**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

**FORM10-QSB**

** **
| ý | **QUARTERLY REPORT UNDER SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD  ENDED OCTOBER 31, 2004** |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------|
|   | ** **                                                                                                                              |
| **o**  | **TRANSITION REPORT UNDER SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**                                                  |

 

**CommissionFile Number 0-33295**

 

**MEDICALCV,INC.**

(Exact Name of SmallBusiness 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)

 

Check whether the issuer:  (1) filed all reports required to befiled by Section 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 ý  No o

 

As of December 13, 2004, the issuer had outstanding 10,730,833 sharesof common stock.

 

Transitional Small Business Disclosure Format (check one)  o Yes  ý No

 

 

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**TABLE OFCONTENTS**

 
| PART I            | FINANCIAL  INFORMATION |                                                                                                                                                                 |
|-------------------|------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|              |                   |                                                                                                                                                                 |   |
|              | ITEM 1                 | Financial Statements                                                                                                                                                 |   |
|              |                   | Consolidated Balance Sheets  at October 31, 2004 (unaudited) and April 30, 2004  (audited)                                                       |   |
|              |                   | Consolidated  Statements of Operations for the three and six-month periods ended  October 31, 2004 (unaudited) and October 31, 2003  (unaudited) |   |
|              |                   | Consolidated  Statements of Cash Flows for the six-month periods ended  October 31, 2004 (unaudited) and October 31, 2003  (unaudited)           |   |
|              |                   | Notes to  Consolidated Financial Statements                                                                                                                          |   |
|              | ITEM  2                | Management’s  Discussion and Analysis or Plan of Operation                                                                                                      |   |
|              | ITEM 3                 | Controls and Procedures                                                                                                                                              |   |
|              |                   |                                                                                                                                                                 |   |
| PART  II          | OTHER  INFORMATION     |                                                                                                                                                                 |
|              |                   |                                                                                                                                                                 |   |
|              | ITEM 1                 | Legal Proceedings                                                                                                                                                    |   |
|              | ITEM  2                | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                         |   |
|              | ITEM 3                 | Defaults Upon  Senior Securities                                                                                                                                     |   |
|              | ITEM  4                | Submission  of Matters to a Vote of Security Holders                                                                                                                 |   |
|              | ITEM 5                 | Other Information                                                                                                                                                    |   |
|              | ITEM 6                 | Exhibits                                                                                                                                                             |   |
|              |                   |                                                                                                                                                                 |   |
| SIGNATURES        |                   |
| INDEX TO EXHIBITS |                   |

 

2

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**PART I**

 

**ITEM 1  FINANCIAL STATEMENTS**

 

**MEDICALCV,INC.**

 

**Consolidated Balance Sheets**

 
| ** **                                                                                                                         | ** ** | **October 31,  2004** | ** ** | **April 30,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| ** **                                                                                                                         | ** ** | **(unaudited)**            | ** ** | **(audited)**            | ** ** |
| **ASSETS**                                                                                                                         |       |                       |       |                     |       |
| Current assets:                                                                                                                    |       |                       |       |                     |       |
| Cash and cash  equivalents                                                                                                         |       | $                          | 239,532    |                     | $          | 659,856 |   |
| Trade and  accounts receivable, net                                                                                                |       | 800,166                    |       | 1,495,401                |       |
| Inventories                                                                                                                        |       | 1,325,775                  |       | 2,518,698                |       |
| Prepaid expenses  and other assets                                                                                                 |       | 112,966                    |       | 211,816                  |       |
| Total current  assets                                                                                                              |       | 2,478,439                  |       | 4,885,771                |       |
| Property, plant  and equipment, net                                                                                                |       | 980,597                    |       | 1,135,618                |       |
| Other long term  assets                                                                                                            |       | 152,500                    |       | —                   |       |
| Deferred  financing costs, net                                                                                                     |       | 61,866                     |       | 74,605                   |       |
| Total assets                                                                                                                       |       | $                          | 3,673,402  |                     | $          | 6,095,994 |   |
|                                                                                                                               |       |                       |       |                     |       |
| **LIABILITIES AND SHAREHOLDERS’ DEFICIT**                                                                                     |       |                       |       |                     |       |
| Current  liabilities:                                                                                                              |       |                       |       |                     |       |
| Accounts payable                                                                                                                   |       | $                          | 1,466,286  |                     | $          | 1,498,848 |   |
| Current portion  of long-term debt with related parties                                                                            |       | 3,443,333                  |       | —                   |       |
| Current portion  of related party lease obligations                                                                                |       | 294,798                    |       | 288,995                  |       |
| Note payable                                                                                                                       |       | —                     |       | 485,708                  |       |
| Accrued expenses                                                                                                                   |       | 312,019                    |       | 266,671                  |       |
| Total current  liabilities                                                                                                         |       | 5,516,436                  |       | 2,540,222                |       |
| Long-term debt  with related parties                                                                                               |       | —                     |       | 3,443,333                |       |
| Related party  lease obligations, less current portion                                                                             |       | 3,024,467                  |       | 3,166,425                |       |
| Total  liabilities                                                                                                                 |       | 8,540,903                  |       | 9,149,980                |       |
|                                                                                                                               |       |                       |       |                     |       |
| Shareholders’  deficit:                                                                                                       |       |                       |       |                     |       |
| Preferred stock,  $.01 par value; 5,000,000 shares authorized; no shares issued and outstanding                                    |       |                       |       |                     |       |
| Common stock;  $.01 par value; 95,000,000 shares authorized; 10,730,833 and 9,189,933 shares  issued and outstanding, respectively |       | 107,308                    |       | 91,899                   |       |
| Additional  paid-in capital                                                                                                        |       | 22,153,332                 |       | 20,168,133               |       |
| Deferred  stock-based compensation                                                                                                 |       | (1,030                     | )          | (1,933                   | )          |
| Accumulated  deficit                                                                                                               |       | (27,127,111                | )          | (23,312,085              | )          |
| Total  shareholders’ deficit                                                                                                  |       | (4,867,501                 | )          | (3,053,986               | )          |
| Total  liabilities and shareholders’ deficit                                                                                  |       | $                          | 3,673,402  |                     | $          | 6,095,994 |   |

 

The accompanying notesare an integral part of these financial statements.

 

3

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**MEDICALCV,INC.**

 

**ConsolidatedStatements of Operations**

**(unaudited)**

 
| ** **                                                     | ** ** | **Three Months Ended October 31,** | ** ** | **Six Months Ended October 31,** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------|------------|----------------------------------|------------|
| ** **                                                     | ** ** | **2004**                           | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net sales                                                      |       | $                                  | 459,627    |                             | $          | 807,532 |   | $ | 1,255,130 |   | $ | 1,707,761 |   |
| Cost of goods  sold                                            |       | 1,537,753                          |       | 426,189                          |       | 1,960,213 |   | 923,292 |   |
| Gross profit  (loss)                                           |       | (1,078,126                         | )          | 381,343                          |       | (705,083 | ) | 784,469 |   |
| Operating  expenses:                                           |       |                               |       |                             |       |   |   |   |   |
| Sales and  marketing                                           |       | 113,328                            |       | 505,274                          |       | 382,764 |   | 1,106,012 |   |
| General and  administrative                                    |       | 874,070                            |       | 624,142                          |       | 1,742,855 |   | 1,181,065 |   |
| Engineering and  regulatory                                    |       | 385,967                            |       | 200,688                          |       | 698,177 |   | 404,682 |   |
| Total operating  expenses                                      |       | 1,373,365                          |       | 1,330,104                        |       | 2,823,796 |   | 2,691,759 |   |
| Loss from  operations                                          |       | (2,451,491                         | )          | (948,761                         | )          | (3,528,879 | ) | (1,907,290 | ) |
| Other (expense)  income:                                       |       |                               |       |                             |       |   |   |   |   |
| Interest expense                                               |       | (112,354                           | )          | (303,009                         | )          | (292,774 | ) | (459,255 | ) |
| Interest income                                                |       | 815                                |       | —                           |       | 3,655 |   | 4,993 |   |
| Other (expense)  income                                        |       | 2,660                              |       | 5,860                            |       | 2,972 |   | (5,321 | ) |
| Total other  expense                                           |       | (108,879                           | )          | (297,149                         | )          | (286,147 | ) | (459,583 | ) |
|                                                           |       |                               |       |                             |       |   |   |   |   |
| Net loss                                                       |       | $                                  | (2,560,370 | )                                | $          | (1,245,910 | ) | $ | (3,815,026 | ) | $ | (2,366,873 | ) |
| Basic and  diluted net loss per share                          |       | $                                  | (.24       | )                                | $          | (.16 | ) | $ | (.36 | ) | $ | (.30 | ) |
|                                                           |       |                               |       |                             |       |   |   |   |   |
| Shares used in  computing basic and diluted net loss per share |       | 10,730,833                         |       | 7,906,825                        |       | 10,554,969 |   | 7,915,306 |   |

 

The accompanying notesare an integral part of these financial statements.

 

4

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**MEDICALCV,INC.**

 

**ConsolidatedStatements of Cash Flows**

(unaudited)

 
| ** **                                                                                                   | ** ** | **Six Months Ended October 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                   | ** ** | **2004**                         | ** ** | **2003** | ** ** |
| Cash flows from  operating activities:                                                                       |       |                             |       |   |   |
| Net loss                                                                                                     |       | $                                | (3,815,026 | ) | $ | (2,366,873 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:                                 |       |                             |       |   |   |
| Depreciation                                                                                                 |       | 144,067                          |       | 158,689 |   |
| Provision for  doubtful accounts                                                                             |       | 117,412                          |       | (15,951 | ) |
| Provision for  inventory obsolescence                                                                        |       | 1,277,691                        |       | — |   |
| Stock-based  compensation                                                                                    |       | 903                              |       | 150,108 |   |
| Interest expense  related to issued warrants and amortization of loan origination costs                      |       | 14,292                           |       | 338,840 |   |
| Changes in  assets and liabilities:                                                                          |       |                             |       |   |   |
| Accounts  receivable                                                                                         |       | 577,823                          |       | 208,357 |   |
| Inventories                                                                                                  |       | (84,768                          | )          | 23,909 |   |
| Prepaid expenses  and other assets                                                                           |       | 98,850                           |       | 34,029 |   |
| Accounts payable                                                                                             |       | (32,562                          | )          | 191,129 |   |
| Accrued expenses                                                                                             |       | 45,348                           |       | (519,515 | ) |
| Net cash used in  operating activities                                                                       |       | (1,655,970                       | )          | (1,797,278 | ) |
|                                                                                                         |       |                             |       |   |   |
| Cash flows from  investing activities:                                                                       |       |                             |       |   |   |
| Purchase of  property, plant and equipment                                                                   |       | (12,169                          | )          | (1,383 | ) |
| Proceeds from  the sale of property, plant and equipment                                                     |       | 23,123                           |       | — |   |
| Purchase of  other long-term assets                                                                          |       | (152,500                         | )          | — |   |
| Net cash used in  investing activities                                                                       |       | (141,546                         | )          | (1,383 | ) |
|                                                                                                         |       |                             |       |   |   |
| Cash flows from  financing activities:                                                                       |       |                             |       |   |   |
| Deferred  financing costs                                                                                    |       | 12,739                           |       | (139,083 | ) |
| Proceeds from  the issuance of common stock and warrants, net of offering costs                              |       | 2,000,608                        |       | 60,000 |   |
| Proceeds from  short-term debt with related party                                                            |       | —                           |       | 2,000,000 |   |
| Principal  payments on short-term debt                                                                       |       | (500,000                         | )          | — |   |
| Principal  payments under capital lease obligations                                                          |       | —                           |       | (27,079 | ) |
| Principal  payments under related party lease obligations                                                    |       | (136,155                         | )          | (204,183 | ) |
| Net cash  provided by financing activities                                                                   |       | 1,377,192                        |       | 1,689,655 |   |
|                                                                                                         |       |                             |       |   |   |
| Net decrease in  cash and cash equivalents                                                                   |       | (420,324                         | )          | (109,006 | ) |
| Cash and cash  equivalents at beginning of year                                                              |       | 659,856                          |       | 184,227 |   |
| Cash and cash  equivalents at end of period                                                                  |       | $                                | 239,532    |   | $ | 75,221 |   |
|                                                                                                         |       |                             |       |   |   |
| Non-cash  investing and financing activities                                                                 |       |                             |       |   |   |
| Discount on  convertible subordinated bridge notes related to warrants granted in  connection with the notes |       | —                           |       | (665,067 | ) |

 

The accompanying notesare an integral part of these financial statements.

 

5

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**MEDICALCV,INC.**

 

**Notes toConsolidated Financial Statements**

 

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

 

The accompanying unaudited consolidated financial statements included hereinhave been prepared by MedicalCV, Inc. (the “Company”) in accordance withaccounting principles generally accepted in the United States of America forinterim financial information and pursuant to the rules and regulations of theSecurities and Exchange Commission.  Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of Americahave been condensed or omitted pursuant to such rules and regulations. These consolidated interim financial statements should be read in conjunctionwith the consolidated financial statements and the notes thereto included inthe Company’s Annual Report on Form 10-KSB for the fiscal year ended April 30,2004.

 

The consolidated balance sheet as of October 31, 2004, the consolidatedstatements of operations for the three and six months ended October 31, 2004and 2003, and the consolidated statements of cash flows for the six monthsended October 31, 2004 and 2003 include, in the opinion of management, alladjustments, consisting solely of normal recurring adjustments, necessary for afair presentation of the financial results for the respective interim periodsand are not necessarily indicative of results of operations to be expected forthe entire fiscal year ending April 30, 2005.

 

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

 

The Company’s consolidated financial statements for the quarter endedOctober 31, 2004, have been prepared on a going concern basis, whichcontemplates the realization of assets and settlement of liabilities andcommitments in the normal course of business.  The Company has sustainedlosses and negative cash flows from operations in recent years and expectsthese conditions to continue for the foreseeable future.  AtOctober 31, 2004, the Company had an accumulated deficit of $27,127,111and has insufficient funds to finance its working capital and capitalexpenditure needs. These matters raise substantial doubt about the Company’sability to continue as a going concern.  The Company is currently seekingsources of financing to fund its operations and working capitalrequirements.  If the Company is unable to obtain additional funds duringfiscal year 2005, it will be required to significantly revise its business plansand drastically reduce operating expenditures such that it may not be able todevelop or enhance its products, gain market share in the United States orrespond to competitive pressures or unanticipated requirements, which couldseriously harm its business, financial position and results of operations.  These financial statements do not include anyadjustments that might result from the outcome of this uncertainty.

 

On November 18, 2004 the Company’s Board of Directors authorizedmanagement to pursue options for exiting the heart valve business.  (See Notes 5 and 10)

 

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

 

**(3)****                                 Stock-basedCompensation**

 

The Company accounts for stock-based employee compensation arrangementsin accordance with the provisions of Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees,” and complies with thedisclosure provisions of SFAS No. 123, “Accounting for Stock-BasedCompensation” and SFAS No. 148 “Accounting for Stock-BasedCompensation-Transition and Disclosure, an amendment of FASB Statement No. 123.”

 

6

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

 
| ** **                                                                                 | ** ** | **For the Periods Ended October 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                 | ** ** | **Three Months**                      | ** ** | **Six Months** | ** ** |
| ** **                                                                                 | ** ** | **2004**                              | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net loss  reported                                                                         |       | $                                     | (2,560,370 | ) | $ | (1,245,910 | ) | $ | (3,815,026 | ) | $ | (2,366,873 | ) |
| Add: Stock-based  employee compensation expense included in operating results, as reported |       | —                                |       | 48,718 |   | — |   | 48,718 |   |
| Less: Pro-forma  stock-based employee compensation cost                                    |       | (100,462                              | )          | (143,912 | ) | (143,963 | ) | (208,181 | ) |
|                                                                                       |       |                                  |       |   |   |   |   |   |   |
| Net loss – pro  forma                                                                 |       | (2,660,832                            | )          | (1,341,104 | ) | (3,958,989 | ) | (2,526,336 | ) |
|                                                                                       |       |                                  |       |   |   |   |   |   |   |
| Net loss per  common share – basic and diluted                                        |       |                                  |       |   |   |   |   |   |   |
| As reported                                                                                |       | (.24                                  | )          | (.16 | ) | (.36 | ) | (.30 | ) |
| Pro Forma                                                                                  |       | (.25                                  | )          | (.17 | ) | (.38 | ) | (.32 | ) |
|                                                                                            |            |                                       |            |  |  |  |  |  |  |  |  |  |  |

 

**(4)****                                 NetLoss Per Share**

 

Net loss per share is computed under the provisions of SFASNo. 128, “Earnings Per Share.” Basic net loss per common share is computed using net loss and theweighted-average number of shares of common stock outstanding.  Diluted earnings per share reflect thepotential dilution of securities that could share in the earnings of anentity.  Diluted net loss per commonshare does not differ from basic net loss per common share in the three andsix-month periods ended October 31, 2004 and 2003, since the potentiallydilutive shares are anti-dilutive.  Potentially dilutive shares excludedfrom the calculation of diluted net loss per share relate to outstanding stockoptions and warrants aggregating 2,329,730 and 5,207,314 shares of the Company’scommon stock at October 31, 2004 and 2003, respectively.

 

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

 

| ** **      | ** ** | **October 31, 2004** | ** ** | **April 30, 2004** | ** ** |
|-----------------|------------|----------------------|------------|--------------------|------------|
| ** **      | ** ** | **(unaudited)**      | ** ** | ** **         | ** ** |
| Raw materials   |       | $                    | —     |               | $          | 97,094 |   |
| Work-in-process |       | —               |       | 216,324            |       |
| Finished goods  |       | 1,325,775            |       | 2,205,300          |       |
|            |       | $                    | 1,325,775  |               | $          | 2,518,698 |   |

 

During November 2004, the Company’s Board of Directors approved a planto suspend production of heart valves and authorized management to pursueoptions for exiting the heart valve business. During the second quarter of fiscal year 2005, the Company experienced adecline in sales of its heart valves which management believes is the result ofchanges to the terms of its arrangements with its distributors and to theCompany’s focus on exiting this business. As a result of these factors, management has determined that currentsales trends indicate that the Company has excess inventories as well asinventories with carrying values in excess of their realizable values.  Accordingly, during the quarter ended October31, 2004, the Company recorded a $1,267,441 reduction in the carrying value ofcertain heart valve inventories.  Thisreduction in carrying value was recorded as a charge to cost of goods sold.

 

**(6)****                                 OtherAssets**

 

In May 2004, the Company purchased certain equipment that will beleased to customers to support customers that purchase its new product for thetreatment of atrial fibrillation.  Theequipment, which has a carrying value of $152,500, is included in otherlong-term assets.

 

7

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**(7)****                                 RestructuringCharge**

 

In the quarter ended July 31, 2004, the Company restructured itsexecutive management team, resulting in the termination of two employees, whichresulted in a charge of approximately $214,000, to general and administrativeexpenses.  This charge represented the amount of future severance paymentsdue to these former employees.  During the quarter ended October 31, 2004,the Company terminated an additional five employees in an effort to reduceoperating costs.  This restructuringresulted in approximately $46,000 of additional severance costs which werecharged to general and administrative expense. The Company expects to pay all amounts due to these former employees byAugust 2005.  As of October 31,2004, $166,761 remained accrued but not paid.

 

**(8)****                                 Equitysale**

 

In February, April and May, 2004, the Company conducted a privateplacement to accredited investors of units, each unit consisting of one shareof common stock and one common stock purchase warrant to purchase one share ofcommon stock.  In this placement, 2,730,763 units were sold at $1.47for aggregate gross proceeds of $4,014,222. During fiscal year 2004, the Company received gross proceeds from thisprivate placement of $1,749,099.  Thefive-year warrants sold with the common stock are exercisable to purchase anaggregate of 2,730,763 shares of common stock at an exercise price of $1.60 pershare.  In connection with such placement, the Company issued its agent afive-year warrant to purchase 123,272 units at an exercise price of $1.8375 perunit, paid its agent cash commissions of $181,210 and paid its agent an expenseallowance of $67,954.  Other offering costs totaling $13,052 were alsoincurred in connection with this transaction. In connection with suchplacement, the Company issued its finder a five-year warrant to purchase190,378 units at an exercise price of $1.8375 per unit, paid its finder afinder’s fee of $140,928 and reimbursed its finder for expenses of$4,163.  The warrants underlying the unit warrants issued to the agent andthe finder are exercisable for a period of five-years at an exercise price of$1.8375 per share.

 

**(9)****                                 SegmentInformation**

 

The Company views its operations and manages its business as onesegment, the development and marketing of cardiothoracic surgery devices. Factors used to identify the Company’s single operating segment include theorganizational structure of the Company and the financial information availablefor evaluation by chief operating decision maker.

 

The following table summarizes net sales by geographic area:

 

| ** **    | ** ** | **Three Months Ended October 31,** | ** **  | **Six Months Ended October 31,** | ** ** |
|---------------|------------|------------------------------------|-------------|----------------------------------|------------|
| ** **    | ** ** | **2004**                           | ** **  | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
| Europe        |       | $                                  | 247,000     |                             | $          | 413,218 |   | $ | 600,317 |   | $ | 860,088 |   |
| South Asia    |       | —                             |        | 121,600                          |       | — |   | 198,400 |   |
| Middle East   |       | 88,756                             |        | 112,067                          |       | 346,088 |   | 254,521 |   |
| Far East      |       | 7,721                              |        | —                           |       | 15,424 |   | 53,180 |   |
| United States |       | 92,700                             |        | 106,100                          |       | 260,398 |   | 286,800 |   |
| Other         |       | 23,450                             |        | 54,547                           |       | 32,903 |   | 54,772 |   |
|          |       |                               |        |                             |       |   |   |   |   |
| **TOTALS**    | ** ** | **$**                              | **459,627** | ** **                       | **$**      | **807,532** | ** ** | **$** | **1,255,130** | ** ** | **$** | **1,707,761** | ** ** |

 

**(10)****                          Subsequentevents**

 

On November 17, 2004, the Company entered into a discretionary creditagreement (the “October 2004 Discretionary Credit Agreement”) with PKMProperties, LLC (“PKM”), an entity controlled by Paul K. Miller, one of itsdirectors and the largest beneficial owner of its securities, covering advancesby PKM of up to $500,000.  The October 2004 Discretionary Credit Agreementhas a maturity date of February 28, 2005.  It requires the payment ofinterest at a rate of 10 percent per year, and it also contains variousrepresentations and loan covenants as are customary in banking and financetransactions.  The Company issued a credit note to PKM to evidence suchindebtedness.

 

In connection with the October 2004 Discretionary Credit Agreement, theCompany entered into an intellectual property security agreement with PKMpursuant to which PKM was granted a security interest in all of the Company’sintellectual property.  The Company and its creditors agreed to anamendment to the first amended and restated

 

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subordination and intercreditor agreement by and between PKM and PeterL. Hauser.  Pursuant to this agreement, proceeds borrowed under theOctober 2004 Discretionary Credit Agreement are deemed “senior debt”.  Further, PKM, pursuant to a waiver agreement,waived past defaults under the January Discretionary Credit Agreement and theNovember 2003 Credit Agreement.  These defaults involved the late paymentsof interest and failure to send periodic financial statements. As additionalconsideration for the October 2004 Discretionary Credit Agreement, the Companyissued to PKM a warrant with a ten-year term to purchase 34,014 shares of theCompany common stock at a per share exercise price equal to the lower of (1)$1.47 or (2) the price at which the Company first sells its common stock orunits (minus the value of the warrant component thereof determined at the dateof sale thereof using the Black Scholes formula) after November 17, 2004, butnot less than $1.00.

 

On November 18, 2004, the Company’s Board of Directors voted todiscontinue all heart valve–related production and authorized management topursue options for exiting the heart valve business.  The Company is still evaluating itsalternatives for exiting the heart valve business, and, at this time, does notbelieve that the carrying value of its long-lived assets is impaired.  However, there can be no assurance that theCompany will not incur a loss in connection with a subsequent exit transaction.

 

9

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**ITEM 2****                                                        MANAGEMENT’SDISCUSSION 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, 2004, under the caption “Management’s Discussion and Analysis orPlan of 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.*

 

**Overview**

 

MedicalCV is a cardiothoracic surgery device manufacturer.  Previously, our primary focus was on heartvalve disease.  We developed and marketedmechanical heart valves known as the OmnicarbonÒ3000 and 4000.  In November 2004, afteran exhaustive evaluation of the business, we decided to explore options forexiting the mechanical valve business. We intend to direct our resources to the development and introduction ofproducts targeting treatment of atrial fibrillation.

 

In September 2003, we entered into an agreement with LightWave AblationSystems, Inc., to purchase technology for the treatment of atrialfibrillation.  This technology providesan important growth platform.  OnDecember 1, 2004, we received FDA 510(k) clearance to market our AtriLazeTMSurgical Ablation System.  The AtriLazeTMSurgical Ablation System is a medical device designed for use on cardiac tissueduring surgery and we anticipate commencing the marketing of such system inJanuary 2005 via a direct sales force in the United States.

 

Atrial fibrillation (“A-Fib”) is the most common occurring cardiacarrhythmia.  It reduces cardiac output,is a major precursor to congestive heart failure and is associated with anincreased incidence of stroke.  Theincidence of A-Fib increases with age. Five and a half million people worldwide are afflicted with A-Fib.  There are 320,000 new diagnoses annuallyworldwide.  Two and a half millionAmericans are afflicted with A-Fib, with 160,000 new diagnoses each year in theU.S.

 

On September 23, 2004 we announced that as a result of our expandedefforts into the atrial fibrillation market, we are reevaluating the long-termstrategic implications and alternatives for our mechanical heart valve andpyrolytic carbon platforms.  On November18, 2004, we determined to discontinue all heart valve related production andto pursue options for exiting the heart valve business.  We are still evaluating our alternatives forexiting the heart valve business, and, at this time, do not believe that thecarrying value of our long-lived assets are impaired.  However, there can be no assurance that wewill not incur a loss in connection with a subsequent exit transaction.

 

During the second quarter of fiscal year 2005, we experienced asignificant decline in sales of our heart valves which we believe is the resultof changes to the terms of our arrangements with our distributors and to ourfocus on exiting the heart valve business. As a result of these factors, we have determined that current salestrends indicate that we have excess inventories as well as inventories withcarrying values in excess of their realizable values.  Accordingly, during the quarter ended October31, 2004, we recorded a $1,267,441 reduction in the carrying value of certainheart valve inventories.  This reductionin carrying value was recorded as a charge to cost of goods sold.

 

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**Periods Ended October 31, 2004 and2003**

 

Our operating results, expressed as a percentage of total revenue, wereas follows:

 
| ** **                  | ** ** | **Three Months Ended October 31,** | ** ** | **Six Months Ended October 31,** | ** ** |
|-----------------------------|------------|------------------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | **2004**                           | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net sales                   |       | 100.0                              | %          | 100.0                            | %          | 100.0 | % | 100.0 | % |
| Cost of goods  sold         |       | 334.6                              |       | 52.8                             | %          | 156.2 | % | 54.1 | % |
|                        |       |                               |       |                             |       |   |   |   |   |
| Gross profit  (loss)        |       | (234.6                             | )%         | 47.2                             | %          | (56.2 | )% | 45.9 | % |
|                        |       |                               |       |                             |       |   |   |   |   |
| Operating  expenses:        |       |                               |       |                             |       |   |   |   |   |
|                        |       |                               |       |                             |       |   |   |   |   |
| Sales and  marketing        |       | 24.6                               | %          | 62.5                             | %          | 30.5 | % | 64.7 | % |
| General and  administrative |       | 190.0                              | %          | 77.3                             | %          | 138.9 | % | 69.2 | % |
| Engineering and  regulatory |       | 84.0                               | %          | 24.9                             | %          | 55.6 | % | 23.7 | % |
|                        |       |                               |       |                             |       |   |   |   |   |
| Total operating  expenses   |       | 298.6                              | %          | 164.7                            | %          | 225.0 | % | 157.6 | % |
|                        |       |                               |       |                             |       |   |   |   |   |
| Loss from  operations       |       | (533.4                             | )%         | (117.5                           | )%         | (281.2 | )% | (111.7 | )% |
|                        |       |                               |       |                             |       |   |   |   |   |
| Other (expense)  income:    |       |                               |       |                             |       |   |   |   |   |
|                        |       |                               |       |                             |       |   |   |   |   |
| Interest expense            |       | (24.5                              | )%         | (37.5                            | )%         | (23.3 | )% | (26.9 | )% |
| Interest income             |       | .2                                 | %          | —                           | %          | .3 | % | .3 | % |
| Other income                |       | .6                                 | %          | .7                               | %          | .2 | % | (.3 | )% |
|                        |       |                               |       |                             |       |   |   |   |   |
| Total other  expense        |       | (23.7                              | )%         | (36.8                            | )%         | (22.8 | )% | (26.9 | )% |
|                        |       |                               |       |                             |       |   |   |   |   |
| Net loss                    |       | (557.1                             | )%         | (154.3                           | )%         | (304.0 | )% | (138.6 | )% |

 

**Critical Accounting Policies**

 

For discussion of critical accounting policies and estimates, see ourAnnual Report on Form 10-KSB for the fiscal year ended April 30, 2004.

 

**Results of Operations**

 

*Net Sales*. Net sales in the second quarter of fiscal year 2005 decreased to $459,627 from$807,532 in the second quarter of the prior year.  Net sales in thesix-month period ended October 31, 2004, decreased to $1,255,130 from$1,707,761 in the comparable period of the prior year.  During fiscal year 2005, we changed certainpricing programs with several of our distributors.  This resulted in a disruption of sales todistributors in certain markets.  Althoughit is difficult to assess the effects of this disruption on future quarters, wedo not expect sales to return to the levels experienced in fiscal year 2004.

 

Unit sales decreased 54.1 percent and 35.0 percent in the quarter andsix-month periods ended October 31, 2004, compared to the same periods in theprevious year, respectively.

 

The average selling price per unit increased 11.7 percent and 12.3percent in the quarter and six-month periods ended October 31, 2004, comparedto the same periods in the previous year, respectively.

 

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*Gross Profit.* Gross profit, as a percentage of net sales, decreased to (234.6) percent in thesecond quarter of fiscal year 2005, from 47.2 percent in the second quarter ofthe prior year.  Fiscal year-to-date gross profit margins in fiscal year2005 decreased to (56.2) percent compared to 45.9 percent in the same periodlast fiscal year.  The gross margindeclined in the three and six-month periods ended October 31, 2004, despite theincreases in average selling prices, primarily due to the $1,267,441 charge tocost of goods sold recorded in the second quarter of fiscal year 2005 to reducethe carrying value of inventories and the decline in unit sales which reducedthe absorption of our fixed manufacturing costs.

 

*Sales and Marketing*. Sales and marketing expenses in the second quarter of fiscal year 2005 were$113,328 or 24.6 percent of net sales compared to $505,274 or 62.5 percent ofnet sales in the second quarter of the prior year.  For the six-monthperiod ended October 31, 2004, sales and marketing expenses totaled $382,764 or30.5 percent of net sales, compared to $1,106,012 or 64.7 percent of net salesin the same period last fiscal year. The decrease in sales and marketingexpenses in the quarter and six-month periods ended October 31, 2004, compared tothe quarter and six-month periods ended October 31, 2003, was primarilyattributable to changes made in fiscal year 2005 in certain pricing programsand compensation arrangements with several of our distributors in an attempt toreduce sales and marketing expense.  Thisresulted in a disruption of sales to distributors in certain markets.  Weexpect that the level of sales and marketing expenses in the remaining quartersof fiscal year 2005 will be higher than the current quarter due to theincreased spending on the marketing of our initial atrial fibrillation product.

 

*General and Administrative*. General and administrative expenses for the second quarter of fiscal year 2005were $874,070 or 190.0 percent of net sales, compared to $624,142 or 77.3percent of net sales in the same period one year ago.  For the six-monthperiod ended October 31, 2004, general and administrative expenses totaled$1,742,855 or 138.9 percent of net sales, compared to $1,181,065 or 69.2percent of net sales in the same period last year. Included in the generaland administrative expense for the three months ended October 31, 2004,was $46,000 for severance costs related to the termination of fiveemployees.  Increases in legal fees of$30,000 and increased consulting fees of $62,000, along with $112,922 in baddebt expense, were the other major components of the $249,928 increase ofgeneral and administrative expense. Included in the general and administrative expense for the six monthsended October 31, 2004, was $260,000 of severance costs resulting from therestructuring of our executive management team and the termination of otheremployees, and $117,412 in bad debt expense. As of October 31, 2004, we have accrued remaining severance payments ofapproximately $166,767, which we expect to finish paying by August 2005.  Other significant components of the increasein general and administrative expenses in the first six months of fiscal year2005 compared to the first six months of fiscal year 2004, included an increasein legal fees of $69,000 and an increase in consulting fees of $88,000.

 

*Engineering and Regulatory*. Engineering and regulatory expenses for the second quarter of fiscal year 2005were $385,967 or 84.0 percent of net sales compared to $200,688 or 24.9 percentof net sales in the second quarter of the prior fiscal year.  For thesix-month period ended October 31, 2004, engineering and regulatory expensestotaled $698,177 or 55.6 percent of net sales, compared to $404,682 or 23.7percent of net sales in the same period last year.  Expenses related tothe development of our initial atrial fibrillation product accounted for theincrease in spending for the quarter and six-month periods ended October 31,2004, compared to the quarter and six-month periods ended October 31, 2003.

 

*Other (Expense) Income*. Interest expense totaled $108,879 in the quarter ended October 31, 2004,compared to $297,149 in the second quarter of the prior fiscal year. Fiscal year-to-date interest expense was $286,147 compared to $459,583 inthe same period one year ago.  The decreases in interest expense in thesecond quarter and year-to-date periods were attributed to a decrease infinancing costs associated with the additional short-term debt obtained infiscal year 2004.

 

*Income Tax Provision*.  In light of our history of operating losses,we have recorded a valuation allowance to fully offset our deferred taxassets.  We have continued to provide a full valuation allowance throughthe second quarter of fiscal year 2005 due to the inherent uncertainty aboutour ability to generate the sufficient taxable income to realize these deferredtax assets.  We have recorded no tax provision in the current period dueto net operating losses generated for income tax reporting purposes.

 

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**Liquidity and Capital Resources**

 

Cash and cash equivalents decreased to $239,532 at October 31,2004, from $659,856 at April 30, 2004.  This decrease in cash andcash equivalents of $420,324 was due to the following:

 

| Net cash used in  operating activities     |   | $         | (1,655,970 | ) |
|--------------------------------------------|--------|-----------|------------|---|
| Net cash used in  investing activities     |   | (141,546  | )          |
| Net cash  provided by financing activities |   | 1,377,192 |       |
| Net decrease                               |   | $         | (420,324   | ) |

 

Net cash used by operating activities for the six-month period ended October 31,2004, totaled $1,655,970.  Negativeoperating cash flows resulted primarily from the net loss of $3,815,026 for theperiod, partially offset by net non-cash adjustments of $1,554,365, relatingprimarily to an increase in the inventory and bad debt provisions anddepreciation.  The net decrease in cashflows from operating activities was also partially offset by changes inoperating assets and liabilities of $604,691, relating primarily to decreasesin accounts receivable and prepaid expenses, net of an increase in inventoriesproduced.

 

Net cash used in investing activities for the six-month period endedOctober 31, 2004, totaled $141,546.  Weused $152,500 to purchase equipment that we will use to support customers ofour initial atrial fibrillation product. The funds used will be partially offset by the proceeds from the sale ofother equipment.

 

Net cash provided by financing activities for the six-month periodended October 31, 2004, totaled $1,377,192. Net proceeds from the issuance of common stock and warrants totaled$2,000,608.  These proceeds werepartially offset by payments of short-term debt and the related-party leaseobligation of $636,155.

 

Since the beginning of fiscal year 2004, we entered into the followingfinancing transactions to provide funds necessary to meet our working capitaland capital expenditure needs and to meet other obligations:

 

In July 2003, we established a $1.0 million term debt with PKMProperties, LLC (“PKM”), an entity controlled by Paul K. Miller, one of ourdirectors and the largest beneficial owner of our securities.  This termdebt, which was amended in November 2003 to provide for an additional$500,000 of borrowing, requires the payment of interest at a rate of 10 percentper year, matures on June 30, 2005, and is collateralized by substantiallyall of our assets.

 

In a simultaneous July 2003 transaction, we entered into a loanagreement and borrowed $1.0 million from Peter L. Hauser (“Hauser”)pursuant to the terms of a subordinated note with an interest rate of 10percent per year.  Pursuant to an intercreditor agreement with PKM, theloan is collateralized by substantially all of our assets. This loan, asamended, matures on June 30, 2005.

 

We also borrowed $500,000 in November 2003 from Draft Co. (“Draft”),under a note that matured on June 30, 2004, which had an interest at arate of 10 percent per year.  The Draft loan was collateralized bysubstantially all our assets pursuant to a restated intercreditor agreementamong PKM, Hauser, and Draft. This note was repaid on June 30, 2004.

 

In April 2004, we entered into another credit agreement with PKMfor up to $250,000.  Under this agreementwe issued a short-term promissory note to PKM in the principal amount of$150,000.  The note required the payment of interest at a rate of 10percent per year.  This note was repaid during April 2004.

 

In February, April and May, 2004, we conducted a private placementto accredited investors of units, each unit consisting of one share of commonstock and one common stock purchase warrant to purchase one share ofcommon stock.  In this placement, we sold 2,730,763 units at $1.47for aggregate gross proceeds of $4,014,222. During fiscal year 2004, we received gross proceeds from this privateplacement of $1,749,099.  The five-yearwarrants sold with the common stock are exercisable to purchase an aggregate of2,730,763 shares of common stock at an exercise price of $1.60 per share. In connection with such placement, we issued our agent a five-year warrant topurchase 123,272 units at an exercise price of $1.8375 per unit, paid our agentcash commissions of $181,210 and paid our agent an expense allowance of$67,954.  In connection with such placement, we issued our finder afive-year warrant to purchase 190,378 units at an exercise price of $1.8375 perunit, paid our finder a finder’s fee of $140,928 and reimbursed our finder forexpenses of $4,163.  The warrants underlying the unit warrants issued tothe agent and the

 

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finder are exercisable for a period of five-years at an exercise priceof $1.8375 per share.

 

Even with the net proceeds from our spring 2004 private placement, weanticipate that we will need to raise additional capital inDecember 2004.  In addition, the report of our independent registeredpublic accounting firm for fiscal year 2004 includes an explanatory paragraphexpressing doubt about our ability to continue as a going concern.

 

We expect that our operating losses and negative operating cash flowwill continue through fiscal year 2005 as we continue adding staff to supportthe development and launch of our atrial fibrillation technology.  Weanticipate that our sales and marketing and general and administrative expenseswill continue to constitute a material use of our cash resources.  The actual amounts and timing of our capitalexpenditures will vary significantly depending upon progress on our productdevelopment projects, the speed at which we are able to expand our distributioncapability in domestic and international markets and the availability offinancing.

 

Our capital requirements may vary depending upon the timing and thesuccess of the implementation of our business plan, regulatory, technologicaland competitive developments, or if:

 

•                  increased saleslevels of our new products are not achieved;

 

•                  operating lossesexceed our projections;

 

•                  manufacturingand development costs exceed our estimates;

 

•                  we determine toacquire, license or develop additional technologies;

 

•                  we requireadditional technologies to complete projected product development; or

 

•                  the amount, ifany, we receive from a transaction in which we exit from the heart valvebusiness.

 

By broadening our portfolio of cardiothoracic surgery products, we hopeto improve our cash flow from operating activities and reduce our reliance uponfinancing transactions, which may not be available to us.  We cannot,however, assure you that our efforts to diversify our product offerings will:

 

•                  be attainable;

 

•                  be profitable;

 

•                  reduce ourreliance upon financing transactions; or

 

•                  enable us tocontinue operations.

 

Our ability to continue as a going concern depends upon our ability toobtain additional debt and/or equity financing. Assuming there are no cash proceeds from the sale of the heart valvebusiness or its assets, our plan to fund the business is outlined as follows:

 

•                  In November2004, we signed a discretionary credit agreement with PKM for up to$500,000.  We expect to draw this entireamount by December 31, 2004.

 

•                  We believe wewill require an additional $4.0 million in financing to fund us to April 30,2005.

 

•                  We believe wewill need to raise and additional $6.0 million to $7.0 million tofund us from May 1, 2005, to December 31, 2005.

 

•                  We will requirean additional $3.5 million in borrowings to repay PKM and Hauser which matureon June 30, 2005, unless the terms are otherwise extended or restructured.

 

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We expect to face substantial difficulty in raising funds in the currentmarket environment and we have no commitments at this time to provide therequired financing.  If we obtain the foregoing financing, we believe wewill have sufficient capital resources to operate and fund the growth of ourbusiness for calendar year 2005.

 

The amount of capital needed for future periods is difficult toestimate and will be dependent on the introduction of our open-heart atrialfibrillation product and development costs on our minimally invasive atrialfibrillation products.

 

We cannot assure you that we will be able to raise sufficientadditional capital on terms that we consider acceptable, or at all.  Theterms of any equity financing are expected to be highly dilutive to ourexisting security holders.  The delisting of our securities from theNasdaq SmallCap Market that occurred in March 2003 negatively affects ourability to raise capital.  If we are unable to obtain adequate financingon acceptable terms, we will be unable to continue operations.

 

**Commitments and Contingent Liabilities**

 

*Related Party Lease Obligation*. On April 4, 2003, we sold our corporate headquarters, manufacturingfacility and surrounding land in Inver Grove Heights, Minnesota, to PKM. In connection with the transaction, we received total consideration of $3.84million consisting of (i) $1.0 million in cash, (ii) PKM’s assumption of our$2.5 million outstanding indebtedness to Associated Bank which eliminated ourindebtedness to Associated Bank, and (iii) PKM’s assumption of our promissorynote with Dakota Electric Association and land special assessments payable toDakota County aggregating $336,105.

 

We simultaneously leased back our facility pursuant to a ten-yearlease, with options to renew and an option to repurchase the facility.  Wecontinue to utilize the facility as we did prior to the financing transaction,with no change in operations.

 

*Clinical Studies*. We entered into agreements with several large institutions to conduct clinicalstudies regarding certain aspects of our Omnicarbon heart valve’s clinicalperformance.  The agreements run through fiscal year 2006.  Ingeneral, recipients of clinical study payments are required to purchase ourproducts in order to complete their studies and collect and submit dataaccording to a study protocol.  As of October31, 2004, we have accruded, but not paid, $10,300 due to one institution.

 

*Deferred compensation.*As part of the restructuring, we are obligated to make severance payments toformer officers and employees.  As ofOctober 31, 2004, our remaining obligations total $166,761.  (See Footnote 6 of the “Notes to ConsolidatedFinancial Statements”.)

 

*Atrial Fibrillation TechnologyPurchase Agreement*.  We entered into an agreement withLightWave Ablation Systems, Inc. (“LightWave”) in August 2003 to purchasetechnology for the treatment of atrial fibrillation.  We issued 15,000shares of common stock and a warrant to purchase 25,000 shares of common stock,and made an initial payment of $10,000 to LightWave for the worldwidetechnology distribution rights.  In April 2004, we paid $15,000coincident with the filing of a 510(k) application with the FDA pertaining toan application of the LightWave technology.  Pursuant to terms of theagreement, additional cash payments will be made and warrants to purchase sharesof our common stock may be issued to LightWave in the event that we meetcertain development and marketing milestones, including obtaining a CE Mark,receipt of 510(k) clearance, and issuance of a U.S. Patent.  Upon thefirst commercial sale in the U.S. or Europe utilizing the purchased technology,a payment of $125,000 will be due and an additional $385,000 will be due whencumulative gross sales of disposable products utilizing the purchasedtechnology reach $1,500,000.  In addition, for a period of 10 yearsmeasured from the first commercial sale utilizing the purchased technology, wewill make a payment totaling 2 to 6 percent of net sales of disposableproducts.  Following the first commercial sale utilizing the purchasedtechnology, the timing of which is indeterminable, minimum payments under thisprovision would total $2,325,000 over nine years.

 

*Debt with Related Parties*. We entered into agreements with PKM and Hauser in July andNovember of 2003 to provide $2.5 million of bridge financing.  We previouslyestablished a line of credit in January 2003 with PKM and have enteredinto various other financing transactions with PKM as previously described.

 

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The following table summarizes our contractual obligations as ofOctober 31, 2004:

 
| **Summary of Contractual  Obligations**               | ** ** | **Payments Due By Period** | ** **             |
|-------------------------------------------------------|------------|----------------------------|------------------------|
| ** **                                            | **TOTAL**  | ** **                 | **Less than One Year** | ** ** | **Two to Three  Years** | ** ** | **Four or More  Years** | ** ** |
| Related Party  Lease Obligation(1)                    |       | $                          | 3,623,134              |   | $ | 384,000 |   | $ | 768,000 |   | $ | 2,471,134 |   |
| Clinical Studies                                      |       | 10,300                     |                   | 10,300 |   |   |   |   |   |
| Deferred  compensation                                |       | 166,761                    |                   | 166,761 |   |   |   |   |   |
| Atrial  Fibrillation Technology Purchase Agreement(2) |       | 15,000                     |                   | 15,000 |   |   |   |   |   |
| Debt with  Related Parties                            |       | 3,443,333                  |                   | 3,443,333 |   |   |   |   |   |
| TOTAL  CONTRACTUAL OBLIGATIONS                        |       | $                          | 7,258,528              |   | $ | 4,019,394 |   | $ | 768,000 |   | $ | 2,471,134 |   |

 

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(1)                                  Futurepayments include interest due.

(2)                                  Excludespayments that are contingent upon achievement of future development and salesmilestones, as described above.

 

**Qualitative and QuantitativeDisclosures about Market Risk**

 

We develop our products in the U.S. and market our productsglobally.  Because we continue to derive our revenue primarily fromsources outside of the U.S., our financial results could be affected by manyfactors, such as changes in currency exchange rates or weak economic conditionsin foreign markets.  Substantially all of our sales are denominated inU.S. dollars.  A strengthening of the U.S. dollar could make our productsless competitive in foreign markets.  We do not currently participate inany currency hedging activities to mitigate this risk.  We assess the needto use financial instruments to hedge our exchange rate exposure on an ongoingbasis.  In addition, we continually evaluate selling prices and billingcurrencies to monitor our exchange rate exposure.  Our interest income andexpenses are sensitive to changes in the general level of U.S. interestrates.  Based on the current nature and levels of our investments anddebt, however, we believe that we currently have no material market riskexposure.

 

Our general investing policy is to limit market and credit risk and therisk of principal loss.  All liquid investments with original maturitiesof three months or less are considered to be cash equivalents.

 

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**ITEM3****                                                        CONTROLSAND PROCEDURES**

 

We maintain a system of disclosure controls and procedures that isdesigned to provide reasonable assurance that information, which is required tobe disclosed, is accumulated and communicated to management timely.  As ofthe end of the period covered by this report, we carried out an evaluationunder the supervision and with the participation of our management, includingour Chief Executive Officer and Chief Financial Officer, of the effectivenessof the design and operation of our disclosure controls and procedures pursuantto Exchange Act Rule 13a-15.  Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures are effective in timely alerting them to materialinformation relating to our company required to be disclosed in our periodicfilings with the SEC.

 

During our most recent fiscal quarter, there has been no change in ourinternal control over financial reporting (as defined in Rule 13a-15(f) or15d-15(f) under the Exchange Act) that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II**

 

**OTHERINFORMATION**

 

ITEM 1                                                        LegalProceedings

 

As of December 15, 2004, the Company was not a party to any materiallitigation.

 

 

ITEM 2                                                        UnregisteredSales of Equity Securities and Use of Proceeds

 

(a)                                  OnAugust 26, 2004, the Company issued a five-year option to Blair P. Mowery, itsformer President, Heart Valve Division, and a former director, for the purchaseof 25,000 shares of our common stock at an exercise price of $1.30 per share,in connection with his severance agreement.

 

The foregoing issuance was made in reliance upon the exemption providedin Section 4(2) of the Securities Act. Such securities are restricted as to sale or transfer, unless registeredunder the Securities Act, and any certificates representing such securitiescontain restrictive legends preventing sale, transfer or other disposition,unless registered under the Securities Act. In addition, the recipient of such securities received materialinformation concerning our company, including, but not limited to, our reportson Form 10-KSB and Form 10-QSB, as filed with the Securities and ExchangeCommission.  No underwriting commissionsor discounts were paid with respect to the issuances of such securities.

 

ITEM 3                                                        Defaultsupon Senior Securities

 

On January 17, 2003, the Company borrowed from PKM Properties, LLC (“PKM”),an entity controlled by Paul K. Miller, one of its directors and the largestbeneficial owner of its securities, $943,666 under a discretionary line ofcredit (the “January 2003 Discretionary Credit Agreement”).  On July 1, 2003, the Company entered into adiscretionary line of credit with PKM to borrow $935,000 (the “May 2003Discretionary Credit Agreement”).  OnNovember 11, 2003, the Company amended the May 2003 Discretionary CreditAgreement to provide for an additional $500,000 of borrowing under the sameterms (the “November 2003 Discretionary Credit Agreement”).  On April 16, 2004, the Company entered intoan additional discretionary line of credit with PKM for up to $250,000, ofwhich $150,000 was advanced (the “April 2004 Discretionary Credit Agreement”).  The Company repaid the April 2004Discretionary Credit Agreement in full during April 2004.

 

The Company has had various payment defaults under certain of theforegoing instruments.  The followingpayments under the January 2003 Discretionary Credit Agreement were not madewhen due:

 

(a)  interest payment of $5,540.37 due on June 30,2003, was paid on July 13, 2003; and

(b)  interest payment of $5,686.20 due on July 31,2003, was paid on August 26, 2003.

 

The following payments under the November 2003 Discretionary CreditAgreement were not made when due:

 

(a)  interest payment of $2,222.22 due on November30, 2003, was paid on December 31, 2003; and

(b)  interest payment of $4,305.56 due on March31, 2004, was paid on April 29, 2004.

 

In addition the Company failed to send periodic financial statements toPKM as required under the foregoing instruments.

 

As of October 31, 2004, MedicalCV was no longer in default under any ofthe foregoing instruments and had received waivers from PKM of the foregoingdefaults.

 

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ITEM 4                                                        Submissionof Matters to a Vote of Security Holders

 

The 2004 Annual Meeting of Shareholders was held on October 5,2004.  Two proposals were submitted forshareholder approval, both of which passed with voting results as follows:

 

(1)                                  Toelect directors for the ensuing year and until their successors shall beelected and duly qualified.

 
| **Name**                           | ** ** | **For**   | ** ** | **Withhold Authority** | ** ** |
|------------------------------------|------------|-----------|------------|------------------------|------------|
| Lawrence L.  Horsch                |       | 7,602,823 |       | 1,200                  |       |
| Marc P. Flores                     |       | 7,602,823 |       | 1,200                  |       |
| Susan L. Critzer                   |       | 7,492,823 |       | 111,200                |       |
| David B. Kaysen                    |       | 7,602,823 |       | 1,200                  |       |
| Salvador Mercé  Cervelló |       | 7,585,823 |       | 18,200                 |       |
| Paul K. Miller                     |       | 7,492,823 |       | 111,200                |       |

 

On September 17, 2004, Adel A. Mikhail, Ph.D., a director of ourcompany, resigned as a director and indicated that he would not stand forre-election to the board.

 

(2)                                  Toratify the amendment of the Company’s bylaws to set the number of directorswithin a range of no fewer than five and no more than nine, and to grant theBoard of Directors the authority to determine from time to time the actualnumber of directors within that range.

 
| **For**   | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Non-Vote** | ** ** |
|-----------|------------|-------------|------------|-------------|------------|--------------|------------|
| 7,502,553 |       | 52,470      |       | 49,000      |       | 0            |       |

 

ITEM 5                                                        OtherInformation

 

Not applicable.

 

 

ITEM 6                                                        Exhibits

 

See Index to Exhibits.

 

19

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**SIGNATURES**

 

In accordance with the requirements of the Exchange Act, the registrantcaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

 
|                          | MedicalCV, Inc. |
|-------------------------------|-----------------|
|                          |            |
|                          |            |
| Date:  December 15, 2004 | By              | /s/ Marc P. Flores |   |
|                          |            | Marc P. Flores |
|                          |            | President and Chief Executive Officer |
|                          |            |   |
| Date:  December 15, 2004 | By              | /s/ John H. Jungbauer |   |
|                          |            | John H. Jungbauer |
|                          |            | Vice President, Finance and |
|                          |            | Chief Financial Officer |

 

20

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**INDEX TO EXHIBITS**

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                       |
|--------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3                  |       | Restated Bylaws of MedicalCV, Inc.                                                                                                                                                                                                                                                                                                                                    |
| 10.1               |       | Amendment No. 2 to First Amended and Restated  Subordination and Intercreditor Agreement by and between Peter L. Hauser and  PKM Properties, LLC, accepted and acknowledged by MedicalCV, Inc., dated  April 16, 2004.                                                                                                                                                |
| 10.2               |       | April 2004 Discretionary Credit Agreement by and  between MedicalCV, Inc. and PKM Properties, LLC, dated April 16, 2004.                                                                                                                                                                                                                                              |
| 10.3               |       | Discretionary Credit Demand Note between MedicalCV,  Inc. (borrower) and PKM Properties, LLC (lender), dated April 16, 2004.                                                                                                                                                                                                                                          |
| 10.4               |       | October 2004 Discretionary Credit Agreement by and  between MedicalCV, Inc. and PKM Properties, LLC, dated October 29, 2004, effective  November 17, 2004 (incorporated by reference to our Current Report on Form  8-K filed on November 23, 2004 (File No. 000-33295)).                                                                                             |
| 10.5               |       | October 2004 Credit Note issued by MedicalCV, Inc.  (maker) to PKM Properties, LLC (payee), dated October 29, 2004, effective  November 17, 2004 (incorporated by reference to our Current Report on Form  8-K filed on November 23, 2004 (File No. 000-33295)).                                                                                                      |
| 10.6               |       | Intellectual Property Security Agreement by and  between PKM Properties, LLC (secured party) and MedicalCV, Inc. (debtor),  dated October 29, 2004, effective November 17, 2004 (incorporated by  reference to our Current Report on Form 8-K filed on November 23, 2004 (File  No. 000-33295)).                                                                      |
| 10.7               |       | Amendment No. 3 to First Amended and Restated  Subordination and Intercreditor Agreement by and between Peter L. Hauser and  PKM Properties, LLC, accepted and acknowledged by MedicalCV, Inc., dated  October 29, 2004, effective November 17, 2004 (incorporated by reference to  our Current Report on Form 8-K filed on November 23, 2004 (File No.  000-33295)). |
| 10.8               |       | Waiver Agreement by and between MedicalCV, Inc.  (borrower) and PKM Properties, LLC (lender), dated October 29, 2004,  effective November 17, 2004 (incorporated by reference to our Current Report  on Form 8-K filed on November 23, 2004 (File No. 000-33295)).                                                                                                    |
| 10.10              |       | Warrant Agreement issued to PKM Properties, LLC,  dated November 17, 2004 (incorporated by reference to our Current Report on  Form 8-K filed on November 23, 2004 (File No. 000-33295)).                                                                                                                                                                             |
| 10.11              |       | Letter agreement between the Registrant and Marc P.  Flores, effective August 30, 2004 (incorporated by reference to our Current  Report on Form 8-K filed September 2, 2004 (File No. 000-33295)).                                                                                                                                                                   |
| 31.1               |       | Chief Executive Officer Certification pursuant to  Rule 13a-14.                                                                                                                                                                                                                                                                                                       |
| 31.2               |       | Chief Financial Officer Certification pursuant to  Rule 13a-14.                                                                                                                                                                                                                                                                                                       |
| 32.1               |       | Chief Executive Officer Certification pursuant to 18  U.S.C. Section 1350.                                                                                                                                                                                                                                                                                       |
| 32.2               |       | Chief Financial Officer Certification pursuant to 18  U.S.C. Section 1350.                                                                                                                                                                                                                                                                                       |

 

 

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