Operation.” These forward-looking statements include, amongother things, statements about:

·       Therate and degree of market acceptance of our products;

·       Thetiming of and our ability to obtain and maintain regulatory clearances for ourproducts;

·       Oursales and marketing strategy;

·       Ourmanufacturing strategy;

·       Ourability to develop and market new and enhanced products;

·       Ourintellectual property portfolio;

·       Thetiming of and ability to obtain reimbursement for procedures utilizing ourproducts;

·       Ourcompetitors;

·       Ourestimates regarding future revenues, expenses and capital requirements; and

·       Theunpredictability of our quarterly results of operations.

These forward-looking statements necessarily dependupon assumptions and estimates that may prove to be incorrect. Although webelieve that the assumptions and estimates reflected in the forward-lookingstatements are reasonable, we cannot guarantee that we will achieve our plans,intentions or expectations. The forward-looking statements involve known and unknownrisks, uncertainties and other factors that may cause actual results to differin significant ways from any future results expressed or implied by theforward-looking statements.

Any of the factorsdescribed above or in our Cautionary Statement could cause our financialresults, including our net income (loss) or growth in net income (loss), todiffer materially from prior results, which in turn could, among other things,cause the price of our common stock to fluctuate substantially.

**ITEM 7**                   FINANCIALSTATEMENTS

See Index to FinancialStatements on Page F-1.

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

As previously reported, on June 9, 2005,PricewaterhouseCoopers LLP (“PwC”) informed the audit committee of our board ofdirectors that it would decline to stand for re-election as our independentregistered public accounting firm and would cease to serve as our independentregistered public accounting firm upon completion of PwC procedures regardingthe following: (1) our financial statements as of and for the year ended April 30,2005 and (2) the Form 10-KSB in which such financial statementswould be included.

The reports of PwC on our financial statements as ofand for the years ended April 30, 2005 and 2004 contained an explanatoryparagraph expressing significant doubt about our ability to continue as a goingconcern, but did not contain an adverse opinion or disclaimer of opinion, andwere not further qualified or modified as to uncertainty, audit scope oraccounting principle.

During the years ended April 30, 2005 and 2004and through June 6, 2006, there have been no disagreements with PwC on anymatter of accounting principles or practices, financial statement disclosure,or auditing scope or procedure, which disagreements, if not resolved to thesatisfaction of PwC, would have caused PwC to make reference thereto in itsreports on our financial statements for such years.

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During the years ended April 30, 2005 and 2004and through June 6, 2006, there has been one reportable event of the typedescribed in Item 304(a)(1)(iv)(B) of Regulation S-B. The reportable eventoccurred in March 2004 when PwC informed our audit committee that therewas a material weakness in internal controls over financial reporting. Specifically,PwC identified a material weakness in the design and operation of internalcontrols relating to documenting and reporting international distributionmarketing expenditures and related reimbursement. Following this communicationfrom PwC, we implemented procedures and reporting to document and supportcustomer marketing expenses which remedied this material weakness.

On August 8, 2005, weengaged Lurie Besikof Lapidus & Company, LLP (“LBL”) as ourindependent registered public accounting firm commencing with work to beperformed in relation to our fiscal quarter ended July 31, 2005 and inconnection with the audit of our financial statements for the fiscal yearending April 30, 2006. In the past two years we have had no occasion toconsult with LBL on any matters. Our audit committee has appointed LBL as ourindependent registered public accounting firm for fiscal year 2006.

**ITEM 8A**           CONTROLSAND PROCEDURES

**Evaluation ofDisclosure Controls and Procedures**

We maintain disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”)) that are designed toensure that information required to be disclosed by us in the reports we fileor submit under the Exchange Act is recorded, processed, summarized, andreported, within the time periods specified in the Securities and ExchangeCommission’s rules and forms and that such information is accumulated andcommunicated to our management, including our principal executive officer andprincipal financial officer, to allow timely decisions regarding requireddisclosure.

Our management, with theparticipation of our Chief Executive Officer and Chief Financial Officer,evaluated the effectiveness of our company’s disclosure controls and proceduresas of the end of the period covered in this Annual Report on Form 10-KSB.Based on this evaluation and because of the material weakness described below,our Chief Executive Officer and Chief Financial Officer have concluded that ourdisclosure controls and procedures were not effective as of the end of theperiod covered in this Annual Report on Form 10-KSB. To address thematerial weakness described below, we have expanded our disclosure controls andprocedures to include additional analysis and other procedures over thepreparation of the financial statements included in this report. Accordingly,our management has concluded that the financial statements included in thisreport fairly present in all material respects our financial position, resultsof operations and cash flows for the periods presented in conformity withgenerally accepted accounting principles.

**Material Weaknessin Internal Control Over Financial Reporting**

A material weakness is acontrol deficiency or a combination of control deficiencies that result in morethan a remote likelihood that a material misstatement of the annual or interimfinancial statements will not be prevented or detected. Our management hasconcluded that, as of April 30, 2006 and 2005, we did not maintaineffective controls over the preparation, review, presentation and disclosure ofour statement of operations. Specifically, our controls did not prevent ordetect the incorrect presentation of certain expenses as part of continuingoperations rather than as part of discontinued operations, in accordance withgenerally accepted accounting principles. This control deficiency resulted inthe restatement of our financial statements for the three and six month periodsended October 31, 2004 and the year ended April 30, 2005.Additionally, this control deficiency could result in a misstatement of thepresentation and disclosure of our statement of operations that would result ina material misstatement in 

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ourannual or interim financial statements that would not be prevented or detected.Accordingly, management determined that this control deficiency constitutes amaterial weakness in our internal control over financial reporting as of April 30,2006 and 2005.

**Changes in InternalControl Over Financial Reporting**

There was no change in ourinternal control over financial reporting, other than those noted below, thatoccurred during our quarter ended April 30, 2006 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

**Plan forRemediation of Material Weakness**

We have developed a planto address the above-referenced material weakness that includes addingadditional professional accounting personnel. We engaged a senior financialconsultant in March 2006 as an interim controller to provide an immediateexpansion in our technical finance and accounting resources. In April 2006,we hired a full-time controller with national public accounting firmexperience. We will continue to assess the adequacy and appropriateness of ourfinancial staff and adjust accordingly as changes in our business warrant.Management believes that our plan to address this material weakness, when fullyimplemented, will remediate it. Although we are not certain when the materialweakness will be remediated, we will need a period of time over which todemonstrate that these controls are functioning appropriately to conclude thatwe have adequately remediated it.

**ITEM 8B**          OTHERINFORMATION

Not applicable.

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**PART III**

**ITEM 9**                   DIRECTORS,EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OFTHE EXCHANGE ACT

The following tableprovides information with respect to our directors and executive officers as ofJune 26, 2006. Our directors hold office until our next annual meeting ofshareholders and until their successors have been elected and qualified. Eachexecutive officer has been appointed to serve until his successor is dulyappointed by the board or his earlier removal or resignation from office. Thereare no family relationships among our directors and executive officers.

**Executive Officers and Directors**

| **Name**                     | ** ** | ** ** | ** ** | **Age**                                                                                    | ** ** | **Principal Occupation**                                 | ** ** | **Position with MedicalCV** | ** ** | **Director  Since** |
|------------------------------|------------|------------|------------|--------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------|------------|---------------------|
| Susan L. Critzer             |       | 50         |       | Retired Chief Executive  Officer and Chief Financial Officer of Restore Medical, Inc. |       | Chairperson of the Board                                      |       | 2002                                  |
| Marc P. Flores               |       | 41         |       | President, Chief  Executive Officer and Director of MedicalCV, Inc.                   |       | President, Chief  Executive Officer and Director              |       | 2004                                  |
| Adam L. Berman               |       | 31         |       | Vice President, Research  and Development                                                  |       | Vice President, Research  and Development                     |       | N/A                                   |
| Eapen Chacko*                |       | 58         |       | Vice President, Finance  and Chief Financial Officer                                       |       | Vice President, Finance  and Chief Financial Officer          |       | N/A                                   |
| Robert W. Clapp              |       | 56         |       | Vice President, Operations                                                                 |       | Vice President,  Operations                                   |       | N/A                                   |
| Larry G. Haimovitch          |       | 59         |       | President of Haimovitch  Medical Technology Consultants                                    |       | Director                                                      |       | 2005                                  |
| Lawrence L. Horsch           |       | 71         |       | Chairman of Eagle  Management & Financial Corp.                                   |       | Director                                                      |       | 2003                                  |
| James E. Jeter               |       | 43         |       | Vice President, Sales                                                                      |       | Vice President, Sales                                         |       | N/A                                   |
| John H. Jungbauer*           |       | 57         |       | Principal Financial  Officer and Principal Accounting Officer                              |       | Principal Financial  Officer and Principal Accounting Officer |       | N/A                                   |
| David B. Kaysen              |       | 56         |       | President and Chief  Executive Officer of Uroplasty, Inc.                             |       | Director                                                      |       | 2002                                  |
| Paul K. Miller               |       | 83         |       | Private Investor                                                                           |       | Director                                                      |       | 1994                                  |
| J. Robert  Paulson, Jr. |       | 49         |       | President, Chief  Executive Officer and Director of Restore Medical, Inc.             |       | Director                                                      |       | 2005                                  |
| Dennis E. Steger             |       | 59         |       | Vice President, Regulatory  Affairs and Quality Assurance                                  |       | Vice President,  Regulatory Affairs and Quality Assurance     |       | N/A                                   |
| Gary O. Tegan                |       | 39         |       | Vice President, Marketing                                                                  |       | Vice President, Marketing                                     |       | N/A                                   |

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*                    In May 2006,we entered into a written, at-will employment agreement with Eapen Chacko, whojoined our company on June 21, 2006, as Vice President, Finance and ChiefFinancial Officer. Mr. Chacko is expected to assume the roles of principalfinancial officer and principal accounting 

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officer upon Mr. Jungbauer’sresignation. Mr. Jungbauer currently serves in the roles of principalfinancial officer and principal accounting officer.

*SusanL. Critzer,* Chairperson of the Board since September 2005and one of our directors since August 2002, has over 25 years of industryexperience in general management, operations and product development. Ms. Critzerserved as Chief Executive Officer and Chief Financial Officer of RestoreMedical, Inc., a company focused on developing and marketing products forthe ear, nose and throat field, from June 2002 to April 2005. From January 2001to June 2002, Ms. Critzer served as Chief Operating Officer ofVenturi Development Group, the business incubator focused on seed level medicaldevice opportunities which founded Restore Medical. Prior to joining Venturi, Ms. Critzerserved as President and Chief Executive Officer and Acting Chief FinancialOfficer of Integ Incorporated, a publicly held development stage glucosemonitoring company from 1998 until it was acquired by Inverness Medical inearly 2001. She joined Integ in 1995 as Vice President, Operations. Beforejoining Integ, Ms. Critzer served in various management roles at the Davis+ Geck Division of American Cyanamid Corp., and the Deseret Medical Division ofBecton-Dickinson Corp. Ms. Critzer began her career with General MotorsCorporation where she spent thirteen years in a variety of engineering andmanagement positions, including managing a $200 million truck front suspensionplant in Detroit. Ms. Critzer serves on the Board of Governors and is a 3MFellow at the University of St. Thomas School of Engineering in St. Paul,Minnesota.

*MarcP. Flores* became our President, Chief ExecutiveOfficer and one of our directors in August 2004. Mr. Flores served asVice President of Sales & Marketing of Coalescent Surgical, Inc.,a company focused on developing advanced technology for blood vesselanastomoses, from March 2000 to August 2004. Prior to joiningCoalescent, Mr. Flores was Western Regional Manager of Sales forCardioThoracic Systems, Inc. from June 1997 to March 2000.Before joining CardioThoracic Systems, he held a variety of management andsales positions with Boston Scientific Corporation, GE Medical Systems andXerox Corporation.

*AdamL. Berman* joinedMedicalCV in September 2004 as Vice President, Research andDevelopment. Mr. Berman has extensive experience and relationships withinthe cardiac surgery industry. From July 2001 to August 2004, he was aregional sales manager for Coalescent Surgical, Inc. From August 1998to June 2001, he was a regional development manager for Computer Motion, acompany focused on robotic-assisted, minimally invasive approaches for surgery.Before joining Computer Motion, Mr. Berman held various clinical researchpositions within the field of cardiac surgery.

*EapenChacko*joined MedicalCV effective June 21, 2006,as Vice President, Finance and Chief Financial Officer. Mr. Chacko willassume the roles of principal financial officer and principal accountingofficer upon the resignation of John H. Jungbauer. Mr. Chacko has over 30years of experience in strategic planning, investor relations, equity researchand economics. From September 2000 to May 2005, he was ChiefFinancial Officer of Possis Medical, Inc., a developer, marketer andmanufacturer of medical devices for the endovascular treatment market. Mr. Chackowas Vice President for Investor and Public Relations, Corporate Communicationat Possis from September 1999 to August 2000. From 1995 to 1999, hewas Director of Investor Relations at Fingerhut Companies, a direct marketerand financial services company. Mr. Chacko is a director of Hawkins, Inc.,a company that formulates, blends and distributes bulk and specialty chemicals.Mr. Chacko has been named, along with his former employer Possis Medical, Inc.and another officer of that company, as a defendant in a securities classaction case entitled Crowell, et al. v. Possis Medical, Inc. et al., No. 05-CV-01084-JMR-FLN,originally filed on June 3, 2005 in the United States District Court forthe District of Minnesota. The consolidated amended class action complaintalleges violations of Section 10(b) and Rule 10b-5 of theExchange Act against all defendants and claims under Section 20(a) againstthe officer defendants, all arising out of alleged misstatements and omissionsabout that company’s AngioJet product and clinical trials for that product.

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*RobertW. Clapp*****joined MedicalCV in August 2004 as VicePresident, Operations. From March 1993 to August 2004, Mr. Clappwas Vice President of Manufacturing, Quality, and Research/Development forEMPI, where he developed and introduced many new products, improvedmanufacturing efficiencies and lowered manufacturing costs. From February 1987to March 1993, he was Vice President of Manufacturing for DacomedCorporation, where he helped introduce five new products into the marketplacein 18 months. Prior to that, Mr. Clapp held engineering andoperations positions at Xerxes Corporation, Medtronic, Inc., Control DataCorporation and AMF Paragon Electric.

*LarryG. Haimovitch,* one of our directors since August 2005,serves as President of Haimovitch Medical Technology Consultants, a SanFrancisco-based health care consulting firm he formed in 1990. His firm, whosecurrent area of emphasis includes minimally invasive surgical technologies,specializes in the analysis of the medical device industry with emphasis on thecurrent trends and future outlook for emerging medical technology.

*LawrenceL. Horsch,* who served as our Acting Chief ExecutiveOfficer from April 2004 to August 2004 and Chairman of the Board fromAugust 2003 to September 2005, became one of our directors in August 2003.He served as a director of Boston Scientific Corporation from February 1995to May 2003. He was one of the founding directors of SciMed Life Systems, Inc.and served as Chairman of the Board from 1977 to 1994, and Acting ChiefFinancial Officer from 1994 to 1995. Since 1990, Mr. Horsch has served asChairman of Eagle Management & Financial Corp., a managementconsulting firm. Mr. Horsch has been involved as a director or consultantto numerous early-stage companies in the Twin Cities area and was a member ofthe University of St. Thomas MBA adjunct faculty from 1979 to 2004. Mr. Horschcurrently serves as a director of Leuthold Funds, Inc., a registeredinvestment company.

*JamesE. Jeter* joined MedicalCV in November 2005 asVice President, Sales. Mr. Jeter most recently served as a Central StatesRegion Manager for Medtronic, Inc. from August 2004 to November 2005,where he led a team charged with revenue growth across three product platforms:cardiac revascularization, atrial fibrillation and Coalescent anastomoticdevices. From January 2001 to August 2004, Mr. Jeter was aRegional Sales Manager, then a Divisional Sales Manager, with CoalescentSurgical, Inc. tasked with starting and building the anastomotic devicebusiness for cardiac and vascular surgeons in the company’s Central StatesDivision. From July 1999 to January 2001, Mr. Jeter was a co-managingpartner of Innovative Surgical Products. Previously, he held a series ofpositions, including Director of Sales, Cardiac Division, with the GenzymeCorporation.

*JohnH. Jungbauer* joined MedicalCV in February 2004 asVice President, Finance and Chief Financial Officer. Mr. Jungbauer came toour company with more than 26 years of experience in financial management andlong-range planning, international financial/treasury operations, informationtechnology systems. From 1990 to 2002, Mr. Jungbauer was Vice President ofFinance and Chief Financial Officer with ATS Medical, Inc. During 1988 and1989, he was Executive Vice President of Titan Medical, Inc. From 1977 to1987, he held several financial management positions at St. Jude Medical, Inc.,including Vice President of Finance and Chief Financial Officer from 1981 to1987. On April 6, 2006, Mr. Jungbauer announced his intention toresign from his executive officer position at our company. On June 21,2006, Mr. Jungbauer’s roles transitioned from Vice President, Finance andChief Financial Officer to principal financial officer and principal accountingofficer. Mr. Chacko will assume the roles of principal financial officerand principal accounting officer upon the resignation of Mr. Jungbauer.Further details regarding the anticipated effective date of Mr. Jungbauer’sresignation are set forth below under “Executive Compensation—EmploymentContracts and Termination of Employment, and Change-in-Control Arrangements.”

*DavidB. Kaysen* has been one of our directors since August 2002.Mr. Kaysen serves as President, Chief Executive Officer and a director ofUroplasty, Inc., a developer, manufacturer and marketer of productsprimarily for the treatment of urinary and fecal incontinence and overactivebladder symptoms. 

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Mr. Kaysen served asPresident and Chief Executive Officer of Advanced Duplication Services LLC, aprivately held duplicator/replicator of CDs and DVDs, from July 2005 untilMay 2006. From December 2002 through July 2005, Mr. Kaysenserved as President, Chief Executive Officer and a director of DiametricsMedical, Inc., a company that develops, manufactures and commercializesblood and tissue analysis systems that provide diagnostic results at the pointof patient care. Mr. Kaysen has more than 25 years of executive managementand sales and marketing experience in the medical products and servicesindustry, most recently serving 10 years as President, Chief ExecutiveOfficer and a director of Rehabilicare Inc. (now Compex Technologies, Inc.),a manufacturer and marketer of home electrotherapy equipment for the physicaltherapy, rehabilitation, occupational and sports medicine markets. From 1988 to1989, Mr. Kaysen served as President, Chief Executive Officer and adirector of Surgidyne, Inc. (now Sterion, Inc.). Mr. Kaysen hasalso held 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. Kaysencurrently serves as a director of Zevex International, Inc., a publiclyheld company engaged in the business of designing, manufacturing anddistributing medical devices.

*PaulK. Miller* has been one our directors since August 1994.Mr. Miller served as President of Acton Construction Management Company, areal estate management company, from 1980 to 2004. Mr. Miller has, overthe course of his business career, been the President and majority shareholderof various companies with offices in Minnesota and Texas which have beenengaged in the construction of municipal wastewater projects throughout thecentral United States and in the acquisition and management of real estateinvestments. He is a significant investor and director of a number ofdevelopment stage companies and has served as a bondholders representative onthe creditors’ committees of several publicly held companies.

*J.Robert Paulson, Jr.,* who became one of ourdirectors in August 2005, was appointed President, Chief Executive Officerand a director of Restore Medical, Inc., a company focused on developingand marketing products for the ear, nose and throat field, in April 2005.Prior to joining Restore Medical, Mr. Paulson served as Chief FinancialOfficer and Vice President of Marketing for Endocardial Solutions, Inc.from August 2002 until March 2005. From 2001 to June of 2002, Mr. Paulsonwas the Sr. Vice President and General Manager of the Auditory Division ofAdvanced Bionics Corporation, and between 1995 and 2001, Mr. Paulsonserved in various capacities at Medtronic, Inc., including Vice Presidentand General Manager of the Surgical Navigation Technologies business unit; VicePresident of Corporate Strategy and Planning; and Director of CorporateDevelopment. From 1988 to 1995, Mr. Paulson held various marketing,business development and in-house counsel positions at General Mills, Inc.,and prior to that practiced law at the Minneapolis firm of Lindquist &Vennum. Mr. Paulson has served on the board of directors of VascularSolutions, Inc. since May 2005.

*DennisE. Steger,*****Vice President,Regulatory Affairs and Quality Assurance, joined MedicalCV in September 2001as Vice President, Quality Assurance. From August 1998 to August 2001,Mr. Steger was Director Design Quality Assurance for Medtronic PerfusionSystems, where he was responsible for controlling the development and transferof new/modified products from research and development to manufacturing. Healso held the position of Director Regulatory Affairs/Quality Assurance &Clinical for AVECOR Cardiovascular, Inc. from July 1991 to August 1998,where he was responsible for quality systems, technical support, risk analysis,documentation, and regulatory affairs. He has also held senior level managementpositions with Johnson & Johnson Cardiovascular, ExtracorporealMedical Specialties and Tompkins Rubber Company.

*Gary O. Tegan,*Vice President, Marketing, joined MedicalCV in April 2006. Most recently, Mr. Teganserved as the Vice President of Sales & Marketing for PneumRx, Inc.from September 2005 through April 2006, where he developed andimplemented the company’s sales and marketing strategy for its initial productlaunch. From June 2004 to September 2005, he served as Vice Presidentof Marketing at Curon 

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Medical, Inc.,a radiofrequency energy based company focused on the treatment ofgastrointestinal disorders. Prior to that, Mr. Tegan was the Director ofMarketing for Coalescent Surgical, Inc. from June 2001 to June 2004,where he helped develop its anastomotic device business using technology-basedmarketing techniques. Previously, Mr. Tegan held a series of senior salesand marketing positions at United States Surgical and Starion Instruments.

**Audit CommitteeMatters**

We have a separately designated standing auditcommittee established in accordance with Section 3(a)(58)(A) of the ExchangeAct. Susan L. Critzer, David B. Kaysen and J. Robert Paulson, Jr. are themembers of our audit committee.

Under Nasdaq Marketplace Rules thatwould apply if our common stock were listed on Nasdaq, each member of our auditcommittee would be required to (i) be independent as defined under NasdaqMarketplace Rule 4200(a)(15); (ii) meet the criteria for independenceset forth in Rule 10A-3(b)(1) under the Exchange Act; (iii) nothave participated in the preparation of the financial statements of the companyor any current subsidiary of the company at any time during the past threeyears; and (iv) be able to read and understand fundamental financialstatements, including a company’s balance sheet, income statement, and cashflow statement. Our board of directors has determined that Ms. Critzer andMessrs. Kaysen and Paulson would meet these requirements. In addition, atleast one member of our audit committee would be required to have pastemployment experience in finance or accounting, requisite professionalcertification in accounting, or other comparable experience or background whichresults in the individual’s financial sophistication, including being or havingbeen a chief executive officer, chief financial officer or other senior officerwith financial oversight responsibilities. Our board of directors hasdetermined that at least Ms. Critzer would meet this requirement.

**Audit CommitteeFinancial Expert**

Our board of directors hasdetermined that each of Susan L. Critzer and J. Robert Paulson, Jr.is an “audit committee financial expert” as defined in Item 401(e) ofRegulation S-B.

**Code of Ethics**

We have adopted a Code ofBusiness Conduct and Ethics that is applicable to all of our employees,officers (including our principal executive officer, principal financialofficer, principal accounting officer or controller, and persons performingsimilar functions) and directors. Our Code of Business Conduct and Ethicssatisfies the requirements of Item 406(b) of Regulation S-B and the NasdaqMarketplace Rules that would apply if our common stock were listed onNasdaq. Our Code of Business Conduct and 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 SouthRobert Trail, Inver Grove Heights, MN 55077. We intend to disclose anyamendments to or waivers from a provision of our Code of Business Conduct andEthics that require disclosure on our website at www.medcvinc.com.

**Section 16(a) BeneficialOwnership Reporting Compliance**

Section 16(a) ofthe Exchange Act requires our officers, directors and persons who own more than10 percent of a registered class of our equity securities to file reportsof ownership and changes in ownership with the SEC. Such officers, directorsand shareholders are required by the SEC to furnish us with copies of all suchreports. To our knowledge, based solely on a review of copies of reports filedwith the SEC during the last fiscal year, all applicable Section 16(a) filingrequirements were met, except that (1) one report on Form 4 settingforth the December 22, 2005 exercise of outstanding warrants for thepurchase of common stock and our purchase of outstanding shares of 5% Series ARedeemable 

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ConvertiblePreferred Stock from PKM Properties, LLC, an entity controlled by Paul K.Miller, one of our directors, and one of the largest beneficial owners of oursecurities, (2) one report on Form 4 setting forth the December 30,2005 exercise of outstanding warrants for the purchase of common stock and ourpurchase of outstanding shares of 5% Series A Redeemable ConvertiblePreferred Stock from Peter L. Hauser, a principal shareholder, (3) onereport on Form 3 setting forth the initial ownership on December 28,2005 of MedCap Partners, LP, one of our principal shareholders, (4) onereport on Form 5 setting forth the December 27, 2005, December 28,2005 and December 29, 2005 exercise of outstanding warrants for thepurchase of common stock and our purchase of outstanding shares of 5% Series ARedeemable Convertible Preferred Stock from MedCap Partners, LP, one of ourprincipal shareholders, (5) one report on Form 4 setting forth the March 21,2006 and March 22, 2006 purchases of common stock by MedCap Partners, LP,one of our principal shareholders, and (6) one report on Form 3setting forth the initial ownership on January 17, 2006 of the Paul K.Miller Irrevocable Trust of 2005, were not filed on a timely basis. With theexception of the Form 3 for the Paul K. Miller Irrevocable Trust of 2005,all such forms for fiscal year 2006 were filed as of June 26, 2006.

**ITEM 10**            EXECUTIVECOMPENSATION

Thefollowing table sets forth information with respect to compensation paid by usto our highest paid executive officers (the “Named Executive Officers”) for thefiscal year ended April 30, 2006.

**Summary Compensation Table**

|                                                   | ** ** | ** ** | ** ** | **Annual Compensation** | ** ** | **Long-Term  Compensation  Awards** | ** ** | ** **         | ** ** |
|---------------------------------------------------|------------|------------|------------|------------------------------|------------|-------------------------------------|------------|--------------------|------------|
| **Name and Principal Position(1)** | ** ** | ** ** | ** ** | **Fiscal  Year**             | ** ** | **Salary ($)(2)**              | ** ** | **Bonus ($)** | ** ** | **Other  Annual  Compensation ($)** | ** ** | **Securities  Underlying  Options** | ** ** | **All Other  Compensation  ($)(3)** | ** ** |
| Marc P. Flores                                    |       |       | 2006       |                         |       |                                | 223,696    |               |       |   | 66,750 | (4) |   |   | 0 |   |   |   | 28,669 |   |   |   | 32,834 | (5) |   |
| President and Chief                               |       |       | 2005       |                         |       |                                | 144,623    |               |       |   | 25,000 |   |   |   | 0 |   |   |   | 363,381 |   |   |   | 322 |   |   |
| Executive Officer                                 |       |       |       |                         |       |                                |       |               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| John H. Jungbauer                                 |       |       | 2006       |                         |       |                                | 199,992    |               |       |   | 0 |   |   |   | 0 |   |   |   | 0 |   |   |   | 132,871 | (6) |   |
| Vice President, Finance                           |       |       | 2005       |                         |       |                                | 157,597    |               |       |   | 0 |   |   |   | 0 |   |   |   | 144,012 |   |   |   | 1,188 |   |   |
| and Chief Financial Officer                       |       |       | 2004       |                         |       |                                | 32,789     |               |       |   | 0 |   |   |   | 0 |   |   |   | 0 |   |   |   | 95 |   |   |
| Adam L. Berman                                    |       |       | 2006       |                         |       |                                | 175,798    |               |       |   | 25,000 |   |   |   | 0 |   |   |   | 7,167 |   |   |   | 44,417 | (7) |   |
| Vice President, Research and  Development         |       |       | 2005       |                         |       |                                | 104,321    |               |       |   | 0 |   |   |   | 0 |   |   |   | 74,506 |   |   |   | 1,200 |   |   |
| Robert W. Clapp                                   |       |       | 2006       |                         |       |                                | 175,530    |               |       |   | 10,000 |   |   |   | 0 |   |   |   | 7,167 |   |   |   | 5,296 |   |   |
| Vice President, Operations                        |       |       | 2005       |                         |       |                                | 107,690    |               |       |   | 0 |   |   |   | 0 |   |   |   | 75,659 |   |   |   | 1,689 |   |   |
| Dennis E. Steger                                  |       |       | 2006       |                         |       |                                | 150,547    |               |       |   | 10,000 |   |   |   | 0 |   |   |   | 2,867 |   |   |   | 4,414 |   |   |
| Vice President,                                   |       |       | 2005       |                         |       |                                | 121,732    |               |       |   | 0 |   |   |   | 0 |   |   |   | 21,502 |   |   |   | 3,124 |   |   |
| Regulatory Affairs and Quality  Assurance         |       |       | 2004       |                         |       |                                | 119,995    |               |       |   | 0 |   |   |   | 0 |   |   |   | 4,048 |   |   |   | 3,773 |   |   |
|                                                   |            |            |            |                              |            |                                     |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Mr. Flores becameour President and Chief Executive Officer in September 2004. Mr. Jungbauerbecame our Vice President, Finance and Chief Financial Officer in February 2004and, in April 2006, announced his intention to resign from our company. Mr. Jungbauercurrently serves as our principal financial officer and principal accountingofficer. Mr. Berman became our Vice President, Research and Development inSeptember 2004. Mr. Clapp became our Vice President, Operations in 

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August 2004. Mr. Stegerbecame our Vice President, Regulatory Affairs and Quality Assurance in September 2001.

(2)          We have entered intoemployment agreement with each of our Named Executive Officers. Annual basesalaries currently in effect under such employment agreements are asfollows:  Mr. Flores ($238,075), Mr. Jungbauer($200,000), Mr. Berman ($185,500), Mr. Clapp ($182,000) and Mr. Steger($156,000).

(3)          Unlessotherwise noted, these entries represent our payment of term life insurancepremiums, long-term disability insurance premiums and 401(k) savings andretirement plan company match contributions in the amounts set forth below:

| Name              | ** ** | ** ** | ** ** | **Fiscal  Year** | ** ** | **Term  Life  Insurance  Premiums** | ** ** | **Long-term  Disability  Insurance  Premiums** | ** ** | **401(k)  Savings and  Retirement  Plan Company  Match Contributions** | ** ** |
|-------------------|------------|------------|------------|------------------|------------|-------------------------------------|------------|------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| Marc P. Flores    |       |       | 2006       |             |       |                                | 349        |                                           |       |                                                                                  | —     |   |   |   | 1,027 |   |   |
|                   |       |       | 2005       |             |       |                                | 322        |                                           |       |                                                                                  | —     |   |   |   | — |   |   |
| John H. Jungbauer |       |       | 2006       |             |       |                                | 145        |                                           |       |                                                                                  | 1,083      |   |   |   | 2,769 |   |   |
|              |       |       | 2005       |             |       |                                | 279        |                                           |       |                                                                                  | 909        |   |   |   | — |   |   |
|              |       |       | 2004       |             |       |                                | 22         |                                           |       |                                                                                  | 73         |   |   |   | — |   |   |
| Adam L. Berman    |       |       | 2006       |             |       |                                | 258        |                                           |       |                                                                                  | —     |   |   |   | 4,305 |   |   |
|                   |       |       | 2005       |             |       |                                | 258        |                                           |       |                                                                                  | —     |   |   |   | 942 |   |   |
| Robert W. Clapp   |       |       | 2006       |             |       |                                | 131        |                                           |       |                                                                                  | 976        |   |   |   | 4,189 |   |   |
|              |       |       | 2005       |             |       |                                | 151        |                                           |       |                                                                                  | 511        |   |   |   | 1,027 |   |   |
| Dennis E. Steger  |       |       | 2006       |             |       |                                | —     |                                           |       |                                                                                  | 824        |   |   |   | 3,590 |   |   |
|                   |       |       | 2005       |             |       |                                | —     |                                           |       |                                                                                  | 732        |   |   |   | 2,392 |   |   |
|                   |       |       | 2004       |             |       |                                | 641        |                                           |       |                                                                                  | 732        |   |   |   | 2,400 |   |   |

 

(4)          Under his employmentagreement, Mr. Flores has an annual bonus potential of up to 30 percent ofhis annual base salary based upon achievement of certain goals.

(5)          In October 2005, weentered into a letter agreement with Mr. Flores that sets forth detailsregarding our company’s agreement to reimburse Mr. Flores for certainexpenses in connection with the sale of his Nevada home, relocation expensesand expenses in connection with the establishment of a Minnesota residence.Such agreement is described in “Employment Contracts and Termination ofEmployment, and Change-in-Control Arrangements” below. Pursuant to suchagreement, we paid $16,458 of moving expenses and $15,000 of temporary housingexpenses on behalf of Mr. Flores during fiscal year 2006. These amountsare included in “All Other Compensation” above. To the extent that such expensereimbursements are taxable to Mr. Flores, we have agreed to gross up theamounts paid.

Previously, we reimbursed Mr. Flores for travel, mealsand lodging associated with his commute from his Incline Village, Nevadaresidence to our company’s headquarters in Inver Grover Heights, Minnesota. Asignificant portion of Mr. Flores’ time was spent traveling on companybusiness and we would have incurrred business travel expenses regardless of thelocation of Mr. Flores’ home. The reimbursements for Mr. Flores’ travel,meals and lodging expenses are not included in compensation. 

(6)          InApril 2006, we entered into an amendment to Mr. Jungbauer’semployment agreement pursuant to which Mr. Jungbauer will receiveseverance payments totaling $200,000 and continuation of COBRA. Severance of $125,000and COBRA of $3,874 was earned and accrued in fiscal year 2006. These amountsare included in “All Other Compensation” above. Pursuant to the amendment, weagreed to amend Mr. Jungbauer’s stock option agreements to provide thathis options, to the extent vested on 

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the terminationdate, will be exercisable for a period of twelve months following thetermination of Mr. Jungbauer’s employment. In July 2006, we agreed toretroactively rescind the provision in the amendment that provided Mr.Jungbauer twelve months following termination of employment to exercise thevested portions thereof and revert to the original terms of the stock optionagreements that provide Mr. Jungbauer three months following termination ofemployment to exercise the vested portions thereof.

(7)          InOctober 2005, our board of directors authorized the payment of Mr. Berman’srelocation expenses. During fiscal year 2006, we paid $39,854 of such expensesfor Mr. Berman. This amount is included in “All Other Compensation” above.

Thefollowing table sets forth information concerning grants of stock optionsduring the fiscal year ended April 30, 2006 to each Named ExecutiveOfficer. We granted no stock appreciation rights during our last fiscal year.

**Option Grants in Last Fiscal Year**

| ** **        | ** ** | **Individual Grants** | ** ** |
|-------------------|------------|----------------------------|------------|
| **Name**          | ** ** | ** **                 | ** ** | **Number of  Securities  Underlying  Options  Granted(1)** | ** ** | **Percent of  Total Options  Granted to  Employees in  Fiscal Year(2)** | ** ** | **Exercise  Price  ($/share)** | ** ** | **Expiration  Date** | ** ** |
| Marc P. Flores    |       |                       | 28,669     |   |   |   | 20.2 |   |   |   | 12.00 |   |   | 04/03/2013 |   |
| John H. Jungbauer |       |                       | 0          |   |   |   | 0 |   |   |   | N/A |   |   | N/A |   |
| Adam L. Berman    |       |                       | 7,167      |   |   |   | 5.0 |   |   |   | 12.00 |   |   | 04/03/2013 |   |
| Robert W. Clapp   |       |                       | 7,167      |   |   |   | 5.0 |   |   |   | 12.00 |   |   | 04/03/2013 |   |
| Dennis E. Steger  |       |                       | 2,867      |   |   |   | 2.0 |   |   |   | 12.00 |   |   | 04/03/2013 |   |
|                   |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Each such option veststo the extent of 25% on the first anniversary of the date of grant and 6.25%quarterly thereafter.

(2)          Based on an aggregate of142,216 shares subject to options granted to our employees during the fiscalyear ended April 30, 2006.

The following table setsforth information concerning the options exercised by each Named ExecutiveOfficer during the fiscal year ended April 30, 2006. It also sets forthinformation concerning unexercised options held by such persons as of April 30,2006. No stock appreciation rights were exercised by such persons during thelast fiscal year or were outstanding at the end of that year.

**Aggregated Option Exercises in Last Fiscal Year andFiscal Year End Option Values**

| ** **        | ** ** | **Shares  Acquired  on** | ** ** | **Value**    | ** ** | **Number of Securities  Underlying Unexercised  Options at  Fiscal Year End** | ** ** | **Value of Unexercised  In the Money Options  at Fiscal Year End ($)(1)** | ** ** |
|-------------------|------------|--------------------------|------------|--------------|------------|-------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|
| **Name**          | ** ** | ** **               | ** ** | **Exercise** | ** ** | **Realized ($)**                                                                                       | ** ** | **Exercisable**                                                                                                        | ** ** | **Unexercisable** | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Marc P. Flores    |       |                     | 0          |         |       |                                                                                                        | N/A        |                                                                                                                   |       |   | 90,846 |   |   |   | 301,204 |   |   |   | 180,619 |   |   |   | 541,853 |   |   |
| John H. Jungbauer |       |                     | 0          |         |       |                                                                                                        | N/A        |                                                                                                                   |       |   | 36,005 |   |   |   | 108,007 |   |   |   | 67,733 |   |   |   | 203,194 |   |   |
| Adam L. Berman    |       |                     | 0          |         |       |                                                                                                        | N/A        |                                                                                                                   |       |   | 18,627 |   |   |   | 63,046 |   |   |   | 37,617 |   |   |   | 112,846 |   |   |
| Robert W. Clapp   |       |                     | 0          |         |       |                                                                                                        | N/A        |                                                                                                                   |       |   | 18,916 |   |   |   | 63,910 |   |   |   | 33,867 |   |   |   | 101,596 |   |   |
| Dennis E. Steger  |       |                     | 0          |         |       |                                                                                                        | N/A        |                                                                                                                   |       |   | 12,624 |   |   |   | 19,793 |   |   |   | 11,290 |   |   |   | 33,865 |   |   |
|                   |            |                          |            |              |            |                                                                                                             |            |                                                                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Representsthe closing price of one share of common stock on the last trading day of thefiscal year ended April 30, 2006, minus the per share exercise price ofthe option to purchase shares of common stock.

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**EmploymentContracts and Termination of Employment, and Change-in-Control Arrangements**

In August 2004, we entered into a letter agreementwith Marc P. Flores. Under this agreement, Mr. Flores agreed to serve asour President and Chief Executive Officer at an annual salary of $222,500per year plus a bonus potential of $10,000 per quarter based uponachievement of certain goals. The agreement provided that, subject todevelopment and adoption of such plan by our board of directors and approval ofsuch award by our compensation committee, we would grant Mr. Flores a 20percent interest in a pool of 80,000 shares of restricted common stock. We alsogranted Mr. Flores a stock option to purchase 19,347 shares of our commonstock at a price of $11.50 per share. Such option vests over four years andexpires on August 30, 2014. In addition, we agreed to pay certain relocationexpenses for Mr. Flores. Effective April 1, 2005, in lieu of theabove-referenced restricted stock award, the compensation committee of ourboard of directors awarded a non-qualified stock option for the purchase of344,034 shares of common stock to Mr. Flores. This option was issuedoutside our employee benefit plans. Such option vests to the extent of 25percent on the first anniversary of the date of grant and 6.25 percentquarterly thereafter. It is exercisable at $8.90 per share. This option expireson April 1, 2012.

On July 11, 2005, our board of directors approvedcertain compensation arrangements for two executive officers, Marc P. Flores,our President and Chief Executive Officer, and John H. Jungbauer, then our VicePresident, Finance and Chief Financial Officer. We have entered into written,at-will employment agreements pursuant to which we continued the existingemployment of these officers at their then current base salary levels, $222,500for Mr. Flores and $200,000 for Mr. Jungbauer. The employmentagreement with Mr. Flores supersedes the above-described letter agreementfrom August 2004. Under the employment agreement, Mr. Flores now hasa bonus potential of up to 30 percent of base salary ($66,750) per year basedupon achievement of certain goals. Each employment agreement provides that aseverance payment will be made if the employment of the officer is terminatedby our company without cause, or by the officer for good reason, including, butnot limited to, a reduction of the officer’s compensation; a reduction ofauthority and responsibility; a relocation of place of employment; or a breachof the employment arrangement by our company. The severance payment to Mr. Floreswould equal one year of base salary, and the severance payment to Mr. Jungbauerwould be six months of base salary; and, if at the end of such six-monthperiod, Mr. Jungbauer was not employed or engaged as an independentcontractor, we would pay him up to an additional six months of base salaryuntil he is employed or engaged as an independent contractor. In addition topayments of base salary, we have agreed to pay or reimburse these officers formedical (COBRA) benefits for the periods covered by the severance payments. Inaddition, the officers have agreed to certain nondisclosure and inventions provisionsand certain noncompetition and nonrecruitment provisions during the term ofemployment and for a period of one year after termination of employment.

On October 24, 2005, we entered into a letteragreement with our President and Chief Executive Officer Marc P. Flores. Theagreement set forth details regarding our company’s agreement to reimburse Mr. Floresfor certain expenses in connection with the sale of his Nevada home, relocationexpenses and expenses in connection with the establishment of a Minnesotaresidence. We entered into this letter agreement because we determined that ouroutlay for reimbursement of travel and lodging expenses would decline when Mr. Florescompletes his move to Minnesota, but Mr. Flores advised us that October wasan inopportune time to put his Nevada home on the market. To assist Mr. Floreswith the financial burden of maintaining a temporary Twin Cities residence, wehave agreed to pay Mr. Flores, for a period of up to one year, asupplemental payment of $2,500 per month (such payments to end November 1,2006, or upon Mr. Flores’ sale of his Nevada residence). We also agreed toreimburse Mr. Flores for the cost of transporting his vehicles andhousehold goods to the temporary Minnesota residence. In addition, if Mr. Floressells his Nevada home on or before November 1, 2006, we agreed to pay for (1) packing,transportation and delivery of household goods by a national freight carrier, (2) reasonableand customary real estate closing costs of the sale of his Nevada home, and (3) reasonableand customary closing costs for 

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the purchase of hisMinnesota residence. If the foregoing benefits result in additional taxableincome to Mr. Flores, we also agreed to gross up the benefits payable to Mr. Floresto cover such taxes. The understanding set forth in the letter agreementsupersedes all prior understandings and agreements covering Mr. Flores’relocation. The provisions set forth in the letter agreement will terminateupon Mr. Flores’ termination, except to the extent that Mr. Floreshas incurred or submitted a reimbursement expense prior to such termination.

In April 2006, the compensation committee of ourboard of directors increased Mr. Flores’ annual base salary to $238,075.Under his employment agreement, Mr. Flores has an annual bonus potentialof up to 30 percent of annual base salary based upon achievement of certaingoals.

In August 2005, we entered into written, at-willemployment agreements with Adam L. Berman, Robert W. Clapp and Dennis E.Steger, each of whom was designated an “executive officer” by our board ofdirectors in September 2005. In November 2005, we entered into awritten, at-will employment agreement with James E. Jeter, who was designatedan “executive officer” by our board of directors in November 2005. In April 2006,we entered into a written, at-will employment agreement with Gary O. Tegan, whowas designated an “executive officer” by our board of directors in May 2006.Pursuant to the employment agreements with Messrs. Berman, Clapp, Steger,Jeter and Tegan, these employees have current annual base salary levels of$175,000 for each of Messrs. Berman, Clapp and Tegan, $150,000 for Mr. Stegerand $125,000 for Mr. Jeter. Our executive officers are eligible to receiveperformance-based cash bonuses. In addition, Mr. Jeter is eligible toreceive bonuses, when our business plan objectives are met, capped at 100percent of his annual base salary. For the first three months of hisemployment, we agreed to pay Mr. Jeter based on annual compensation of$175,000 per year (base and bonus). In each of February 2006 and May 2006,we agreed to continue paying Mr. Jeter at the same fixed rate for anadditional three months. In May 2006, we entered into a written, at-willemployment agreement with Eapen Chacko, who joined our company on June 21,2006, as Vice President, Finance and Chief Financial Officer. Mr. Chackowill receive an annual base salary of $200,000 and is eligible to receiveperformance-based cash bonuses. Each employment agreement provides that aseverance payment will be made if the employment of the employee is terminatedby our company without cause, or by the employee for good reason, including,but not limited to, a reduction of the employee’s compensation; a reduction ofauthority and responsibility; a relocation of place of employment; or a breachof the employment agreement by our company. The severance payment would be sixmonths of base salary; and, if at the end of such six-month period, theindividual was not employed or engaged as an independent contractor, we wouldpay him up to an additional six months of base salary until he is employed orengaged as an independent contractor. In addition to payments of base salary,we have agreed to pay or reimburse these individuals for medical (COBRA) benefitsfor the periods covered by the severance payments. In addition, these employeeshave agreed to certain nondisclosure and inventions provisions and certainnoncompetition and nonrecruitment provisions during the term of employment andfor a period of one year after termination of employment.

In October 2005, our board of directorsauthorized the payment of Mr. Berman’s relocation expenses. During fiscalyear 2006, we paid $39,854 of such expenses for Mr. Berman.

In April 2006, the compensation committee of our boardof directors increased Mr. Berman’s annual base salary to $185,500; increasedMr. Clapp’s annual base salary to $182,000; and increased Mr. Steger’s annualbase salary to $156,000.

In connection with the commencement of his employment,we granted Mr. Jeter a ten-year stock option under our Amended andRestated 2001 Equity Incentive Plan to purchase 23,250 shares of common stockat $8.40 per share with vesting of 25 percent on the first anniversary of thedate of grant and 6.25 percent quarterly thereafter. In connection with thecommencement of his employment, we granted Mr. Tegan a ten-year stockoption under our Amended and Restated 2001 Equity Incentive Plan to purchase25,000 shares of common stock at $10.50 per share with vesting of 25 percent onthe first 

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anniversary of the date ofgrant and 6.25 percent quarterly thereafter. In connection with thecommencement of his employment, we granted Mr. Chacko a ten-year stockoption under our Amended and Restated 2001 Equity Incentive Plan to purchase91,229 shares of common stock at $5.95 per share with vesting of25 percent on the first anniversary of the date of grant and 6.25 percentquarterly thereafter.

In April 2006, weentered into an amendment to our employment agreement with Mr. Jungbauerto reflect the mutual decision reached concerning Mr. Jungbauer’sdeparture from our company. Pursuant to the amendment, Mr. Jungbauer’semployment will terminate on the date we advise him that we have engaged a newchief financial officer and/or principal accounting officer. We agreed,however, that the actual date of termination of Mr. Jungbauer’s employmentwill be no earlier than July 31, 2006. We also have the right, at ouroption, to extend Mr. Jungbauer’s employment (as a non-officer) for atransition period. Such transition period will not, without Mr. Jungbauer’sconsent, continue beyond December 31, 2006. Mr. Jungbauer’scompensation and benefits will continue to be paid under the employmentagreement at their current rates through the termination date and anytransition period. Except for the severance payments described below, Mr. Jungbauerwill no longer be eligible for bonus or other incentive compensation. Under theterms of the employment agreement, Mr. Jungbauer has the right toterminate his employment upon 60 days’ prior notice and is entitled to aseverance payment equal to six months of base compensation. Under theemployment agreement, Mr. Jungbauer will receive a severance payment of$100,000 on his termination date. To facilitate a smooth transition, we haveagreed to make an additional severance payment to Mr. Jungbauer. Under theamendment, Mr. Jungbauer will receive an additional severance payment of$100,000 on January 2, 2007. In addition to these severance payments, wehave agreed to pay or reimburse Mr. Jungbauer for medical (COBRA) benefitsfor the periods covered by the severance payments. Mr. Jungbauer holdsstock options for the purchase of 144,012 shares of our common stock. His stockoption agreements provide that he has three months following termination ofemployment to exercise the vested portions thereof. Options to purchase 44,065shares of our common stock will be vested as of July 1, 2006. Pursuant tothe amendment, we agreed to amend Mr. Jungbauer’s stock option agreementsto provide that his options, to the extent vested on the termination date, willbe exercisable for a period of twelve months following the termination of Mr. Jungbauer’semployment. In July 2006, we agreed to retroactively rescind the provision in theamendment that provided Mr. Jungbauer twelve months following termination ofemployment to exercise the vested portions thereof and revert to the originalterms of the stock option agreements that provide Mr. Jungbauer three monthsfollowing termination of employment to exercise the vested portions thereof.

**Non-EmployeeDirector Compensation**

Through November 2003, our non-employee directorswere entitled to receive automatic annual stock option grants for the purchaseof 700 shares under our 1993 Director Stock Option Plan. Between the expirationof such plan and August 2004, automatic annual stock option grants for thepurchase of 700 shares were made to our non-employee directors under our2001 Equity Incentive Plan.

On March 21, 2005, we granted a stock option forthe purchase of 5,000 shares of common stock to each of David B. Kaysen andSusan L. Critzer for their service as non-employee directors. These optionswere granted outside our shareholder-approved plans, were fully vested at thedate of grant, and are exercisable at $10.00 per share. These options expire onMarch 21, 2015.

On June 8, 2005, our compensation committeeadopted cash and equity-based compensatory arrangements for non-employeedirectors. On August 3, 2005, our compensation committee made certainrevisions to the equity-based compensatory arrangements, which revisions arereflected in the following discussion.

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EffectiveMay 1, 2005, each non-employee director receives the following cashcompensation for a full year of service to our company (paid quarterly):

| **Position**                                                      | ** ** | ** ** | ** ** | **Annual  Retainer** | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|----------------------|------------|
| Board Member  (other than Board Chairperson)                      |       | $          | 6,000      |                 |
| Board Chairperson                                                 |       | $          | 12,000     |                 |
| Audit Committee  Member (other than Committee Chairperson)        |       | $          | 500        |                 |
| Audit Committee  Chairperson                                      |       | $          | 2,000      |                 |
| Compensation  Committee Member (other than Committee Chairperson) |       | $          | 500        |                 |
| Compensation Committee  Chairperson                               |       | $          | 1,000      |                 |

 

Our directors are also reimbursed for certainreasonable expenses incurred in attending board meetings.

In addition, each year, as of the date of the annualmeeting of shareholders of our company, commencing with the 2005 annual meetingof the shareholders, each eligible director who has been elected or reelectedor who is continuing as a member of the board as of the adjournment of the annualmeeting, automatically receives an option award in the amount of 5,000 shares(the “Annual Grant”) under our 2005 Director Stock Option Plan. In addition,each eligible director who is elected to the board other than at an annualmeeting of shareholders shall automatically receive an option award (the“Initial Award”) under such plan. The number of shares to be covered by anInitial Award shall equal the nearest whole number, rounded down, equal to(a) 5,000 shares multiplied by (b) the quotient obtained by dividing(1) the number of whole weeks between the date of such person’s electionof the board and the scheduled date of the next annual meeting of shareholdersand (2) 52 weeks. The date of an Initial Award shall be the date ofelection of such person to the board. Pursuant to our 2005 Director StockOption Plan, we granted options for the purchase of 673 shares of commonstock to each of Larry G. Haimovitch and J. Robert Paulson, Jr. onAugust 3, 2005, and options for the purchase of 5,000 shares of commonstock to each of Susan L. Critzer, Larry G. Haimovitch, Lawrence L. Horsch,David B. Kaysen, Paul K. Miller and J. Robert Paulson, Jr. onSeptember 22, 2005.

In May 2006, our Board of Directors awardednon-qualified stock options for the purchase of 5,000 shares of common stock toeach of Susan L. Critzer, Larry G. Haimovitch, Lawrence L. Horsch, David B.Kaysen, Paul K. Miller and J. Robert Paulson, Jr. The foregoing optionswere issued to each of our non-employee directors under our Amended and Restated2001 Equity Incentive Plan. Such options vested immediately. They areexercisable at $10.50 per share. These options expire on May 10, 2016.

Each non-employee director shall also automatically begranted the right to elect to receive additional options in lieu of the amountof the director’s cash compensation (“Annual Retainer”), or a portion thereof,for the year following election or reelection to, or continuation on, theboard.

The Initial Awards, the Annual Grants and any optionsissued in lieu of the Annual Retainer have ten-year terms and vest 100 percenton the first anniversary of the date of grant. The vesting of such optionsaccelerates in the event of a change of control of our company.

Directors who are also employees receive noremuneration for services as members of the board or any board committee.

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**ITEM 11    SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS**

Thefollowing table sets forth certain information known to us regarding beneficialownership of our common stock as of June 26, 2006, by (a) each personwho is known to us to own beneficially more than five percent of our commonstock, (b) each director, (c) each executive officer, and (d) allexecutive officers and directors as a group. The percentage of beneficialownership is based on 9,122,938 shares outstanding as of June 26,2006. As indicated in the footnotes, shares issuable pursuant to warrants andoptions are deemed outstanding for computing the percentage of the personholding such warrants or options but are not deemed outstanding for computingthe percentage of any other person. Unless otherwise noted, each personidentified below has sole voting and investment power with respect to suchshares. Except as otherwise noted below, we know of no agreements among ourshareholders which relate to voting or investment power with respect to ourcommon stock. Unless otherwise indicated, the address for each listedshareholder is c/o MedicalCV, Inc., 9725 South Robert Trail, Inver GroveHeights, Minnesota 55077. 

| **Name and Address of Beneficial Owner(1)**                                           | ** ** | ** ** | ** ** | **Amount and  Nature of  Beneficial  Ownership(1)** | ** ** | **Percent  of Class(1)** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|------------|------------|---------------------------------------------------------------|------------|-------------------------------|------------|
| MedCap Management  and Research LLC  500 Third St., Ste 535  San Francisco, CA 94107-6809                      |       |       | 1,856,050  | (2)                                                           |       |                          | 20.3       | % |   |
| Paul K. Miller                                                                                                 |       |       | 1,754,362  | (3)                                                           |       |                          | 18.3       | % |   |
| SF Capital  Partners, Ltd.  c/o Stark Offshore Man agement, LLC  3600 S Lake Dr.  St. Francis, WI 53235-3716   |       |       | 1,373,100  | (4)                                                           |       |                          | 15.1       | % |   |
| Paul K. Miller  Irrevocable Trust of 2005  606 24th Avenue South, Suite B12  Minneapolis, MN 55454        |       |       | 1,139,226  |                                                          |       |                          | 12.5       | % |   |
| Whitebox Advisors,  LLC.  3033 Excelsior Blvd., Ste 300  Minneapolis, MN 55416                                 |       |       | 1,126,654  | (5)                                                           |       |                          | 12.3       | % |   |
| MedCap Partners,  L.P.  500 Third St., Ste 535  San Francisco, CA 94107-6809                                   |       |       | 1,101,007  | (2)                                                           |       |                          | 12.1       | % |   |
| Millennium  Partners, L.P.  c/o Millennium Management, L.L.C.  666 Fifth Ave., 8th Fl  New York, NY 10103-0899 |       |       | 903,430    | (6)                                                           |       |                          | 9.9        | % |   |
| MedCap Master  Fund, L.P.  500 Third St., Ste 535  San Francisco, CA 94107-6809                                |       |       | 755,043    | (2)                                                           |       |                          | 8.3        | % |   |
| Perkins Capital  Management, Inc.  730 East Lake Street  Wayzata, MN 55391                                |       |       | 548,333    | (7)                                                           |       |                          | 5.9        | % |   |
| Peter L. Hauser  16913 Kings Court  Lakeville, Minnesota 55044                                                 |       |       | 535,477    | (8)                                                           |       |                          | 5.8        | % |   |
| Marc P. Flores                                                                                                 |       |       | 115,346    | (9)                                                           |       |                          | 1.2        | % |   |
| Lawrence L. Horsch                                                                                             |       |       | 52,791     | (10)                                                          |       |                          | *          |   |   |
| John H. Jungbauer                                                                                              |       |       | 49,065     | (11)                                                          |       |                          | *          |   |   |
| Larry G. Haimovitch                                                                                            |       |       | 39,735     | (12)                                                          |       |                          | *          |   |   |
| Robert W. Clapp                                                                                                |       |       | 26,734     | (13)                                                          |       |                          | *          |   |   |
| Adam L. Berman                                                                                                 |       |       | 23,908     | (14)                                                          |       |                          | *          |   |   |
| Susan L. Critzer                                                                                               |       |       | 15,100     | (15)                                                          |       |                          | *          |   |   |
| Dennis E. Steger                                                                                               |       |       | 14,967     | (16)                                                          |       |                          | *          |   |   |
| David B. Kaysen                                                                                                |       |       | 12,100     | (17)                                                          |       |                          | *          |   |   |
| J. Robert  Paulson, Jr.                                                                                   |       |       | 5,000      | (17)                                                          |       |                          | *          |   |   |
| James E. Jeter                                                                                                 |       |       | 1,290      |                                                          |       |                          | *          |   |   |
| Eapen Chacko                                                                                                   |       |       | 0          |                                                          |       |                          | 0          |   |   |
| Gary O. Tegan                                                                                                  |       |       | 0          |                                                          |       |                          | 0          |   |   |
| All current  directors and executive officers as a group (14 persons)                                     |       |       | 2,110,398  | (18)                                                          |       |                          | 21.4       | % |   |

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*                      Less than one percent.

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(1)                Beneficial ownership is determined in accordance withthe rules of the SEC and includes voting or investment power with respectto securities. Securities “beneficially owned” by a person may includesecurities owned by or for, among others, the spouse, children, or certainother relatives of such person as well as other securities as to which theperson has or shares voting or investment power or has the option or right toacquire within 60 days of June 26, 2006. Shares beneficially owned reflectthe one-for-ten reverse stock split of our common stock andpreferred stock effective May 31, 2006.

(2)                Based solely upon the Schedule 13G filed with the SECon April 7, 2006. As set forth in the Schedule 13G, as supplementedby the Form 4 filed with the SEC on May 2, 2006, Medcap Management &Research LLC (“MMR”) as general partner and investment manager of MedCapPartners L.P. and MedCap Master Fund L.P. and C. Fred Toney as managingmember of MMR may be deemed to beneficially own the shares owned by MedCapPartners and MedCap Master Fund in that they may be deemed to have the power todirect the voting or disposition of the shares. Neither the filing of theSchedule 13G nor any of its contents is deemed to constitute an admission thateither MMR or Mr. Toney is, for any purpose, the beneficial owner of anysecurities to which the Schedule 13G relates, and MMR and Mr. Toneydisclaim beneficial ownership as to the securities reported in theSchedule 13G, except to the extent of their respective pecuniary intereststherein.

(3)                Represents (a) 146,758 shares, (b) 12,000shares owned by Gracon Contracting Co., an entity over which Mr. Millerexercises control, (c) 7,800 shares purchasable upon the exercise ofoptions, (d) 448,128 shares purchasable upon the exercise of warrants heldby PKM Properties, LLC, an entity over which Mr. Miller exercises control,(e) 1,139,226 shares held by the Paul K. Miller Irrevocable Trust of 2005,of which Mr. Miller is the sole beneficiary, and (f) 450 shares ownedby Mr. Miller’s spouse.

(4)                Based solely upon the Schedule 13G filed with the SECon April 8, 2005. As set forth in the Schedule 13G, Michael A. Rothand Brian J. Stark are the Managing Members of Stark Offshore Management, LLC (“StarkOffshore”), which acts as investment manager and has sole power to direct themanagement of SF Capital Partners Ltd. Through Stark Offshore, Messrs. Rothand Stark possess voting and dispositive power over all of the shares to whichthe Schedule 13G relates. Messrs. Roth and Stark disclaim beneficialownership of the shares.

(5)                Represents (a) 345,985 shares held by WhiteboxHedged High Yield Partners, L.P. (“WHHYP”), (b) 320,922 shares held byWhitebox Intermarket Partners, L.P. (“WIP”), (c) 201,724 shares heldby Pandora Select Partners (“PSP”), (d) 185,837 shares held by WhiteboxConvertible Arbitrage Partners, L.P. (“WCAP”), (e) 56,590 shares held byGPC LIX, LLC, and (f) 15,596 shares held by Guggenheim Portfolio Company XXXI,LLC. Whitebox Advisors, LLC (“WA”) is the investment advisor for GPC LIX, LLCand Guggenheim Portfolio Company XXXI, LLC. WA, the managing member ofeach of (i) Whitebox Hedged High Yield Advisors, LLC (“WHHYA”), (ii) WhiteboxIntermarket Advisors, LLC (“WIA”), (iii) Pandora Select Advisors, LLC (“PSA”)and (iv) Whitebox Convertible Arbitrage Advisors, LLC (“WCAA”), has thepower to direct the affairs of each of WHHYA, WIA, PSA and WCAA. WHHYA, WIA,PSA and WCAA manage accounts for the benefit of its respective clients WHHYP,WIP, PSP and WCAP. As a result of these relationships, WA may be deemed to haveindirect beneficial ownership of the shares of common stock beneficially ownedby each of WHHYP, WIP, PSP, WCAP, GPC LIX, LLC and Guggenheim Portfolio CompanyXXXI, LLC.

(6)                The managing partner of Millennium Partners, L.P., aCayman Islands exempted limited partnership (“Millennium Partners”), is MillenniumManagement, L.L.C., a Delaware limited liability company (“MillenniumManagement”), and consequently may be deemed to have voting control andinvestment discretion over securities owned by Millennium Partners. Israel A.Englander is the managing member of Millennium Management. As a result, Mr. Englandermay be deemed to be the beneficial owner of any shares deemed to bebeneficially owned by Millennium Management. The foregoing should not beconstrued in and of itself as an admission by either of Millennium Managementor Mr. Englander as to beneficial ownership of the shares owned byMillennium Partners. Millennium Partners is a limited partner of Millenco,L.P., a Delaware limited partnership and a registered broker-dealer, and isaffiliated with two other broker-dealer entities.

(7)                Includes 98,550 shares purchasable upon theexercise of warrants.

(8)                Represents (a) 386,907 shares, (b) 16,740shares held by Mr. Hauser’s IRA, and (c) 131,830 shares purchasableupon the exercise of warrants.

(9)                Represents (a) 3,000 shares and (b) 112,346shares purchasable upon the exercise of options.

(10)           Represents (a) 11,571 shares, (b) 3,000shares purchasable upon the exercise of warrants, and (c) 38,220 sharespurchasable upon the exercise of options.

(11)           Represents (a) 2,500 shares, (b) 2,500 sharespurchasable upon the exercise of warrants, and (c) 44,065 sharespurchasable upon the exercise of options.

(12)           Represents (a) 34,735 shares held by TheHaimovitch 2000 Separate Property Revocable Trust and (b) 5,000 sharespurchasable upon the exercise of options.

(13)           Represents (a) 1,000 shares and (b) 25,734shares purchasable upon the exercise of options.

(14)           Represents (a) 1,250 shares and (b) 22,658shares purchasable upon the exercise of options.

(15)           Represents (a) 3,000 shares and (b) 12,100shares purchasable upon the exercise of options.

(16)           Represents (a) 1,000 shares and (b) 13,967shares purchasable upon the exercise of options.

(17)           Represents shares purchasable upon the exercise ofoptions.

(18)           Represents (a) 1,357,780 shares, (b) 453,628shares purchasable upon the exercise of warrants, and (c) 298,990 sharespurchasable upon the exercise of options.

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**Equity CompensationPlan 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**     |       |       | 257,192    |                                                                                                                                                  |       |                                                                                                         | $          | 11.69                                                                                                                                                                                                         |       |   |   | 497,883 | (1) |   |
| **Equity  compensation plans not approved by security holders** |       |       | 1,482,983  | (2)                                                                                                                                                   |       |                                                                                                         | $          | 7.57                                                                                                                                                                                                          |       |   |   | — |   |   |
| **Total**                                                       |       |       | 1,740,175  |                                                                                                                                                  |       |                                                                                                         | $          | 8.17                                                                                                                                                                                                          |       |   |   | 497,883 |   |   |

 

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(1)          Represents 6,359 sharesremaining available for future issuance under our 1997 Stock Option Plan,422,870 shares remaining available for future issuance under our Amended andRestated 2001 Equity Incentive Plan, and 68,654 shares remaining available forfuture issuance under our 2005 Director Stock Option Plan.

(2)          Represents(a) 59,600 shares of common stock underlying a ten-year warrantexercisable at $3.50 per share issued to Paul K. Miller in connection with the January 2003Discretionary Credit Agreement with PKM, which warrant expires on January 17,2013, (b) 60,763 shares of common stock underlying a ten-year warrantexercisable at $3.60 per share issued to Paul K. Miller in connection with asale-leaseback transaction entered into on April 4, 2003, which warrantexpires on April 4, 2013, (c) 5,000 shares of common stock underlyinga seven-year warrant exercisable at $29.50 per share issued to Segmed Inc. inconnection with a purchase of technology, which warrants expire on August 7,2009, (d) 15,000 shares of common stock underlying a five-year warrant exercisableat $67.50 per share issued to Equity Securities Investments, Inc. inconnection with its services as underwriter of our initial public offering,which warrant expires on November 20, 2006, (e) 73,958 shares ofcommon stock underlying a ten-year warrant exercisable at $3.60 per shareissued to Peter L. Hauser in connection with a July 2003 financing, whichwarrant expires on July 1, 2013, (f) 73,957 shares of common stockunderlying a ten-year warrant exercisable at $3.60 per share issued to PKM inconnection with the May 2003 Discretionary Credit Agreement, which warrantexpires to the extent of 62,256 shares on July 1, 2013 and 11,701 shareson August 20, 2013, (g) 5,000 shares of common stock underlyingseven-year warrants exercisable at $14.60 per share issued to LightWaveAblation Systems, Inc. in connection with a purchase of technology, whichwarrants expire to the extent of 2,500 shares on August 27, 2010 and 2,500shares on December 1, 2011, (h) 28,888 shares of common stockunderlying a ten-year warrant exercisable at $4.50 per share issued to PKM inconnection with the November 2003 Credit Agreement, which warrant expireson November 13, 2013, (i) 30,230 shares of common stock underlying aten-year warrant exercisable at $4.30 per share issued to Draft Co. inconsideration of a loan agreement with Draft Co., which warrant expires on November 24,2013, (j) 140,822 shares of common stock underlying a ten-year warrantexercisable at $4.70 per share issued to PKM in connection with a November 2003extension of the maturity date of an existing discretionary credit agreement,which warrant expires on February 3, 2014, (k) 57,872 shares ofcommon stock underlying a ten-year warrant exercisable at $4.70 per shareissued to Peter L. Hauser in connection with the extension of the maturity dateof the $1.0 million financing provided by Mr. Hauser, which warrantexpires February 3, 2014, (l) 11,363 shares of common stockunderlying a 

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ten-year warrantexercisable at $4.40 per share issued to PKM in connection with the October 2004Discretionary Credit Agreement, which warrant expires on November 17,2014, (m) 10,000 shares of common stock underlying a ten-year stock optionexercisable at $7.00 per share granted to Lawrence L. Horsch in August 2003,which option expires on August 19, 2013, (n) 2,500 shares of commonstock underlying a five-year stock option exercisable at $13.00 per sharegranted to Blair P. Mowery in August 2004, which option expires on August 26,2009, (o) 5,000 shares of common stock underlying a ten-year stock optionexercisable at $10.00 per share granted to each of Susan L. Critzer and DavidB. Kaysen in March 2005, which options expires on March 21, 2015, (p) 623,561shares of common stock underlying seven-year stock options exercisable at $8.90per share granted outside our stock option plans to members of management,which options expire on April 1, 2015, (q) 48,187 units underlying afive-year warrant exercisable at $4.70 per unit issued to Feltl &Company in connection with its services as our agent in our 2004 privateplacement, each unit consisting of one share of common stock and a warrant topurchase a share of our common stock at $18.375 per share, which warrantexpires on May 21, 2009, (r) 110,291 shares of common stock underlyinga ten-year warrant exercisable at $3.40 per share originally issued to PKM inconsideration of a February 2005 Credit Agreement, which warrant expireson March 3, 2015, (s) 40,996 shares of common stock underlying afive-year warrant exercisable at $3.25 per share issued to Tower Finance Ltd.in connection with its services as a finder in our 2005 private placement,which warrant expires on April 1, 2010, (t) 6,800 shares of commonstock underlying a five-year warrant exercisable at $6.25 per share issued toTower Finance Ltd. in connection with its services as a finder in our January 2005bridge financing, which warrant expires on January 13, 2010, and (u) anaggregate of 20,008 shares of common stock underlying warrants exercisable at$18.375 per share issued to Tower Finance Ltd., which warrants expire on April 30,2009.

**ITEM12    CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

*Agreements with Lawrence L. Horsch*

Effective August 19,2003, we entered into a letter agreement with Lawrence L. Horsch, who becameone of our directors in August 2003, who served as Chairman of the Boardfrom August 2003 to September 2005, and who served as our ActingChief Executive Officer from April 2004 to August 2004. Pursuant tothis agreement, Mr. Horsch agreed to provide 32 hours of service per monthas Chairman for a retainer of $60,000 per year. Pursuant to the agreement, Mr. Horschagreed to purchase 8,571 shares of common stock from our company at a price of$7.00 per share. As additional consideration, we issued a ten-year option to Mr. Horschfor the purchase of 10,000 shares of common stock exercisable at $7.00 pershare. This option vests in full upon the fourth anniversary of the date ofgrant. However, this vesting was accelerated to the extent of two-thirds of theshares purchasable under the option because of certain advances in productdevelopment and achievement of certain stock performance. Mr. Horsch hasorally agreed to relinquish options for the purchase of 3,333 shares ofcommon stock because one milestone under the applicable option agreement, whichwould have accelerated the vesting of such option to the extent of 3,333 sharesof common stock had it been achieved, was not achieved. Our board of directorsceased paying the $60,000 per year retainer effective March 31, 2005.

On April 16, 2004, we entered into an arrangementwith Mr. Horsch to compensate him for the extra hours he worked beyond the32 hours per month agreed upon in the August 19, 2003 letter agreement.Pursuant to this arrangement, Mr. Horsch has been granted (1) aten-year option to purchase 4,464 shares of common stock at $16.80 pershare, (2) a ten-year option to purchase 14,985 shares of common stock at$16.70 per share, and (3) a ten-year option to purchase 6,205 shares ofcommon stock at $20.00 per share. The number of shares of common stockpurchasable pursuant to such options is the value of the hours (at $150 perhour) divided by 0.3 with the result divided by the exercise price. Theseoptions represent payment for the additional hours of service rendered to ourcompany from February 19, 2004, to December 31, 2004.

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Mr. Horsch resigned fromthe position of Chairman of the Board at the commencement of the 2005 annualmeeting of shareholders, but remains a director of our company.

*Arrangements andTransactions with PKM Properties, LLC*

*Credit Agreements.*   Tomeet critical working capital shortages in recent fiscal years, weestablished the following credit agreements with PKM Properties, LLC (“PKM”),an entity controlled by Paul K. Miller, one of our directors, and oneof the largest beneficial owners of our securities. While outstanding, theamounts borrowed from PKM were collateralized by substantially all of ourassets.

| **Date**           | ** ** | ** **                      | ** ** | **Nature of Financing** | ** ** | **Interest  Rate** | ** ** | **Amount  Borrowed** | ** ** | **Disposition** | ** ** |
|--------------------|------------|---------------------------------|------------|-----------------------------------|------------|--------------------|------------|----------------------|------------|-----------------|------------|
| January 2003  |       | Discretionary  Credit Agreement |       |                              | 10.0       | %                  |       | $                    | 943,666    |            | Converted  |   |
| May 2003      |       | Discretionary  Credit Agreement |       |                              | 10.0       | %                  |       | $                    | 935,000    | (1)             | Converted  |   |
| November 2003 |       | Credit  Agreement               |       |                              | 10.0       | %                  |       | $                    | 500,000    |            | Converted  |   |
| April 2004    |       | Short-Term  Note                |       |                              | 10.0       | %                  |       | $                    | 140,250    | (1)             | Repaid     |   |
| October 2004  |       | Discretionary  Credit Agreement |       |                              | 10.0       | %                  |       | $                    | 500,000    |            | Converted  |   |
| February 2005 |       | Credit Agreement                |       |                              | 10.0       | %                  |       | $                    | 500,000    |            | Repaid     |   |

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(1)          Represents amountborrowed less a placement fee of 6.5 percent of such amount.

During the fiscal year ended April 30, 2005, wemade interest payments to PKM of $164,104.

We entered into debt conversion agreements as of April 1,2005, with certain debt holders for the conversion of an aggregate of$4,402,000 of debt into equity securities. Pursuant to one such agreement, PKMconverted $2,968,678 of outstanding indebtedness into 297 shares of 5% Series ARedeemable Convertible Preferred Stock at a stated value of $10,000 per share.Each share of preferred stock was convertible into the number of shares ofcommon stock equal to the stated value divided by $5.00, subject toanti-dilution adjustments. The terms of the preferred stock included dividend,protective, liquidation and conversion rights. In December 2005, wepurchased such preferred stock from PKM in consideration of the issuance of913,253 shares of common stock. For further information, please review “Management’sDiscussion and Analysis or Plan of Operation—Liquidity and Capital Resources.”The preferred stock sold to PKM was issued along with a warrant to purchase445,200 shares of common stock. The warrant had a term of five years and wasoriginally exercisable at $5.00 per share, subject to anti-dilutionadjustments. In December 2005, PKM exercised such warrant on a netexercise basis, using an exercise price of $3.25 per share and a market priceof $6.60 per share, resulting in the issuance of 225,972 shares of commonstock. For further information, please review “Management’s Discussion andAnalysis or Plan of Operation—Liquidity and Capital Resources.” In April 2004,we repaid in full the April 2004 Short-Term Note. In April 2005, werepaid in full the February 2005 Credit Agreement. As a result, we fullyrepaid our indebtedness to PKM.

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Asadditional consideration for the foregoing credit agreements, we issued thefollowing warrants to PKM with terms and conditions that includedweighted-average anti-dilution rights and certain rights to requireregistration of the common stock underlying the warrants under federal andstate securities laws. The exercise prices and the number of shares purchasableunder such warrants have adjusted pursuant to the anti-dilution provisionsthereof. Such adjusted numbers are also presented below. There were no warrantsissued to PKM in connection with the April 2004 Short-Term Note.

| **Date**                        | ** ** | ** ** | ** ** | **Term** | ** ** | **Original  Number of  Shares** | ** ** | **Original  Exercise  Price** | ** ** | **Adjusted  Number of  Shares** | ** ** | **Adjusted  Exercise  Price** | ** ** |
|---------------------------------|------------|------------|------------|----------|------------|--------------------------------------|------------|-------------------------------|------------|--------------------------------------|------------|-------------------------------|------------|
| January 2003               |       | Ten-Year   |       |     | 35,000     |                                 |       |                          | $          | 5.96                                 |       |                          |       | 59,600 |   |   |   | $ | 3.50 |   |   |
| May 2003                   |       | Ten-Year   |       |     | 38,034     |                                 |       |                          | $          | 7.00                                 |       |                          |       | 73,957 |   |   |   | $ | 3.60 |   |   |
| November 2003              |       | Ten-Year   |       |     | 7,738      |                                 |       |                          | $          | 16.80                                |       |                          |       | 28,888 |   |   |   | $ | 4.50 |   |   |
| November 2003  (extension) |       | Ten-Year   |       |     | 33,093     |                                 |       |                          | $          | 20.00                                |       |                          |       | 140,822 |   |   |   | $ | 4.70 |   |   |
| October 2004               |       | Ten-Year   |       |     | 3,401      |                                 |       |                          | $          | 14.70                                |       |                          |       | 11,363 |   |   |   | $ | 4.40 |   |   |
| February 2005              |       | Ten-Year   |       |     | 49,459     |                                 |       |                          | $          | 5.00                                 |       |                          |       | 72,734 | (1) |   |   | $ | 3.40 |   |   |

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(1)          Represents the adjustednumber of shares purchasable by PKM under such warrant following PKM’sreallocation of warrants for the purchase of 37,557 shares to third parties.

In addition to theforegoing warrants, we made the following payments to PKM in connection with thecredit agreements:

·       Placementfee of 6.5 percent of the amount borrowed under the May 2003 DiscretionaryCredit Agreement

·       $56,404in fees and expenses incurred on behalf of PKM in connection with the May 2003Discretionary Credit Agreement

·       Placementfee of 6.5 percent of the amount borrowed under the April 2004 Short-TermNote

·       $32,113in fees and expenses incurred on behalf of PKM in connection with the October 2004Discretionary Credit Agreement

·       $19,143in legal and administrative expenses incurred by PKM in connection with the February 2005Credit Agreement

·       $18,086in fees and expenses incurred on behalf of PKM in connection with the DebtConversion Agreement

*FinancingTransaction and Lease.*   On April 4, 2003, wesold our real estate, including real property andoffice-warehouse-manufacturing facility, together with certain personalproperty related thereto, to PKM. The purchase price for the property was $3.84million, paid with (1) $1.0 million in cash (subject to certainreductions, prorations and credits), (2) PKM’s assumption of a mortgagenote against the property in the amount of $2.5 million in favor of AssociatedBank Minnesota, dated November 23, 1999, and (3) PKM’s assumption ofour promissory note with Dakota Electric Association and land specialassessments payable to Dakota County aggregating $336,105. As additionalconsideration, we issued to PKM a ten-year warrant for the purchase of 35,000shares of our common stock at an exercise price of $6.25 per share. As a resultof anti-dilution adjustments through April 30, 2006, this warrant isexercisable for 60,763 shares at $3.60 per share.

Concurrent with the sale of the property, we enteredinto a ten-year lease for the property with a base annual rent of $360,000 forthe first and second year; $370,800 per year for the third, fourth and fifthyear, and $389,340 for the remaining years of the lease subject to an increasefor additional interest payable by PKM on its long-term permanent financing ofthe property, which may increase base monthly rents by up 

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to one-twelfth of theadditional annual interest payable by PKM. Assuming we are not in default underthe terms 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 alsopay under the lease operating costs and real estate taxes.

Under certain conditions, we also have an option topurchase the building at the end of the initial ten-year term at the fairvalue at that time. The purpose of the transaction was to retire our bank debtand provide us with additional required working capital.

On June 29, 2005, we entered into a leasetermination agreement with PKM. In order to induce PKM, the landlord of ourcorporate headquarters, to attempt to sell or lease the property to a thirdparty and to terminate the lease with our company, we agreed, among otherthings, to reimburse PKM for all costs and expenses relating to the lease orthe sale of the property, and to termination of the lease on not less than 120days’ notice. We also agreed that, if we request the landlord to accept lessthan its minimum required net sale proceeds, we would pay a lease terminationfee equal to the difference between the landlord’s minimum net sale proceedsand the actual net sale proceeds. We also agreed to pay a lease termination feeif the landlord re-leases the property on economic terms and conditions lessdesirable than those of the existing lease.

During the fiscal yearsended April 30, 2006 and 2005, we made lease payments to PKM of $496,136and $451,015, respectively.

*Transactions withOther Five Percent Owners*

In July 2003, we entered into a loan agreementand borrowed $1.0 million from Peter L. Hauser, an existing shareholder,pursuant to a subordinated note with an interest rate of 10 percent per year.While outstanding, the amount borrowed from Mr. Hauser was collateralizedby substantially all of our assets. We issued to Mr. Hauser a ten-yearwarrant for the purchase of 38,035 shares of our common stock on terms comparableto the warrants issued to PKM in connection with the May 2003Discretionary Credit Agreement. As a result of anti-dilution adjustmentsthrough April 30, 2006, this warrant is exercisable for 73,958 shares at$3.60 per share. In February 2004, the maturity date of this loan wasextended to June 30, 2005. In connection with the extension, we issued awarrant with a ten-year term to purchase up to 13,600 shares of our commonstock at an exercise price of $20.00 per share. As a result of anti-dilutionadjustments through April 30, 2006, this warrant is exercisable for 57,872shares at $4.70 per share.

We entered into debtconversion agreements as of April 1, 2005, with certain existing debtholders for the conversion of an aggregate of $4,402,000 of debt into equitysecurities. Pursuant to one such agreement, Mr. Hauser converted $1,008,611of outstanding indebtedness into 100 shares of 5% Series A RedeemableConvertible Preferred Stock at a stated value of $10,000 per share. Each shareof preferred stock was convertible into the number of shares of common stockequal to the stated value divided by $5.00, subject to anti-dilutionadjustments. The terms of the preferred stock included dividend, protective,liquidation and conversion rights. In December 2005 and January 2006,we repurchased all of our outstanding preferred stock, including shares held byMr. Hauser and shares held by SF Capital Partners Ltd., MedCap Partners,L.P., Millennium Partners, L.P. and MedCap Master Fund, L.P., other beneficialowners of more than five percent of our common stock. For further information,please review “Management’s Discussion and Analysis or Plan of Operation—Liquidityand Capital Resources.” The preferred stock sold to these investors was issuedalong with warrants to purchase a number of shares of common stock equal to 75%of the number of shares originally issuable upon conversion of their preferredstock. These warrants had a term of five years and were originally exercisableat $5.00 per share, subject to anti-dilution adjustments. In December 2005and January 2006, all of the common stock purchase warrants issued withthe preferred stock, including those held by the above-referenced shareholders,were exercised at $3.25 per share. Mr. Hauser exercised his warrant on anet exercise basis, using an exercise price of 

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$3.25 pershare and a market price of $6.60 per share. For further information,please review “Management’s Discussion and Analysis or Plan of Operation—Liquidityand Capital Resources.”

*Employment Agreements*

We have employmentagreements with Marc P. Flores, our President, Chief Executive Officer and oneof our directors, John H. Jungbauer, our principal financial officer andprincipal accounting officer, Adam L. Berman, our Vice President, Researchand Development, Robert W. Clapp, our Vice President, Operations, Dennis E.Steger, our Vice President, Regulatory Affairs and Quality Assurance, James E.Jeter, our Vice President, Sales, Gary O. Tegan, our Vice President, Marketing,and Eapen Chacko, who joined our company as Vice President, Finance and ChiefFinancial Officer. You should review “Executive Compensation—EmploymentContracts and Termination of Employment, and Change-in-Control Arrangements”for more information about such agreements.

*Director Options*

In March 2005, we granted a stock option for thepurchase of 5,000 shares of common stock to David B. Kaysen and we granteda stock option for the purchase of 5,000 shares of common stock toSusan L. Critzer. Mr. Kaysen and Ms. Critzer are two of ournon-employee directors. These options were granted outside ourshareholder-approved plans, they were 100 percent vested at the date of grant,and they are exercisable at $10.00 per share. These options expire on March 21,2015.

Pursuant to our 2005 Director Stock Option Plan, wegranted options for the purchase of 673 shares of common stock, exercisable at$8.00 per share, to each of Larry G. Haimovitch and J. Robert Paulson, Jr.on August 3, 2005, and options for the purchase of 5,000 shares of commonstock, exercisable at $7.40 per share, to each of Susan L. Critzer, Larry G.Haimovitch, Lawrence L. Horsch, David B. Kaysen, Paul K. Miller andJ. Robert Paulson, Jr. on September 22, 2005. These awards haveten-year terms and vest 100 percent on the first anniversary of the dateof grant. The vesting of such options accelerates in the event of a change ofcontrol of our company.

In May 2006, weawarded non-qualified stock options for the purchase of 5,000 shares of commonstock to each of Susan L. Critzer, Larry G. Haimovitch, Lawrence L. Horsch,David B. Kaysen, Paul K. Miller and J. Robert Paulson, Jr. The foregoingoptions were issued to each of our non-employee directors under our Amended andRestated 2001 Equity Incentive Plan. Such options vested immediately. They areexercisable at $10.50 per share. These options expire on May 10, 2016.

*Management Options*

Effective April 1, 2005, we awarded (1) anon-qualified stock option for the purchase of 344,034 shares ofcommon stock to Marc P. Flores, our President and Chief Executive Officer, (2) anon-qualified stock option for the purchase of 129,013 shares of commonstock to John H. Jungbauer, our principal financial officer and principalaccounting officer, (3) a non-qualified stock option for the purchase of64,506 shares of common stock to Adam L. Berman, our Vice President, Researchand Development, (4) a non-qualified stock option for the purchase of64,506 shares of common stock to Robert W. Clapp, our Vice President,Operations, (5) a non-qualified stock option for the purchase of 21,502shares of common stock to Dennis E. Steger, our Vice President, RegulatoryAffairs and Quality Assurance, and (6) a non-qualified stock option forthe purchase of 43,004 shares of common stock to a former employee. The foregoingoptions were issued outside our employee benefit plans. Such options vest tothe extent of 25 percent on the first anniversary of the date of grant and6.25 percent quarterly thereafter. They are exercisable at $8.90 per share.These options expire on April 1, 2012.

In April 2006, we awarded (1) anon-qualified stock option for the purchase of 28,669 shares of common stock toMr. Flores, (2) a non-qualified stock option for the purchase of7,167 shares of common 

61

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stock to Adam L. Berman,our Vice President, Research and Development, (3) a non-qualified stockoption for the purchase of 7,167 shares of common stock to Robert W. Clapp, ourVice President, Operations, and (4) a non-qualified stock option for thepurchase of 2,867 shares of common stock to Dennis E. Steger, our VicePresident, Regulatory Affairs and Quality Assurance. The foregoing options wereissued under our Amended and Restated 2001 Equity Incentive Plan. Such optionsvest to the extent of 25 percent on the first anniversary of the date of grantand 6.25 percent quarterly thereafter. They are exercisable at $12.00 per shareand expire on April 3, 2013.

We have also awardedoptions to James E. Jeter, our Vice President, Sales, Gary O. Tegan, our VicePresident, Marketing, and Eapen Chacko, our Vice President, Finance and ChiefFinancial Officer. You should review “Executive Compensation—EmploymentContracts and Termination of Employment, and Change-in-Control Arrangements”for more information about such options.

*Related PartyDistributor*

Prior to our exit from theheart valve business, we sold heart valves through a distribution network of 37exclusive distributors, including Mercé v. Electromedicina, S.L. The Managingand General Director of Mercé v. Electromedicina, Salvador Mercé Cervelló, isone of our former board members. During the fiscal year ended April 30,2005, such distributor made net purchases of product from our company equal toapproximately 42.4 percent of our net sales, respectively. Our accountsreceivable with this distributor accounted for approximately 54.4 percentof our accounts receivable at April 30, 2005. Obligations to us from thisdistributor are unsecured. During the quarter ended January 31, 2005, inan effort to raise $250,000 in cash to continue operations, we sold 400 heartvalves at a fifty-five percent discount to Mercé v. Electromedicina.

*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 such transactions were made on terms no lessfavorable to us than we could have obtained from unaffiliated third parties. Inthe future, all material affiliated transactions will be approved by a majorityof our independent, disinterested directors who will have access, at ourexpense, 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

See “Index to Exhibits.”

62

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**ITEM 14**            PRINCIPALACCOUNTANT FEES AND SERVICES

*Audit and Non-Audit Fees*

The following tablepresents fees for audit and other services provided by PwC in fiscal year 2005 andLBL in fiscal year 2006. Fees for audit and other services provided by PwC infiscal year 2006 as a non-principal accountant of $156,184 are excludedfrom the following table.

| ** **            | ** ** | **Year Ended**          | ** ** |
|-----------------------|------------|------------------------------|------------|
| ** **            | ** ** | **April 30, 2005** | ** ** | **April 30, 2006** | ** ** |
| Audit fees(1)         |       |                         | $          | 145,395 |   |   |   | $ | 170,509 |   |   |
| Audit-related fees(2) |       |                         | 14,062     |   |   |   | 16,940 |   |   |
| Tax fees(3)           |       |                         | 0          |   |   |   | 4,200 |   |   |
| All other fees        |       |                         | 0          |   |   |   | 0 |   |   |
| Total Fees            |       |                         | $          | 159,457 |   |   |   | $ | 191,649 |   |   |

----

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

(2)          Audit-related feesconsist of assurance and related services that include, but are not limited to,consultation concerning financial accounting and reporting standards.

(3)          Taxfees consist of fees for services provided in connection with the preparationof tax returns.

*Pre-Approval Policies and Procedures*

All services provided by our independent auditors aresubject to pre-approval by the audit committee of our board of directors. Theaudit committee has authorized each of its members to approve services by ourindependent auditors in the event there is a need for such approval prior tothe 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 our auditor’sindependence. The audit committee pre-approved all services provided byPwC in the fiscal year ended April 30, 2005, and all services provided byLBL in the fiscal year ended April 30, 2006.

63

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**SIGNATURES**

Inaccordance with Section 13 or 15(d) of the Exchange Act, theregistrant 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 20, 2006.

|        |   | MEDICALCV, INC. |
|--------|--------|----------------------|
|   |   | By                   | /s/ MARC P. FLORES |
|   |   |                 | Marc P. Flores, *President, Chief  Executive Officer* |
|   |   |                 | *and Director (Principal Executive Officer)* |

 

KNOW ALL BY THESE PRESENT, that each person whosesignature appears below constitutes and appoints Marc P. Flores and EapenChacko as his or her true and lawful attorney-in-fact and agent, with fullpowers of substitution and resubstitution, for him or her and in his or hername, place and stead, in any and all capacities, to sign any or all amendmentsto this report, and to file the same, with all exhibits thereto, and otherdocuments 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 his or her substitute or substitutes, may lawfully do or cause to bedone by virtue hereof.

Inaccordance with the Exchange Act, this report has been signed below by thefollowing persons on behalf of the registrant, and in the capacities and on thedate indicated.
|                                  | **Signature** | ** **                              | ** ** |                    | **Title** | ** ** | ** ** |  | **Date** | ** ** |
|----------------------------------|---------------|-----------------------------------------|------------|--------------------|-----------|------------|------------|--|----------|------------|
| /s/ MARC P.  FLORES              |          | President, Chief  Executive Officer and |       | July 20, 2006 |
| Marc  P. Flores                  |          | Director (Principal  Executive Officer) |       |               |
| /s/ JOHN H.  JUNGBAUER           |          | Principal  Financial Officer and        |       | July 20, 2006 |
| John  H. Jungbauer               |          | Principal Accounting  Officer           |       |               |
| /s/ SUSAN L.  CRITZER            |          | Chairperson of  the Board               |       | July 20, 2006 |
| Susan  L. Critzer                |          |                                    |       |               |
| /s/ LARRY G.  HAIMOVITCH         |          | Director                                |       | July 20, 2006 |
| Larry  G. Haimovitch             |          |                                    |       |               |
| /s/ LAWRENCE  L. HORSCH          |          | Director                                |       | July 20, 2006 |
| Lawrence  L. Horsch              |          |                                    |       |               |
| /s/ DAVID B.  KAYSEN             |          | Director                                |       | July 20, 2006 |
| David  B. Kaysen                 |          |                                    |       |               |
| /s/ PAUL K.  MILLER              |          | Director                                |       | July 20, 2006 |
| Paul  K. Miller                  |          |                                    |       |               |
| /s/ J. ROBERT  PAULSON, JR. |          | Director                                |       | July 20, 2006 |
| J. Robert  Paulson, Jr.     |          |                                    |       |               |

 

64

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**INDEX TO FINANCIALSTATEMENTSMedicalCV, Inc.**

| Report of Independent  Registered Public Accounting Firm           |   | F-2    |
|--------------------------------------------------------------------|--------|--------|
| Report  of Independent Registered Public Accounting Firm           |   | F-3    |
| Financial Statements for years ended April 30,  2006 and 2005 |   |   |
| Balance Sheets                                                     |   | F-4    |
| Statements  of Operations                                          |   | F-5    |
| Statements  of Shareholders’ Equity (Deficit)                 |   | F-6    |
| Statements  of Cash Flows                                          |   | F-7    |
| Notes  to Financial Statements                                     |   | F-8    |

 

F-1

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

Board of Directors and ShareholdersMedicalCV, Inc.Inver Grove Heights, Minnesota

We have audited the accompanying balance sheet ofMedicalCV, Inc. as of April 30, 2006, and the related statements ofoperations, shareholders’ equity (deficit) and cash flows for the year thenended. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also 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, aswell as evaluating the overall financial statement presentation. We believethat our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the financial position ofMedicalCV, Inc. as of April 30, 2006, and the results of itsoperations and its cash flows for the year then ended in conformity withaccounting principles generally accepted in the United States of America.

The accompanying financialstatements have been prepared assuming that the Company will continue as agoing concern. As discussed in Note 2 to the financial statements, the Companyhas incurred operating losses and negative cash flows from operations in recentyears and will require additional funds to finance its working capital andcapital expenditure needs. These factors raise substantial doubt about theCompany’s ability to continue as a going concern. Management’s plans regardingthese matters are also discussed in Note 2. The financial statements do notinclude any adjustments that might result from the outcome of this uncertainty.
|                         | /s/ LURIE  BESIKOF LAPIDUS & COMPANY, LLP |
|-------------------------|----------------------------------------------------|
| Minneapolis,  Minnesota |                                               |
| June 27,  2006     |                                               |

 

F-2

----

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

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

In our opinion, the accompanying balance sheet and therelated statements of operations, shareholders’ equity (deficit) and cash flowspresent fairly, in all material respects, the financial position of MedicalCV, Inc.at April 30, 2005, and the results of its operations and its cash flowsfor the year then ended in conformity with accounting principles generallyaccepted in the United States of America. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audit. We conducted ouraudit of these statements in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includes examining,on a test basis, evidence supporting the amounts and disclosures in thefinancial statements, assessing the accounting principles used and significantestimates made by management, and evaluating the overall financial statementpresentation. We believe that our audit provides a reasonable basis for ouropinion.

As discussed in Note 15 to the financial statementsincluded in the Company’s Form 10-KSB for the year ended April 30, 2005, theCompany has restated its financial statements for the year ended April 30,2005.

Theaccompanying financial statements have been prepared assuming that the Companywill continue as a going concern. As discussed in Note 2 to the financialstatements, the Company has sustained losses and negative cash flows from operationsin recent years and will require additional funds to finance its workingcapital and capital expenditure needs. These factors raise substantial doubtabout the Company’s ability to continue as a going concern. Management’s plansin regard to these matters are also described in Note 2. The financialstatements do not include any adjustments that might result from the outcome ofthis uncertainty.
| /s/ PRICEWATERHOUSECOOPERS  LLP                                                                                                                                           |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| PricewaterhouseCoopers LLP                                                                                                                                                |
| Minneapolis, Minnesota                                                                                                                                                    |
| July 8, 2005, except as to Notes 3, 12 and 15 (not  presented herein) for which the date is March 10,  2006 and Note 15 for which the date is June 5, 2006 |

 

F-3

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**MEDICALCV, INC.BALANCE SHEETS**

| ** **                                                                                                                                                                                                                                | ** ** | **April 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                                                                                | ** ** | **2006**           | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                                                                                                                                                                | ** ** | ** **         | ** ** | ** ** | ** ** |
| CURRENT ASSETS                                                                                                                                                                                                                            |       |               |       |   |   |
| Cash and cash equivalents                                                                                                                                                                                                                 |       | $                  | 10,351,570 |   | $ | 10,637,796 |   |
| Prepaid expenses and other assets                                                                                                                                                                                                         |       | 242,975            |       | 199,978 |   |
| Current assets of discontinued operations                                                                                                                                                                                                 |       | 89,782             |       | 875,648 |   |
| TOTAL CURRENT ASSETS                                                                                                                                                                                                                      |       | 10,684,327         |       | 11,713,422 |   |
| PROPERTY, PLANT AND EQUIPMENT, net                                                                                                                                                                                                        |       | 740,010            |       | 827,791 |   |
| DEFERRED  FINANCING COSTS, net                                                                                                                                                                                                            |       | 50,942             |       | 58,226 |   |
| OTHER LONG-TERM  ASSETS                                                                                                                                                                                                                   |       | 23,400             |       | 30,798 |   |
| NON-CURRENT  ASSETS OF DISCONTINUED OPERATIONS                                                                                                                                                                                            |       | 87,323             |       | 367,799 |   |
| TOTAL ASSETS                                                                                                                                                                                                                              |       | $                  | 11,586,002 |   | $ | 12,998,036 |   |
| **LIABILITIES, CONVERTIBLE PREFERRED STOCK AND  SHAREHOLDERS’ EQUITY (DEFICIT)**                                                                                                                                                     | ** ** | ** **         | ** ** | ** ** | ** ** |
| CURRENT LIABILITIES                                                                                                                                                                                                                       |       |               |       |   |   |
| Accounts payable                                                                                                                                                                                                                          |       | $                  | 605,313    |   | $ | 399,588 |   |
| Current portion of related party lease obligation                                                                                                                                                                                         |       | 322,586            |       | 311,155 |   |
| Accrued expenses                                                                                                                                                                                                                          |       | 377,507            |       | 179,095 |   |
| Current liabilities of discontinued operations                                                                                                                                                                                            |       | —             |       | 202,595 |   |
| TOTAL CURRENT LIABILITIES                                                                                                                                                                                                                 |       | 1,305,406          |       | 1,092,433 |   |
| FAIR VALUE OF  PUTABLE WARRANTS                                                                                                                                                                                                           |       | —             |       | 27,992,609 |   |
| RELATED PARTY  LEASE OBLIGATION, less current portion                                                                                                                                                                                     |       | 2,542,233          |       | 2,824,977 |   |
| TOTAL LIABILITIES                                                                                                                                                                                                                         |       | 3,847,639          |       | 31,910,019 |   |
| COMMITMENTS AND  CONTINGENCIES                                                                                                                                                                                                            |       |               |       |   |   |
| 5% SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK;  $.01 par value; stated value $10,000 per share; 1,900 shares authorized; 0 and  1,803 shares issued and outstanding; aggregate liquidation value $18,109,116  at April 30, 2005 |       | —             |       | — |   |
| SHAREHOLDERS’  EQUITY (DEFICIT)                                                                                                                                                                                                      |       |               |       |   |   |
| Preferred stock; $.01 par value; 998,100 and 498,100  shares authorized; no shares issued and outstanding                                                                                                                                 |       | —             |       | — |   |
| Common stock; $.01 par value; 24,000,000 and  9,500,000 shares authorized; 9,122,946 and 1,084,958 shares issued and  outstanding                                                                                                         |       | 91,229             |       | 10,850 |   |
| Additional paid-in capital                                                                                                                                                                                                                |       | 55,088,734         |       | 23,484,124 |   |
| Deferred stock-based compensation                                                                                                                                                                                                         |       | (98,512            | )          | — |   |
| Accumulated deficit                                                                                                                                                                                                                       |       | (47,343,088        | )          | (42,406,957 | ) |
| TOTAL SHAREHOLDERS’ EQUITY (DEFICIT)                                                                                                                                                                                                 |       | 7,738,363          |       | (18,911,983 | ) |
| TOTAL  LIABILITIES, CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY (DEFICIT)                                                                                                                                                   |       | $                  | 11,586,002 |   | $ | 12,998,036 |   |

 

See notes to financial statements.

F-4

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**MEDICALCV, INC.STATEMENTS OF OPERATIONS**

| ** **                                                                       | ** ** | **Year Ended April 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                       | ** ** | **2006**                                | ** ** | **2005** | ** ** |
| OPERATING EXPENSES,  CONTINUING OPERATIONS                                       |       |                                    |       |   |   |
| Sales and marketing                                                              |       | $                                       | 525,384    |   | $ | 317,386 |   |
| General and administrative                                                       |       | 3,459,916                               |       | 4,012,506 |   |
| Research and development services                                                |       | 3,471,241                               |       | 1,581,016 |   |
| Total operating expenses                                                         |       | 7,456,541                               |       | 5,910,908 |   |
| LOSS FROM  OPERATIONS                                                            |       | (7,456,541                              | )          | (5,910,908 | ) |
| OTHER INCOME  (EXPENSE)                                                          |       |                                    |       |   |   |
| Interest income                                                                  |       | 384,773                                 |       | 22,994 |   |
| Interest expense                                                                 |       | (177,401                                | )          | (1,352,183 | ) |
| Other income (expense) (primarily changes in fair  value of putable warrants)    |       | 16,563,359                              |       | (9,981,394 | ) |
| Total other income (expense)                                                     |       | 16,770,731                              |       | (11,310,583 | ) |
| INCOME (LOSS)  FROM CONTINUING OPERATIONS                                        |       | 9,314,190                               |       | (17,221,491 | ) |
| LOSS FROM DISCONTINUED OPERATIONS                                                |       | (81,800                                 | )          | (1,873,381 | ) |
| NET INCOME (LOSS)                                                                |       | $                                       | 9,232,390  |   | $ | (19,094,872 | ) |
| BASIC AND DILUTED  LOSS TO COMMON SHAREHOLDERS                                   |       |                                    |       |   |   |
| Net income (loss)                                                                |       | $                                       | 9,232,390  |   | $ | (19,094,872 | ) |
| Inducement to acquire redeemable convertible  preferred stock                    |       | (13,579,979                             | )          | — |   |
| Redeemable convertible preferred stock cash  dividends                           |       | (588,542                                | )          | — |   |
| NET LOSS TO  COMMON SHAREHOLDERS                                                 |       | $                                       | (4,936,131 | ) | $ | (19,094,872 | ) |
| NET LOSS PER  COMMON SHARE—CONTINUING OPERATIONS, AFTER PREFERRED DIVIDENDS |       |                                    |       |   |   |
| Basic                                                                            |       | $                                       | (1.28      | ) | $ | (16.16 | ) |
| Diluted                                                                          |       | (3.75                                   | )          | (16.16 | ) |
| NET LOSS PER  COMMON SHARE—DISCONTINUED OPERATIONS                          |       |                                    |       |   |   |
| Basic                                                                            |       | (0.02                                   | )          | (1.76 | ) |
| Diluted                                                                          |       | (0.01                                   | )          | (1.76 | ) |
| NET LOSS PER  COMMON SHARE                                                       |       |                                    |       |   |   |
| Basic                                                                            |       | (1.30                                   | )          | (17.92 | ) |
| Diluted                                                                          |       | (3.76                                   | )          | (17.92 | ) |
| WEIGHTED-AVERAGE  COMMON SHARES OUTSTANDING                                      |       |                                    |       |   |   |
| Basic                                                                            |       | 3,806,112                               |       | 1,065,349 |   |
| Diluted                                                                          |       | 5,711,893                               |       | 1,065,349 |   |

 

See notes to financial statements.

F-5

----

**MEDICALCV, INC.STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)**

| ** **                                                              | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | **Deferred**     | ** ** | ** **  | ** ** | ** **  | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|------------------|------------|-------------|------------|-------------|------------|
| ** **                                                              | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Stock-Based** | ** ** | **Accumulated**  | ** ** | ** **  | ** ** |
| ** **                                                              | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Compensation** | ** ** | **Deficit** | ** ** | **Total**   | ** ** |
| BALANCE AT APRIL 30,   2004                                        |       | 918,993               |       | $           | 9,190      |            | $          | 20,250,842       |       |        | $          | (1,933      | )          |   | $ | (23,312,085 | ) | $ | (3,053,986 | ) |
| Net loss                                                                |       | —                |       | —      |       | —          |       |             | —     |        |       | (19,094,872 | )          | (19,094,872 | ) |
| Issuance of common stock and warrants, net of  offering  costs     |       | 154,090               |       | 1,541       |       | 1,999,067       |       |             | —     |        |       | —      |       | 2,000,608 |   |
| Warrants  issued in connection with:                                    |       |                  |       |        |       |            |       |             |       |        |       |        |       |   |   |
| Short term financing                                                    |       | —                |       | —      |       | 711,337         |       |             | —     |        |       | —      |       | 711,337 |   |
| Convertible debt                                                        |       | —                |       | —      |       | 58,253          |       |             | —     |        |       | —      |       | 58,253 |   |
| Technology purchase                                                     |       | —                |       | —      |       | 18,373          |       |             | —     |        |       | —      |       | 18,373 |   |
| Beneficial conversion feature associated with  convertible debt         |       | —                |       | —      |       | 68,000          |       |             | —     |        |       | —      |       | 68,000 |   |
| Common stock issued for services                                        |       | 11,250                |       | 113         |       | 127,962         |       |             | —     |        |       | —      |       | 128,075 |   |
| Stock compensation expense                                              |       | —                |       | —      |       | 247,796         |       |             | —     |        |       | —      |       | 247,796 |   |
| Stock options exercised                                                 |       | 625                   |       | 6           |       | 2,494           |       |             | —     |        |       | —      |       | 2,500 |   |
| Amortization of stock-based compensation                           |       | —                |       | —      |       | —          |       |             | 1,933      |        |       | —      |       | 1,933 |   |
| BALANCE AT APRIL 30,   2005                                        |       | 1,084,958             |       | 10,850      |       | 23,484,124      |       |             | —     |        |       | (42,406,957 | )          | (18,911,983 | ) |
| Net income                                                              |       | —                |       | —      |       | —          |       |             | —     |        |       | 9,232,390   |       | 9,232,390 |   |
| Warrants  exercised, net of   costs:                                    |       |                  |       |        |       |            |       |             |       |        |       |        |       |   |   |
| Putable warrants                                                        |       | 2,503,791             |       | 25,038      |       | 17,477,736      |       |             | —     |        |       | —      |       | 17,502,774 |   |
| Other—cashless                                                     |       | 20,008                |       | 200         |       | (200            | )          |             | —     |        |       | —      |       | — |   |
| Acquisition of redeemable convertible preferred stock                   |       | 5,447,814             |       | 54,478      |       | 13,525,501      |       |             | —     |        |       | —      |       | 13,579,979 |   |
| Conversion of redeemable convertible preferred stock                    |       | 66,000                |       | 660         |       | (660            | )          |             | —     |        |       | —      |       | — |   |
| Inducement to acquire redeemable convertible  preferred stock |       | —                |       | —      |       | —          |       |             | —     |        |       | (13,579,979 | )          | (13,579,979 | ) |
| Preferred stock cash  dividends                                         |       | —                |       | —      |       | —          |       |             | —     |        |       | (588,542    | )          | (588,542 | ) |
| Warrant valuation after removal of put option                      |       | —                |       | —      |       | 375,518         |       |             | —     |        |       | —      |       | 375,518 |   |
| Stock options exercised                                                 |       | 375                   |       | 3           |       | 1,122           |       |             | —     |        |       | —      |       | 1,125 |   |
| Stock options issued for technical advisory services                    |       | —                |       | —      |       | 124,802         |       |             | (124,802   | )           |       | —      |       | — |   |
| Modification of stock options in connection with  severance             |       | —                |       | —      |       | 100,791         |       |             | (100,791   | )           |       | —      |       | — |   |
| Amortization of stock-based compensation                           |       | —                |       | —      |       | —          |       |             | 127,081    |        |       | —      |       | 127,081 |   |
| BALANCE AT  APRIL 30,  2006                                        |       | 9,122,946             |       | $           | 91,229     |            | $          | 55,088,734       |       |        | $          | (98,512     | )          |   | $ | (47,343,088 | ) | $ | 7,738,363 |   |

 

See notes to financial statements.

F-6

----

**MEDICALCV, INC.STATEMENTS OF CASH FLOWS**

| ** **                                                                                        | ** ** | **Year Ended April 30,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                        | ** ** | **2006**                                | ** ** | **2005** | ** ** |
| OPERATING ACTIVITIES                                                                              |       |                                    |       |   |   |
| Net income (loss)                                                                                 |       | $                                       | 9,232,390  |   | $ | (19,094,872 | ) |
| Adjustments to reconcile  net income (loss) to net cash used by operating activities:             |       |                                    |       |   |   |
| (Decrease)  increase in fair value of putable warrants                                            |       | (16,549,457                             | )          | 9,987,609 |   |
| Depreciation and  amortization                                                                    |       | 286,919                                 |       | 315,225 |   |
| Impairment of  fixed assets                                                                       |       | 154,341                                 |       | — |   |
| Provision for  doubtful accounts                                                                  |       | 23,935                                  |       | 220,281 |   |
| Gain from the sale  of property, plant and equipment                                              |       | (138,474                                | )          | — |   |
| Provision for  inventory obsolescence                                                             |       | —                                  |       | 2,573,656 |   |
| Common stock  issued for services                                                                 |       | —                                  |       | 128,075 |   |
| Stock-based  compensation expense                                                                 |       | 127,081                                 |       | 249,729 |   |
| Interest and other  expense related to issued warrants and amortization of loan origination costs |       | —                                  |       | 851,882 |   |
| Warrant expense  related to purchase of technology                                                |       | —                                  |       | 18,373 |   |
| Changes in operating  assets and liabilities:                                                     |       |                                    |       |   |   |
| Accounts  receivable                                                                              |       | 533,356                                 |       | 717,829 |   |
| Inventories                                                                                       |       | 228,665                                 |       | (283,622 | ) |
| Prepaid expenses  and other assets                                                                |       | 40,677                                  |       | (271,928 | ) |
| Accounts payable                                                                                  |       | 13,430                                  |       | (906,964 | ) |
| Accrued expenses                                                                                  |       | 188,112                                 |       | (43,610 | ) |
| Net cash used by  operating activities                                                            |       | (5,859,025                              | )          | (5,538,337 | ) |
| INVESTING ACTIVITIES                                                                              |       |                                    |       |   |   |
| Purchases of  property, plant and equipment                                                       |       | (350,418                                | )          | (218,666 | ) |
| Proceeds from the  sales of property, plant and equipment                                         |       | 346,807                                 |       | 23,123 |   |
| Net cash used by  investing activities                                                            |       | (3,611                                  | )          | (195,543 | ) |
| FINANCING ACTIVITIES                                                                              |       |                                    |       |   |   |
| Borrowings on  long-term debt                                                                     |       | —                                  |       | 1,425,000 |   |
| Principal payments  of term debt                                                                  |       | —                                  |       | (1,000,000 | ) |
| Principal payments  under related party lease obligations                                         |       | (271,313                                | )          | (319,288 | ) |
| Proceeds from  exercise of warrants, net of costs                                                 |       | 6,435,140                               |       | — |   |
| Proceeds from  issuance of redeemable convertible preferred stock and warrants                    |       | —                                  |       | 13,603,000 |   |
| Proceeds from  issuance of common stock and warrants, net of offering costs                       |       | —                                  |       | 2,000,608 |   |
| Proceeds from  exercise of stock options                                                          |       | 1,125                                   |       | 2,500 |   |
| Preferred stock  cash dividends                                                                   |       | (588,542                                | )          | — |   |
| Net cash provided  by financing activities                                                        |       | 5,576,410                               |       | 15,711,820 |   |
| NET (DECREASE)  INCREASE IN CASH AND CASH EQUIVALENTS                                             |       | (286,226                                | )          | 9,977,940 |   |
| CASH AND CASH EQUIVALENTS                                                                         |       |                                    |       |   |   |
| Beginning of year                                                                                 |       | 10,637,796                              |       | 659,856 |   |
| End of year                                                                                       |       | $                                       | 10,351,570 |   | $ | 10,637,796 |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION                                                 |       |                                    |       |   |   |
| Cash paid for  interest                                                                           |       | $                                       | 177,401    |   | $ | 457,342 |   |
| Non-cash financing  activities:                                                                   |       |                                    |       |   |   |
| Inducement to  acquire redeemable convertible preferred stock                                     |       | 13,579,979                              |       | — |   |
| Fair value of  putable warrants at date of exercise and removal of put option                     |       | 11,443,152                              |       | — |   |
| Stock options  issued for technical advisory services                                             |       | 124,802                                 |       | — |   |
| Modification of  stock options in connection with severance                                       |       | 100,791                                 |       | — |   |
| Cashless exercise  of other warrants                                                              |       | 200                                     |       | — |   |
| Related party and  other debt converted to redeemable convertible preferred stock                 |       | —                                  |       | 4,368,333 |   |
| Accrued interest  converted to redeemable convertible preferred stock                             |       | —                                  |       | 33,667 |   |

 

See notes to financial statements.

F-7

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**MedicalCV, Inc.Notes to Financial Statements**

**1.      Basis of Presentation and SignificantAccounting Policies**

**Nature of Business**

The core technology of MedicalCV, Inc. (the “Company”)is the ATRILAZE system which utilizes laser energy in cardiac tissue ablationprocedures. The Company acquired the initial technology in August 2003 andhas developed several generations of products beyond the initial technologypurchase. The Company received FDA 510(k) clearances for the firstgeneration product in November 2004 and the second generation product in October 2005.In addition, the Company received a third 510(k) clearance in April 2006which covered an additional laser wavelength. The Company’s strategy is toleverage its laser technology to develop a stand-alone, minimally invasivetreatment for atrial fibrillation.

Previously, the Company’sprimary focus was on heart valve disease and the Company was engaged in themanufacture and marketing of cardiovascular surgery devices. In April 2005,the Company elected to discontinue the sale of mechanical heart valves whichhad been the Company’s primary product and its sole source of revenues (seeNote 3).

**Fiscal Year**

References in this reportto a particular fiscal year are to the year ended April 30 of that calendaryear. The Company’s interim periods end on the last day of the month.

**Revenue Recognition**

The Company recognizesrevenue using guidance from SEC Staff Accounting Bulletin (SAB) No. 104 “RevenueRecognition in Financial Statements.” Revenue from the sale of itsproducts is recognized provided that the Company has received a written order,the price is fixed, title has transferred, collection of the resultingreceivable is probable and there are no remaining obligations. The Company didnot generate any revenues related to its ATRILAZE system during the fiscal yearended April 30, 2006. All revenues for fiscal years 2006 and prior wererelated to the heart valve business and are reported as part of discontinuedoperations.

**Use of Estimates**

The preparation of thesefinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that impact the reported amounts and disclosures in the financialstatements and accompanying notes. Actual results could differ from thoseestimates. Significant management estimates relate to the valuation allowanceon deferred tax assets and the estimated fair value of the putable warrants.

**Cash and CashEquivalents**

Cash and cash equivalentsconsist of highly liquid investments that are readily convertible into cash.The Company considers securities purchased with maturities of three months orless to be cash equivalents.

F-8

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**Fair Value ofFinancial Instruments**

The carrying amounts offinancial instruments consist primarily of cash and cash equivalents, tradeaccounts receivable, accounts payable, accrued expenses, putable warrants andrelated party lease obligations which approximate their fair values.

**Inventories**

At April 30, 2005,inventories were reported as current assets of discontinued operations andconsisted of various mechanical heart valves that were stated at the lower ofcost or market, with cost determined utilizing standard costs, whichapproximated the first-in, first-out method of inventory valuation.

**Property, Plant andEquipment**

Property, plant andequipment are stated at cost. Depreciation and amortization is computed usingthe straight-line method over the estimated useful lives of the related assets.The building is depreciated over a 30-year life. Machinery and equipment,furniture and fixtures, and computers are depreciated and amortized over theirtwo-year to five-year lives. At April 30, 2005, equipment held for salewas carried at the lower of its cost or estimated market value. The Companyceased depreciation of equipment held for sale upon determination that suchequipment will no longer be used in operations. Maintenance and repairs arecharged to current operations when incurred. The cost and related accumulateddepreciation or amortization of assets disposed of are removed from the relatedaccounts and any resulting gains or losses are included in the statement ofoperations.

**Long-Lived Assets**

All long-lived assets arereviewed when events or changes in circumstances indicate that the carryingamounts of such assets may not be recoverable. This evaluation is performed atleast annually. An impairment loss is recognized when estimated undiscountedcash flows to be generated by those assets are less than the carrying value ofthe assets. When an impairment loss is recognized, the carrying amount isreduced to its estimated fair value, based on appraisals or other reasonablemethods to estimate value.

**Research andDevelopment**

Research and developmentcosts are expensed as incurred.

**Stock-BasedCompensation**

The Company accounts for stock-based employeecompensation arrangements in accordance with the provisions of AccountingPrinciples Board Opinion (APB) No. 25, “Accounting for Stock Issued toEmployees,” and its interpretations whereby the difference between the exerciseprice and the fair value on the date of grant is recognized as compensationexpense. Under the intrinsic value method of accounting, no compensationexpense is recognized in the Company’s statement of operations when theexercise price of the Company’s employee/director stock option grants equals oris greater than the market price of the underlying common stock at the date ofgrant, and the measurement date of the option grant is certain. The measurementdate is certain when the date of grant is fixed and determinable. Compensationcost for employee stock options is measured as the excess, if any, of thequoted market price of the Company’s stock at the date of grant over the amountthat the employee is required to pay for the stock. Compensation expense of$87,353 was recorded in fiscal year 2006 as the exercise date through whichcertain options granted in fiscal year 2005 was extended in fiscal year 2006and the market price of the Company’s stock at that time exceeded the exerciseprice of the stock options. Options issued to 

F-9

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non-employees/non-directorsare accounted for as required by Statement of Financial Accounting Standards(SFAS) No. 123, “Accounting for Stock-Based Compensation.”

SFAS No. 123established a fair value method of accounting for stock-based compensationplans. Companies that elected to account for stock-based compensation plans inaccordance with APB No. 25 are required to disclose the pro forma net lossthat would have resulted from the use of the fair value method as follows:

| ** **                                       | ** ** | **Year Ended April 30,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                       | ** ** | **2006**                                | ** ** | **2005** | ** ** |
| Net loss to  common shareholders:                |       |                                    |       |   |   |
| As reported                                      |       | $                                       | (4,936,131 | ) | $ | (19,094,872 | ) |
| Pro forma stock-based employee compensation cost |       | (1,280,323                              | )          | (554,463 | ) |
| Pro forma                                        |       | $                                       | (6,216,454 | ) | $ | (19,649,335 | ) |
| Basic net loss per common share:                 |       |                                    |       |   |   |
| As reported                                      |       | $                                       | (1.30      | ) | $ | (17.92 | ) |
| Pro forma                                        |       | (1.63                                   | )          | (18.44 | ) |
| Diluted net loss  per common share:              |       |                                    |       |   |   |
| As reported                                      |       | (3.76                                   | )          | (17.92 | ) |
| Pro forma                                        |       | (3.99                                   | )          | (18.44 | ) |

 

**Income Taxes**

Deferred income tax assetsand liabilities are recognized for the expected future tax consequences ofevents that have been included in the financial statements or tax returns.Deferred income tax assets and liabilities are determined based on differencesbetween the financial statement and tax bases of assets and liabilities usingcurrently enacted tax rates in effect for the years in which the differencesare expected to reverse. Deferred tax assets are evaluated and a valuation allowanceis established if it is more likely than not that all or a portion of the taxasset will not be utilized.

**Credit Risk**

The Company maintains cashand cash equivalents in bank accounts which may exceed federally insuredlimits. The Company has not experienced any losses on such accounts andbelieves it is not exposed to any significant credit risk on cash and cashequivalents.

**Net Loss Per Common Share**

Basicnet loss per common share was computed by dividing the net loss to commonshareholders by the weighted-average common shares outstanding during the year.Diluted net loss per common share reflects the potential dilution that couldoccur if holders of warrants and options that are not anti-dilutive converttheir holdings into common stock. Diluted net loss per common share does notdiffer from the basic net loss per common share in the year ended April 30,2005 since the potentially dilutive shares are anti-dilutive. Certain warrantsoutstanding during the year ended April 30, 2006 were potentially dilutiveand considered to be common stock equivalents because they can be settled incommon stock. The net loss to common shareholders for that year was increasedby the decrease in fair value of putable warrants and the weighted averagenumber of shares used for the basic net loss per share computation wasincreased by the shares issuable under the warrants as follows:

| Net loss to common  shareholders for basic net loss per common share                |   | $           | (4,936,131  | ) |
|-------------------------------------------------------------------------------------|--------|-------------|-------------|---|
| Effect of dilutive  securities—decrease in fair value of putable warrants |   | (16,549,457 | )           |
| Net loss to common  shareholders for diluted net loss per common share              |   | $           | (21,485,588 | ) |

 

F-10

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| Weighted-average  shares outstanding for basic net loss per common share          |   | 3,806,112 |   |
|-----------------------------------------------------------------------------------|--------|-----------|--------|
| Effect of  dilutive securities—shares issuable under warrant agreements |   | 1,905,781 |   |
| Weighted-average shares  outstanding for diluted net loss per common share        |   | 5,711,893 |   |

 

Options and warrants topurchase 1,887,880 and 749,290 shares of common stock were excluded from thecomputation for the years ended April 30, 2006 and 2005, respectively,because they were anti-dilutive.

**Recent IssuedAccounting Pronouncements**

In December 2004, the FASB issued SFAS No. 123R,“Share-Based Payment—an amendment of SFAS No. 123,” which requirescompanies to recognize in the statement of operations the grant-date fair valueof stock options and other equity-based compensation issued to employees. SFAS No. 123Ris effective for companies filing under Securities and Exchange Commission(SEC) Regulation SB as of the beginning of the first interim or annualreporting period of the company’s first fiscal year that begins after December 15,2005, which for the Company will be the first quarter of its year ending April 30,2007. The Company will use the modified prospective application method. Underthe modified prospective application method, awards that are granted, modifiedor settled after the date of adoption will be measured and accounted for inaccordance with SFAS No. 123R. Compensation costs for awards granted priorto, but not vested, as of the date SFAS No. 123R is adopted will be basedon grant date attributes similar to those originally used to value those awardsfor the pro forma purposes under SFAS No. 123. The Company is in theprocess of evaluating the impact of the adoption of SFAS No. 123R.

In March 2005, theSEC released SAB No. 107, “Share-Based Payments.” The interpretations inSAB No. 107 express views of the SEC staff regarding the interactionbetween SFAS No. 123R and certain SEC rules and regulations, andprovide the staff’s views regarding the valuation of share-based paymentarrangements for public companies. In particular, SAB No. 107 providesguidance related to share-based payment transactions with non-employees,valuation methods (included assumptions such as expected volatility andexpected term), the classification of compensation expense, non-GAAP financialmeasures, first-time adoption of SFAS No. 123R in an interim period,capitalization of compensation costs related to share-based paymentarrangements, accounting for income tax effects of share-based paymentarrangements upon adoption of SFAS No. 123R, modification of employeeshare options prior to adoption of SFAS No. 123R and disclosures inManagement’s Discussion and Analysis subsequent to the adoption of SFAS No. 123R.SAB No. 107 requires stock-based compensation to be classified in the sameexpense lines as cash compensation is reported for the same employees. TheCompany will apply the interpretations of SAB No. 107 in conjunction ofits adoption of SFAS No. 123R.

**2.      Going Concern**

The Company’s financialstatements for the years ended April 30, 2006 and 2005 have been preparedon a going concern basis, which contemplates the realization of assets andsettlement of liabilities and commitments in the normal course of business. TheCompany has sustained operating losses and negative cash flows from operationsin recent years and expects these conditions to continue for the foreseeablefuture. At April 30, 2006 and 2005, the Company had an accumulated deficitof $47,343,088 and $42,406,957, respectively. The level of cash required foroperations during fiscal year 2007 is difficult to predict, and managementanticipates that development of its new products will require additional capital.These matters raise substantial doubt about the Company’s ability to continueas a going concern. Management intends to seek additional debt or equityfinancing as it continues development of new products. However, the Company maynot be able to obtain such financing on acceptable terms or at all. If theCompany is unable to obtain such additional financing, it will be required tosignificantly 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 competitive 

F-11

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pressuresor unanticipated requirements, which could seriously harm its business,financial position and results of operations. The financial statements do notinclude any adjustments that might result from the outcome of this uncertainty.

**3.      Discontinued Operations**

On November 17, 2004, the Company’s board ofdirectors authorized management to cease production of heart valves but tocontinue marketing the valves while exploring the merits of possible strategicalternatives for the heart valve business, including, but not limited to, ajoint venture with another party or the sale of the business. Followingexploration of a number of alternatives, management concluded during April 2005that an orderly winding up of the valve business was the Company’s bestalternative. On April 6, 2005, the Company’s Board authorized managementto discontinue sales of heart valves effective April 30, 2005, and to seeka buyer for the related production equipment.

As a result of the Company’s discontinuance of theheart valve business, the Company made a determination during the fourthquarter of fiscal year 2005 that the remaining assets of the heart valveoperations should be considered “held for sale” pursuant to SFAS No. 144, “Accountingfor Impairment or Disposal of Long-Lived Assets.” Pursuant to SFAS No. 144,the Company ceased depreciation of property and equipment held for sale andevaluated whether any of the long-lived assets of the discontinued heart valvebusiness were impaired. Based upon the estimated selling prices of theseassets, management concluded that the carrying value of these assets was notimpaired. As of April 30, 2005, the carrying value of the remaining netassets of the heart valve business was reported as assets of discontinuedoperations on the Company’s balance sheet. In connection with this decision todiscontinue the sale of heart valves, the Company reduced the carrying value ofcertain excess inventories, resulting in a provision recorded during the fourthquarter of fiscal year 2005 of $1,306,215. This provision was included in thefiscal year 2005 loss from discontinued operations.

Valvebusiness revenue and loss before income taxes included in discontinuedoperations are as follows:

| ** **               | ** ** | **Year Ended April 30,** | ** ** |
|--------------------------|------------|-----------------------------------------|------------|
| ** **               | ** ** | **2006**                                | ** ** | **2005** | ** ** |
| Revenues                 |       | $                                       | 338,333    |   | $ | 2,304,897 |   |
| Loss Before Income Taxes |       | $                                       | (81,800    | ) | $ | (1,873,381 | ) |

 

F-12

----

Thecarrying amounts and major classes of the assets and liabilities, which are presentedas assets and liabilities of discontinued operations on the accompanyingbalance sheet, are as follows:

| ** **                                                | ** ** | **April 30,** | ** ** |
|-----------------------------------------------------------|------------|--------------------|------------|
| ** **                                                | ** ** | **2006**           | ** ** | **2005** | ** ** |
| **ASSETS**                                                |       |               |       |   |   |
| Accounts  receivable, net of allowance of $0 and $196,521 |       | $                  | —     |   | $ | 557,291 |   |
| Inventories                                               |       | —             |       | 228,665 |   |
| Prepaid expenses                                          |       | 89,782             |       | 89,692 |   |
| Total current  assets of discontinued operations          |       | $                  | 89,782     |   | $ | 875,648 |   |
| Property, plant and equipment, net                        |       | $                  | —     |   | $ | 188,145 |   |
| Other long-term  assets                                   |       | 87,323             |       | 179,654 |   |
| Total non-current  assets of discontinued operations      |       | $                  | 87,323     |   | $ | 367,799 |   |
| **LIABILITIES**                                           |       |               |       |   |   |
| Accounts payable                                          |       | $                  | —     |   | $ | 192,295 |   |
| Accrued expenses                                          |       | —             |       | 10,300 |   |
| Total current  liabilities of discontinued operations     |       | $                  | —     |   | $ | 202,595 |   |
| Net assets of  discontinued operations                    |       | $                  | 177,105    |   | $ | 1,040,852 |   |

 

**4.      Property, Plant and Equipment**

Property,plant and equipment, excluding property and equipment of discontinuedoperations, consisted of the following at April 30:

| ** **                                 | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|--------------------------------------------|------------|------------|------------|------------|------------|
| Land                                       |       | $          | 182,000    |       | $          | 182,000 |   |
| Building                                   |       | 1,251,601  |       | 1,251,601  |       |
| Machinery and  equipment                   |       | 476,931    |       | 287,571    |       |
| Furniture and  fixtures                    |       | 12,743     |       | 12,743     |       |
| Computers and  related                     |       | 242,208    |       | 106,484    |       |
|                                       |       | 2,165,483  |       | 1,840,399  |       |
| Accumulated  depreciation and amortization |       | (1,425,473 | )          | (1,012,608 | )          |
|                                       |       | $          | 740,010    |       | $          | 827,791 |   |

 

**5.      Debt from Related Parties, Note Payableand Convertible Bridge Notes**

**Debt from RelatedParties**

In January 2003, the Company established adiscretionary line of credit with PKM Properties, LLC (PKM), an entitycontrolled by Paul K. Miller. Mr. Miller is one of the Company’s directorsand one of the largest beneficial owners of the Company’s securities. This lineof credit was initially scheduled to mature on April 17, 2003. On April 15,2003, the maturity date was extended to September 17, 2003. In October 2003,the Company further amended the line of credit to extend the maturity date to May 27,2004, and to increase the interest rate to 10 percent per year. Additionally,on February 3, 2004, the maturity date of the line of credit was extendedto June 30, 2005. The Company issued PKM a second mortgage on the Company’sreal estate and a security interest in all remaining assets of the Company. Inconnection with the original line of credit, the Company issued a ten-yearwarrant to PKM to purchase 35,000 shares of the Company’s common stock at anexercise price of $5.96 per share. As a result of anti-dilution adjustmentsthrough April 30, 2006, this warrant is exercisable for 59,600 shares at$3.50 per share. The debt of $943,333 borrowed under this line of credit wasconverted to redeemable convertible preferred stock on April 1, 2005 (seeNote 9).

F-13

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On July 8, 2003, the Company entered into a $1.0million term debt agreement with PKM. Pursuant to the agreement, the Companyborrowed $1.0 million during fiscal year 2004. The debt, which wascollateralized by substantially all of the Company’s assets, bore interest at10 percent per year, with an original maturity date of May 27, 2004. Inconnection with the borrowings during fiscal year 2004, the Company issuedwarrants to PKM with a ten-year term for the purchase of 38,034 shares of theCompany’s common stock at an exercise price of $7.00 per share. As a result ofanti-dilution adjustments through April 30, 2006, these warrants areexercisable for an aggregate of 73,957 shares at $3.60 per share. In connectionwith this financing, the Company agreed to extend the term of 70,000 previouslyissued warrants from five years to ten years. The Company incurred direct andincremental costs of $65,000 in completing the debt arrangement, which wereincluded in deferred financing costs and were amortized as interest expenseover the original eleven-month term of the debt. On February 3, 2004, thematurity date of the term debt was extended to June 30, 2005. Inconnection with the extension, the Company issued a warrant to PKM with aten-year term for the purchase of 33,093 shares of the Company’s common stockat an exercise price of $20.00 per share. As a result of anti-dilutionadjustments through April 30, 2006, this warrant is exercisable for140,822 shares at $4.70 per share. The $1.0 million borrowed under thisagreement was converted to redeemable convertible preferred stock on April 1,2005 (see Note 9).

In November 2003, the Company amended theone-year $1.0 million term debt agreement with PKM, initiated on July 8,2003, to provide for an additional $500,000 of borrowings with the same termsas the July 8, 2003 financing and extended the term of the loan to June 30,2005. The Company issued, as additional consideration, a warrant with aten-year term for the purchase of 7,738 shares of Company’s common stock at anexercise price of $16.80 per share. As a result of anti-dilution adjustmentsthrough April 30, 2006, this warrant is exercisable for 28,888 shares at$4.50 per share. The debt of $500,000 borrowed under this agreement wasconverted to redeemable convertible preferred stock on April 1, 2005 (seeNote 9).

On July 8, 2003, the Company entered into a $1.0million term debt agreement with Peter L. Hauser, a principal shareholder.The Company borrowed $1.0 million under this bridge financing during fiscalyear 2004. The debt, which was collateralized by substantially all of the Company’sassets pursuant to an intercreditor agreement with PKM, bore interest at 10percent per year and had a maturity date of June 30, 2004. In connectionwith the term debt, the Company also issued a warrant with a ten-year term topurchase 38,035 shares of the Company’s common stock at an exercise price of$7.00 per share. As a result of anti-dilution adjustments through April 30,2006, this warrant is exercisable for 73,958 shares at $3.60 per share. TheCompany incurred direct and incremental costs of $71,772 in completing the debtarrangement, which were included in deferred financing costs and were amortizedas interest expense 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. Inconnection with the extension, the Company issued a warrant to Mr. Hauserwith a ten-year term for the purchase of 13,600 shares of the Company’s commonstock at an exercise price of $20.00 per share. As a result of anti-dilutionadjustments through April 30, 2006, this warrant is exercisable for 57,872shares at $4.70 per share. This debt of $1.0 million was converted toredeemable convertible preferred stock on April 1, 2005 (see Note 9).

On November 17, 2004, the Company entered into aDiscretionary Credit Agreement with PKM, covering advances by PKM of up to$500,000. The Discretionary Credit Agreement had a maturity date of February 28,2005, that was subsequently extended to June 30, 2005. The creditagreement required the payment of interest at 10 percent per year, and it alsocontained various representations and loan covenants as are customary inbanking and finance transactions. The Company issued a credit note to PKM toevidence such indebtedness. In connection with the Discretionary CreditAgreement, the Company entered into an intellectual property security agreementwith PKM pursuant to which PKM was granted a security interest in all of theCompany’s intellectual property. The Company and its creditors agreed to anamendment to the first amended and restated subordination and inter-creditoragreement by 

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and between PKM and Mr. Hauser.Pursuant to this agreement, proceeds borrowed under the Discretionary CreditAgreement were deemed “senior debt.” Further, PKM, pursuant to a waiveragreement, waived past defaults under the January 2003 DiscretionaryCredit Agreement and the November 2003 Credit Agreement. These defaultsinvolved the late payments of interest and failure to send periodic financialstatements. As additional consideration for the Discretionary Credit Agreement,the Company issued to PKM a warrant with a ten-year term to purchase 3,401shares of the Company’s common stock at an exercise price of $14.70 per share.As a result of anti-dilution adjustments through April 30, 2006, thiswarrant is exercisable for 11,363 shares at $4.40 per share. The allocated fairvalue of the newly issued warrant was $42,986 and was accounted for as adiscount on the borrowings. This discount, which was presented as a reductionof the carrying value of the debt on the balance sheet was amortized asinterest expense over the original four-month term of the debt.

On March 3, 2005, theCompany entered into a February 2005 Credit Agreement (the “Agreement”)with PKM. The Agreement provided for a $500,000 discretionary credit facilityunder which PKM made loans available to the Company up to $500,000 and bearinginterest at 10 percent per year. Principal and interest were due on the amountsborrowed no later than June 16, 2005. This debt and the other amounts theCompany had borrowed from PKM were collateralized by substantially all of theCompany’s assets. A February 2005 Discretionary Credit Note reflected thisindebtedness. In consideration of the foregoing financing, the Company issuedto PKM a ten-year warrant for the purchase of 75,000 shares of the Company’scommon stock with an exercise price of $5.00 per share. As a result ofanti-dilution adjustments through April 30, 2006, this warrant isexercisable for 110,291 shares at $3.40 per share. The allocated fair value ofthe warrant was $589,321 and was accounted for as a discount on the borrowings.This discount, which was presented as a reduction of the carrying value of thedebt on the balance sheet, was fully amortized as interest expense duringfiscal year 2005. The Company repaid this note in April 2005.

**Note Payable**

In November 2003, the Company entered into a loanagreement and borrowed $500,000 from Draft Co. (“Draft”), pursuant to anote that matured on June 30, 2004, which bore interest at an annual rateof 10 percent. Pursuant to an amended intercreditor agreement among PKM, Mr. Hauser,and Draft, the loan was collateralized by substantially all of the Company’sassets. The Company issued Draft warrants to purchase up to 9,090 shares of commonstock at an exercise price of $14.30 per share with other terms comparable tothe warrants issued to PKM as described above. As a result of anti-dilutionadjustments through April 30, 2006, this warrant is exercisable for 30,230shares at $4.30 per share. The allocated fair value of the warrants was$100,056 and was accounted for as a discount on the borrowings under the termdebt. This discount, which was presented as a reduction of the carrying valueof the debt on the balance sheet, was amortized as interest expense over theseven-month term of the debt. In addition, the Company incurred directand incremental costs of $31,850 in completing the debt arrangement, which wereincluded in deferred financing costs and were amortized as interest expenses overthe term of the debt. The Company repaid this note in June 2004.

The Company determined the fair value of all warrantsdescribed above using the Black Scholes option pricing model. The model takesinto consideration weighted average assumptions related to the following:risk-free interest rate; expected life years; expected volatility; and expecteddividend rate.

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**Convertible BridgeNotes**

In December 2004 and January 2005, theCompany issued convertible bridge notes totaling $425,000. The notes, whichwere due on May 31, 2005, bore interest at 10 percent per year and wereconvertible into securities to be issued in the Company’s next equityfinancing, if any. Within 10 days of the consummation of the Company’s nextequity financing each note holder was required to elect one of the followingtwo alternatives: (1) convert the entire unpaid principal and all accruedbut unpaid interest under the note into equity securities sold by the Companyin its next equity financing (“Next Shares”) at a price per share equal to 80percent of the issuance price of the Next Shares, and retain the warrantsissued in connection with the convertible bridge notes, or (2) surrenderthe note and the warrants issued in connection with the bridge notes to theCompany in exchange for the issuance of a number of Next Shares and anyaccompanying warrants issuable in connection with the Next Shares, equal to theamount of such securities that could be purchased using the entire unpaidprincipal and all accrued but unpaid interest under the note.

In April 2005, these notes were converted inconnection with the redeemable convertible preferred stock financing at 100percent of the issuance price of such securities (see Note 9). In considerationof converting at 100 percent rather than 80 percent of the issuance price ofthe redeemable convertible preferred stock, the note holders were permitted toretain the warrants issued to them in connection with the convertible bridgefinancing. Because the convertible bridge notes provided a contingentconversion option to the note holders which resulted in a beneficial conversionprice when converted, the Company recorded an interest charge of $68,000 uponconversion of these notes in April 2005.

In connection withissuance of the convertible bridge notes, the Company issued to the noteholders warrants to purchase up to an aggregate of 8,500 shares of commonstock. The warrants, which have a five-year term, are exercisable at a priceper share equal to the per share or per unit price of equity securities sold inthe Company’s next offering. However, such exercise price could not exceed$14.90 per share. The warrants contain anti-dilution provisions, but there wasno anti-dilution as of April 30, 2006. The allocated fair value of thenewly issued warrants was $79,030 and was accounted for as a discount on theborrowings. This discount, which was initially presented as a reduction of thecarrying value of the debt, was amortized as interest expense through the April 2005conversion date of the notes.

**6.      Related Party Lease Obligation**

On April 4, 2003, the Company sold its corporateheadquarters and manufacturing facility and surrounding land in Inver GroveHeights, Minnesota, to PKM (see Note 5 regarding the Company’s relationshipwith PKM).

In connection with the transaction, the Companyreceived total consideration of $3.84 million consisting of: (1) $1.0million in cash, (2) PKM’s assumption of the Company’s $2.5 millionoutstanding indebtedness to Associated Bank, and (3) PKM’s assumption ofthe Company’s promissory note with Dakota Electric Association and land specialassessments payable to Dakota County aggregating $336,105. Also in connectionwith the transaction, the Company issued to PKM a ten-year warrant for thepurchase of 35,000 shares of the Company’s common stock at an exercise price of$6.25 per share. The warrant had an allocated fair value of $89,602 asdetermined by the Black Scholes option pricing model. As a result ofanti-dilution adjustments through April 30, 2006, this warrant isexercisable for 60,763 shares at $3.60 per share.

Simultaneous with the sale of the facility, theCompany entered into a lease with PKM to lease back the facility and a portionof the land. The lease has a ten-year initial term with options for the Companyto extend the lease up to ten additional years. Under certain conditions, theCompany also has an option to purchase the building at the end of the initialten-year term at the fair value at that time.

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Due to the Company’s continued involvement with theproperty including the ability to buy back the property at a future date, thetransaction is accounted for as a financing of the property sold and leasedback. Accordingly, the land and building continue to be presented as part ofthe Company’s property, plant and equipment balance and had a net book value of$572,551 (gross value of $1,433,601 net of accumulated depreciation of$861,050) at April 30, 2006 (see Note 4). The related party leaseobligation of $2,864,819 represents the remaining minimum amounts due to PKMfor the initial ten year term discounted at 4 percent and additional paymentsto be paid to PKM for the Dakota Electric Association and Dakota Countyobligations assumed by PKM.

Scheduledmaturities of the related party lease obligation are as follows:

| **Year Ending April 30,** | ** ** | ** ** | ** ** | **Amount** | ** ** |
|------------------------------------------|------------|------------|------------|------------|------------|
| 2007                                     |       | $          | 322,586    |       |
| 2008                                     |       | 334,633    |       |
| 2009                                     |       | 366,042    |       |
| 2010                                     |       | 352,991    |       |
| 2011                                     |       | 355,251    |       |
| Thereafter                               |       | 1,133,316  |       |
|                                     |       | $          | 2,864,819  |       |

 

**7.      Commitments**

**Operating Lease**

The Company has an operating lease for a certain pieceof office equipment, which expires in fiscal year 2011. At the end of theinitial lease term, the Company has the option to purchase the equipment at thefair market value, renew the lease, or return the equipment.

Rental expense, excludingexecutory costs and insurance, under the operating lease was $5,069 in fiscalyear 2006. The future minimum lease payments are $5,530 in fiscal years 2007-2010,and $460 in fiscal year 2011.

**EmploymentAgreements**

During fiscal year 2006, the Company entered intoemployment agreements with seven executive officers. The agreements give theofficers and the Company the right to terminate the contract with or withoutcause with sixty (60) days’ written notice. The agreements also contain aprovision for lump sum payments of up to twelve months severance if theemployment of the officer is terminated without cause by the Company or forgood reason by the officer as defined in the agreements. The agreements alsocontain various other provisions.

On April 6,2006, the Company entered into an amendment to the executive employmentagreement (the “Amendment”) with John H. Jungbauer to reflect the mutualdecision reached concerning his departure from the Company. Pursuant to theAmendment, Mr. Jungbauer’s employment will terminate on the date theCompany advises him that it has engaged a new chief financial officer and/orprincipal accounting officer. The actual termination date will be no earlierthan July 31, 2006. The Company also has the right, at its option, toextend Mr. Jungbauer’s employment (as a non-officer) for a transitionperiod. Such transition period will not, without Mr. Jungbauer’s consent,continue beyond December 31, 2006. Mr. Jungbauer’s compensation andbenefits will continue to be paid under the employment agreement at theircurrent rates through the termination date and any transition period. Underterms of the employment agreement, Mr. Jungbauer has the right toterminate his employment upon 60 days’ prior notice and is entitled to aseverance payment equal to six months of base compensation. Under theemployment agreement, Mr. Jungbauer will receive a severance payment of$100,000 on his termination date. To 

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facilitate a smooth transition, the Company has alsoagreed to make an additional severance payment to Mr. Jungbauer. Under theAmendment, Mr. Jungbauer will receive an additional severance payment of $100,000on January 2, 2007. In addition to these severance payments, the Companyhas agreed to pay or reimburse Mr. Jungbauer for medical (COBRA) benefitsfor the periods covered by the severance payments. A liability of $131,793 forthe severance payments, related payroll taxes, and medical benefits is includedin accrued expenses on the balance sheet at April 30, 2006 and the expenseis included in general and administrative expenses in the statement ofoperations for the fiscal year then ended. Mr. Jungbauer holds stockoptions for the purchase of 144,012 shares of the Company’s common stock. Mr. Jungbauer’sstock option agreements provide that he has three months following terminationof employment to exercise the vested portions thereof. Options to purchase44,065 shares of the Company’s common stock will be vested on July 1,2006. Pursuant to the Amendment, the Company agreed to amend Mr. Jungbauer’sstock option agreements to provide that his options, to the extent vested onthe termination date, will be exercisable for a period of twelve monthsfollowing the termination of Mr. Jungbauer’s employment.

| Severance charges                  |   | $ | 131,793 |   |
|------------------------------------|--------|---|---------|--------|
| Balance as of  April 30, 2006 |   | $ | 131,793 |   |

 

**Atrial FibrillationTechnology Purchase Agreement**

In August 2003, the Company entered into atechnology purchase agreement with LightWave Ablation Systems, Inc. (“LightWave”)and its principals, one of whom became an employee of the Company, relating tothe acquisition of LightWave’s interests in technology consisting of acatheter/probe containing elements of optical fiber, coolant passages and otherfeatures for the purpose of delivering laser energy to the epicardial surfaceof the heart for treatment of atrial fibrillation. The Company paid LightWavean initial standstill payment consisting of 1,500 shares of the Company’scommon stock, $10,000 upon closing and an additional $30,000 to LightWave ininstallments in 2004 and 2005. An additional $125,000 was paid to LightWave in January 2006.The Company will be obligated to pay an additional $385,000 within 45 daysfollowing the Company’s achievement of $1,500,000 of cumulative gross sales ofdisposable products. In addition, at closing, during fiscal year 2004, theCompany issued LightWave a warrant for the purchase of 2,500 shares of commonstock at $14.60 per share and, during fiscal year 2005, a warrant for thepurchase of 2,500 shares of common stock at $14.60 per share upon receiving FDA510(k) clearance. In addition, the Company is obligated to issue a warrantfor the purchase of 2,500 shares of common stock upon a receipt of a U.S.utility patent covering the product and a warrant for the purchase of 2,500shares of common stock upon the first commercial sale of the product.

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Followingthe first commercial sale, the Company has agreed to make payments to LightWavefor ten years equal to 6 percent of net sales of the LightWave product incountries in which the Company obtains patent protection and 4 percent of netsales of the LightWave product in territories in which there is no patentprotection. Commencing with the second year following the Company’s firstcommercial sale, the Company agreed to make minimum annual payments as follows:

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

 

LightWave and two of its principals agreed to certainnoncompetition obligations, nondisclosure obligations, and certain obligationsto assign new developments or inventions relating to the acquired technology tothe Company. The Company agreed to use its reasonable commercial efforts tocommercialize the technology within three years following the acquisition ofthe technology from LightWave.

If the Company fails inany year to make the minimum annual payments, the Company may be obligated togrant LightWave a nonexclusive right to use the technology acquired fromLightWave, or pay LightWave the difference between payments actually made andminimum payments due for a given year.

**8.      Income Taxes**

The Company provided no income tax expense for theyear ended April 30, 2006, because the taxes provided on the income beforeincome taxes was more than offset by permanent tax differences, primarilyrelating to the decrease in fair value of putable warrants.

Incometax computed at the U.S. federal statutory rate reconciled to the effective taxrate is as follows:

| ** **                                             | ** ** | **Year Ended**          | ** ** | **Year Ended**          | ** ** |
|--------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                             | ** ** | **April 30, 2006** | ** ** | **April 30, 2005** | ** ** |
| Taxes at  statutory tax rate                           |       |                         | 36         | %                            |       |   | (36 | )% |   |
| (Decrease) increase  in fair value of putable warrants |       |                         | (65        | )%                           |       |   | 22 | % |   |
| Other                                                  |       |                         | 1          | %                            |       |   | 0 | % |   |
| Effect of net  operating loss carryforwards            |       |                         | 28         | %                            |       |   | 14 | % |   |
|                                                   |       |                         | 0          | %                            |       |   | 0 | % |   |

 

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Thecomponents of deferred income taxes at April 30, 2006 and 2005 are asfollows:

| ** **                                         | ** ** | **2006**    | ** ** | **2005**    | ** ** |
|----------------------------------------------------|------------|-------------|------------|-------------|------------|
| Federal net operating  loss carryforwards          |       | $           | 12,565,737 |        | $          | 9,955,309 |   |
| Research and  experimentation credit carryforwards |       | 466,533     |       | 466,533     |       |
| State net  operating loss carryforwards            |       | 612,807     |       | 498,170     |       |
| Other  carryforwards                               |       | 11,767      |       | 11,937      |       |
| Property, plant  and equipment                     |       | (142,457    | )          | (263,771    | )          |
| Accrued expenses  and other                        |       | 51,244      |       | (7,409      | )          |
| Inventories                                        |       | —      |       | 47,418      |       |
| Allowance for  uncollectible accounts              |       | —      |       | 70,748      |       |
| Net deferred tax  assets                           |       | 13,565,631  |       | 10,778,935  |       |
| Valuation  allowance                               |       | (13,565,631 | )          | (10,778,935 | )          |
| Net deferred tax asset                             |       | $           | —     |        | $          | — |   |

 

The Company established valuation allowances to fullyoffset tax assets due to uncertainty about the Company’s ability to generatethe future taxable income necessary to realize these deferred tax assets,particularly in light of the Company’s history of significant operating losses.In addition, future utilization of available net operating loss carryforwardsmay be limited under Internal Revenue Code Section 382 as a result ofchanges in ownership that have or may result from the issuance of common stock,convertible preferred stock or common stock options and warrants.

The Company’s federal netoperating loss carryforwards of approximately $35,000,000 and state netoperating loss carryforwards of approximately $9,500,000 expire in variousfiscal years from 2012 through 2026. Available research and experimentationcredit carryforwards at April 30, 2006, represent federal and stateamounts with expiration dates in fiscal years 2011 through 2021.

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

**Common Stock**

The holder of each Class A Warrant issued in November 2001as part of the Company’s initial public offering was entitled to purchase, atany time until November 20, 2004, one share of common stock at an exerciseprice of $65.00 per share, subject to anti-dilution adjustments. The Companycould redeem the Class A Warrants for $0.10 per warrant at any time, uponten business days’ written notice, if the closing price of the Company’s commonstock or units exceeded $85.00, subject to customary anti-dilution adjustments,for any ten consecutive trading days before such notice. The Company did notredeem any of these warrants prior to their expiration in November 2004.

During the fourth quarter of fiscal year 2004 and thefirst quarter of fiscal year 2005, the Company closed on the private sale of273,076 units for $14.70 per unit. Each unit consisted of one share of commonstock and one five-year warrant to purchase a common share for $16.00 pershare. Proceeds from the offering, net of offering costs of $455,190, were$3,559,032 (proceeds were $2,000,608 in fiscal year 2005). In addition to cashcommissions included in the offering costs, the Company issued to the privateplacement agent and finder five-year warrants to purchase an aggregate of21,845 units at $18.375 per unit. As a result of anti-dilution adjustmentsthese warrants became exercisable for 85,401 units at $4.70 per unit. In March andApril 2006, warrants to purchase 37,214 units were exercised on a netexercise basis, resulting in the issuance of (1) 20,008 shares of theCompany’s common stock and (2) warrants to purchase 20,008 shares of theCompany’s common stock, at an exercise price of $18.375 per share, which expireon April 30, 2009. At April 30, 2006, warrants to purchase 48,187units at $4.70 per unit remained exercisable.

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During the fiscal yearended April 30, 2005, the Company issued 11,250 shares of common stock toconsultants for services. The fair value of these shares was expensed and isincluded in operating expenses for the fiscal year ended April 30, 2005.

**RedeemableConvertible Preferred Stock and Warrants**

On April 1, 2005, under the terms of a SecuritiesPurchase Agreement with accredited investors, the Company issued 1,803 sharesof 5% Series A Redeemable Convertible Preferred Stock (“preferred stock”)to such investors, five-year warrants for the purchase of 2,705,250 shares ofcommon stock to such investors exercisable at $5.00 per share, and five-yearwarrants for the purchase in the aggregate of 163,596 shares of common stock tothe placement agent and finder exercisable at $5.00 per share. Each share ofpreferred stock, which was non-voting, had a stated value of $10,000 per shareand accrued cumulative dividends at a rate of 5% of the stated value annually,was convertible into the number of shares of common stock equal to the $10,000stated value divided by $5.00, subject to anti-dilution adjustments. As aresult, at April 30, 2005, the 1,803 preferred shares could be convertedinto 3,607,000 shares of common stock, subject to anti-dilution adjustments.The Company obtained gross cash proceeds of $13,603,000 at the closing (net of$30,000 in legal fees which were withheld by the lead investor). The Companyalso converted $4,402,000 of indebtedness into the above referenced securities.The Company incurred cash offering costs of $817,980, including agentcommissions, a finder’s fee and out-of-pocket expense reimbursements. TheCompany also paid legal and administrative expenses of $18,086 incurred by PKMin this transaction.

In certain circumstances, the Company had the optionto require the holders of preferred stock to convert their shares into commonstock. In the event of a fundamental transaction, as defined, the preferredshareholders had the right to require the Company to redeem the preferredshares at their stated value, including any accrued but unpaid dividends. Inthe event of certain defaults, the preferred shareholders had the right torequire the Company to redeem the preferred shares at 110% of their statedvalue, including any accrued but unpaid dividends. As a result of theseredemption provisions, the carrying value of these preferred shares wasconsidered to be redeemable and was reported as a “mezzanine” instrument on theCompany’s balance sheet. However, the carrying value of this preferred stock atApril 30, 2005 was zero, net of a discount associated with the warrantsissued to the shareholders, the placement agent and the finder, as describedbelow.

The Company was required to register the common sharesunderlying the preferred stock and the common shares underlying the warrants.If the Company did not meet certain registration deadlines, the holders ofpreferred stock were entitled to liquidated damages, as defined. In the eventof a fundamental transaction, as defined, the warrants issued to the preferredshareholders, the placement agent and the finder, all provided the warrantholders with the right to put the warrants to the Company for cash in an amountequal to the fair value of the warrants, as determined using the Black Scholesoption pricing model. As a result of this put right, the warrants were reportedat their fair value as a liability on the Company’s balance sheet and changesin the fair value of the warrant resulted in charges or benefits to the Company’sresults of operations. The fair value of these warrants upon closing thepreferred stock sale was $22,271,047. Because the fair value of these warrantsat April 1, 2005 exceeded the proceeds received in the preferred stock andwarrant issuances, the excess of the fair value of the warrants over theproceeds received (including the converted debt) was recognized as otherexpense of $4,266,047 upon closing. During the period between closing and April 30,2005, the fair value of these warrants increased to $27,992,609. The Companyreported the $5,721,562 increase in fair value of putable warrants in otherexpense in the statement of operations for the fiscal year ended April 30,2005. The fair value of the warrants, after the changes in terms noted below,was $11,443,152 at the date the warrants were exercised or the put optionremoved. The Company reported the $16,549,457 decrease in fair value of putablewarrants in other income in the statement of operations for the fiscal yearended April 30, 2006.

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TheCompany measured the fair value of the putable warrants using the Black Scholesoption pricing model. The Company believed this was the appropriate valuationmodel because the redemption terms of the warrants provided for the holders toput them to the Company at their fair value as measured using the Black Scholesmodel. The assumptions used to value the warrants when they were issued on April 1,2005 and when they were valued at the end of the Company’s 2005 fiscal year (April 30,2005) and at date of exercise were as follows:

| ** **               | ** ** | **April 1, 2005 and  April 30, 2005** | ** ** | **Date of  Exercise** | ** ** |
|--------------------------|------------|----------------------------------------------------------------|------------|----------------------------|------------|
| Expected life            |       |                                                           | 5 years    |                       |       | 0 years |   |
| Volatility               |       |                                                           | 116        | %                          |       | 132 | % |
| Risk free  interest rate |       |                                                           | 4.24       | %                          |       | 4.38 | % |
| Dividend yield rate      |       |                                                           | 0          | %                          |       | 0 | % |

 

Holders of a majority of the outstanding shares of thepreferred stock authorized the Company to proceed with a preferred stockacquisition plan. Pursuant to such plan, on December 21, 2005, the Companyentered into preferred stock acquisition agreements with the holders of anaggregate of 1,499 shares of preferred stock. Under the agreements, the Companyacquired the preferred stock of each such holder in consideration of theissuance 3,077 shares of common stock for each share of preferred stock beingacquired. On January 6, 2006, under the same form of preferred stockacquisition agreements, the Company acquired an additional 271 shares ofpreferred stock, representing all of the remaining then-outstanding shares ofthe Company’s preferred stock, for the same per share consideration. In theaggregate, the Company issued 5,447,814 shares of common stock in considerationof the acquisition of 1,770 shares of preferred stock. The Company originallysold 1,803 shares of preferred stock. The 33 shares of preferred stock notpurchased in December 2005 or January 2006 were converted between June 2005and October 2005 into shares of common stock at a conversion ratio of2,000 shares of common stock for each share of preferred stock.

Also on December 21, 2005, the Company andholders of a majority of the outstanding shares of preferred stock and relatedcommon stock purchase warrants entered into an amendment to the securitiespurchase agreement as of April 1, 2005, to revise certain definitions.Following such amendment, on December 21, 2005, the Company and each ofthe holders who originally agreed to sell preferred stock to the Companyentered into amendments to such holders’ warrants issued under the securitiespurchase agreement. Pursuant to these amendments, the Company (1) reducedthe exercise price on outstanding warrants for the purchase of an aggregate of2,296,950 shares of common stock held by such persons from $5.00 per share to$3.25 per share, and (2) accelerated the expiration date of such warrantsfrom April 1, 2010, to January 6, 2006. Concurrent with such warrantamendments, investors delivered warrant exercise notices to the Company. TheCompany authorized one of such warrants, namely the warrant for the purchase of445,200 shares held by PKM to be exercised on a net exercise basis (using amarket price of $6.60 per share).

On January 6, 2006, under the same form ofamended warrant agreements, investors exercised warrants for the purchase of423,050 shares of common stock. The Company authorized one of such warrants,namely the warrant for the purchase of 151,200 shares held by Mr. Hauser,to be exercised on a net exercise basis (using a market price of $6.60 pershare).

In the aggregate, the Company issued 2,411,567 sharesof common stock in connection with the exercises by investors of investorwarrants issued in the Company’s April 2005 private placement. The Companyalso issued an additional 14,750 shares of common stock in connection withexercises of warrants originally issued to its agent and finder in itsApril 2005 private placement.

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Also on January 6, 2006, pursuant to exercisenotices dated January 5, 2006, the Company issued shares of common stockupon the exercise of certain other warrants. In particular, holders of warrantsfor the purchase of an aggregate of 107,850 shares of common stock, which wereoriginally issued to the Company’s placement agent in its April 2005financing, were exercised. Of such number, warrants for the purchase of 1,500shares were exercised for cash and warrants for the purchase of 106,350 shareswere exercised on a net exercise basis, resulting in the issuance of 75,974shares of common stock. Also effective January 6, 2006, the Companyamended the outstanding finder warrant for the purchase of 40,996 shares ofcommon stock to adjust the exercise price to $3.25 per share and eliminate theright to put the warrant to the Company for cash in an amount equal to the fairvalue of the warrants in the event of a fundamental transaction.

The net effect of the December 2005and January 2006 transactions, including the changes in the terms of thepreferred stock and warrants referred to above, was to increase cash by$6,435,140 (net of expenses of $471,435), decrease the warrant liabilityassociated with the warrants containing a put feature by $18,188,082, increasecommon stock and additional paid-in capital by $31,458,271, increase non-cashdividends on preferred stock, because of the change in the number of commonshares issued upon acquisition of the preferred stock, by $13,579,979 andincrease other income by $6,744,930. The outstanding shares of common stockwere increased by 7,951,605 shares.

**Stock Options**

In September 2005, the shareholders adopted theAmended and Restated 2001 Equity Incentive Plan which, among other provisions,increased the number of shares available for grant of awards under the plan to600,000 shares and the 2005 Director Stock Option Plan under which a total of100,000 shares of common stock have been reserved for issuance. The Company’sshareholders have authorized the issuance of stock options, including the aboveoptions, for the aggregate purchase of 756,075 shares of common stock undervarious other plans covering certain employees, members of the board ofdirectors and certain 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 immediately to fouryears after grant date and have a maximum term of ten years. At April 30,2006, 497,883 shares were available for grant under the Company’s stock optionplans.

Thefollowing is a summary of stock option activity with respect to the Company’svarious plans as well as option grants made outside the Company’s plans(described below), and includes option activity for employees, directors andnon-employees:

| ** **                        | ** ** | **Options** | ** ** | **Weighted  Average  Exercise Price  Per Share** | ** ** |
|-----------------------------------|------------|-------------|------------|------------------------------------------------------------|------------|
| Outstanding,  April 30, 2004 |       | 125,172     |       |                                                       | $          | 26.44 |   |   |
| Granted                           |       | 768,804     |       |                                                       | 9.60       |   |   |
| Exercised                         |       | (625        | )          |                                                       | 4.00       |   |   |
| Cancelled/Expired                 |       | (68,885     | )          |                                                       | 36.15      |   |   |
| Outstanding,  April 30, 2005 |       | 824,466     |       |                                                       | 10.10      |   |   |
| Granted                           |       | 162,216     |       |                                                       | 8.97       |   |   |
| Exercised                         |       | (375        | )          |                                                       | 3.00       |   |   |
| Cancelled/Expired                 |       | (83,054     | )          |                                                       | 12.28      |   |   |
| Outstanding,  April 30, 2006 |       | 903,253     |       |                                                       | 9.70       |   |   |

 

On April 1, 2005, the Company awarded (1) anon-qualified stock option for the purchase of 344,034 shares of common stockto the Company’s President and Chief Executive Officer, (2) anon-qualified stock 

F-23

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option for the purchase of129,013 shares of common stock to the Company’s Vice President, Finance andChief Financial Officer, (3) a non-qualified stock option for the purchaseof 64,506 shares of common stock to the Company’s Vice President, Research andDevelopment, (4) a non-qualified stock option for the purchase of 64,506shares of common stock to the Company’s Vice President, Operations, (5) anon-qualified stock option for the purchase of 21,502 shares of common stock tothe Company’s Vice President, Regulatory Affairs and Quality Assurance, and (6) anon-qualified stock option for the purchase of 43,004 shares of common stock toa former employee (which options expired in June 2005). The foregoingoptions were issued outside the Company’s stock option plans.

In December 2005, the Company amended the vestingprovisions of such options as follows: (1) 25% on the first anniversary ofthe date of grant and (2) 6.25% on each subsequent quarterly anniversary.As a result of the amendments, such options will still vest in full on thefourth anniversary of the date of grant, but incremental vesting after the firstanniversary of the date of grant will be on a quarterly, rather than annualbasis. The options are exercisable at $8.90 per share, which was the closingprice of the Company’s common stock on the OTC Bulletin Board on April 1,2005. These options expire on April 1, 2012.

On March 21, 2005, the Company granted stockoptions for the aggregate purchase of 10,000 shares of common stock to two ofthe Company’s directors for their services as directors. The foregoing optionswere issued outside the Company’s stock option plans. The options were fullyvested at the date of the grant, and are exercisable at $10.00 per share, whichwas the closing price of the Company’s common stock on the OTC Bulletin Boardon March 21, 2005. These options expire on March 21, 2015.

During the year ended April 30, 2006, the Companyissued four and ten-year options to purchase an aggregate of 20,000 shares ofthe Company’s common stock at exercise prices ranging from $7.10 to $8.70 pershare to certain non-employees who are providing technical advisory services tothe Company. The options vest over two years. The aggregate fair value of theoptions was $124,802 using the Black-Sholes valuation model. The amountexpensed in fiscal year 2006 related to these options was $39,728. During theyear ended April 30, 2005, the Company issued ten-year options to purchasean aggregate of 21,190 shares of the Company’s common stock at exercise pricesranging from $16.70 to $20.00 per share to a non-employee who providedtechnical advisory services to the Company. The options vested immediately. Theaggregate fair value of the options using the Black-Scholes valuation model was$247,796 and was expensed in fiscal year 2005.

Thefollowing table summarizes information about stock options outstanding andexercisable at April 30, 2006:

| ** **                              | ** ** | **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** | ** ** |
| $ 5.10 - $ 9.50               |       |                         | 756,857    |                         |       |   | 6.44 |   |   |   | $ | 8.70 |   |   |   | 174,579 |   |   |   | $ | 8.74 |   |   |
|  10.00 -   16.80              |       |                         | 115,269    |                         |       |   | 7.54 |   |   |   | 12.70 |   |   |   | 44,025 |   |   |   | 13.83 |   |   |
|  20.00 -   45.00              |       |                         | 31,127     |                         |       |   | 7.81 |   |   |   | 22.81 |   |   |   | 19,079 |   |   |   | 23.79 |   |   |
|                                    |       |                         | 903,253    |                         |       |   |   |   |   |   |   |   |   |   | 237,683 |   |   |   |   |   |   |
|                                         |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

F-24

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Thefollowing assumptions were used to value the options for the years ended April 30,2006 and 2005:

| ** **               | ** ** | **2006**      | ** ** | **2005**      | ** ** |
|--------------------------|------------|---------------|------------|---------------|------------|
| Dividend yield  rate     |       | 0             | %          | 0             | %          |
| Risk free  interest rate |       | 4.22          | %          | 3.32 - 4.27   | %          |
| Expected life            |       | 4 to 10 years |       | 4 to 10 years |       |
| Volatility               |       | 136 percent   |       | 125 percent   |       |

 

**Stock Warrants**

At April 30, 2006 and 2005, the Company hadoutstanding and exercisable warrants to purchase 1,168,498 and 3,828,207shares, respectively, of the Company’s common stock at prices ranging from$3.25 to $67.50 per share. The warrants expire at various dates through March 2015.At April 30, 2006 and 2005, the weighted average remaining contractuallife of the warrants was 5.47 and 9.02 years and the weighted average exerciseprice of the warrants was $11.24 and $7.10, respectively.

As discussed above under “Common Stock” during thefourth quarter of fiscal year 2006, warrants to purchase 37,214 units wereexercised on a net exercise basis. The net result of the exercises was areduction of 54,420 warrants to purchase shares of the Company’s common stock.

As discussed above under “Redeemable ConvertiblePreferred Stock and Warrants,” during the fourth quarter of fiscal year 2005,the Company issued warrants to purchase 2,705,250 shares of common stock toinvestors and issued warrants to purchase 163,596 shares to an agent and finderinvolved in the Company’s private placement. Also, as noted above, 2,827,850 ofthese warrants were exercised in fiscal year 2006.

As discussed in Note 5, the Company issued to certainlenders, warrants to purchase 86,901 common shares during the year ended April 30,2005. In addition, warrants to purchase 31,454 common shares were issued toagents or finders in fiscal year 2005.

As discussed in Note 5, several warrants issuedcontain anti-dilution features. Due to these features, holders of theoutstanding warrants became eligible to purchase an additional 251,561 and235,299 common shares during fiscal year 2006 and 2005, respectively.

As discussed in Note 7, the Company issued aseven-year warrant to purchase 2,500 shares of common stock for the achievementof a milestone in connection with a technology purchase agreement during theyear ended April 30, 2005.

Duringthe year ended April 30, 2006, warrants to purchase 29,000 shares ofcommon stock expired.

Asummary of warrant activity during the years ended April 30, 2006 and 2005 isas follows:

| ** **                        | ** ** | **Warrants** | ** ** |
|-----------------------------------|------------|--------------|------------|
| Outstanding,  April 30, 2004 |       | 624,112      |       |
| Issued                            |       | 3,143,796    |       |
| Impact of antidilution features   |       | 235,299      |       |
| Expired                           |       | (175,000     | )          |
| Outstanding,  April 30, 2005 |       | 3,828,207    |       |
| Impact of antidilution features   |       | 251,561      |       |
| Exercised                         |       | (2,882,270   | )          |
| Expired                           |       | (29,000      | )          |
| Outstanding,  April 30, 2006 |       | 1,168,498    |       |

 

F-25

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**10.   Research and Development Costs**

Research and developmentservices include expenses the Company previously referred to as research anddevelopment expenses and engineering and regulatory expenses. Research anddevelopment costs included as part of research and development services in thestatement of operations, totaled $3,471,241 and $1,278,709 for the fiscal yearsended April 30, 2006 and 2005, respectively. Research and developmentcosts relate primarily to product and process development initiatives.

**11.   Savings and Retirement Plan**

The Company sponsors a 401(k) savingsand retirement plan (the “Plan”) for all eligible employees. Under the Plan,the Company may make a discretionary contribution to the Plan upon approval bythe Company’s board of directors. Employees are fully vested in their owncontributions and related earnings and become fully vested in the Company’scontributions and related earnings. The Company made contributions to the Planof $31,996 and $18,943 in fiscal years 2006 and 2005, respectively.

**12.   Restructuring Charge**

In the quarter ended July 31,2004, the Company restructured its executive management team, resulting in thetermination of two employees, which resulted in a charge of $182,315 to generaland administrative expenses. This charge represented the amount of futureseverance payments due to these former employees. During the quarter ended October 31,2004, the Company terminated an additional five employees in an effort toreduce operating costs. This restructuring resulted in additional severancecosts of $45,987, of which $19,999 is included in general and administrativeexpenses and $25,988 is included in discontinued operations. During the quarterended January 31, 2005, the Company terminated an additional elevenemployees resulting in $48,835 of severance costs, of which $17,206 included ingeneral and administrative expenses and $31,629 is included in discontinuedoperations. During the quarter ended April 30, 2005, the Companyterminated two additional employees resulting in $28,709 of severance costscharged to general and administrative expenses. At April 30, 2005, $24,834of severance costs was accrued but not paid. During the quarter ended July 31,2005, the Company entered into a separation agreement with an employee,resulting in a charge to general and administrative expense for severance payof $40,382. The Company paid all amounts due to these former employees by September 30,2005.

**13.   Contingencies and Uncertainty**

In March 2005, the Company became aware that apatient who was utilizing the Company’s heart valve had died. The Company hasnot received any claims related to this matter but believes that any such claimwould be covered by its existing liability insurance. Based upon theexpectation that insurance would cover the cost of any claims after the Company’spayment of the deductible, the Company does not expect the ultimate resolutionof this matter to have a material effect on the Company’s business, financialcondition, operating results or cash flows.

On March 9, 2006, JGiordano Securities LLC (d/b/a J Giordano Securities Group) (“JGSG”) filed suitagainst the Company in U.S. District Court, District of Connecticut. JGSGclaims that it is entitled to damages due to an alleged breach of theengagement agreement, as amended, between the Company and JGSG. In particular, JGSGclaims that the exercise of outstanding warrants for the purchase of commonstock by certain JGSG-identified investors and the Company’s purchase ofoutstanding shares of preferred stock from certain JGSG-identified investors inDecember 2005 and January 2006 entitle JGSG to damages no less than$1,431,769. In particular, JGSG seeks (1) $279,191 in cash commissions, (2) warrantsfor the purchase of 85,905 shares at $3.25 per share, (3) lost profits of$751,669 on the argument that JGSG would have exercised the foregoing warrantand sold 85,905 shares on December 30, 2005, at a price of $12.00 pershare, and (4) the $400,909 in cash commissions the Company paid C.E.Unterberg, Towbin, 

F-26

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LLC.JGSG also seeks reimbursement for reasonable expenses, interest, costs andattorneys’ fees. In addition, JGSG notified us by letter dated May 26,2006 that, pursuant to the agreement, it may claim compensation arising out ofalleged rights to serve as a co-managing underwriter or member of theunderwriting group of a proposed public offering set forth in the registrationstatement on Form SB-2 we filed with the Securities and ExchangeCommission on May 19, 2006. The Company believes that this lawsuit iswithout merit and intends to vigorously defend itself.

**14.   Geographic Information**

Thefollowing table summarizes net sales, all of which are reported as part of theloss from discontinued operations, by geographic area:

| ** **    | ** ** | **Year Ended April 30,** | ** ** |
|---------------|------------|-----------------------------------------|------------|
| ** **    | ** ** | **2006**                                | ** ** | **2005** | ** ** |
| Europe        |       | $                                       | 279,435    |   | $ | 1,190,967 |   |
| United States |       | 58,898                                  |       | 391,042 |   |
| South Asia    |       | —                                  |       | 51,800 |   |
| Middle East   |       | —                                  |       | 379,280 |   |
| Far East      |       | —                                  |       | 70,511 |   |
| Other         |       | —                                  |       | 221,297 |   |
| Total         |       | $                                       | 338,333    |   | $ | 2,304,897 |   |

 

At April 30, 2006 and2005, substantially all of the Company’s operations and assets were based inthe United States.

**15.   Subsequent event**

**Reverse Stock Split**

The Company’s board ofdirectors approved a one-for-ten reverse stock split of its common stock andpreferred stock, effective May 31, 2006. The accompanying financialstatements and related notes give retroactive effect to this reverse stocksplit.

F-27

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**INDEX TO EXHIBITS**

| Exhibit   Number | ** ** | **Description**                                                                                                                                                                                                                                                                     |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1              |       | Restated Articles of Incorporation of the  Registrant, as Amended (incorporated by reference to Amendment No. 1 to  our Registration Statement on Form SB-2, filed on June 6,  2006 (File No. 333-134315)).                                                |
| 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 Amendment No. 1 to our  Registration Statement on Form SB-2, filed on June 6, 2006  (File No. 333-134315)).                                                                                    |
| 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             |       | Amended and Restated  2001 Equity Incentive Plan (incorporated by reference to our Definitive  Schedule 14A (Proxy Statement), filed on August 25, 2005 (File  No. 000-33295)).                                                                                      |
| 10.5             |       | 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)).                                     |
| 10.6             |       | 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 on July 14, 2003 (File No. 000-33295)).                                             |
| 10.7             |       | Warrant Agreement to  purchase 32,017 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 on July 14, 2003 (File  No. 000-33295)).                 |
| 10.8             |       | Warrant Agreement to  purchase 6,017 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)). |
| 10.9             |       | Warrant Agreement to  purchase 7,738 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)).        |
| 10.10            |       | Warrant Agreement to  purchase 33,093 shares of common stock issued by the Registrant to PKM  Properties, LLC, dated February 3, 2004 (incorporated by reference to  our Annual Report on Form 10-KSB filed on July 29, 2004 (File  No. 000-33295)).            |
| 10.11            |       | Non-Qualified Stock  Option Agreement issued by the Registrant to Lawrence L. Horsch in the amount  of 10,000 shares, dated August 19, 2003 (incorporated by reference to  our Annual Report on Form 10-KSB filed on July 29, 2004 (File  No. 000-33295)).      |
| 10.12            |       | Building Lease Agreement  between the Registrant and PKM Properties, LLC, dated April 4, 2003  (incorporated by reference to our Annual Report on Form 10-KSB  filed on July 29, 2004 (File No. 000-33295)).                                                    |

E-1

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| 10.13 |   | Technology Purchase Agreement between the Registrant  and LightWave Ablation Systems, Inc., Gregory Brucker and Robert Svenson  M.D., dated August 27, 2003 (incorporated by reference to our Annual  Report on Form 10-KSB filed on July 29, 2004 (File  No. 000-33295)).                                 |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.14 |   | Technology Assignment Agreement between the  Registrant, LightWave Ablation Systems, Inc., Robert H. Svenson, M.D.  and Gregory Brucker, dated August 27, 2003 (incorporated by reference to  our Annual Report on Form 10-KSB filed on July 29, 2004 (File  No. 000-33295)).                              |
| 10.15 |   | Proprietary Information  and Inventions Agreement between the Registrant, Robert H. Svenson, M.D. and  Gregory Brucker, dated August 10, 2003 (incorporated by reference to our  Annual Report on Form 10-KSB filed on July 29, 2004 (File  No. 000-33295)).                                                    |
| 10.16 |   | Severance and Release  Agreement between the Registrant and Blair P. Mowery, effective  August 11, 2004 (incorporated by reference to Post Effective Amendment  No. 1 to our Registration Statement on Form SB-2 filed on  September 9, 2004 (File No. 333-116394)).                                       |
| 10.17 |   | Severance and Release  Agreement between the Registrant and Allan R. Seck, effective August 6,  2004 (incorporated by reference to Post Effective Amendment No. 1 to our  Registration Statement on Form SB-2 filed on September 9,  2004 (File No. 333-116394)).                                          |
| 10.18 |   | Letter Agreement between  the Registrant and Marc P. Flores, effective August 30, 2004  (incorporated by reference to our Current Report on Form 8-K,  filed on September 2, 2004 (File No. 000-33295)).                                                                                                   |
| 10.19 |   | October 2004  Discretionary Credit Agreement by and between MedicalCV, Inc. and PKM  Properties, LLC, dated October 29, 2004, effective November 17,  2004 (incorporated by reference to our Current Report on Form 8-K  filed on November 23, 2004 (File No. 000-33295)).                       |
| 10.20 |   | October 2004 Credit  Note issued by MedicalCV, Inc. (maker) to PKM Properties, LLC (payee),  dated October 29, 2004, effective November 17, 2004 (incorporated  by reference to our Current Report on Form 8-K filed on  November 23, 2004 (File No. 000-33295)).                                |
| 10.21 |   | Intellectual Property  Security Agreement by and between PKM Properties, LLC (secured party) and  MedicalCV, Inc. (debtor), dated October 29, 2004, effective  November 17, 2004 (incorporated by reference to our Current Report on  Form 8-K filed on November 23, 2004 (File No. 000-33295)). |
| 10.22 |   | Waiver Agreement by and  between MedicalCV, Inc. (borrower) and PKM Properties, LLC (lender),  dated October 29, 2004, effective November 17, 2004 (incorporated  by reference to our Current Report on Form 8-K filed on  November 23, 2004 (File No. 000-33295)).                                   |
| 10.23 |   | Warrant Agreement issued  to PKM Properties, LLC, dated November 17, 2004 (incorporated by  reference to our Current Report on Form 8-K filed on  November 23, 2004 (File No. 000-33295)).                                                                                                                      |
| 10.24 |   | Form of Bridge Note  Purchase Agreement including form of convertible promissory note and form of  common stock purchase warrant), dated December 31, 2004 (incorporated by  reference to our Current Report on Form 8-K filed on  January 14, 2005 (File No. 000-33295)).                                 |
| 10.25 |   | February 2005  Discretionary Credit Agreement by and between MedicalCV, Inc. and PKM  Properties, LLC, dated February 16, 2005, effective March 3, 2005  (incorporated by reference or our Current Report on Form 8-K/A  filed on March 9, 2005 (File No. 000-33295)).                           |
| 10.26 |   | February 2005  Discretionary Credit Note issued by MedicalCV, Inc. (maker) and PKM  Properties, LLC (payee), dated February 16, 2005, effective  March 3, 2005 (incorporated by reference or our Current Report on  Form 8-K/A filed on March 9, 2005 (File No. 000-33295)).                     |

E-2

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| 10.27 |   | Warrant Agreement issued to PKM Properties, LLC,  dated February 16, 2005, effective March 3, 2005 (incorporated by  reference or our Current Report on Form 8-K/A filed on  March 9, 2005 (File No. 000-33295)).                                                  |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.28 |   | Form of  Non-Qualified Stock Option Agreement under the MedicalCV, Inc. 2001  Equity Incentive Plan issued to Executive Officers.                                                                                                                                                 |
| 10.29 |   | Form of Non-Qualified Stock Option Agreement  under the MedicalCV, Inc. 1997 Stock Option Plan (incorporated by  reference to our Quarterly Report on Form 10-QSB filed on  March 17, 2005 (File No. 000-33295)).                                                  |
| 10.30 |   | Form of  Non-Qualified Stock Option Agreement under the MedicalCV, Inc. 1993  Director Stock Option Plan (incorporated by reference to our Quarterly Report  on Form 10-QSB filed on March 17, 2005 (File No. 000-33295)).                                         |
| 10.31 |   | Form of Stand-Alone  Non-Qualified Stock Option Agreement issued to Non-Employee Directors  (incorporated by reference to our Current Report on Form 8-K filed  on March 25, 2005 (File No. 000-33295)).                                                                |
| 10.32 |   | Securities Purchase  Agreement between the Registrant and the Investors named as signatories  thereto, dated March 31, 2005 (effective April 1, 2005)  (incorporated by reference to our Current Report on Form 8-K filed  on April 4, 2005 (File No. 000-33295)). |
| 10.33 |   | Form of 2005  Private Placement Warrant (incorporated by reference to our Current Report on  Form 8-K filed on April 4, 2005 (File No. 000-33295)).                                                                                                                     |
| 10.34 |   | Form of Debt  Conversion Agreement dated March 29, 2005 (effective April 1, 2005)  (incorporated by reference to our Current Report on Form 8-K filed  on April 4, 2005 (File No. 000-33295)).                                                           |
| 10.35 |   | Registration Rights  Agreement between the Registrant and the Investors named as signatories  thereto, dated March 31, 2005 (effective April 1, 2005)  (incorporated by reference to our Current Report on Form 8-K filed  on April 4, 2005 (File No. 000-33295)). |
| 10.36 |   | Engagement Letter  between the Registrant and J Giordano Securities Group, dated  December 17, 2004 (incorporated by reference to our Current Report on  Form 8-K filed on April 4, 2005 (File No. 000-33295)).                                                         |
| 10.37 |   | Amendment to Engagement  Letter between the Registrant and J Giordano Securities Group, dated  March 16, 2005 (incorporated by reference to our Current Report on  Form 8-K filed on April 4, 2005 (File No. 000-33295)).                                               |
| 10.38 |   | Letter Agreement between  the Registrant and Tower Finance, Ltd., dated December 8, 2004  (incorporated by reference to our Current Report on Form 8-K filed  on April 4, 2005 (File No. 000-33295)).                                                              |
| 10.39 |   | Amendment to Letter  Agreement between the Registrant and Tower Finance, Ltd., dated  March 16, 2005 (incorporated by reference to our Current Report on  Form 8-K filed on April 4, 2005 (File No. 000-33295)).                                                        |
| 10.40 |   | 2005 Director Stock  Option Plan (incorporated by reference to our Definitive 14A (Proxy  Statement), filed on August 25, 2005 (File No. 000-33295)).                                                                                                                             |
| 10.41 |   | Lease Termination Agreement  entered into by and between PKM Properties, LLC and the Registrant, dated  June 29, 2005 (incorporated by reference to our Quarterly Report on  Form 10-QSB filed on September 14, 2005 (File No. 000-33295)).                             |

E-3

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| 10.42 |   | Employment Agreement by and between Marc P. Flores  and the Registrant, dated August 9, 2005 (incorporated by reference to  our Current Report on Form 8-K/A filed on August 9, 2005  (File No. 000-33295)).                                           |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.43 |   | Employment Agreement by  and between John H. Jungbauer and the Registrant, dated August 9, 2005  (incorporated by reference to our Current Report on Form 8-K/A  filed on August 9, 2005 (File No. 000-33295)).                                        |
| 10.44 |   | Form of  Non-Qualified Stock Option Agreement Issued to Executive Officers  (incorporated by reference to our Current Report on Form 8-K/A  filed on August 9, 2005 (File No. 000-33295)).                                                             |
| 10.45 |   | Form of Non-Employee Director Stock Option  Agreement issuable under the 2005 Director Stock Option Plan (incorporated by  reference to our Current Report on Form 8-K filed on  September 23, 2005 (File No. 000-33295)).                             |
| 10.46 |   | Letter Agreement by and  between MedicalCV, Inc. and Marc P. Flores, dated November 2, 2005  (incorporated by reference to our Current Report on Form 8-K filed  on November 8, 2005 (File No. 000-33295)).                                  |
| 10.47 |   | Form of Amendment  to Non-Qualified Stock Option Agreement (incorporated by reference to our  Quarterly Report on Form 10-QSB filed on December 14, 2005  (File No. 000-33295)).                                                                       |
| 10.48 |   | Form of Preferred  Stock Acquisition Agreement, dated December 21, 2005 (including form of  Registration Rights Agreement) (incorporated by reference to our Current  Report on Form 8-K filed on December 22, 2005 (File  No. 000-33295)).       |
| 10.49 |   | Form of Amendment  No. 1 to Securities Purchase Agreement (originally dated March 31,  2005), dated December 21, 2005 (incorporated by reference to our Current  Report on Form 8-K filed on December 22, 2005 (File  No. 000-33295)).  |
| 10.50 |   | Form of Amendment  No. 1 to Warrant Agreement (originally issued April 1, 2005), dated  December 21, 2005 (incorporated by reference to our Current Report on  Form 8-K filed on December 22, 2005 (File No. 000-33295)).               |
| 10.51 |   | Form of Amendment  to Executive Employment Agreement by and between John H. Jungbauer and  MedicalCV, Inc., dated April 6, 2006 (incorporated by reference to  our Current Report on Form 8-K filed on April 7, 2006 (File  No. 000-33295)). |
| 10.52 |   | Executive Employment  Agreement by and between Adam L. Berman and the Registrant, dated  August 17, 2005.                                                                                                                                                             |
| 10.53 |   | Executive Employment  Agreement by and between Robert W. Clapp and the Registrant, dated  August 17, 2005.                                                                                                                                                            |
| 10.54 |   | Executive Employment  Agreement by and between Dennis E. Steger and the Registrant, dated  August 18, 2005.                                                                                                                                                           |
| 10.55 |   | Executive Employment  Agreement by and between James E. Jeter and the Registrant, dated November 7,  2005.                                                                                                                                                            |
| 10.56 |   | Executive Employment  Agreement by and between Gary O. Tegan and the Registrant, dated  April 19, 2006.                                                                                                                                                               |
| 10.57 |   | Restated Employment  Agreement by and between Eapen Chacko and the Registrant, dated May 30,  2006 (incorporated by reference to our Current Report on Form 8-K  filed on June 5, 2006 (File No. 000-33295)).                                          |
| 10.58 |   | Form of Non-Qualified  Stock Option Agreement issued to Directors under Amended and Restated 2001  Equity Incentive Plan.                                                                                                                                                  |

E-4

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| 10.59 |   | Second Amendment to Executive Employment Agreement  by and between John H. Jungbauer and the Registrant, dated July 18, 2006  (incorporated by reference to our Current Report on Form 8-K filed on July 20,  2006 (File No. 000-33295)). |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 16.1  |   | Letter on Change in  Certifying Accountant, dated June 14, 2005 (incorporated by reference to  our Current Report on Form 8-K filed on June 14, 2005 (File  No. 000-33295)).                                          |
| 16.2  |   | Letter on Change in Certifying Accountant, dated  July 25, 2005 (incorporated by reference to our Current Report on  Form 8-K filed on July 25, 2005 (File No. 000-33295)).                                           |
| 23.1  |   | Consent of Independent  Registered Public Accounting Firm.                                                                                                                                                                                |
| 23.2  |   | Consent of Independent  Registered Public Accounting Firm.                                                                                                                                                                                |
| 24    |   | Power of Attorney  (included on signature page to Form 10-KSB).                                                                                                                                                                 |
| 31.1  |   | Chief Executive Officer  Certification pursuant to Exchange Act Rule 13a-14(a).                                                                                                                                                      |
| 31.2  |   | Chief Financial Officer  Certification pursuant to Exchange Act Rule 13a-14(a).                                                                                                                                                      |
| 32.1  |   | Chief Executive Officer  Certification pursuant to 18 U.S.C. Section 1350.                                                                                                                                                           |
| 32.2  |   | Chief Financial Officer  Certification pursuant to 18 U.S.C. Section 1350.                                                                                                                                                           |

 

E-5

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