**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM 10-QSB/A**

 

**(AmendmentNo. 1)**

 
| **ý** |   | **QUARTERLY REPORT UNDER****SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934** |
|------------|--------|----------------------------------------------------------------------------------------------|
|       |   |                                                                                         |
|       |   | **FOR THE QUARTERLY PERIOD ENDED JULY 31, 2003**                                        |
|       |   |                                                                                         |
| **o**      |   | **TRANSITION REPORT UNDER****SECTION 13 OR 15(d) OF THE EXCHANGE ACT**                  |

 

**Commission File Number  0-33295**

 

| **MEDICALCV, INC.**                                                                               |
|---------------------------------------------------------------------------------------------------|
| (Exact  Name of Small Business Issuer as Specified in Its Charter)                                |
|                                                                                              |   |   |
| **Minnesota**                                                                                     |   | **41-1717208** |
| (State  or Other Jurisdictionof Incorporation or Organization)                                    |   | (I.R.S.  EmployerIdentification No.) |
|                                                                                              |   |   |
| **9725 South Robert Trail**                                                                       |
| **Inver Grove Heights, Minnesota 55077**                                                          |
| **(651) 452-3000**                                                                                |
| (Address  of Principal Executive Offices and Issuer’sTelephone Number, including Area  Code) |

 

Check whether theissuer:  (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act duringthe past 12 months (or such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirements forthe past 90 days.

 

Yes ý  No o

 

As of September 15, 2003, the issuer had outstanding7,894,356 shares of common stock.  This number includes 1,500,000 units,each consisting of one share of common stock and one redeemable Class AWarrant, sold in the issuer’s initial public offering.

 

Transitional SmallBusiness Disclosure Format (check one)  o Yes  ý No

 

 

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**Explanatory Note**

 

MedicalCV, Inc. (the “Company”) is filingthis Amendment No. 1 to its Quarterly Report on Form 10-QSB for the fiscalquarter ended July 31, 2003, originally filed September 15, 2003(“Form 10-QSB”), solely to amend specific items of the Form 10-QSB to reflectchanges in classification of certain items in the Company’s statement ofoperations.

 

The Company changed the classification ofcertain expenditures previously classified as sales and marketing expenses, toa reduction in net sales.  Theseexpenditures consist of payments made to international distributors forassistance in marketing the Company's products that are required to be reportedas a reduction in net sales pursuant to application of the Consensus for EITFIssue 01-9, “Accounting for Consideration Given by a Vendor to a Customer(Including a Reseller of the Vendor’s Products)”.  The revision resulted in a reduction in net sales and sales andmarketing expense, and a corresponding reduction in gross profit and totaloperating expense.

 

The Company also changed the classificationof income from inventories returned from two former international distributors,which had previously been reported as a reduction of cost of goods sold ratherthan as a reduction of general and administrative expenses.  The revision resulted in an increase to costof goods sold, a reduction in gross profit and a reduction in general andadministrative expenses.

 

The financial statements for the three monthperiods ended July 31, 2003 and 2002, have been restated to give effect tothese changes in classifications  SeeNote 11 to the Consolidated Financial Statements.  The changes in classification had no effect on the Company’s lossfrom operations or net loss, nor any effect on the consolidated balance sheet,statement of shareholders’ equity (deficit) or statement of cash flows.  This Amendment No. 1 amends only portions ofthe Form 10-QSB; the remainder of the Form 10-QSB is unchanged and is notreproduced in this Amendment No. 1. This Amendment No. 1 does not reflect events occurring after theoriginal filing of the Form 10-QSB.

 

This Amendment No.1 contains changes to the following disclosures:

 

Part I – Item 1.  Consolidated FinancialStatements (Unaudited)

 

Part I – Item 2.  Managements Discussion andAnalysis or Plan of Operation

 

Part I – Item 3.  Controls and Procedures

 

2

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TABLEOF CONTENTS

 
| PART I            | FINANCIAL INFORMATION |                                                                                                                                       |
|-------------------|-----------------------|--------------------------------------------------------------------------------------------------------------------------------------------|
|              |                  |
|              | ITEM 1                | Financial Statements                                                                                                                       |   |
|              |                  | Consolidated Balance Sheet at July 31, 2003 (unaudited) and  April 30, 2003                                                      |   |
|              |                  | Consolidated Statement of Operations for  the three month periods ended July 31, 2003 (unaudited) and July 31,  2002 (unaudited) |   |
|              |                  | Consolidated Statement of Cash Flows for  the three month periods ended July 31, 2003 (unaudited) and July 31,  2002 (unaudited) |   |
|              |                  | Notes to Consolidated Financial Statements                                                                                                 |   |
|              | ITEM 2                | Management’s Discussion and Analysis or  Plan of Operation                                                                            |   |
|              | ITEM 3                | Controls and Procedures                                                                                                                    |   |
|              |                  |
| SIGNATURES        |                  |
| INDEX TO EXHIBITS |                  |

 

3

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**PART I**

 

ITEM 1  Financial Statements

 

**MEDICALCV, INC.**

 

**ConsolidatedBalance Sheet**

 
|                                                                                                                              |   | **July 31,  2003** |      | **April 30,2003** |   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|-----------|------------------------|--------|
|                                                                                                                              |   | **(unaudited)**         |      |                   |   |
| **ASSETS**                                                                                                                        |   |                    |      |                   |   |
| Current  assets:                                                                                                                  |   |                    |      |                   |   |
| Cash  and cash equivalents                                                                                                        |   | $                       | 202,790   |                   | $      | 184,227 |   |
| Trade  and accounts receivable, net                                                                                               |   | 1,629,417               |      | 1,472,995              |   |
| Inventories                                                                                                                       |   | 2,711,013               |      | 2,782,613              |   |
| Prepaid  expenses and other assets                                                                                                |   | 197,327                 |      | 183,856                |   |
| Total  current assets                                                                                                             |   | 4,740,547               |      | 4,623,691              |   |
|                                                                                                                              |   |                    |      |                   |   |
| Property,  plant and equipment, net                                                                                               |   | 1,288,419               |      | 1,368,240              |   |
| Deferred  financing costs, net                                                                                                    |   | 178,186                 |      | 62,989                 |   |
| Total  assets                                                                                                                     |   | $                       | 6,207,152 |                   | $      | 6,054,920 |   |
|                                                                                                                              |   |                    |      |                   |   |
| **LIABILITIES AND SHAREHOLDERS’ DEFICIT**                                                                                    |   |                    |      |                   |   |
| Current  liabilities:                                                                                                             |   |                    |      |                   |   |
| Short-term debt with related parties                                                                                              |   | $                       | 2,101,320 |                   | $      | 943,333 |   |
| Current  portion of related party lease obligations                                                                               |   | 274,241                 |      | 273,843                |   |
| Current  portion of capital lease obligations                                                                                     |   | 28,870                  |      | 42,069                 |   |
| Accounts  payable                                                                                                                 |   | 738,206                 |      | 895,405                |   |
| Accrued  expenses                                                                                                                 |   | 496,336                 |      | 813,539                |   |
| Total  current liabilities                                                                                                        |   | 3,638,973               |      | 2,968,189              |   |
|                                                                                                                              |   |                    |      |                   |   |
| Related  party lease obligations, less current portion                                                                            |   | 3,380,480               |      | 3,472,661              |   |
| Total  liabilities                                                                                                                |   | 7,019,453               |      | 6,440,850              |   |
|                                                                                                                              |   |                    |      |                   |   |
| Shareholders’ deficit:                                                                                                       |   |                    |      |                   |   |
| Preferred  stock, $.01 par value; 5,000,000 shares authorized; no shares issued and  outstanding                                  |   |                    |      |                   |   |
| Common  stock; $.01 par value; 95,000,000 shares authorized; 7,894,356 and 7,843,834  shares issued and outstanding, respectively |   | 78,943                  |      | 78,438                 |   |
| Additional  paid-in  capital                                                                                                      |   | 17,306,899              |      | 16,613,337             |   |
| Deferred  stock-based  compensation                                                                                               |   | (4,085                  | )         | (4,610                 | )      |
| Accumulated  deficit                                                                                                              |   | (18,194,058             | )         | (17,073,095            | )      |
| Total  shareholders’  deficit                                                                                                |   | (812,301                | )         | (385,930               | )      |
| Total  liabilities and shareholders’ deficit                                                                                 |   | $                       | 6,207,152 |                   | $      | 6,054,920 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

4

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**MEDICALCV, INC.**

 

**Consolidated Statement ofOperations**

(unaudited)

 
|                                                           |   | **Three Months Ended****July 31,** |       |
|----------------------------------------------------------------|--------|-----------------------------------------|------------|
|                                                           |   | **2003****Restated  (Note 11)**         |       | **2002****Restated  (Note 11)** |   |
|                                                           |   |                                    |       |   |   |
| Net  sales                                                     |   | $                                       | 900,229    |   | $ | 696,384 |   |
| Cost  of goods sold                                            |   | 497,103                                 |       | 569,869 |   |
| Gross  profit                                                  |   | 403,126                                 |       | 126,515 |   |
| Operating  expenses:                                           |   |                                    |       |   |   |
| Sales  and marketing                                           |   | 600,738                                 |       | 633,639 |   |
| General  and administrative                                    |   | 556,923                                 |       | 445,591 |   |
| Engineering  and regulatory                                    |   | 203,994                                 |       | 201,117 |   |
| Total  operating expenses                                      |   | 1,361,655                               |       | 1,372,347 |   |
| Loss  from operations                                          |   | (958,529                                | )          | (1,280,347 | ) |
| Other  (expense) income:                                       |   |                                    |       |   |   |
| Interest  expense                                              |   | (156,246                                | )          | (38,980 | ) |
| Interest  income                                               |   | 4,993                                   |       | 11,019 |   |
| Other  (expense) income                                        |   | (11,181                                 | )          | 15,927 |   |
| Total  other expense                                           |   | (162,434                                | )          | (12,034 | ) |
|                                                           |   |                                    |       |   |   |
| Net  loss                                                      |   | $                                       | (1,120,963 | ) | $ | (1,165,866 | ) |
| Basic  and diluted net loss per share                          |   | $                                       | (.14       | ) | $ | (.15 | ) |
|                                                           |   |                                    |       |   |   |
| Shares  used in computing basic and diluted net loss per share |   | 7,894,356                               |       | 7,843,834 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

5

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**MEDICALCV, INC.**

 

**Consolidated Statement of CashFlows**

(unaudited)

 
|                                                                                         |   | **Three Months Ended****July 31,** |       |
|----------------------------------------------------------------------------------------------|--------|-----------------------------------------|------------|
|                                                                                         |   | **2003**                                |       | **2002** |   |
| Cash  flows from operating activities:                                                       |   |                                    |       |   |   |
| Net  loss                                                                                    |   | $                                       | (1,120,963 | ) | $ | (1,165,866 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities:                 |   |                                    |       |   |   |
| Depreciation                                                                                 |   | 79,821                                  |       | 86,635 |   |
| Provision  for doubtful accounts, excluding return of inventory                              |   | 5,960                                   |       | 74,424 |   |
| Return  of inventory                                                                         |   |                                    |       | (92,000 | ) |
| Provision  for inventory obsolescence                                                        |   |                                    |       | 55,564 |   |
| Stock-based compensation                                                                     |   | 29,526                                  |       | 1,291 |   |
| Interest  expense associated with warrant grants and amortization of loan origination  costs |   | 114,895                                 |       | 31,972 |   |
| Changes  in assets and liabilities:                                                          |   |                                    |       |   |   |
| Accounts  receivable                                                                         |   | (162,382                                | )          | (169,906 | ) |
| Inventories                                                                                  |   | 71,600                                  |       | (232,370 | ) |
| Prepaid  expenses and other assets                                                           |   | (142,283                                | )          | (94,182 | ) |
| Accounts  payable                                                                            |   | (157,199                                | )          | (58,820 | ) |
| Accrued  expenses                                                                            |   | (317,203                                | )          | 33,500 |   |
| Net  cash used in operating activities                                                       |   | (1,598,228                              | )          | (1,529,758 | ) |
|                                                                                         |   |                                    |       |   |   |
| Cash  flows from investing activities:                                                       |   |                                    |       |   |   |
| Purchase  of property, plant and equipment                                                   |   |                                    |       | (84,593 | ) |
| Net  cash used in investing activities                                                       |   |                                    |       | (84,593 | ) |
|                                                                                         |   |                                    |       |   |   |
| Cash  flows from financing activities:                                                       |   |                                    |       |   |   |
| Proceeds  from short-term  debt with related parties                                         |   | 1,764,728                               |       |   |   |
| Principal  payments on other long-term debt                                                  |   |                                    |       | (16,783 | ) |
| Principal  payments under capital lease obligations                                          |   | (13,199                                 | )          | (21,796 | ) |
| Principal  payments under related party lease obligations                                    |   | (134,738                                | )          |   |   |
| Net  cash provided (used in) by financing activities                                         |   | 1,616,791                               |       | (38,579 | ) |
|                                                                                         |   |                                    |       |   |   |
| Net  increase (decrease) in cash and cash equivalents                                        |   | 18,563                                  |       | (1,652,930 | ) |
| Cash  and cash equivalents at beginning of year                                              |   | 184,227                                 |       | 2,781,675 |   |
| Cash  and cash equivalents at end of period                                                  |   | $                                       | 202,790    |   | $ | 1,128,745 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

6

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**MEDICALCV, INC.**

 

**Notes to Consolidated FinancialStatements**

 

**(1)****                                 Basis of Financial Statement Presentation**

 

The accompanyingunaudited consolidated financial statements included herein have been preparedby MedicalCV, Inc. (the “Company”) in accordance with accounting principles generallyaccepted in the United States of America for interim financial information andpursuant to the rules and regulations of the Securities and ExchangeCommission.  Certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with accountingprinciples generally accepted in the United States of America have beencondensed or omitted pursuant to such rules and regulations.  Theseconsolidated interim financial statements should be read in conjunction withthe consolidated financial statements and the notes thereto included in theCompany’s AnnualReport on Form 10-KSB for the fiscal year ended April 30, 2003.

 

The consolidatedbalance sheet as of July 31, 2003, the consolidated statement of operations for thethree months ended July 31, 2003 and 2002, and the consolidated statement of cashflows for the three months ended July 31, 2003 and 2002 include, in the opinion of management,all adjustments, consisting solely of normal recurring adjustments, necessaryfor a fair presentation of the financial results for the respective interimperiods and are not necessarily indicative of results of operations to beexpected for the entire fiscal year ending April 30, 2004.  Certainamounts previously reported have been reclassified to conform to their July 31 2003, presentation.  Thesereclassifications had no effect on net loss, cash flow or shareholders’(deficit) as previously reported.

 

**(2)****                                 Going Concern**

 

The Company’s consolidated financial statements forthe quarter ended July 31, 2003, have been prepared on a going concern basis,which contemplates the realization of assets and settlement of liabilities andcommitments in the normal course of business.  The Company has sustainedlosses and negative cash flows from operations in recent years and expectsthese conditions to continue for the foreseeable future.  At July 31, 2003, the Company had an accumulateddeficit of $18,194,058 and has insufficient funds to finance its workingcapital and capital expenditure needs.  Accordingly, these matters raisesubstantial doubt about the Company’s ability to continue as a going concern.  The Companyis currently seeking other sources of financing to fund its operations andworking capital requirements.  If the Company is unable to obtain sourcesof additional funds beginning in September 2003, 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 or respond to competitive pressures orunanticipated requirements, which could seriously harm its business, financialposition and results of operations.  These financial statements do not includeany adjustments that might result from the outcome of this uncertainty.

 

The Company issubject to risks and uncertainties common to medical technology-basedcompanies, including rapid technological change, dependence on one principalproduct, new product development and acceptance, actions of competitors,dependence on key personnel and United States market penetration.

 

**(3)****                                 Stock-based Compensation**

 

The Companyaccounts for stock-based employee compensation arrangements in accordance withthe provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and complies with the disclosureprovisions of SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148 “Accounting for Stock-Based Compensation-Transitionand Disclosure, an amendment of FASB Statement No. 123.”

 

For purposes of thepro forma disclosures below, the estimated fair value of the options isamortized to expense over the options’ vesting period.  Had compensation cost for the Company’s stock options been recognized based onthe fair value at the grant date consistent with the provisions of SFASNo. 123, the Company’s net loss would have been adjusted to the pro formaamounts indicated below:

 

7

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|                                                                    |   | **For Quarters Ended****July 31,** |       |
|-------------------------------------------------------------------------|--------|-----------------------------------------|------------|
|                                                                    |   | **2003**                                |       | **2002** |   |
| Net  loss reported                                                      |   | $                                       | (1,120,963 | ) | $ | (1,165,866 | ) |
| Less:   Pro forma stock based employee compensation (cost) benefit |   | (64,269                                 | )          | (73,535 | ) |
|                                                                    |   |                                    |       |   |   |
| Net  loss – pro  forma                                             |   | (1,185,232                              | )          | (1,239,401 | ) |
|                                                                    |   |                                    |       |   |   |
| Net  loss per common share – basic and diluted                     |   |                                    |       |   |   |
| As  reported                                                            |   | (.14                                    | )          | (.15 | ) |
| Pro  forma                                                              |   | (.15                                    | )          | (.16 | ) |
|                                                                         |        |                                         |            |  |  |  |  |

 

**(4)****                                 Net Loss per Share**

 

Net loss per shareis computed under the provisions of SFAS No. 128, “Earnings Per Share.” Basic net loss per common share iscomputed using net loss and the weighted-average number of shares of commonstock outstanding. Diluted earnings per share reflect the potential dilution ofsecurities that could share in the earnings of an entity. Diluted net loss percommon share does not differ from basic net loss per common share in thethree-month periods ended July 31, 2003 and 2002, since the potentially dilutive sharesare anti-dilutive.  Potentially dilutive shares excluded from thecalculation of diluted net loss per share relate to outstanding stock optionsand warrants for the purchase of 5,010,975 and 3,546,890 shares of the Company’s common stock at July 31, 2003 and 2002, respectively.

 

**(5)****                                 Inventories**

 

Inventory consistsof the following components:

 
|            |   | **July 31, 2003** |      | **April 30, 2003** |   |
|-----------------|--------|------------------------|-----------|-------------------------|--------|
|            |   | **(unaudited)**        |      |                    |   |
| Raw  materials  |   | $                      | 377,887   |                    | $      | 377,961 |   |
| Work-in-process |   | 594,792                |      | 529,668                 |   |
| Finished  goods |   | 1,738,334              |      | 1,874,984               |   |
|            |   | $                      | 2,711,013 |                    | $      | 2,782,613 |   |

 

**(6)****                                 Short-term Debt**

 

On July 8, 2003, the Company issued $1.0 million ofterm debt to PKM Properties, LLC (“PKM”), an entity controlled by a principal shareholder, who also serves onthe Company’s Boardof Directors.  The Company borrowed $764,728 under this bridge financingduring the quarter and, subsequent to July 31, 2003, borrowed the final draw of$235,272 on August 20, 2003.  The debt, which is collateralized by substantially allof our assets, bears interest at a rate of 10 percent per year and is due onMay 27, 2004.  In connection with the debt, the Company also issued awarrant to PKM with a ten-year term to purchase 320,178 shares of the Company’s common stock at an exercise price of$0.70 per share.  The Company issued a warrant to purchase an additional60,179 shares of the Company’s common stock on the same terms in conjunction with thefinal draw on August 20, 2003.  In addition, the Company agreed to extendthe term of 700,000 previously issued warrants from five years to tenyears.  The allocated fair value of the warrants issued prior to July 31, 2003, and the incremental value ofthe existing warrants was $383,361, and was accounted for as a discount on theborrowings under the bridge debt.  This discount, which is presented as areduction of the face value of the debt on the consolidated balance sheet, isbeing amortized as interest expense over the eleven-month term of thedebt.  As of July 31, 2003, the unamortized balance of the discount was$348,510.  In addition, the Company incurred direct financing costs of$54,728, which are included in other current assets and are being amortized asexpenses over the eleven-month term of the debt.

 

On July 8, 2003, the Company also issued $1.0million of term debt to Peter L. Hauser (“Hauser”), a principal shareholder.  The Company borrowed $1.0million under this bridge financing during the quarter ended July 31, 2003.  The debt which iscollateralized by substantially all of our assets pursuant to our intercreditoragreement with PKM bears interest at a rate of 10 percent per year and is dueon June 30,2004.  In connection with the term debt, the Company also issued a warrantwith a ten-year term to purchase 380,357 shares of the Company’s common

 

8

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stock at anexercise price of $0.70 per share.  The allocated fair value of the newlyissued warrant was $281,706 and is accounted for as a discount on theborrowings under the bridge debt.  This discount, which is presented as areduction of the face value of thedebt on the consolidated balance sheet is being amortized as interest expenseover the twelve-month term of the debt.  As of July 31, 2003, the unamortized balance of thediscount was $258,231.  In addition, the Company incurred direct financingcosts of $71,772, which are included in other current assets and are beingamortized as expenses over the twelve-month term of the debt.

 

**(7)****                                 New Accounting Pronouncements**

 

InJune 2002,the FASB issued SFAS No. 146, “Accounting for Exit or Disposal Activities.”  The new statement addresses theaccounting for costs associated with exit or disposal activities.  Theprovisions of the statement were effective for disposal activities initiatedafter December 31,2002.  The adoption of SFAS No. 146 did not have an impact on the Company’s financial position or results ofoperations.  The Company has had no exit or disposal activities subsequentto December 31,2002.

 

The Company adoptedthe provisions of FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others” in the third quarter of fiscal year2003.  The disclosure provisions of the interpretation are effective forthe Company’sfinancial statements for the third quarter of fiscal year 2003.  Theprovisions for initial recognition and measurement are effective on aprospective basis for guarantees that are issued or modified after December 31, 2002.  The implementation ofthis accounting pronouncement did not have an effect on the Company’s results of operations, financialposition or cash flows.

 

In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable InterestEntities, an interpretation of Accounting Research Bulletin No. 51.” FIN No. 46 requires certain variableinterest entities (VIEs), to be consolidated by the primary beneficiary of theentity if the equity investors in the entity do not have the characteristics ofa controlling financial interest or do not have sufficient equity at risk forthe entity to finance its activities without additional subordinated financialsupport from other parties.  FIN No. 46 is effective for all VIEs createdor acquired after January 31, 2003.  For VIEs created or acquired prior to February 1, 2003, the provisions of FIN No. 46must be applied for the first interim or annual period beginning after June 15, 2003.  The Company currently hasno contractual relationship or other business relationship with a VIE andtherefore the adoption of FIN No. 46 did not have an effect on its consolidatedfinancial position, results of operations or cash flows.

 

**(8)****                                 Segment Information**

 

The Company viewsits operations and manages its business as one segment, the manufacturing andmarketing of cardiothoracic surgery devices.  Factors used to identify theCompany’ssingle operating segment include the organizational structure of the Companyand the financial information available for evaluation by chief operatingdecision maker.

 

The following tablesummarizes net sales by geographic area:

 
|           |   | **Three Months Ended****July 31,** |    |
|----------------|--------|-----------------------------------------|---------|
|           |   | **(unaudited)**                         |    |
|           |   | **2003****Restated  (Note 11)**         |    | **2002****Restated  (Note 11)** |   |
| Europe         |   | $                                       | 446,870 |   | $ | 330,915 |   |
| South  Asia    |   | 76,800                                  |    | 124,100 |   |
| Middle  East   |   | 142,454                                 |    | 165,967 |   |
| Far  East      |   | 53,180                                  |    | 42,827 |   |
| United  States |   | 180,700                                 |    | 25,100 |   |
| Other          |   | 225                                     |    | 7,475 |   |
| **TOTALS**     |   | $                                       | 900,229 |   | $ | 696,384 |   |

 

**(9)****                                 Returnof Inventory**

 

During the quarter ended July 31, 2002,the Company obtained inventories from two former internationaldistributors.  The heart valves weresold to these customers during fiscal year 2000 and the first half of fiscalyear

 

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2001. Due to financial difficulties experienced by these distributors, theCompany provided allowances for the remaining uncollected accounts receivablebalances in fiscal years 2001 and 2002. The Company did not anticipate the return of these products at the timethe uncollectible accounts were established. Upon obtaining title to the heart valves from these former distributorsduring the quarter ended July 31, 2002, the Company increased itsinventories and recorded a recovery of its prior provision for doubtful accounts which reduced its general andadministrative costs by $92,000 representing the cost of the returnedinventories. As described in Note 11, the Company had previously reported thereturn of inventory as a reduction of cost of goods sold and has restated itsfinancial statements for the three month period ended October 31, 2002 tochange the classification to a reduction of general and administrativeexpenses.

 

**(10)****                          Subsequent Event**

 

On September 2, 2003, the Company signed an agreementwith LightWave Ablation Systems, Inc. to purchase technology for the treatmentof atrial fibrillation.  This acquisition is consistent with the Company’s strategy to diversify its productoffering.

 

**(11)****                         ****Restatement**

 

The Company has restated its financialstatements for the three-month periods ended July 31, 2003 and 2002, to changethe classification of marketing support expenditures, which had previously beenreported as sales and marketing expense rather than a reduction in net salespursuant to application of the Consensus for Emerging Issues Task Force No.01-09, “Accounting for Consideration Given by a Vendor to a Customer (Includinga Reseller of the Vendor’s Products).” The effect of this change in classification is to decrease net sales,gross profit and sales and marketing expenses by corresponding amounts for allperiods presented.

 

The Company has also restated its financialstatements for the three-month period ended July 31, 2002 to change theclassification of income from inventories returned from two formerinternational distributors, which had previously been reported as a reductionof cost of goods sold rather than as a reduction of general and administrativeexpenses (see Note 9).  The effect ofthis change in classification is to increase cost of goods sold, decrease grossprofit and decrease general and administrative expenses by $92,000 for thethree month period ended July 31, 2002.

 

The changes in classifications described inthe above two paragraphs had no effect on the Company’s loss from operations ornet loss, nor any effect on the Company’s consolidated balance sheet, statementof changes in stockholders’ equity (deficit) or statement of cash flows.  The table below summarizes the aggregate effectof theses changes in classifications.

 

 
|                        |   | **Three Months Ended July 31,** |      |
|-----------------------------|--------|--------------------------------------|-----------|
|                        |   | **2003**                             |      | **2002** |   |
|                        |   | **As reported**                      |      | **As restated** |   | **As reported** |   | **As restated** |   |
|                        |   |                                 |      |   |   |   |   |   |   |
| Net sales                   |   | $                                    | 1,094,579 |   | $ | 900,229 |   | $ | 818,332 |   | $ | 696,384 |   |
| Cost of  goods sold         |   | n/a                                  |      | n/a |   | 477,869 |   | 569,869 |   |
| Gross profit                |   | 597,476                              |      | 403,126 |   | 340,463 |   | 126,515 |   |
|                        |   |                                 |      |   |   |   |   |   |   |
| Operating  expenses:        |   |                                 |      |   |   |   |   |   |   |
| Sales and  marketing        |   | 795,088                              |      | 600,738 |   | 755,587 |   | 633,639 |   |
| General and  administrative |   | n/a                                  |      | n/a |   | 537,591 |   | 445,591 |   |
| Total operating  expenses   |   | 1,556,005                            |      | 1,361,655 |   | 1,494,295 |   | 1,280,347 |   |
|                             |        |                                      |           |  |  |  |  |  |  |  |  |  |  |

 

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n/a – not applicable

10

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**ITEM 2  MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OFOPERATION**

 

*Thefollowing discussion contains various forward-looking statements within themeaning of Section 21E of the Exchange Act.  Although we believe that, inmaking any such statement, our expectations are based on reasonableassumptions, any such statement may be influenced by factors that could cause actualoutcomes and results to be materially different from those projected. When used in the following discussion, the words “anticipates,”“believes,”“expects,”“intends,”“plans,”“estimates” and similar expressions, as they relate to us or ourmanagement, are intended to identify such forward-looking statements. These forward-looking statements are subject to numerous risks anduncertainties that could cause actual results to differ materially from thoseanticipated.  Factors that could cause actual results to differ materiallyfrom those anticipated, certain of which are beyond our control, are set forthin this document and in our Annual Report on Form 10-KSB for the fiscal yearended April 30,2003, under the caption “Management’s Discussion and Analysis or Plan of Operation-CautionaryStatement.”*

 

*Ouractual results, performance or achievements could differ materially from thoseexpressed in, or implied by, forward-looking statements.  Accordingly, wecannot be certain that any of the events anticipated by forward-lookingstatements will occur or, if any of them do occur, what impact they will haveon us.  We caution you to keep in mind the cautions and risks described inthis document and in our Cautionary Statement and to refrain from attributing unduecertainty to any forward-looking statements, which speak only as of the date ofthe document in which they appear.*

 

**Overview**

 

We are a cardiothoracic surgery devicemanufacturer.  Our primary products are mechanical heart valves known asthe Omnicarbon® Series 3000 and Series 4000, which we manufacture andmarket.  Our heart valves are used to treat heart failure caused by theaging process, heart diseases, prosthetic heart valve failure and congenitaldefects.  To date, we have distributed the Omnicarbon 3000 and 4000 heartvalves primarily in Europe, South Asia, the Middle East and the Far East. In fiscal year 2003, we derived 62 percent of our net sales from Europe. As an innovator of heart valve technology, we have more than 33 years ofexperience in developing, manufacturing and marketing five generations of heartvalves, and we have sold approximately 140,000 heart valves worldwide.

 

On July 26, 2001, the FDA gave us notice ofpremarket approval to sell our Omnicarbon 3000 heart valve in the U.S., thelargest geographic market for mechanical heart valves.  In anticipation ofFDA premarket approval, we invested in our sales and marketing infrastructure,including adding sales management to our staff and recruiting field salesrepresentatives to call on domestic surgery centers in the U.S.  Basedupon our Omnicarbon heart valve’s 18 years of implants in patients in Europe, we believethat we can establish a competitive position in the mechanical heart valveindustry in the U.S. and leverage this position into other critical areas ofcardiothoracic surgery.  We also expect that our ability to market theOmnicarbon 3000 heart valve in the U.S. will favorably affect our internationalsales, as we believe many cardiovascular surgeons and others who make purchasingdecisions are aware of the FDA’s rigorous premarket approval process and consider it to bea validation of the safety and efficacy of medical devices.  Our companyhad its first implant of the Omnicarbon 3000 heart valve in the U.S. in December 2001.

 

The worldwide heart valve market is dynamicand highly competitive.  In addition, technology and competitiveofferings, such as new tissue heart valves, place increased pressure on us aswe seek to increase our market share and revenue.  For more informationregarding these risks, you should review our Cautionary Statement.

 

We have restated our financial information to reflect changes inclassification of certain items in the Company’s Statement of Operations forthe three month periods ended July 31, 2003 and 2002.

 

We have changed the classification of certain expenditures previouslyclassified as sales and marketing expenses to a reduction in net sales. Theseexpenditures consist of payments made to international distributors forassistance in marketing our products that are required to be reported as areduction in net sales pursuant to application of the Consensus for EITF Issue01-9 “Accounting for Consideration Given by a Vendor to a Customer (Including aReseller of the Vendor’s Products)”.  Thechanges in these classifications decreased net sales, gross profit, sales andmarketing expense and total operating expenses by corresponding amounts.

 

We have also changed the classification of income from inventoriesreturned from two former international distributors, which had previously beenreported as a reduction of cost of goods sold rather than as a reduction ofgeneral and

 

11

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administrative expenses.  Thechange in classification increased cost of goods sold, decreased gross profitand decreased general and administrative expenses by $92,000 for the threemonth period ended July 31, 2002.

 

The changes in classifications had no effect on our loss fromoperations or net loss, nor any effect on the consolidated balance sheet,statement of shareholders’ equity (deficit) or cash flows.  See Note 11 to the Consolidated FinancialStatements.

 

**QuartersEnded July 31,2003 and 2002**

 

Our operating results, expressed as apercentage of total revenue, were as follows:

 

|                       |   | **Three  Months Ended****July 31,** |   |
|----------------------------|--------|------------------------------------------|--------|
|                       |   | **(unaudited)**                          |   |
|                       |   | **2003****Restated (1)**                 |   | **2002****Restated (1)** |   |
| Net sales                  |   | 100.0                                    | %      | 100.0 | % |
| Cost of goods sold         |   | 55.2                                     | %      | 81.8 | % |
|                       |   |                                     |   |   |   |
| Gross profit               |   | 44.8                                     | %      | 18.2 | % |
|                       |   |                                     |   |   |   |
| Operating expenses:        |   |                                     |   |   |   |
|                       |   |                                     |   |   |   |
| Sales and marketing        |   | 66.7                                     | %      | 91.0 | % |
| General and administrative |   | 61.9                                     | %      | 64.0 | % |
| Engineering and regulatory |   | 22.7                                     | %      | 28.9 | % |
|                       |   |                                     |   |   |   |
| Total operating expenses   |   | 151.3                                    | %      | 183.9 | % |
|                       |   |                                     |   |   |   |
| Loss from operations       |   | (106.5                                   | )%     | (165.7 | )% |
|                       |   |                                     |   |   |   |
| Other (expense) income:    |   |                                     |   |   |   |
| Interest expense           |   | (17.4                                    | )%     | (5.6 | )% |
| Interest income            |   | 0.6                                      | %      | 1.6 | % |
| Other income               |   | (1.2                                     | )%     | 2.3 | % |
|                       |   |                                     |   |   |   |
| Total other expense        |   | (18.0%                                   | )      | (1.7 | )% |
|                       |   |                                     |   |   |   |
| Net loss                   |   | (124.5                                   | )%     | (167.4 | )% |

 

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(1) — As described in Note 11 to our consolidatedfinancial statements, we restated our financial statements for the three monthperiods ended July 31, 2003 and 2002 to change the classification ofcertain expenditures previouslyclassified as sales and marketing expenses to a reduction in net sales and tochange the classification of income from inventories returned from two formerinternational distributors previously classified as a reduction of cost ofgoods sold to a reduction of general and administrative expenses.

 

**CriticalAccounting Policies**

 

For discussion of our critical accountingpolicies and estimates, see our Annual Report on Form 10-KSB for the fiscalyear ended April 30, 2003.

 

**Resultsof Operations**

 

*NetSales*. Net sales in the quarter ended July 31, 2003 increased 29.3 percent to $900,229 from $696,384in the first quarter of the prior year.  The increase was attributable tohigher Omnicarbon unit sales in key European markets and the U.S., withapproximately half attributable to each geographic area.

 

In the first three months fiscal years 2004and 2003, the vast majority of our sales were denominated in U.S.dollars.  Fluctuations in foreign currency exchange rates have notresulted in significant losses or gains on outstanding trade accountsreceivable.  All of our distributors are required to pay for products inU.S. dollars, other than our Japanese distributor, which pays in Japanese yen,and two European customers, which pay in euros.  Because we do not engagein foreign currency

 

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hedging transactions, we recognize that astrong U.S. dollar can adversely affect unit sales denominated in currenciesother than U.S. dollars for our foreign distributors.

 

*GrossProfit.* Gross profit as a percentage of net sales increased to 44.8 percent in thequarter ended July 3 1, 2003, from 18.2 percent in the comparable period one year ago.  Theimprovement in fiscal year 2004 gross profit margin was attributable primarilyto reductions in Omnicarbon 4000 product costs, which we sell in marketsoutside the U.S. and Japan, combined with favorable margin impacts due to unitsales growth in the U.S. market.  We have expended considerable resourcesin developing our new carbon manufacturing process technologies utilized inmanufacturing the Omnicarbon 4000 heart valve.  Our strategy is to obtainFDA approval of our proprietary pyrolytic carbon manufacturing process in orderto market the Omnicarbon 4000 in the U.S.  Due to its lower manufacturingcost, we believe the Omnicarbon 4000 will generate significantly higher gross profitmargins when sold in the U.S. than the Omnicarbon 3000 heart valve. However, there can be no assurance that the FDA will approve our proprietarymanufacturing process.

 

*Salesand Marketing*.  Sales and marketing expenses in the quarter ended July 31, 2003, were $600,738 or 66.7 percentof net sales compared to $633,639 or 91.0 percent of net sales in the sameperiod last fiscal year.  The decrease in fiscal year 2004 is

primarily attributable to restructuring ofthe company’ssales and distribution organization..  Our overall strategy is to promotethe clinical results of the Omnicarbon heart valve and the technical strengthsof our company in designing and manufacturing mechanical heart valves.

 

*Generaland Administrative*.  General and administrative expenses for the quarterended July 31,2003, were $556,923 or 61.9 percent of net sales compared to $445,591or 64% percent of net sales in the prioryear.  The slight increase in spending in the current period related tofees paid for financial advisory services and higher professional service fees.

 

*Engineeringand Regulatory*.  Engineering and regulatory expenses for the quarterended July 31,2003, were $203,994 or 22.7 percent of net sales compared to $201,117 or 28.9percent of net sales in the prior year.  We anticipate increased spendingin this area as initiatives move forward to develop and commercializeadditional new products.

 

*Other(Expense) Income*.  Interest expense totaled $156,246 in the quarterended July 31,2003, compared to $38,980 in the comparable period last fiscal year.  Theincrease in interest expense in the first quarter of fiscal 2004 was primarilydue to financing costs related to short-term related party borrowings.

 

*IncomeTax Provision*.  In light of our recent history of operating losses, we recordeda valuation allowance to fully offset our deferred tax assets in fiscal year2000.  We have continued to provide a full valuation allowance through thefirst quarter of fiscal 2004 due to the inherent uncertainty about the sufficiencyof future taxable income necessary to realize our deferred tax assets.

 

*Lossfrom Operations*.  As of July 31, 2003, we had an accumulated deficit of$18,194,058.  We have incurred losses in each of the last seven fiscalyears.  Since 1994, we have invested in developing a bileaflet heartvalve, a proprietary pyrolytic carbon coating process and obtaining premarketapproval from the FDA to market our Omnicarbon 3000 heart valve in theU.S.  Our strategy has been to invest in technology to better positionourselves competitively once FDA premarket approval was obtained.  Weexpect cumulative net losses to continue at least through fiscal year 2004because of anticipated spending necessary to market the Omnicarbon 3000 heartvalve in the U.S. and to establish and maintain a strong marketing organizationfor domestic and foreign markets.

 

**Liquidityand Capital Resources**

 

Cash and cash equivalents increased slightlyto $202,790 at July 3 1, 2003, from $184,227 at April 30, 2003.  This increase in cash andcash equivalents of $18,563, was due to the following:

 
| Net  cash used in operating activities     |   | $         | (1,598,228 | )      |
|--------------------------------------------|--------|-----------|------------|--------|
| Net  cash used in investing activities     |   | —    |       |
| Net  cash provided by financing activities |   | 1,616,791 |       |
| Net  increase                              |   | $         | 18,563     |   |

 

Net cash used in operating activitiesincreased $168,740 to $1,598,228 in the quarter ended July 31, 2003, from $1,529,758 in the quarterended July 31,2002.  The use of cash in operations in the first quarter of both fiscalyear 2003 and fiscal year 2004 were net losses of $1,165,866 and $1,120,963,respectively.  The increase in the use of cash in operations in the firstquarter of 2004 relative to 2003 was due principally to decreases in accruedexpenses and accounts payable, partially offset by a decrease in inventories inthe first quarter of fiscal year 2004 versus an increase in inventories in thefirst quarter of fiscal year 2003.  The decreases in accrued expenses andaccounts payable were a function of the timing of when we paid certaincosts.  The increase in inventories in the first quarter of fiscal year2003 was to support anticipated sales growth in the U.S. and internationalmarkets.  The decrease in inventories in the first quarter of fiscal year2004 reflects the results of our concerted effects to more closely control ourinventory levels combined with lower manufacturing costs.

 

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No funds were used in investing activities inthe quarter ended July 31, 2003.  Net cash used in investing activities was$84,593 in the quarter ended July 31, 2002, and was entirely for property, plant, andequipment purchases to support manufacturing and sales.

 

Net cash provided by financing activities was$1,616,791 in the quarter ended July 31, 2003, and consisted of short-term borrowingsfrom related parties of $1,764,728; partially offset by principal payments of$147,937.  In the quarter ended July 31, 2002, net cash used in financing activities was $38,579and related entirely to principal payments on debt and capital lease obligations.

 

Throughout fiscal year 2003 and in the firstquarter of fiscal year 2004, we entered into a number of financing transactionsto provide funds necessary to meet our working capital and capital expenditureneeds and to meet other obligations.  These financing activities consistedof the following:

 

In December 2002, we received a $60,000 unsecuredadvance from an executive officer.  Principal and interest on this advancewas repaid in April 2003.

 

In January 2003, we established a line of credit withPKM Properties, LLC (“PKM”), an entity controlled by Paul K.Miller.  Mr. Miller is a member of our board of directors and is ourlargest beneficial owner of securities.  The line of credit bears interestat the higher of 7 percent or 1 percent above a bank reference rate (7 percentis the rate in effect as of July 31, 2003).  The line of credit is currentlycollateralized by a security interest in substantially all of our assets. This line of credit matures on September 17, 2003.  We are currently discussing an extension ofthe line of credit with PKM.  In connection with the line of credit, wealso issued a warrant to PKM with a five-year term to purchase 350,000 sharesof our common stock at an exercise price of $0.596 per share.  The allocatedfair value of the warrants was $128,995.  This discount was completelyamortized to interest expense as of July 31, 2003.  The amount outstanding under thisshort-term debt with related party at July 31, 2003 was $943,333.

 

On April 4, 2003, we sold our corporateheadquarters, manufacturing facility and surrounding land in Inver GroveHeights, Minnesota to PKM.  In connection with the transaction, wereceived total consideration of $3.84 million consisting of (1) $1.0 million incash, (ii) PKM’sassumption of our $2.5 million outstanding indebtedness to Associated Bankwhich eliminated our indebtedness to Associated Bank, and (iii) PKM’s assumption of our promissory note withDakota Electric Association and land special assessments payable to DakotaCounty aggregating $336,105.  We relied on a fair market value appraisalof the property in determining the amount of such consideration.  Also in connection with the transaction, we issued to PKM a five-year warrantfor the purchase of 350,000 shares of our common stock at an exercise price of$0.625 per share.   These warrants had an allocated fair value of$89,602.

 

Of the net cashproceeds, $300,000 plus interest was applied to our indebtedness to PKMpursuant to the line of credit agreement described above.

 

Simultaneous withthe sale of the facility, we entered into a lease with PKM to lease back thefacility and a portion of the land.  The lease has a ten-year initial termwith options for us to extend the lease up to ten additional years.  Undercertain conditions, we also have an option to purchase the building at the endof the initial ten-year term at the fair value at that time.

 

Due to ourcontinued involvement with the property, including the ability to buy back theproperty at a future date, the transaction is accounted for as a financing ofthe property sold and leased back.  Accordingly, the net book value of thefacility and land sold to PKM with a net book value of $759,146 continues to bepresented as part of our property, plant and equipment balance.  Therelated party lease obligation of $3,652,572 at July 31, 2003, represents the minimum amountsdue PKM for the initial ten-year term discounted at 4.4 percent and additionalpayments to be paid to PKM for the Dakota Electric Association and Dakota Countyobligations assumed by PKM.

 

On July 8, 2003, we obtained $2.0 million inbridge financing, resulting in net proceeds of approximately $1.87 million.

 

Under the terms ofthe financing, we established a one-year $1.0 million of term debt withPKM.  The line, which requires the payment of interest at a rate of 10percent per year, matures on May 27, 2004, and is collateralized bysubstantially all of our assets.   As additional consideration forthe financing, we agreed to issue PKM ten-year warrants for the purchase of upto 380,357 shares of our common stock at an exercise price of $0.70 per sharewith terms and conditions that include weighted-average anti-dilutionrights.  We also agreed to modify certain terms of the warrants issued toPKM in connection with a credit facility extended by PKM in January 2003, to conform to the terms of thewarrants issued as part of this bridge debt financing.

 

14

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In a simultaneoustransaction, we entered into a loan agreement and borrowed $1.0 million fromPeter L. Hauser pursuant to a one-year subordinated note with an interest rateof 10 percent per year. Pursuant to an intercreditor agreement with PKM, theloan is collateralized by substantially all of our assets.  The lender wasissued ten-year warrants for the purchase of 380,357 shares of our common stockon terms comparable to the PKM warrants described above.  As a result ofthe transaction, Mr. Hauser became the beneficial owner of approximately 10.3percent of our securities.

 

We expect that our operating losses andnegative operating cash flow will continue at least through fiscal year 2004 aswe expand our manufacturing capabilities, continue increasing our corporatestaff to support the U.S. roll-out of our Omnicarbon 3000 heart valve, and addmarketing programs domestically and internationally to build awareness of andcreate demand for our Omnicarbon heart valves. We anticipate that our sales andmarketing and general and administrative expenses will continue to constitute amaterial use of our cash resources.  The actual amounts and timing of ourcapital expenditures will vary significantly depending upon the speed at whichwe are able to expand our distribution capability in domestic and internationalmarkets and the availability of financing.

 

Our capital requirements may vary dependingupon the timing and the success of the implementation of our business plan,regulatory, technological andcompetitive developments, or if:

 

•                  increased sales levels of our coreproducts and new products are not achieved;

 

•                  operating losses exceed our projections;

 

•                  our manufacturing and development costsor estimates prove to be inaccurate;

 

•                  we determine to acquire, license ordevelop additional technologies;

 

•                  we experience substantial difficulty ingaining U.S. market acceptance or delays in obtaining FDA clearance of ourproprietary carbon coating process for heart valves sold in the U.S. market; or

 

•                  we make acquisitions.

 

Our ability to continue as a going concerndepends upon our ability to obtain additional debt and/or equity financing inthe second quarter of fiscal year 2004.  We are currently seekingadditional financing to fund our operations and working capitalrequirements.  We cannot provide any assurance, however, that suchadditional financing will be available on terms acceptable to us or atall.  We will need to obtain additional capital prior to the maturity dateof our revolving line of credit with PKM on September 17, 2003, or otherwise extend or restructurethis debt to continue operations.

 

We anticipate that we will need to raisebetween $8,000,000 and $10,000,000 of additional equity or debt financing tofund operations and working capital requirements beginning in September 2003.  We expect to face substantialdifficulty in raising funds in the current market environment and we have nocommitments at this time to provide the required financing.  If we obtainthe foregoing financing, we believe we will have sufficient capital resourcesto operate and fund the growth of our business for the remainder of fiscal year2004 and fiscal year 2005.

 

We cannot assure you that we will be able toraise sufficient additional capital on terms that we consider acceptable, or atall.  The terms of any equity financing are expected to be highly dilutiveto our existing security holders.  The delisting of our securities fromthe Nasdaq SmallCap Market that occurred in March 2003 will negatively affect our abilityto raise capital.  If we are unable to obtain adequate financing onacceptable terms, we will be unable to continue operations.

 

Until such time as the level of U.S. marketacceptance of our heart valves increases and the FDA approves our pyrolyticcarbon process, we anticipate that we will continue to depend upon cashprovided by financing activities to address our working capitalrequirements.  By broadening our portfolio of cardiothoracic surgeryproducts, we hope to reduce our dependence on sales of heart valves and reduceour reliance upon financing transactions, which may not be available tous.  We cannot, however, assure you that our efforts to diversify ourproduct offerings will:

 

•                  be attainable;

 

•                  be profitable;

 

•                  reduce our reliance upon financingtransactions; or

 

15

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•                  enable us to continue operations.

 

**Commitmentsand Contingent Liabilities**

 

*SniaS.p.A. Carbomedics (formerly Sulzer Carbomedics).* In July 1998, we entered into a three-year supplyagreement with Snia S.p.A. Carbomedics, the source of certain raw materialcomponents used in the manufacture of our Omnicarbon 3000 heart valves. The supply agreement was extended for an additional two years in March 2001.  The agreement provides thatwe purchase a minimum number of raw material units each calendar year through December 2003.  Under the terms of theagreement, we are required to compensate Snia S.p.A. Carbomedics for anypurchase shortfalls up to a maximum of $200,000 per year.  We have not metthe minimum purchase requirements for the past three calendar years.  Inaddition, we do not believe we will meet the minimum purchase requirement forcalendar year 2003.  As a result, we expensed $33,935 in the quarter endedJuly 31, 2003,and $17,050 in the quarter ended July 31, 2002, related to these purchase shortfalls.  Thesecharges were reflected in cost of goods sold.  Future purchase shortfallscould adversely affect our ongoing relationship with Snia S.p.A. Carbomedics.

 

*UROPACE*.  In July 1995, we established a wholly ownedsubsidiary, UROPACE, Inc., to commercialize technology for

treating female urinary incontinence. On November 1, 2000, we completed the spin-off of UROPACE to our existingshareholders.  The separation was effected by transferring from ourcompany to UROPACE all assets, tangible and intangible, relating to thedevelopment of female urinary incontinence technology.  Our shareholdersof record on September 15, 2000 received one share of common stock of UROPACE foreach 6.882 shares of our common stock they held on that date.  The assetstransferred to UROPACE had no book value at November 1, 2000, and the operations of UROPACEbefore the spin-off had no revenues and minimal expenses during fiscal year2000 and fiscal year 2001.  As a part of this spin-off, we agreed to loanUROPACE up to $356,250 at a variable interest rate.  Principal andinterest on the note will be payable in installments equal to 5 percent ofUROPACE’s futureannual net sales until the note and interest is paid in full.  At July 31, 2003, we had loaned UROPACE $235,000,none of which had been repaid.  Due to the development stage of UROPACEand the uncertainty associated with the collection of these borrowings, we haverecorded an allowance for the entire balance of the loan, with thecorresponding expense included in other (expense) income in the ConsolidatedStatement of Operations.

 

*RelatedParty Lease Obligation. *On April 4, 2003, we sold our corporate headquarters, manufacturingfacility and surrounding land in Inver Grove Heights, Minnesota to PKM. In connection with the transaction, we received total consideration of $3.84million consisting of (1) $1.0 million in cash, (ii) PKM’s assumption of our $2.5 millionoutstanding indebtedness to Associated Bank which eliminated our indebtednessto Associated Bank, and (iii) PKM’s assumption of our promissory note with Dakota ElectricAssociation and land special assessments payable to Dakota County aggregating$336,105.

 

We simultaneously leased back our facilitypursuant to a ten-year lease, with options to renew and an option to repurchasethe facility.  We will continue to utilize the facility as we did prior tothe sale-leaseback transaction, with no change in operations.

 

*CapitalLeases*. We lease certain manufacturing equipment under various capital leases. The capital lease terms extend into fiscal year 2004 with implicit interestrates ranging from 6.9 to 16.2 percent.  The capital leases arecollaterized by the underlying equipment with a total original cost of$322,733.

 

*ClinicalStudies. *We entered into an agreement with several large non-U.S.hospitals to conduct clinical studies regarding certain aspects of ourOmnicarbon heart valve’sclinical performance.  The agreement runs through fiscal year 2006. In general, recipients of clinical study payments are required to purchase ourproducts in order to complete their studies.

 

*Consulting*.  We entered into an employmentseparation agreement with an officer in late 2002, which provides forconsulting services through calendar 2003.

 

*Short-TermDebt with Related Parties.*  We entered into an agreement with PKM and anothershareholder in early July to provide $2.0 million of bridge financing.  Wepreviously established a line of credit in January 2003 with PKM.  As noted above, PKMis an entity controlled by a principal shareholder, who also serves on ourboard of directors.

 

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|                                      |   | **Payments Due By Period** |      |
|-------------------------------------------|--------|----------------------------|-----------|
| **Summary of Contractual****Obligations** |   | **TOTAL**                  |      | **Less than One****Year** |   | **Two to Three****Years** |   | **Four or More****Years** |   |
| Snia S.p.A. Carbomedics                   |   | $                          | 153,972   |   | $ | 153,972 |   | $ |   |   | $ |   |   |
| UROPACE  Loan                             |   | 121,250                    |      | 121,250 |   |   |   |   |   |
| Related  Party Lease Obligation(1)        |   | 4,060,588                  |      | 412,584 |   | 835,968 |   | 2,812,036 |   |
| Capital  Leases(1)                        |   | 28,870                     |      | 28,870 |   |   |   |   |   |
| Clinical  Studies                         |   | 410,380                    |      | 137,762 |   | 192,247 |   | 80,371 |   |
| Consulting                                |   | 43,270                     |      | 43,270 |   |   |   |   |   |
| Short-Term Debt with Related Party        |   | 2,708,061                  |      | 2,708,061 |   |   |   |   |   |
| TOTAL  CONTRACTUAL OBLIGATIONS            |   | $                          | 7,526,391 |   | $ | 3,605,769 |   | $ | 1,028,215 |   | $ | 2,892,407 |   |

 

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(1)                                  Future payments include interest due.

 

**RecentAccounting Pronouncements**

 

In June 2002, the FASB issued SFAS No. 146, “Accounting for Exit or DisposalActivities.” The new statement addresses the accounting for costs associated with exit ordisposal activities.  The provisions of the statement were effective fordisposal activities initiated after December 31, 2002.  The adoption of SFAS No.146 did not have an impact on the Company’s financial position or results of operations.  TheCompany has had no exit or disposal activities subsequent to December 31, 2002.

 

The Company adoptedthe provisions of FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others” in the third quarter of fiscal year 2003. The disclosure provisions of the interpretation are effective for the Company’s financial statements for the thirdquarter of fiscal year 2003.  The provisions for initial recognition andmeasurement are effective on a prospective basis for guarantees that are issuedor modified after December 31, 2002.  The implementation of this accountingpronouncement did not have an effect on the Company’s results of operations, financialposition or cash flows.

 

In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable InterestEntities, an interpretation of Accounting Research Bulletin No. 51.” FIN No. 46 requires certain variableinterest entities (VIEs), to be consolidated by the primary beneficiary of theentity if the equity investors in the entity do not have the characteristics ofa controlling financial interest or do not have sufficient equity at risk forthe entity to finance its activities without additional subordinated financialsupport from other parties.  FIN No. 46 is effective for all VIEs createdor acquired after January 31, 2003.  For VIEs created or acquired prior to February 1, 2003, the provisions of FIN No. 46must be applied for the first interim or annual period beginning after June 15, 2003.  The Company currently hasno contractual relationship or other business relationship with a VIE andtherefore the adoption of FIN No. 46 did not have an effect on its consolidatedfinancial position, results of operations or cash flows.

 

**Qualitativeand Quantitative Disclosures about Market Risk**

 

We develop our products in the U.S. andmarket our products globally.  Because we continue to derive our revenueprimarily from sources outside of the U.S., our financial results could beaffected by many factors, such as changes in currency exchange rates or weakeconomic conditions in foreign markets.  Substantially all of our salesare denominated in U.S. dollars.  A strengthening of the U.S. dollar couldmake our products less competitive in foreign markets.  We do notcurrently participate in any currency hedging activities to mitigate thisrisk.  We intend to assess the need to use financial instruments to hedgeour exchange rate exposure on an ongoing basis.  Our interest income andexpenses are sensitive to changes in the general level of U.S. interest rates,particularly since our investments are in short-term instruments and ourlong-term debt and revolving line of credit require interest paymentscalculated at variable rates.  Based on the current nature and levels ofour investments and debt, however, we believe that we currently have nomaterial market risk exposure.

 

Our general investing policy is to limitmarket and credit risk and the risk of principal loss.  All liquidinvestments with original maturities of three months or less are considered tobe cash equivalents.

 

**SubsequentEvent**

 

On September 2, 2003, we signed an agreement withLightWave Ablation Systems, Inc. to purchase technology for the treatment ofatrial fibrillation.  This acquisition is consistent with our strategy todiversify our product offering.

 

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**ITEM 3****                                CONTROLSAND PROCEDURES**

 

Wemaintain a system of disclosure controls and procedures that is designed toprovide reasonable assurance that information, which is required to bedisclosed, is accumulated and communicated to management timely.  As of the end of the period covered by thisreport, we carried out an evaluation under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures pursuant to Exchange Act Rule13a-15.  In connection with its reviewof our financial statements for the quarter ended January 31, 2004,PricewaterhouseCoopers LLP informed our audit committee that there was amaterial weakness in our internal controls. Specifically, PricewaterhouseCoopers LLP identified a significantdeficiency in the design and operation of internal controls relating todocumenting and reporting international distribution marketing expenditures andrelated reimbursement.  We initiatedprocedures and reporting to document and support customer marketing expenses toremedy this deficiency in the future. Except for that deficiency, based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures are effective in timely alerting them to materialinformation relating to our company required to be disclosed in our periodicfilings with the SEC.

 

During our most recent fiscal quarter, there has beenno change in our internal control over financial reporting (as defined in Rule13a-15(f) or 15d-15(f) under the Exchange Act) that has materially affected, oris reasonably likely to materially affect, our internal control over financialreporting.

 

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**SIGNATURES**

 

In accordance with the requirements of theExchange Act, the registrant caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
|                             | MedicalCV, Inc. |
|----------------------------------|-----------------|
|                             |            |
| Date:  March 22,  2004 | By              | /s/ Blair P. Mowery |   |
|                             |            | Blair P. Mowery |
|                             |            | President and Chief  Executive Officer |
|                             |            |   |
|                             | By              | /s/ John H. Jungbauer |   |
|                             |            | John H. Jungbauer |
|                             |            | Chief Financial Officer |

 

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**INDEX TOEXHIBITS**

 
|   | **Exhibit****Number** |                                                                                                                                                                                                                                                      | **Description** |   |
|--------|-----------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------|--------|
| 10.1   |                  | Loan  Agreement by and between Peter L. Hauser and MedicalCV, Inc., dated July 1,  2003 (incorporated by reference to our current report on Form 8-K filed July  14, 2003).                                                                               |
| 10.2   |                  | $1.0 Million  Subordinated Note issued by MedicalCV, Inc. (Maker) to Peter Ludwig Hauser  (Payee), dated July 1, 2003 (incorporated by reference to our current report  on Form 8-K filed July 14, 2003).                                                 |
| 10.3   |                  | Subordination  and Intercreditor Agreement by and between Peter L. Hauser and PKM  Properties, LLC, accepted and acknowledged by MedicalCV, Inc., dated July 1,  2003 (incorporated by reference to our current report on Form 8-K filed July  14, 2003). |
| 10.4   |                  | May Security  Agreement in favor of PKM Properties, LLC and Peter L. Hauser, securing  property of MedicalCV, Inc., dated July 1, 2003 (incorporated by reference to  our current report on Form 8-K filed July 14, 2003).                                |
| 10.5   |                  | Warrant  Agreement to purchase 380,357 shares of common stock issued by MedicalCV,  Inc. to Peter Ludwig Hauser, dated July 1, 2003 (incorporated by reference to  our current report on Form 8-K filed July 14, 2003).                                   |
| 10.6   |                  | May  Discretionary Credit Agreement by and between MedicalCV, Inc. and PKM  Properties, LLC, dated July 1, 2003 (incorporated by reference to our current  report on Form 8-K filed July 14, 2003).                                                       |
| 10.7   |                  | May  Discretionary Credit Note issued by MedicalCV, Inc. (Maker) to PKM  Properties, LLC (Payee), dated July 1, 2003 (incorporated by reference to our  current report on Form 8-K filed July 14, 2003).                                                  |
| 10.8   |                  | Amendment to  Warrants by and between MedicalCV, Inc. and PKM Properties, LLC, dated July  1, 2003 (incorporated by reference to our current report on Form 8-K filed  July 14, 2003).                                                                    |
| 10.9   |                  | Warrant  Agreement to purchase 320,178 shares of common stock issued by MedicalCV,  Inc. to PKM Properties, LLC, dated July 1, 2003 (incorporated by reference to  our current report on Form 8-K filed July 14, 2003).                                   |
| 31.1   |                  | Chief Executive Officer  Certification pursuant to Rule 13a-14.                                                                                                                                                                                           |
| 31.2   |                  | Chief Financial Officer  Certification pursuant to Rule 13a-14.                                                                                                                                                                                           |
| 32.1   |                  | Chief Executive Officer  Certification pursuant to 18 U.S.C. Section 1350.                                                                                                                                                                           |
| 32.2   |                  | Chief Financial Officer  Certification pursuant to 18 U.S.C. Section 1350.                                                                                                                                                                           |
|        |                       |                                                                                                                                                                                                                                                           |                 |        |  |

 

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