**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

** **

**FORM 10-QSB/A**

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

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

 

**Commission File Number 0-33295**

 

**MEDICALCV, INC.**

(Exact Name of Small Business Issuer asSpecified in Its Charter)

 

| **Minnesota**                                                                                      |   | **41-1717208**      |
|----------------------------------------------------------------------------------------------------|--------|---------------------|
| (State or Other  Jurisdiction                                                                      |   | (I.R.S. Employer    |
| of Incorporation or  Organization)                                                                 |   | Identification No.) |
|                                                                                               |   |                |
| **9725 South Robert Trail  Inver Grove Heights, Minnesota 55077  (651) 452-3000**                  |
| (Address of Principal  Executive Offices and Issuer’s  Telephone Number, including Area Code) |

 

Check whether the issuer:  (1) filed all reports required to be filed by Section 13 or 15(d)of the Exchange Act during the past 12 months (or such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes ý  No o

 

As of March 17, 2003, the issuer had outstanding7,843,834 shares of common stock.  Thisnumber includes 1,500,000 units, each consisting of one share of common stockand one redeemable Class A Warrant, sold in the issuer’s initial publicoffering.

 

Transitional Small Business Disclosure Format (checkone)  o Yes  ý No

 

 

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**TABLE OF CONTENTS**

 
| PART I            | FINANCIAL INFORMATION |
|-------------------|-----------------------|
|              |                  |   |
|              | ITEM 1                | Financial Statements |
|              |                  | Consolidated Balance Sheet  at January 31, 2003 (unaudited) and April 30, 2002 |
|              |                  | Consolidated  Statement of Operations for the three and nine-month periods ended January  31, 2003 (unaudited) and January 31, 2002 (unaudited) |
|              |                  | Consolidated  Statement of Cash Flows for the nine-month periods ended January 31, 2003  (unaudited) and January 31, 2002 (unaudited) |
|              |                  | Notes to  Consolidated Financial Statements |
|              | ITEM  2               | Management’s  Discussion and Analysis or Plan of Operation |
|              | ITEM 3                | Controls and Procedures |
|              |                  |   |
| PART II           | OTHER INFORMATION     |
|              |                  |   |
|              | ITEM  1               | Legal Proceedings |
|              | ITEM 2                | Changes  in Securities and Use of Proceeds |
|              | ITEM 3                | Defaults upon  Senior Securities |
|              | ITEM  4               | Submission  of Matters to a Vote of Security Holders |
|              | ITEM  5               | Other Information |
|              | ITEM 6                | Exhibits and  Reports on Form 8-K |
|              |                  |   |
| SIGNATURES        |                  |
| CERTIFICATIONS    |                  |
| INDEX TO EXHIBITS |                  |

 

 

2

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**PART I**

**ITEM 1   FINANCIALSTATEMENTS**

**MEDICALCV, INC.**

**Consolidated Balance Sheet**

(unaudited)

 
|                                                                                                 |   | **January  31,  2003** |      | **April 30,  2002** |   |
|------------------------------------------------------------------------------------------------------|--------|------------------------|-----------|---------------------|--------|
| **ASSETS**                                                                                           |   |                   |      |                |   |
| Current assets:                                                                                      |   |                   |      |                |   |
| Cash and cash equivalents                                                                            |   | $                      | 208,814   |                | $      | 2,781,675 |   |
| Trade accounts receivable, net                                                                       |   | 1,112,313              |      | 1,258,616           |   |
| Inventories                                                                                          |   | 2,834,687              |      | 2,322,535           |   |
| Prepaid expenses and other assets                                                                    |   | 132,587                |      | 78,993              |   |
| Total current assets                                                                                 |   | 4,288,401              |      | 6,441,819           |   |
|                                                                                                 |   |                   |      |                |   |
| Property, plant and equipment, net                                                                   |   | 1,416,456              |      | 1,575,153           |   |
| Deferred financing costs, net                                                                        |   | 50,871                 |      | 72,860              |   |
| Other assets                                                                                         |   |                   |      | 1,394               |   |
| Total assets                                                                                         |   | $                      | 5,755,728 |                | $      | 8,091,226 |   |
|                                                                                                 |   |                   |      |                |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                        |   |                   |      |                |   |
| Current liabilities:                                                                                 |   |                   |      |                |   |
| Current portion of long-term debt                                                                    |   | $                      | 2,544,928 |                | $      | 2,542,460 |   |
| Short-term debt with affiliates, net of  discount of $109,388                                        |   | 693,945                |      |                |   |
| Current portion of capital lease  obligations                                                        |   | 39,759                 |      | 59,854              |   |
| Accounts payable                                                                                     |   | 1,096,926              |      | 589,520             |   |
| Accrued expenses                                                                                     |   | 631,824                |      | 491,760             |   |
| Total current liabilities                                                                            |   | 5,007,382              |      | 3,683,594           |   |
|                                                                                                 |   |                   |      |                |   |
| Long-term debt, less current portion                                                                 |   | 299,017                |      | 339,523             |   |
| Capital lease obligations less current  portion                                                      |   | 15,197                 |      | 42,069              |   |
| Total liabilities                                                                                    |   | 5,321,596              |      | 4,065,186           |   |
|                                                                                                 |   |                   |      |                |   |
| Shareholders’ equity:                                                                           |   |                   |      |                |   |
| Preferred stock, $.01 par value; 5,000,000  shares authorized; no shares issued and outstanding      |   |                   |      |                |   |
| Common stock; $.01 par value; 95,000,000  shares authorized; 7,843,834 shares issued and outstanding |   | 78,438                 |      | 78,438              |   |
| Additional paid-in capital                                                                           |   | 16,515,887             |      | 16,362,050          |   |
| Deferred stock-based compensation                                                                    |   | (5,398                 | )         | (9,062              | )      |
| Accumulated deficit                                                                                  |   | (16,154,795            | )         | (12,405,386         | )      |
| Total shareholders’ equity                                                                      |   | 434,132                |      | 4,026,040           |   |
| Total liabilities and shareholders’ equity                                                      |   | $                      | 5,755,728 |                | $      | 8,091,226 |   |

 

The accompanying notes are an integralpart of these financial statements.

 

3

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**MEDICALCV, INC.**

 

**ConsolidatedStatement of Operations**

**(unaudited)**

 
|                                                                            |   | **Three  Months Ended January 31,** |       | **Nine  Months Ended January 31,** |   |
|---------------------------------------------------------------------------------|--------|-------------------------------------|------------|------------------------------------|--------|
|                                                                            |   | **2003**                            |       | **2002**                           |   | **2003** |   | **2002** |   |
| Net sales                                                                       |   | $                                   | 867,105    |                               | $      | 735,260 |   | $ | 2,111,206 |   | $ | 2,207,475 |   |
| Cost of goods sold                                                              |   | 423,312                             |       | 546,894                            |   | 1,292,838 |   | 1,447,457 |   |
| Gross profit                                                                    |   | 443,793                             |       | 188,366                            |   | 818,368 |   | 760,018 |   |
| Operating expenses:                                                             |   |                                |       |                               |   |   |   |   |   |
| Sales and marketing                                                             |   | 744,026                             |       | 574,994                            |   | 2,152,876 |   | 1,511,966 |   |
| General and administrative                                                      |   | 544,964                             |       | 639,266                            |   | 1,636,333 |   | 1,400,791 |   |
| Engineering and regulatory                                                      |   | 198,050                             |       | 211,397                            |   | 699,721 |   | 581,895 |   |
| Total operating expenses                                                        |   | 1,487,040                           |       | 1,425,657                          |   | 4,488,930 |   | 3,494,652 |   |
| Loss from operations                                                            |   | (1,043,247                          | )          | (1,237,291                         | )      | (3,670,562 | ) | (2,734,634 | ) |
| Other (expense) income:                                                         |   |                                |       |                               |   |   |   |   |   |
| Interest expense                                                                |   | (46,379                             | )          | (75,198                            | )      | (124,002 | ) | (174,735 | ) |
| Interest income                                                                 |   | 43                                  |       | 16,790                             |   | 12,704 |   | 32,988 |   |
| Other income                                                                    |   | 6,367                               |       | 12,529                             |   | 32,451 |   | 33,944 |   |
| Total other expense                                                             |   | (39,969                             | )          | (45,879                            | )      | (78,847 | ) | (107,803 | ) |
|                                                                            |   |                                |       |                               |   |   |   |   |   |
| Net loss                                                                        |   | $                                   | (1,083,216 | )                                  | $      | (1,283,170 | ) | $ | (3,749,409 | ) | $ | (2,842,437 | ) |
| Basic and diluted net loss per share                                            |   | $                                   | (.14       | )                                  | $      | (.17 | ) | $ | (.48 | ) | $ | (.42 | ) |
|                                                                            |   |                                |       |                               |   |   |   |   |   |
| Weighted average shares used in computing  basic and diluted net loss per share |   | 7,843,834                           |       | 7,419,921                          |   | 7,843,834 |   | 6,702,530 |   |

 

The accompanying notes are an integral partof these financial statements.

 

4

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**MEDICALCV,INC.**

 

**ConsolidatedStatement of Cash Flows**

(unaudited)

 
|                                                                                                       |   | **Nine  Months Ended January 31,** |       |
|------------------------------------------------------------------------------------------------------------|--------|------------------------------------|------------|
|                                                                                                       |   | **2003**                           |       | **2002** |   |
| Cash flows from operating activities:                                                                      |   |                               |       |   |   |
| Net loss                                                                                                   |   | $                                  | (3,749,409 | ) | $ | (2,842,437 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities:                               |   |                               |       |   |   |
| Depreciation                                                                                               |   | 256,465                            |       | 217,571 |   |
| Amortization                                                                                               |   | 109,424                            |       | 190,750 |   |
| Provision for doubtful accounts                                                                            |   | 47,132                             |       | 113,623 |   |
| Return of inventory                                                                                        |   | (92,000                            | )          |   |   |
| Provision for inventory obsolescence                                                                       |   | 116,027                            |       | 24,445 |   |
| Warrant expense related to purchase of  technology                                                         |   | 12,361                             |       |   |   |
| Stock-based compensation                                                                                   |   | 16,145                             |       | 20,639 |   |
| Changes in assets and liabilities:                                                                         |   |                               |       |   |   |
| Accounts receivable                                                                                        |   | 99,171                             |       | (111,152 | ) |
| Inventories                                                                                                |   | (536,179                           | )          | (158,686 | ) |
| Prepaid expenses and other assets                                                                          |   | (52,200                            | )          | 68,728 |   |
| Accounts payable                                                                                           |   | 507,406                            |       | 31,196 |   |
| Accrued expenses                                                                                           |   | 140,583                            |       | 71,171 |   |
| Net cash used in operating activities                                                                      |   | (3,125,074                         | )          | (2,374,152 | ) |
|                                                                                                       |   |                               |       |   |   |
| Cash flows from investing activities:                                                                      |   |                               |       |   |   |
| Purchase of property, plant and equipment                                                                  |   | (97,768                            | )          | (77,266 | ) |
| Loan to UROPACE                                                                                            |   |                               |       | (66,000 | ) |
| Net cash used in investing activities                                                                      |   | (97,768                            | )          | (143,266 | ) |
|                                                                                                       |   |                               |       |   |   |
| Cash flows from financing activities:                                                                      |   |                               |       |   |   |
| Borrowings on bank line of credit                                                                          |   |                               |       | 1,570,000 |   |
| Borrowings on short-term debt with  affiliates, net of financing costs                                     |   | 735,505                            |       |   |   |
| Principal payments on bank line of credit                                                                  |   |                               |       | (475,000 | ) |
| Principal payments on other long-term debt                                                                 |   | (38,557                            | )          | (40,620 | ) |
| Issuance of convertible subordinated bridge  notes, net                                                    |   |                               |       | 438,885 |   |
| Principal payments under capital lease  obligations                                                        |   | (46,967                            | )          | (46,207 | ) |
| Proceeds from issuance of common stock, net                                                                |   |                               |       | 5,402,417 |   |
| Proceeds from issuance of warrants                                                                         |   |                               |       | 550 |   |
| Net cash provided by financing activities                                                                  |   | 649,981                            |       | 6,850,025 |   |
|                                                                                                       |   |                               |       |   |   |
| Net (decrease) increase in cash and cash  equivalents                                                      |   | (2,572,861                         | )          | 4,332,607 |   |
| Cash and cash equivalents at beginning of  year                                                            |   | 2,781,675                          |       | 111,977 |   |
| Cash and cash equivalents at end of period                                                                 |   | $                                  | 208,814    |   | $ | 4,444,584 |   |
|                                                                                                       |   |                               |       |   |   |
| Non-cash investing and financing activities                                                                |   |                               |       |   |   |
| Discount on short-term debt with affiliate  related to warrants                                            |   | $                                  | 128,995    |   |   |   |
| Land special assessments due in future  years, net                                                         |   |                               |       | $ | 54,000 |   |
| Capital lease obligation incurred for the  purchase of fixed assets                                        |   |                               |       | 34,796 |   |
| Discount on convertible subordinated bridge  notes related to warrants’ beneficial conversion feature |   |                               |       | 497,125 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

5

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**MEDICALCV, INC.**

 

**Notes to Consolidated Financial Statements**

**(unaudited)**

 

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

 

The accompanying unaudited consolidated financialstatements included herein have been prepared by MedicalCV, Inc. (the Company)in accordance with accounting principles generally accepted in the UnitedStates of America for interim financial information and pursuant to the rulesand regulations of the Securities and Exchange Commission.  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance withaccounting principles generally accepted in the United States of America havebeen condensed or omitted pursuant to such rules and regulations.  These consolidated interim financialstatements should be read in conjunction with the consolidated financialstatements and the notes thereto included in the Company’s Annual Report onForm 10-KSB for the fiscal year ended April 30, 2002.

 

The consolidated balance sheet as of January 31,2003, the consolidated statement of operations for the three and nine monthsended January 31, 2003 and 2002, and the consolidated statement of cash flowsfor the nine months ended January 31, 2003 and 2002, include, in the opinion ofmanagement, all adjustments, consisting solely of normal recurring adjustments,necessary for a fair presentation of the financial results for the respectiveinterim periods and are not necessarily indicative of results of operations tobe expected for the entire fiscal year ending April 30, 2003.

 

Certain amounts previously reported have beenreclassified to conform to their January 31, 2003, presentation.  These reclassifications had no effect on netloss, cash flow or shareholders’ equity as previously reported.

 

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

 

TheCompany’s consolidated financial statements for the quarter ended January 31,2003, have been prepared on a going concern basis, which contemplates therealization of assets and settlement of liabilities and commitments in thenormal course of business.  The Companyhas sustained losses and negative cash flows from operations in recent yearsand expects these conditions to continue for the foreseeable future.  At January 31, 2003, the Company had anaccumulated deficit of $16,154,795, and has insufficient funds to meet therequirements of its revolving line of credit, and short-term borrowings fromaffiliates.  These matters raisesubstantial doubt about the Company’s ability to continue as a going concern.

 

InFebruary 2003, the maturity date of the Company’s revolving line of credit withAssociated Bank was extended to April 23, 2003.  The Company also established a temporary line of credit with PKMProperties, LLC, an affiliated entity (see Note 8), to fund working capitalrequirements.  The PKM Properties, LLCline of credit matures on April 17, 2003. On December 11, 2002, the Company also received a $60,000 unsecuredadvance from an executive officer to fund working capital requirements.  The Company is currently pursuing therefinancing of its revolving line of credit and is seeking other financing tofund its operations and working capital requirements.  However, the Company cannot provide any assurance that suchadditional financing will be available on terms acceptable to the Company or atall.  The Company will need to obtainadditional capital prior to the maturity date of its revolving line of credit,or otherwise extend or restructure its debit, to continue operations.

 

TheCompany is subject to risks and uncertainties common to emerging medicaltechnology companies, including rapid technological change, dependence on oneprincipal product, new product development and acceptance, actions ofcompetitors, dependence on key personnel and United States market penetration.

 

**(3)****                                ****Net Loss Per Share**

 

Net loss per share is computed under the provisions of SFASNo. 128, “Earnings Per Share.” Basic net loss per common share is computedusing net loss and the weighted-average number of shares of common stockoutstanding. Diluted earnings per share reflect the potential dilution ofsecurities that could share in the earnings of an entity. Diluted net loss percommon share does not differ from basic net loss per common share in the threeand nine-month periods ended January 31, 2003 and 2002, since the potentiallydilutive shares are anti-dilutive. Potentially dilutive shares excluded from the calculation of diluted netloss per share relate to outstanding stock options and warrants 

 

6

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aggregating 4,028,440 and 2,030,390 shares of the Company’s common stockat January 31, 2003 and 2002, respectively.

 

**(4)****                                ****Inventories**

 

|            |   | **January  31, 2003** |       | **April 30,  2002** |       |
|-----------------|--------|-----------------------|------------|---------------------|------------|
|            |   |                  | ** ** |                | ** ** |
| Raw materials   |   | $                     | 585,189    |                | $          | 436,855 |   |
| Work-in-process |   | 665,228               |       | 551,561             |       |
| Finished goods  |   | 1,584,270             |       | 1,334,119           |       |
|            |   | $                     | 2,834,687  |                | $          | 2,322,535 |   |

 

**(5)****                                ****Return of Inventory**

 

Duringthe quarter ended July 31, 2002, the Company obtained inventories from twoformer international distributors with an original cost to the Company ofapproximately $92,000.  The heart valveswere sold to these customers during fiscal year 2000 and the first half offiscal year 2001.  Due to financialdifficulties experienced by these distributors, the Company provided allowancesfor the remaining uncollected accounts receivable balances in fiscal years 2001and 2002.  The Company did notanticipate the return of these products at the time the uncollectible accountswere established.  Upon obtaining titleto the heart valves from these former distributors during the quarter endedJuly 31, 2002, the Company increased its inventories and reduced cost of goodssold by its original cost of $92,000.

 

**(6)****                                ****Recent Accounting Pronouncements**

 

In June 2002, the FASB issuedSFAS No. 146, “Accounting for Exit or Disposal Activities”. The new statementaddresses the accounting for costs associated with exit or disposal activities.The provisions of the statement were effective for disposal activitiesinitiated after December 31, 2002. The adoption of SFAS No. 146 did not have animpact on the Company's financial position or results of operations.  Thenew standard principally affects the Company’s timing of when charges arerecorded as opposed to the amount of the ultimate charge. There have been noexit or disposal activities subsequent to December 31, 2002.

 

The Company adopted the provisions of FASBInterpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Others” in thethird quarter of fiscal year 2003.  Thedisclosure provisions of the interpretation are effective for the Company’sfinancial statements for the third quarter of fiscal year 2003.  The provisions for initial recognition andmeasurement are effective on a prospective basis for guarantees that are issuedor modified after December 31, 2002. The implementation of this accountingpronouncement did not have a material effect on the Company’s results ofoperations, financial position or cash flows.

 

In December 2002,the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation - Transition andDisclosure — anamendment of FAS 123.”SFAS No. 148 provides alternative methods of transition for a voluntary changeto the fair value based method of accounting for stock-based employeecompensation and amends certain disclosure requirements of SFAS No. 123. Thetransition provisions of this statement are effective for fiscal years ending afterDecember 15, 2002, and the disclosure requirements of thisstatement are effective for interim periods beginning afterDecember 15, 2002. The Company currently plans to continue to apply theintrinsic-value based method to account for stock options and will comply withthe new disclosure requirements with the Company's April 30, 2003fiscal year-end reporting.

 

**(7)****                                ****Segment Information**

 

The Company views its operations and manages its business as onesegment, the manufacturing and marketing of mechanical heart valves.  Factors used to identify the Company’ssingle operating segment include the organizational structure of the Companyand the financial information available for evaluation by the chief operatingdecision maker.

 

7

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The following table summarizes net sales by geographic area:

 

|        |   | **Three  Months Ended January 31,** |        | **Nine  Months Ended January 31,** |   |
|-------------|--------|-------------------------------------|-------------|------------------------------------|--------|
|        |   | **2003**                            |        | **2002**                           |   | **2003** |   | **2002** |   |
| Europe      |   | $                                   | 537,921     |                               | $      | 474,405 |   | $ | 1,221,328 |   | $ | 1,419,245 |   |
| South Asia  |   | 116,350                             |        | 109,320                            |   | 339,640 |   | 366,060 |   |
| Middle East |   | 93,598                              |        | 16,000                             |   | 342,265 |   | 101,371 |   |
| Far East    |   | 22,171                              |        | 109,825                            |   | 39,873 |   | 284,129 |   |
| Other       |   | 97,065                              |        | 25,710                             |   | 168,100 |   | 36,670 |   |
|        |   |                                |        |                               |   |   |   |   |   |
| **TOTALS**  |   | **$**                               | **867,105** | ** **                         | **$**  | **735,260** | ** ** | **$** | **2,111,206** | ** ** | **$** | **2,207,475** | ** ** |

 

**(8)****                                 Short-TermDebt with Affiliates**

 

In January 2003, the Company established adiscretionary line of credit with PKM Properties, LLC, an entity controlled bya principal shareholder, who also serves on the Company’s Board ofDirectors.  The line of credit currentlyprovides for borrowing up to $1.1 million and matures on April 17, 2003.  Through January 31, 2003, the Company hadborrowed $743,333 under the line of credit. In February and March 2003, the Company borrowed an additional $300,000 under the PKM Properties, LLC line of creditto fund working capital requirements and continue operations.  In addition, the Company incurreddirect financing costs of $67,828, which are included in other current assetsand are being amortized as part of general and administrative expenses over thethree-month life of the line of credit. The line of credit bears interest at the higher of 7 percent or 1percent above a bank reference rate (7 percent is the rate in effect as ofJanuary 31, 2003).  PKM Properties, LLCwas issued a second mortgage on the Company’s real estate and a security interestin all remaining assets.

 

In connection with the line of credit, theCompany also issued a warrant to PKM Properties, LLC with a five-year term topurchase 350,000 shares of the Company’s common stock at an exercise price of$0.596 per share.  The allocated fairvalue of the warrants was $128,995 and is accounted for as a discount on theborrowings under the line of credit. This discount, which is presented as a reduction of the face value ofthe line of credit on the consolidated balance sheet is being amortized overthe three-month life of the line of credit. As of January 31, 2003, the unamortized balance of the discount was$109,388.

 

The Company also received a $60,000 unsecuredadvance in December 2002 from an executive officer to fund working capitalrequirements.  This loan bears interestat 6 percent per year and matures on March 31, 2003.

 

As of January 31, 2003, a summary ofshort-term debt with affiliates is as follows:

 

|                                    |   | **January  31, 2003** |       |
|-----------------------------------------|--------|-----------------------|------------|
|                                    |   |                  | ** ** |
| Line of credit with PKM Properties, LLC |   | $                     | 743,333    |   |
| Less discount                           |   | 109,388               |       |
| Net balance of line of credit           |   | 633,945               |       |
| Officer advance                         |   | 60,000                |       |
| Total short-term debt with affiliates   |   | $                     | 693,945    |   |

 

 

**(9)****                               RevolvingLine of Credit with Associated Bank**

 

Included in the current portion of long-termdebt at January 31, 2003 is $2,500,000 of borrowings under a revolving line ofcredit with Associated Bank.  InNovember 2002, the Company obtained a 90-day extension on its revolving line ofcredit.  In February 2003, the Company obtained anadditional 60-day extension onits revolving line of credit with Associated Bank to April 23, 2003.

 

As of January 31, 2003, the Company was inviolation of the debt covenant with Associated Bank that requires the Companyto maintain a minimum tangible net worth of not less than $1,000,0000 measuredas of the last day of each calendar month. The existence of this covenant violation gives Associated Bank theability to declare an event of default and demand immediate repayment of suchindebtedness.

 

8

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

 

*The followingdiscussion contains various forward-looking statements within the meaning ofSection 21E of the Exchange Act. Although we believe that, in making any such statement, our expectationsare based on reasonable assumptions, any such statement may be influenced byfactors that could cause actual outcomes and results to be materially differentfrom those projected.  When used in thefollowing discussion, the words**“anticipates,”“believes,”“expects,”“intends,”“plans,”“estimates” and similar expressions, as they relate to us or ourmanagement, are intended to identify such forward-looking statements.  These forward-looking statements are subjectto numerous risks and uncertainties that could cause actual results to differmaterially from those anticipated. Factors that could cause actual results to differ materially from thoseanticipated, certain of which are beyond our control, are setforth in this document and in our Annual Report on Form 10-KSB for the fiscalyear ended April 30, 2002, under the caption “Management’s Discussion andAnalysis or Plan of Operation-Cautionary Statement.”*

 

*Our actualresults, performance or achievements could differ materially from thoseexpressed in, or implied by, forward-looking statements.  Accordingly, we cannot be certain that anyof the events anticipated by forward-looking statements will occur or, if anyof them do occur, what impact they will have on us.  We caution you to keep in mind the cautions and risks described**in this document and in our Cautionary Statement and to refrain from attributing undue certainty to anyforward-looking statements, which speak only as of the date of the document inwhich they appear.*

 

**Overview**

 

We manufacture and market mechanical heart valves known as theOmnicarbon Series 3000 and Series 4000. Our heart valves are used to treat heart valve failure caused by theaging process, heart diseases, prosthetic heart valve failure and congenitaldefects.  To date, we have distributedthe Omnicarbon 3000 and 4000 heart valves primarily in Europe, South Asia, theMiddle East and the Far East.  In fiscalyear 2002, we derived 65.0 percent of our net sales from Europe.  As an innovator of heart valve technology,we have more than 30 years of experience in developing, manufacturing andmarketing five generations of heart valves, and we have sold more than 135,000heart valves worldwide.

 

On July 26, 2001, the FDA gave us notice of premarket approval tosell our Omnicarbon 3000 heart valve in the U.S., the largest geographic marketfor mechanical heart valves.  Inanticipation of FDA premarket approval, we invested in our sales and marketinginfrastructure, including adding sales management to our staff in fiscal year2001, and recruiting field sales representatives to call ondomestic surgery centers in the U.S.  Whileour sales of the Omnicarbon heart valve in the U.S. market have been belowexpectations to date, we believe, basedupon our Omnicarbon heart valve’s 18 years of implants in patients in Europe, that we can establish acompetitive position in the mechanical heart valve industry in the U.S. andleverage this position into other critical areas of cardiothoracicsurgery.  We also expect that ourability to market the Omnicarbon 3000 heart valve in the U.S. will favorablyaffect our international sales, as many cardiovascular surgeons and others whomake purchasing decisions are aware of the FDA’s rigorous premarket approval process and consider it to bea validation of the safety and efficacy of medical devices.  Our company had its first implant of theOmnicarbon 3000 heart valve in the U.S. in December 2001.

 

The worldwide heart valve market is dynamic and highlycompetitive.  In addition, technologyand competitive offerings, such as new tissue heart valves, place increasedpressure on us as we seek to increase our market share and revenue.  We must raise substantial additional funding in order to continue tooperate. For more informationregarding these risks, you should review our Cautionary Statement.

 

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**Three and Nine Month Periods Ended January 31, 2002and 2003**

 

Our operating results, expressed as a percentage oftotal revenue, were as follows:

 
|                        |   | **Three  Months Ended January 31,** |   | **Nine  Months Ended January 31,** |   |
|-----------------------------|--------|-------------------------------------|--------|------------------------------------|--------|
|                        |   | **2003**                            |   | **2002**                           |   | **2003** |   | **2002** |   |
| Net sales                   |   | 100.0                               | %      | 100.0                              | %      | 100.0 | % | 100.0 | % |
| Cost of goods  sold         |   | 48.8                                | %      | 74.4                               | %      | 61.2 | % | 65.6 | % |
|                        |   |                                |   |                               |   |   |   |   |   |
| Gross profit                |   | 51.2                                | %      | 25.6                               | %      | 38.8 | % | 34.4 | % |
|                        |   |                                |   |                               |   |   |   |   |   |
| Operating  expenses:        |   |                                |   |                               |   |   |   |   |   |
|                        |   |                                |   |                               |   |   |   |   |   |
| Sales and  marketing        |   | 85.8                                | %      | 78.2                               | %      | 102.0 | % | 68.5 | % |
| General and  administrative |   | 62.9                                | %      | 86.9                               | %      | 77.5 | % | 63.4 | % |
| Engineering  and regulatory |   | 22.8                                | %      | 28.8                               | %      | 33.1 | % | 26.4 | % |
|                        |   |                                |   |                               |   |   |   |   |   |
| Total operating  expenses   |   | 171.5                               | %      | 193.9                              | %      | 212.6 | % | 158.3 | % |
|                        |   |                                |   |                               |   |   |   |   |   |
| Loss from  operations       |   | (120.3                              | )%     | (168.3                             | )%     | (173.8 | )% | (123.9 | )% |
|                        |   |                                |   |                               |   |   |   |   |   |
| Other income  (expense):    |   |                                |   |                               |   |   |   |   |   |
|                        |   |                                |   |                               |   |   |   |   |   |
| Interest  expense           |   | (5.3                                | )%     | (10.2                              | )%     | (5.9 | )% | (7.9 | )% |
| Interest  income            |   | —                              | %      | 2.3                                | %      | .6 | % | 1.5 | % |
| Other income                |   | .7                                  | %      | 1.7                                | %      | 1.5 | % | 1.5 | % |
|                        |   |                                |   |                               |   |   |   |   |   |
| Total other  expense        |   | (4.6                                | )%     | (6.2                               | )%     | (3.8 | )% | (4.9 | )% |
|                        |   |                                |   |                               |   |   |   |   |   |
| Net loss                    |   | (124.9                              | )%     | (174.5                             | )%     | (177.6 | )% | (128.8 | )% |

 

**CriticalAccounting Policies**

 

Fordiscussion of critical accounting policies and estimates, see our Annual Reporton Form 10-KSB for the fiscal year ended April 30, 2002.

 

**Results ofOperations**

 

*Net Sales*.  Net sales in the third quarter of fiscal year 2003increased 18 percent to $867,105 from $735,260 in the third quarter of the prior year.  The increase was primarily attributable to higherOmnicarbon heart valve unit sales in the European and U.S. markets.

 

Netsales in the nine-month period ended January 31, 2003, decreased to $2,111,206from $2,207,475 in the same period one year ago. The decrease in net sales inthe nine-month period was primarily attributable to lower Omnicarbon unit salesto distributors in Europe and Far East in the first six months of fiscal 2003,partially offset by increased unit sales in the Middle East.

 

In the firstnine months of fiscal years 2003 and 2002, the vast majority of our sales were denominated in U.S.dollars.  Fluctuations in foreigncurrency exchange rates have not resulted in significant losses or gains onoutstanding trade accounts receivable. All of our distributors are required to pay for products in U.S.dollars, other than our Japanese distributor, which pays inJapanese yen, and twoEuropean customers, which pay in euros. We recognize that a strongU.S. dollar can adversely affect unit sales payable in currencies other thanU.S. dollars for our foreign distributors.

 

*Gross Profit.*  Gross profit as a percentage of net sales increased to 51.2 percent in the third quarterof fiscal year 2003 from 25.6 percent in the thirdquarter of the prior year.  Gross profit margins for the first ninemonths of fiscal year 2003 were 38.8 percent compared to 34.4 percent in thesame period last fiscal year.  Grossprofit margins in the current quarter and nine-month periods were favorablyimpacted by reductions in product costs as manufacturing efficiencies continuedto improve, partially offset by an unfavorable international sales mix.  Wehave expended considerable resources in developing our new carbon manufacturingprocess technologies utilized in manufacturing the Omnicarbon 4000 heart valve,which is currently 

 

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sold outside the U.S. market.  Our strategy is to obtain FDA approval ofour proprietary pyrolyticcarbon manufacturing process in order to market the Omnicarbon 4000 in theU.S.  Due to its lower manufacturingcost, we believe the Omnicarbon 4000 will generate significantly higher grossprofit margins when sold in the U.S. than the Omnicarbon 3000 heart valve.

 

*Sales andMarketing*.  Sales andmarketing expenses in the thirdquarter of fiscal year 2003 were $744,026 or 85.8 percent of net sales compared to $574,994 or 78.2 percent of net sales in the third quarter of the prior year.  For the nine-month period endingJanuary 31, 2003, sales and marketing expenses totaled $2,152,876 or 102.0percent of net sales, compared to $1,511,966 or 68.5 percent of net sales inthe same period last fiscal year.  The increases in spending related to expandedOmnicarbon marketing efforts in the U.S. and international markets.  Despite our lower thanexpected sales-to-date in the U.S. market, we believe we can establish acompetitive position in the U.S. and leverage this position into other areas ofcardiothoracic surgery.  Our overall marketing strategy is topromote the clinical results of the Omnicarbon heart valve and the technicalstrengths of our company in designing and manufacturing mechanical heartvalves.

 

*General andAdministrative*.  General andadministrative expenses for the third quarter of fiscal year 2003 were $544,964 or 62.9 percent of net sales, compared to $639,266 or 86.9 percent of net sales in the same period oneyear ago. For the nine-month period ended January 31, 2003, general andadministrative expenses totaled $1,636,333 or 77.5 percent of net sales,compared to $1,400,791 or 63.4 percent of net sales in the same period lastyear.  The decrease in the third quarterof this fiscal year related primarily to reduced amortization of financingcosts.  The third quarter one year agoalso included non-recurring IPO related expenses.  The increasein the first nine months of fiscal year 2003 was primarily attributable to increased professional fees associated with operating as apublic company, and salary and related expenses associated with strengtheningthe executive management staff.

 

*Engineering andRegulatory*.  Engineering andregulatory expenses for the thirdquarterof fiscalyear 2003 were $198,050 or 22.8 percent of net sales compared to $211,397 or 28.8 percent of net sales in the third quarter ofthe prior fiscal year. For the nine-month period ended January 31, 2003,engineering and regulatory expenses totaled $699,721 or 33.1 percent, comparedto $581,895 or 26.4 percent of net sales in the same period last year.  Theincrease inthe first nine months of fiscal year 2003 was primarily attributable to expenses associated with thepurchase and development of the Northrup Universal Heart Valve Repair SystemTMand the IMA AccessTM Retractor device combined with costs related to the pursuitof FDA approval for our proprietary pyrolytic carbon manufacturing process inorder to market the Omnicarbon 4000 heart valve in the U.S.

 

*Other (Expense)Income*.  Interest expense totaled$46,379 in the quarter ended January 31, 2003, compared to $75,198 in the third quarter of the prior fiscal year. Fiscalyear-to-date interest expense was $124,002, compared to $174,735 in the sameperiod one year ago.  The decrease isprimarily due to interest expense and related discount amortization onconvertible subordinated bridge notes in the third quarter of the prior fiscalyear and in the nine-month period ending January 31, 2002.

 

*Income TaxProvision*.  In light of ourrecent history of operating losses, we recorded a valuation allowance to fullyoffset our deferred tax assets in fiscal year 2000.  We have continued to provide a full valuation allowance through the third quarter of fiscal year 2003 due to the inherent uncertainty ofpredicting the sufficiency of future taxable income necessary to realize ourdeferred tax assets.

 

*Loss fromOperations*.  As of January31,2003, we had anaccumulated deficit of $16,154,795.  We have incurredlosses in each of the last six fiscal years. Since 1994, we have invested in developing a bileaflet heart valve, aproprietary pyrolytic carbon coating process and obtaining premarket approvalfrom the FDA to market our Omnicarbon 3000 heart valve in the U.S.  Our strategy has been to invest intechnology to better position ourselves competitively once FDA premarketapproval was obtained.  We expect netlosses to continue through fiscal year 2004 because of anticipated spending necessary tomarket the Omnicarbon 3000 heart valve in the U.S., and to establish and maintain a strongmarketing organization for domestic and foreign markets.

 

**Liquidity and Capital Resources**

 

Cash and cash equivalents decreased to $208,814 at January 31, 2003, from $2,781,675 at April 30, 2002.  The decrease in cash in thecurrent fiscal year wasattributable primarily tooperating losses.  Net cash used in operating activities was $712,636 in the third quarter ended January 31, 2003, and $1,071,257 in the same period last year. Net cash used in operating activities for the nine-month period infiscal year 2003 was $3,125,074 compared to $2,374,152 in the prior year.

 

Net cash used in operating activities decreased $358,621 in the currentquarter over the same period one year ago due to a decrease in accountsreceivable combined with increases in accounts payable and accruedexpenses.  Net cash used in operating activitiesincreased $750,922 in the nine-month period over the same period in the prioryear due primarily to funding higher operating losses and increases ininventory.  Inventories increased$536,179 in the nine-month period due primarily to carrying additionalOmnicarbon 3000 inventory to support the U.S. product launch.

 

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Net cash used in investing activities was $97,768 and $143,266 for the nine-monthperiods ended January 31, 2003 and 2002, respectively.  Weinvested $97,768 inproperty, plant, and equipment in the nine-month period ended January 31, 2003, compared to $77,266 in the same period last fiscal year.

 

Net cash providedby financing activities was $649,981 in the nine-month period ended January 31, 2003, and consistedprimarily of short term borrowings from affiliates, partially offset byprincipal payments on long-term debt and capital leases.  Inthe nine-month period ended January 31, 2002, net cash provided by financing activities was$6,850,025.  In that period, we completed our initial public offeringwhich generated net proceeds of $5,396,475, and we borrowed an additional $1,570,000 on our bank line of credit,and $438,885 pursuant to convertible bridge notes, partially offset by $561,827 of principal payments on our bankline of credit, long-term debt, and capital leases.

 

From March 1992 through July 2002, our primarysource of funding was through the sales of equity securities, which totaled $9,775,704 ingross cash proceeds.  We have alsofunded our operations through collateralized equipment financing term loans and equipment leases.  In addition, we have financed our operations since fiscalyear 2000 through a bank line of credit collateralized by our real estate, tangible andintangible property and a guarantee by a principal shareholder.  This line of credit, which wasscheduled to mature in November2002, has been extended to April 23, 2003, while we seek new debtfinancing.  There can be no assurance thatsuch financing will be available on acceptable terms or at all.  Amountsborrowed under this line of credit currently bear interest at 6.5 percent per year.  Asof January 31, 2003, we had borrowed the maximum amount available of $2,500,000under this line of credit.

 

As part of our credit agreement with Associated Bank Minnesota, wewere required to maintain a minimum tangible net worth of not less than$3,000,000, measured as of the last day of each fiscal quarter.  At April 30, 2001, we failed to comply withthe minimumtangible net worth covenant.  On August 24, 2001, Associated BankMinnesota waived such covenant defaults, and we amended our credit agreement,which now provides that we must maintain a minimum tangible net worth of notless than $1,000,000, measured as of the last day of each calendar month.  We were not in compliance with the tangible net worth covenant as of January 31, 2003.  Theexistence of this covenant violation gives Associated Bank the ability todeclare an event of default and demand immediate repayment of suchindebtedness.

 

We established a line of credit in January 2003 with PKM Properties,LLC, an entity controlled by a principal shareholder, who also serves on ourBoard of Directors.  The line of creditprovides for borrowing up to $1.1 million and matures on April 17, 2003.  Through January 31, 2003, we borrowed$743,333 under the line of credit.  Inaddition, we incurred direct financing costs of $67,828, which are included inother current assets and are being amortized as part of general andadministrative expenses over the three-month life of the line of credit.  The line of credit bears interest at thehigher of 7 percent or 1 percent above a bank reference rate (7 percent is therate in effect as of January 31, 2003). The line of credit is secured by a second mortgage on our real estateand a security interest in all remaining assets in favor of PKM Properties,LLC.

 

In connection with the line of credit, we also issued a warrant to PKMProperties, LLC with a five-year term to purchase 350,000 shares of ourCompany’s common stock at an exercise price of $0.596 per share.  The allocated fair value of the warrants was$128,995 and is accounted for as a discount on the borrowings under the line ofcredit.  This discount, which ispresented as a reduction of the face value of the line of credit on theconsolidated balance sheet, is being amortized over the three-month life of theline of credit.  As of January 31, 2003,the unamortized balance of the discount was $109,388.

 

We also received a $60,000 unsecured advance in December 2002 from anexecutive officer.  Principal andinterest on this advance is payable on March 31, 2003.

 

Subjectto the uncertainties surrounding our need for financing as described below, we expect to continue developing ourbusiness and to build market share in the U.S. now that we have FDA premarketapproval of our Omnicarbon 3000 heart valve for sales in the U.S.  These activities will require significantexpenditures to develop, train and supply marketing materials to ourindependent sales representatives and to build our sales and marketinginfrastructure.  As a result, weanticipate that our sales and marketing and general and administrative expenseswill continue to constitute a material use of our cash resources.  The actual amounts and timing of our capitalexpenditures will vary significantly depending upon the speed at which we are able to expandour distribution capability in domestic and international markets and the availabilityof financing.

 

We expect that our operating losses and negative operating cashflow will continue for theremainder of fiscal year 2003 and fiscalyear 2004 as we expand ourmanufacturing capabilities, continue increasing our corporate staff to supportthe U.S. roll-out of our Omnicarbon 3000 heart valve, and add marketingprograms domestically and internationally to build awareness of and createdemand for our Omnicarbon heart valves.

 

Our capital requirements may varydepending upon the timing and the success of the implementation of our businessplan, regulatory, technological and competitive developments, or if:

 

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•                  operatinglosses exceed our projections,

 

•                  our manufacturing and developmentcosts or projections prove to be inaccurate,

 

•                  we determine to license or developadditional technologies,

 

•                  we experience substantial difficulty in gaining U.S. market acceptanceor delays in obtaining FDAclearance of our proprietary carbon coating process for heart valves sold in the U.S. market, or

 

•                  we make acquisitions.

 

Ourability to continue as a going concern is dependent on our ability to obtaindebt and/or equity financing in the fourth quarter of fiscal 2003.  We are currently pursuing the refinancing ofour revolving line of credit and are seeking other financing to fund ouroperations and working capital requirements. We are also considering the sale and leaseback of our real estate toretire our bank debt and increase working capital.  We cannot provide any assurance , however, that such additionalfinancing will be available on terms acceptable to us or at all.  We will need to obtain additional capitalprior to the maturity date of our revolving line of credit or otherwise extendor restructure this debt to continue operations.

 

Inaddition to our need to refinance our current $2,500,000 of bank debt, whichmatures on April 23, 2003, and complete a sale and leaseback of our realestate, we also anticipate that we will need to raisebetween $2,000,000and $4,000,000 ofadditional equity or debt financing to fund operations and working capitalrequirements in thenext 2 to 6 months.  We also anticipate the need to raise aminimum of $1,500,000 in new debt or equity financing within 9 to 12 months.  Weexpect to face substantial difficulty in raising funds in the current marketenvironment and we have no commitments at this time to provide the requiredfinancing.  If we refinance our bank debt, engage in a sale andleaseback, and obtain $2,000,000 to $4,000,000 of additional financing, webelieve we willhavesufficient capital resources tooperate and fund the growth of ourbusiness for the remainder of calendar year 2003.

 

We cannot assure you that we will be able to raise sufficientcapital on terms that we consider acceptable, or at all.  The terms of any equity financing are expected to be highly dilutive toour existing security holders.  Thedelisting of our securities from the NASDAQ SmallCap Market will negativelyaffect our ability to raise capital.  If we are unable to obtain adequate financing on acceptable terms, wewill be unable to continue operations.

 

**Commitments andContingent Liabilities**

 

*SulzerCarbomedics.* In July 1998, weentered into a three-year supply agreement with Sulzer Carbomedics, the sourceof certain raw material components used in the manufacture of our Omnicarbon3000 heart valves.  The supply agreementwas extended for an additional two years in March 2001.  The agreement provides that we purchase aminimum number of raw material units each calendar year through 2003.  Under the terms of the agreement, we arerequired to compensate Sulzer Carbomedics for any purchase shortfalls up to amaximum of $200,000 per year.  We havenot met the minimum purchase requirements for the past three calendar years.  In addition, we do not believe we will meetthe minimum purchase requirement for calendar year 2003.  As a result, we expensed $148,991in fiscalyear 2002, and $108,174 in fiscal year 2001 related to these purchase shortfalls.  We expensed $83,613 in thethird quarter of fiscal year 2003 and $15,657 in the third quarter lastyear.  For the first nine months offiscal year 2003 we expensed $113,738 and we expensed $115,657 in thecomparable period last year.  These charges were reflected in cost ofgoods sold.  Future purchase shortfallscould adversely affect our ongoing relationship with Sulzer Carbomedics.

 

*UROPACE*.  In July 1995, we established a wholly owned subsidiary, UROPACE, Inc., to commercialize technology fortreating female urinary incontinence. On November 1, 2000, we completed the spin-off of UROPACE to ourexisting shareholders.  The separationwas effected by transferring from our company to UROPACE all assets, tangibleand intangible, relating to the development of female urinary incontinencetechnology.  Our shareholders of recordon September 15, 2000 received one share of common stock of UROPACE for each6.882 shares of our common stock they held on that date.  The assets transferred to UROPACE had no bookvalue at November 1, 2000, and the operations of UROPACE before the spin-offhad no revenues and minimal expenses during fiscal year 2000 and fiscal year2001.  As a part of this spin-off, weagreed to loan UROPACE up to $356,250 at a variable interest rate.  Principal and interest on the note will bepayable in installments equal to 5 percent of UROPACE’s future annual net sales until the noteand interest is paid in full.  At January31, 2003, we had loaned UROPACE $235,000,none of which had been repaid.  Due to the development stage of UROPACE andthe uncertainty associated with the collection of these borrowings, we haverecorded an allowance for the entire balance of the loan, with thecorresponding expense included in other (expense) income in the ConsolidatedStatement of Operations.

 

*Bank Line of Credit*.  Since fiscal year 2000, we havefinanced our operations in part through a bank line of credit collateralized by our real estate, tangible and intangible property and aguarantee by a principal shareholder. This line of credit,which was scheduled to mature on November 23, 2002, has been extended toApril 23, 2003.  Amounts borrowed under this line of 

 

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credit currently bear interest at a fixedrate of 6.5 percent per year.  As of January 31, 2003, we had borrowed the maximum amount available of$2,500,000 under this line of credit.

 

As part of our revolving credit agreement with Associated BankMinnesota, we were formerly required to maintain a minimum tangible net worthof not less than $3,000,000, measured as of the last day of each fiscalquarter.  At April 30, 2001, we failed to comply with the minimum tangible networth covenant.  On August 24, 2001,Associated Bank Minnesota waived such covenant defaults, and we amended ourcredit agreement, which now provides that we must maintain a minimum tangiblenet worth of not less than $1,000,000, measured as of the last day of eachcalendar month.  With the net proceedsfrom our November 2001 IPO, we met our minimum tangible net worth requirement through October31, 2002.  As of the quarter ended January 31, 2003,our tangible net worth fell below the required $1,000,000 minimum.  This covenant violation gives AssociatedBank the ability to declare an event of default and demand immediate repaymentof such indebtedness.

 

As of January31, 2003, we were in compliancewith all othercovenants or other requirements set forth in our credit agreement.  We do not have any rating downgrade triggersthat would accelerate the maturity dates of our debt.  A downgrade in our credit rating could adversely affect ourability to renew existing, or obtain access to new, credit facilities in thefuture and could increase the cost of such facilities.

 

*Dakota ElectricAssociation. *At January 31, 2003, we were indebted to Dakota Electric Association in theprincipal amount of $151,426. Payments are due in monthly installmentsthrough May 2009, with interest at 5.75 percent, collateralized by our lightingequipment and rooftop air-conditioning units.

 

*DakotaCounty. *At January 31, 2003, we owed Dakota County for special land assessments with principaland interest due at 8 percent in semi-annual installments through May 2010.

 

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

 

*ClinicalStudies. *We entered intoan agreement with several large non-U.S. hospitals to conduct clinical studiesregarding certain aspects of our Omnicarbon heart valve’sclinical performance.  The agreementruns through fiscal year 2006.  Ingeneral, recipients of clinical study payments are required to purchase ourproducts in order tocomplete their studies.

 

*Consulting*.  In November 2001, we entered intoa separation agreement and release with Adel A. Mikhail, Ph.D., who was ourfounder and served as our President and Chief Executive Officer from March 1992until June 15, 2001, when he retired. Dr. Mikhail continues to serve as Chairman of our Board ofDirectors.  As part of the agreement, weagreed to retain Dr. Mikhail as an independent consultant for a period of twoyears.  Dr. Mikhail receives a $6,000per month retainer.  The agreementexpires in June 2003.  We also entered into an employmentseparation agreement with an officer in late 2002, which provides forconsulting services through calendar 2003.

 

*Short-Term Financing.*  Weestablished a line of credit in January 2003 with PKM Properties, LLC, anentity controlled by a principal shareholder, who also serves on our Board ofDirectors.  This line matures on April17, 2003.  On December 11, 2002, we alsoreceived a $60,000 unsecured advance from an executive officer to fund workingcapital requirements.  This loan maturesMarch 31, 2003.

 
| **Summary of Contractual Obligations** |   | **Payments Due By Period** |      |
|----------------------------------------|--------|----------------------------|-----------|
|                                   |   | **TOTAL**                  |      | **Less than One****Year** |   | **Two to Three****Years** |   | **Four or More****Years** |   |
| Sulzer  Carbomedics                    |   | $                          | 200,000   |   | $ | 200,000 |   | $ |   | $ |   |
| UROPACE Loan                           |   | 121,250                    |      | 121,250 |   |   |   |   |   |
| Bank Line of  Credit                   |   | 2,500,000                  |      | 2,500,000 |   |   |   |   |   |
| Dakota Electric  Association(1)        |   | 181,032                    |      | 28,584 |   | 57,168 |   | 95,280 |   |
| Dakota County(1)                       |   | 261,120                    |      | 39,360 |   | 72,960 |   | 148,800 |   |
| Capital Leases(1)                      |   | 59,570                     |      | 56,454 |   | 3,116 |   |   |   |
| Clinical Studies                       |   | 422,380                    |      | 143,762 |   | 198,247 |   | 80,371 |   |
| Consulting                             |   | 119,425                    |      | 119,425 |   |   |   |   |   |
| Short-Term Financing                   |   | 803,333                    |      | 803,333 |   |   |   |   |   |
| TOTAL CONTRACTUAL  OBLIGATIONS         |   | $                          | 4,668,110 |   | $ | 4,012,168 |   | $ | 331,491 |   | $ | 324,451 |   |
|                                        |        |                            |           |  |  |  |  |  |  |  |  |  |  |

 

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(1)           Futurepayments include interest due.

 

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**Recent AccountingPronouncements**

 

In June 2002, the FASB issuedSFAS No. 146, “Accounting for Exit or Disposal Activities”. The new statementaddresses the accounting for costs associated with exit or disposal activities.The provisions of the statement were effective for disposal activitiesinitiated after December 31, 2002. The adoption of SFAS No. 146 did not have animpact on our financial position or results of operations.  Thenew standard principally affects the timing of when charges are recorded asopposed to the amount of the ultimate charge. There have been no exit or disposal activities subsequent to December31, 2002.

 

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

 

InDecember 2002, the FASB issued SFAS No. 148, “Accounting for Stock-BasedCompensation - Transition and Disclosure — an amendment of FAS 123.” SFAS No.148 provides alternative methods of transition for a voluntary change to thefair value based method of accounting for stock-based employee compensation andamends certain disclosure requirements of SFAS No. 123.  The transition provisions of this statementare effective for fiscal years ending after December 15, 2002, and thedisclosure requirements of this statement are effective for interim periodsbeginning after December 15, 2002.  Wecurrently plan to continue to apply the intrinsic-value based method to accountfor stock options and will comply with the new disclosure requirementsbeginning with our April 30, 2003 fiscal year-end reporting.

 

**Qualitative andQuantitative Disclosures about Market Risk**

 

We develop our products in the U.S. and market our productsglobally.  Because we continue to deriveour revenue primarily from sources outside of the U.S., our financial resultscould be affected by many factors, such as changes in currency exchange ratesor weak economic conditions in foreign markets.  Substantially all of our sales are denominated in U.S.dollars.  A strengthening of the U.S.dollar could make our products less competitive in foreign markets.  We do not currently participate in anycurrency hedging activities to mitigate this risk.  We intend to assess the need to use financial instruments tohedge our exchange rate exposure on an ongoing basis.  Our interest income and expenses are sensitive to changes in thegeneral level of U.S. interest rates, particularly since our investments are inshort-term instruments and our long-term debt and revolving line of creditrequire interest payments calculated at variable rates.  Based on the current nature and levels ofour investments and debt, however, we believe that we currently have nomaterial market risk exposure.

 

Our general investing policy is to limit market and credit riskand the risk of principal loss.  Allliquid investments with original maturities of three months or less areconsidered to be cash equivalents.

 

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**ITEM 3                   CONTROLSAND PROCEDURES**

 

Wemaintain a system of disclosure controls and procedures that is designed toprovide reasonable assurance that information, which is required to bedisclosed, is accumulated and communicated to management timely.  Within the 90-day period prior to the filingdate of this periodic report, we carried out an evaluation under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures pursuant toExchange Act Rule 13a-15.  Based uponthat evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures are effective in timelyalerting them to material information relating to our company required to bedisclosed in our periodic filings with the SEC.

 

Therewere no significant changes in our internal controls or in other factors thatcould significantly affect our internal controls subsequent to the date oftheir most recent evaluation.

 

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**PART II                 OTHER INFORMATION**

 

ITEM 1   Legal Proceedings

 

Asof March 17, 2003, we were not a party to any material litigation.

 

ITEM 2   Changes in Securities and Use of Proceeds

 

(a)   Not applicable.

 

(b)   Not applicable.

 

(c)   On January 17, 2003, weissued to PKM Properties, LLC, an entity controlled by a principal shareholderwho also serves on the Company’s Board of Directors, a five-year warrant topurchase 350,000 shares of our common stock at $0.596 per share.  We issued this warrant in connection with aline of credit we established with PKM Properties, LLC.

 

The foregoing issuance wasmade in reliance upon the exemption provided in Section 4(2) of the SecuritiesAct.  Such securities are restricted asto sale or transfer, unless registered under the Securities Act, and thecertificate representing such securities contains a restrictive legendpreventing sale, transfer or other disposition, unless registered under theSecurities Act.  In addition, therecipient of such securities received material information concerning ourcompany, including, but not limited to, our reports on Form 10-KSB and Form10-QSB, as filed with the Securities and Exchange Commission.  No underwriting commissions or discountswere paid with respect to the issuance of such securities.

 

(d)   Our Registration Statement on Form SB-2 (File No. 333-68884) wasdeclared effective by the SEC on November 20, 2001.

 

After deducting the total expenses of $1,353,515 ofour initial public offering, our net proceeds were approximately $5,396,485.  We estimate that we used 100 percent or$5,396,485of theinitial public offering net proceeds through January 31, 2003.  Such uses of proceeds represent: (1)$4,526,485 to fund sales and marketing initiatives, including general andadministrative expenses tosupport infrastructure and engineering andregulatory expenses to supportoperations,(2)$93,000 to fundworking capital requirements, (3) $237,000 to purchase capital equipment, (4) $500,000 to repay bridge notes, and (5) $40,000in advances to UROPACE.

 

ITEM 3   Defaults upon Senior Securities

 

Notapplicable.

 

ITEM 4   Submission of Matters to a Vote of Security Holders

 

Notapplicable.

 

ITEM 5   Other Information

 

OnMarch 17, 2003, our securities were delisted from The Nasdaq SmallCapMarket.  As a result of the delisting,MedicalCV securities will become subject to additional rules of the SEC.  Such rules require broker-dealers to make asuitability determination for purchasers and to receive the purchaser's priorwritten consent for a purchase transaction, thus restricting the ability topurchase or sell the securities in the open market.  Trading, if any, will be conducted in an over-the-counter marketestablished for securities that do not meet Nasdaq listing requirements.

 

ITEM 6   Exhibits and Reports on Form 8-K

 

(a)   Exhibits

 
| 10.1 |   | Discretionary Credit Agreement by and  between the Registrant and PKM Properties, LLC, dated January 17, 2003.                                                             |
|------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.2 |   | Discretionary Credit Note in the principal  amount of $943,666, issued by the Registrant, Maker, to PKM Properties, LLC,  Payee, dated January 17, 2003.                   |
| 10.3 |   | Security Agreement by and between the  Registrant, Debtor, and PKM Properties, LLC, Secured Party, dated January 17,  2003.                                                |
| 10.4 |   | Second Mortgage by the Registrant for the  benefit of PKM Properties, LLC, dated January 17, 2003.                                                                         |
| 10.5 |   | Common Stock Purchase Warrant issued by the  Registrant to PKM Properties, LLC, dated January 17, 2003.                                                                    |
| 10.6 |   | Promissory Note in the principal amount of  $60,000, issued by the Registrant, Maker, to Allan R. Seck, Payee, dated December  11, 2002.                                   |
| 10.7 |   | Working Capital Line of Credit - Change in  Terms Agreement by and between Associated Bank Minnesota, lender, and the  Registrant, borrower, dated November 23, 2002. |
| 10.8 |   | Commercial Guaranty from Paul K. Miller,  guarantor, to Associated Bank Minnesota, lender, dated November 23,  2002.                                                  |

 

(b)   Reports on Form 8-K

 

Theregistrant filed no Current Reports on Form 8-K during the quarter endedJanuary 31, 2003.

 

17

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**SIGNATURES**

 

Inaccordance with the requirements of the Exchange Act, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

 
|                           | MedicalCV,  Inc. |
|--------------------------------|------------------|
|                           |             |   |
|                           |             |   |
|                           |             |   |
| Date:  April 4, 2003 | By               | /s/  Blair P. Mowery |
|                           |             | Blair  P. Mowery |
|                           |             | President  and Chief Executive Officer |
|                           |             |   |
| Date:  April 4, 2003 | By               | /s/  Jules L. Fisher |
|                           |             | Jules  L. Fisher |
|                           |             | Chief  Financial Officer |

 

18

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**CERTIFICATIONS**

 

*CHIEFEXECUTIVE OFFICER CERTIFICATION PURSUANT TO RULE 13a-14*

 

I, Blair P. Mowery, President and Chief Executive Officer of MedicalCV,Inc., certify that:

 

1.                                       I have reviewed this quarterly report on Form10-QSB/A of MedicalCV, Inc.;

 

2.                                       Based on my knowledge, this quarterly reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.                                       Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periods presentedin this quarterly report;

 

4.                                       The registrant’s other certifying officers andI are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and have:

 

a)                                      designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

 

b)                                     evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)                                      presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.                                       The registrant’s other certifying officers andI have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent functions):

 

a)                                      all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b)                                     any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.                                       The registrant’s other certifying officers andI have indicated in this quarterly report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

 
| Dated: | April 4, 2003 |   |   | By     | /s/  Blair P. Mowery                   |
|--------|--------------------|--------|--------|--------|----------------------------------------|
|   |               |   |   |   | Blair  P. Mowery                       |
|   |               |   |   |   | President  and Chief Executive Officer |

 

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*CHIEFFINANCIAL OFFICER CERTIFICATION PURSUANT TO RULE 13a-14*

 

I, Jules L. Fisher, Chief Financial Officer of MedicalCV, Inc., certifythat:

 

1.                                       I have reviewed this quarterly report on Form10-QSB/A of MedicalCV, Inc.;

 

2.                                       Based on my knowledge, this quarterly reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.                                       Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.                                       The registrant’s other certifying officers andI are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and have:

 

a)                                      designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

 

b)                                     evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)                                      presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.                                       The registrant’s other certifying officers andI have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent functions):

 

a)                                      all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b)                                     any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.                                       The registrant’s other certifying officers andI have indicated in this quarterly report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

 
| Dated: | April 4, 2003 | By     | /s/  Jules L. Fisher     |
|--------|--------------------|--------|--------------------------|
|   |               |   | Jules  L. Fisher         |
|   |               |   | Chief  Financial Officer |

 

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*CHIEFEXECUTIVE OFFICER CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350*

 

In connection with theQuarterly Report of MedicalCV, Inc. (the “Company”) on Form 10-QSB/A for thequarterly period ended January 31, 2003, as filed with the Securities andExchange Commission on the date hereof (the “Report”), I, Blair P. Mowery,President and Chief Executive Officer of the Company, certify, pursuant to 18U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-OxleyAct of 2002, that:

 

1.                                       the Report fully complies with therequirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934;and

 

2.                                       the information contained in the Report fairlypresents, in all material respects, the financial condition and results ofoperations of the Company.

 

 
| Dated: | April 4, 2003 | By     | /s/  Blair P. Mowery                   |
|--------|--------------------|--------|----------------------------------------|
|   |               |   | Blair  P. Mowery                       |
|   |               |   | President  and Chief Executive Officer |

 

 

*CHIEFFINANCIAL OFFICER CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350*

 

In connection with theQuarterly Report of MedicalCV, Inc. (the “Company”) on Form 10-QSB/A for thequarterly period ended January 31, 2003, as filed with the Securities andExchange Commission on the date hereof (the “Report”), I, Jules L. Fisher,Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,that:

 

1.                                       the Report fully complies with therequirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934;and

 

2.                                       the information contained in the Report fairlypresents, in all material respects, the financial condition and results ofoperations of the Company.

 

 
| Dated: | April 4, 2003 | By     | /s/  Jules L. Fisher     |
|--------|--------------------|--------|--------------------------|
|   |               |   | Jules  L. Fisher         |
|   |               |   | Chief  Financial Officer |

 

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**Indexto Exhibits**

 
| **Exhibit   Number** |   | **Description**                                                                                                                                                                   |
|----------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                 |   | Discretionary Credit Agreement by and  between the Registrant and PKM Properties, LLC, dated January 17, 2003.                                                                    |
| 10.2                 |   | Discretionary Credit Note in the principal  amount of $943,666, issued by the Registrant, Maker, to PKM Properties, LLC,  Payee, dated January 17, 2003.                          |
| 10.3                 |   | Security Agreement by and between the  Registrant, Debtor, and PKM Properties, LLC, Secured Party, dated January 17,  2003.                                                       |
| 10.4                 |   | Second Mortgage by the Registrant for the  benefit of PKM Properties, LLC, dated January 17, 2003.                                                                                |
| 10.5                 |   | Common Stock Purchase Warrant issued by the  Registrant to PKM Properties, LLC, dated January 17, 2003.                                                                           |
| 10.6                 |   | Promissory Note in the principal amount of  $60,000, issued by the Registrant, Maker, to Allan R. Seck, Payee, dated December  11, 2002.                                          |
| 10.7                 |   | Working Capital Line of Credit — Change in  Terms Agreement by and between   Associated Bank Minnesota, lender, and the Registrant, borrower, dated  November 23, 2002. |
| 10.8                 |   | Commercial Guaranty from Paul K. Miller,  guarantor, to Associated Bank Minnesota, lender, dated November 23, 2002.                                                               |

 

 

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