**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

**FORM 10-QSB**

** **

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

 

**Commission File Number0-33295**

 

**MEDICALCV, INC.**

(Exact Name of Small Business Issuer as Specified in Its Charter)

 

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

 

**9725 South Robert Trail**

**Inver Grove Heights, Minnesota 55077**

**(651) 452-3000**

(Address of PrincipalExecutive Offices and Issuer’sTelephone Number)

 

Checkwhether the issuer:  (1) filed allreports required to be filed by Section 13 or 15(d) of the Exchange Act duringthe past 12 months (or such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirements forthe past 90 days.

 

Yesý  No o

 

Asof December 15, 2003, the issuer had outstanding 7,995,070 shares of commonstock.  This number includes 1,500,000units, each consisting of one share of common stock and one redeemable Class AWarrant, sold in the issuer’s initial public offering.

 

Transitional Small Business Disclosure Format (check one)  oYes  ý No

 

 

----

 

**TABLE OF CONTENTS**

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

 

2

----

 

**PART I**

**ITEM 1   FINANCIALSTATEMENTS**

**MEDICALCV, INC.**

 

**Consolidated Balance Sheet**

 
|                                                                                                                              |   | **October  31,  2003** |      | **April 30,  2003** |   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|-----------|---------------------|--------|
|                                                                                                                              |   | **(unaudited)**        |      |                |   |
| **ASSETS**                                                                                                                        |   |                   |      |                |   |
| Current assets:                                                                                                                   |   |                   |      |                |   |
| Cash and cash equivalents                                                                                                         |   | $                      | 75,221    |                | $      | 184,227 |   |
| Trade and accounts receivable, net                                                                                                |   | 1,280,589              |      | 1,472,995           |   |
| Inventories                                                                                                                       |   | 2,758,704              |      | 2,782,613           |   |
| Prepaid expenses and other assets                                                                                                 |   | 149,827                |      | 183,856             |   |
| Total current assets                                                                                                              |   | 4,264,341              |      | 4,623,691           |   |
|                                                                                                                              |   |                   |      |                |   |
| Property, plant and equipment, net                                                                                                |   | 1,210,934              |      | 1,368,240           |   |
| Deferred financing costs, net                                                                                                     |   | 150,705                |      | 62,989              |   |
| Total assets                                                                                                                      |   | $                      | 5,625,980 |                | $      | 6,054,920 |   |
|                                                                                                                              |   |                   |      |                |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                     |   |                   |      |                |   |
| Current liabilities:                                                                                                              |   |                   |      |                |   |
| Short-term debt with related parties                                                                                              |   | $                      | 2,511,570 |                | $      | 943,333 |   |
| Current portion of related party lease  obligations                                                                               |   | 284,257                |      | 273,843             |   |
| Current portion of capital lease  obligations                                                                                     |   | 14,990                 |      | 42,069              |   |
| Accounts payable                                                                                                                  |   | 1,086,534              |      | 895,405             |   |
| Accrued expenses                                                                                                                  |   | 294,024                |      | 813,539             |   |
| Total current liabilities                                                                                                         |   | 4,191,375              |      | 2,968,189           |   |
|                                                                                                                              |   |                   |      |                |   |
| Related party lease obligations, less  current portion                                                                            |   | 3,312,233              |      | 3,472,661           |   |
| Total liabilities                                                                                                                 |   | 7,503,608              |      | 6,440,850           |   |
|                                                                                                                              |   |                   |      |                |   |
| Shareholders’ equity:                                                                                                        |   |                   |      |                |   |
| Preferred stock, $.01 par value; 5,000,000  shares authorized; no shares issued and outstanding                                   |   |                   |      |                |   |
| Common stock; $.01 par value; 95,000,000  shares authorized; 7,995,070 and 7,843,834 shares issued and outstanding,  respectively |   | 79,950                 |      | 78,438              |   |
| Additional paid-in capital                                                                                                        |   | 17,485,687             |      | 16,613,337          |   |
| Deferred stock-based compensation                                                                                                 |   | (3,297                 | )         | (4,610              | )      |
| Accumulated deficit                                                                                                               |   | (19,439,968            | )         | (17,073,095         | )      |
| Total shareholders’ deficit                                                                                                  |   | (1,877,628             | )         | (385,930            | )      |
| Total liabilities and shareholders’ deficit                                                                                  |   | $                      | 5,625,980 |                | $      | 6,054,920 |   |

 

The accompanying notes are an integral part of thesefinancial statements.

 

3

----

 

**MEDICALCV, INC.**

 

**ConsolidatedStatement of Operations**

**(unaudited)**

 
|                                                           |   | **Three  Months Ended October 31,** |       | **Six Months  Ended October 31,** |   |
|----------------------------------------------------------------|--------|-------------------------------------|------------|-----------------------------------|--------|
|                                                           |   | **2003**                            |       | **2002**                          |   | **2003** |   | **2002** |   |
| Net sales                                                      |   | $                                   | 887,225    |                              | $      | 425,769 |   | $ | 1,981,804 |   | $ | 1,244,101 |   |
| Cost of goods sold                                             |   | 426,189                             |       | 391,657                           |   | 923,292 |   | 869,526 |   |
| Gross profit                                                   |   | 461,036                             |       | 34,112                            |   | 1,058,512 |   | 374,575 |   |
| Operating expenses:                                            |   |                                |       |                              |   |   |   |   |   |
| Sales and marketing                                            |   | 584,967                             |       | 653,263                           |   | 1,380,055 |   | 1,408,850 |   |
| General and administrative                                     |   | 624,142                             |       | 553,778                           |   | 1,181,065 |   | 1,091,369 |   |
| Engineering and regulatory                                     |   | 200,688                             |       | 300,554                           |   | 404,682 |   | 501,671 |   |
| Total operating expenses                                       |   | 1,409,797                           |       | 1,507,595                         |   | 2,965,802 |   | 3,001,890 |   |
| Loss from operations                                           |   | (948,761                            | )          | (1,473,483                        | )      | (1,907,290 | ) | (2,627,315 | ) |
| Other (expense) income:                                        |   |                                |       |                              |   |   |   |   |   |
| Interest expense                                               |   | (303,009                            | )          | (38,643                           | )      | (459,255 | ) | (77,623 | ) |
| Interest income                                                |   |                                |       | 1,642                             |   | 4,993 |   | 12,661 |   |
| Other (expense) income                                         |   | 5,860                               |       | 10,157                            |   | (5,321 | ) | 26,084 |   |
| Total other expense                                            |   | (297,149                            | )          | (26,844                           | )      | (459,583 | ) | (38,878 | ) |
|                                                           |   |                                |       |                              |   |   |   |   |   |
| Net loss                                                       |   | $                                   | (1,245,910 | )                                 | $      | (1,500,327 | ) | $ | (2,366,873 | ) | $ | (2,666,193 | ) |
| Basic and diluted net loss per share                           |   | $                                   | (.16       | )                                 | $      | (.19 | ) | $ | (.30 | ) | $ | (.33 | ) |
|                                                           |   |                                |       |                              |   |   |   |   |   |
| Shares used in computing basic and diluted  net loss per share |   | 7,906,825                           |       | 7,843,834                         |   | 7,915,306 |   | 7,843,834 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

4

----

 

**MEDICALCV, INC.**

 

**Consolidated Statement of Cash Flows**

(unaudited)

 
|                                                                                                        |   | **Six Months  Ended October 31,** |       |
|-------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|------------|
|                                                                                                        |   | **2003**                          |       | **2002** |   |
| Cash flows from operating activities:                                                                       |   |                              |       |   |   |
| Net loss                                                                                                    |   | $                                 | (2,366,873 | ) | $ | (2,666,193 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities:                                |   |                              |       |   |   |
| Depreciation                                                                                                |   | 158,689                           |       | 174,806 |   |
| Provision for doubtful accounts                                                                             |   | (15,951                           | )          | 80,793 |   |
| Return of inventory                                                                                         |   |                              |       | (92,000 | ) |
| Provision for inventory obsolescence                                                                        |   |                              |       | 116,028 |   |
| Warrant expense related to purchase of  technology                                                          |   |                              |       | 12,361 |   |
| Stock-based compensation                                                                                    |   | 150,108                           |       | 10,980 |   |
| Interest expense related to issued warrants  and amortization of loan origination costs                     |   | 338,840                           |       | 63,944 |   |
| Changes in assets and liabilities:                                                                          |   |                              |       |   |   |
| Accounts receivable                                                                                         |   | 208,357                           |       | 211,978 |   |
| Inventories                                                                                                 |   | 23,909                            |       | (486,559 | ) |
| Prepaid expenses and other assets                                                                           |   | 34,029                            |       | (62,880 | ) |
| Accounts payable                                                                                            |   | 191,129                           |       | 163,647 |   |
| Accrued expenses                                                                                            |   | (519,515                          | )          | 60,657 |   |
| Deferred financing costs                                                                                    |   | (139,083                          | )          |   |   |
| Net cash used in operating activities                                                                       |   | (1,936,361                        | )          | (2,412,438 | ) |
|                                                                                                        |   |                              |       |   |   |
| Cash flows from investing activities:                                                                       |   |                              |       |   |   |
| Purchase of property, plant and equipment                                                                   |   | (1,383                            | )          | (97,768 | ) |
| Net cash used in investing activities                                                                       |   | (1,383                            | )          | (97,768 | ) |
|                                                                                                        |   |                              |       |   |   |
| Cash flows from financing activities:                                                                       |   |                              |       |   |   |
| Borrowings from related party                                                                               |   | 2,000,000                         |       |   |   |
| Principal payments on other long-term debt                                                                  |   |                              |       | (27,635 | ) |
| Issuance of common shares                                                                                   |   | 60,000                            |       |   |   |
| Principal payments under capital lease  obligations                                                         |   | (27,079                           | )          | (33,802 | ) |
| Related party lease obligations                                                                             |   | (204,183                          | )          |   |   |
| Net cash provided by (used in) financing  activities                                                        |   | 1,828,738                         |       | (61,437 | ) |
|                                                                                                        |   |                              |       |   |   |
| Net decrease in cash and cash equivalents                                                                   |   | (109,006                          | )          | (2,571,643 | ) |
| Cash and cash equivalents at beginning of  year                                                             |   | 184,227                           |       | 2,781,675 |   |
| Cash and cash equivalents at end of period                                                                  |   | $                                 | 75,221     |   | $ | 210,032 |   |
|                                                                                                        |   |                              |       |   |   |
| Non-cash investing and financing activities                                                                 |   |                              |       |   |   |
| Discount on convertible subordinated bridge  notes related to warrants granted in connection with the notes |   | (665,067                          | )          |   |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

5

----

 

**MEDICALCV, INC.**

 

**Notes toConsolidated Financial Statements**

 

**(1)****        ****Basis ofFinancial Statement Presentation**

 

Theaccompanying unaudited consolidated financial statements included herein havebeen prepared by MedicalCV, Inc. (the “Company”) in accordance with accountingprinciples generally accepted in the United States of America for interimfinancial information and pursuant to the rules and regulations of theSecurities and Exchange Commission. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have been condensed oromitted pursuant to such rules and regulations.  These consolidated interim financial statements should be read inconjunction with the consolidated financial statements and the notes theretoincluded in the Company’s Annual Report on Form 10-KSB for the fiscal yearended April 30, 2003.

 

Theconsolidated balance sheet as of October 31, 2003, the consolidated statementof operations for the three and six months ended October 31, 2003 and 2002, andthe consolidated statement of cash flows for the six months ended October 31,2003 and 2002 include, in the opinion of management, all adjustments,consisting solely of normal recurring adjustments, necessary for a fairpresentation of the financial results for the respective interim periods andare not necessarily indicative of results of operations to be expected for theentire fiscal year ending April 30, 2004.

 

Certainamounts previously reported have been reclassified to conform to their October31, 2003, presentation.  Thesereclassifications had no effect on net loss, cash flow or shareholders’ equityas previously reported.

 

**(2)           GoingConcern**

 

The Company’s consolidatedfinancial statements for the quarter ended October 31, 2003, have beenprepared on a going concern basis, which contemplates the realization of assetsand settlement of liabilities and commitments in the normal course ofbusiness.  The Company has sustainedlosses and negative cash flows from operations in recent years and expectsthese conditions to continue for the foreseeable future.  At October 31, 2003, the Company had anaccumulated deficit of $19,439,968 and has insufficient funds to finance itsworking capital and capital expenditure needs. These matters raise substantialdoubt about the Company’s ability to continue as a going concern.  The Company is currently seeking othersources of financing to fund its operations and working capitalrequirements.  If the Company is unableto obtain sources of additional funds beginning in January 2004, it willbe required to significantly revise its business plans and drastically reduceoperating expenditures such that it may not be able to develop or enhance itsproducts, gain market share in the United States or respond to competitivepressures or unanticipated requirements, which could seriously harm itsbusiness, financial position and results of operations.  These financial statements do not includeany adjustments that might result from the outcome of this uncertainty.

 

The Company is subject torisks and uncertainties common to medical technology-based companies, includingrapid technological change, dependence on one principal product, new productdevelopment and acceptance, actions of competitors, dependence on key personneland United States market penetration.

 

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

 

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

 

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

 

6

----

 
|                                                                                             |   | **For Quarters Ended October 31,** |       |
|--------------------------------------------------------------------------------------------------|--------|-----------------------------------------|------------|
|                                                                                             |   | **2003**                                |       | **2002** |   |
| Net  loss reported                                                                               |   | $                                       | (1,245,910 | ) | $ | (1,500,327 | ) |
| Add:  Stock-based employee compensation expense  included in operating results, as reported |   | 48,718                                  |       | — |   |
| Less:  Pro forma stock based employee  compensation cost                                    |   | (143,912                                | )          | (147,071 | ) |
|                                                                                             |   |                                    |       |   |   |
| Net  loss - pro forma                                                                            |   | (1,341,104                              | )          | (1,647,398 | ) |
|                                                                                             |   |                                    |       |   |   |
| Net  loss per common share - basic and diluted                                                   |   |                                    |       |   |   |
| As  reported                                                                                     |   | (.16                                    | )          | (.19 | ) |
| Pro  forma                                                                                       |   | (.17                                    | )          | (.21 | ) |
|                                                                                                  |        |                                         |            |  |  |  |  |

 

**(4)           NetLoss Per Share**

 

Netloss per share is computed under the provisions of SFAS No. 128, “EarningsPer Share.” Basic net loss per common share is computed using net loss and theweighted-average number of shares of common stock outstanding. Diluted earningsper share reflect the potential dilution of securities that could share in theearnings of an entity. Diluted net loss per common share does not differ frombasic net loss per common share in the three and six-month periods endedOctober 31, 2003 and 2002, since the potentially dilutive shares areanti-dilutive.  Potentially dilutiveshares excluded from the calculation of diluted net loss per share relate tooutstanding stock options and warrants aggregating 5,207,314 and 3,616,390shares of the Company’s common stock at October 31, 2003 and 2002,respectively.

 

**(5)           Inventories**

 
|            |   | **October  31, 2003** |      | **April 30,  2003** |   |
|-----------------|--------|-----------------------|-----------|---------------------|--------|
|            |   | **(unaudited)**       |      |                |   |
| Raw materials   |   | $                     | 310,033   |                | $      | 377,961 |   |
| Work-in-process |   | 744,593               |      | 529,668             |   |
| Finished goods  |   | 1,704,078             |      | 1,874,984           |   |
|            |   | $                     | 2,758,704 |                | $      | 2,782,613 |   |

 

**(6)           Short-termDebt**

 

OnJuly 8, 2003, the Company issued $1.0 million of term debt to PKMProperties, LLC (“PKM”), an entity controlled by a principal shareholder, whoalso serves on the Company’s Board of Directors.  The Company borrowed $764,728 under this bridge financing duringthe first quarter and borrowed the final draw of $235,272 on August 20,2003.  The debt, which is collateralizedby substantially all of the Company’s assets, bears interest at a rate of 10.0percent per year and is due on May 27, 2004.  In connection with the debt, the Company also issued a warrant toPKM with a ten-year term to purchase 320,178 shares of the Company’s commonstock at an exercise price of $0.70 per share. The Company issued a warrant to purchase an additional 60,179 shares ofthe Company’s common stock on the same terms in conjunction with the final drawon August 20, 2003.  In addition,on July 8, 2003, the Company agreed to extend the term of 700,000 previouslyissued warrants from five years to ten years. The allocated fair value of the warrants issued prior to July 31,2003, and the incremental value of the existing warrants was $383,361, and wasaccounted for as a discount on the borrowings under the bridge debt.  This discount, which is presented as areduction of the face value of the debt on the consolidated balance sheet, isbeing amortized as interest expense over the eleven-month term of thedebt.  As of October 31, 2003, theunamortized balance of the discount was $243,957.  In addition, the Company incurred direct financing costs of$65,000, which are included in other assets and are being amortized as expensesover the eleven-month term of the debt. In November 2003, the Company negotiated an increase in this debt to$1.5 million.  See Note 8 SubsequentEvents.

 

OnJuly 8, 2003, the Company also issued $1.0 million of term debt to PeterL. Hauser (“Hauser”), a principal shareholder. The Company borrowed $1.0 million under this bridge financing during thequarter ended July 31, 2003.  Thedebt, which is collateralized by substantially all of our assets pursuant toour intercreditor agreement with PKM, bears interest at a rate of 10.0 percentper year and is due on June 30, 2004. In connection with the term debt, the Company also issued a warrant witha ten-year term to purchase 380,357 shares of the Company’s common stock at anexercise price of $0.70 per share.  Theallocated fair value of the newly issued warrant was $281,706 and is accountedfor as a discount on the borrowings under the bridge debt.  This discount, which is presented as a

 

7

----

 

reductionof the face value of the debt on the consolidated balance sheet is beingamortized as interest expense over the twelve-month term of the debt.  As of October 31, 2003, the unamortizedbalance of the discount was $187,806. In addition, the Company incurred direct financing costs of $71,772,which are included in other assets and are being amortized as expenses over thetwelve-month term of the debt.

 

InOctober 2003, the Company amended the discretionary line of credit with PKMestablished in January 2003 to extend the maturity date to May 27, 2004, andincrease the interest rate to 10 percent. As of October 31, 2003, the Company had borrowed $943,333 under thisline of credit.

 

**(7)           SegmentInformation**

 

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

 

Thefollowing table summarizes net sales by geographic area:

 
|          |   | **Three  Months Ended October 31,** |        | **Six Months  Ended October 31,** |   |
|---------------|--------|-------------------------------------|-------------|-----------------------------------|--------|
|          |   | **2003**                            |        | **2002**                          |   | **2003** |   | **2002** |   |
| Europe        |   | $                                   | 466,871     |                              | $      | 239,244 |   | $ | 1,068,591 |   | $ | 683,407 |   |
| South Asia    |   | 121,600                             |        | 99,190                            |   | 198,400 |   | 223,290 |   |
| Middle East   |   | 133,307                             |        | 74,000                            |   | 312,611 |   | 248,667 |   |
| Far East      |   | 0                                   |        | (25,125                           | )      | 53,180 |   | 17,702 |   |
| United States |   | 106,100                             |        | 37,950                            |   | 286,800 |   | 63,050 |   |
| Other         |   | 59,347                              |        | 510                               |   | 62,222 |   | 7,985 |   |
|          |   |                                |        |                              |   |   |   |   |   |
| **TOTALS**    |   | **$**                               | **887,225** | ** **                        | **$**  | **425,769** | ** ** | **$** | **1,981,804** | ** ** | **$** | **1,244,101** | ** ** |

 

**(8)           Airial Fibrillation TechnologyPurchase Agreement**

** **

The Company entered into an agreement with LightWave Ablation Systems,Inc. (LightWave) in September 2003 to purchase technology for the treatment ofatrial fibrillation. The Company issued 15,000 shares of common stock and madean initial payment of $10,000 to LightWave Ablation Systems, Inc. for theworldwide distribution rights for the technology to treat atrial fibrillation.Pursuant to terms of the agreement, additional cash payments may be made andwarrants to purchase shares of the Company's common stock may be issued toLightWave in the event that LightWave meets certain development and marketingmilestones, including obtaining a CE Mark, completion of a FDA 510(k) filingand the company meeting certain revenue milestones.

 

**(9****)           SubsequentEvents**

 

InNovember 2003, the Company amended the one-year $1.0 million term debt with PKMinitiated on July 3, 2003, to provide for an additional $500,000 of borrowingunder the same terms as the July 8, 2003 financing.  The Company issued, as additional consideration, ten-yearwarrants to purchase up to 77,381 shares of common stock at an exercise price of$1.68 per share with terms and conditions that include weighted-averageanti-dilution rights.

 

InNovember 2003, the Company also entered into a loan agreement and borrowed$500,000 from Draft Co., an unrelated third party, pursuant to a note maturingJune 30, 2004, which bears interest at an annual rate of 10.0 percent.  Pursuant to a restated intercreditoragreement among PKM, Hauser, and Draft, the loan is collateralized bysubstantially all of the Company’s assets. The lender was issued warrants to purchase 90,909 shares of common stockat an exercise price of $1.43 per share with other terms comparable to the PKMwarrants described above.

 

8

----

 

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

 

*The followingdiscussion contains various forward-looking statements within the meaning of**Section 21Eof the Exchange Act.  Although webelieve that, in making any such statement, our expectations are based onreasonable assumptions, any such statement may be influenced by factors thatcould cause actual outcomes and results to be materially different from thoseprojected.  When used in the followingdiscussion, the words “anticipates,”“believes,”“expects,”“intends,”“plans,”“estimates” and similar expressions, as they relate to us or ourmanagement, are intended to identify such forward-looking statements.  These forward-looking statements are subjectto numerous risks and uncertainties that could cause actual results to differmaterially from those anticipated. Factors that could cause actual results to differ materially from thoseanticipated, certain of which are beyond our control, are setforth in this document and in our Annual Report on Form 10-KSB for the fiscalyear ended April 30, 2003, under the caption “Management’s Discussion andAnalysis or Plan of Operation-Cautionary Statement.”*

 

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

 

**Overview**

 

We area cardiothoracic surgery device manufacturer. Our primary products are mechanicalheart valves known as the Omnicarbon® Series 3000 and Series 4000, which wemanufacture and market.  Our heart valves are used to treat heartfailure caused by the aging process, heart diseases, prosthetic heart valvefailure and congenital defects.  Todate, we have distributed the Omnicarbon 3000 and 4000 heart valves primarilyin Europe, South Asia, the Middle East and the Far East.  In fiscal year 2003, we derived 62 percent of our net sales fromEurope.  As an innovator of heart valve technology,we have more than 33years of experience in developing, manufacturing and marketing five generationsof heart valves, and we have sold approximately 141,000 heart valves worldwide.

 

On July 26, 2001, the FDA gave us notice ofpremarket approval to sell our Omnicarbon 3000 heart valve in the U.S., thelargest geographic market for mechanical heart valves.  In anticipation of FDA premarket approval,we invested in our sales and marketing infrastructure, including adding salesmanagement to our staff and recruiting field sales representatives to call ondomestic surgery centers in the U.S. Based upon our Omnicarbon heart valve’s 18 years of implants in patients in Europe, we believe that we canestablish a competitive position in the mechanical heart valve industry in theU.S. and leverage this position into other critical areas of cardiothoracicsurgery.  We also expect that ourability to market the Omnicarbon 3000 heart valve in the U.S. will favorablyaffect our international sales, as we believe many cardiovascular surgeons and others who make purchasingdecisions are aware of the FDA’s rigorous premarket approval process and consider it to bea validation of the safety and efficacy of medical devices.  Our company had its first implant of the Omnicarbon3000 heart valve in the U.S. in December 2001.

 

The worldwideheart valve market is dynamic and highly competitive.  In addition, technology and competitive offerings, such as newtissue heart valves, place increased pressure on us as we seek to increase ourmarket share and revenue.  For moreinformation regarding these risks, you should review our Cautionary Statement.

 

In September 2003, we entered into anagreement with LightWave Ablation Systems, Inc. to purchase technology for thetreatment of atrial fibrillation.  Webelieve this technology adds an important growth platform to our portfolio ofproducts for the cardiothoracic surgeon.

 

9

----

 

**Periods Ended October 31,2003 and 2002**

 

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

 
|                       |   | **Three  Months Ended October 31,** |   | **Six Months  Ended October 31,** |   |
|----------------------------|--------|-------------------------------------|--------|-----------------------------------|--------|
|                       |   | **2003**                            |   | **2002**                          |   | **2003** |   | **2002** |   |
| Net sales                  |   | 100.0                               | %      | 100.0                             | %      | 100.0 | % | 100.0 | % |
| Cost of goods sold         |   | 48.0                                |   | 92.0                              | %      | 46.6 | % | 69.9 | % |
|                       |   |                                |   |                              |   |   |   |   |   |
| Gross profit               |   | 52.0                                | %      | 8.0                               | %      | 53.4 | % | 30.1 | % |
|                       |   |                                |   |                              |   |   |   |   |   |
| Operating expenses:        |   |                                |   |                              |   |   |   |   |   |
|                       |   |                                |   |                              |   |   |   |   |   |
| Sales and marketing        |   | 65.9                                | %      | 153.4                             | %      | 69.7 | % | 113.3 | % |
| General and administrative |   | 70.3                                | %      | 130.1                             | %      | 59.6 | % | 87.7 | % |
| Engineering and regulatory |   | 22.6                                | %      | 70.6                              | %      | 20.4 | % | 40.3 | % |
|                       |   |                                |   |                              |   |   |   |   |   |
| Total operating expenses   |   | 158.9                               | %      | 354.1                             | %      | 149.7 | % | 241.3 | % |
|                       |   |                                |   |                              |   |   |   |   |   |
| Loss from operations       |   | (106.9                              | )%     | (346.1                            | )%     | (96.2 | )% | (211.2 | )% |
|                       |   |                                |   |                              |   |   |   |   |   |
| Other income (expense):    |   |                                |   |                              |   |   |   |   |   |
|                       |   |                                |   |                              |   |   |   |   |   |
| Interest expense           |   | (34.2                               | )%     | (9.1                              | )%     | (23.2 | )% | (6.2 | )% |
| Interest income            |   | —                              | %      | 0.4                               | %      | 0.3 | % | 1.0 | % |
| Other income               |   | 0.7                                 | %      | 2.4                               | %      | (0.3 | )% | 2.1 | % |
|                       |   |                                |   |                              |   |   |   |   |   |
| Total other expense        |   | (33.5                               | )%     | (6.3                              | )%     | (23.2 | )% | (3.1 | )% |
|                       |   |                                |   |                              |   |   |   |   |   |
| Net loss                   |   | (140.4                              | )%     | (352.4                            | )%     | (119.4 | )% | (214.3 | )% |
|                            |        |                                     |        |                                   |        |  |  |  |  |  |  |  |

 

**Critical Accounting Policies**

 

For discussion of critical accounting policiesand estimates, see our Annual Report on Form 10-KSB for the fiscal year endedApril 30, 2003.

 

**Results of Operations**

 

*Net Sales*.  Net sales in the second quarter of fiscal year 2004increased to $887,225 from $425,769 in the second quarter of the prior year.  Net sales in the six-month period ended October 31,2003, increased to $1,981,804 from $1,244,101 in the same period one yearago.  The increases were attributable primarilyto higher Omnicarbon unit sales in Europe, the Middle East and the U.S.

 

In the first six months of fiscal years 2004 and 2003, the vast majority of our sales were denominated in U.S.dollars.  Fluctuations in foreigncurrency exchange rates have not resulted in significant losses or gains onoutstanding trade accounts receivable. All of our distributors are required to pay for products in U.S.dollars, other than our Japanese distributor, which pays inJapanese yen, and oneEuropean customer, which pays in euros. We recognize that a strongU.S. dollar can adversely affect unit sales payable in currencies other thanU.S. dollars for our foreign distributors.

 

*Gross Profit.*  Gross profit as a percentage of net sales increased to 52.0 percent in the second quarterof fiscal 2004 from 8.0 percent in the second quarter of the prior year.  Fiscal year-to-date gross profit margins in2004 were 53.4 percent compared to 30.1 percent in the same period last fiscalyear.  Gross profit margins in thecurrent quarter and year-to-date periods were positively impacted by lowerfixed costs per unit on higher sales volume, a favorable sales mix ininternational markets due to a higher proportion of sales being generated incountries where prices charged are higher, and higher gross margin sales in theU.S.  Our strategy is to obtain FDA approval of our proprietarypyrolytic carbonmanufacturing process in order to market the Omnicarbon 4000 in the U.S.  Due to its lower manufacturing cost, webelieve the Omnicarbon 4000 will generate significantly higher gross profitmargins when sold in the U.S. than the Omnicarbon 3000 heart valve.

 

10

----

 

*Sales and Marketing*.  Sales and marketing expenses in the second quarter of fiscal year 2004 were $584,967 or 65.9 percent of net sales compared to $653,263 or 153.4 percent of net sales in the second quarterof the prior year.  For the six-month period endedOctober 31, 2003, sales and marketing expenses totaled $1,380,055 or 69.7 percentof net sales, compared to $1,408,850 or 113.3 percent of net sales in the sameperiod last fiscal year.  The decrease in spending related to a more focused Omnicarbon marketing effort in the U.S. and internationalmarkets.  We believe wecan establish a competitive position in the U.S. and leverage this positioninto other areas of cardiothoracic surgery. Our overall marketingstrategy is to promote the clinical results of the Omnicarbon heart valve andthe technical strengths of our company in designing and manufacturingmechanical heart valves.

 

*General and Administrative*.  General and administrative expenses for the second quarter of fiscal year 2004 were $624,142 or 70.3 percent of net sales, compared to $553,778 or 130.1 percent of net sales in the same period oneyear ago.  For the six-month periodended October 31, 2003, general and administrative expenses totaled $1,181,065or 59.6 percent of net sales, compared to $1,091,369 or 87.7 percent of netsales in the same period last year.  The increasesfor the quarter andyear-to-date periods were primarily attributable tocertain non-cash stock-based incentives associated with strengthening the executive managementstaff and board of directors.

 

*Engineering and Regulatory*.  Engineering and regulatory expenses for the second quarterof fiscal year 2004 were $200,688 or 22.6 percent of net sales compared to $300,554 or 70.6 percent of net sales in the second quarter ofthe prior fiscal year. For the six-month period ended October 31, 2003,engineering and regulatory expenses totaled $404,682 or 20.4 percent, comparedto $501,671 or 40.3 percent of net sales in the same period last year.  Thesecond quarter of last fiscal year included non-recurringexpenses associated with the purchase and development of the Northrup UniversalHeart Valve Repair SystemTM and IMA AccessTM Retractor Device.

 

*Other (Expense) Income*.  Interest expense totaled $303,009 in the quarter ended October 31, 2003, compared to $38,643 in the second quarter of the prior fiscal year. Fiscalyear-to-date interest expense was $459,255, compared to $77,623 in the sameperiod one year ago.  The increases ininterest expense in the second quarter and year-to-date periods were attributedto higher financing costs associated with the additional short-term debtobtained in fiscal 2004 and the related-party property sale leaseback.

 

*Income Tax Provision*.  In light of our recent history of operatinglosses, we recorded a valuation allowance to fully offset our deferred taxassets in fiscal year 2000.  We havecontinued to provide a full valuation allowance through the second quarter of fiscal year 2004 due to the current uncertainty aboutgenerating the future taxableincome necessary to realize our deferred tax assets.

 

*Loss from Operations*.  As of October31, 2003, we had an accumulated deficit of $19,439,968. We have incurred losses in each of the last six fiscal years.  Since 1994, we have invested in developing abileaflet heart valve, a proprietary pyrolytic carbon coating process andobtaining premarket approval from the FDA to market our Omnicarbon 3000 heartvalve in the U.S.  Our strategy has beento invest in technology to better position ourselves competitively once FDApremarket approval was obtained.  Weexpect to continue to generate operating  losses intofiscal year 2005 because ofanticipated spending necessary to market the Omnicarbon 3000 heart valve in theU.S., to establishand maintain a strong marketing organization for domestic and foreign marketsand our continuing investment in research and development.

 

**Liquidityand Capital Resources**

 

 

Cash and cash equivalents decreasedto $75,221 at October 31, 2003, from $184,227 at April 30, 2003.  Thisdecrease in cash and cash equivalents of$109,006 was due to the following:

 
| Net cash used in operating  activities     |   | $         | (1,936,361 | ) |
|--------------------------------------------|--------|-----------|------------|---|
| Net cash used in investing  activities     |   | (1,383    | )          |
| Net cash provided by  financing activities |   | 1,828,738 |       |
| Net decrease                               |   | $         | (109,006   | ) |

 

Net cash used in operating activities decreased$476,077 to $1,936,361 in the six-month periodended October 31, 2003, from $2,412,438 in the six-month period ended October 31, 2002. The use of cash in operations in the six-month periods of both fiscalyears 2004 and 2003 was primarily due to net losses of $2,366,873 and $2,666,193,respectively.  The decrease in the useof cash in operations in fiscal year 2004 relative to fiscal year 2003 was due principally to anincrease in accrued expenses and amortization combined with a decrease ininventories.  The increase in accrued expenseswas a function of the

 

11

----

 

timingof when we paid certain costs.  Thedecrease in inventories in fiscal year 2004 reflected the results of ourconcerted efforts to more closely control our inventory levels combined withlower manufacturing costs.

 

Netcash used in investing activities was$1,383 in the six-month period ended October 31, 2003.  Net cash used in investing activities was$97,768 in the six-month period ended October 31, 2002. In both periods, the cash was used forcapital expenditures. Management anticipates total capital expenditures infiscal 2004 to be no greater than $200,000.

 

Net cash provided by financing activities was $1,828,738 in the quarter ended October 31,2003, and consisted of short-term borrowings from related partiesof $2.0 million, partially offset by principal payments of $27,079, and$204,183 of payments on related-party lease obligations.  Inthe six-month period ended October 31, 2002, net cash used in financing activitieswas $61,437 and related entirely to principal payments on debt and capitallease obligations.

 

Throughoutfiscal year 2003 and in the first six months of fiscal year 2004, we enteredinto a number of financing transactions to provide funds necessary to meet ourworking capital and capital expenditure needs and to meet otherobligations.  These financing activitiesconsisted of the following:

 

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

 

InJanuary 2003, we established a line of credit with PKM Properties, LLC(“PKM”), an entity controlled by Paul K. Miller.  Mr. Miller is a member of our board of directors and is ourlargest beneficial owner of securities. The line of credit, as amended, bears interest at 10.0 percent.  The line of credit is currentlycollateralized by a security interest in substantially all of our assets.  This line of credit was amended and matureson May 27, 2004.  In connection with theline of credit, we also issued a warrant to PKM, originally with a five-yearterm, to purchase 350,000 shares of our common stock at an exercise price of$0.596 per share.  The allocated fairvalue of the warrants was $128,995. This discount was completely amortized to interest expense as ofJuly 31, 2003.  The amountoutstanding under this short-term debt with related party at October 31,2003 was $943,333.

 

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

 

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

 

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

 

Dueto our continued involvement with the property, including the ability to buyback the property at a future date, the transaction is accounted for as afinancing of the property sold and leased back.  Accordingly, the net book value of the facility and land sold toPKM with a net book value of $759,146 continues to be presented as part of ourproperty, plant and equipment balance. The related party lease obligation of $3,596,490 at October 31,2003, represents the minimum amounts due PKM for the initial ten-year termdiscounted at 4.4 percent and additional payments to be paid to PKM for theDakota Electric Association and Dakota County obligations assumed by PKM.

 

OnJuly 8, 2003, under the terms of a bridge financing transaction, weestablished a one-year $1.0 million of term debt with PKM.  The line, which requires the payment ofinterest at a rate of 10.0 percent per year, matures on May 27, 2004, andis collateralized by substantially all of our assets.   As additional consideration for the financing, we issued toPKM  ten-year warrants for the purchaseof 380,357 shares of our common stock at an exercise price of $0.70 per sharewith terms and conditions that include weighted-average anti-dilutionrights.  We agreed to extend the term of700,000 previously issued warrants from five years to ten years.  The allocated fair value of the warrantsissued prior to July 31, 2003, and the incremental value of the existingwarrants was $383,361, and was accounted for as a discount on the borrowingsunder the bridge debt.  This discount,which is presented as a reduction of the face value of the debt on theconsolidated balance sheet,

 

12

----

 

isbeing amortized as interest expense over the eleven-month term of thedebt.  We also agreed to modify thesewarrants to conform to the terms of the warrants issued as part of this bridgedebt financing.

 

Ina simultaneous transaction, we entered into a loan agreement and borrowed $1.0million from Peter L. Hauser (“Hauser”) pursuant to a one-year subordinatednote with an interest rate of 10 percent per year. Pursuant to an intercreditoragreement with PKM, the loan is collateralized by substantially all of ourassets.  We issued to Hauser ten-yearwarrants for the purchase of 380,357 shares of our common stock on termscomparable to the PKM warrants described above.  As a result of the transaction, Hauser became the beneficialowner of approximately 10.3 percent of our securities.

 

InNovember 2003, we amended the one-year $1.0 million term debt with PKMinitiated on July 8, 2003, to provide for an additional $500,000 of borrowingunder the same terms.  We issued, asadditional consideration, a ten-year warrant to purchase 77,381 shares of ourcommon stock at an exercise price of $1.68 per share with terms and conditionsthat include weighted-average anti-dilution rights.

 

InNovember 2003, we also entered into a loan agreement and borrowed $500,000 fromDraft Co. (“Draft”), an unrelated third party, pursuant to a note maturing June30, 2004, which bears interest at a rate of 10 percent per year. The loan iscollateralized by substantially all of our assets pursuant to a restated intercreditoragreement among PKM, Hauser and Draft. We issued to Draft a warrant to purchase 90,909 shares of our commonstock at an exercise price of $1.43 per share with terms and conditionscomparable to the PKM warrants described above.

 

We expect that our operating losses and negative operating cashflow will continue intofiscal year 2005 as we continue increasing our corporate staff to supportthe development and launch of our atrial fibrillation and heartvalve repair products, and addmarketing programs domestically and internationally to build awareness of andcreate demand for our Omnicarbon heart valves. We anticipate that our sales and marketingand general and administrative expenses will continue to constitute a materialuse of our cash resources.  The actualamounts and timing of our capital expenditures will varysignificantly depending upon thespeed at which we are able to expand our distribution capability in domesticand international markets and the availability of financing.

 

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

 

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

 

operatinglosses exceed our projections;

 

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

 

we determine to acquire, license or developadditional technologies;

 

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

 

we make acquisitions.

 

Ourability to continue as a going concern depends upon our ability to obtainadditional debt and/or equity financing early in calendar year 2004.  We are currently seeking to raise between $3,000,000 and $5,000,000 of additional equity or debt financingto fund our operations and working capital requirements for the next 9 to 12months.  We also anticipate that we willneed to raise approximately $8 million of additional capital later in calendar2004.  We expect to face substantial difficulty in raising fundsin the current market environment, we have no commitments at this time to provide therequired financing, and, we cannot provide any assurance thatsuch additional financing will be available on terms acceptable to us or atall.  In addition, we will need toobtain additional capital prior to the maturity of our debt with PKM on May 27,2004, or otherwise extend or restructure this debt to continue operations.

 

Theterms of any equity financing are expected to be highly dilutive to ourexisting security holders.  Thedelisting of our securities from the Nasdaq SmallCap Market that occurred inMarch 2003 will negatively affect our ability to raise capital.  Ifwe are unable to obtain adequate financing on acceptable terms, we will be unable tocontinue operations.

 

Unlessthe level of U.S. market acceptance of our heart valves increases and the FDAapproves our pyrolytic carbon process, we anticipate that we will continue todepend upon cash provided by financing activities to address our workingcapital

 

13

----

 

requirements.  By broadening our portfolio of cardiothoracicsurgery products, we hope to reduce our dependence on sales of heart valves andreduce our reliance upon financing transactions, which may not be available tous.  We cannot, however, assure you thatour efforts to diversify our product offerings will:

 

beattainable;

 

beprofitable;

 

reduceour reliance upon financing transactions; or

 

enableus to continue operations.

 

**Commitments and Contingent Liabilities**

 

*Snia S.p.A. Carbomedics (formerlySulzer Carbomedics).* In July 1998, we enteredinto a three-year supply agreement with Snia S.p.A. Carbomedics, the source of certain raw materialcomponents used in the manufacture of our Omnicarbon 3000 heart valves.  The supply agreement was extended for anadditional two years in March 2001.  The agreementprovides that we purchase a minimum number of raw material units each calendaryear through December 2003.  Under theterms of the agreement, we are required to compensate Snia S.p.A.Carbomedics for any purchaseshortfalls up to a maximum of $200,000 per year.  We have not met the minimum purchase requirements for the pastthree calendar years.  In addition, wedo not believe we will meet the minimum purchase requirement for calendar year2003.  As a result, we expensed $51,986in the quarter ended October 31, 2003, and $13,074 in the quarter endedOctober 31, 2002, related tothese purchase shortfalls. For the first six months of fiscal year 2004, we expensed $85,981compared to $30,124 during the first six months of fiscal year 2003.  Thesecharges were reflected in cost of goods sold. Future purchase shortfalls could adversely affect our ongoingrelationship with Snia S.p.A. Carbomedics.

 

*UROPACE*.  In July 1995, we established a wholly owned subsidiary, UROPACE, Inc., tocommercialize technology fortreating female urinary incontinence.  On November 1, 2000, we completed the spin-off ofUROPACE to our existing shareholders. The separation was effected by transferring from our company to UROPACEall assets, tangible and intangible, relating to the development of femaleurinary incontinence technology.  Ourshareholders of record on September 15, 2000, received one share of common stock of UROPACE for each6.882 shares of our common stock they held on that date.  The assets transferred to UROPACE had nobook value at November 1, 2000, and the operations of UROPACE before the spin-offhad no revenues and minimal expenses during fiscal year 2000 and fiscal year2001.  As a part of this spin-off, weagreed to loan UROPACE up to $356,250 at a variable interest rate.  Principal and interest on the note will bepayable in installments equal to 5 percent of UROPACE’s future annual net sales until the noteand interest is paid in full.  At October 31,2003, we had loaned UROPACE $235,000,none of which had been repaid.  Due to the development stage of UROPACE andthe uncertainty associated with the collection of these borrowings, we establisheda reserve for the entire balance ofthe loan in the prior year. The corresponding expense was included in other (expense) income in theConsolidated Statement of Operations.

 

*Related Party LeaseObligation. *On April 4, 2003, we sold our corporateheadquarters, manufacturing facility and surrounding land in Inver GroveHeights, Minnesota to PKM.  Inconnection with the transaction, we received total consideration of $3.84million consisting of (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.

 

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

 

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

 

*ClinicalStudies. *We entered intoagreements with several large non-U.S. hospitals toconduct clinical studies regarding certain aspects of our Omnicarbon heartvalve’s clinicalperformance.  The agreements run through fiscal year 2006.  In general, recipients of clinical studypayments are required to purchase our products in order to complete their studies.

 

14

----

 

*Consulting*.  Weentered into an employment separation agreement with an officer in late 2002,which provides for consulting services through calendar year 2003.  We also entered into an employmentseparation agreement with an officer in September 2003, which provides forconsulting services through April 2004.

 

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

 

*Atrial FibrillationTechnology Purchase Agreement. *We entered into an agreement with LightWaveAblation Systems, Inc. (LightWave)  inSeptember 2003 to purchase technology for the treatment of atrial fibrillation.We issued 15,000 shares of common stock and made an initial payment of $10,000to LightWave Ablation Systems, Inc. for the worldwide distribution rights forthe technology to treat atrial fibrillation. Pursuant to terms of theagreement, additional cash payments may be made and warrants to purchase sharesof our common stock may be issued to LightWave in the event that LightWavemeets  certain development and marketingmilestones, including obtaining a CE Mark, completion of a FDA 510(k) filingand the company meeting certain revenue milestones.

 
|                                              |   | **Payments Due By Period** |      |
|---------------------------------------------------|--------|----------------------------|-----------|
| **Summary of Contractual****Obligations**         |   | **TOTAL**                  |      | **Less than****OneYear** |   | **Two to Three****Years** |   | **Four or More****Years** |   |
| Snia S.p.A. Carbomedics                           |   | $                          | 153,972   |   | $ | 153,972 |   | $ |   |   | $ |   |   |
| UROPACE Loan                                      |   | 121,250                    |      | 121,250 |   |   |   |   |   |
| Related Party Lease Obligation(1)                 |   | 3,990,558                  |      | 412,584 |   | 835,968 |   | 2,742,006 |   |
| Capital Leases(1)                                 |   | 14,990                     |      | 14,990 |   |   |   |   |   |
| Clinical Studies                                  |   | 410,380                    |      | 137,762 |   | 192,247 |   | 80,371 |   |
| Consulting                                        |   | 49,039                     |      | 49,039 |   |   |   |   |   |
| Atrial Fibrillation Technology Purchase Agreement |   | 30,000                     |      |   |   | 30,000 |   |   |   |
| Short-Term Debt with Related Party                |   | 2,943,333                  |      | 2,943,333 |   |   |   |   |   |
| TOTAL CONTRACTUAL OBLIGATIONS                     |   | $                          | 7,713,522 |   | $ | 3,832,930 |   | $ | 1,058,215 |   | $ | 2,822,377 |   |

 

----

(1)           Future payments include interest due.

 

**Qualitative and Quantitative Disclosuresabout Market Risk**

 

We develop ourproducts in the U.S. and market our products globally.  Because we continue to derive our revenueprimarily from sources outside of the U.S., our financial results could beaffected by many factors, such as changes in currency exchange rates or weakeconomic conditions in foreign markets. Substantially all of our sales are denominated in U.S. dollars.  A strengthening of the U.S. dollar couldmake our products less competitive in foreign markets.  We do not currently participate in anycurrency hedging activities to mitigate this risk.  We assess the need to use financial instruments to hedge ourexchange rate exposure on an ongoing basis.  Inaddition, we continually evaluate selling prices and billing currencies tomonitor our exchange rate exposure.  Our interest income and expenses aresensitive to changes in the general level of U.S. interest rates. Based on the current nature and levels of our investments and debt,however, we believe that we currently have no material market risk exposure.

 

Our generalinvesting policy is to limit market and credit risk and the risk of principalloss.  All liquid investments withoriginal maturities of three months or less are considered to be cashequivalents.

 

15

----

 

**ITEM 3                   CONTROLSAND PROCEDURES**

 

We maintain a system of disclosure controlsand procedures that is designed to provide reasonable assurance thatinformation, which is required to be disclosed, is accumulated and communicatedto management timely.  As of the end ofthe period covered by this report, we carried out an evaluation under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures pursuant toExchange Act Rule 13a-15.  Based uponthat evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures are effective in timelyalerting them to material information relating to our company required to bedisclosed in our periodic filings with the SEC.

 

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.

 

16

----

 

**PARTII     OTHER INFORMATION**

ITEM 1   Legal Proceedings

 

As of December 15, 2003, wewere not a party to any material litigation.

 

ITEM 2   Changes in Securities

 

(a)   Not applicable.

 

(b)   Not applicable.

 

(c)          On August 19, 2003, we granted to Lawrence L. Horsch, our Chairman ofthe Board, a ten-year non-qualified stock option for the purchase of 100,000shares of our common stock at an exercise price of $0.70 per share. We grantedthis stock option to Mr. Horsch pursuant to the terms of a letter agreementdated August 19, 2003, under which Mr. Horsch became our Chairman of the Board.

 

On August 20, 2003, we issuedto PKM Properties, LLC, an entity controlled by Paul K. Miller, a member of ourboard of directors and our largest beneficial owner of securities, a ten-yearwarrant to purchase 60,179 shares of our common stock at an exercise price of$0.70 per share.  We issued this warrantin consideration of our final draw under the one-year $1.0 milliondiscretionary line of credit we established with PKM on July 8, 2003.

 

On September 29, 2003, wesold 85,714 shares of our common stock to Lawrence L. Horsch, our Chairman ofthe Board, at a purchase price of $0.70 per share.  We agreed to sell these shares to Mr. Horsch pursuant to theterms of a letter agreement dated August 19, 2003, under which Mr. Horschbecame our Chairman of the Board.

 

OnSeptember 29, 2003, we issued 15,000 shares of our common stock to LightWaveAblation Systems, Inc. pursuant to the terms of a letter agreement dated April22, 2003.  We issued these shares inpartial consideration of our acquisition of a technology platform for thetreatment of atrial fibrillation from such company.

 

Theforegoing issuances were made in reliance upon the exemption provided inSection 4(2) of the Securities Act. Such securities are restricted as to sale or transfer, unless registeredunder the Securities Act, and the certificate representing such securitiescontains a restrictive legend preventing sale, transfer or other disposition,unless registered under the Securities Act.  In addition, the recipients of such securities received materialinformation concerning our company, including, but not limited to, our reportson Form 10-KSB and Form 10-QSB, as filed with the Securities and ExchangeCommission.  No underwriting commissionsor discounts were paid with respect to the issuance of such securities.

 

(d)    Not applicable.

 

ITEM 3   Defaults upon Senior Securities

 

Not applicable.

 

ITEM 4   Submission of Matters to a Vote of Security Holders

 

The 2003 Annual Meeting of Shareholders washeld on October 6, 2003.  Two proposalswere submitted for shareholder approval, both of which passed with votingresults as follows:

 

(1)   To elect seven directors for the ensuing year and until theirsuccessors shall be elected and duly qualified.

 
| **Name**                          |   | **For**   |   | **Withhold  Authority** |   |
|-----------------------------------|--------|-----------|--------|-------------------------|--------|
| Lawrence L. Horsch                |   | 4,449,962 |   | 0                       |   |
| Blair P. Mowery                   |   | 4,449,962 |   | 0                       |   |
| Susan L. Critzer                  |   | 4,449,962 |   | 0                       |   |
| David B. Kaysen                   |   | 4,449,962 |   | 0                       |   |
| Salvador Mercé Cervelló |   | 4,339,962 |   | 110,000                 |   |
| Adel A. Mikhail, Ph.D.            |   | 4,339,962 |   | 110,000                 |   |
| Paul K. Miller                    |   | 4,339,962 |   | 110,000                 |   |

 

17

----

 

(2)   To ratify the appointment ofPricewaterhouseCoopers LLP as our independent accountants for the fiscal yearending April 30, 2004.

 
| **For**   |   | **Against** |   | **Abstain** |   | **Non-Vote** |   |
|-----------|--------|-------------|--------|-------------|--------|--------------|--------|
| 4,339,962 |   | 110,000     |   | 0           |   | 0            |   |

 

ITEM 5   Other Information

 

Not applicable.

 

ITEM 6   Exhibits and Reports on Form 8-K

 

(a)   Exhibits

 

None.

 

(b)   Reports on Form 8-K

 

OnSeptember 11, 2003, the registrant furnished a Current Report on Form 8-K(under Item 12) regarding its release of material non-public informationrelating to its results of operations for the fiscal period ended July 31,2003.

 

18

----

 

**SIGNATURES**

 

In accordance with the requirements of theExchange Act, the registrant caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

 
|                          | MedicalCV, Inc. |
|-------------------------------|-----------------|
|                          |            |   |
|                          |            |   |
| Date:  December 15, 2003 | By              | /s/ Blair P. Mowery |   |
|                          |            | Blair P. Mowery |
|                          |            | President and Chief  Executive Officer |
|                          |            |   |
| Date:  December 15, 2003 | By              | /s/ Jules L. Fisher |   |
|                          |            | Jules L. Fisher |
|                          |            | Chief Financial Officer |

 

19

----

 

**INDEX TO EXHIBITS**

 

 
| **Exhibit  Number** |   | **Description**                                                                                                                        |
|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                |   | Warrant Agreement to  purchase 60,179 shares of common stock issued by MedicalCV, Inc. to PKM  Properties, LLC, dated August 20, 2003. |
| 31.1                |   | Chief Executive Officer  Certification pursuant to Rule 13a-14.                                                                        |
| 31.2                |   | Chief Financial Officer  Certification pursuant to Rule 13a-14.                                                                        |
| 32.1                |   | Chief Executive Officer Certification  pursuant to 18 U.S.C. Section 1350.                                                             |
| 32.2                |   | Chief Financial Officer  Certification pursuant to 18 U.S.C. Section 1350.                                                             |

 

20

----