**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

**FORM 10-QSB/A**

 
| **ý** | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934****FOR THE QUARTERLY PERIOD ENDED  OCTOBER 31, 2005** |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                       |
|       |       |                                                                                                                                                             |
| **o**      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                         |

 

**CommissionFile Number 0-33295**

 

**MedicalCV, Inc.**

(Exact Name ofSmall Business Issuer as Specified in Its Charter)

 
| **Minnesota**                                                    | ** ** | **41-1717208**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or Other  Jurisdiction  of Incorporation or Organization) |       | (I.R.S. Employer  Identification No.) |

 

**9725South Robert Trail**

**InverGrove Heights, Minnesota 55077**

**(651)452-3000**

(Address ofPrincipal Executive Offices and Issuer’s

Telephone Number,including Area Code)

 

Check whether theissuer:  (1) filed all reports required to be filed by Section 13or 15(d) of the Exchange Act during the past 12 months (or such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.

 

Yes  ý No  o

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

 

Yes  o No  ý

 

As of December 14,2005, the issuer had outstanding 11,513,333 shares of common stock and 17,705shares of convertible preferred stock.

 

Transitional SmallBusiness Disclosure Format (check one)   oYes   ý No

 

 

----

 

**EXPLANATORYNOTE**

 

We are filing thisQuarterly Report on Form 10-QSB/A for the quarterly and six-month periods endedOctober 31, 2005, to reflect changes in classification of certain general andadministrative expenses, as discontinued operations for the quarterly andsix-month periods ended October 31, 2004, and to report a material weakness inour internal control over financial reporting.

 

We have restated ourfinancial statements for the three and six-month periods ended October 31,2004, to correct the classification of certain general and administrativeexpenses from continuing operations to discontinued operations.  See Note 1 of the Notes to FinancialStatements.  The costs for which theclassification has been corrected are related directly to our discontinuedheart valve business.  The correction inclassifications had no effect on our net loss or net loss per share, nor anyeffect on our balance sheet or statement of cash flows. This Form 10-QSB/Aamends only Part I, Items 1, 2 and 3. The remaining items are unaffected by thecorrection in classification, have not been updated and are not reproduced inthis Form 10-QSB/A. In addition, this Form 10-QSB/A contains currently-datedcertifications from our Chief Executive Officer and Chief Financial Officer, asrequired by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. Thecertifications of our Chief Executive Officer and Chief Financial Officer areattached to this Form 10-QSB/A as Exhibits 31.1, 31.2, 32.1 and 32.2.

 

TABLE OF CONTENTS

 
| PART I       | FINANCIAL  INFORMATION |                                                                                                                                         |
|-------------------|------------------------|----------------------------------------------------------------------------------------------------------------------------------------------|
|              |                   |                                                                                                                                         |   |
|              | ITEM 1                 | Financial Statements                                                                                                                         |   |
|              |                   | Balance Sheets at October 31, 2005  (unaudited) and April 30, 2005                                                                 |   |
|              |                   | Statements of Operations for the three and  six-month periods ended October 31, 2005 (unaudited) and October 31,  2004 (unaudited) |   |
|              |                   | Statements of Cash Flows for the six-month  periods ended October 31, 2005 (unaudited) and October 31, 2004  (unaudited)           |   |
|              |                   | Notes to Financial Statements                                                                                                                |   |
|              | ITEM 2                 | Management’s Discussion and  Analysis or Plan of Operation                                                                              |   |
|              | ITEM 3                 | Controls and Procedures                                                                                                                      |   |
|              |                   |                                                                                                                                         |   |
| SIGNATURES        |                   |                                                                                                                                         |
| INDEX TO EXHIBITS |                   |                                                                                                                                         |

 

2

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**PART I**

 

**FINANCIALINFORMATION**

 

**ITEM 1****                                FINANCIALSTATEMENTS**

 

**MEDICALCV, INC.**

**BalanceSheets**

 
| ** **                                                                                                                                                                                                                                                                | ** ** | **October 31,** | ** ** | **April 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                                                                                                                | ** ** | **2005**             | ** ** | **2005**           | ** ** |
| ** **                                                                                                                                                                                                                                                                | ** ** | **(unaudited)**      | ** ** | ** **         | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                |       |                 |       |               |       |
|                                                                                                                                                                                                                                                                      |       |                 |       |               |       |
| Cash  and cash equivalents                                                                                                                                                                                                                                                |       | $                    | 7,589,391  |               | $          | 10,637,796 |   |
| Prepaid  expenses and other assets                                                                                                                                                                                                                                        |       | 120,566              |       | 199,978            |       |
| Current  assets of discontinued operations                                                                                                                                                                                                                                |       | 44,891               |       | 875,648            |       |
| Total  current assets                                                                                                                                                                                                                                                     |       | 7,754,848            |       | 11,713,422         |       |
|                                                                                                                                                                                                                                                                      |       |                 |       |               |       |
| Property,  plant and equipment, net                                                                                                                                                                                                                                       |       | 1,005,352            |       | 827,791            |       |
| Deferred  financing costs, net                                                                                                                                                                                                                                            |       | 54,587               |       | 58,226             |       |
| Other  long-term assets                                                                                                                                                                                                                                                   |       | 30,798               |       | 30,798             |       |
| Non-current  assets of discontinued operations                                                                                                                                                                                                                            |       | 367,799              |       | 367,799            |       |
| Total  assets                                                                                                                                                                                                                                                             |       | $                    | 9,213,384  |               | $          | 12,998,036 |   |
|                                                                                                                                                                                                                                                                      |       |                 |       |               |       |
| **LIABILITIES  AND SHAREHOLDERS’ DEFICIT**                                                                                                                                                                                                                           |       |                 |       |               |       |
|                                                                                                                                                                                                                                                                      |       |                 |       |               |       |
| Accounts  payable                                                                                                                                                                                                                                                         |       | $                    | 248,992    |               | $          | 399,588 |   |
| Current  portion of related party lease obligations                                                                                                                                                                                                                       |       | 290,303              |       | 311,155            |       |
| Accrued  expenses                                                                                                                                                                                                                                                         |       | 213,410              |       | 179,095            |       |
| Current  liabilities of discontinued operations                                                                                                                                                                                                                           |       | 10,300               |       | 202,595            |       |
| Total  current liabilities                                                                                                                                                                                                                                                |       | 763,005              |       | 1,092,433          |       |
| Fair  value of puttable warrants                                                                                                                                                                                                                                          |       | 20,716,507           |       | 27,992,609         |       |
| Related  party lease obligations, less current portion                                                                                                                                                                                                                    |       | 2,729,176            |       | 2,824,977          |       |
| Total  liabilities                                                                                                                                                                                                                                                        |       | $                    | 24,208,688 |               | $          | 31,910,019 |   |
|                                                                                                                                                                                                                                                                      |       |                 |       |               |       |
| Commitments  and contingencies                                                                                                                                                                                                                                            |       |                 |       |               |       |
|                                                                                                                                                                                                                                                                      |       |                 |       |               |       |
| 5%  series A redeemable, convertible preferred stock; $.01 par value; stated  value $1,000; 19,000 shares authorized; 17,705 and 18,035 shares issued and  outstanding as of October 31, 2005 and April 30, 2005, respectively                                  |       | —               |       | —             |       |
|                                                                                                                                                                                                                                                                      |       |                 |       |               |       |
| Shareholders’  deficit:                                                                                                                                                                                                                                              |       |                 |       |               |       |
| Common  stock; $.01 par value; 240,000,000 and 95,000,000 shares authorized as of October 31,2005  and April 30, 2005 respectively; 11,513,333 and 10,849,583 shares issued  and outstanding as of October 31, 2005 and April 30, 2005,  respectively |       | 115,133              |       | 108,496            |       |
| Preferred  stock; $.01 par value; 9,981,000 and 0 shares authorized as of October 31,2005  and April 30, 2005 respectively; 0 shares issued and outstanding as of October 31,  2005 and April 30, 2005, respectively                                  |       | —               |       | —             |       |
| Additional  paid-in capital                                                                                                                                                                                                                                               |       | 23,380,500           |       | 23,386,478         |       |
| Accumulated  deficit                                                                                                                                                                                                                                                      |       | (38,490,937          | )          | (42,406,957        | )          |
| Total  shareholders’ deficit                                                                                                                                                                                                                                         |       | (14,995,304          | )          | (18,911,983        | )          |
| Total  liabilities and shareholders’ deficit                                                                                                                                                                                                                         |       | $                    | 9,213,384  |               | $          | 12,998,036 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

3

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**MEDICALCV,INC.**

**Statementsof Operations**

**(unaudited)**

 
| ** **                                                 | ** ** | **Three months ended October 31,** | ** ** | **Six months ended October 31,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                 | ** ** | **2005**                                | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                 | ** ** | ** **                              | ** ** | **(Restated)**                        | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| Operating  expenses, continuing operations:                |       |                                    |       |                                  |       |   |   |   |   |
| Sales  and marketing                                       |       | $                                       | 28,617     |                                  | $          | — |   | $ | 133,834 |   | $ | — |   |
| General  and administrative                                |       | 721,251                                 |       | 848,082                               |       | 1,484,580 |   | 1,716,867 |   |
| Research  and development                                  |       | 789,450                                 |       | —                                |       | 1,192,675 |   | — |   |
| Engineering  and regulatory                                |       | —                                  |       | 385,967                               |       | — |   | 698,177 |   |
| Total  operating expenses                                  |       | 1,539,318                               |       | 1,234,049                             |       | 2,811,089 |   | 2,415,044 |   |
| Loss  from operations                                      |       | (1,539,318                              | )          | (1,234,049                            | )          | (2,811,089 | ) | (2,415,044 | ) |
| Other  income (expense):                                   |       |                                    |       |                                  |       |   |   |   |   |
| Decrease  in warrant liability                             |       | 822,164                                 |       | —                                |       | 7,276,102 |   | — |   |
| Interest  income                                           |       | 77,068                                  |       | 815                                   |       | 146,030 |   | 3,655 |   |
| Interest  expense                                          |       | (21,043                                 | )          | (112,354                              | )          | (100,079 | ) | (292,774 | ) |
| Other  income (expense)                                    |       | (4,664                                  | )          | 2,660                                 |       | (3,604 | ) | 2,972 |   |
| Total  other income (expense)                              |       | 873,525                                 |       | (108,879                              | )          | 7,318,449 |   | (286,147 | ) |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Income  (loss) from continuing operations                  |       | (665,793                                | )          | (1,342,928                            | )          | 4,507,360 |   | (2,701,191 | ) |
| Income  (loss) from discontinued operations                |       | (46,681                                 | )          | (1,217,442                            | )          | (149,650 | ) | (1,113,835 | ) |
| Net  income (loss)                                         |       | $                                       | (712,474   | )                                     | $          | (2,560,370 | ) | $ | 4,357,710 |   | $ | (3,815,026 | ) |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Basic  and dilutive income (loss) to common shareholders   |       |                                    |       |                                  |       |   |   |   |   |
| Net  income (loss)                                         |       | (712,474                                | )          | (2,560,370                            | )          | 4,357,710 |   | (3,815,026 | ) |
| Convertible  preferred stock dividends                     |       | (223,058                                | )          | —                                |       | (441,691 | ) | — |   |
| Net  income (loss) to common shareholders                  |       | $                                       | (935,532   | )                                     | $          | (2,560,370 | ) | $ | 3,916,019 |   | $ | (3,815,026 | ) |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Earning  (loss)  per share - Continuing  operations   |       |                                    |       |                                  |       |   |   |   |   |
| Basic                                                      |       | $                                       | (0.06      | )                                     | $          | (0.13 | ) | $ | 0.40 |   | $ | (0.26 | ) |
| Diluted                                                    |       | (0.06                                   | )          | (0.13                                 | )          | (0.13 | ) | (0.26 | ) |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Earning  (loss)  per share - Discontinued  operations |       |                                    |       |                                  |       |   |   |   |   |
| Basic                                                      |       | (0.00                                   | )          | (0.11                                 | )          | (0.01 | ) | (0.10 | ) |
| Diluted                                                    |       | (0.00                                   | )          | (0.11                                 | )          | (0.01 | ) | (0.10 | ) |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Earnings  (loss) per share                                 |       |                                    |       |                                  |       |   |   |   |   |
| Basic                                                      |       | (0.08                                   | )          | (0.24                                 | )          | 0.35 |   | (0.36 | ) |
| Diluted                                                    |       | (0.08                                   | )          | (0.24                                 | )          | (0.16 | ) | (0.36 | ) |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Weighted  average shares used                              |       |                                    |       |                                  |       |   |   |   |   |
| Basic                                                      |       | 11,411,811                              |       | 10,730,833                            |       | 11,218,116 |   | 10,554,969 |   |
| Diluted                                                    |       | 11,411,811                              |       | 10,730,833                            |       | 21,241,795 |   | 10,554,969 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

4

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**MEDICALCV,INC.**

**Statementsof Cash Flows**

**(unaudited)**

 
| ** **                                                                                         | ** ** | **Six months ended October 31,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                         | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Cash  flows from operating activities:                                                             |       |                                  |       |   |   |
| Net  income (loss)                                                                                 |       | $                                     | 4,357,710  |   | $ | (3,815,026 | ) |
| Adjustments  to reconcile net income (loss) to net cash used in operating activities:              |       |                                  |       |   |   |
| Depreciation                                                                                       |       | 129,793                               |       | 144,067 |   |
| Decrease  in warrant liability                                                                     |       | (7,276,102                            | )          | — |   |
| Provision  for doubtful accounts                                                                   |       | 23,935                                |       | 117,412 |   |
| Provision  for inventory obsolescence                                                              |       | —                                |       | 1,277,691 |   |
| Stock-based  compensation                                                                          |       | —                                |       | 903 |   |
| Interest  and other expense related to issued warrants and amortization of loan  origination costs |       | —                                |       | 14,292 |   |
| Changes  in assets and liabilities:                                                                |       |                                  |       |   |   |
| Accounts  receivable                                                                               |       | —                                |       | 577,823 |   |
| Inventories                                                                                        |       | —                                |       | (84,768 | ) |
| Prepaid  expenses and other assets                                                                 |       | 889,783                               |       | 98,850 |   |
| Accounts  payable                                                                                  |       | (150,596                              | )          | (32,562 | ) |
| Accrued  expenses                                                                                  |       | (157,980                              | )          | 45,348 |   |
| Net  cash used in operating activities                                                             |       | (2,183,457                            | )          | (1,655,970 | ) |
|                                                                                               |       |                                  |       |   |   |
| Cash  flows from investing activities:                                                             |       |                                  |       |   |   |
| Purchase  of property, plant and equipment                                                         |       | (307,264                              | )          | (12,169 | ) |
| Proceeds  from the sale of property, plant and equipment                                           |       | —                                |       | 23,123 |   |
| Purchase  of other long-term assets                                                                |       | —                                |       | (152,500 | ) |
| Net  cash used in investing activities                                                             |       | (307,264                              | )          | (141,546 | ) |
|                                                                                               |       |                                  |       |   |   |
| Cash  flows from financing activities:                                                             |       |                                  |       |   |   |
| Payments  of term debt                                                                             |       | —                                |       | (500,000 | ) |
| Deferred  financing costs                                                                          |       | —                                |       | 12,739 |   |
| Proceeds  from the issuance of common stock and warrants, net of offering costs                    |       | —                                |       | 2,000,608 |   |
| Preferred  dividend paid                                                                           |       | (441,691                              | )          | — |   |
| Proceeds  from exercise of options                                                                 |       | 660                                   |       | — |   |
| Principal  payments under related party lease obligations                                          |       | (116,653                              | )          | (136,155 | ) |
| Net  cash provided by (used in) financing activities                                               |       | (557,684                              | )          | 1,377,192 |   |
|                                                                                               |       |                                  |       |   |   |
| Net  decrease in cash and cash equivalents                                                         |       | (3,048,405                            | )          | (420,324 | ) |
| Cash  and cash equivalents at beginning of year                                                    |       | 10,637,796                            |       | 659,856 |   |
| Cash  and cash equivalents at end of period                                                        |       | $                                     | 7,589,391  |   | $ | 239,532 |   |
|                                                                                               |       |                                  |       |   |   |
| Supplemental  disclosure of cash flow information:                                                 |       |                                  |       |   |   |
|                                                                                               |       |                                  |       |   |   |
| Cash  paid for interest                                                                            |       | $                                     | 105,667    |   | $ | 112,829 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

5

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**MEDICALCV,INC.**

 

**Notesto Financial Statements**

 

**(1)****                                 Basisof Financial Statement Presentation**

 

The accompanyingunaudited financial statements included herein have been prepared by MedicalCV, Inc.(the “Company”) in accordance with accounting principles generally accepted inthe United States of America for interim financial information and pursuant tothe rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America have been condensed or omitted pursuant to suchrules and regulations.  These interim financial statements should beread in conjunction with the financial statements and the notes theretoincluded in the Company’s Annual Report on Form 10-KSB, as amended, forthe fiscal year ended April 30, 2005.

 

The balance sheet as of October 31,2005, the statements of operations for the three and six months ended October 31,2005 and 2004, and the statements of cash flows for the six months ended October 31,2005 and 2004 include, in the opinion of management, all adjustments,consisting solely of normal recurring adjustments, necessary for a fairpresentation of the financial results for the respective interim periods andare not necessarily indicative of results of operations to be expected for theentire fiscal year ending April 30, 2006.

 

***Restatement of Financial Statements***

 

The Company has restated its financial statements for the three andsix-month periods ended October 31, 2004, to correct the classification ofcertain general and administrative expenses from continuing operations todiscontinued operations.  The costs forwhich the classification has been corrected are related directly to theCompany’s discontinued heart valve business (see Note 5).  The Company has made the appropriatemodifications to the statement of operations to give effect to the correctionin classification of $25,988 of general and administrative expenses todiscontinued operations.

 

The change in classification described above had no effect on theCompany’s net loss or net loss per share, nor any effect on the Company’sbalance sheet or statement of cash flows. The table below presents the effect of this change in classification.

 
| ** **                                                                     | ** ** | **Three months ended  October 31, 2004** | ** ** | **Six months ended  October 31, 2004** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                     | ** ** | **As Previously  Reported**              | ** ** | **As Restated**                        | ** ** | **As Previously  Reported** | ** ** | **As Restated** | ** ** |
| General and administrative expenses                                            |       | $                                        | 874,070    |                                   | $          | 848,082 |   | $ | 1,742,855 |   | $ | 1,716,867 |   |
| Total operating expenses                                                       |       | 1,260,037                                |       | 1,234,049                              |       | 2,441,032 |   | 2,415,044 |   |
| Loss from operations                                                           |       | (1,260,037                               | )          | (1,234,049                             | )          | (2,441,032 | ) | (2,415,044 | ) |
| Income (loss) from continuing operations                                       |       | (1,368,916                               | )          | (1,342,928                             | )          | (2,727,179 | ) | (2,701,191 | ) |
| Income (loss) from discontinued operations                                     |       | (1,191,454                               | )          | (1,217,442                             | )          | (1,087,847 | ) | (1,113,835 | ) |
| Net income (loss)                                                              |       | (2,560,370                               | )          | (2,560,370                             | )          | (3,815,026 | ) | (3,815,026 | ) |
| Earnings (loss)  per share—Continuing Operations—basic and diluted   |       | $                                        | (.13       | )                                      | $          | (.13 | ) | $ | (.26 | ) | $ | (.26 | ) |
| Earnings (loss)  per share—Discontinued Operations—basic and diluted |       | $                                        | (.11       | )                                      | $          | (.11 | ) | $ | (.10 | ) | $ | (.10 | ) |
| Earnings (loss) per share—basic and diluted                               |       | $                                        | (.24       | )                                      | $          | (.24 | ) | $ | (.36 | ) | $ | (.36 | ) |
|                                                                                |            |                                          |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |

 

**(2)****                                 GoingConcern**

 

The Company’s financialstatements for the quarter ended October 31, 2005, have been prepared on agoing concern basis, which contemplates the realization of assets andsettlement of liabilities and commitments in the normal course ofbusiness.  The Company has sustained losses and negative cash flows fromoperations in recent years and expects these conditions to continue for theforeseeable future.  At October 31, 2005, the Company had anaccumulated deficit of $38,490,937.  Although the Company raised fundsthrough the sale of convertible preferred stock in the last quarter of fiscalyear 2005, the level of cash required for operations during fiscal year 2006 isdifficult to predict, and management anticipates that development of its newproducts will require additional capital by the first quarter of fiscal year2007.  These matters raise substantial doubt about the Company’s abilityto continue as a going concern.  Management intends to seek additionaldebt or equity financing as it continues development of new products. However, the Company may not be able to obtain such financing on acceptableterms or at all.  If the Company is unable to obtain such additionalfinancing, it will be required to significantly revise its business plans anddrastically reduce operating expenditures such that it may not be able todevelop or enhance its products, gain market share in the United States ofAmerica or respond to competitive pressures or unanticipated requirements,which could seriously harm its business, financial position and results ofoperations.

 

The Company is subject torisks and uncertainties common to medical technology-based companies, includingrapid technological change, new product development and acceptance, actions ofcompetitors and regulators, dependence on key personnel and market penetration.

 

**(3)****                                 Stock-BasedCompensation**

 

The Company accounts forstock-based employee compensation arrangements in accordance with theprovisions of Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees,” and related interpretations and complies with thedisclosure provisions of Statement of Financial Accounting Standards (SFAS) No. 123,“Accounting for Stock-Based Compensation” and SFAS No. 148 “Accounting forStock-Based Compensation-Transition and Disclosure, an amendment of SFASStatement No. 123.”

 

In December 2004,the Financial Accounting Standards Board (FASB) issued a revised FAS No. 123,“Share-Based Payment (revised 2004)” (FAS No. 123R), which supersedes APB No. 25and amends FAS No. 123 to require companies to expense the value ofstock-based compensation plans. Additionally, FAS 123R, once adopted, disallowsthe use of the prospective transition method permitted by FAS No. 148. FAS123R is effective as of the beginning of the first interim reporting periodthat begins after the Company’s fiscal year ending April 30, 2006.

 

6

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For purposes of the proforma disclosures below, the estimated fair value of the options is amortizedto expense over the options’ vesting period.  Had compensation cost forthe Company’s stock options been recognized based on the fair value at thegrant date consistent with the provisions of SFAS No. 123, the Company’snet income (loss) would have been adjusted to the pro forma amounts indicatedbelow:

 
|                                                    |   | **For  the Periods Ended October 31,** |       |
|---------------------------------------------------------|--------|---------------------------------------------|------------|
|                                                    |   | **Three  Months**                           |       | **Six  Months** |   |
|                                                    |   | **2005**                                    | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** |   |
| Net income (loss) to  common shareholders               |   | $                                           | (935,532   | ) | $ | (2,560,370 | ) | $ | 3,916,019 |   | $ | (3,815,026 | ) |
|                                                    |   |                                        |       |   |   |   |   |   |   |
| Less:  Pro-forma stock-based employee compensation cost |   | (419,096                                    | )          | (100,462 | ) | (801,277 | ) | (143,963 | ) |
|                                                    |   |                                        |       |   |   |   |   |   |   |
| Net income (loss) – pro  forma                     |   | (1,354,628                                  | )          | (2,660,832 | ) | 3,114,742 |   | (3,958,989 | ) |
|                                                    |   |                                        |       |   |   |   |   |   |   |
| Basic earnings (loss)  per common share                 |   |                                        |       |   |   |   |   |   |   |
| As reported                                             |   | (.08                                        | )          | (.24 | ) | .35 |   | (.36 | ) |
| Pro forma                                               |   | (.12                                        | )          | (.25 | ) | .28 |   | (.38 | ) |
|                                                    |   |                                        |       |   |   |   |   |   |   |
| Diluted loss per common  share                          |   |                                        |       |   |   |   |   |   |   |
| As reported                                             |   | (.08                                        | )          | (.24 | ) | (.16 | ) | (.36 | ) |
| Pro forma                                               |   | (.12                                        | )          | (.25 | ) | (.20 | ) | (.38 | ) |
|                                                         |        |                                             |            |  |  |  |  |  |  |  |  |  |  |

 

**(4)****                                 Earnings(loss) per Share**

 

Earnings (loss) per commonshare are computed under the provisions of SFAS No. 128, “Earnings PerShare.”  Basic earnings (loss) per common share are computed using netincome (loss) and the weighted-average number of shares of common stockoutstanding.  Diluted earnings (loss) per common share reflect thepotential dilution of securities that could share in the earnings of anentity.  Diluted net loss per common share does not differ from basic netloss per common share in the three-month periods ended October 31, 2005and October 31, 2004 and the six-month period ended October 31, 2004since the potentially dilutive shares are anti-dilutive to net loss per common share. Potentially dilutive shares excluded from the calculation of diluted net lossper common share related to outstanding stock options and warrants totaling10,917,514 in 2005 and outstanding stock options and warrants totaling 2,329,730in 2004**.**

 
| ** **                                                                    | ** ** | **Six months ended October 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                    | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Net  income (loss) to common shareholders for basic earnings per common share |       | $                                     | 3,916,019  |   | $ | (3,815,026 | ) |
|                                                                          |       |                                  |       |   |   |
| Effect  of dilutive securities:                                               |       |                                  |       |   |   |
|                                                                          |       |                                  |       |   |   |
| Decrease  in warrant liability                                                |       | (7,276,102                            | )          | — |   |
|                                                                          |       |                                  |       |   |   |
| Net  loss to common shareholders for diluted loss per common share            |       | $                                     | (3,360,083 | ) | $ | (3,815,026 | ) |

 
| ** **                                                            | ** ** | **Six months ended October 31,** | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                            | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Weighted  average shares for basic (loss) earnings per common share   |       | 11,218,116                            |       | 10,554,969 |   |
| Effect  of dilutive securities:                                       |       |                                  |       |   |   |
| Shares  issuable under warrant agreements                             |       | 10,023,679                            |       | — |   |
| Weighted  average shares for diluted (loss) earnings per common share |       | 21,241,795                            |       | 10,554,969 |   |

 

The warrants areconsidered a common stock equivalent as they are potentially dilutive becausethey can be settled in common stock.

 

7

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**(5)****                                 DiscontinuedOperations**

 

On November 18,2004, the Company’s board of directors voted to authorize management to ceaseproduction of heart valves but to continue marketing the valves while exploringthe merits of possible strategic alternatives for the heart valve business,including, but not limited to, a joint venture with another party or the saleof the business.  Following exploration of a number of alternatives,management concluded in April 2005 that an orderly winding up of the valvebusiness was the Company’s best alternative.  On April 6, 2005, theCompany’s board authorized management to discontinue sales of heart valveseffective April 30, 2005, and to seek a buyer for the related productionequipment.

 

As a result of theCompany’s discontinuance of the heart valve business, the Company made adetermination during the fourth quarter of fiscal year 2005 that the remainingassets of the heart valve operations should be considered “held for sale”pursuant to SFAS No. 144, “Accounting for Impairment or Disposal ofLong-Lived Assets.”  (SFAS No. 144)  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 not impaired.  Management expects the disposition of theseassets will be resolved in the third quarter.  As of October 31, 2005and April 30, 2005, the carrying value of the remaining net assets of theheart valve business is reported as assets of discontinued operations on theCompany’s balance sheet.  In connection with this decision to discontinuethe sale of heart valves, the Company reduced the carrying value of certainexcess inventories, resulting in a provision recorded during fiscal year 2005of $2,573,656.  This provision was included in the 2005 loss fromdiscontinued operations.

 

Valve business revenueand loss before income taxes included in discontinued operations are asfollows:

 
| ** **                | ** ** | **For the Periods Ended October 31,** | ** ** |
|---------------------------|------------|--------------------------------------------|------------|
| ** **                | ** ** | **Three Months**                           | ** ** | **Six Months** | ** ** |
| ** **                | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues                  |       | $                                          | —     |   | $ | 459,627 |   | $ | 338,333 |   | $ | 1,255,130 |   |
|                      |       |                                       |       |   |   |   |   |   |   |
| Loss before income  taxes |       | (46,681                                    | )          | (1,217,442 | ) | (149,650 | ) | (1,113,835 | ) |
|                           |            |                                            |            |  |  |  |  |  |  |  |  |  |  |

 

The carrying amounts andmajor classes of the assets and liabilities, which are presented as assets andliabilities of discontinued operations on the accompanying balance sheet as of October 31,2005 and April 30, 2005, are as follows:

 
| ** **                                                                                                                     | ** ** | **October 31, 2005** | ** ** | **April 30, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|-------------------------|------------|
| **ASSETS**                                                                                                                     |       |                      |       |                    |       |
| Accounts  receivable, net of allowance of $37,909 and $196,521 at October 31, 2005  and April 30, 2005, respectively |       | $                         | —     |                    | $          | 557,291 |   |
| Inventories                                                                                                                    |       | —                    |       | 228,665                 |       |
| Prepaid  expenses                                                                                                              |       | 44,891                    |       | 89,692                  |       |
| Total  current assets of discontinued operations                                                                               |       | $                         | 44,891     |                    | $          | 875,648 |   |
|                                                                                                                           |       |                      |       |                    |       |
| Property,  plant and equipment, net                                                                                            |       | $                         | 188,145    |                    | $          | 188,145 |   |
| Other  long-term assets                                                                                                        |       | 179,654                   |       | 179,654                 |       |
| Total  non-current assets of discontinued operations                                                                           |       | $                         | 367,799    |                    | $          | 367,799 |   |
|                                                                                                                           |       |                      |       |                    |       |
| **LIABILITIES**                                                                                                                |       |                      |       |                    |       |
| Accounts  payable                                                                                                              |       | $                         | —     |                    | $          | 192,295 |   |
| Accrued  expenses                                                                                                              |       | 10,300                    |       | 10,300                  |       |
| Total  current liabilities of discontinued operations                                                                          |       | $                         | 10,300     |                    | $          | 202,595 |   |
|                                                                                                                           |       |                      |       |                    |       |
| Net  assets of discontinued operations                                                                                         |       | $                         | 402,390    |                    | $          | 1,040,852 |   |

 

8

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**(6)****                                 Restructuringand Severance Charges**

 

In the quarter ended July 31,2004 (the first quarter of fiscal year 2005), the Company restructured itsexecutive management team, resulting in the termination of two employees, whichresulted in a charge of approximately $182,000 to general and administrativeexpenses.  This charge represented the amount of future severance paymentsdue 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 additionalseverance costs of approximately $46,000, of which $20,000 is included ingeneral and administrative expenses and $26,000 (restated) is included indiscontinued operations.  In the quarterended January 31, 2005, the Company terminated an additional elevenemployees resulting in approximately $48,000 of severance costs, of which$16,000 is included in general and administrative expenses and $32,000 (restated)is included in discontinued operations. During the quarter ended April 30, 2005, the Company terminated twoadditional employees resulting in approximately $32,000 of severance costscharged to general and administrative expenses.  During the quarter ended July 31,2005 (the first quarter of fiscal year 2006), the Company entered into aseparation agreement with an employee, resulting in a charge to general andadministrative expense for severance pay of $40,382. The Company paid allamounts due to these former employees by September 30, 2005.

 
| ** **                                           | ** ** | **Total**  | ** ** |
|------------------------------------------------------|------------|------------|------------|
| ** **                                           | ** ** | ** ** | ** ** |
| Restructuring charges  fiscal year 2005              |       | $          | 308,000    |   |
| Cash usage fiscal year  2005                         |       | (283,166   | )          |
| Balance as of April 30,  2005                   |       | $          | 24,834     |   |
| Severance charges first  quarter of fiscal year 2006 |       | 40,382     |       |
| Cash usage first  quarter of fiscal year 2006        |       | (37,414    | )          |
| Balance as of July 31,  2005                    |       | $          | 27,802     |   |
| Cash usage second  quarter of fiscal year 2006       |       | $          | (27,802    | ) |
| Balance as of October 31,  2005                 |       | $          | —     |   |

 

**(7)****                                 EquitySale**

 

**CommonStock and Warrants**

 

During the fourth quarterof fiscal year 2004 and the first quarter of fiscal year 2005, the Companycompleted the private sale of 2,730,763 units for $1.47 per unit.  Eachunit consisted of one share of common stock and one five-year warrant topurchase a common share for $1.60 per share.  Proceeds from the offering,net of offering costs of $452,892, were $3,561,330.  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 of218,461 units at $1.8375 per unit.  As a result of anti-dilutionadjustments through October 31, 2005, these warrants are exercisable for599,137 units at $0.67 per unit.

 

**PreferredStock and Warrants**

 

On April 1, 2005,under the terms of a Securities Purchase Agreement with accredited investors,the Company issued 18,035 shares of 5% Series A Redeemable ConvertiblePreferred Stock to such investors, warrants for the purchase of 27,052,500shares of common stock to such investors exercisable at $0.50 per share, andwarrants for the purchase in the aggregate of 1,635,960 shares of common stockto the placement agent and finder exercisable at $0.50 per share. Thesewarrants have a term of five years. The preferred stock, which is non-voting,has a stated value of $1,000 and accrues cumulative dividends at a rate of 5percent of this stated value annually.  Dividends are payable quarterlybut may, at the option of the Company, be added to the stated value rather thanpaid in cash, if certain conditions are met.  Each share of preferredstock is convertible into the number of shares of common stock equal to the$1,000 stated value divided by $0.50, subject to anti-dilutionadjustments.  As of October 31, 2005, there were 17,705 preferredshares outstanding, which may be converted into 35,410,000 shares of commonstock, subject to anti-dilution adjustments.

 

In certain circumstances,the Company may have the option to require the preferred stockholders toconvert their shares into common stock.  In the event of a fundamentaltransaction, as defined, the preferred shareholders have the right to requirethe Company to redeem the preferred shares at their stated value, including anyaccrued but unpaid dividends.  In the event of certain defaults, the preferredshareholders have the right to require the Company to redeem the preferredshares at 110 percent of their stated value, including any accrued but unpaiddividends.  As a result of these redemption provisions, the carrying valueof these preferred shares is considered to be redeemable and is reported as a “mezzanine”instrument on the Company’s balance sheet beginning on April 30,2005.  The aggregate fair value of the preferred stock outstanding was $11,331,200on October 31, 2005.  However, the carrying value of this redeemablepreferred stock is zero, net of a discount associated with the warrants issuedto the shareholders, the placement agent

 

9

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and finder, as describedbelow.

 

If the Company, at any time while shares ofpreferred stock are outstanding, issues any common stock or any common stockequivalents entitling any person to acquire shares of common stock at a priceper share less than the conversion price, then the conversion price will automaticallyadjust to the lowest conversion, exchange or purchase price for such commonstock or common stock equivalents.

 

In addition, the following events could resultin a reduction to the conversion price of the preferred stock:  (1) stockdividends and splits, (2) changes in the exercise or conversion price ofoutstanding warrants, rights, options or convertible securities, and (3) fundamentaltransactions (as defined), including a merger, consolidation, sale ofsubstantially all assets, tender offer, exchange offer, reclassification of theCompany’s common stock, or compulsory share exchange.

 

The following issuances are excepted fromapplication of these anti-dilution provisions:  (1) issuances ofsecurities upon the exercise or conversion of any common stock or common stockequivalent issued prior to the issuance of the preferred stock, (2) grantsof common stock equivalents under duly authorized stock option, restrictedstock or stock purchase plans, and the issuance of common stock in respectthereof, (3) issuances of securities pursuant to the transaction documents(as defined), (4) the issuance of up to an aggregate of 1,680,000 sharesof common stock underlying warrants to the Company’s placement agent and its finderas compensation in connection with the issuance of the preferred stock, (5) theissuance of an aggregate of 10,000,000 shares of common stock or common stockequivalents in connection with strategic transactions (as defined), of which upto 3,000,000 shares of common stock or common stock equivalents may be issuedin connection with strategic transactions not approved by the Company’sshareholders, (6) the issuance of up to an aggregate of 1,000,000 sharesof common stock or common stock equivalents to the Company’s primary landlordin connection with any restructuring of its headquarters’ lease, and (7) theissuance of up to an aggregate of 8,171,000 shares of common stock pursuant tooptions that may be issued to members of the Company’s management.

 

The preferred stock is not currently redeemableat the option of the preferred stockholders or at the Company’s option. The preferred stock will become redeemable, at a price per share equal to 110percent of the stated value plus any accrued but unpaid dividends, at theoption of the preferred stockholders in the following conditions:

 

•                                          If we fail tocomply with terms of the securities purchase agreement, the preferred stock,the certificate of designation relating to the preferred stock, theregistration rights agreement, the escrow agreement, the warrants or any otherdocuments or agreements executed in connection with the preferred stocktransaction (the “transaction documents”), or

 

•                                          If (1) atleast 25 percent of the shares of preferred stock are outstanding, (2) theCompany enters into any agreement with respect to a change in controltransaction (as defined), including a fundamental transaction (as defined), (3) theCompany does not obtain the affirmative vote of the holders of at least amajority of the shares of preferred stock then outstanding for the change incontrol transaction, and (4) the equity conditions (as defined) are notsatisfied with respect to all of the shares of common stock then issuable onaccount of all outstanding shares of preferred stock.

 

Although it is possible that, in the future,the Company will sell or merge the Company or fail to comply with the terms ofthe transaction documents, at this time, the Company does not believe that itis probable that these conditions will occur.  The Company does not believeredemption is probable because it believes it is in compliance with terms ofthe transaction documents and we are not presently engaged in any activitiesthat suggest that a sale or merger of the Company is probable.

 

Consistent with EITF Topic D-98, because theCompany does not believe that redemption is probable, it has not accreted thecarrying value of the preferred stock to its redemption value.  However,the Company has disclosed and will continue to disclose the aggregateliquidation value of the preferred stock.  If redemption becomes probable,the Company will accrete the carrying value of the preferred stock to itsredemption value and charge paid-in capital (based upon the absence of retainedearnings).  If there are subsequent increases or decreases in theredemption value of the preferred stock, the Company will also record suchincreases and decreases as charges to paid-in capital.

 

10

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In connection with the Securities Purchase Agreement,the Company entered into a Registration Rights Agreement with the investorswhereby it agreed to prepare and file with the SEC registration statementscovering the resale of all registrable securities on a continuous basis, and touse the Company’s best efforts to keep the registration statement effectiveuntil the earlier of the fifth anniversary after its effective date or the dateon which all of such securities have been sold or may be sold by the holderspursuant to SEC Rule 144(k).  Such registration statement(s) are at the expense of the Company.  If a registration statement is notfiled on or before its filing date, or a registration statement is not declaredeffective on or before a required effectiveness date, or, after its effectivedate, a registration statement ceases to be effective for more than anaggregate of 40 trading days in any 12-month period, the Company has agreed topay each preferred shareholder an amount as liquidated damages equal to 1.5percent of the aggregate investment amount originally paid by the holder forshares pursuant to the securities purchase agreement and on each monthlyanniversary of the Company’s failure to effect such registration (in theaggregate, this equates to approximately $9,000 per day).  There is no capon the amount of liquidated damages the Company may be required to pay underthis agreement.

 

The Company has also agreed to customaryprovisions with respect to the indemnification of investors, their officers,directors, agents, investment advisors, partners, members and employees andcontrolling persons against losses and expenses incurred or arising out ofuntrue or alleged untrue statements of material fact in any registrationstatement or prospectus, and the holders have agreed to indemnify the Company,its directors, officers, agents, employees and controlling persons againstlosses arising out of an investor’s failure to comply with prospectus deliveryrequirements or any untrue statement of material fact in any registrationstatement or prospectus furnished by an investor in writing for use therein.

 

The significant terms of each settlementalternative, including the entity that controls such alternative, are set forthbelow.

 

The preferred stock is convertible into commonstock at the then applicable conversion ratio, at the option of a holder, atany time.  In general, the number of shares of common stock that may beacquired by a holder upon any conversion of preferred stock is limited to theextent necessary to ensure that, following such conversion, the total number ofshares then beneficially owned by such holder does not exceed 9.999% of thetotal number of issued and outstanding shares of common stock.

 

All, but not less than all, of the outstandingpreferred stock also is convertible into common stock at the then applicableconversion ratio, at the Company’s option, in either of the followingscenarios:  if (A) following the second anniversary of the issuanceof the preferred stock, (1) the daily volume weighted average price of thecommon stock for each of 20 consecutive trading days is greater than $1.50, (2) thedaily trading volume of the common stock on its trading market is at least40,000 shares during such period, and (3) all of the equity conditions (asdefined) are satisfied, or (B) the Company closes an underwritten publicoffering of its common stock at a price per share of at least $4.00 and receivegross proceeds in such offering of not less than $15,000,000.  If the9.999% limitation described above would restrict the ability of a holder toconvert the full amount of its preferred stock, then the conversion notice theCompany would send to such holder would be deemed automatically amended toapply only to such portion as may be converted.

 

Upon any liquidation, dissolultion orwinding-up, whether voluntary or involuntary, by operation of law or otherwise,the holders of the preferred stock would be entitled to receive out of theCompany’s assets for each share of preferred stock an amount equal to thestated value per share before any distribution or payment is made to theholders of any junior securities.

 

In addition, at each holder’s option andrequest, any successor to the Company or surviving entity in a fundamentaltransaction (as defined), will either issue to such holder shares of preferredstock having rights, privileges and preferences substantially similar to therights, privileges and preferences of the preferred stock, or purchase thepreferred stock from the holder for a purchase price equal to the sum of (1) thegreater of (A) the stated value of the preferred stock held by such holderand (B) the stated value of the preferred stock divided by the applicableconversion price multiplied by the applicable closing price, and (2) allthen accrued and unpaid dividends, liquidated damages and other amounts owingin respect of such preferred stock.

 

The Company is requiredto register the common shares underlying the preferred stock conversion optionand the purchaser warrants.  If the Company does not meet certainregistration deadlines, the preferred stockholders will be entitled toliquidated damages, as defined.  In the event of a fundamentaltransaction, as defined, the warrants issued to the preferred shareholders, theplacement agent and finder, all provide the warrant holders with the right toput the

 

11

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warrants to the Companyfor cash in an amount equal to the fair value of the warrants, as determinedusing the Black-Scholes option pricing model.  As a result of this putright, the warrants are reported at their fair value as a liability on theCompany’s balance sheet beginning on April 30, 2005, and future changes inthe fair value of the warrant will result in charges or benefits to the Company’sresults of operations. The fair value of these warrants upon closing of thepreferred stock sale was $22,271,047.  Because the fair value of thesewarrants at April 30, 2005, exceeded the proceeds received in thepreferred stock and warrant issuances, the excess of the fair value of the warrantsover the proceeds received (including the converted debt) was recognized as aninterest charge of $4,266,047 upon closing.  During the period betweenclosing and April 30, 2005, the fair value of these warrants increased to$27,992,609.  The Company reported this $5,721,562 increase in fair valueas other expense in the fourth quarter of fiscal year 2005. During the quartersended July 31, 2005 and October 31, 2005, the fair value of thesewarrants decreased to $21,538,671 and $20,716,507, respectively. The Companyreported the $6,453,938 and $822,164 decrease in fair value as a decrease inwarrant liability in other income (expense) in the first and second quarters offiscal year 2006.

 

The Company measured thefair value of the warrant liability using the Black Scholes option pricingmodel. The Company will continue to value the warrants using this model infuture periods. The Company believes this is the appropriate valuation modelbecause the redemption terms of the warrants provide for the holders to putthem to the Company at their fair value as measured using the Black Scholesmodel.  The assumptions used to value thewarrants when they were issued on April 1, 2005 and when they were valuedat the end of the Company’s 2005 fiscal year (April 30, 2005) and at October 31,2005 are as follows:

 
| ** **              | ** ** | **April 1,  2005 and April 30, 2005** | ** ** | **October 31,  2005** | ** ** |
|-------------------------|------------|-------------------------------------------------|------------|----------------------------|------------|
| Term                    |       | 5 years                                         |       | 4.5 years                  |       |
| Expected volatility     |       | 116%                                            |       | 129%                       |       |
| Risk-free interest rate |       | 4.24%                                           |       | 4.22%                      |       |
| Expected dividend yield |       | 0                                               |       | 0                          |       |

 

The terms related to changes in the exerciseprice of the warrants are set forth below.

 

If the Company, at any time while the warrantsare outstanding, issue any common stock or any common stock equivalentsentitling any person to acquire shares of common stock at a price per shareless than the exercise price, then the exercise price will automatically adjustto the lowest conversion, exchange or purchase price for such common stock orcommon stock equivalents.

 

In addition, the following events could resultin a reduction to the exercise price of the warrants:  (1) stockdividends and splits, (2) changes in the exercise or conversion price ofoutstanding warrants, rights, options or convertible securities, and (3) fundamentaltransactions (as defined), including a merger, consolidation, sale ofsubstantially all assets, tender offer, exchange offer, reclassification of theCompany’s common stock, or compulsory share exchange.

 

The following issuances are excepted fromapplication of these anti-dilution provisions:  (1) issuances ofsecurities upon the exercise or conversion of any common stock or common stockequivalent issued prior to the issuance of the preferred stock, (2) grantsof common stock equivalents under duly authorized stock option, restrictedstock or stock purchase plans, and the issuance of common stock in respectthereof, (3) issuances of securities pursuant to the transaction documents(as defined), (4) the issuance of up to an aggregate of 1,680,000 sharesof common stock underlying warrants to the Company’s placement agent and its finderas compensation in connection with the issuance of the preferred stock, (5) theissuance of an aggregate of 10,000,000 shares of common stock or common stockequivalents in connection with strategic transactions (as defined), of which upto 3,000,000 shares of common stock or common stock equivalents may be issuedin connection with strategic transactions not approved by the Company’sshareholders, (6) the issuance of up to an aggregate of 1,000,000 sharesof common stock or common stock equivalents to our primary landlord inconnection with any restructuring of our headquarters’ lease, and (7) theissuance of up to an aggregate of 8,171,000 shares of common stock pursuant tooptions that may be issued to members of the Company’s management.

 

As the events that could trigger a reduction inthe exercise price are contingent and currently not probable there has been noreduction to the exercise price of the warrants to date.  In the eventthat one of the events described above becomes probable, the measurement of theeffect of the change in the exercise price of the warrant liability will be measuredand recorded through the Company’s periodic mark-to-market adjustment of thewarrant liability.

 

12

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The Company obtainedgross cash proceeds of $13,603,000 at the closing (net of $30,000 in legal feeswhich were withheld by the lead investor).  The Company also converted$4,402,000 of indebtedness into the above-referenced securities.  TheCompany incurred cash offering costs of $817,980, including agent commissions,a finder’s fee and out-of-pocket expense reimbursements to certain thirdparties.  The Company also paid legal and administrative expenses of$18,086 incurred by PKM Properties, LLC (“PKM”) in this transaction.  PKMis an entity controlled by Paul K. Miller.  Mr. Miller serves on theCompany’s Board of Directors and is our largest shareholder.

 

**(8)****                                 SegmentInformation**

 

The Company views itsoperations and manages its business as one segment, the manufacturing andmarketing of cardiothoracic surgery devices.  Factors used to identify theCompany’s single operating segment include the organizational structure of theCompany and the financial information available for evaluation by chiefoperating decision maker.

 

The following tablesummarizes net sales by geographic area:

 
| ** **    | ** ** | **Six Months Ended October 31,** | ** ** |
|---------------|------------|---------------------------------------|------------|
| ** **    | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **    | ** ** | **(unaudited)**                       | ** ** |
| Europe        |       | $                                     | 279,435    |   | $ | 600,317 |   |
| Middle East   |       |                                  |       | 346,088 |   |
| Far East      |       |                                  |       | 15,424 |   |
| United States |       | 58,898                                |       | 260,398 |   |
| Other         |       |                                  |       | 32,903 |   |
| **TOTALS**    |       | $                                     | 338,333    |   | $ | 1,255,130 |   |

 

All sales listed in thetable above relate to heart valves, a product the Company no longer sells.  These sales are reported as part ofdiscontinued operations.  The last sale occurredin May 2005, as such there were no reported revenues in the quarter ended October 31,2005.

 

**(9)****                                 EmploymentContracts**

 

In August 2005, theCompany entered into an employment agreement with its President and CEO and itsVice President, Finance and CFO.  Bothcontracts give the executive and the Company the right to terminate thecontract with or without cause with sixty (60) day written notice.  The contracts also contain a provision forlump sum payments of up to twelve months severance if the executive isterminated without cause by the Company or for good reason by the executive asdefined in the contracts.  The contractsalso contain various other provisions.

 

13

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**ITEM 2****                                MANAGEMENT’SDISCUSSION AND ANALYSIS OR PLAN OF OPERATION**

 

*Thefollowing discussion contains various forward-looking statements within themeaning of Section 21E of the Exchange Act.  Although we believethat, in making any such statement, our expectations are based on reasonableassumptions, any such statement may be influenced by factors that could causeactual outcomes and results to be materially different from thoseprojected.  When used in the following discussion, the words “anticipates,”“believes,” “expects,” “intends,” “plans,” “estimates” and similar expressions,as they relate to us or our management, are intended to identify suchforward-looking statements.  These forward-looking statements are subjectto numerous risks and uncertainties that could cause actual results to differmaterially from those anticipated.  Factors that could cause actualresults to differ materially from those anticipated, certain of which arebeyond our control, are set forth in this document and in our Annual Report on Form 10-KSB,as amended, for the fiscal year ended April 30, 2005, under the caption “Management’sDiscussion and Analysis or Plan of Operation — Cautionary Statement.”*

 

*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 attributingundue certainty to any forward-looking statements, which speak only as of thedate of the document in which they appear.*

 

**Restatement**

 

Asdiscussed in Note 1 to our financial statements, we restated our financialstatements for the three and six-month periods ended October 31, 2004, tocorrect the classification of certain general and administrative expenses fromcontinuing operations to discontinued operations.  The costs for which the classification hasbeen corrected are related directly to our discontinued heart valvebusiness.  The correction inclassifications had no effect on our net loss or net loss per share, nor anyeffect on our balance sheet or statement of cash flows.  The “Results of Operations for the ThreeMonths Ended October 31, 2005 and 2004” and the “Results of Operations for theSix Months Ended October 31, 2005 and 2004” sections of this Management’sDiscussion and Analysis or Plan of Operation have been corrected to reflectthis restatement. 

 

**Overview**

 

Our core technology isthe ATRILAZETM Surgical Ablation System for use in cardiac tissueablation procedures in open-heart surgery.  We acquired this technology inAugust 2003 and received FDA 510(k) clearance in November 2004. The AtriLaze system is currently being utilized as a potential means to treatatrial fibrillation in concomitant open-heart surgical procedures.

 

Atrial fibrillation, orAF, is the most commonly occurring cardiac arrhythmia.  It reduces cardiacoutput, is a major precursor to congestive heart failure and is associated withan increased incidence of stroke.  The incidence of AF increases withage.  Approximately 5.5 million people worldwide are afflicted with AF. There are 320,000 new diagnoses annually worldwide.  Approximately 2.5million Americans are afflicted with AF, with 160,000 new diagnoses each yearin the U.S.

 

With our presence in thecardiovascular surgery market, we intend during the next 12 to 18 months todefine the market and develop a stand-alone, minimally invasive (closed-chest,beating heart) surgical procedure for ablating cardiac tissue as a potentialmeans to treat AF.

 

Previously, our primaryfocus was on heart valve disease.  We developed and marketed mechanicalheart 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 were unsuccessful and thatwe would stop selling heart valves and were exiting the heart valvebusiness.  At that time, we also determined to direct all of our resourcesto the development and introduction of products targeting the treatment of AF.

 

Although our AtriLazesystem is being used by cardiovascular surgeons at select centers to ablatecardiac tissue in human concomitant open-heart surgical procedures, we have notgenerated any revenue from these procedures.  We have been providing our AtriLazesystem to these surgeons at no cost for proof-of-concept in the clinicalsetting, prior to commencing clinical sales of our AtriLaze system.  We werevalidating our technology with key cardiovascular surgeons in concomitantopen-heart procedures for the first half of fiscal year 2006.  We expectto begin selling hand-held devices for these procedures on a limited basisbeginning in the second half of fiscal year 2006.  We do not expectsignificant revenue until we introduce a version of our AtriLaze system forstand-alone, minimally invasive (closed-chest, beating heart) ablation ofcardiac tissue.

 

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

 

14

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**PeriodsEnded October 31, 2005 and 2004**

 

**CriticalAccounting Policies**

 

For discussion of ourcritical accounting policies and estimates, see our Annual Report on Form 10-KSB,as amended, for the fiscal year ended April 30, 2005.

 

In June, 2005 the Financial Accounting Standards Board (FASB) issuedDIG Issue B 38.  This implementationissue requires companies to assess whether puts and calls embedded in financialcontracts, require that the host contract and embedded derivative be bifurcatedand valued separately.  DIG Issue B 38specifically addresses debt host contracts.

 

At the time we sold our preferred stock instrument we concluded that itis an equity host contract.  We alsoconcluded that DIG Issue B 38, which is effective for fiscal periods beginningafter December 15, 2005, will not apply to the put obligation embedded in ourpreferred stock.

 

**Resultsof Operations for the Three Months Ended October 31, 2005 and 2004**

 

*Salesand Marketing*.  Sales and marketing expenses in the quarterended October 31, 2005 were $28,617 compared to $0 in the same period lastfiscal year. Sales and marketing expenses for the quarter ended October 31,2005 were comprised of expenses related to the marketing of our AtriLazeproduct. Sales and marketing expenses for the quarter ended October 31,2004, related entirely to heart valve sales and were classified as part ofdiscontinued operations in fiscal year 2005.

 

*Generaland Administrative*.  General and administrative expensesfor the quarter ended October 31, 2005, were $721,251 compared to $848,082in the prior year.  The major componentsin the reduction in general and administrative expense were a reduction inoutside consulting fees of $257,000 and a reduction in severance costs of $20,000.  These reductions were offset by increases inpersonnel costs of $117,000 and increased travel expense of $34,000.

 

*Researchand Development / Engineering and Regulatory.* Consistent with our decision to exit the heart valve business and focuson our AtriLaze product, we have included our Engineering and Regulatoryexpenditures in Research and Development for the quarter ended October 31,2005.  As a result of this, research and development expenses for thequarter ended October 31, 2005 were $789,450 compared to $0 in the prioryear.  Engineering and regulatory expenses for the quarter ended October 31,2005 were $0 compared to $385,967 in the prior year.  The increase in total research anddevelopment/engineering and regulatory expenses was attributable to increasedpersonnel costs of $57,000, increased outside consulting fees of $98,000,increased advisory board fees and expenses of $83,000, increased material costsof $50,000, increases in clinical studies of $77,000 and increased travelexpense of $44,000.

 

*Other(Expense) Income*.  Interest expense totaled $21,043 inthe quarter ended October 31, 2005, compared to $112,354 in the comparableperiod last fiscal year.  The decrease in interest expense was due to thedecreased amount of borrowings outstanding.  Due to the decrease in ourstock price at October 31, 2005, we recorded a reduction to the fair valueof our warrant liability of $822,164 during the quarter ended October 31,2005.  The accounting for the warrants issued in connection with our April 1,2005, preferred stock sale is discussed more fully in Liquidity and CapitalResources on the following pages.  Interest income for the quarter ended October 31,2005 was $77,068 compared to $815 for the quarter ended October 31,2004.  The increase was due to theadditional cash available for investment in fiscal year 2006.

 

*IncomeTax Provision*.  In light of our history of operatinglosses, we have historically recorded a valuation allowance to fully offset ourdeferred tax assets.  We have continued to provide a full valuation allowancethrough the second quarter of fiscal year 2006 due to the inherent uncertaintyabout our ability to generate the sufficient taxable income to realize thesedeferred tax assets.  We have recorded no tax provision in the current perioddue to net operating losses generated for income tax reporting purposes.

 

**Resultsof Operations for the Six Months Ended October 31, 2005 and 2004**

 

*Salesand Marketing*.  Sales and marketing expenses for the sixmonths ended October 31, 2005 were $133,834 compared to $0 in the sameperiod last fiscal year.  As previously noted, sales and marketingexpenses for the six months ended October 31, 2005 and 2004, relatedentirely to heart valve sales and were reclassified as part of discontinuedoperations.

 

*Generaland Administrative*.  General and administrative expensesfor the six months ended October 31, 2005, were $1,484,580 compared to $1,716,867for the same period in the prior year.  Reductionsin severance expense of $194,000 and reductions in outside consulting fees of$203,000 were in part offset by increases in salaries, travel and director feesand expenses.

 

15

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*Researchand Development / Engineering and Regulatory.* Consistent with our decision to exit the heart valve business and focuson our AtriLaze product, we have included our Engineering and Regulatoryexpenditures in Research and Development for the six months ended October 31,2005.  As a result of this, research and development/engineering andregulatory expenses for the six months ended October 31, 2005 were $1,192,675compared to $698,177 for the same period in the prior year.  Increasedspending on salaries, clinical studies, materials, consulting and travelcomprised the increase in spending.

 

*Other(Expense) Income*.  Interest expense totaled $100,079 inthe six months ended October 31, 2005, compared to $292,774 in thecomparable period last fiscal year.  The decrease in interest expense wasdue to the decreased amount of borrowings outstanding after our last financingactivity.  Due to the decrease in our stock price at October 31,2005, we recorded a reduction to the fair value of our warrant liability of $7,276,102during the six months ended October 31, 2005.  The accounting for thewarrants issued in connection with our April 1, 2005, preferred stock saleis discussed more fully in Liquidity and Capital Resources on the followingpages.  Interest income totaled $146,030for the six months ended October 31, 2005 compared to $3,655 for the sameperiod in the previous fiscal year.  Theincrease was due to a greater amount of cash available in fiscal year 2006.

 

*IncomeTax Provision*.  In light of our history of operatinglosses, we have historically recorded a valuation allowance to fully offset ourdeferred tax assets.  We have continued to provide a full valuationallowance through the six months of fiscal year 2006 due to the inherentuncertainty about our ability to generate the sufficient taxable income torealize these deferred tax assets.  We have recorded no tax provision inthe six month period due to net operating losses generated for income taxreporting purposes.

 

**Liquidityand Capital Resources**

 

Cash and cash equivalentsdecreased to $7,589,391 at October 31, 2005, from $10,637,796 at April 30,2005.  This decrease in cash and cash equivalents of $3,048,405 was due tothe following:

 
| Net cash used in  operating activities    |   | $        | (2,183,457 | ) |
|-------------------------------------------|--------|----------|------------|---|
| Net cash used in  investing activities    |   | (307,264 | )          |
| Net cash used in by  financing activities |   | (557,684 | )          |
| Net decrease                              |   | $        | (3,048,405 | ) |

 

Net cash used foroperating activities increased $527,487 to $2,183,457 for the six months ended October 31,2005, from $1,655,970 for the six months ended October 31, 2004.  Theuse of cash in operations for the first six months of fiscal year 2006 wasprimarily due to net losses of $2,918,392, before the non-cash adjustment tothe fair value of the warrant liability.  The use of cash in operationsfor the first six months of fiscal year 2005 was primarily due to net losses of$3,815,026, partially offset by net non-cash adjustments of $1,554,365,relating primarily to an increase in the inventory and bad debt provisions anddepreciation.  The net decrease in cash flows from operating activitieswas also partially offset by changes in operating assets and liabilities of$604,691, relating primarily to decreases in accounts receivable and prepaidexpenses, net of an increase in inventories produced.

 

Net cash used ininvesting activities was $307,264 for the six months ended October 31,2005.  This was attributable to purchases of equipment to be used in theclinical studies for our atrial fibrillation product and the purchase of a newcomputer and accounting system as well as computer upgrades for research andadministrative personnel. Net cash used in investing activities for thesix-month period ended October 31, 2004, totaled $141,546.  We used$152,500 to purchase equipment that we will use to support customers of ourinitial atrial fibrillation product.  The funds used will be partiallyoffset by the proceeds from the sale of other equipment.

 

Net cash used by financingactivities was $557,684 for the six months ended October 31, 2005, andconsisted mainly of principal payments on the related party lease obligation of$116,653 and the payment of the preferred dividend of $441,691.  Net cashprovided by financing activities was $1,377,192 for the six months ended October 31,2004, and consisted primarily of net proceeds from the sale of common stock andwarrants of $2,000,608, offset by principal payments on related parties leasesof $136,155, and payments on term debt of $500,000.

 

Throughout fiscal year2004 and in the first quarter of fiscal year 2005, we entered into a number offinancing transactions to provide funds necessary to meet our working capitaland capital expenditure needs and to meet other obligations.  Details ofthese activities are contained in our annual report on Forms 10-KSB, asamended, for the year

 

16

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ended April 30,2005.  With the exception of the related party sale leaseback, all termdebt and lines of credit were converted to equity or repaid on April 1,2005, as part of the close on the $18 million financing described below.

 

On April 1, 2005,under the terms of a Securities Purchase Agreement with accredited investors,we issued 18,035 shares of 5% Series A Redeemable Convertible PreferredStock to such investors, warrants for the purchase of 27,052,500 shares ofcommon stock to such investors, and warrants for the purchase in the aggregateof 1,635,960 shares of common stock to the placement agent and finder. Each share of preferred stock is convertible into the number of shares ofcommon stock equal to the $1,000 stated value divided by $0.50, subject toanti-dilution adjustments.  As of October 31,2005, there were 17,705 preferred shares outstanding, which may be convertedinto 35,410,000 shares of common stock, subject to anti-dilution adjustments..

 

The preferred stock,which is non-voting, has a stated value of $1,000 and accrues cumulativedividends at a rate of 5 percent of this stated value annually.  Dividendsare payable quarterly but may, at our option, be added to the stated valuerather than paid in cash, if certain conditions are met.  The preferredstock, including any accrued dividends, are convertible, at the option of theholders, into shares of common stock at a conversion price of $0.50 pershare.  In certain circumstances, we may have the option to require thepreferred stockholders to convert their shares into common stock.  In theevent of a fundamental transaction, as defined, the preferred shareholders havethe right to require us to redeem the preferred shares at their stated value,including any accrued but unpaid dividends.  In the event of certaindefaults, the preferred shareholders have the right to require us to redeem thepreferred shares at 110 percent their stated value, including any accrued butunpaid dividends.  As a result of these redemption provisions, thecarrying value of these preferred shares is considered to be redeemable and isreported as a “mezzanine” instrument on our balance sheet beginning on April 30,2005.  The aggregate liquidation value of these redeemable preferredshares at October 31, 2005, was $17,779,039.  However, the carryingvalue of this redeemable preferred stock at October 31, 2005, was zero,net of a discount associated with the warrants issued to the shareholders, theplacement agent and the finder, as described below.

 

In connection with thepreferred stock sale, we issued the preferred stock purchasers warrants for thepurchase of 27,052,500 shares of common stock at $0.50 per share, and we alsoissued warrants for the purchase of 1,635,960 common shares at $0.50 per shareto the preferred stock placement agent and finder.  These warrants have aterm of five years.  We are required to register the common sharesunderlying the preferred stock conversion option and the purchaserwarrants.  If we do not meet certain registration deadlines, the preferredstockholders will be entitled to liquidated damages, as defined.  In theevent of a fundamental transaction, as defined, the warrants issued to thepreferred shareholders, the placement agent and finder, all provide the warrantholders with the right to put the warrants to us for cash in an amount equal tothe fair value of the warrants, as determined using the Black Scholes optionpricing model.  As a result of this put right, the warrants are reportedat their fair value as a liability on our balance sheet beginning on April 30,2005, and future changes in the fair value of the warrant will result incharges or benefits to our results of operations. The fair value of thesewarrants upon closing of the preferred stock sale was $22,271,047. Because the fair value of these warrants at April 30, 2005, exceeded theproceeds received in the preferred stock and warrant issuances, the excess ofthe fair value of the warrants over the proceeds received (including theconverted debt) was recognized as an interest charge of $4,266,047 uponclosing.  During the period between closing and April 30, 2005, thefair value of these warrants increased to $27,992,609.  We have reportedthis $5,721,562 increase in fair value as other expense in the fourth quarterof fiscal year 2005.  During the six months ended October 31, 2005,the fair value of these warrants decreased to $20,716,507.  We havereported this $7,276,102 decrease in fair value as decrease in warrantliability in other income (expense) in the first six months of fiscal year2006.

 

We obtained gross cashproceeds of $13,603,000 at the closing (net of $30,000 in legal fees which werewithheld by the lead investor).  We also converted $4,402,000 ofindebtedness into the above-referenced securities.  We incurred cashoffering costs of $817,980, including agent commissions, a finder’s fee andout-of-pocket expense reimbursements to certain third parties.  We alsopaid legal and administrative expenses of $18,086 incurred by PKM in thistransaction.

 

We expect that ouroperating losses and negative operating cash flow will continue through fiscalyear 2006 and into fiscal year 2007 as we continue adding staff to support thedevelopment and launch of our atrial fibrillation technology.  We anticipatethat our sales and marketing, general and administrative and research anddevelopment expenses will continue to constitute a material use of our cashresources.  The actual amounts and timing of our capital expenditures willvary significantly depending upon progress on our product development projectsand the availability of financing.

 

17

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We have been progressingon our business plan at a more rapid rate than originally contemplated.  Our cash balance of $7,589,390 at October 31,2005 is in line with the original plan, but we have accelerated the hiring ofour Vice President of Sales and taken other steps to go to market in the secondhalf of FY 2006.  This will result in anacceleration of our cash utilization in the coming months.  Management now estimates the cash-on-hand at October 31,2005 will last into the first quarter of fiscal year 2007.

 

Our capital requirementsmay vary depending upon the timing and the success of the implementation of ourbusiness 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 to enter the market for treating atrialfibrillation through laser ablation will:

 

•                                          beattainable;

 

•                                          beprofitable;

 

•                                          reduceour reliance upon financing transactions; or

 

•                                          enableus to continue operations.

 

**Commitmentsand Contingent Liabilities**

 

*ProductLiability Contingency.*  In March 2005, we becameaware that a patient who had been implanted with our heart valve haddied.  We have not received any claims related to this matter but believethat any such claim would be covered by our existing liability insurance. Based upon the expectation that insurance will cover the cost of any claimsafter our payment of the deductible, we do not expect the ultimate resolutionof this matter to have a material effect on our financial position, results ofoperations or cash flows.

 

*RelatedParty Lease Obligation. * On April 4, 2003, we soldour corporate headquarters, manufacturing facility and surrounding land inInver Grove Heights, Minnesota, to PKM.  In connection with thetransaction, we received total consideration of $3.84 million consisting of (1) $1.0million in cash, (2) PKM’s assumption of our $2.5 million outstandingindebtedness to Associated Bank which eliminated our indebtedness to AssociatedBank, and (3) PKM’s assumption of our promissory note with Dakota ElectricAssociation and land special assessments payable to Dakota County aggregating$336,105.

 

We simultaneously leasedback our facility pursuant to a ten-year lease, with options to renew and anoption to repurchase the facility.  We continue to utilize the facility aswe did prior to the financing transaction.  In July 2005, PKM listedthe building for sale.  PKM is seeking a buyer for the property tofacilitate our release from the remaining eight years of the lease, therebypermitting us to relocate to a more cost-effective facility.  We have anagreement with PKM that releases us from our lease if the building sells abovea certain price.  However, there can be no assurance the building will besold and that we will be successful in obtaining a release from our lease.

 

*ClinicalStudies. * We entered into agreements with several largeinstitutions to conduct clinical studies regarding certain aspects of ourOmnicarbon heart valve’s clinical performance.  The agreements run throughfiscal year 2006.  In general, recipients of clinical study payments wererequired to utilize our products in order to complete their studies and collectand submit data according to a study protocol.  As of October 31,2005, we had accrued, but not paid, $10,300 for clinical study payments. In April 2005, we announced our exit from the mechanical heart valvebusiness.  We have assigned any financial responsibility for studiesoutside the United States to our former distributors.

 

18

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*AccruedSeverance. * As part of the change in our strategic plan,we have changed personnel and eliminated certain positions; we are makingseverance payments to former officers and employees.  As of October 31,2005, our obligations were paid in full.

 
| ** **                                     | ** ** | **Total** | ** ** |
|------------------------------------------------|------------|-----------|------------|
| Restructuring charges  fiscal year 2005        |       | $         | 308,000    |   |
| Cash usage                                     |       | (283,166  | )          |
| **Balance as of April 30,  2005**         | ** ** | **$**     | **24,834** | ** ** |
| Adjustments to  provision                      |       | 40,382    |       |
| Cash usage first  quarter of fiscal year 2006  |       | (37,414   | )          |
| **Balance as of July 31,  2005**          | ** ** | **$**     | **27,802** | ** ** |
| Cash usage second  quarter of fiscal year 2006 |       | (27,802   | )          |
| **Balance as of October 31,  2005**       | ** ** | **$**     | **—** | ** ** |

 

*AtrialFibrillation Technology Purchase Agreement. * In August 2003,we entered into a technology purchase agreement with LightWave and itsprincipals relating to the acquisition of LightWave’s interests in technologyconsisting of a catheter/probe containing elements of optical fiber, coolantpassages and other features for the purpose of delivering laser energy to theepicardial surface of the heart for treatment of atrial fibrillation.  Wepaid LightWave an initial standstill payment consisting of 15,000 shares of ourcommon stock, $10,000 upon closing and an additional $30,000 to LightWave ininstallments in 2004 and 2005.  We will be obligated to pay $125,000 toLightWave within 45 days after the first commercial sale of our product in theUnited States or Europe to two or more parties and $385,000 within 45 daysfollowing our achievement of $1,500,000 of cumulative gross sales of disposableproducts.  In addition, during fiscal year 2004, we issued to LightWave awarrant for the purchase of 25,000 shares at closing and, during fiscal year2005, a warrant for the purchase of 25,000 shares upon receiving FDA 510(k)clearance.  In addition, we are obligated to issue a warrant for thepurchase of 25,000 shares upon a receipt of a U.S. utility patent covering theproduct and a warrant for the purchase of 25,000 shares upon the firstcommercial sale of our product.

 

Following the firstcommercial sale, we have agreed to pay LightWave payments equal to 6 percent ofnet sales of the LightWave product in countries in which we obtain patentprotection and 4 percent of net sales of the LightWave product in territoriesin which there is no patent protection. Commencing with the second yearfollowing our first commercial sale, we have agreed to pay minimum annualpayments as follows:

 

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

 

We are obligated to paypayments for a period of ten years following the first commercial sale. Our technology purchase agreement with LightWave contains other customaryconditions, including mutual indemnification obligations.  LightWave andtwo of its principals have agreed to certain noncompetition obligations,nondisclosure obligations, and certain obligations to assign new developmentsor inventions relating to the acquired technology to our company.  We haveagreed to use our reasonable commercial efforts to commercialize the technologywithin three years following the acquisition of the technology fromLightWave.  If we fail in any year to pay minimum annual payments, we maybe obligated to grant LightWave a nonexclusive right to use the technologyacquired from LightWave, or pay LightWave the difference between paymentsactually made and minimum payments due for a given year.

 

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The following tablesummarizes our contractual obligation as of October 31, 2005, excludingpayments that are contingent upon achievement of future development of salesmilestones, as described 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)       |       | $                          | 2,873,700  |   | $ | 370,800 |   | $ | 746,235 |   | $ | 1,756,665 |   |
| Clinical Studies                         |       | 10,300                     |       | 10,300 |   | — |   | — |   |
| TOTAL CONTRACTUAL  OBLIGATIONS           |       | $                          | 2,884,000  |   | $ | 381,100 |   | $ | 746,235 |   | $ | 1,756,665 |   |

 

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(1)                                  Futurepayments include interest due.

 

**Qualitativeand Quantitative Disclosures about Market Risk**

 

We have discontinuedsales of the heart valve and are focusing all of our resources on thedevelopment and introduction of our ATRILAZE Surgical Ablation System. Sales in fiscal year 2006 are not expected to be material, and we expectthat any sales will be in the United States denominated in U.S. dollars. Our interest income and expenses are sensitive to changes in the general levelof U.S. interest rates, particularly since our investments are in short-terminstruments.  In June 2005, we placed a majority of our temporarilyidle cash in a fund managed by a large brokerage firm.  This fund buys,sells and holds interest rate sensitive investments.  If investors in thefund tried to redeem a significant portion of their shares simultaneously, thefund might be forced to sell investments below cost and we could incur a lossof principal in addition to a reduction or loss of interest.  Based on thecurrent nature and levels of our investments and debt, however, we believe thatwe currently have no material market risk exposure.

 

Our general investingpolicy is to limit market and credit risk and the risk of principal loss. All liquid investments with original maturities of three months or less areconsidered to be cash equivalents.

 

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

 

**Restatementof Previously Issued Financial Statements**

 

As described in Note 16 to the financial statements set forth in ourAnnual Report on Form 10-KSB/A for the year ended April 30, 2005, we identifiederrors in the presentation of our previously issued statements ofoperations.  As a result of these errors,we have restated our financial statements for the the quarter ended October 31,2004 and the year ended April 30, 2005.  

 

**Evaluationof Disclosure Controls and Procedures**

 

We maintain disclosure controls and procedures (as defined in Rules13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended(the "Exchange Act")) that are designed to ensure that informationrequired to be disclosed by us in the reports we file or submit under theExchange Act is recorded, processed, summarized, and reported, within the timeperiods specified in the Securities and Exchange Commission’s rules and formsand that such information is accumulated and communicated to our management,including our principal executive officer and principal financial officer, toallow timely decisions regarding required disclosure. 

 

Our management, with the participation of our Chief Executive Officer andChief Financial Officer, evaluated the effectiveness of our company'sdisclosure controls and procedures as of the end of the period covered in thisQuarterly Report on Form 10-QSB/A. Based on this evaluation and because of thematerial weakness described below, our Chief Executive Officer and ChiefFinancial Officer have concluded that our disclosure controls and procedureswere not effective as of the end of the period covered in this Quarterly Reporton Form 10-QSB/A.  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 concludedthat the financial statements included in this report fairly present in allmaterial respects our financial position, results of operations and cash flowsfor the periods presented in conformity with generally accepted accountingprinciples. 

 

**MaterialWeakness in Internal Control Over Financial Reporting**

 

A material weakness is a control deficiency or a combination of controldeficiencies that result in more than a remote likelihood that a materialmisstatement of the annual or interim financial statements will not beprevented or detected.  Our managementhas concluded that, as of October 31, 2005, we did not maintain effectivecontrols over the preparation, review, presentation and disclosure of ourstatement of operations.  Specifically,our controls did not prevent or detect the incorrect presentation of certainexpenses as part of continuing operations rather than as part of discontinuedoperations, in accordance with generally accepted accounting principles.  This control deficiency resulted in therestatement of our financial statements for the quarter ended October 31, 2004and the year ended April 30, 2005. Additionally, this control deficiency could result in a misstatement ofthe presentation and disclosure of our statement of operations that wouldresult in a material misstatement in our annual or interim financial statementsthat would not be prevented or detected. Accordingly, management determined that this control deficiencyconstitutes a material weakness in our internal control over financialreporting as of October 31, 2005.

 

**Changesin Internal Control Over Financial Reporting**

 

There was no change in our internal control over financial reporting thatoccurred during our quarter ended October 31, 2005 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**Plan forRemediation of Material Weakness**

 

We have developed a plan to address this material weakness that includesadding additional professional accounting personnel.  On an interim basis, we engaged a seniorfinancial consultant in February 2006 to provide an immediate expansion in ourtechnical finance and accounting resources. This individual will be retained until additional accounting personnelhave been employed.  We will continue toassess the adequacy and appropriateness of our financial staff and adjustaccordingly as changes in our business warrant. Management believes that our plan to address this material weakness,when fully implemented, will remediate this material weakness.  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 the material weakness.

 

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**SIGNATURES**

 

In accordance with therequirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized, on March 20,2006.

 
|   | MedicalCV, Inc. |
|--------|----------------------|
|   |                 |   |
|   | By                   | /s/ Marc P. Flores |   |
|   |                 | Marc P. Flores |
|   |                 | President and Chief  Executive Officer |
|   |                 |   |
|   | By                   | /s/ John H. Jungbauer |   |
|   |                 | John H. Jungbauer |
|   |                 | Vice President, Finance  and  Chief Financial Officer |

 

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**INDEX TOEXHIBITS**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                              |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                         |
| 3.1                 |       | Restated Articles of  Incorporation of the Registrant, as Amended (incorporated by reference to our  Current Report on Form 8-K, filed September 23, 2005 (File No. 000-33295)).                                              |
|                |       |                                                                                                                                                                                                                                         |
| 4.1                 |       | Reference is made to Exhibit 3.1.                                                                                                                                                                                                       |
|                |       |                                                                                                                                                                                                                                         |
| 10.1                |       | Employment Agreement by  and between Marc P. Flores and the Company, dated August 9, 2005  (incorporated by reference to our Current Report on Form 8-K/A, filed August 9,  2005 (File No. 000-33295)).                  |
|                |       |                                                                                                                                                                                                                                         |
| 10.2                |       | Employment Agreement by  and between John H. Jungbauer and the Company, dated August 9, 2005  (incorporated by reference to our Current Report on Form 8-K/A, filed August 9,  2005 (File No. 000-33295)).               |
|                |       |                                                                                                                                                                                                                                         |
| 10.3                |       | Form of Non-Qualified  Stock Option Agreement Issued to Executive Officers and Other Key Employees  (incorporated by reference to our Current Report on Form 8-K/A, filed August 9,  2005 (File No. 000-33295)).         |
|                |       |                                                                                                                                                                                                                                         |
| 10.4                |       | Amended and Restated  2001 Equity Incentive Plan (incorporated by reference to our Definitive Schedule 14A  (Proxy Statement), filed August 25, 2005 (File No. 000-33295)).                                                   |
|                |       |                                                                                                                                                                                                                                         |
| 10.5                |       | 2005 Director Stock  Option Plan (incorporated by reference to our Definitive Schedule 14A  (Proxy Statement), filed August 25, 2005 (File No. 000-33295)).                                                                   |
|                |       |                                                                                                                                                                                                                                         |
| 10.6                |       | 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  September 23, 2005 (File No. 000-33295)). |
|                |       |                                                                                                                                                                                                                                         |
| 10.7                |       | Form of Stock  Option Amendment, dated December 13, 2005.*                                                                                                                                                                         |
|                |       |                                                                                                                                                                                                                                         |
| 31.1                |       | Chief Executive Officer  Certification pursuant to Exchange Act Rule 13a-14(a).                                                                                                                                                         |
|                |       |                                                                                                                                                                                                                                         |
| 31.2                |       | Chief Financial Officer  Certification pursuant to Exchange Act Rule 13a-14(a).                                                                                                                                                         |
|                |       |                                                                                                                                                                                                                                         |
| 32.1                |       | Chief Executive Officer  Certification pursuant to 18 U.S.C. Section 1350.                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                         |
| 32.2                |       | Chief Financial Officer  Certification pursuant to 18 U.S.C. Section 1350.                                                                                                                                                              |

 

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* Previously filed.

 

23

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