**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, DC 20549**

 

**FORM 10-QSB**

**ý****      QUARTERLY REPORTUNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THEQUARTERLY PERIOD ENDED JULY 31, 2002**

**o****      TRANSITION REPORTUNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT**

**Commission FileNumber  0-33295**

**MedicalCV, Inc.**

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

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

**9725South Robert Trail**

**InverGrove Heights, Minnesota 55077**

**(651)452-3000**

(Address of Principal Executive Offices and Issuer’s

Telephone Number, including Area Code)

 

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.

Yes ý  No o

As ofSeptember 14, 2002, the issuer had outstanding 7,843,834 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 (checkone)  oYes  ýNo

 

----

 

TABLE OF CONTENTS

 
| PART I         | FINANCIAL  INFORMATION |                                                                                                                             |
|----------------|------------------------|----------------------------------------------------------------------------------------------------------------------------------|
|           |                   |                                                                                                                             |
|           | ITEM 1                 | Financial Statements                                                                                                             |   |
|           |                   | Consolidated Balance Sheet  at July 31, 2002 (unaudited) and  April 30, 2002                                                     |   |
|           |                   | Consolidated  Statement of Operations for the three month periods ended July 31, 2002  (unaudited) and July 31, 2001 (unaudited) |   |
|           |                   | Consolidated  Statement of Cash Flows for the three month periods ended July 31, 2002  (unaudited) and July 31, 2001 (unaudited) |   |
|           |                   | Notes to Consolidated Financial  Statements                                                                                      |   |
|           | ITEM 2                 | Management’s Discussion and  Analysis or Plan of Operation                                                                  |   |
|           |                   |                                                                                                                             |   |
| PART II        | OTHER INFORMATION      |                                                                                                                             |
|           |                   |                                                                                                                             |
|           | ITEM 1                 | Legal Proceedings                                                                                                                |   |
|           | ITEM 2                 | Changes in Securities and Use of  Proceeds                                                                                       |   |
|           | ITEM 3                 | Defaults upon Senior Securities                                                                                                  |   |
|           | ITEM 4                 | Submission of Matters to a  Vote of Security Holders                                                                             |   |
|           | ITEM 5                 | Other  Information                                                                                                               |   |
|           | ITEM 6                 | Exhibits and Reports on Form 8-K                                                                                                 |   |
|           |                   |                                                                                                                             |   |
| SIGNATURES     |                   |                                                                                                                             |
| CERTIFICATIONS |                   |                                                                                                                             |
|                |                        |                                                                                                                                  |  |  |  |  |

 

----

 

**PART I**

ITEM 1   FinancialStatements

**MEDICALCV, INC.**

**ConsolidatedBalance Sheet**

 
|                                                                                                 |   | **July 31,  2002 (unaudited)** |      | **April 30,  2002** |   |
|------------------------------------------------------------------------------------------------------|--------|--------------------------------|-----------|---------------------|--------|
| **ASSETS**                                                                                           |   |                           |      |                |   |
| Current assets:                                                                                      |   |                           |      |                |   |
| Cash and cash equivalents                                                                            |   | $                              | 1,128,745 |                | $      | 2,781,675 |   |
| Trade and accounts receivable, net                                                                   |   | 1,354,098                      |      | 1,258,616           |   |
| Inventories                                                                                          |   | 2,591,341                      |      | 2,322,535           |   |
| Prepaid expenses and other assets                                                                    |   | 153,753                        |      | 78,993              |   |
| Total current assets                                                                                 |   | 5,227,937                      |      | 6,441,819           |   |
|                                                                                                 |   |                           |      |                |   |
| Property, plant and equipment, net                                                                   |   | 1,573,111                      |      | 1,575,153           |   |
| Deferred financing costs, net                                                                        |   | 40,888                         |      | 72,860              |   |
| Other assets                                                                                         |   | 20,816                         |      | 1,394               |   |
| Total assets                                                                                         |   | $                              | 6,862,752 |                | $      | 8,091,226 |   |
|                                                                                                 |   |                           |      |                |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                        |   |                           |      |                |   |
| Current liabilities:                                                                                 |   |                           |      |                |   |
| Current portion of long-term debt                                                                    |   | $                              | 2,543,832 |                | $      | 2,542,460 |   |
| Current portion of capital lease obligations                                                         |   | 59,854                         |      | 59,854              |   |
| Accounts payable                                                                                     |   | 530,700                        |      | 589,520             |   |
| Accrued expenses                                                                                     |   | 525,260                        |      | 491,760             |   |
| Total current liabilities                                                                            |   | 3,659,646                      |      | 3,683,594           |   |
|                                                                                                 |   |                           |      |                |   |
| Long-term debt, less current portion                                                                 |   | 321,368                        |      | 339,523             |   |
| Capital lease obligations less current portion                                                       |   | 20,273                         |      | 42,069              |   |
| Total liabilities                                                                                    |   | 4,001,287                      |      | 4,065,186           |   |
|                                                                                                 |   |                           |      |                |   |
| Shareholders’ equity:                                                                           |   |                           |      |                |   |
| Preferred stock, $.01 par value; 5,000,000 shares authorized; no  shares issued and outstanding      |   |                           |      |                |   |
| Common stock; $.01 par value; 95,000,000 shares authorized; 7,843,834  shares issued and outstanding |   | 78,438                         |      | 78,438              |   |
| Additional paid-in capital                                                                           |   | 16,362,050                     |      | 16,362,050          |   |
| Deferred stock-based compensation                                                                    |   | (7,771                         | )         | (9,062              | )      |
| Accumulated deficit                                                                                  |   | (13,571,252                    | )         | (12,405,386         | )      |
| Total shareholders’ equity                                                                      |   | 2,861,465                      |      | 4,026,040           |   |
| Total liabilities and shareholders’ equity                                                      |   | $                              | 6,862,752 |                | $      | 8,091,226 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

 

3

----

 

**MEDICALCV, INC.**

**ConsolidatedStatement of Operation**s

**(unaudited)**

 
|                                                          |   | **Three  Months Ended July 31,** |       |
|---------------------------------------------------------------|--------|----------------------------------|------------|
|                                                          |   | **2002**                         |       | **2001** |   |
|                                                          |   |                             |       |   |   |
| Net sales                                                     |   | $                                | 818,332    |   | $ | 641,351 |   |
| Cost of goods sold                                            |   | 477,869                          |       | 438,349 |   |
| Gross profit                                                  |   | 340,463                          |       | 203,002 |   |
| Operating expenses:                                           |   |                             |       |   |   |
| Sales and marketing                                           |   | 755,587                          |       | 449,843 |   |
| General and administrative                                    |   | 537,591                          |       | 399,400 |   |
| Engineering and regulatory                                    |   | 201,117                          |       | 207,123 |   |
| Total operating expenses                                      |   | 1,494,295                        |       | 1,056,366 |   |
| Loss from operations                                          |   | (1,153,832                       | )          | (853,364 | ) |
| Other (expense) income:                                       |   |                             |       |   |   |
| Interest expense                                              |   | (38,980                          | )          | (42,206 | ) |
| Interest income                                               |   | 11,019                           |       | 142 |   |
| Other income                                                  |   | 15,927                           |       | 14,640 |   |
| Total other expense                                           |   | (12,034                          | )          | (27,424 | ) |
|                                                          |   |                             |       |   |   |
| Net loss                                                      |   | $                                | (1,165,866 | ) | $ | (880,788 | ) |
| Basic and diluted net loss per share                          |   | $                                | (.15       | ) | $ | (.14 | ) |
|                                                          |   |                             |       |   |   |
| Shares used in computing basic and diluted net loss per share |   | 7,843,834                        |       | 6,343,834 |   |

** **

Theaccompanying notes are an integral part of these financial statements.

 

 

4

----

 

**MEDICALCV, INC.**

 

**ConsolidatedStatement of Cash Flow****s**

(unaudited)

 
|                                                                         |   | **Three  Months Ended July 31,** |       |
|------------------------------------------------------------------------------|--------|----------------------------------|------------|
|                                                                         |   | **2002**                         |       | **2001** |   |
| Cash flows from operating activities:                                        |   |                             |       |   |   |
| Net loss                                                                     |   | $                                | (1,165,866 | ) | $ | (880,788 | ) |
| Adjustments to reconcile net loss to net cash used in operating  activities: |   |                             |       |   |   |
| Depreciation                                                                 |   | 86,635                           |       | 74,045 |   |
| Amortization                                                                 |   | 31,972                           |       | 11,196 |   |
| Provision for doubtful accounts                                              |   | 74,424                           |       | 48,731 |   |
| Return of Inventory                                                          |   | (92,000                          | )          |   |   |
| Provision for inventory obsolescence                                         |   | 55,564                           |       |   |   |
| Stock-based compensation                                                     |   | 1,291                            |       | 16,458 |   |
| Changes in assets and liabilities:                                           |   |                             |       |   |   |
| Accounts receivable                                                          |   | (169,906                         | )          | 12,358 |   |
| Inventories                                                                  |   | (232,370                         | )          | (10,066 | ) |
| Prepaid expenses and other assets                                            |   | (94,182                          | )          | 26,266 |   |
| Accounts payable                                                             |   | (58,820                          | )          | 20,186 |   |
| Accrued expenses                                                             |   | 33,500                           |       | (63,060 | ) |
| Net cash used in operating activities                                        |   | (1,529,758                       | )          | (744,674 | ) |
|                                                                         |   |                             |       |   |   |
| Cash flows from investing activities:                                        |   |                             |       |   |   |
| Purchase of property, plant and equipment                                    |   | (84,593                          | )          | (22,000 | ) |
| Loan to UROPACE                                                              |   |                             |       | (26,000 | ) |
| Net cash used in investing activities                                        |   | (84,593                          | )          | (48,000 | ) |
|                                                                         |   |                             |       |   |   |
| Cash flows from financing activities:                                        |   |                             |       |   |   |
| Borrowings on bank line of credit                                            |   |                             |       | 740,000 |   |
| Principal payments on other long-term debt                                   |   | (16,783                          | )          | (16,517 | ) |
| Principal payments under capital lease obligations                           |   | (21,796                          | )          | (17,970 | ) |
| Net cash (used in) provided by financing activities                          |   | (38,579                          | )          | 705,513 |   |
|                                                                         |   |                             |       |   |   |
| Net decrease in cash and cash equivalents                                    |   | (1,652,930                       | )          | (87,161 | ) |
| Cash and cash equivalents at beginning of year                               |   | 2,781,675                        |       | 111,977 |   |
| Cash and cash equivalents at end of period                                   |   | $                                | 1,128,745  |   | $ | 24,816 |   |

 

The accompanying notesare an integral part of these financial statements.

 

 

 

5

----

 

**MEDICALCV, INC.**

 

**Notes toConsolidated****Financial Statements**

**(1)   Basis of FinancialStatement 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.  Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with accounting principles generally accepted in theUnited States of America have been condensed or omitted pursuant to such rulesand regulations.  These consolidatedinterim financial statements should be read in conjunction with theconsolidated financial statements and the notes thereto included in theCompany’s Annual Report on Form 10-KSB for the fiscal year ended April 30,2002.

 

Theconsolidated balance sheet as of July 31, 2002, the consolidated statement ofoperations for the three months ended July 31, 2002 and 2001, and theconsolidated statement of cash flows for the three months ended July 31, 2002and 2001 include, in the opinion of management, all adjustments, consistingsolely of normal recurring adjustments, necessary for a fair presentation ofthe financial results for the respective interim periods and are notnecessarily indicative of results of operations to be expected for the entirefiscal year ending April 30, 2003.

 

Certainamounts previously reported have been reclassified to conform to their July 31,2002 presentation.  Thesereclassifications had no effect on net loss, cashflow or shareholders’ equityas previously reported.

 

**(2)           GoingConcern**

 

The Company’s consolidated financial statements forthe quarter ended July 31, 2002, have been prepared on a going concern basis,which contemplates the realization of assets and settlement of liabilities andcommitments in the normal course of business. The Company has sustained losses and negative cash flows from operationsin recent years and expects these conditions to continue for the foreseeablefuture.  At July 31, 2002, the Companyhad an accumulated deficit of $13,571,252, and has insufficient funds to meetthe requirements of its revolving line of credit, which matures November 2002,and finance its working capital and capital expenditure needs.  These matters raise substantial doubt aboutthe Company’s ability to continue as a going concern.  The Company is currently pursuing the refinancing of itsrevolving line of credit and seeking other financing to fund its operations andworking capital requirements.  If theCompany is unable to refinance its revolving line of credit and obtain sourcesof additional funds by the end of calendar year 2002, it will be required tosignificantly revise its business plans and drastically reduce operatingexpenditures such that it may not be able to develop or enhance its products,gain market share in the United States or respond to competitive pressures orunanticipated requirements, which could seriously harm its business, financialposition and results of operations.  Tocontinue operations past October 2002 without additional capital, the Companywill need to implement drastic cost cutting measures and significantly reduceits working capital to conserve cash. In any event, the Company will need additional capital by at least theend of calendar year 2002 to continue its operations.

 

The Company is subject to risks and uncertaintiescommon to rapidly growing medical technology-based companies, including rapidtechnological change, dependence on one principal product, new productdevelopment and acceptance, actions of competitors, dependence on key personneland United States market penetration.

 

**(3)           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-month periods ended July 31, 2002and 2001 since the potentially dilutive shares are anti-dilutive.  Potentially dilutive shares excluded fromthe calculation of diluted net loss per share relate to outstanding stockoptions and warrants aggregating 3,546,890 and 1,129,640 shares of theCompany’s common stock at July 31, 2002 and 2001, respectively.

 

6

----

 

**(4)           Inventories**

 
|            |   | **July 31,  2002** |      | **April 30,  2002** |   |
|-----------------|--------|--------------------|-----------|---------------------|--------|
|            |   | **(unaudited)**    |      |                |   |
| Raw materials   |   | $                  | 733,495   |                | $      | 436,855 |   |
| Work-in-process |   | 904,694            |      | 551,561             |   |
| Finished goods  |   | 953,152            |      | 1,334,119           |   |
|            |   | $                  | 2,591,341 |                | $      | 2,322,535 |   |

 

**(5)           Returnof Inventory**

 

        During the quarter ended July 31, 2002,the Company obtained inventories from two former international distributorswith an original cost to the Company of approximately $92,000.  The heart valves were sold to thesecustomers during fiscal year 2000 and the first half of fiscal year 2001.  Due to financial difficulties experienced bythese distributors, the Company provided allowances for the remaininguncollected accounts receivable balances in fiscal years 2001 and 2002.  The Company did not anticipate the return ofthese products at the time the uncollectible accounts were established.  Upon obtaining title to the heart valvesfrom these former distributors during the quarter ended July 31, 2002, theCompany increased its inventories and reduced cost of goods sold for itsoriginal cost of $92,000.

 

**(6)           NewAccounting Pronouncements**

 

In May 2002, the Financial Accounting Standards Board(FASB) issued Statement of Financial Accounting Standards (SFAS) No. 145,“Rescission of SFAS Nos. 4, 44 and 64, Amendments to SFAS No. 13, and TechnicalCorrections as of April 30, 2002.”  Thenew standard amends existing authoritative pronouncements to make variouscorrections, clarifying meanings, or describe their applicability under changedconditions.  SFAS No. 145 was adopted bythe Company effective May 1, 2001.  Theadoption of SFAS No. 145 required the classification of the loss on earlyextinguishment of convertible subordinated bridge notes as a component of netloss from recurring operations for the year ended April 30, 2002 versus beingclassified as an extraordinary item.

 

In June 2002, the FASB issued SFAS No. 146, “Accountingfor Exit or Disposal Activities”.  Thenew statement addresses the accounting for costs associated with exit ordisposal activities.  The provisions ofthe statement will be effective for disposal activities initiated afterDecember 31, 2002.  The adoption of SFASNo. 146 is not expected to have a material impact on the Company’s financialposition or results of operations.

 

**(7)           SegmentInformation**

 

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

 

Thefollowing table summarizes net sales by geographic area:

 

|        |   | **Three  Months Ended July 31,**

**(unaudited)** |    |
|-------------|--------|---------------------------------------------------|---------|
|        |   | **2002**                                          |    | **2001** |   |
| Europe      |   | $                                                 | 444,163 |   | $ | 440,842 |   |
| South Asia  |   | 124,100                                           |    | 114,380 |   |
| Middle East |   | 174,667                                           |    | 44,187 |   |
| Far East    |   | 42,827                                            |    | 41,942 |   |
| Other       |   | 32,575                                            |    |   |   |
| **TOTALS**  |   | $                                                 | 818,332 |   | $ | 641,351 |   |

 

 

7

----

 

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

 

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

 

*Our actual results, performance or achievements could differmaterially from those expressed in, or implied by, forward-lookingstatements.  Accordingly, we cannot becertain that any of the events anticipated by forward-looking statements willoccur or, if any of them do occur, what impact they will have on us.  We caution you to keep in mind the cautionsand risks described**in this document andin our CautionaryStatement and to refrain fromattributing undue certainty to any forward-looking statements, which speak onlyas of the date of the document in which they appear.*

 

**Overview**

 

We manufacture and market mechanical heartvalves known as the Omnicarbon Series 3000 and Series 4000.  Our heart valves are used to treat heartvalve failure caused by the aging process, heart diseases, prosthetic heartvalve failure and congenital defects. To date, we have distributed the Omnicarbon 3000 and 4000 heart valvesprimarily in Europe, South Asia, the Middle East and the Far East.  In fiscal year 2002, we derived 65.0 percentof our net sales from Europe.  As aninnovator of heart valve technology, we have more than 30 years of experiencein developing, manufacturing and marketing five generations of heart valves,and we have sold more than 135,000 heart valves worldwide.

 

On July 26, 2001, the FDA gave us noticeof premarket 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 in fiscal year 2001 and recruiting field salesrepresentatives to call on domestic surgery centers in the U.S.  Based upon our Omnicarbon heart valve’s 17 years of implants in patients in Europe, we believethat we can establish a competitive position in the mechanical heart valveindustry in the U.S. and leverage this position into other critical areas ofcardiothoracic surgery.  We also expectthat our ability to market the Omnicarbon 3000 heart valve in the U.S. willfavorably affect our international sales, as many cardiovascular surgeons andothers who make purchasing decisions are aware of the FDA’s rigorous premarket approval process andconsider it to be a validation of the safety and efficacy of medicaldevices.  Our company had its firstimplant of the Omnicarbon 3000 heart valve in the U.S. in December 2001.

 

The worldwide heart valve market isdynamic and highly competitive.  Inaddition, technology and competitive offerings, such as new tissue heartvalves, place increased pressure on us as we seek to increase our market shareand revenue.  For more informationregarding these risks, you should review our Cautionary Statement.

 

8

----

 

**QuartersEnded July 31, 2002 and 2001**

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

 

 
|                       |   | **Three Months Ended July 31,**

**(unaudited)** |   |
|----------------------------|--------|--------------------------------------------------|--------|
|                       |   | **2002**                                         |   | **2001** |   |
| Net sales                  |   | 100.0                                            | %      | 100.0 | % |
| Cost of goods sold         |   | 58.4                                             | %      | 68.3 | % |
|                       |   |                                             |   |   |   |
| Gross profit               |   | 41.6                                             | %      | 31.7 | % |
|                       |   |                                             |   |   |   |
| Operating expenses:        |   |                                             |   |   |   |
|                       |   |                                             |   |   |   |
| Sales and marketing        |   | 92.3                                             | %      | 70.1 | % |
| General and administrative |   | 65.7                                             | %      | 62.3 | % |
| Engineering and regulatory |   | 24.6                                             | %      | 32.3 | % |
|                       |   |                                             |   |   |   |
| Total operating expenses   |   | 182.6                                            | %      | 164.7 | % |
|                       |   |                                             |   |   |   |
| Loss from operations       |   | (141.0                                           | )%     | (133.0 | )% |
|                       |   |                                             |   |   |   |
| Other (expense) income:    |   |                                             |   |   |   |
| Interest expense           |   | (4.7                                             | )%     | (6.6 | )% |
| Interest income            |   | 1.3                                              | %      | 0.0 | % |
| Other income               |   | 1.9                                              | %      | 2.3 | % |
|                       |   |                                             |   |   |   |
| Total other expense        |   | (1.5                                             | )%     | (4.3 | )% |
|                       |   |                                             |   |   |   |
| Net loss                   |   | (142.5                                           | )%     | (137.3 | )% |

 

 

**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, 2002.

 

**Results of Operations**

 

*Net Sales*.  Netsales in the quarter ended July 31, 2002 increased 27.6 percent to $818,332 from $641,351 in the first quarter ofthe prior year.  The increase was attributableprimarily to higher Omnicarbon unit sales in the Middle East and Asia.

 

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

 

*Gross Profit.* Gross profit as a percentage of net sales increasedto 41.6 percent inthe quarter ended July31, 2002 from 31.7 percent in the firstquarter of the prior year.  After adjusting fornon-recurring items, the gross margin was 37.0 percent in the quarter endedJuly 31, 2002.  The non-recurring itemsrelated to a return of heart valves (See Note 5 of Consolidated FinancialStatements), partially offset by additional obsolescence reserves for the bloodfilter and Omniscience product lines we are phasing out.  Our gross margin was also favorably impactedby reduced manufacturing costs this quarter as compared to the same period lastyear. We have expended considerableresources in developing our new carbon manufacturing process technologiesutilized in manufacturing the Omnicarbon 4000 heart valve which is currentlysold outside the U.S. market.  Our strategy is toobtain FDA approval of our proprietary pyrolitic carbon manufacturing processin order to market the Omnicarbon 4000 in the U.S.  Due to its lower manufacturing cost, we believe the Omnicarbon4000 will generate significantly higher gross profit margins when sold in theU.S. than the Omnicarbon 3000 heart valve.

 

9

----

 

*Sales and Marketing*.  Sales and marketing expenses in the quarter ended July 31, 2002 were $755,587 or 92.3 percent of net sales compared to $449,843 or 70.1 percent of net sales in the first quarter of the prior year.  The increase in spending related to expandedOmnicarbon marketing efforts in the U.S. and international markets.  Our overall marketing strategy is to promotethe clinical results of the Omnicarbon heart valve and the technical strengthsof our company in designing and manufacturing mechanical heart valves.

 

*General and Administrative*.  General and administrative expenses for the quarter ended July 31, 2002 were $537,591 or 65.7 percent of net sales compared to $399,400 or 62.3 percent of net sales in the first quarter ofthe prior year.  The increase was primarily attributable toincreased professionalfees associated with operating as a public company, and salary and relatedexpenses associated with strengthening the executive management staff.

 

*Engineering and Regulatory*.  Engineering and regulatory expenses for the quarter ended July 31, 2002 were $201,117 or 24.6 percent of net sales compared to $207,123 or 32.3 percent of net sales in the first quarter ofthe prior year.  The decrease was attributable to shiftingpriorities from new product development to installation of new equipment andprocesses for the production of the Omnicarbon 4000 heart valve.

 

*Other (Expense) Income*.  Interest expense totaled $38,980 in the quarter ended July 31, 2002 compared to $42,206 in the first quarter of the prior year. Interestincome increased to $11,019 in the quarter ended July 31, 2002 from $142 in thesame period one year ago due to maintaining a higher cash balance this quarter.

 

*Income Tax Provision*.  In light of our recent history of operatinglosses, we recorded a valuation allowance to fully offset our deferred taxassets in fiscal year 2000.  We havecontinued to provide a full valuation allowance through the first quarter of fiscal 2002 due to the inherent uncertainty ofpredicting the sufficiency of future taxable income necessary to realize ourdeferred tax assets.

 

*Loss from Operations*.  As of July 31,2002, we had an accumulated deficit of $13,571,252. 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 cumulative net losses to continue at least through fiscal year 2003because of anticipated spending necessary to market the Omnicarbon 3000 heartvalve in the U.S. and to establish and maintain a strong marketing organizationfor domestic and foreign markets.

 

**Liquidity and CapitalResources**

 

Cash and cash equivalents decreased to $1,128,745 at July 31, 2002, from $2,781,675 at April 30, 2002.  The decrease in cash in thecurrent quarter was attributable primarilyto funding operatinglosses and working capital requirements.  Net cash used inoperating activities was $1,529,758 in the quarter ended July 31,2002, and $744,674 inthe first quarter of the prior year.

 

Net cash used in operating activitiesincreased $785,084 due primarily to increases in workingcapital requirements combined with funding higher operating losses.  Inventories increased $324,370 in the currentquarter as a result of carrying additional purchased raw material componentinventory to support the launch of the Omnicarbon 3000 in the U.S. The increase in accounts receivable of $169,906 wasattributable to the increased level of sales combined with sales growth inmarkets which require longer credit terms.

 

Net cash used in investing activities was$84,593 and $48,000 for the periods ended July 31, 2002 and 2001, respectively.  We invested $84,593 in property, plant, and equipment in theperiod ended July 31, 2002, compared to $22,000 in the same period lastfiscal year.

 

Net cash used in financing activities was $38,579 in the period ended July 31, 2002 and consisted ofprincipal payments on long-term debt and capital leases.  Inthe period ended July 31, 2001 net cash provided by financing activities was$705,513. In thatperiod, we borrowed an additional $740,000 on our bank line of credit partiallyoffset by $34,487 ofprincipal payments on our long-term debt and capital leases.

 

From March 1992 through July 2002, our primary source of funding has been private salesof equity securities, which totaled $9,775,704 in gross cash proceeds.  We have also funded our operations through collateralized equipment financing term loans andequipment leases.  In addition, wefinanced our operations since fiscal year 2000 through a bank line of credit collateralized by our real estate, tangible andintangible property and a guarantee by a principal shareholder.  This line of credit will expire in November2002.  Amounts borrowed under this lineof credit generally bear interest at the prime rate.  Asof April 30, 2002, we had borrowedthe maximum amount available of $2,500,000 under this line of credit.

 

As part of our credit agreement withAssociated Bank Minnesota, we were required to maintain a minimum tangible networth of not less than $3,000,000, measured as of the last day of each fiscalquarter.  At April 30, 2001, we failedto comply with the minimum 

 

 

10

----

 

tangible net worth covenant.  On August 24, 2001, Associated BankMinnesota waived such covenant defaults, and we amended our credit agreement,which now provides that we must maintain a minimum tangible net worth of notless than $1,000,000, measured as of the last day of each calendar month.  We were in compliance with our debt covenantsas of  July 31, 2002. We are currently in negotiations torefinance our bank line of credit.

 

In August 2001, we sold $500,000 principalamount of 10% convertible subordinated bridge notes due August 2002, along withfive-year warrants to purchase 500,000 shares of common stock at an exerciseprice of $6.50 per share.  The unsecurednotes were convertible into shares of our common stock at any time beforerepayment at a price of $4.50 per share. We repaid the convertible subordinated bridge notes in full in thefourth quarter of fiscal year 2002.

 

We expect to continue developing ourbusiness and to build market share in the U.S. now that we have FDA premarketapproval of our Omnicarbon 3000 heart valve for sales in the U.S.  These activities will require significantexpenditures to develop, train and supply marketing materials to ourindependent sales representatives and to build our sales and marketinginfrastructure.  As a result, weanticipate that our sales and marketing and general and administrative expenseswill continue to constitute a material use of our cash resources.  Although we have no commitment for theseexpenditures, we currently anticipate spending between $4,700,000 and $5,600,000 in fiscal year 2003.  In addition, we project capital expendituresof approximately $250,000 to $350,000 for fiscal year 2003 to increase manufacturingcapacity in certain functions and make necessary improvements to our corporatefacility.  The actual amounts and timingof our capital expenditures will vary depending upon the speed at which we are ableto expand our distribution capability in domestic and international markets andthe availability of financing as described below.

 

We expect that our operating losses andnegative operating cash flow will continue in fiscal years 2003 and 2004 as weexpand our manufacturing capabilities, continue increasing our corporate staffto support the U.S. roll-out of our Omnicarbon 3000 heart valve, and addmarketing programs domestically and internationally to build awareness of andcreate demand for our Omnicarbon heart valves. We will require additional financing in the currentyear.  We anticipate that we will needto raise between $1,500,000 and $2,000,000 of additional equity or debtfinancing to fund operations and working capital requirements in the next 2 to 6 months.  Wealso anticipate the need to raise an additional $1,500,000 to $2,000,000 within12 to 18 months. We may also seek to dispose of certain assets and enter into asale leaseback arrangement as a means to improve liquidity. We expect to face substantial difficulty in raising fundsin the current market environment and we have no commitments at this time toprovide the required financing.  We willalso seek torefinance our bank debt before November 2002 to give us additional borrowingcapacity and flexibility in funding the growth of our business.  Our capital requirements may vary dependingupon the timing and the success of the implementation of our business plan,regulatory, technological and competitive developments, or if:

 

•      operating losses exceed our projections,

 

•      ourmanufacturing and development costs or projections prove to be inaccurate,

 

•      wedetermine to license or develop additional technologies,

 

•      weexperience substantial delays in obtaining FDA clearance of our proprietarycarbon coating process for heart valves sold in the U.S. market, or

 

•      wemake acquisitions.

 

We cannot assure you that we will be ableto raise sufficient capital on terms that we consider acceptable, or atall.  If we are unable to obtainadequate funds on acceptable terms, our ability to fund the expansion of ourbusiness or respond to competitive pressures would be significantly impaired.  We also would be required to revise ourbusiness plans and reduce operating expenditures.  In the event that we are unable to refinance orextend our revolving line of creditand obtain funds by the end of calendar year 2002, we will be required tosignificantly revise our business plans,substantially reduce our operating expenditures andconsider the sale of certain assets.  To continue operations past October 2002without additional capital, we will need to implement drastic cost cuttingmeasures and significantly reduce our working capital to conserve cash.  In any event, we will need additionalcapital by at least the end of calendar year 2002 to continue our operations.

 

**Commitments and Contingent Liabilities**

 

*Sulzer Carbomedics.* In July 1998, we entered into a three-yearsupply agreement with Sulzer 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.  Theagreement provides that we purchase a minimum number of raw material units eachcalendar year through 2003.  Under theterms of the agreement, we are required to compensate Sulzer Carbomedics forany purchase shortfalls up to a maximum of $200,000 per year.  We have not met the minimum purchaserequirements for the past three calendar years.  In addition, we do not believe we will meet the minimum purchaserequirement for calendar year 2002.  Asa result, we expensed $17,050in the period ended July 31, 2002,and $50,000 in theperiod ended July 31, 2001 relatedto these purchase 

 

 

11

----

 

shortfalls.  These charges were reflected in cost of goods sold.  Future purchase shortfalls could adverselyaffect our ongoing relationship with Sulzer Carbomedics.

 

*UROPACE*.  In July 1995, weestablished a wholly-owned subsidiary, UROPACE, Inc., to commercializetechnology for treating female urinary incontinence.  On November 1, 2000, we completed the spin-off of UROPACE to ourexisting shareholders.  The separationwas effected by transferring from our company to UROPACE all assets, tangibleand intangible, relating to the development of female urinary incontinencetechnology.  Our shareholders of recordon September 15, 2000 received one share of common stock of UROPACE for each6.882 shares of our common stock they held on that date.  The assets transferred to UROPACE had nobook value at November 1, 2000, and the operations of UROPACE before thespin-off had no revenues and minimal expenses during fiscal year 2000 andfiscal year 2001.  As a part of thisspin-off, we agreed to loan UROPACE up to $356,250 at a variable interestrate.  Principal and interest on thenote will be payable in installments equal to 5 percent of UROPACE’s future annual net sales until the note and interest ispaid in full.  At July 31, 2002, we had loaned UROPACE $235,000.  Due to the development stage of UROPACE andthe uncertainty associated with the collection of these borrowings, we haverecorded an allowance for the entire balance of the loan, with thecorresponding expense included in other (expense) income in the ConsolidatedStatement of Operations.

 

*Bank Line of Credit*.  Since fiscal year 2000,we have financed our operations in part through a bank line of credit securedby our real estate, tangible and intangible property and a guarantee by aprincipal shareholder.  This line ofcredit will expire in November 2002. Amounts borrowed under this line of credit generally bear interest atthe prime rate.  As of  July 31, 2002, we hadborrowed the maximum amount available of $2,500,000 under this line of credit.

 

As part of our revolving credit agreementwith Associated Bank Minnesota, we were formerly required to maintain a minimumtangible net worth of not less than $3,000,000, measured as of the last day ofeach fiscal quarter.  At April 30, 2001, we failed to comply with the minimum tangible networth covenant.  On August 24, 2001,Associated Bank Minnesota waived such covenant defaults, and we amended ourcredit agreement, which now provides that we must maintain a minimum tangiblenet worth of not less than $1,000,000, measured as of the last day of eachcalendar month.  With the net proceedsfrom our November 2001 IPO, we met our minimum tangible net worth requirement through July31, 2002.  As of July 31, 2002, wehad fully utilized our line of credit.

 

As of  July 31, 2002, we were in compliance with allcovenants or other requirements set forth in our credit agreement.  We do not have any rating downgrade triggersthat would accelerate the maturity dates of our debt.  A downgrade in our credit rating could adversely affect ourability to renew existing, or obtain access to new, credit facilities in thefuture and could increase the cost of such facilities.

 

*Dakota Electric Association. *AtJuly 31, 2002, we were indebted toDakota Electric Association in the principal amount of $161,200. Payments are due inmonthly installments through May 2009, with interest at 5.75 percent,collateralized by our lighting equipment and rooftop air-conditioning units.

 

*Dakota County. *At July 31, 2002, we owed Dakota County for special land assessments with principaland interest due at 8 percent in semi-annual installments through May 2010.

 

*Operating and Capital Leases*.  We lease certain manufacturing equipmentunder various operating and capital leases. The operating leases expire at various dates through fiscal year2003.  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.

 

*Clinical Studies. *We entered intoan agreement with several large non-U.S. hospitals to conduct clinical studiesregarding certain aspects of our Omnicarbon heart valve’s clinical performance. The agreement runs through fiscal year 2006.  In general, recipients of clinical study payments are required topurchase our productsin order to complete their studies.

 

*Consulting*.  In November 2001, weentered into a separation agreement and release with Adel A. Mikhail, Ph.D.,who was our founder and served as our President and Chief Executive Officerfrom March 1992 until June 15, 2001, when he retired.  Dr. Mikhail continues to serve as Chairman of our Board ofDirectors.  As part of the agreement, weagreed to retain Dr. Mikhail as an independent consultant for a period of twoyears.  Dr. Mikhail receives a $6,000per month retainer.  The agreementexpires in June 2003.

 

12

----

 
| **Summary of Contractual Obligations** |   | **Payments Due By Period** |      |
|----------------------------------------|--------|----------------------------|-----------|
|                                   |   | **TOTAL**                  |      | **Less than One****Year** |   | **Two to Three****Years** |   | **Four or More****Years** |   |
| Sulzer Carbomedics                     |   | $                          | 200,000   |   | $ | 200,000 |   | $ |   | $ |   |
| UROPACE Loan                           |   | 121,250                    |      | 121,250 |   |   |   |   |   |
| Bank Line of Credit                    |   | 2,500,000                  |      | 2,500,000 |   |   |   |   |   |
| Dakota Electric Association (1)        |   | 195,324                    |      | 28,584 |   | 57,168 |   | 109,572 |   |
| Dakota County (1)                      |   | 249,360                    |      | 39,360 |   | 72,960 |   | 137,040 |   |
| Operating Leases                       |   | 13,161                     |      | 13,161 |   |   |   |   |   |
| Capital Leases (1)                     |   | 87,797                     |      | 56,454 |   | 31,343 |   |   |   |
| Clinical Studies                       |   | 422,380                    |      | 143,762 |   | 198,247 |   | 80,371 |   |
| Consulting                             |   | 75,000                     |      | 72,000 |   | 3,000 |   |   |   |
| TOTAL CONTRACTUAL OBLIGATIONS          |   | $                          | 3,864,272 |   | $ | 3,174,571 |   | $ | 362,718 |   | $ | 326,983 |   |
|                                        |        |                            |           |  |  |  |  |  |  |  |  |  |  |

 

----

(1)           Futurepayments include interest due.

 

**Recent Accounting Pronouncements**

 

In May 2002, the FASB issued SFAS No. 145,“Rescission of SFAS Nos. 4, 44, and 64, Amendments to SFASNo. 13, and Technical Corrections as of April 2002.” The new statement amends existing authoritative pronouncements to makevarious technical corrections, clarify meanings, or describe their applicabilityunder changed conditions.  SFAS No. 145was adopted by us effective May 1, 2001. The adoption of SFAS No. 145 required the classification of the loss onearly extinguishment of convertible subordinated bridge notes as a component ofnet loss from recurring operations for fiscal year 2002 versus being classifiedas an extraordinary item.

 

In June 2002, theFASB issued SFAS No. 146, “Accounting for Exit or Disposal Activities”. The newstatement addresses the accounting for costs associated with exit or disposalactivities. The provisions of the statement will be effective for disposalactivities initiated after December 31, 2002. The adoption  of SFAS No. 146 is not expected to have amaterial impact on our financial position or results of operations.

 

**Qualitative and Quantitative Disclosures about Market Risk**

 

We develop our products in the U.S. andmarket our products globally.  Becausewe continue to derive our revenue primarily from sources outside of the U.S.,our financial results could be affected by many factors, such as changes incurrency exchange rates or weak economic conditions in foreign markets.  Substantially all of our sales aredenominated in U.S. dollars.  Astrengthening of the U.S. dollar could make our products less competitive inforeign markets.  We do not currentlyparticipate in any currency hedging activities to mitigate this risk.  We intend to assess the need to usefinancial instruments to hedge our exchange rate exposure on an ongoing basis.  Our interest income and expenses aresensitive to changes in the general level of U.S. interest rates, particularlysince our investments are in short-term instruments and our long-term debt and revolvingline of credit require interest payments calculated at variable rates.  Based on the current nature and levels ofour investments and debt, however, we believe that we currently have nomaterial market risk exposure.

 

Our general investing policy is to limitmarket and credit risk and the risk of principal loss.  All liquid investments with originalmaturities of three months or less are considered to be cash equivalents.

 

**InternalControls**

 

There were no significant changes in our internal controls or in otherfactors that could significantly affect these controls subsequent to the dateof our most recent evaluation.

 

 

13

----

 

**PART II OTHER INFORMATION**

 

ITEM 1   Legal Proceedings

 

As of September 16, 2002, we were not a party to any materiallitigation.

 

ITEM 2   Changes inSecurities and Use of Proceeds

 

Our RegistrationStatement on Form SB-2 (File No. 333-68884) was declared effective by the SECon November 20, 2001.

 

After deducting the totalexpenses of $1,353,515 of our initial public offering, our net proceeds wereapproximately $5,396,485**.**** **We estimate that weused $4,562,000 ofthe initial public offering net proceeds through July 31, 2002.  Such uses of proceeds represent: (1) $3,264,000 to fund sales andmarketing initiatives, including general and administrative expenses to support infrastructure and engineering and regulatory expenses to support operations,(2) $534,000to fund working capital requirements, (3) $224,000 to purchase capital equipment, (4) $500,000 to repay bridge notes,and (5) $40,000in advances to UROPACE.

 

ITEM 3   Defaults uponSenior Securities

 

Not applicable.

 

ITEM 4   Submission ofMatters to a Vote of Security Holders

 

Not applicable.

 

ITEM 5   OtherInformation

 

Not applicable.

 

ITEM 6   Exhibits andReports on Form 8-K

 

                (a)           Exhibits

 

                                None.

 

                (b)           Reports on Form 8-K

 

The registrant filed noCurrent Reports on Form 8-K during the quarter ended July 31, 2002.

 

14

----

 

**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:   September 16, 2002 | By              | /s/ Blair P. Mowery |   |
|                            |            | Blair P. Mowery |
|                            |            | President and Chief Executive Officer |
|                            |            |   |
|                            | By              | /s/ Jules L. Fisher |   |
|                            |            | Jules L. Fisher |
|                            |            | Chief Financial Officer |

 

 

 

15

----

**CERTIFICATIONS**

* *

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

 

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

 

1.             I have reviewed this quarterly report on Form 10-QSB ofMedicalCV, Inc.;

 

2.             Based on my knowledge, this quarterly report does notcontain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report; and

 

3.             Based on my knowledge, the financial statements, and otherfinancial information included in this quarterly report, fairly present in allmaterial respects the financial condition, results of operations and cash flowsof the registrant as of, and for, the periods presented in this quarterlyreport.

 

 
| Dated: | September 16,  2002 | By     |   | /s/ Blair P.  Mowery                   |
|--------|---------------------|--------|--------|----------------------------------------|
|   |                |   |   | Blair P. Mowery                        |
|   |                |   |   | President and  Chief Executive Officer |

 

 

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

 

I, Jules L. Fisher, ChiefFinancial Officer of MedicalCV, Inc., certify that:

 

1.             I have reviewed this quarterly report on Form 10-QSB ofMedicalCV, Inc.;

 

2.             Based on my knowledge, this quarterly report does notcontain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report; and

 

3.             Based on my knowledge, the financial statements, andother financial information included in this quarterly report, fairly presentin all material respects the financial condition, results of operations andcash flows of the registrant as of, and for, the periods presented in thisquarterly report.

 

 
| Dated: | September 16,  2002 | By     |   | /s/ Jules L.  Fisher     |
|--------|---------------------|--------|--------|--------------------------|
|   |                |   |   | Jules L. Fisher          |
|   |                |   |   | Chief Financial  Officer |

 

 

16

----

 

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

 

In connection with theQuarterly Report of MedicalCV, Inc. (the “Company”) on Form 10-QSB for thequarterly period ended July 31, 2002, as filed with the Securities and ExchangeCommission on the date hereof (the “Report”), I, Blair P. Mowery, President andChief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,that:

 

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

 

(2)           the information contained in theReport fairly presents, in all material respects, the financial condition andresults of operations of the Company.

 

 
| Dated: | September 16,  2002 | By     |   | /s/ Blair P.  Mowery                   |
|--------|---------------------|--------|--------|----------------------------------------|
|   |                |   |   | Blair P. Mowery                        |
|   |                |   |   | President and  Chief Executive Officer |

 

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

 

In connection with theQuarterly Report of MedicalCV, Inc. (the “Company”) on Form 10-QSB for thequarterly period ended July 31, 2002, as filed with the Securities and ExchangeCommission on the date hereof (the “Report”), I, Jules L. Fisher, ChiefFinancial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350,as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

 

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

 

(2)           the information contained in theReport fairly presents, in all material respects, the financial condition andresults of operations of the Company.

 

 
| Dated: | September 16,  2002 | By     |   | /s/ Jules L.  Fisher     |
|--------|---------------------|--------|--------|--------------------------|
|   |                |   |   | Jules L. Fisher          |
|   |                |   |   | Chief Financial  Officer |

 

17

----