**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

**FORM 10-QSB**
| **x**                                            | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|--------------------------------------------------|----------------------------------------------------------------------------------------------------------|
| ** **                                       | ** **                                                                                               |
| **FOR THE QUARTERLY PERIOD ENDED JULY 31, 2007** |
| ** **                                       | ** **                                                                                               |
| **o**                                            | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |

 

**CommissionFile Number 000-33295**

**MedicalCV, Inc.**

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

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

 

**9725South Robert Trail**

**InverGrove Heights, Minnesota 55077**

**(651)452-3000**

(Address of PrincipalExecutive Offices and Issuer’s

Telephone Number,including Area Code)

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

Yes  x  No  o

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

Yes  o  No  x

As of September 7, 2007,the issuer had outstanding 9,839,724 shares of common stock, $0.01 par value.

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

 

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**TABLEOF CONTENTS**
| PART I        | FINANCIAL INFORMATION |                                                            |
|--------------------|-----------------------|-----------------------------------------------------------------|
|               |                  |                                                            |   |
|               | ITEM 1                | Condensed  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 6                | Exhibits                                                        |   |
|               |                  |
| SIGNATURES         |                  |
| INDEX  TO EXHIBITS |                  |

 

2

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**PART I**

**FINANCIAL INFORMATION**

**ITEM 1 CONDENSED FINANCIAL STATEMENTS**

**MEDICALCV, INC.**

**CONDENSEDBALANCE SHEETS**
| ** **                                                                                                                                                                | ** ** | **July 31, 2007** | ** ** | **April 30, 2007** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                | ** ** | **(unaudited)**             | ** ** | ** **                   | ** ** |
| **ASSETS**                                                                                                                                                                |       |                        |       |                         |       |
| CURRENT ASSETS                                                                                                                                                            |       |                        |       |                         |       |
| Cash and cash  equivalents                                                                                                                                                |       | $                           | 10,687,210 |                         | $          | 8,950,983 |   |
| Prepaid expenses  and other current assets                                                                                                                                |       | 260,124                     |       | 280,150                      |       |
| Current asset of  discontinued operations                                                                                                                                 |       | 64,878                      |       | 87,323                       |       |
| TOTAL CURRENT  ASSETS                                                                                                                                                     |       | 11,012,212                  |       | 9,318,456                    |       |
| PROPERTY, PLANT AND  EQUIPMENT, net                                                                                                                                       |       | 794,457                     |       | 788,835                      |       |
| DEFERRED FINANCING  COSTS, net                                                                                                                                            |       | 416,942                     |       | 349,053                      |       |
| OTHER NONCURRENT ASSETS                                                                                                                                                   |       | 15,600                      |       | 15,600                       |       |
| TOTAL ASSETS                                                                                                                                                              |       | $                           | 12,239,211 |                         | $          | 10,471,944 |   |
|                                                                                                                                                                      |       |                        |       |                         |       |
| **LIABILITIES,  CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY**                                                                                               |       |                        |       |                         |       |
| ** **                                                                                                                                                                |       |                        |       |                         |       |
| CURRENT LIABILITIES                                                                                                                                                       |       |                        |       |                         |       |
| Current amount  of related party lease obligation                                                                                                                         |       | $                           | 342,371    |                         | $          | 334,633 |   |
| Accounts payable                                                                                                                                                          |       | 583,355                     |       | 685,753                      |       |
| Accrued expenses                                                                                                                                                          |       | 246,684                     |       | 353,640                      |       |
| TOTAL CURRENT  LIABILITIES                                                                                                                                                |       | 1,172,410                   |       | 1,374,026                    |       |
| SECURED PROMISSORY  NOTES, net of discount                                                                                                                                |       | 6,331,633                   |       | 4,248,173                    |       |
| RELATED PARTY LEASE  OBLIGATION, less current amount                                                                                                                      |       | 2,117,352                   |       | 2,207,600                    |       |
| TOTAL  LIABILITIES                                                                                                                                                        |       | 9,621,395                   |       | 7,829,799                    |       |
| COMMITMENTS AND  CONTINGENCIES                                                                                                                                            |       |                        |       |                         |       |
| 5% SERIES A REDEEMABLE  CONVERTIBLE PREFERRED STOCK  $.01 par value; stated value $10,000 per share; 1,900 shares authorized;  no shares issued and outstanding |       | —                      |       | —                       |       |
| SHAREHOLDERS’ EQUITY                                                                                                                                                 |       |                        |       |                         |       |
| Preferred stock;  $.01 par value; 998,100 shares authorized; no shares issued and  outstanding                                                                       |       | —                      |       | —                       |       |
| Common stock;  $.01 par value; 24,000,000 shares authorized; 9,839,724 and 9,837,224 shares  issued and outstanding                                                       |       | 98,397                      |       | 98,372                       |       |
| Additional  paid-in capital                                                                                                                                               |       | 65,943,416                  |       | 62,603,147                   |       |
| Accumulated  deficit                                                                                                                                                      |       | (63,423,997                 | )          | (60,059,374                  | )          |
| TOTAL  SHAREHOLDERS’ EQUITY                                                                                                                                          |       | 2,617,816                   |       | 2,642,145                    |       |
| TOTAL LIABILITIES,  CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY                                                                                        |       | $                           | 12,239,211 |                         | $          | 10,471,944 |   |

 

See notes to condensed financial statements.

3

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**MEDICALCV, INC.CONDENSED STATEMENTS OF OPERATIONS**

**(UNAUDITED)**
| ** **                                                    | ** ** | **Three months ended July 31,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                    | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| SALES                                                         |       | $                                                   | 23,200     |   | $ | — |   |
| COST OF GOODS  SOLD                                           |       | 1,392                                               |       | — |   |
| GROSS PROFIT                                                  |       | 21,808                                              |       | — |   |
|                                                          |       |                                                |       |   |   |
| OPERATING  EXPENSES                                           |       |                                                |       |   |   |
| Sales and marketing                                           |       | 290,833                                             |       | 390,682 |   |
| General and administrative                                    |       | 1,274,496                                           |       | 2,217,613 |   |
| Research and development                                      |       | 1,166,649                                           |       | 1,588,362 |   |
| TOTAL OPERATING EXPENSES                                      |       | 2,731,978                                           |       | 4,196,657 |   |
| LOSS FROM  OPERATIONS                                         |       | (2,710,170                                          | )          | (4,196,657 | ) |
|                                                          |       |                                                |       |   |   |
| OTHER INCOME  (EXPENSE)                                       |       |                                                |       |   |   |
| Interest income                                               |       | 118,750                                             |       | 108,349 |   |
| Interest expense                                              |       | (751,577                                            | )          | (37,235 | ) |
| Other income                                                  |       | 820                                                 |       | 18,927 |   |
| TOTAL OTHER (EXPENSE) INCOME                                  |       | (632,007                                            | )          | 90,041 |   |
|                                                          |       |                                                |       |   |   |
| LOSS FROM  CONTINUING OPERATIONS                              |       | (3,342,177                                          | )          | (4,106,616 | ) |
| (LOSS) INCOME  FROM DISCONTINUED OPERATIONS                   |       | (22,446                                             | )          | 9,054 |   |
| NET LOSS                                                      |       | $                                                   | (3,364,623 | ) | $ | (4,097,562 | ) |
|                                                          |       |                                                |       |   |   |
| BASIC AND  DILUTED NET (LOSS) EARNINGS PER COMMON SHARE       |       |                                                |       |   |   |
| Continuing operations                                         |       | $                                                   | (0.34      | ) | $ | (0.45 | ) |
| Discontinued operations                                       |       | (0.00                                               | )          | 0.00 |   |
| NET LOSS                                                      |       | $                                                   | (0.34      | ) | $ | (0.45 | ) |
|                                                          |       |                                                |       |   |   |
| BASIC AND DILUTED  WEIGHTED AVERAGE COMMON SHARES OUTSTANDING |       | 9,838,175                                           |       | 9,122,941 |   |

 

See notes to condensed financial statements.

4

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

**(UNAUDITED)**
| ** **                                                                              | ** ** | **Three months ended July 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| OPERATING  ACTIVITIES                                                                   |       |                                                |       |   |   |
| Net loss                                                                                |       | $                                                   | (3,364,623 | ) | $ | (4,097,562 | ) |
| Adjustments to reconcile net loss to net cash used  by operating activities:            |       |                                                |       |   |   |
| Share-based compensation                                                                |       | 433,392                                             |       | 673,240 |   |
| Depreciation                                                                            |       | 36,268                                              |       | 31,000 |   |
| Impairment of fixed assets                                                              |       | —                                              |       | 20,753 |   |
| Gain from the sales of property, plant and equipment                                    |       | —                                              |       | (49,649 | ) |
| Amortization of discount on secured promissory notes                                    |       | 272,522                                             |       | — |   |
| Accrued interest and warrant expense on secured  promissory notes                       |       | 422,650                                             |       | — |   |
| Amortization of deferred financing costs                                                |       | 31,149                                              |       | 1,821 |   |
| Changes in operating assets and liabilities:                                            |       |                                                |       |   |   |
| Prepaid expenses and other assets                                                       |       | 42,471                                              |       | (55,447 | ) |
| Accounts payable                                                                        |       | (118,923                                            | )          | 280,309 |   |
| Accrued expenses                                                                        |       | (106,956                                            | )          | 37,495 |   |
| NET CASH USED BY OPERATING ACTIVITIES                                                   |       | (2,352,050                                          | )          | (3,158,040 | ) |
|                                                                                    |       |                                                |       |   |   |
| INVESTING  ACTIVITIES                                                                   |       |                                                |       |   |   |
| Purchases of property, plant and equipment                                              |       | (25,365                                             | )          | (16,515 | ) |
| Proceeds from the sales of property, plant and  equipment                               |       | —                                              |       | 50,668 |   |
| NET CASH (USED) PROVIDED BY INVESTING ACTIVITIES                                        |       | (25,365                                             | )          | 34,153 |   |
|                                                                                    |       |                                                |       |   |   |
| FINANCING  ACTIVITIES                                                                   |       |                                                |       |   |   |
| Proceeds from issuance of secured promissory notes  and warrants, net of offering costs |       | 4,196,152                                           |       | — |   |
| Principal payments under related party lease  obligation                                |       | (82,510                                             | )          | (79,543 | ) |
| Payments of fractional share interests                                                  |       | —                                              |       | (229 | ) |
| NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES                                        |       | 4,113,642                                           |       | (79,772 | ) |
|                                                                                    |       |                                                |       |   |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                                   |       | 1,736,227                                           |       | (3,203,659 | ) |
| CASH AND CASH  EQUIVALENTS                                                              |       |                                                |       |   |   |
| Beginning of year                                                                       |       | 8,950,983                                           |       | 10,351,570 |   |
| End of period                                                                           |       | $                                                   | 10,687,210 |   | $ | 7,147,911 |   |
|                                                                                    |       |                                                |       |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION                                       |       |                                                |       |   |   |
| Cash paid for interest                                                                  |       | $                                                   | 25,256     |   | $ | 37,235 |   |
| NONCASH  INVESTING AND FINANCING ACTIVITIES                                             |       |                                                |       |   |   |
| Purchases of property, plant and equipment in  accounts payable                         |       | $                                                   | 16,525     |   | $ | — |   |
| Fair value of  warrants issued in connection with secured promissory notes              |       | $                                                   | 2,970,000  |   | $ | — |   |

 

See notes to condensed financial statements.

5

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**MEDICALCV, INC.Notes to Condensed Financial Statements**

**1.****                 Basis ofFinancial Statement Presentation**

The accompanying unaudited condensed 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 therules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America have been condensed or omitted pursuant to suchrules and regulations.  These interim financial statements should beread in conjunction with the financial statements and the notes theretoincluded in the Company’s Annual Report on Form 10-KSB for the fiscal yearended April 30, 2007.

The balance sheet as of July 31, 2007, thestatements of operations for the three months ended July 31, 2007 and 2006, andthe statements of cash flows for the three months ended July 31, 2007 and2006 include, in the opinion of management, all adjustments, consisting solelyof normal recurring adjustments, necessary for a fair presentation of the financialresults for the respective interim periods and are not necessarily indicativeof results of operations to be expected for the entire fiscal year endingApril 30, 2008.

**2.****                 Going Concern**

The Company’s financial statements as of and for thethree months ended July 31, 2007 have been prepared on a going concern basis,which contemplates the realization of assets and settlement of liabilities andcommitments in the normal course of business. The Company has sustained lossesand negative cash flows from operations in recent years and expects theseconditions to continue in the foreseeable future. As of July 31, 2007, theCompany had an accumulated deficit of $63,423,997. The level of cash requiredfor operations during the remaining quarters of fiscal year 2008 is difficultto predict, and management anticipates that continued development and fullcommercialization of its ablation systems will require additional capital.These matters raise substantial doubt about the Company’s ability to continueas a going concern. Management intends to seek additional debt or equityfinancing as it continues to develop and commercialize its ablation systems.However, the Company may not be able to obtain such financing on acceptableterms or at all. If the Company is unable to obtain such additional financing,it will be required to significantly revise its business plan and drasticallyreduce operating expenditures such that it may not be able to develop orenhance its products, gain market share, or respond to competitive pressures orunanticipated requirements, which could seriously harm its business, financialcondition and results of operations. The financial statements do not includeany adjustments that might result from the outcome of this uncertainty.

**3.****                 Net (Loss) Earningsper Common Share**

Basic net (loss) earnings per common share wascomputed by dividing the net (loss) income to common shareholders by theweighted average number of common shares outstanding. Diluted net (loss)earnings per common share reflects the potential dilution that could occur ifholders of warrants, options, and other derivative instruments that are notanti-dilutive convert their holdings into common stock. Diluted net (loss) earningsper common share does not differ from basic net (loss) earnings per commonshare in the three months ended July 31, 2007 and 2006 due to the loss fromcontinuing operations which would cause the potentially dilutive shares to beanti-dilutive. Options and warrants outstanding to purchase 3,763,045 and2,159,351 shares of common stock were excluded from the computation for thethree months ended July 31, 2007 and 2006, respectively, because the loss fromcontinuing operations would cause such shares to be anti-dilutive.

6

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**4.****      Secured Promissory Notes**

On April 20, 2007 and June 15, 2007, the Companyentered into Secured Note Purchase Agreements for the issuance and sale of 11%Secured Promissory Notes (“11% Notes”) and warrants for the purchase of theCompany’s common stock as follows:
| Holder                                 | ** ** | **11% Notes  Issued at  Closing** | ** ** | **Shares Issuable  upon Exercise  of Warrants  Issued at  Closing** | ** ** |
|----------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| *1**st Closing on April 20, 2007* | * *   | * *                                    | * *   | * *                                                                                | * *   |
| Whitebox (1)                           |       | $                                           | 8,000,000  |                                                                                    | 1,200,000  |   |
|                                   |       |                                        |       |                                                                                    |       |
| *2**nd Closing on June 15, 2007*  | * *   | * *                                    | * *   | * *                                                                                | * *   |
| Whitebox (1)                           |       | 2,000,000                                   |       | 300,000                                                                                 |       |
| Potomac (2)                            |       | 1,500,000                                   |       | 224,998                                                                                 |       |
| Other accredited investors             |       | 1,000,000                                   |       | 150,000                                                                                 |       |
|                                   |       | 4,500,000                                   |       | 674,998                                                                                 |       |
| Total Initial Issuance  at Closings    |       | $                                           | 12,500,000 |                                                                                    | 1,874,998  |   |

 

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(1)          Representsa related party entity that is an affiliate of Whitebox Advisors, LLC (“Whitebox”),a beneficial owner of more than 10% of the Company’s common stock.

(2)          Representsrelated party entities that are affiliates of Potomac Capital Management, LLC (“Potomac”),a beneficial owner of more than 5% of the Company’s common stock.

The 11% Notes are secured****by a first priority security interest in the Company’sassets.  The Secured Note PurchaseAgreements contain a restrictive covenant that prohibits the Company fromissuing more than an aggregate of $12,500,000 of 11% Notes. The Company has theright to prepay the 11% Notes, subject to a premium payment of 8% if prepaymentis made within the first year; 6% if prepayment is made within the second year;and 3% if prepayment is made within the third year. The prepayment premium doesnot apply if the prepayment of the 11% Notes is a result of a change ofcontrol.

The principal amount of each 11% Note and any accruedbut unpaid interest is due and payable three years following the respectivedate of issuance of each note. During the first year, interest on the 11% Noteswill accrue and be added to the principal balance of the note. Within 30 daysfollowing the end of the first year from issuance of each note, the Company isobligated to issue to each holder an interest accrual warrant for the purchaseof the number of shares of the Company’s common stock that is equal to thequotient obtained by dividing 60% of the accrued interest for the first year by$4.00. During the second and third years from issuance of each note, theCompany has the option each quarter to either (i) pay the accrued intereston each note on or before the 15th day following the end of such quarter or (ii) allowthe interest for such quarter to accrue and be added to the principal balanceof the note and issue to each holder, within 30 days following the end of suchquarter, an interest accrual warrant for the purchase of the number of sharesof the Company’s common stock that is equal to the quotient obtained bydividing 60% of the accrued interest for the quarter by $4.00. The form of eachinterest accrual warrant provides for a term of five years and an exerciseprice of $4.00 per share, subject to basic and, for 12 months from the dateissued, full-ratchet anti-dilution adjustments. In addition, the form ofinterest accrual warrant contains a cashless exercise feature and a provisionthat restricts exercise to the extent that, after exercise, the holder wouldotherwise beneficially own in excess of 9.99% of the Company’s common stockoutstanding.

7

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The warrants issued at the 1st and 2nd closings (“Closing Warrants”) of the 11% Notesfor the purchase of an aggregate of 1,874,998 shares of the Company’s commonstock have a term of five years from their respective dates of issuance andhave exercise prices of $4.00 per share, subject to basic and, for 12 monthsfrom their respective dates of issuance, full-ratchet anti-dilution adjustmentprovisions. The Closing Warrants contain a provision that restricts exercise tothe extent that, after exercise, the holder would otherwise beneficially own inexcess of 9.99% of the Company’s common stock outstanding. In addition, theClosing Warrants had a cashless exercise right as to any shares the SEC wouldhave not permitted the Company to include in the resale registration statementand any reductions imposed by the SEC in the number of shares covered by theresale registration statement would have been made on a pro-rata basis.  The Company filed a registration statement onAugust 6, 2007, which became effective on August 13, 2007, to enable the resaleof the shares of common stock underlying the Closing Warrants. The Company isrequired to use commercially reasonable efforts to keep the registrationstatement current, effective and free from any material misstatement oromission to state a material fact for a specified period, not to exceed 2 yearsfrom the effective date of the registration statement. The Company is notrequired to register for resale the shares of common stock underlying theinterest accrual warrants.

The Company used the Black-Scholes-Merton formula toestimate the fair value of the 1st and 2nd Closing Warrants for the purchase of anaggregate of 1,200,000 and 674,998 shares, respectively, of the Company’scommon stock using the following assumptions:
|                          | ** ** | **1**st Closing  Warrant  (issued April 20, 2007) | ** ** | **2**nd Closing  Warrants  (issued June 15, 2007) | ** ** |
|--------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| Expected term            |       | 5.0 years                                                             |       | 5.0 years                                                             |       |
| Volatility               |       | 106.7                                                                 | %          | 105.9                                                                 | %          |
| Risk free  interest rate |       | 4.6                                                                   | %          | 5.1                                                                   | %          |
| Expected dividend rate   |       | 0                                                                     | %          | 0                                                                     | %          |

 

The fair value of the warrants issued at the 1st and 2nd closings were estimated to be $3,804,000 and$2,970,000, respectively.  The fair valueof each Closing Warrant was recorded as a discount to the principal balance ofeach 11% Note and is amortized into interest expense, using the effectiveinterest rate method, over the 3-year term of each 11% Note. The impact of thediscount created from the issuance of the Closing Warrants and 11% interestrate on the principal balance of each note results in an effective interestrate of 41% and 64% for the 1st and 2nd Closings, respectively.

The Company used the Black-Scholes-Merton formula toestimate the fair value of the first-year interest accrual warrants required tobe issued within 30 days following the end of the first year of the 1st and 2nd Closings of the 11% Notes for the purchase ofan aggregate of 132,000 and 74,250 shares of the Company’s common stock,respectively, using the following assumptions:
|                          | ** ** | **1**st Year Interest  Accrual  Warrants | ** ** |
|--------------------------|------------|----------------------------------------------------|------------|
| Expected term            |       | 5.0 years                                          |       |
| Volatility               |       | 104.6                                              | %          |
| Risk free  interest rate |       | 4.6                                                | %          |
| Expected dividend rate   |       | 0                                                  | %          |

 

8

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Interest expense of $695,172, which included $272,522of amortization of the discount created from the Closing Warrants, $280,938 ofaccrued interest on the 11% Notes, and $141,712 of expense related to theinterest accrual warrants to be issued within 30 days following the end of thefirst year of each respective issuance of each 11% Note, was included in thestatement of operations for the three months ended July 31, 2007.

The Company paid a 6% commission on the gross proceedsof each closing to the placement agent and certain expenses incurred by theholders and placement agent associated with this transaction. Total financingcosts of $892,000 were incurred by the Company associated with the aggregate of$12,500,000 in financing. The Company capitalized $407,523 as deferredfinancing costs and this amount will be amortized into interest expense overthe 3-year term of each respective 11% Note. The remaining $484,477 infinancing costs reduced the amount recorded in additional paid-in capitalassociated with the fair value of the Closing Warrants.

The secured promissory notes, net of discount,outstanding at July 31, 2007 consisted of the following:
| ** **                                         | ** ** | **1**st Closing  (Due April 2010) | ** ** | **2**nd Closing  (Due June 2010) | ** ** | **Total**  | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|------------|------------|
| 11% Secured  Promissory Notes and accrued interest |       | $                                                | 8,245,246  |                                            | $          | 4,562,213  |       | $ | 12,807,459 |   |
| Unamortized  discount remaining                    |       | (3,566,779                                       | )          | (2,909,047                                      | )          | (6,475,826 | )          |
| Net balance at July 31,  2007                      |       | $                                                | 4,678,467  |                                            | $          | 1,653,166  |       | $ | 6,331,633 |   |

 

**5.****                 ManagementIncentive Plan**

The Company’sManagement Incentive Plan (“MIP”) provides an additional performance incentiveto all executive officers and managers identified by the Chief ExecutiveOfficer and approved by the Compensation Committee of the Company’s Board ofDirectors. Subject to applicable award opportunity levels described below, thetotal dollar value of the annual cash bonus, paid no later than 50 days afterthe performance year, for each participant is calculated as follows:  (corporate achievement level times basesalary times 70%) plus (individual achievement level times base salary times30%). The Board of Directors, upon the recommendation of the CompensationCommittee, set the following minimum, target and maximum payouts under the MIPas a percentage of base salary for the fiscal year ending April 30, 2008:
|                          | ** ** | **Minimum** | ** ** | **Target** | ** ** | **Maximum** | ** ** |
|--------------------------|------------|-------------|------------|------------|------------|-------------|------------|
| Chief Executive  Officer |       | 20          | %          | 30         | %          | 45          | %          |
| All other participants   |       | 15          | %          | 25         | %          | 30          | %          |

 

Based on management’s current estimate of the anticipatedachievement of at least the minimum level of performance, the Company hasrecorded an expense of $34,530 in the statement of operations for the threemonths ended July 31, 2007.

9

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**6.****                 Income Taxes**

On May 1, 2007, the Company adopted the provisions ofFinancial Accounting Standards Board (“FASB”) Interpretation No. 48, *Accounting for Uncertainty in Income Taxes – an Interpretation of FASBStatement No. 109*, (“FIN 48”) which clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with FASB Statement No. 109, *Accountingfor Income Taxes*.  FIN 48prescribes a financial statement recognition threshold and measurementattribute of a tax position taken or expected to be taken in a tax return, andprovides guidance on derecognition, classification, interest and penalties,accounting in interim periods, disclosure and transition. Previously, theCompany had accounted for tax contingences in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 5, *Accountingfor Contingencies*. 

As required by FIN 48, the Company recognizes thefinancial statement benefit of a tax position only after determining whether itis more-likely-than-not that a tax position will be sustained by the relevanttax authority upon examination, including resolution of any related appeals orlitigation processes, based on the technical merits of the position.  For tax positions that meet the more-likely-than-notrecognition threshold, the amount recognized in the financial statements is thelargest amount of benefit that has a greater than 50% likelihood of beingrealized upon ultimate settlement with the relevant tax authority.

On May 1, 2007, the date of adoption of FIN 48, the Company applied FIN48 to all tax positions within the statute of limitations. The adoption of FIN48 did not result in a cumulative adjustment to the Company’s accumulateddeficit and the Company determined that it had no unrecognized tax benefits asof May 1, 2007. Therefore, the impact of implementing FIN 48 did not impact theeffective tax rate. As of May 1, 2007, the Company did not have any significanttax positions for which it is reasonably possible that the total amounts ofunrecognized tax benefits will significantly change during the next twelvemonths.

The Company’s policy is to recognize and classify interest andpenalties accrued on any unrecognized tax benefits as a component of income taxexpense in the statement of operations. As of the date of adoption of FIN 48 on May 1, 2007, the Company did nothave any accrued interest or penalties associated with unrecognized taxbenefits, and the Company did not recognize any interest or penalties in thestatement of operations for the three months ended July 31, 2007.  

The Company is subject to income taxes in the U.S. federal jurisdictionand various state jurisdictions.  Taxregulations within each jurisdiction are subject to the interpretation of therelated tax laws and regulations and require significant judgment to apply. Asof July 31, 2007, the Company was not under examination by the Internal RevenueService (“IRS”) or any state taxing jurisdiction in connection with theCompany’s income taxes.  However, all ofthe Company’s federal and state tax returns within the statue of limitationsremain open and subject to examination by taxing authorities. With fewexceptions, the Company is no longer subject to U.S. federal, state or localincome tax examinations by tax authorities for the years before 2003.  

In connection with the adoption of FIN 48 on May 1, 2007, the Company commencedan analysis of its historical equity transactions with respect to ownership changeswithin the meaning of Internal Revenue Code Section 382 (“§382”).  The Company is in the process of completingthe analysis necessary to establish ownership change dates and quantify theamount of pre-change net operating loss carryforwards that will belimited.  Preliminary analysis indicatesthat the limitation could be significant; however, the Company has historicallyrecorded a full valuation allowance to offset its deferred tax assets and, assuch, the final determinations will not require an adjustment to the Company’saccumulated deficit.

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**7.****                 EmploymentAgreements and Severance Commitments**

Employment agreements with five officers of theCompany as of July 31, 2007 contain a provision for payments of up to twelvemonths severance if the employment of the officer is terminated without causeby the Company or for good reason by the officer as defined in the agreements.The agreements also contain various other provisions customary for agreementsof such nature.

**Vice President, Finance and ChiefFinancial Officer**

On June 28, 2007, the Company entered into anamendment to the restated Executive Employment Agreement with Eapen Chacko, theCompany’s Vice President, Finance and Chief Financial Officer, to reflect themutual decision reached concerning Mr. Chacko’s departure from theCompany. Pursuant to the amendment, Mr. Chacko’s employment will terminateon September 15, 2007. It was agreed that Mr. Chacko would fullyparticipate as the Company’s Vice President, Finance and Chief FinancialOfficer in the preparation and filing of: 1) Form 10-KSB for the fiscal yearended April 30, 2007; 2) registration statement on Form SB-2 to register forresale the shares underlying the warrants sold in the April and June 2007financings; 3) post-effective amendments to the three existing resaleregistration statements; and 4) the Form 10-QSB for the quarter ended July 31,2007.  Performance of such jobresponsibilities is a condition to the payment of compensation, benefits, andseverance.  Mr. Chacko’scompensation and benefits will continue to be paid at their current ratesthrough the date of termination. Except for the severance described below,Mr. Chacko is no longer eligible for bonus or other incentivecompensation.

Subject to the performance conditions above and set forthin the amendment, Mr. Chacko is entitled to a lump sum severance paymentof six months base salary on the date of termination and may be entitled tomonthly installments of base salary beginning six months after the date oftermination. In addition to these severance payments, the Company has agreed topay or reimburse Mr. Chacko for medical (COBRA) benefits as set forth inthe employment agreement. The Company has recorded an expense of $42,500 in theresults of operations for the three months ended July 31, 2007 related to thelump sum severance payment of $100,000 Mr. Chacko may be eligible toreceive on the date of termination.  IfMr. Chacko is not reemployed or serving as an independent contractor, Mr.Chacko may be eligible for monthly installments of base salary of $16,667beginning six months after the date of termination and such payments will ceaseon the earlier of: 1) the date Mr. Chacko is reemployed or serves as anindependent contractor; and 2) six months.

**Former Vice President, RegulatoryAffairs and Quality Assurance**

On May 31, 2007, the Company entered into a letteragreement amending certain provisions of the Executive Employment Agreementwith Dennis E. Steger, then the Company’s Vice President, Regulatory Affairsand Quality Assurance, who advised the Company of his plan to retire.  Mr. Steger’s employment terminated on July 1,2007 and, in lieu of any severance compensation payable under the ExecutiveEmployment Agreement with Mr. Steger, the Company paid Mr. Steger $20,000 andissued to Mr. Steger a fully vested non-qualified stock option in the form usedwith the Company’s executive officers under the Amended and Restated 2001Equity Incentive Plan for the purchase of 5,734 shares of the Company’s commonstock on July 1, 2007.  The stock optionissued to Mr. Steger on July 1, 2007, which has an exercise price of $5.50 pershare and expires on January 1, 2008, resulted in a non-cash share-basedcompensation expense of $8,911 in the three months ended July 31, 2007.

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**8.****                 Shareholders’ Equity**

**Share-Based Compensation Expense**

Share-based compensation expense included in thestatement of operations is as follows:
|                                 | ** ** | **Three months ended July 31,** | ** ** |
|---------------------------------|------------|-----------------------------------------------------|------------|
| ** **                      | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| Sales and  marketing            |       | $                                                   | 14,620     |   | $ | 22,054 |   |
| General and administrative  (1) |       | 281,139                                             |       | 530,841 |   |
| Research and  development (2)   |       | 137,633                                             |       | 120,345 |   |
| Total  share-based compensation |       | $                                                   | 433,392    |   | $ | 673,240 |   |

 

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(1)          Includes$13,750 of share-based compensation expense in the three months ended July 31,2007 related to a restricted stock award for 2,500 shares, which vestedimmediately, and was granted under the Company’s Amended and Restated 2001Equity Incentive Plan.

(2)          Includes$13,566 and $14,910 of share-based compensation expense in the three monthsended July 31, 2007 and 2006, respectively, related to stock options grantedunder the Company’s Amended and Restated 2001 Equity Incentive Plan tonon-employees serving on the Company’s scientific advisory board.

As of July 31, 2007, there was $2,444,832 of totalunrecognized share-based compensation cost. The Company expects that cost to berecognized over a weighted-average remaining recognition period of 2.2 years.

**Share-Based Awards**

The Company has the following shareholder approvedstock option and equity incentive plans as of July 31, 2007:
|                                  | ** ** | **Shares of  Common Stock  Reserved** | ** ** | **Shares of  Common Stock   Remaining  Available for Grant** | ** ** |
|----------------------------------|------------|-------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| 1992 Stock  Option Plan          |       | 50,000                                          |       | —                                                                                |       |
| 1993 Director  Stock Option Plan |       | 30,000                                          |       | —                                                                                |       |
| 1997 Stock  Option Plan          |       | 50,000                                          |       | 5,500                                                                                 |       |
| 2001 Equity  Incentive Plan (1)  |       | 600,000                                         |       | 257,819                                                                               |       |
| 2005 Director  Stock Option Plan |       | 100,000                                         |       | 36,154                                                                                |       |
| Total                            |       | 830,000                                         |       | 299,473                                                                               |       |

 

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(1)             TheAmended and Restated 2001 Equity Incentive Plan provides for awards to begranted in the form of stock options, restricted stock, performance awards,restricted stock units, and/or tax offset payments.

In addition to the shareholder approved plans, theCompany had stock options outstanding outside of the Company’s authorized plansfor the purchase of an aggregate of 504,307 shares of the Company’s commonstock as of July 31, 2007.

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The following table summarizes information about theCompany’s stock options for the three months ended July 31, 2007:
| **Options**                                      | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted Average  Remaining  Contractual Term  (in years)** | ** ** | **Aggregate  Intrinsic  Value(1)** | ** ** |
|--------------------------------------------------|------------|------------|------------|----------------------------------------|------------|------------------------------------------------------------------------------|------------|------------------------------------|------------|
| Outstanding,  April 30, 2007                |       | 895,454    |       | $                                      | 8.78       |                                                                         |       |                               |       |   |
| Granted                                          |       | 80,234     |       | 5.48                                   |       |                                                                         |       |                               |       |
| Forfeited/Expired                                |       | (19,379    | )          | 9.42                                   |       |                                                                         |       |                               |       |
| Outstanding, July 31,  2007                      |       | 956,309    |       | 8.49                                   |       | 5.97                                                                         |       | $                                  | 27,075     |   |
| Vested and expected to  vest, July 31, 2007 |       | 822,975    |       | 8.58                                   |       | 5.88                                                                         |       | $                                  | 23,257     |   |
| Exercisable, July 31, 2007                  |       | 472,388    |       | 9.20                                   |       | 5.39                                                                         |       | $                                  | —     |   |
|                                                  |            |            |            |                                        |            |                                                                              |            |                                    |            |  |  |

 

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(1)           Thisdisclosure excludes those options that have no intrinsic value (i.e. thoseoptions that are out-of-the-money using the closing market price of the Company’scommon stock on July 31, 2007 of $4.25 per share).

As of July 31, 2007, the exercise prices of stockoptions outstanding ranged from $3.00 to $28.60 per share and the stock optionsexpire at various dates through June 29, 2017. The exercise price of astock option is set at the closing market price of the Company’s common stockon the grant date. Stock options typically vest over four years and have amaximum contractual term of ten years. Substantially all awards provide foraccelerated vesting if there is a change in control. There were no stockoptions exercised in the three months ended July 31, 2007 and 2006.

The Company used the Black-Scholes-Merton formula toestimate the grant date fair value of its stock options using the followingassumptions:
|                                         | ** ** | **Three months ended July 31,** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                              | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| Weighted average  grant-date fair value |       | $                                                   | 4.08       |   | $ | 6.25 |   |
| Expected  dividend rate (1)             |       | 0                                                   | %          | 0 | % |
| Risk free  interest rate (2)            |       | 4.6 to 5.0                                          | %          | 5.0 to 5.1 | % |
| Expected term  (3)                      |       | 0.5 to 6.3 years                                    |       | 5.0 to 6.3 years |   |
| Expected volatility  (4)                |       | 99.0 to 105.9                                       | %          | 111.1 to 111.2 | % |
| Weighted-average  volatility            |       | 104.5                                               | %          | 111.1 | % |
|                                         |            |                                                     |            |  |  |  |  |

 

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(1)    **Expected dividend rate**—The Company has nothistorically paid a cash dividend to common shareholders and does not expect topay dividends in the future.

(2)    **Risk free interest rate**—The Company usedyield rates on U.S. Treasury securities for a period approximating the expectedterm of the award.

(3)    **Expected term**—Due to the limited number ofstock options exercised historically, the Company elected to use the “simplified”method for estimating the expected term of options as allowed under SEC StaffAccounting Bulletin 107. Under this approach, the expected term was calculatedby taking the average of the vesting term and the original contract term.

(4)    **Expected volatility**—The Company used atleast three years of historical monthly price observations to estimatevolatility.

On June 27, 2007, the Company granted to thechairperson of the Company’s Board of Directors a restricted stock award for2,500 shares of the Company’s common stock. The 2,500 shares, which had a fair value of $5.50 per share on the dateof grant, vested immediately and had an aggregate grant date fair value of$13,750.

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**Warrants**

In connection with various financings and otheractivities, the Company has warrants outstanding for the purchase of theCompany’s common stock. The following table summarizes information about allwarrants for the three months ended July 31, 2007:
| **Warrants**                      | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted Average  Remaining  Contractual Term  (in years)** | ** ** | **Aggregate  Intrinsic  Value(1)** | ** ** |
|-----------------------------------|------------|------------|------------|----------------------------------------|------------|------------------------------------------------------------------------------|------------|------------------------------------|------------|
| Outstanding,  April 30, 2007 |       | 2,498,075  |       | $                                      | 5.80       |                                                                         |       |                               |       |   |
| Issued                            |       | 674,998    |       | 4.00                                   |       |                                                                         |       |                               |       |
| Impact of  anti-dilution features |       | 2,276      |       | 0.02                                   |       |                                                                         |       |                               |       |
| Outstanding, July 31, 2007        |       | 3,175,349  |       | 5.41                                   |       | 5.93                                                                         |       | $                                  | 831,871    |   |
|                                   |            |            |            |                                        |            |                                                                              |            |                                    |            |  |  |

 

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(1)    This disclosureexcludes those warrants that have no intrinsic value (i.e. those warrants thatare out-of-the-money using the closing market price of the Company’s commonstock on July 31, 2007 of $4.25 per share).

As of July 31, 2007, the exercise prices of thewarrants ranged from $3.25 to $29.50 per share and the warrants expire atvarious dates through March 3, 2015. As of July 31, 2007, warrants for thepurchase of 1,915,994 shares of the Company’s common stock contained afull-ratchet anti-dilution provision with a weighted average exercise price of$3.98 per share and warrants for the purchase of 707,405 shares of the Company’scommon stock contained a weighted-average anti-dilution provision with aweighted average exercise price of $3.97 per share.

**9.****                 Litigation**

On March 10, 2006, J Giordano Securities LLC(d/b/a J Giordano Securities Group) (“JGSG”) filed suit against the Company inU.S. District Court for the District of Connecticut. JGSG, which acted as aprivate placement agent for the Company in connection with sales of the Company’ssecurities to private investors in April 2005, asserts claims for breachof contract, unjust enrichment and quantum meruit. JGSG contends it is owedcertain fees as a result of “follow on transactions” executed by investorsidentified by JGSG, pursuant to the engagement agreement, as amended, betweenthe Company and JGSG or, in the alternative, that it should be awarded suchfees on an equitable basis. In particular, JGSG originally claimed that theexercise of outstanding warrants for the purchase of common stock by certainJGSG-identified investors and the Company’s purchase of outstanding shares of5% Series A Redeemable Convertible Preferred Stock from certainJGSG-identified investors in December 2005 and January 2006 entitledJGSG to damages no less than $1,431,769. JGSG originally sought(a) $279,191 in cash commissions, (b) warrants for the purchase of85,905 shares at $3.25 per share, (c) lost profits of $751,669 on theargument that JGSG would have exercised the foregoing warrant and sold 85,905shares on December 30, 2005, at a price of $12.00 per share, and(d) $400,909 in cash commissions the Company paid C.E. Unterberg, Towbin,LLC (“CEUT”).

On September 22, 2006, the Company asserted acounterclaim against JGSG for fraud and breach of contract based upon JGSG’smisrepresentations to induce the Company to enter the engagement agreement andJGSG’s failure to perform its promised services thereunder. The Company seeksdamages of (a) the $30,000 retainer and $543,000 cash paid to JGSG;(b) the value of the Company’s warrants for 114,600 shares of common stockissued to JGSG; (c) the $445,328 fee and $27,016 expense reimbursementthat the Company paid CEUT for its advisory services in December 2005 andJanuary 2006; (d) the $3.7 million cash the Company did not obtain oninvestor warrant exercises due to the reduced warrant exercise price theCompany was required to accept during those months; and (e) the value ofthe additional 1.9 million shares of common stock the Company was required toissue to effectuate the preferred stock purchase during those months. As aresult, the Company counterclaims in excess of $5.0 million.

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On November 20, 2006, JGSG filed an amendedstatement of claim. JGSG added new claims for additional compensation basedupon the issuance of additional common stock to preferred stock holders in thealleged “follow-on transactions,” the Company’s alleged failure to timely filea resale registration statement for JGSG, and for additional compensation basedupon the October 2006 private placement. JGSG currently seeks allegeddamages of $3,346,565 as follows: (a) $279,191 in cash commissions;(b) warrants for the purchase of 85,905 shares at $3.25 per share;(c) lost profits of $751,669 on the argument that JGSG would haveexercised the foregoing warrant and sold 85,905 shares on December 30,2005, at a price of $12.00 per share; (d) $249,690 in cash pursuant to thealleged failure to timely file the resale registration statement for JGSG;(e) $6,726 in liquidated damages based upon the Company’s alleged failureto timely file the resale registration statement for JGSG; (f) $556,214 incash commissions that JGSG claims it was entitled to based upon preferred stockholders’ receipt of additional common stock in the alleged “follow-ontransactions”; (g) warrants for the purchase of 171,142 shares at $3.25per share; (h) lost profits of $952,166 on the argument that JGSG wouldhave exercised the foregoing warrant and sold 171,142 shares on January 3,2006, at a price of $11.00 per share; (i) $400,909 in cash commissions theCompany paid to CEUT; and (j) $150,000 based upon the fee the Company paidto CEUT for the October 2006 private placement. JGSG also seeksreimbursement for reasonable expenses, interest, costs and attorneys’ fees.

The U.S. District Court for the District ofConnecticut has referred the matter to NASD arbitration. The Company believesthat JGSG’s lawsuit is without merit and intends to vigorously defend itself.Given the nature of arbitration, however, it is reasonably possible that theCompany may be expected to pay certain amounts in connection with this claim.Since this is a breach of contract claim, it may not be covered by the Company’sinsurance. As of July 31, 2007, the Company has not recorded an accrualfor this matter since the amount to be paid, if any, cannot be reasonablyestimated.

**10.****          Discontinued Operations**

On April 6, 2005, the Company’s Board ofDirectors authorized management to discontinue sales and marketing of heartvalves effective April 30, 2005, and to seek a buyer for the relatedproduction equipment. The carrying amount of asset of discounted operations asof July 31, 2007 consisted of a prepaid insurance policy which is amortized tothe loss from discontinued operations over the policy period.

**11.****          SubsequentEvent**

On September 7, 2007, Michael A. Brodeur agreed tojoin the Company as Vice President, Finance and Chief Financial Officer,effective September 17, 2007.  Mr. Brodeur will assume these rolesfollowing the September 15, 2007 resignation of Eapen Chacko, the Company’scurrent Vice President, Finance and Chief Financial Officer. The Companyentered into an employment agreement with Mr. Brodeur, pursuant to which Mr.Brodeur will receive an annual base salary of $225,000 and is eligible toreceive performance-based cash bonuses.  Under the Company’s MIP,Mr. Brodeur is eligible to receive a pro-rated minimum bonus payout of15%, target bonus payout of 25% and maximum bonus payout of 30% of base salaryfor fiscal year 2008.  The employment agreement provides that a severancepayment will be made if the employment of Mr. Brodeur is terminated by theCompany without cause, or by Mr. Brodeur for good reason.  The severancepayment would be six months of base salary; and, if at the end of suchsix-month period, Mr. Brodeur was not employed or engaged as an independentcontractor, the Company would pay him up to an additional six months of basesalary until he is employed or engaged as an independent contractor.  Inaddition, Mr. Brodeur has agreed to certain nondisclosure and inventionsprovisions and certain noncompetition and nonrecruitment provisions during theterm of employment and for a period of one year after termination ofemployment.  

Contingent upon the commencement of his employment,the Company agreed to grant Mr. Brodeur a ten-year stock option under theCompany’s Amended and Restated 2001 Equity Incentive Plan to purchase 98,397****shares of the Company’s common stock at aprice per share equal to the per share closing price of the Company’s commonstock on the date Mr. Brodeur commences his employment, with vesting of 25percent on the first anniversary of the date of grant and 6.25 percentquarterly thereafter.

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**ITEM2  MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION**

*The following discussion containsvarious forward-looking statements within the meaning of Section 21E ofthe Exchange Act.  Although we believe that, in making any such statement,our expectations are based on reasonable assumptions, any such statement may beinfluenced by factors that could cause actual outcomes and results to bematerially different from those projected.  When used in the followingdiscussion, the words “anticipates,” “believes,” “expects,” “intends,” “plans,”“estimates” and similar expressions, as they relate to us or our management,are intended to identify such forward-looking statements.  Theseforward-looking statements are subject to numerous risks and uncertainties thatcould cause actual results to differ materially from those anticipated. Factors that could cause actual results to differ materially from thoseanticipated, certain of which are beyond our control, are set forth in thisdocument and in our Annual Report on Form 10-KSB for the fiscal year endedApril 30, 2007, under the caption “Management’s Discussion and Analysis or Planof Operation – Cautionary Statement.”*

*Our actual results, performance orachievements could differ materially from those expressed in, or implied by,forward-looking statements.  Accordingly, we cannot be certain that any ofthe events anticipated by forward-looking statements will occur or, if any ofthem do occur, what impact they will have on us.  We caution you to keepin mind the cautions and risks described in this document and in our CautionaryStatement and to refrain from attributing undue certainty to anyforward-looking statements, which speak only as of the date of the document inwhich they appear.  We do not undertake to update any forward-looking statement.*

**Overview**

We are a medical devicecompany that develops, manufacturers, and sells innovative, laser-basedsurgical ablation systems designed to create precise, clinically relevantlesions, or scars, in soft tissue and in cardiac tissue.  This process of creating lesions with anenergy source is referred to as “ablation.” Cardiac tissue ablations have become increasingly common for treatingpatients with irregular heartbeats (“arrhythmias”) that cannot be treated withlifestyle changes or medications.  Atrialfibrillation (“AF”) is the most commonly occurring cardiac arrhythmia.  Our long-term goal is to provide astand-alone, closed chest, beating heart, minimally invasive surgical ablationtreatment option for AF.

Our ATRILAZETM SurgicalAblation System (“ATRILAZE System”), which has U.S. Food and DrugAdministration (“FDA”) 510(k) clearance for ablating soft tissue to includecardiac tissue, utilizes laser energy, delivered through both rigid andmalleable handheld wands, for cardiac tissue ablation in open-heart surgicalprocedures and robotically in stand-alone ablation procedures.  In November 2005, we began offering theATRILAZE System to select centers in the U.S. for surgical ablation.

Our SOLARTM Surgical AblationSystem (“SOLAR System”), which has FDA 510(k) clearance for ablating softtissue, includes a sophisticated computerized controller which serves toautomate the movement and dosing of laser energy so as to deliver consistent,reproducible tissue ablation.  It is ourgoal to obtain an FDA clearance for *cardiac* tissueablation in the future by providing appropriate clinical data.

Widespread adoption of oursystems for the treatment of AF will likely require one or more clinical trialsto provide safety and clinical efficacy data in support of a Premarket Approval(“PMA”).  We anticipate pursuing alabeling claim for AF through such a trial.

Our company was incorporatedin Minnesota on March 30, 1992 and in April 2005 exited the mechanical heartvalve business.

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**Critical Accounting Policies**

For further discussion of our critical accountingpolicies and estimates, see our Annual Report on Form 10-KSB for thefiscal year ended April 30, 2007.  Also, see Note 6 in Part I, Item 1“Condensed Financial Statements” for additional information on the adoption ofFIN 48 on May 1, 2007.

*Revenue Recognition. *We currently generaterevenue from the sales of our single-use medical devices. There is no right ofreturn unless the product is defective, damaged, or does not perform accordingto technical specifications.  Revenue isconsidered to be earned when there is a written sales invoice specifying theterms and conditions of the transaction; the price is fixed; collection of theresulting receivable is probable; title has transferred; and there are noremaining performance obligations, such as installation, set-up, or usertraining.

*Share-Based Compensation. *We recognize share-basedcompensation expense, based on the grant-date fair value of the award, duringthe service period of share-based awards that are granted, modified,repurchased, or cancelled after May 1, 2006, the date of adoption ofStatement of Financial Accounting Standards (“SFAS”) No. 123R (revised2004), *Share-Based Payment*. Inaddition, compensation expense is recognized for the remaining service periodof awards granted prior to, but not yet vested as of May 1, 2006, based onthe grant-date fair value of the award. We recognize compensation expense forshare-based awards on a straight-line basis over the requisite service periodof the award.  The amount of share-basedcompensation recognized is based on the value of the portions of the awardsthat are ultimately expected to vest. Forfeitures are estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates.  We use historical forfeituresand employee turnover to estimate the number of options that will actuallyvest.  We reevaluate this estimateperiodically and adjust the forfeiture rate on a prospective basis asnecessary.  Previously recognizedcompensation expense for the vested portion of share-based awards is notreversed if an award expires unexercised or if an award is forfeited due toemployee termination.  No compensationcost is recognized for unvested awards that employees forfeit because therequisite service was not rendered.

**RecentAccounting Pronouncements**

In September 2006, the FASB issuedSFAS No. 157, *Fair ValueMeasurements*, which defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles, and expandsdisclosures about fair value measurements. SFAS No. 157 is effective forfinancial statements issued for fiscal years beginning after November 15,2007, and interim periods within those fiscal years. We do not anticipate theadoption of SFAS No. 157 on May 1, 2008 will have a material impacton our financial statements.

In February 2007, the FASB issued SFASNo. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities—Including an amendment of FASBStatement No. 115*, which permits entities to choose to measuremany financial instruments and certain other items at fair value. SFASNo. 159 is effective as of the beginning of an entity’s first fiscal yearthat begins after November 15, 2007. We do not anticipate the adoption ofSFAS No. 159 on May 1, 2008 will have a material impact on ourfinancial statements.

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**Resultsof Operations for the Three Months Ended July 31, 2007 and 2006**

*Sales. *Sales of our ATRILAZESystem single-use medical device of $23,200 were recognized as revenue in thethree months ended July 31, 2007. Sales of the SOLAR System are not expecteduntil we conduct the full commercial launch of such product in calendar year2008.  We do not expect to generatematerial sales of the SOLAR System until the fiscal year ending April 30, 2009at the earliest. Prior to November 2006, historical sales of our ATRILAZESystem were recorded as a reduction of research and development expenses sincethe primary purpose of offering the device was to obtain clinical researchinformation to assist in the development of the SOLAR System.  We anticipate that product revenue for thefiscal year ending April 30, 2008 will be limited to the single-use disposablecomponents of the ATRILAZE and SOLAR Systems.

*Cost of Goods Sold. *The historical cost of theATRILAZE System single-use device inventory was previously recorded as researchand development expense in the fiscal year ended April 30, 2006 since, at thattime, it was believed to have no future economic value.  As a result, the cost of goods sold in thethree months ended July 31, 2007 consisted exclusively of a 6% royalty expense.  The current replacement cost of the ATRILAZESystem single-use device inventory, had it been included in cost of goods sold,would not have had a material impact on gross margins or net loss for the threemonths ended July 31, 2007.

*Sales and Marketing. *Sales and marketingexpenses decreased from $390,682 in the three months ended July 31, 2006 to$290,833 in the three months ended July 31, 2007.  The $99,849 decrease in sales and marketingexpenses resulted primarily from a decrease in payroll expense in the threemonths ended July 31, 2007 compared to the three months ended July 31,2006.  The three months ended July 31,2006 included relocation expenses of $65,000 for our Vice President, Marketingand payroll expenses of our Vice President, Sales who terminated employment onMarch 31, 2007.

*General and Administrative. *General and administrativeexpenses decreased from $2,217,613 in the three months ended July 31, 2006 to$1,274,496 in the three months ended July 31, 2007.  The $943,117 decrease in general andadministrative expenses resulted primarily from a decrease of $329,878 inunderwriter and consulting services, $205,399 in accounting services, $90,634in document processing and printing, and $85,921 in legal services relatedprimarily to a proposed public offering of our common stock that we decided notto pursue in the three months ended July 31, 2006.  The three months ended July 31, 2006 alsoincluded share-based compensation expense of $255,690 related to certainnon-qualified stock options granted to non-employee directors for the purchaseof our common stock that vested immediately.

*Research and Development. *Research and developmentexpenses decreased from $1,588,362 in the three months ended July 31, 2006 to$1,166,649 in the three months ended July 31, 2007.  The $421,713 decrease in research and developmentexpenses resulted primarily from a reduction of $397,977 in externaldevelopment of our controller component of our ablation systems.

*Interest Expense. *Interest expense increasedfrom $37,235 in the three months ended July 31, 2006 to $751,577 in the threemonths ended July 31, 2007.  The $714,342increase in interest expense resulted primarily from the 11% Secured PromissoryNotes (“11% Notes”) outstanding during the three months ended July 31,2007.  The interest expense related tothe 11% Notes consisted of $280,938 of accrued interest on the 11% Notes,$272,522 of amortization of the discount on the debt related to the warrantsissued at each closing, and $141,712 of expense related to the interest accrualwarrants to be issued within 30 days following the end of the first year ofeach respective issuance of each 11% Note. Interest expense in the three months ended July 31, 2007 also included$29,328 in amortization of deferred financing costs related to the 11% Notes.

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*Discontinued Operations. *The loss from discontinuedoperations of $22,446 in the three months ended July 31, 2007 consisted ofinsurance expense from an insurance policy related to the heart valvebusiness.  The income from discontinuedoperations of $9,054 in the three months ended July 31, 2006 consisted ofinsurance expense of $22,446 offset by a gain of $31,500 from the sale of fixedassets.

*Income Tax Provision. *We have no income taxprovision in the three months ended July 31, 2007 and 2006 due to the netoperating losses generated for income tax reporting purposes.  We have established a valuation allowance tofully offset deferred tax assets due to the uncertainty about our ability togenerate the future taxable income necessary to realize these deferred taxassets, particularly in light of our history of significant operating lossesand changes in ownership.

**Liquidityand Capital Resources**

Cash and cashequivalents increased from $8,950,983 at April 30, 2007 to $10,687,210 atJuly 31, 2007 due to the following:
| Net cash used by operating  activities     |   | $         | (2,352,050 | )      |
|--------------------------------------------|--------|-----------|------------|--------|
| Net cash used by  investing activities     |   | (25,365   | )          |
| Net cash provided by  financing activities |   | 4,113,642 |       |
| Net increase in cash and cash equivalents  |   | $         | 1,736,227  |   |

 

*OperatingActivities.  *The net cash used by operatingactivities of $2,352,050 in the three months ended July 31, 2007 resultedprimarily from the net loss of $3,364,623 partially offset by non-cash interestexpense of $726,321 and share-based compensation expense of $433,392. The netcash used by operating activities of $3,158,040 in the three months ended July31, 2006 resulted primarily from the net loss of $4,097,562 partially offset bynon-cash share-based compensation expense of $673,240.

*InvestingActivities.  *The net cash used by investingactivities of $25,365 in the three months ended July 31, 2007 resultedfrom purchases of property, plant and equipment. The net cash provided byinvesting activities of $34,153 in the three months ended July 31, 2006resulted from cash proceeds from the sales of property, plant and equipment of$50,668 partially offset by purchases of property, plant and equipment of$16,515.

*FinancingActivities.  *The net cash provided by financingactivities of $4,113,642 in the three months ended July 31, 2007 resultedprimarily from the $4,196,152 in net cash proceeds obtained from the June 2007debt financing (described below) partially offset by payments under our relatedparty lease obligation.  The net cashused by financing activities of $79,772 in the three months ended July 31,2006 resulted primarily from payments under our related party lease obligation.

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*Apriland June 2007 Debt Financing.  *On April 20,2007 and June 15, 2007, we entered into Secured Note Purchase Agreements forthe issuance and sale of 11% Notes and warrants for the purchase of our commonstock as follows:
| Holder                                 | ** ** | **11% Notes  Issued at  Closing** | ** ** | **Shares Issuable   upon Exercise   of Warrants  Issued at  Closing** | ** ** |
|----------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|
| *1**st Closing on April 20, 2007* | * *   | * *                                    | * *   | * *                                                                                            | * *   |
| Whitebox (1)                           |       | $                                           | 8,000,000  |                                                                                                | 1,200,000  |   |
|                                   |       |                                        |       |                                                                                                |       |
| *2**nd Closing on June 15, 2007*  | * *   | * *                                    | * *   | * *                                                                                            | * *   |
| Whitebox (1)                           |       | 2,000,000                                   |       | 300,000                                                                                             |       |
| Potomac (2)                            |       | 1,500,000                                   |       | 224,998                                                                                             |       |
| Other accredited  investors            |       | 1,000,000                                   |       | 150,000                                                                                             |       |
|                                   |       | 4,500,000                                   |       | 674,998                                                                                             |       |
| Total Initial Issuance at Closings     |       | $                                           | 12,500,000 |                                                                                                | 1,874,998  |   |

 

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(1)   Represents arelated party entity that is an affiliate of Whitebox Advisors, LLC (“Whitebox”),a beneficial owner of more than 10% of our common stock.

(2)   Represents relatedparty entities that are affiliates of Potomac Capital Management, LLC (“Potomac”),a beneficial owner of more than 5% of our common stock.

The 11% Notes are secured****by a first priority security interest in our assets.  The Secured Note Purchase Agreements containa restrictive covenant that prohibits us from issuing more than an aggregate of$12,500,000 of 11% Notes. We have the right to prepay the 11% Notes, subject toa premium payment of 8% if prepayment is made within the first year; 6% ifprepayment is made within the second year; and 3% if prepayment is made withinthe third year. The prepayment premium does not apply if the prepayment of the11% Notes is a result of a change of control.

The principal amount of each 11% Note and any accruedbut unpaid interest is due and payable three years following the respectivedate of issuance of each note. During the first year, interest on the 11% Noteswill accrue and be added to the principal balance of the note. Within 30 daysfollowing the end of the first year from issuance of each note, we areobligated to issue to each holder an interest accrual warrant for the purchaseof the number of shares of our common stock that is equal to the quotientobtained by dividing 60% of the accrued interest for the first year by $4.00.During the second and third years from issuance of each note, we have theoption each quarter to either (i) pay the accrued interest on each note onor before the 15th dayfollowing the end of such quarter or (ii) allow the interest for suchquarter to accrue and be added to the principal balance of the note and issueto each holder, within 30 days following the end of such quarter, an interestaccrual warrant for the purchase of the number of shares of our common stockthat is equal to the quotient obtained by dividing 60% of the accrued interest forthe quarter by $4.00. The form of each interest accrual warrant provides for aterm of five years and an exercise price of $4.00 per share, subject to basicand, for 12 months from the date issued, full-ratchet anti-dilutionadjustments. In addition, the form of interest accrual warrant contains acashless exercise feature and a provision that restricts exercise to the extentthat, after exercise, the holder would otherwise beneficially own in excess of9.99% of our common stock outstanding.

The warrants issued at the 1st and 2nd closings (“Closing Warrants”) of the 11% Notesfor the purchase of an aggregate of 1,874,998 shares of our common stock have aterm of five years from their respective dates of issuance and have exerciseprices of $4.00 per share, subject to basic and, for 12 months from theirrespective dates of issuance, full-ratchet anti-dilution adjustment provisions.The Closing Warrants contain a provision that restricts exercise to the extentthat, after exercise, the holder would otherwise beneficially own in excess of9.99% of our common stock outstanding. In addition, the Closing Warrants had acashless exercise right as to any shares the SEC would have not permitted us toinclude in the resale registration statement and any reductions imposed by theSEC in the number of shares covered by the resale registration statement wouldhave been made on a pro-rata basis.  Wefiled a registration statement on August 6, 2007, which became effective onAugust 13, 2007, to enable the resale of the shares of common stock underlyingthe Closing Warrants. We are required to use commercially reasonable

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effortsto keep the registration statement current, effective and free from anymaterial misstatement or omission to state a material fact for a specifiedperiod, not to exceed 2 years from the effective date of the registrationstatement. We are not required to register for resale the shares of commonstock underlying the interest accrual warrants.

We paid a 6%commission on the gross proceeds of each closing to the placement agent andcertain expenses incurred by the holders and placement agent associated withthis transaction. Total financing costs of $892,000 were incurred by usassociated with the aggregate of $12,500,000 in financing.

*Analysis*

We expect to continue to incur operating losses andnegative operating cash flow as we support the continued development andcommence full commercial launch of our SOLAR System. We did not have anyclinical-ready SOLAR System inventory at July 31, 2007. Once we have qualified,built, and released clinical-ready SOLAR System inventory, we anticipate thatwe will require several additional weeks to place the capital equipment inhospitals and train physicians on the use of our SOLAR System before we cancommence the full commercial launch of such product. During fiscal year 2008,we plan to validate our technology, collect data, submit for expanded labeling,and submit clinical results for presentation and publication. We do not expectto generate material sales of the SOLAR System until fiscal year 2009, at theearliest. However, we anticipate that our general and administrative, researchand development, and sales and marketing expenses will continue to constitute amaterial use of our cash resources. The actual amounts and timing of ourexpenditures will vary significantly depending upon the progress of our productdevelopment and the availability of financing. During the remaining quarters ofour fiscal year ending April 30, 2008, we expect to incur capital expendituresaggregating approximately $200,000, including approximately $100,000 forfacility and building improvements and approximately $100,000 for equipment. Weanticipate using our available cash to fund such capital expenditures. Our cashbalance of $10,687,210 at July 31, 2007, is expected to last throughApril 2008.

Given the level of our capital resources, we expect torequire additional financing to continue operations, to complete the fullcommercial launch of our SOLAR System, and to achieve our long-term goal ofproviding a surgical ablation treatment option for AF. Because we are notgenerating positive cash flow from operations, we will be required to raiseadditional funds through public or private sales of equity securities or theincurrence of indebtedness. If financing is not available to us when necessary,we will be required to cease operating.

Our ability to fund continued operations depends onthe availability of equity and debt financing, which is affected by prevailingeconomic conditions in the medical device industry and financial, business andother factors, some of which are beyond our control. We cannot assure you thatwe will obtain financing on favorable terms or at all. If we elect to raiseadditional capital through the issuance and sale of equity securities, thesales may be at prices below the market price of our stock, and ourshareholders may suffer significant dilution. In particular, as part of ourApril and June 2007 debt financing, we issued warrants for the purchaseof an aggregate of 1,874,998 shares of common stock and we agreed to issuecertain additional interest accrual warrants, all of which contain full-ratchetanti-dilution provisions for a period of 12 months from their respective datesof issuance. Such provisions may increase the dilution other shareholderssuffer if we were to raise additional capital through the issuance and sale ofequity securities.

Debt financing, if available, may involve significantcash payment obligations, covenants and financial ratios that restrict ourability to operate and grow our business, and would cause us to incuradditional interest expense and financing costs. We issued an aggregate of$12,500,000 of 11% Notes in April and June 2007. Because we arecontractually precluded from issuing additional 11% Notes, and substantiallyall of our assets are pledged to our existing lenders, our ability to fundcontinued operations through the issuance of debt is further restricted.Interest on our outstanding debt will accrue and be added to the principalbalance during the first year. Thereafter, we will have the option to payinterest in cash, or have the interest accrue and be added to the principalbalance and issue interest accrual warrants. Making interest payments in cashwould reduce the cash available for other purposes; however, allowing suchpayments to accrue would prompt further dilution to shareholders through theissuance of interest accrual warrants.

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Our capital requirements may vary depending upon thetiming and the success of the implementation of our business plan, regulatory,technological and competitive developments, or if:

·       significantsales of our products are not achieved;

·       operatinglosses exceed our expectations;

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

·       weacquire, license or develop additional technologies.

We cannot, however, assure you that our efforts toimplement our business strategy will:

·       beattainable;

·       beprofitable;

·       reduceour reliance upon financing transactions; or

·       enableus to continue operations.

**Commitmentsand Contingent Liabilities**

*SecuredPromissory Notes.  *On April 20, 2007 and June 15,2007, we entered into Secured Note Purchase Agreements for the issuance andsale of an aggregate of $12,500,000 in 11% Notes.  The 11% Notes, and accrued interest, are dueand payable three years following the respective date of issuance of each note.

*RelatedParty Lease Obligation.  *Simultaneous with thesale of our land and building in April 2003 to PKM Properties, LLC (“PKM”), anentity controlled by Paul K. Miller, we entered into a lease with PKM to leaseback the building and a portion of the land. Mr. Miller is one of our directors and one of the largestbeneficial owners of our securities. The lease has a ten-year initial term withoptions for us to extend the lease up to ten additional years. Under certainconditions, we also have an option to purchase the building at the end of theinitial ten-year term at the fair value at that time. We are also responsible formaintenance and operating costs, utilities and real estate taxes under thelease. In addition, the lease makes it our responsibility for any constructioncosts deemed necessary or required by the landlord in connection with therelocation or removal of the private septic system and/or drain field as wellas costs associated with responding to any release of hazardous materials atthe property.

*LightWaveTechnology Purchase Agreement.  *InAugust 2003, we entered into a technology purchase agreement with LightWaveAblation Systems, Inc. (“LightWave”) and its principals, one of whom became anemployee of our company, relating to the acquisition of LightWave’s interestsin technology consisting of a catheter/probe containing elements of opticalfiber, coolant passages and other features for the purpose of delivering laserenergy to the epicardial surface of the heart for treatment of AF. We agreed touse our reasonable commercial efforts to commercialize the technology withinthree years following the acquisition of the technology from LightWave.LightWave and two of its principals have agreed to certain noncompetitionobligations, nondisclosure obligations, and certain obligations to assign newdevelopments or inventions relating to the acquired technology to our company.

We paid LightWavean initial standstill payment consisting of 1,500 shares of our common stock,$10,000 upon closing and an additional $30,000 to LightWave in installments infiscal year 2004 and 2005. An additional $125,000 was paid to LightWave inJanuary 2006. We will be obligated to pay an additional $385,000 within 45days following our achievement of $1,500,000 of cumulative gross sales ofdisposable products. In addition, at closing, during fiscal year 2004, weissued to LightWave a warrant for the purchase of 2,500 shares of our commonstock at $14.60 per share and, during fiscal year 2005, a warrant for thepurchase of 2,500 shares of our common stock at $14.60 per share uponreceiving an FDA 510(k) clearance. During fiscal year 2007, we issued toLightWave a warrant for the purchase of 2,500 shares of our common stock at$14.60 per share due to the receipt of a U.S. utility patent covering theproduct and a warrant for the purchase of 2,500 shares of our common stock at$14.60 per share due to the first commercial sale of our ATRILAZE Systemsingle-use device.

FollowingNovember 29, 2005, the date of the first commercial sale of our ATRILAZESystem single-use device, we have agreed to make payments to LightWave for tenyears equal to 6% of net sales of such product in countries in which we havepatent protection, including the United States, and 4% of net sales of suchproduct in countries in which there is no patent protection. These payments aredue within 60 days following each fiscal quarter.

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Commencing withthe second year following the first commercial sale on November 29, 2005,we have agreed to make minimum annual payments as follows:
| Annual Period Ending | ** ** | **Minimum Annual  Payment** | ** ** |
|--------------------------------|------------|----------------------------------|------------|
| November 29,  2007        |       | $                                | 50,000     |   |
| November 29,  2008        |       | $                                | 75,000     |   |
| November 29,  2009        |       | $                                | 100,000    |   |
| November 29,  2010        |       | $                                | 200,000    |   |
| November 29,  2011        |       | $                                | 300,000    |   |
| November 29,  2012        |       | $                                | 350,000    |   |
| November 29,  2013        |       | $                                | 350,000    |   |
| November 29,  2014        |       | $                                | 400,000    |   |
| November 29,  2015        |       | $                                | 500,000    |   |
| Total minimum payments         |       | $                                | 2,325,000  |   |

 

If we fail in anyyear to pay minimum annual payments, we may be obligated to grant LightWave anonexclusive right to use the technology acquired from LightWave, or payLightWave the difference between payments actually made and minimum paymentsdue for a given year. If we discontinue the development or marketing of theproduct, we would have no further obligation to make the minimum annualpayments due to LightWave. However, LightWave may, upon written request, obtainfrom us a license to use the intellectual property or, at our option, we mayassign our rights in the intellectual property to LightWave.

*OperatingLease.  *We have an operating lease for a certainpiece of office equipment, which expires in fiscal year 2011. At the end of theinitial lease term, we have the option to purchase the equipment at the fairmarket value, renew the lease, or return the equipment.

*ProductLiability Contingency.  *In March 2005, webecame aware that a patient who was utilizing one of our heart valves had died.We have not received any claims related to this matter but believe that anysuch claim would be covered by our existing liability insurance. Based upon theexpectation that insurance would cover the cost of any claims after our paymentof the deductible, we do not expect the ultimate resolution of this matter tohave a material effect on our business, financial condition, operating resultsor cash flows.

*Breachof Contract Claim Contingency.*   J GiordanoSecurities LLC (“JGSG”) has asserted claims for, among other things, breach ofcontract.  The U.S. District Court forthe District of Connecticut has referred the matter to arbitration.  We believe that JGSG’s claim is without meritand intend to vigorously defend ourselves. Given the nature of arbitration, however, it is reasonably possible thatwe may be expected to pay certain amounts in connection with this claim.  Since this is a breach of contract claim, itmay not be covered by our insurance.  Asof July 31, 2007, we have not recorded an accrual for this matter since theamount to be paid, if any, cannot be reasonably estimated.

*Severance Contingencies.  *Employment agreements with five officers as of July 31, 2007contain a provision for payments of up to twelve months severance if theemployment of the officer is terminated without cause by us or for good reasonby the officer as defined in the agreements. The agreements also containvarious other provisions customary for agreements of such nature.

*Severance Contract.  *OnJune 28, 2007, we entered into an amendment to the restated ExecutiveEmployment Agreement with Eapen Chacko, our Vice President, Finance and ChiefFinancial Officer, to reflect the mutual decision reached concerningMr. Chacko’s departure from our company. Pursuant to the amendment,Mr. Chacko’s employment will terminate on September 15, 2007. It wasagreed that Mr. Chacko would fully participate as our Vice President, Financeand Chief Financial Officer in the preparation and filing of: 1) Form 10-KSBfor the fiscal year ended April 30, 2007; 2) registration statement on FormSB-2 to register for resale the shares underlying the warrants sold in theApril and June 2007 financings; 3) post-effective amendments to the threeexisting resale registration statements; and 4) the Form 10-QSB for the quarterended July 31, 2007.  Performance of suchjob responsibilities is a condition to the payment of compensation, benefits,and severance.  Mr. Chacko’scompensation and benefits will continue to be paid at their current ratesthrough the date of termination. Except for the severance described below,Mr. Chacko is no longer eligible for bonus or other incentivecompensation.

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Subject to the performance conditions above and setforth in the amendment, Mr. Chacko is entitled to a lump sum severancepayment of six months base salary on the date of termination and may beentitled to monthly installments of base salary beginning six months after thedate of termination. In addition to these severance payments, we have agreed topay or reimburse Mr. Chacko for medical (COBRA) benefits as set forth in theemployment agreement. We have recorded an expense of $42,500 in the results ofoperations for the three months ended July 31, 2007 related to the lump sumseverance payment of $100,000 Mr. Chacko may be eligible to receive on the dateof termination.  If Mr. Chacko is notreemployed or serving as an independent contractor, Mr. Chacko may be eligiblefor monthly installments of base salary of $16,667 beginning six months after thedate of termination and will cease on the earlier of: 1) the date Mr. Chacko isreemployed or serves as an independent contractor; and 2) six months.

The followingtable summarizes our contractual obligations as of July 31, 2007, excluding theproduct liability contingency, the breach of contract claim contingency, andthe severance contingencies, as described above:
|                                                       | ** ** | **Payments Due By Period** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------|------------|
| **Summary of Contractual Obligations** | ** ** | **TOTAL**                                 | ** ** | **Less than  One Year** | ** ** | **Two to  Three  Years** | ** ** | **Four or  More  Years** | ** ** |
| Secured  Promissory Notes (1)(2)                      |       | $                                         | 17,238,030 |   | $ | — |   | $ | 17,238,030 |   | $ | — |   |
| Related Party  Lease Obligation (2)(3)                |       | 2,373,924                                 |       | 434,579 |   | 857,860 |   | 1,081,485 |   |
| LightWave  Minimum Payments (4)                       |       | 2,325,000                                 |       | 50,000 |   | 175,000 |   | 2,100,000 |   |
| Operating Lease  (3)                                  |       | 15,668                                    |       | 5,530 |   | 10,138 |   | — |   |
| Severance  Contract (5)                               |       | 200,000                                   |       | 183,333 |   | 16,667 |   | — |   |
| Total  Contractual Obligations                        |       | $                                         | 22,152,622 |   | $ | 673,442 |   | $ | 18,297,695 |   | $ | 3,181,485 |   |

 

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(1)    Future paymentamount assumes we elect to exercise our option to allow interest payable toaccrue and be added to the principal balance of the note.

(2)    Future paymentsinclude interest.

(3)    Excludesexecutory costs, such as taxes, repairs, and maintenance.

(4)    Excludes anadditional $385,000 payable within 45 days following our achievement of$1,500,000 of cumulative gross sales of our ATRILAZE System single-use devices.

(5)    Future paymentamount assumes Mr. Chacko is not reemployed or serving as an independentcontractor prior to September 15, 2008.

**Off-Balance Sheet Arrangements**

Other than as setforth above in “Commitments and Contingent Liabilities,” we do not have anyoff-balance sheet arrangements that have or are reasonably likely to have amaterial current or future effect on our financial condition, changes infinancial conditions, revenues or expenses, results of operations, liquidity,capital expenditures or capital resources.

**Qualitative and QuantitativeDisclosures about Market Risk**

We are focusingsubstantially all of our resources on the development and introduction of ourSOLAR System. Sales of our SOLAR System are not expected until we conduct thefull commercial launch of such product. We expect that any sales will be in theU.S. denominated in U.S. dollars. Our interest income and expenses aresensitive to changes in the general level of U.S. interest rates, particularlysince our investments are in short-term instruments. At July 31, 2007, we helda majority of our cash in a money market account. Based on the current natureand levels of our investments we believe that we currently have no materialmarket risk exposure.

Our generalinvesting policy is to limit market and credit risk and the risk of principalloss. All liquid investments with maturities of three months or less areconsidered to be cash equivalents.

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**ITEM 3   CONTROLS ANDPROCEDURES**

**Evaluation of Disclosure Controls and Procedures**

We maintaindisclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)under the Securities Exchange Act of 1934, as amended (the “Exchange Act”))that are designed to ensure that information required to be disclosed by us inthe reports we file or submit under the Exchange Act is recorded, processed,summarized, and reported, within the time periods specified in the U.S.Securities and Exchange Commission’s rules and forms, and that such informationis accumulated and communicated to our management, including our principalexecutive officer and principal financial officer, to allow timely decisionsregarding required disclosure.

Our management,with the participation of our Chief Executive Officer and Chief FinancialOfficer, evaluated the effectiveness of our Company’s disclosure controls andprocedures as of the end of the period covered in this Quarterly Report on Form10-QSB.  Based on this evaluation, our Chief Executive Officer and ChiefFinancial Officer have concluded that our disclosure controls and procedureswere effective as of the end of the period covered in this Quarterly Report onForm 10-QSB.

**Changes in Internal Control Over Financial Reporting**

There was nochange in our internal control over financial reporting that occurred duringour quarter ended July 31, 2007 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

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**PART II**

**OTHERINFORMATION**

**ITEM 1   LEGAL PROCEEDINGS**

On March 10, 2006, J Giordano Securities LLC(d/b/a J Giordano Securities Group) (“JGSG”) filed suit against our company inU.S. District Court for the District of Connecticut. JGSG, which acted as aprivate placement agent for our company in connection with sales of oursecurities to private investors in April 2005, asserts claims for breachof contract, unjust enrichment and quantum meruit. JGSG contends it is owedcertain fees as a result of “follow on transactions” executed by investorsidentified by JGSG, pursuant to the engagement agreement, as amended, betweenus and JGSG or, in the alternative, that it should be awarded such fees on anequitable basis. In particular, JGSG originally claimed that the exercise ofoutstanding warrants for the purchase of common stock by certainJGSG-identified investors and our purchase of outstanding shares of 5%Series A Redeemable Convertible Preferred Stock from certainJGSG-identified investors in December 2005 and January 2006 entitledJGSG to damages no less than $1,431,769. JGSG originally sought(a) $279,191 in cash commissions, (b) warrants for the purchase of85,905 shares at $3.25 per share, (c) lost profits of $751,669 on theargument that JGSG would have exercised the foregoing warrants and sold 85,905shares on December 30, 2005, at a price of $12.00 per share, and(d) $400,909 in cash commissions we paid C.E. Unterberg, Towbin, LLC (“CEUT”).

On September 22, 2006, we asserted a counterclaimagainst JGSG for fraud and breach of contract based upon JGSG’smisrepresentations to induce us to enter the engagement agreement and JGSG’sfailure to perform its promised services thereunder. We seek damages of(a) the $30,000 retainer and $543,000 cash paid to JGSG; (b) the valueof our warrants for 114,600 shares of common stock issued to JGSG; (c) the$445,328 fee and $27,016 expense reimbursement that we paid CEUT for itsadvisory services in December 2005 and January 2006; (d) the$3.7 million cash we did not obtain on investor warrant exercises due to thereduced warrant exercise price we were required to accept during those months;and (e) the value of the additional 1.9 million shares of common stock wewere required to issue to effectuate the preferred stock purchase during thosemonths. As a result, we counterclaim in excess of $5.0 million.

On November 20, 2006, JGSG filed an amendedstatement of claim. JGSG added new claims for additional compensation basedupon the issuance of additional common stock to preferred stock holders in thealleged “follow-on transactions,” our alleged failure to timely file a resaleregistration statement for JGSG, and for additional compensation based upon ourOctober 2006 private placement. JGSG currently seeks alleged damages of$3,346,565 as follows: (a) $279,191 in cash commissions; (b) warrantsfor the purchase of 85,905 shares at $3.25 per share; (c) lost profits of$751,669 on the argument that JGSG would have exercised the foregoing warrantsand sold 85,905 shares on December 30, 2005, at a price of $12.00 pershare; (d) $249,690 in cash pursuant to the alleged failure to timely filea resale registration statement for JGSG; (e) $6,726 in liquidated damagesbased upon our alleged failure to timely file the resale registration statementfor JGSG; (f) $556,214 in cash commissions that JGSG claims it wasentitled to based upon preferred stock holders’ receipt of additional commonstock in the alleged “follow-on transactions”; (g) warrants for thepurchase of 171,142 shares at $3.25 per share; (h) lost profits of$952,166 on the argument that JGSG would have exercised the foregoing warrantsand sold 171,142 shares on January 3, 2006, at a price of $11.00 pershare; (i) $400,909 in cash commissions we paid to CEUT; and (j) $150,000based upon the fee we paid to CEUT for our October 2006 private placement.JGSG also seeks reimbursement for reasonable expenses, interest, costs andattorneys’ fees.

The U.S. District Court for the District ofConnecticut has referred the matter to NASD arbitration. We believe that JGSG’slawsuit is without merit and intend to vigorously defend ourselves. Given thenature of arbitration, however, it is reasonably possible that we may beexpected to pay certain amounts in connection with this claim. Since this is abreach of contract claim, it may not be covered by our insurance. As ofJuly 31, 2007, we have not recorded an accrual for this matter since theamount to be paid, if any, cannot be reasonably estimated.

**ITEM 6   EXHIBITS**

See “Index to Exhibits.”

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**SIGNATURES**

In accordance with therequirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.
|                               | MedicalCV, Inc. |                                                 |   |
|-------------------------------|-----------------|------------------------------------------------------|--------|
|                          |            |                                                 |   |
|                          |            |                                                 |   |
| Date: September 14, 2007 | By              | /s/ Marc P. Flores                                   |   |
|                          |            | Marc P. Flores                                       |
|                          |            | President and Chief Executive Officer                |
|                          |            |                                                 |
|                          | By              | /s/ Eapen Chacko                                     |   |
|                          |            | Eapen Chacko                                         |
|                          |            | Vice President, Finance and  Chief Financial Officer |
|                               |                 |                                                      |        |  |  |  |

 

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**INDEX TO EXHIBITS**
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|-----------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 3.1             |       | Restated Articles of Incorporation of the  Registrant, as Amended (incorporated by reference to Amendment No. 1 to our  Registration Statement on Form SB-2, filed on June 6, 2006 (File No.  333-134315)).                                                                                                                                                                                                                                                                                                                                                                   |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 3.2             |       | Bylaws of the Registrant (incorporated by reference  to our Registration Statement on Form SB-2, filed on August 31, 2001 (File  No. 333-68884)).                                                                                                                                                                                                                                                                                                                                                                                                                             |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.1             |       | Reference is made to Exhibits 3.1 and 3.2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.2             |       | Specimen Common Stock Certificate (incorporated by  reference to Amendment No. 1 to our Registration Statement on Form SB-2,  filed on June 6, 2006 (File No. 333-134315)).                                                                                                                                                                                                                                                                                                                                                                                                   |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.1            |       | Amendment to Secured Note Purchase Agreement between  the Registrant and Whitebox Ready Ltd., dated June 15, 2007 (incorporated by  reference to our Current Report on Form 8-K, filed on June 15, 2007 (File No.  000-33295)).                                                                                                                                                                                                                                                                                                                                               |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.2            |       | Amendment to Warrant Agreement between the  Registrant and Whitebox Ready Ltd., dated June 15, 2007 (incorporated by  reference to our Current Report on Form 8-K, filed on June 15, 2007 (File No.  000-33295)).                                                                                                                                                                                                                                                                                                                                                             |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.3            |       | Secured Note Purchase Agreement between the  Registrant and Whitebox Ready Ltd., Craig-Hallum Partners LP, ASA Opportunity  Fund, L.P., Burguete Investment Partnership LP, Potomac Capital Partners LP,  Potomac Capital International Ltd. and Pleaides Investment Partners-R LP,  dated June 15, 2007, including form of Secured Promissory Note, forms of  Closing Warrant and Interest Warrant, and form of Security Agreement and UCC  Financing Statement (incorporated by reference to our Current Report on Form  8-K, filed on June 15, 2007 (File No. 000-33295)). |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.4            |       | Amendment to Executive Employment Agreement by and  between Eapen Chacko and the Registrant, dated June 28, 2007 (incorporated by  reference to our Current Report on Form 8-K, filed on June 29, 2007 (File No.  000-33295)).                                                                                                                                                                                                                                                                                                                                                |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.5            |       | Non-Employee Director Compensation Policy, as  amended and restated on August 16, 2007 (incorporated by reference to our  Current Report on Form 8-K, filed on August 21, 2007 (File No. 000-33295)).                                                                                                                                                                                                                                                                                                                                                                         |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.6            |       | Management Incentive Plan, adopted August 16, 2007  (incorporated by reference to our Current Report on Form 8-K, filed on August  21, 2007 (File No. 000-33295)).                                                                                                                                                                                                                                                                                                                                                                                                            |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.7            |       | Executive Employment Agreement, effective September  17, 2007, by and between the Registrant and Michael A. Brodeur (incorporated  by reference to our Current Report on Form 8-K, filed September 11, 2007  (File No. 000-33295)).                                                                                                                                                                                                                                                                                                                                           |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 31.1            |       | Chief Executive Officer Certification pursuant to  Exchange Act Rule 13a-14(a).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 31.2            |       | Chief Financial Officer Certification pursuant to  Exchange Act Rule 13a-14(a).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 32.1            |       | Chief Executive Officer Certification pursuant to 18  U.S.C. Section 1350.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 32.2            |       | Chief Financial Officer Certification pursuant to 18  U.S.C. Section 1350.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 99.1            |       | Amendment to Executive Employment Agreement by and  between Dennis E. Steger and the Registrant, dated May 31, 2007 (incorporated  by reference to our Current Report on Form 8-K, filed on June 4, 2007 (File  No. 000-33295)).                                                                                                                                                                                                                                                                                                                                              |

 

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