**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM 10-QSB**

** **
| **ý**                                            | **QUARTERLY  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------------------------------------------------------|----------------------------------------------------------------------------------------|
|                                                  |                                                                                   |
| **FOR THE QUARTERLY PERIOD ENDED JULY 31, 2003** |
|                                                  |                                                                                   |
| **o**                                                 | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT**                   |
|                                                  |                                                                                   |
| **Commission  File Number  0-33295**             |

 

**MEDICALCV, INC.**

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

 

| **Minnesota**                                                                                      |   | **41-1717208**                        |
|----------------------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or Other  Jurisdiction  of Incorporation or Organization)                                   |   | (I.R.S. Employer  Identification No.) |
|                                                                                               |   |                                  |
| **9725 South Robert Trail  Inver Grove Heights, Minnesota 55077  (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 or15(d) of the Exchange Act during the past 12 months (or such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

Yes ý  No o

 

As of September 15, 2003, the issuer hadoutstanding 7,894,356 shares of common stock. This number includes 1,500,000 units, each consisting of one share ofcommon stock and one redeemable Class A Warrant, sold in the issuer’s initialpublic offering.

 

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

 

 

----

 

TABLE OF CONTENTS

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

 

----

 

**PART I**

 

ITEM 1  FinancialStatements

 

**MEDICALCV,INC.**

** **

**Consolidated Balance Sheet**

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

 

The accompanying notes are an integralpart of these financial statements.

 

3

----

 

**MEDICALCV,INC.**

 

**ConsolidatedStatement of Operations**

(unaudited)

 
|                                                           |   | **Three  Months Ended July 31,** |       |
|----------------------------------------------------------------|--------|---------------------------------------|------------|
|                                                           |   | **2003**                              |       | **2002** |   |
|                                                           |   |                                  |       |   |   |
| Net sales                                                      |   | $                                     | 1,094,579  |   | $ | 818,332 |   |
| Cost of goods sold                                             |   | 497,103                               |       | 477,869 |   |
| Gross profit                                                   |   | 597,476                               |       | 340,463 |   |
| Operating expenses:                                            |   |                                  |       |   |   |
| Sales and marketing                                            |   | 795,088                               |       | 755,587 |   |
| General and administrative                                     |   | 556,923                               |       | 537,591 |   |
| Engineering and regulatory                                     |   | 203,994                               |       | 201,117 |   |
| Total operating expenses                                       |   | 1,556,005                             |       | 1,494,295 |   |
| Loss from operations                                           |   | (958,529                              | )          | (1,153,832 | ) |
| Other (expense) income:                                        |   |                                  |       |   |   |
| Interest expense                                               |   | (156,246                              | )          | (38,980 | ) |
| Interest income                                                |   | 4,993                                 |       | 11,019 |   |
| Other (expense) income                                         |   | (11,181                               | )          | 15,927 |   |
| Total other expense                                            |   | (162,434                              | )          | (12,034 | ) |
|                                                           |   |                                  |       |   |   |
| Net loss                                                       |   | $                                     | (1,120,963 | ) | $ | (1,165,866 | ) |
| Basic and diluted net loss per share                           |   | $                                     | (.14       | ) | $ | (.15 | ) |
|                                                           |   |                                  |       |   |   |
| Shares used in computing basic and diluted net loss  per share |   | 7,894,356                             |       | 7,843,834 |   |

 

The accompanying notes are an integralpart of these financial statements.

 

4

----

 

**MEDICALCV,INC.**

 

**Consolidated Statement of Cash Flows**

(unaudited)

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

 

The accompanying notes are an integral part of these financialstatements.

 

5

----

 

**MEDICALCV, INC.**

 

**Notes to Consolidated Financial Statements**

 

**(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 theUnited States of America for interim financial information and pursuant to therules and 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, 2003.

 

The consolidated balance sheet as of July 31,2003, the consolidated statement of operations for the three months endedJuly 31, 2003 and 2002, and the consolidated statement of cash flows forthe three months ended July 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, 2004.

 

Certain amounts previously reported have beenreclassified to conform to their July 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 July 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 July 31, 2003, the Company had anaccumulated deficit of $18,194,058 and has insufficient funds to finance itsworking capital and capital expenditure needs. Accordingly, these matters raise substantial doubt about the Company’sability to continue as a going concern. The Company is currently seeking other sources of financing to fund itsoperations and working capital requirements. If the Company is unable to obtain sources of additional funds beginningin September 2003, it will be required to significantly revise itsbusiness plans and drastically reduce operating expenditures such that it maynot be able to develop or enhance its products, gain market share in the UnitedStates or respond to competitive pressures or unanticipated requirements, whichcould seriously harm its business, financial position and results ofoperations.  These financial statementsdo not include any adjustments that might result from the outcome of thisuncertainty.

 

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

 

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

 

TheCompany accounts for stock-based employee compensation arrangements inaccordance with the provisions of Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees,” and complies with thedisclosure provisions of SFAS No. 123, “Accounting for Stock-BasedCompensation” and SFAS No. 148 “Accounting for Stock-Based Compensation-Transitionand Disclosure, an amendment of FASB Statement No. 123.”

 

Forpurposes of the pro forma disclosures below, the estimated fair value of theoptions is amortized to expense over the options’ vesting period.  Had compensation cost for the Company’sstock options been recognized based on the fair value at the grant dateconsistent with the provisions of SFAS No. 123, the Company’s net losswould have been adjusted to the pro forma amounts indicated below:

 

6

----

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

 

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

 

Netloss per share is computed under the provisions of SFAS No. 128, “EarningsPer Share.” Basic net loss per common share is computed using net loss and theweighted-average number of shares of common stock outstanding. Diluted earningsper share reflect the potential dilution of securities that could share in theearnings of an entity. Diluted net loss per common share does not differ frombasic net loss per common share in the three-month periods ended July 31,2003 and 2002, since the potentially dilutive shares are anti-dilutive.  Potentially dilutive shares excluded fromthe calculation of diluted net loss per share relate to outstanding stockoptions and warrants for the purchase of 5,010,975 and 3,546,890 shares of theCompany’s common stock at July 31, 2003 and 2002, respectively.

 

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

 

Inventoryconsists of the following components:

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

 

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

 

OnJuly 8, 2003, the Company issued $1.0 million of term debt to PKM Properties,LLC (“PKM”), an entity controlled by a principal shareholder, who also serveson the Company’s Board of Directors. The Company borrowed $764,728 under this bridge financing during thequarter and, subsequent to July 31, 2003, borrowed the final draw of$235,272 on August 20, 2003.  Thedebt, which is collateralized by substantially all of our assets, bearsinterest at a rate of 10 percent per year and is due on May 27, 2004.  In connection with the debt, the Companyalso issued a warrant to PKM with a ten-year term to purchase 320,178 shares ofthe Company’s common stock at an exercise price of $0.70 per share.  The Company issued a warrant to purchase anadditional 60,179 shares of the Company’s common stock on the same terms inconjunction with the final draw on August 20, 2003.  In addition, the Company agreed to extendthe term of 700,000 previously issued warrants from five years to tenyears.  The allocated fair value of thewarrants issued prior to July 31, 2003, and the incremental value of theexisting warrants was $383,361, and was accounted for as a discount on theborrowings under the bridge debt.  Thisdiscount, which is presented as a reduction of the face value of the debt onthe consolidated balance sheet, is being amortized as interest expense over theeleven-month term of the debt.  As ofJuly 31, 2003, the unamortized balance of the discount was $348,510.  In addition, the Company incurred directfinancing costs of $54,728, which are included in other current assets and arebeing amortized as expenses over the eleven-month term of the debt.

 

OnJuly 8, 2003, the Company also issued $1.0 million of term debt to PeterL. Hauser (“Hauser”), a principal shareholder. The Company borrowed $1.0 million under this bridge financing during thequarter ended July 31, 2003.  Thedebt which is collateralized by substantially all of our assets pursuant to ourintercreditor agreement with PKM bears interest at a rate of 10 percent peryear and is due on June 30, 2004. In connection with the term debt, the Company also issued a warrant witha ten-year term to purchase 380,357 shares of the Company’s common stock at anexercise price of $0.70 per share.  Theallocated fair value of the newly issued warrant was $281,706 and is accountedfor as a discount on the borrowings under the bridge debt.  This discount, which is presented as a 

 

7

----

 

reductionof the face value of the debt on the consolidated balance sheet is beingamortized as interest expense over the twelve-month term of the debt.  As of July 31, 2003, the unamortizedbalance of the discount was $258,231. In addition, the Company incurred direct financing costs of $71,772,which are included in other current assets and are being amortized as expensesover the twelve-month term of the debt.

 

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

 

In June 2002, the FASBissued SFAS No. 146, “Accounting for Exit or Disposal Activities.”  The new statement addresses the accountingfor costs associated with exit or disposal activities.  The provisions of the statement wereeffective for disposal activities initiated after December 31, 2002.  The adoption of SFAS No. 146 did not have animpact on the Company’s financial position or results of operations.  The Company has had no exit or disposalactivities subsequent to December 31, 2002.

 

TheCompany adopted the provisions of FASB Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others” in the third quarter of fiscal year2003.  The disclosure provisions of theinterpretation are effective for the Company’s financial statements for thethird quarter of fiscal year 2003.  Theprovisions for initial recognition and measurement are effective on aprospective basis for guarantees that are issued or modified afterDecember 31, 2002.  Theimplementation of this accounting pronouncement did not have an effect on theCompany’s results of operations, financial position or cash flows.

 

InJanuary 2003, the FASB issued FIN No. 46, “Consolidation of VariableInterest Entities, an interpretation of Accounting Research Bulletin No. 51.”FIN No. 46 requires certain variable interest entities (VIEs), to beconsolidated by the primary beneficiary of the entity if the equity investorsin the entity do not have the characteristics of a controlling financialinterest or do not have sufficient equity at risk for the entity to finance itsactivities without additional subordinated financial support from otherparties.  FIN No. 46 is effective forall VIEs created or acquired after January 31, 2003.  For VIEs created or acquired prior toFebruary 1, 2003, the provisions of FIN No. 46 must be applied for thefirst interim or annual period beginning after June 15, 2003.  The Company currently has no contractualrelationship or other business relationship with a VIE and therefore theadoption of FIN No. 46 did not have an effect on its consolidated financialposition, results of operations or cash flows.

 

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

 

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

 

**(9)****                                ****Subsequent Event**

** **

OnSeptember 2, 2003, the Company signed an agreement with LightWave AblationSystems, Inc. to purchase technology for the treatment of atrialfibrillation.  This acquisition isconsistent with the Company's strategy to diversify its product offering.

 

8

----

 

Thefollowing table summarizes net sales by geographic area:

 
|          |   | **Three  Months Ended July 31,  (unaudited)** |      |
|---------------|--------|----------------------------------------------------|-----------|
|          |   | **2003**                                           |      | **2002** |   |
| Europe        |   | $                                                  | 601,720   |   | $ | 444,163 |   |
| South Asia    |   | 76,800                                             |      | 124,100 |   |
| Middle East   |   | 179,304                                            |      | 174,667 |   |
| Far East      |   | 53,180                                             |      | 42,827 |   |
| United States |   | 180,700                                            |      | 25,100 |   |
| Other         |   | 2,875                                              |      | 7,475 |   |
| **TOTALS**    |   | $                                                  | 1,094,579 |   | $ | 818,332 |   |

 

9

----

 

**ITEM 2****       ****MANAGEMENT’S DISCUSSION ANDANALYSIS OR PLAN OF OPERATION**

 

*The followingdiscussion contains various forward-looking statements within the meaning of**Section 21Eof the Exchange Act.  Although webelieve that, in making any such statement, our expectations are based onreasonable assumptions, any such statement may be influenced by factors thatcould cause actual outcomes and results to be materially different from thoseprojected.  When used in the followingdiscussion, 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, 2003, 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 area cardiothoracic surgery device manufacturer. Our primary products are mechanicalheart valves known as the Omnicarbon® Series 3000 and Series 4000, which wemanufacture and market.  Our heart valves are used to treat heartfailure caused by the aging process, heart diseases, prosthetic heart valvefailure and congenital defects.  Todate, we have distributed the Omnicarbon 3000 and 4000 heart valves primarily inEurope, South Asia, the Middle East and the Far East.  In fiscal year 2003, we derived 62 percent of our net sales from Europe.  As an innovator of heart valve technology,we have more than 33years of experience in developing, manufacturing and marketing five generationsof heart valves, and we have sold approximately 140,000 heart valves worldwide.

 

On July 26, 2001, the FDA gave us notice ofpremarket approval to sell our Omnicarbon 3000 heart valve in the U.S., thelargest geographic market for mechanical heart valves.  In anticipation of FDA premarket approval,we invested in our sales and marketing infrastructure, including adding salesmanagement to our staff and recruiting field sales representatives to call ondomestic surgery centers in the U.S. Based upon our Omnicarbon heart valve’s 18 years of implants in patients in Europe, we believe that we canestablish a competitive position in the mechanical heart valve industry in theU.S. and leverage this position into other critical areas of cardiothoracicsurgery.  We also expect that our abilityto market the Omnicarbon 3000 heart valve in the U.S. will favorably affect ourinternational sales, as we believe many cardiovascular surgeons and others who make purchasingdecisions are aware of the FDA’s rigorous premarket approval process and consider it to bea validation of the safety and efficacy of medical devices.  Our 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.  For more information regarding these risks,you should review our Cautionary Statement.

 

10

----

 

**Quarters Ended July 31, 2003 and 2002**

 

Ouroperating results, expressed as a percentage of total revenue, were as follows:

 

|                       |   | **Three Months Ended July 31,  (unaudited)** |   |
|----------------------------|--------|---------------------------------------------------|--------|
|                       |   | **2003**                                          |   | **2002** |   |
| Net sales                  |   | 100.0                                             | %      | 100.0 | % |
| Cost of goods sold         |   | 45.4                                              | %      | 58.4 | % |
|                       |   |                                              |   |   |   |
| Gross profit               |   | 54.6                                              | %      | 41.6 | % |
|                       |   |                                              |   |   |   |
| Operating expenses:        |   |                                              |   |   |   |
|                       |   |                                              |   |   |   |
| Sales and marketing        |   | 72.7                                              | %      | 92.3 | % |
| General and administrative |   | 50.9                                              | %      | 65.7 | % |
| Engineering and regulatory |   | 18.6                                              | %      | 24.6 | % |
|                       |   |                                              |   |   |   |
| Total operating expenses   |   | 142.2                                             | %      | 182.6 | % |
|                       |   |                                              |   |   |   |
| Loss from operations       |   | (87.6                                             | )%     | (141.0 | )% |
|                       |   |                                              |   |   |   |
| Other (expense) income:    |   |                                              |   |   |   |
| Interest expense           |   | (14.3                                             | )%     | (4.7 | )% |
| Interest income            |   | 0.5                                               | %      | 1.3 | % |
| Other income               |   | (1.0                                              | )%     | 1.9 | % |
|                       |   |                                              |   |   |   |
| Total other expense        |   | (14.8                                             | )%     | (1.5 | )% |
|                       |   |                                              |   |   |   |
| Net loss                   |   | (102.4                                            | )%     | (142.5 | )% |

 

**CriticalAccounting Policies**

 

Fordiscussion of our critical accounting policies and estimates, see our AnnualReport on Form 10-KSB for the fiscal year ended April 30, 2003.

 

**Results ofOperations**

 

*Net Sales*.  Net sales in the quarter ended July 31, 2003 increased 33.8 percent to $1,094,579 from $818,332 in the first quarter of the prior year.  The increase was attributable to higher Omnicarbonunit sales in key European markets and the U.S., with approximately halfattributable to each geographic area.

 

In thefirst three months fiscal years 2004 and 2003, 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 in Japaneseyen, and two Europeancustomers, which pay in euros.  Because we do not engage inforeign currency hedging transactions, we recognize that a strong U.S. dollar can adversely affectunit sales denominated incurrencies other than U.S. dollars for our foreign distributors.

 

*Gross Profit.*  Gross profit as a percentage of net sales increased to 54.6 percent in the quarter ended July 31,2003, from 41.6 percent in the comparableperiod one year ago.  The improvement infiscal year 2004 gross profit margin was attributable primarily to reductionsin Omnicarbon 4000 product costs, which we sell in markets outside the U.S. andJapan, combined with favorable margin impacts due to unit sales growth in theU.S. market. Wehave expended considerable resources in developing our new carbon manufacturingprocess technologies utilized in manufacturing the Omnicarbon 4000 heart valve. Our strategy is to obtain FDA approval of our proprietary pyrolytic carbon manufacturing process in order tomarket the Omnicarbon 4000 in the U.S. Due to its lower manufacturing cost, we believe the Omnicarbon 4000 willgenerate significantly higher gross profit margins when sold in the U.S. thanthe Omnicarbon 3000 heart valve. However, there can be no assurance that the FDA will approve ourproprietary manufacturing process.

 

*Sales and Marketing*.  Sales and marketing expenses in the quarter ended July 31,2003, were $795,088 or 72.7 percent of net sales compared to $755,587 or 92.3 percent of net sales in the same period lastfiscal year.  The increase in fiscal year 2004is

 

11

----

 

primarilyattributable to selling expenses associated with the higher level of net salesin the current period.  Our overallstrategy is to promote the clinical results of the Omnicarbon heart valve andthe technical strengths of our company in designing and manufacturingmechanical heart valves.

 

*General and Administrative*.  General and administrative expenses for the quarter ended July 31,2003, were $556,923 or 50.9 percent of net sales compared to $537,591 or 59.7 percent of net sales in the prior year.  The slight increase in spending in thecurrent period related to fees paid for financial advisory services and higherprofessional service fees.

 

*Engineering and Regulatory*.  Engineering and regulatory expenses for the quarter ended July 31,2003, were $203,994 or 18.6 percent of net sales compared to $201,117 or 24.6 percent of net sales in the prior year.  We anticipate increasedspending in this area as initiatives move forward to develop and commercializeadditional new products.

 

*Other (Expense) Income*.  Interest expense totaled $156,246 in the quarter ended July 31,2003, compared to $38,980 in the comparable periodlast fiscal year.  The increase in interestexpense in the first quarter of fiscal 2004 was primarily due to financingcosts related to short-term related party borrowings.

 

*Income Tax Provision*.  In light of our recent history of operatinglosses, we recorded a valuation allowance to fully offset our deferred taxassets in fiscal year 2000.  We havecontinued to provide a full valuation allowance through the first quarter of fiscal 2004 due to the inherent uncertainty about the sufficiency of future taxable incomenecessary to realize our deferred tax assets.

 

*Loss from Operations*.  As of July 31, 2003, we had an accumulated deficit of $18,194,058. We have incurred losses in each of the last seven fiscal years.  Since 1994, we have invested in developing a bileaflet heartvalve, a proprietary pyrolytic carbon coating process and obtaining premarketapproval from the FDA to market our Omnicarbon 3000 heart valve in theU.S.  Our strategy has been to invest intechnology to better position ourselves competitively once FDA premarketapproval was obtained.  We expectcumulative net losses to continue at least through fiscal year 2004 because of anticipated spendingnecessary to market the Omnicarbon 3000 heart valve in the U.S. and toestablish and maintain a strong marketing organization for domestic and foreignmarkets.

 

**Liquidity and Capital Resources**

 

Cash and cash equivalents increasedslightly to $202,790 at July 31, 2003, from $184,227 at April 30, 2003.  Thisincrease in cash and cash equivalents of$18,563, was due to the following:

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

 

Net cash used in operating activities increased$168,740to $1,598,228 in the quarter endedJuly 31, 2003, from $1,529,758 in the quarter ended July 31, 2002. The use of cash in operations in the first quarter of both fiscal year2003 and fiscal year 2004 were net losses of $1,165,866 and $1,120,963,respectively.  The increase in the useof cash in operations in the first quarter of 2004 relative to 2003 was due principally to decreasesin accrued expenses and accounts payable, partially offset by a decrease ininventories in the first quarter of fiscal year 2004 versus an increase ininventories in the first quarter of fiscal year 2003.  The decreases in accrued expenses and accounts payable were afunction of the timing of when we paid certain costs.  The increase in inventories in the first quarter of fiscal year2003 was to support anticipated sales growth in the U.S. and internationalmarkets.  The decrease in inventories inthe first quarter of fiscal year 2004 reflects the results of our concertedeffects to more closely control our inventory levels combined with lowermanufacturing costs.

 

Nofunds were used in investingactivities in the quarter ended July 31, 2003.  Net cash used in investing activities was$84,593 in the quarter ended July 31, 2002, and was entirely for property, plant, and equipmentpurchases to support manufacturing and sales.

 

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

 

Throughoutfiscal year 2003 and in the first quarter of fiscal year 2004, we entered intoa number of financing transactions to provide funds necessary to meet our workingcapital and capital expenditure needs and to meet other obligations.  These financing activities consisted of thefollowing:

 

InDecember 2002, we received a $60,000 unsecured advance from an executiveofficer.  Principal and interest on thisadvance was repaid in April 2003.

 

12

----

 

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

 

OnApril 4, 2003, we sold our corporate headquarters, manufacturing facilityand surrounding land in Inver Grove Heights, Minnesota to PKM.  In connection with the transaction, wereceived total consideration of $3.84 million consisting of (1) $1.0 million incash, (ii) PKM’s assumption of our $2.5 million outstanding indebtedness toAssociated Bank which eliminated our indebtedness to Associated Bank, and (iii)PKM’s assumption of our promissory note with Dakota Electric Association andland special assessments payable to Dakota County aggregating $336,105.  We relied on a fair market value appraisalof the property in determining the amount of such consideration.   Also in connection with the transaction, weissued to PKM a five-year warrant for the purchase of 350,000 shares of ourcommon stock at an exercise price of $0.625 per share.   These warrants had an allocated fair valueof $89,602.

 

Ofthe net cash proceeds, $300,000 plus interest was applied to our indebtednessto PKM pursuant to the line of credit agreement described above.

 

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

 

Dueto our continued involvement with the property, including the ability to buyback the property at a future date, the transaction is accounted for as afinancing of the property sold and leased back.  Accordingly, the net book value of the facility and land sold toPKM with a net book value of $759,146 continues to be presented as part of ourproperty, plant and equipment balance. The related party lease obligation of $3,652,572 at July 31, 2003,represents the minimum amounts due PKM for the initial ten-year term discountedat 4.4 percent and additional payments to be paid to PKM for the DakotaElectric Association and Dakota County obligations assumed by PKM.

 

OnJuly 8, 2003, we obtained $2.0 million in bridge financing, resulting innet proceeds of approximately $1.87 million.

 

Underthe terms of the financing, we established a one-year $1.0 million of term debtwith PKM.  The line, which requires thepayment of interest at a rate of 10 percent per year, matures on May 27,2004, and is collateralized by substantially all of our assets.   As additional consideration for thefinancing, we agreed to issue PKM ten-year warrants for the purchase of up to380,357 shares of our common stock at an exercise price of $0.70 per share withterms and conditions that include weighted-average anti-dilution rights.  We also agreed to modify certain terms ofthe warrants issued to PKM in connection with a credit facility extended by PKMin January 2003, to conform to the terms of the warrants issued as part ofthis bridge debt financing.

 

Ina simultaneous transaction, we entered into a loan agreement and borrowed $1.0million from Peter L. Hauser pursuant to a one-year subordinated note with aninterest rate of 10 percent per year. Pursuant to an intercreditor agreementwith PKM, the loan is collateralized by substantially all of our assets.  The lender was issued ten-year warrants forthe purchase of 380,357 shares of our common stock on terms comparable to thePKM warrants described above.  As aresult of the transaction, Mr. Hauser became the beneficial owner ofapproximately 10.3 percent of our securities.

 

We expect that our operating losses and negative operating cashflow will continue atleastthroughfiscal year 2004 as we expand our manufacturingcapabilities, continue increasing our corporate staff to support the U.S.roll-out of our Omnicarbon 3000 heart valve, and add marketing programs domestically andinternationally to build awareness of and create demand for our Omnicarbonheart valves. 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 theavailability of financing.

 

Our capital requirements may varydepending upon the timing and the success of the implementation of our businessplan,

 

13

----

 

regulatory, technological and competitive developments, or if:

 

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

 

operatinglosses exceed our projections;

 

our manufacturing and development costs or estimates prove to be inaccurate;

 

we determine to acquire, 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 depends upon our ability to obtainadditional debt and/or equity financing in the second quarter of fiscal year2004.  We are currently seekingadditional financing to fund our operations and working capitalrequirements.  We cannot provide anyassurance, however, that such additional financing will be available on termsacceptable to us or at all.  We willneed to obtain additional capital prior to the maturity date of our revolvingline of credit with PKM on September 17, 2003, or otherwise extend orrestructure this debt to continue operations.

 

Weanticipate that we will need to raise between $8,000,000 and $10,000,000 of additional equity or debtfinancing to fund operations and working capital requirementsbeginning in September 2003. 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 weobtain the foregoingfinancing, we believe we willhavesufficient capital resources tooperate and fund the growth of ourbusiness for the remainder of fiscal year 2004 and fiscal year2005.

 

We cannot assure you that we will be able to raise sufficient additional capital on terms that we consider acceptable, or atall.  The terms of anyequity financing are expected to be highly dilutive to our existing securityholders.  The delisting of oursecurities from the Nasdaq SmallCap Market that occurred in March 2003will negatively affect our ability to raise capital.  If we are unable toobtain adequate financing on acceptable terms, we will be unable tocontinue operations.

 

Untilsuch time as the level of U.S. market acceptance of our heart valves increasesand the FDA approves our pyrolytic carbon process, we anticipate that we willcontinue to depend upon cash provided by financing activities to address ourworking capital requirements.  By broadeningour portfolio of cardiothoracic surgery products, we hope to reduce ourdependence on sales of heart valves and reduce our reliance upon financingtransactions, which may not be available to us.  We cannot, however, assure you that our efforts to diversify ourproduct offerings will:

 

beattainable;

 

beprofitable;

 

reduceour reliance upon financing transactions; or

 

enableus to continue operations.

 

**Commitments andContingent Liabilities**

 

*Snia S.p.A. Carbomedics (formerlySulzer Carbomedics).* In July 1998, we enteredinto a three-year supply agreement with Snia S.p.A. Carbomedics, the source of certain raw materialcomponents used in the manufacture of our Omnicarbon 3000 heart valves.  The supply agreement was extended for anadditional two years in March 2001.  The agreementprovides that we purchase a minimum number of raw material units each calendaryear through December 2003.  Under theterms of the agreement, we are required to compensate Snia S.p.A.Carbomedics for any purchaseshortfalls up to a maximum of $200,000 per year.  We have not met the minimum purchase requirements for the pastthree calendar years.  In addition, wedo not believe we will meet the minimum purchase requirement for calendar year2003.  As a result, we expensed $33,935in the quarter ended July 31, 2003, and $17,050 in the quarter endedJuly 31, 2002, related tothese purchase shortfalls. These charges were reflectedin cost of goods sold.  Future purchaseshortfalls could adversely affect our ongoing relationship with SniaS.p.A. Carbomedics.

 

*UROPACE*.  In July 1995, we established a wholly owned subsidiary, UROPACE, Inc., tocommercialize technology for

 

14

----

 

treating female urinary incontinence.  On November 1, 2000, we completed the spin-off ofUROPACE to our existing shareholders. The separation was effected by transferring from our company to UROPACEall assets, tangible and intangible, relating to the development of femaleurinary incontinence technology.  Ourshareholders of record on September 15, 2000 received one share of common stock of UROPACE foreach 6.882 shares of our common stock they held on that date.  The assets transferred to UROPACE had nobook value 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 July 31,2003, 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.

 

*Related Party LeaseObligation. *On April 4, 2003, we sold our corporateheadquarters, manufacturing facility and surrounding land in Inver GroveHeights, Minnesota to PKM.  Inconnection with the transaction, we received total consideration of $3.84million consisting of (1) $1.0 million in cash, (ii) PKM’s assumption of our$2.5 million outstanding indebtedness to Associated Bank which eliminated ourindebtedness to Associated Bank, and (iii) PKM’s assumption of our promissorynote with Dakota Electric Association and land special assessments payable toDakota County aggregating $336,105.

 

Wesimultaneously leased back our facility pursuant to a ten-year lease, withoptions to renew and an option to repurchase the facility.  We will continue to utilize the facility aswe did prior to the sale-leaseback transaction, with no change in operations.

 

*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*.  Weentered into an employment separation agreement with an officer in late 2002,which provides for consulting services through calendar 2003.

 

*Short-Term Debt with RelatedParties.*  We entered into an agreement with PKM andanother shareholder in early July to provide $2.0 million of bridgefinancing.  We previously established aline of credit in January 2003 with PKM. As noted above, PKM is an entity controlled by a principal shareholder,who also serves on our board of directors.

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

 

----

(1)                                  Future payments includeinterest due.

 

**Recent AccountingPronouncements**

 

In June 2002, the FASBissued SFAS No. 146, “Accounting for Exit or Disposal Activities.”  The new statement addresses the accountingfor costs associated with exit or disposal activities.  The provisions of the statement wereeffective for disposal activities initiated after December 31, 2002.  The adoption of SFAS No. 146 did not have animpact on the Company’s financial position or results of operations.  The Company has had no exit or disposalactivities subsequent to December 31, 2002.

 

15

----

 

TheCompany adopted the provisions of FASB Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others” in the third quarter of fiscal year2003.  The disclosure provisions of theinterpretation are effective for the Company’s financial statements for thethird quarter of fiscal year 2003.  Theprovisions for initial recognition and measurement are effective on aprospective basis for guarantees that are issued or modified afterDecember 31, 2002.  Theimplementation of this accounting pronouncement did not have an effect on theCompany’s results of operations, financial position or cash flows.

 

In January 2003, theFASB issued FIN No. 46, “Consolidation of Variable Interest Entities, aninterpretation of Accounting Research Bulletin No. 51.” FIN No. 46 requirescertain variable interest entities (VIEs), to be consolidated by the primarybeneficiary of the entity if the equity investors in the entity do not have thecharacteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties.  FIN No. 46 is effective for all VIEs created or acquired afterJanuary 31, 2003.  For VIEs createdor acquired prior to February 1, 2003, the provisions of FIN No. 46 must beapplied for the first interim or annual period beginning after June 15,2003.  The Company currently has nocontractual relationship or other business relationship with a VIE andtherefore the adoption of FIN No. 46 did not have an effect on its consolidatedfinancial position, results of operations or cash flows.

 

**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.

 

**Subsequent Event**

 

OnSeptember 2, 2003, we signed an agreement with LightWave Ablation Systems, Inc.to purchase technology for the treatment of atrial fibrillation.  This acquisition is consistent with ourstrategy to diversify our product offering.

 

16

----

 

**ITEM 3****       ****CONTROLS AND PROCEDURES**

 

Wemaintain a system of disclosure controls and procedures that is designed toprovide reasonable assurance that information, which is required to bedisclosed, is accumulated and communicated to management timely.  As of the end of the period covered by thisreport, we carried out an evaluation, under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures pursuant to Exchange Act Rule13a-15.  Based upon that evaluation, theChief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures are effective in timely alerting them tomaterial information required to be included in our periodic filings with theSEC.

 

17

----

 

**PART II****   OTHERINFORMATION**

 

ITEM 1        Legal Proceedings

 

Asof September 15, 2003, we were not a party to any material litigation.

 

ITEM 2        Changes in Securities

 

(c)                                  Sales of Unregistered Securities

 

OnJuly 8, 2003, we completed a $2.0 million bridge financing transaction,resulting in net proceeds of approximately $1.87 million.

 

Underthe terms of the financing, we established a one-year $1.0 milliondiscretionary line of credit with PKM. The line, which requires the payment of interest at a rate of 10 percentper year, matures on May 27, 2004, and is collateralized by substantiallyall of our assets.   As additionalconsideration for the financing, we agreed to issue PKM ten-year warrants forthe purchase of up to 380,357 shares of our common stock at an exercise priceof $0.70 per share with terms and conditions that include weighted-averageanti-dilution rights.  Of such securities,warrants for the purchase of 320,178 shares expire on July 8, 2013, andwarrants for the purchase of 60,179 shares expire on August 20, 2013.  We also agreed to modify certain terms ofthe warrants issued to PKM in connection with a credit facility extended by PKMin January 2003, to conform to the terms of the warrants issued as part ofthis bridge debt financing.

 

Ina simultaneous transaction, we entered into a loan agreement and borrowed $1.0million from Peter L. Hauser pursuant to a one-year subordinated note with aninterest rate of 10 percent per year. Pursuant to an intercreditor agreementwith PKM, the loan is collateralized by substantially all of our assets.  The lender was issued ten-year warrants forthe purchase of 380,357 shares of our common stock on terms comparable to thePKM warrants described above.  As aresult of the transaction, Mr. Hauser became the beneficial owner ofapproximately 10.3 percent of our securities.

 

EffectiveJuly 15, 2003, we issued 50,522 shares of common stock to Tower Finance, Ltd.,a financial advisory firm, in conjunction with Tower's agreement to provideconsulting services.

 

Theforegoing issuances were made in reliance upon the exemption provided inSection 4(2) of the Securities Act. Such securities are restricted as to sale or transfer, unless registeredunder the Securities Act, and the certificates representing such securitiescontains restrictive legends preventing sale, transfer or other disposition,unless registered under the Securities Act. In addition, the recipients of such securities received materialinformation concerning our company, including, but not limited to, our reportson Form 10-KSB and Form 10-QSB, as filed with the Securities and ExchangeCommission.  Other than a 6.5 percentplacement fee paid to PKM and Mr. Hauser, no underwriting commissions ordiscounts were paid with respect to the issuances of such securities.

 

ITEM 3        Defaults upon Senior Securities

 

Notapplicable.

 

ITEM 4        Submission of Matters to a Vote of SecurityHolders

 

Notapplicable.

 

ITEM 5        Other Information

 

Notapplicable.

 

ITEM 6        Exhibits and Reports on Form 8-K

 

(a)                                  Exhibits

 

None.

 

(b)                                 Reports on Form 8-K

 

Theregistrant filed two current reports on Form 8-K during the quarter endedJuly 31, 2003:

 

Onecurrent report on Form 8-K relating to financial results for the fiscal yearended April 30, 2003, furnished on June 12, 2003.

 

Onecurrent report on Form 8-K relating to the completion of $2.0 million of bridgedebt financing transactions with private investors, filed on July 14, 2003.

 

18

----

 

**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:  September 15, 2003 | By               | /s/  Blair P. Mowery |   |
|                                |             | Blair  P. Mowery |
|                                |             | President  and Chief Executive Officer |
|                                |             |   |
|                                | By               | /s/  Jules L. Fisher |   |
|                                |             | Jules  L. Fisher |
|                                |             | Chief  Financial Officer |

 

19

----

 

**INDEX TO EXHIBITS**

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

 

 

20

----