**UNITED STATES**

**SECURITIES 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 JANUARY 31, 2005** |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                             |
| **o**      | ** ** | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                     |

 

**CommissionFile Number 0-33295**

 

**MEDICALCV, INC.**

(Exact Name of Small BusinessIssuer as Specified in Its Charter)

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

 

**9725South Robert Trail**

**InverGrove Heights, Minnesota 55077**

**(651)452-3000**

(Address of Principal ExecutiveOffices and Issuer’s

Telephone Number)

 

Check whether the issuer:  (1) filed all reports required tobe filed by Section 13 or 15(d) of the Exchange Act during the past12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

 

Yes ý  No o

 

As of March 15, 2005, the issuer had outstanding 10,737,083 sharesof common stock.

 

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

 

 

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**TABLEOF CONTENTS**

 
| PART I       | FINANCIAL INFORMATION |
|-------------------|-----------------------|
|              |                  |   |
|              | ITEM 1                | Financial Statements |   |
|              |                  | Consolidated Balance Sheets at January 31, 2005 (unaudited) and April 30, 2004 |   |
|              |                  | Consolidated Statements of Operations for  the three and nine-month periods ended January 31, 2005 (unaudited) and January 31, 2004  (unaudited) |   |
|              |                  | Consolidated Statements of Cash Flows for  the nine-month periods ended January 31, 2005 (unaudited) and January 31, 2004  (unaudited) |   |
|              |                  | Notes to Consolidated Financial Statements |   |
|              | ITEM 2                | Management’s Discussion and Analysis or  Plan of Operation |   |
|              | ITEM 3                | Controls and Procedures |   |
|              |                  |   |
| PART II      | OTHER INFORMATION     |   |
|              |                  |   |
|              | ITEM 1                | Legal Proceedings |   |
|              | ITEM 2                | Unregistered Sales of Equity Securities and  Use of Proceeds |   |
|              | ITEM 3                | Defaults Upon Senior Securities |   |
|              | ITEM 4                | Submission of Matters to a Vote of Security  Holders |   |
|              | ITEM 5                | Other Information |   |
|              | ITEM 6                | Exhibits |   |
|              |                  |   |
| SIGNATURES        |                  |
| INDEX TO EXHIBITS |                  |

 

2

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**PART I**

** **

**ITEM 1FINANCIAL STATEMENTS**

 

**MEDICALCV,INC.**

**Consolidated Balance Sheets**

 

 

 
| ** **                                                                                                                         | ** ** | **January 31,  2005** | ** ** | **April 30,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| ** **                                                                                                                         | ** ** | **(unaudited)**            | ** ** | ** **               | ** ** |
| **ASSETS**                                                                                                                         |       |                       |       |                     |       |
| Current  assets:                                                                                                                   |       |                       |       |                     |       |
| Cash and  cash equivalents                                                                                                         |       | $                          | 197,279    |                     | $          | 659,856 |   |
| Trade and  accounts receivable, net                                                                                                |       | 468,240                    |       | 1,495,401                |       |
| Inventories                                                                                                                        |       | 1,025,552                  |       | 2,518,698                |       |
| Prepaid  expenses and other assets                                                                                                 |       | 96,581                     |       | 211,816                  |       |
| Total  current assets                                                                                                              |       | $                          | 1,787,652  |                     | $          | 4,885,771 |   |
| Property,  plant and equipment, net                                                                                                |       | 1,077,213                  |       | 1,135,618                |       |
| Deferred  financing costs, net                                                                                                     |       | 60,044                     |       | 74,605                   |       |
| Total assets                                                                                                                       |       | $                          | 2,924,909  |                     | $          | 6,095,994 |   |
|                                                                                                                               |       |                       |       |                     |       |
| **LIABILITIES  AND SHAREHOLDERS’ DEFICIT**                                                                                    |       |                       |       |                     |       |
| Current  liabilities:                                                                                                              |       |                       |       |                     |       |
| Accounts  payable                                                                                                                  |       | $                          | 1,264,573  |                     | $          | 1,498,848 |   |
|                                                                                                                               |       |                       |       |                     |       |   |   |
| Current  portion of long-term debt with related parties and shareholders                                                           |       | 3,443,333                  |       | —                   |       |
| Current  portion of related party lease obligations                                                                                |       | 295,124                    |       | 288,995                  |       |
| Short term  convertible notes payable, including note payable to related party                                                     |       | 851,031                    |       | —                   |       |
| Note payable                                                                                                                       |       | —                     |       | 485,708                  |       |
| Accrued  expenses                                                                                                                  |       | 443,683                    |       | 266,671                  |       |
| Total  current liabilities                                                                                                         |       | $                          | 6,297,744  |                     | $          | 2,540,222 |   |
| Long-term  debt with related parties                                                                                               |       | —                     |       | 3,443,333                |       |
| Related  party lease obligations, less current portion                                                                             |       | 2,954,444                  |       | 3,166,425                |       |
| Total  liabilities                                                                                                                 |       | $                          | 9,252,188  |                     | $          | 9,149,980 |   |
|                                                                                                                               |       |                       |       |                     |       |
| Shareholders’  deficit:                                                                                                       |       |                       |       |                     |       |
| Preferred  stock, $.01 par value; 5,000,000 shares authorized; no shares issued and  outstanding                                   |       |                       |       |                     |       |
| Common  stock; $.01 par value; 95,000,000 shares authorized; 10,733,333 and 9,189,933  shares issued and outstanding, respectively |       | $                          | 107,333    |                     | $          | 91,899 |   |
| Additional  paid-in capital                                                                                                        |       | 22,557,866                 |       | 20,168,133               |       |
| Deferred stock-based  compensation                                                                                                 |       | (681                       | )          | (1,933                   | )          |
| Accumulated  deficit                                                                                                               |       | (28,991,797                | )          | (23,312,085              | )          |
| Total  shareholders’ deficit                                                                                                  |       | $                          | (6,327,279 | )                        | $          | (3,053,986 | ) |
| Total  liabilities and shareholders’ deficit                                                                                  |       | $                          | 2,924,909  |                     | $          | 6,095,994 |   |

 

The accompanying notes arean integral part of these financial statements.

 

3

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**MEDICALCV, INC.**

**Consolidated Statements of Operations**

**(unaudited)**

 
| ** **                                                                          | ** ** | **Three Months Ended January 31,** | ** ** | **Nine Months Ended January 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                          | ** ** | **2005**                                | ** ** | **2004**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Net  sales**                                                                      |       | $                                       | 550,528    |                                   | $          | 836,733 |   | $ | 1,805,658 |   | $ | 2,544,494 |   |
| **Cost of  goods sold**                                                             |       | 569,244                                 |       | 481,144                                |       | 2,529,457 |   | 1,404,436 |   |
| **Gross  profit (loss)**                                                            |       | $                                       | (18,716    | )                                      | $          | 355,589 |   | $ | (723,799 | ) | $ | 1,140,058 |   |
| **Operating  expenses:**                                                            |       |                                    |       |                                   |       |   |   |   |   |
| **Sales  and marketing**                                                            |       | 413,949                                 |       | 396,297                                |       | 796,713 |   | 1,502,308 |   |
| **General  and administrative**                                                     |       | 744,493                                 |       | 649,552                                |       | 2,487,348 |   | 1,830,617 |   |
| **Engineering  and regulatory**                                                     |       | 552,266                                 |       | 279,537                                |       | 1,250,443 |   | 684,219 |   |
| **Total  operating expenses**                                                       |       | $                                       | 1,710,708  |                                   | $          | 1,325,386 |   | $ | 4,534,504 |   | $ | 4,017,144 |   |
| **Loss  from operations**                                                           |       | $                                       | (1,729,424 | )                                      | $          | (969,797 | ) | $ | (5,258,303 | ) | $ | (2,877,086 | ) |
| **Other  (expense) income:**                                                        |       |                                    |       |                                   |       |   |   |   |   |
| **Interest  expense**                                                               |       | (136,941                                | )          | (368,863                               | )          | (429,715 | ) | (828,119 | ) |
| **Interest  income**                                                                |       | 56                                      |       | —                                 |       | 3,711 |   | 4,993 |   |
| **Other  (expense) income, net**                                                    |       | 1,623                                   |       | 10,609                                 |       | 4,595 |   | 6,038 |   |
| **Total  other expense**                                                            |       | $                                       | (135,262   | )                                      | $          | (358,254 | ) | $ | (421,409 | ) | $ | (817,088 | ) |
|                                                                                |       |                                    |       |                                   |       |   |   |   |   |
| **Net loss**                                                                        |       | $                                       | (1,864,686 | )                                      | $          | (1,328,051 | ) | $ | (5,679,712 | ) | $ | (3,694,174 | ) |
| **Basic  and diluted net loss per share**                                           |       | $                                       | (0.17      | )                                      | $          | (0.15 | ) | $ | (0.54 | ) | $ | (0.42 | ) |
|                                                                                |       |                                    |       |                                   |       |   |   |   |   |
| **Weighted  average shares used in computing basic and diluted net loss per share** |       | 10,730,944                              |       | 8,737,214                              |       | 10,613,627 |   | 8,737,214 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

4

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**MEDICALCV, INC.**

 

**Consolidated Statements of Cash Flows**

(unaudited)

 
| ** **                                                                                                   | ** ** | **Nine Months Ended January 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                   | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Cash flows  from operating activities:                                                                       |       |                                   |       |   |   |
| Net loss                                                                                                     |       | $                                      | (5,679,712 | ) | $ | (3,694,924 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities:                                 |       |                                   |       |   |   |
| Depreciation                                                                                                 |       | 236,595                                |       | 236,352 |   |
| Provision  for doubtful accounts                                                                             |       | 220,281                                |       | (33,451 | ) |
| Provision  for inventory obsolescence                                                                        |       | 1,277,691                              |       | — |   |
| Warrant  expense related to purchase of technology                                                           |       | 18,373                                 |       | 31,280 |   |
| Stock-based  compensation                                                                                    |       | 249,048                                |       | 178,417 |   |
| Interest  expense related to issued warrants and amortization of loan origination costs                      |       | 62,339                                 |       | 630,909 |   |
| Changes in  assets and liabilities:                                                                          |       |                                   |       |   |   |
| Accounts  receivable                                                                                         |       | 806,880                                |       | 138,598 |   |
| Inventories                                                                                                  |       | 215,455                                |       | (63,195 | ) |
| Prepaid  expenses and other assets                                                                           |       | 144,795                                |       | 53,059 |   |
| Accounts  payable                                                                                            |       | (234,275                               | )          | 357,549 |   |
| Accrued  expenses                                                                                            |       | 177,012                                |       | (489,544 | ) |
| Net cash  used in operating activities                                                                       |       | $                                      | (2,505,518 | ) | $ | (2,654,950 | ) |
|                                                                                                         |       |                                   |       |   |   |
| Cash flows  from investing activities:                                                                       |       |                                   |       |   |   |
| Purchase of  property, plant and equipment                                                                   |       | $                                      | (201,313   | ) | $ | (6,852 | ) |
| Proceeds  from the sale of property, plant and equipment                                                     |       | 23,123                                 |       | — |   |
| Net cash  used in investing activities                                                                       |       | $                                      | (178,190   | ) | $ | (6,852 | ) |
|                                                                                                         |       |                                   |       |   |   |
| Cash flows  from financing activities:                                                                       |       |                                   |       |   |   |
| Borrowings  under term debt arrangements                                                                     |       | 925,000                                |       | 3,293,038 |   |
| Deferred  financing costs                                                                                    |       | —                                 |       | (210,424 | ) |
| Proceeds  from the issuance of common stock and warrants, net of offering costs                              |       | 2,000,608                              |       | 96,650 |   |
| Proceeds  from option exercise                                                                               |       | 1,375                                  |       | — |   |
| Payments of  long-term debt                                                                                  |       | (500,000                               | )          | — |   |
| Principal  payments under capital lease obligations                                                          |       | —                                 |       | (42,069 | ) |
| Principal  payments under related party lease obligations                                                    |       | (205,852                               | )          | (508,456 | ) |
| Net cash  provided by financing activities                                                                   |       | $                                      | 2,221,131  |   | $ | 2,628,739 |   |
|                                                                                                         |       |                                   |       |   |   |
| Net decrease  in cash and cash equivalents                                                                   |       | (462,577                               | )          | (33,063 | ) |
| Cash and  cash equivalents at beginning of year                                                              |       | 659,856                                |       | 184,227 |   |
| Cash and  cash equivalents at end of period                                                                  |       | $                                      | 197,279    |   | $ | 151,164 |   |
|                                                                                                         |       |                                   |       |   |   |
| Supplemental  cash flow information                                                                          |       |                                   |       |   |   |
|                                                                                                         |       |                                   |       |   |   |
| Cash paid  for interest                                                                                      |       | 345,387                                |       | 420,966 |   |
| Non-cash  investing and financing activities                                                                 |       |                                   |       |   |   |
| Discount on  convertible subordinated bridge notes related to warrants granted in  connection with the notes |       | $                                      | 48,047     |   | $ | 896,536 |   |

 

The accompanying notes are an integral part of thesefinancial statements.

 

5

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**MEDICALCV,INC.**

 

**Notes to Consolidated Financial Statements**

 

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

 

The accompanying unaudited consolidated financial statements includedherein have been prepared by MedicalCV, Inc. (the “Company”) in accordancewith accounting principles generally accepted in the United States of America forinterim financial information and pursuant to the rules and regulations ofthe Securities and Exchange Commission.  Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of Americahave been condensed or omitted pursuant to such rules andregulations.  These consolidated interim financial statements should beread in conjunction with the consolidated financial statements and the notesthereto included in the Company’s Annual Report on Form 10-KSB forthe fiscal year ended April 30, 2004.

 

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

 

During the quarter ended January 31, 2005, certain equipment witha carrying value of $152,500, that was previously included in other long-termassets, was placed into use at customer sites. Accordingly, the Company has reclassified this equipment into property,plant and equipment and is depreciating it over its estimated useful life of 18months.

 

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

 

The Company’s consolidated financial statements for the quarter ended January 31,2005, have been prepared on a going concern basis, which contemplates therealization of assets and settlement of liabilities and commitments in thenormal course of business.  The Company has sustained losses and negativecash flows from operations in recent years and expects these conditions tocontinue for the foreseeable future.  At January 31, 2005, theCompany had an accumulated deficit of $28,991,797 and has insufficient funds tofinance its working capital and capital expenditure needs. These matters raisesubstantial doubt about the Company’s ability to continue as a goingconcern.  The Company is currently seeking sources of financing to fundits operations and working capital requirements.  If the Company is unableto obtain additional funds during fiscal year 2005, 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 or respond to competitive pressures or unanticipatedrequirements, which could seriously harm its business, financial position andresults of operations.  These financial statements do not include anyadjustments that might result from the outcome of this uncertainty.

 

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

 

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

 

The Company accounts for stock-based employee compensation arrangementsin accordance with the provisions of Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees,” and complies with the disclosureprovisions of SFAS No. 123, “Accounting for Stock-Based Compensation” andSFAS No. 148 “Accounting for Stock-Based Compensation-Transition andDisclosure, an amendment of FASB Statement No. 123.”

 

6

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For purposes of the pro forma disclosures below, the estimated fairvalue of the options is amortized to expense over the options’ vestingperiod.  Had compensation cost for the Company’s stock options beenrecognized based on the fair value at the grant date consistent with theprovisions of SFAS No. 123, the Company’s net loss would have beenadjusted to the pro forma amounts indicated below:

 
| ** **                                              | ** ** | **For the Periods Ended January 31,** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                              | ** ** | **Three Months**                           | ** ** | **Nine Months** | ** ** |
| ** **                                              | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss  reported                                      |       | $                                          | (1,796,732 | ) | $ | (1,328,051 | ) | $ | (5,611,758 | ) | $ | (3,694,925 | ) |
| Less:  Pro-forma stock-based employee compensation cost |       | (211,066                                   | )          | (119,294 | ) | (211,066 | ) | (259,954 | ) |
|                                                    |       |                                       |       |   |   |   |   |   |   |
| Net loss –  pro forma                              |       | (2,007,798                                 | )          | (1,447,345 | ) | (5,822,824 | ) | (3,954,879 | ) |
|                                                    |       |                                       |       |   |   |   |   |   |   |
| Net loss per  common share – basic and diluted     |       |                                       |       |   |   |   |   |   |   |
| As reported                                             |       | (.17                                       | )          | (.15 | ) | (.53 | ) | (.42 | ) |
| Pro Forma                                               |       | (.19                                       | )          | (.17 | ) | (.55 | ) | (.45 | ) |
|                                                         |            |                                            |            |  |  |  |  |  |  |  |  |  |  |

 

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

 

Net loss per shareis computed under the provisions of SFAS No. 128, “Earnings Per Share.” Basic net loss per common share is computed using net loss and theweighted-average number of shares of common stock outstanding.  Dilutedearnings per share reflect the potential dilution of securities that couldshare in the earnings of an entity.  Diluted net loss per common sharedoes not differ from basic net loss per common share in the three andnine-month periods ended January 31, 2005 and 2004, since the potentiallydilutive shares are anti-dilutive.  Potentially dilutive shares excludedfrom the calculation of diluted net loss per share relate to outstanding stockoptions and warrants, excluding shares issuable upon conversion of contingentlyconvertible notes, aggregating 2,185,488 and 5,457,731 shares of the Company’scommon stock at January 31, 2005 and 2004, respectively.

 

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

 
| ** **      | ** ** | **January 31, 2005** | ** ** | **April 30, 2004** | ** ** |
|-----------------|------------|---------------------------|------------|-------------------------|------------|
| ** **      | ** ** | ** **                | ** ** | ** **              | ** ** |
| Raw  materials  |       | $                         | —     |                    | $          | 97,094 |   |
| Work-in-process |       | —                    |       | 216,324                 |       |
| Finished  goods |       | 1,025,552                 |       | 2,205,300               |       |
|            |       | $                         | 1,025,552  |                    | $          | 2,518,698 |   |

 

During November 2004, the Company’s Board of Directors approved aplan to suspend production of heart valves and authorized management to pursueoptions for exiting the heart valve business.  During the second quarterof fiscal year 2005, the Company experienced a decline in sales of its heartvalves which management believed was the result of changes to the terms of itsarrangements with its distributors and to the Company’s focus on exiting thisbusiness.  As a result of these factors, management had determined thatcurrent sales trends indicated that the Company had excess inventories as wellas inventories with carrying values in excess of their realizable values. Accordingly, during the quarter ended October 31, 2004, the Companyrecorded a $1,267,441 reduction in the carrying value of certain heart valveinventories.  This reduction in carrying value was recorded as a charge tocost of goods sold.

 

**(6)****                                 RestructuringCharge**

 

In the quarter ended July 31, 2004, the Company restructured itsexecutive management team, resulting in the termination of two employees, whichresulted in a charge of approximately $214,000, to general and administrative

 

7

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expenses.  This charge represented the amount of future severancepayments due to these former employees.  During the quarter ended October 31,2004, the Company terminated an additional five employees in an effort toreduce operating costs.  This restructuring resulted in approximately$46,000 of additional severance costs, which were charged to general andadministrative expense.  In the quarterended January 31, 2005, the Company terminated an additional elevenemployees resulting in approximately $49,000 of severance costs charged togeneral and administrative expense.  The Company expects to pay allamounts due to these former employees by August 2005.  As of January 31,2005, $97,953 remained accrued but not paid.

 
| ** **                               | ** ** | **Total** | ** **  |
|------------------------------------------|------------|-----------|-------------|
| Restructuring  charges                   |       | $         | 214,000     |   |
| Cash usage                               |       | —    |        |
| **Balance  as of July 31, 2004**    | ** ** | **$**     | **214,000** | ** ** |
| Adjustments  to provision                |       | 46,000    |        |
| Cash usage                               |       | 93,239    |        |
| **Balance  as of October 31, 2004** | ** ** | **$**     | **116,761** | ** ** |
| Adjustments  to provision                |       | 48,000    |        |
| Cash usage                               |       | 116,808   |        |
| **Balance  as of January 31, 2005** | ** ** | **$**     | **97,953**  | ** ** |

 

**(7)****                                 Equitysale**

 

In February, April and May, 2004, the Company conducted a privateplacement to accredited investors of units, each unit consisting of one shareof common stock and one common stock purchase warrant to purchase one share ofcommon stock.  In this placement, 2,730,763 units were sold at $1.47for aggregate gross proceeds of $4,014,222.  During fiscal year 2004, theCompany received gross proceeds from this private placement of$1,749,099.  The five-year warrants sold with the common stock areexercisable to purchase an aggregate of 2,730,763 shares of common stock at anexercise price of $1.60 per share.  In connection with such placement, theCompany issued its agent a five-year warrant to purchase 123,272 units at anexercise price of $1.8375 per unit, paid its agent cash commissions of $181,210and paid its agent an expense allowance of $67,954.  Other offering coststotaling $13,052 were also incurred in connection with this transaction. Inconnection with such placement, the Company issued its finder a five-yearwarrant to purchase 190,378 units at an exercise price of $1.8375 per unit,paid its finder a finder’s fee of $140,928 and reimbursed its finder forexpenses of $4,163.  The warrants underlying the unit warrants issued tothe agent and the finder are exercisable for a period of five-years at anexercise price of $1.8375 per share.

 

**(8)****                                 SegmentInformation**

 

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

 

8

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The following table summarizes net sales by geographic area:

 
| ** **     | ** ** | **Three Months Ended January 31,** | ** **  | **Nine Months Ended January 31,** | ** ** |
|----------------|------------|-----------------------------------------|-------------|----------------------------------------|------------|
| ** **     | ** ** | **2005**                                | ** **  | **2004**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Europe         |       | $                                       | 300,500     |                                   | $          | 415,509 |   | $ | 900,817 |   | $ | 1,275,597 |   |
| South Asia     |       | 30,000                                  |        | 92,800                                 |       | 30,000 |   | 291,200 |   |
| Middle East    |       | 98,772                                  |        | 149,070                                |       | 444,860 |   | 403,591 |   |
| Far East       |       | 26,810                                  |        | 16,090                                 |       | 42,234 |   | 69,270 |   |
| United  States |       | 53,446                                  |        | 153,508                                |       | 313,844 |   | 440,308 |   |
| Other          |       | 41,000                                  |        | 9,756                                  |       | 73,903 |   | 64,528 |   |
|           |       |                                    |        |                                   |       |   |   |   |   |
| **TOTALS**     | ** ** | **$**                                   | **550,528** | ** **                             | **$**      | **836,733** | ** ** | **$** | **1,805,658** | ** ** | **$** | **2,544,494** | ** ** |

 

**(9)****                                 DebtFinancing**

 

In December 2004 and January 2005, theCompany issued convertible bridge notes totaling $425,000.  The notes, which are due on May 31,2005, bear interest at the rate of 10 percent per year and are convertible intosecurities to be issued in the Company’s next equity financing, if any.  Within 10 days of the consummation of theCompany’s next equity financing, if any, each note holder will be required toelect one of the following two alternatives: (1) convert the entire unpaid principal and all accrued but unpaidinterest under the note into equity securities sold by the Company in its nextequity financing (“Next Shares”) at a price per share equal to eighty percent(80%) of the issuance price of the Next Shares, and retain the warrants issuedin connection with the convertible bridge notes, or (2) surrender the noteand the warrants issued in connection with the bridge notes to the Company inexchange for the issuance of a number of Next Shares and any accompanyingwarrants issuable in connection with the Next Shares, equal to the amount ofsuch securities that could be purchased using the entire unpaid principal andall accrued but unpaid interest under the note.

 

In connection with issuance of the convertible bridgenotes, the Company issued to the note holders warrants to purchase up to 85,000shares of common stock.  The warrants, which have a five-year term,are exercisable at a price per share equal to the per share or per unit priceof equity securities sold in the Company’s next offering.  However, such exercise price will not exceed$1.49 per share.  The warrants containanti-dilution provisions.  Theallocated fair value of the newly issued warrants was $79,030 and is accountedfor as a discount on the borrowings. This discount, which is presented as areduction of the carrying value of the debt on the consolidated balance sheetis being amortized as interest expense over the five-month term of the debt. Asof January 31, 2005, the unamortized balance of the discount was $63,224.

 

Because the convertible bridge notes provide a contingent conversionoption to the note holders which will result in a beneficial conversion priceif converted, the Company will record an interest charge in the event the notesare converted.  The amount of thisinterest charge will be determined at the time of the conversion, if any.

 

On November 17, 2004, the Company entered into a discretionarycredit agreement (the “October 2004 Discretionary Credit Agreement”) withPKM Properties, LLC (“PKM”), an entity controlled by Paul K. Miller, one of itsdirectors and the largest beneficial owner of its securities, covering advancesby PKM of up to $500,000.  The October 2004 Discretionary CreditAgreement had a maturity date of February 28, 2005, that was subsequentlyextended to June 30, 2005.  It requires the payment of interest at arate of 10 percent per year, and it also contains various representations andloan covenants as are customary in banking and finance transactions.  TheCompany issued a credit note to PKM to evidence such indebtedness.

 

In connection with the October 2004 DiscretionaryCredit Agreement, the Company entered into an intellectual property securityagreement with PKM pursuant to which PKM was granted a security interest in allof the Company’s intellectual property.  The Company and its creditorsagreed to an amendment to the first amended and restated subordination andinter-creditor agreement by and between PKM and Peter L. Hauser (“Hauser”). Pursuant to this agreement, proceeds borrowed under the October 2004Discretionary Credit Agreement are deemed “senior debt”.  Further, PKM,pursuant to a waiver agreement, waived past defaults under the January 2003Discretionary Credit Agreement and the November 2003 CreditAgreement.  These defaults involved the late payments of interest andfailure to send periodic financial statements. As additional consideration forthe October 2004 Discretionary

 

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Credit Agreement, the Company issued to PKM a warrantwith a ten-year term to purchase 34,014 shares of the Company common stock at aper share exercise price equal to the lower of (1) $1.47 or (2) theprice at which the Company first sells its common stock or units (minus thevalue of the warrant component thereof determined at the date of sale thereofusing the Black Scholes formula) after November 17, 2004, but not lessthan $1.00.  The warrant containsanti-dilution provisions.  The allocatedfair value of the newly issued warrant was $42,986 and is accounted for as adiscount on the borrowings. This discount, which is presented as a reduction ofthe carrying value of the debt on the consolidated balance sheet is beingamortized as interest expense over the original four-month term of the debt. Asof January 31, 2005, the unamortized balance of the discount was $10,747.

 

**(10)****                          SubsequentEvent**

 

On March 3, 2005, we entered into a February 2005 Credit Agreement (the“Agreement”) with PKM Properties, LLC, an entity controlled by Paul K. Miller,one of our directors and the largest beneficial owner of our securities.  The Agreement provides for a $500,000discretionary credit facility under which PKM will make available to us up to$500,000 in the form of loans bearing interest at 10% per year.  Principal and interest are due on the amountsborrowed no later than June 16, 2005. This debt and the other amounts we have borrowed from PKM are collateralizedby substantially all of our assets.  AFebruary 2005 Discretionary Credit Note (“Note”) reflects thisindebtedness.  As additionalconsideration, we issued to PKM a five-year warrant (the “Warrant”).  We also acknowledged Amendment No. 4 to the FirstAmended and Restated Subordination and Intercreditor Agreement (the“Amendment”) by and between Peter L. Hauser and PKM.  We also paid the legal and administrativeexpenses incurred by PKM associated with this transaction.

 

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##### **ITEM2**                                                        MANAGEMENT’SDISCUSSION AND ANALYSIS OR PLAN OF OPERATION

 

*The following discussion contains variousforward-looking statements within the meaning of Section 21E of theExchange Act.  Although we believe that, in making any such statement, ourexpectations are based on reasonable assumptions, any such statement may beinfluenced by factors that could cause actual outcomes and results to bematerially different from those projected.  When used in the followingdiscussion, the words “anticipates,” “believes,” “expects,” “intends,” “plans,”“estimates” and similar expressions, as they relate to us or our management,are intended to identify such forward-looking statements.  Theseforward-looking statements are subject to numerous risks and uncertainties thatcould cause actual results to differ materially from those anticipated. Factors that could cause actual results to differ materially from thoseanticipated, certain of which are beyond our control, are set forth in thisdocument and in our Current Report on Form 8-K filed January 6,2005, under the caption “Cautionary Statement.”*

 

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

 

**Overview**

 

MedicalCV is a cardiothoracic surgery device manufacturer. Previously, our primary focus was on heart valve disease.  We developedand marketed mechanical heart valves known as the Omnicarbon 3000 and4000.  In November 2004, after an exhaustive evaluation of thebusiness, we decided to explore options for exiting the mechanical valvebusiness.  We intend to direct our resources to the development andintroduction of products targeting treatment of atrial fibrillation.

 

Atrial fibrillation (“AF”) is the most common occurring cardiacarrhythmia.  It reduces cardiac output, is a major precursor to congestiveheart failure and is associated with an increased incidence of stroke. The incidence of AF increases with age.  Five and a half million peopleworldwide are afflicted with AF.  There are 320,000 new diagnoses annuallyworldwide.  Two and a half million Americans are afflicted with AF, with160,000 new diagnoses each year in the U.S.

 

In September 2003, we entered into an agreement with LightWaveAblation Systems, Inc., to purchase technology for the treatment of atrialfibrillation.  This technology provides an important growthplatform.  On December 1, 2004, we received FDA 510(k) clearance tomarket our AtriLazeTM Surgical Ablation System, which is a medical devicedesigned for ablating on cardiac tissue during surgery.

 

The AtriLaze System was used in four human atrial fibrillationprocedures during January 2005.  Wedid not generate any revenue from these procedures.  The AtriLaze system was provided, at no cost,to cardiovascular surgeons in order to begin marketing for proof-of-concept inthe clinical setting.  We expect tocontinue validating our technology with key cardiovascular surgeons during concomitantopen-heart procedures.  We expect tobegin selling hand-held devices for these procedures on a limited basisbeginning in the first quarter of fiscal year 2006.  Significant revenue is not expected until weintroduce a version of the AtriLaze System for stand-alone, minimally invasive,(closed-chest beating heart) ablation treatment of cardiac tissue.

 

On September 23, 2004, we announced that as a result of ourexpanded efforts into the atrial fibrillation market, we are reevaluating thelong-term strategic implications and alternatives for our mechanical heartvalve and pyrolytic carbon platforms.  On November 18, 2004, wedetermined to discontinue all heart valve related production and to pursueoptions for exiting the heart valve business.  We are still evaluating ouralternatives for exiting the heart valve business, and, at this time, do notbelieve that the carrying value of our long-lived assets are impaired. However, there can be no assurance that we will not incur a loss in connectionwith a subsequent exit transaction.

 

During the second and third quarters of fiscal year 2005, weexperienced a significant decline in sales of our heart valves, which webelieve is the result of changes to the terms of our arrangements with ourdistributors and to our focus on exiting the heart valve business.  As aresult of these factors, we determined, during the second quarter, that thesesales trends indicated that we had excess inventories as well as inventorieswith carrying values in excess of

 

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their realizable values.  Accordingly, during the quarter ended October 31,2004, we recorded a $1,267,441 reduction in the carrying value of certain heartvalve inventories.  This reduction in carrying value was recorded as acharge to cost of goods sold.

 

**Periods Ended January 31, 2005 and 2004**

 

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

 
| ** **                  | ** ** | **Three Months Ended January 31,** | ** ** | **Nine Months Ended January 31,** | ** ** |
|-----------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                  | ** ** | **2005**                                | ** ** | **2004**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net sales                   |       | 100.0                                   | %          | 100.0                                  | %          | 100.0 | % | 100.0 | % |
| Cost of  goods sold         |       | 103.4                                   | %          | 57.5                                   | %          | 140.1 | % | 55.2 | % |
|                        |       |                                    |       |                                   |       |   |   |   |   |
| Gross profit  (loss)        |       | (3.4                                    | )%         | 42.5                                   | %          | (40.1 | )% | 44.8 | % |
|                        |       |                                    |       |                                   |       |   |   |   |   |
| Operating  expenses:        |       |                                    |       |                                   |       |   |   |   |   |
|                        |       |                                    |       |                                   |       |   |   |   |   |
| Sales and  marketing        |       | 75.2                                    | %          | 47.4                                   | %          | 44.1 | % | 59.1 | % |
| General and  administrative |       | 135.2                                   | %          | 77.6                                   | %          | 137.8 | % | 71.9 | % |
| Engineering  and regulatory |       | 100.3                                   | %          | 33.4                                   | %          | 69.3 | % | 26.9 | % |
|                        |       |                                    |       |                                   |       |   |   |   |   |
| Total  operating expenses   |       | 310.7                                   | %          | 158.4                                  | %          | 251.1 | % | 157.9 | % |
|                        |       |                                    |       |                                   |       |   |   |   |   |
| Loss from  operations       |       | (314.1                                  | )%         | (115.9                                 | )%         | (291.2 | )% | (113.1 | )% |
|                        |       |                                    |       |                                   |       |   |   |   |   |
| Other  (expense) income:    |       |                                    |       |                                   |       |   |   |   |   |
|                        |       |                                    |       |                                   |       |   |   |   |   |
| Interest  expense           |       | (24.9                                   | )%         | (44.1                                  | )%         | (23.8 | )% | (32.5 | )% |
| Interest  income            |       | —                                  | %          | —                                 | %          | .2 | % | .2 | % |
| Other income                |       | .3                                      | %          | 1.3                                    | %          | .3 | % | .2 | % |
|                        |       |                                    |       |                                   |       |   |   |   |   |
| Total other  expense        |       | (24.6                                   | )%         | (42.8                                  | )%         | (23.3 | )% | (32.1 | )% |
|                        |       |                                    |       |                                   |       |   |   |   |   |
| Net loss                    |       | (338.7                                  | )%         | (158.7                                 | )%         | (314.6 | )% | (145.2 | )% |

 

**Critical Accounting Policies**

 

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

 

**Results of Operations**

 

*Net Sales*.  Netsales in the third quarter of fiscal year 2005 decreased to $550,528 from$836,733 in the third quarter of the prior year.  Net sales in thenine-month period ended January 31, 2005, decreased to $1,805,658 from$2,544,494 in the comparable period of the prior year.  During fiscal year2005, we changed certain pricing programs with several of ourdistributors.  This resulted in a disruption of sales to distributors incertain markets.  On November 18, 2004, the Company’s Board ofDirectors voted to discontinue all heart valve-related production andauthorized management to pursue options for exiting the heart valvebusiness.  Following this decision, weplaced all of our customers on cash, prepaid terms.  We believe these new terms and ourcompetitors’ efforts to capitalize on our decision to pursue exit of thismarket have caused a significant decrease in the volume of our heart valvesales.

 

Unit sales decreased 10.3 percent and 26.7 percent in the quarter andnine-month periods ended January 31, 2005, compared to the same periods inthe previous year, respectively.

 

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The average selling price per unit decreased 25.8 percent and 1.0percent in the quarter and nine-month periods ended January 31, 2005,compared to the same periods in the previous year, respectively.  During the quarter ended January 31,2005, in an effort to raise $250,000 in cash to continue operations, we sold800 heart valves at a fifty-five percent discount to one of our distributors,Mercé v. Electromedicina.

 

*Gross Profit.* Gross profit, as a percentage of net sales, decreased to (3.4) percent in thethird quarter of fiscal year 2005, from 42.5 percent in the third quarter ofthe prior year.  Fiscal year-to-date gross profit margins in fiscal year2005 decreased to (40.1) percent compared to 44.8 percent in the same periodlast fiscal year.  The gross margin declined in the three-month periodended January 31, 2005, as a result of the decision to curtailmanufacturing heart valves causing unfavorable overhead variances, which wereincluded in cost of goods sold.  Theyear-to-date decline was due primarily to the $1,267,441 charge to cost ofgoods sold recorded in the second quarter of fiscal year 2005 to reduce thecarrying value of inventories and the decline in unit sales which reduced theabsorption of our fixed manufacturing costs.

 

*Sales and Marketing*. Sales and marketing expenses in the third quarter of fiscal year 2005 were$413,949 or 75.2 percent of net sales compared to $396,297 or 47.4 percent ofnet sales in the third quarter of the prior year.  For the nine-monthperiod ended January 31, 2005, sales and marketing expenses totaled$796,713 or 44.1 percent of net sales, compared to $1,502,308 or 59.1 percentof net sales in the same period last fiscal year. The increase in sales andmarketing expenses in the three-month period ended January 31, 2005compared to the three-month period ended January 31, 2004 was attributableto consulting expenses incurred by foreign distributors. The decrease insales and marketing expenses in the nine-month period ended January 31,2005, compared to the nine-month period ended January 31, 2004 wasprimarily attributable to a decline in sales that resulted primarily fromchanges made in terms of distributor arrangements in fiscal year 2005. This resulted in a disruption of sales to distributors in certain markets.

 

*General and Administrative*. General and administrative expenses for the third quarter of fiscal year 2005were $744,493 or 135.2 percent of net sales, compared to $649,552 or 77.6percent of net sales in the same period one year ago.  For the nine-monthperiod ended January 31, 2005, general and administrative expenses totaled$2,487,348 or 137.8 percent of net sales, compared to $1,830,617 or 71.9percent of net sales in the same period last year. Included in the generaland administrative expense for the three months ended January 31, 2005,are reductions in executive salary due to the restructuring of the managementteam during fiscal year 2005.  Decreasesin consulting fees were partially offset by increases in travel and legal feesrelated to AtriLazeTM Surgical Ablation System. Included in the general and administrative expenses for the nine monthsended January 31, 2005, were $277,000 of severance costs resulting fromthe restructuring of our executive management team and the termination of otheremployees, $117,412 in bad debt expenses and increased legal fees relating tonew product development. Increased travel expenses of $120,000 and non-cashexpenses of $82,386 related to warrants issued accounted for the majority ofthe remainder of the increase. As of January 31, 2005, we have accruedremaining severance payments of approximately $97,953, which we expect tofinish paying by August 2005.

 

*Engineering and Regulatory*. Engineering and regulatory expenses for the third quarter of fiscal year 2005were $552,266 or 100.3 percent of net sales compared to $279,537 or 33.4percent of net sales in the third quarter of the prior fiscal year.  Forthe nine-month period ended January 31, 2005, engineering and regulatoryexpenses totaled $1,250,443 or 69.3 percent of net sales, compared to $684,219or 26.9 percent of net sales in the same period last year.  Expensesrelated to the development of our initial atrial fibrillation product accountedfor the increase in spending for the quarter and nine-month periods ended January 31,2005, compared to the quarter and nine-month periods ended January 31, 2004.

 

*Other (Expense) Income*. Interest expense totaled $136,941 in the quarter ended January 31, 2005,compared to $368,863 in the third quarter of the prior fiscal year. Fiscal year-to-date interest expense was $429,715 compared to $828,119 inthe same period one year ago.  The decreases in interest expense in thethird quarter and year-to-date periods were attributed to a decrease infinancing costs associated with the private placement completed in May 2004.

 

*Income Tax Provision*. In light of our history of operating losses, we have recorded a valuationallowance to fully offset our deferred tax assets.  We have continued toprovide a full valuation allowance through the third quarter of fiscal year2005 due to the inherent uncertainty about our ability to generate sufficienttaxable income to realize

 

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these deferred tax assets.  We have recorded no tax provision inthe current period due to net operating losses generated for income taxreporting purposes.

 

**Liquidity and Capital Resources**

 

Cash and cashequivalents decreased to $197,279 at January 31, 2005, from $659,856 at April 30,2004.  This decrease in cash and cash equivalents of $462,577 was due tothe following:

 
| Net cash  used in operating activities     |   | $         | (2,413,062 | ) |
|--------------------------------------------|--------|-----------|------------|---|
| Net cash  used in investing activities     |   | (178,190  | )          |
| Net cash  provided by financing activities |   | 2,128,675 |       |
| Net decrease                               |   | $         | (462,577   | ) |

 

Net cash used by operating activities for the nine-month period ended January 31,2005, totaled $2,413,062.  Negative operating cash flows resultedprimarily from the net loss of $5,679,712 for the period, partially offset bynet non-cash adjustments of $2,186,343, relating primarily to an increase inthe inventory and bad debt provisions, depreciation and expense related to theissuance of warrants for services.  The net decrease in cash flows fromoperating activities was also partially offset by changes in operating assetsand liabilities of $1,080,307, relating primarily to decreases in accounts receivableand prepaid expenses, net of an increase in accounts payable.  The decrease in accounts receivable resultedfrom the decline in sales of heart valves. The increase in accounts payable was primarily the result of our effortsto conserve cash.

 

Net cash used in investing activities for the nine-month period ended January 31,2005, totaled $178,190.  We used $152,500 to purchase equipment that wewill use to support customers of our initial atrial fibrillation product. The funds used were partially offset by the proceeds from the sale of otherequipment.

 

Net cash provided by financing activities for the nine-month periodended January 31, 2005, totaled $2,128,675.  Net proceeds from theissuance of common stock and warrants totaled $2,016,982.  Proceeds from the issuance of  convertible notes totaled $425,000. We alsoreceived $500,000 from a related party as a short term loan. These proceedswere partially offset by payments of short-term debt and the related-partylease obligation of $327,868.

 

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

 

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

 

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

 

We also borrowed$500,000 in November 2003 from Draft Co. (“Draft”), under a note thatmatured on June 30, 2004, which had an interest at a rate of 10 percentper year.  The Draft loan was collateralized by substantially all our assetspursuant to a restated inter-creditor agreement among PKM, Hauser, and Draft.This note was repaid on June 30, 2004.

 

In April 2004, we entered into another credit agreement with PKMto borrow up to $250,000.  Under this agreement we issued a short-termpromissory note to PKM in the principal amount of $150,000.  The noterequired the payment of interest at a rate of 10 percent per year.  Thisnote was repaid during April 2004.

 

In February, April and May, 2004, we conducted a private placementto accredited investors of units, each unit consisting of one share of commonstock and one common stock purchase warrant to purchase one share ofcommon stock.  In this placement, we sold 2,730,763 units at $1.47for aggregate gross proceeds of $4,014,222.

 

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During fiscal year 2004, we received gross proceeds from this privateplacement of $1,749,099.  The five-year warrants sold with the commonstock are exercisable to purchase an aggregate of 2,730,763 shares of commonstock at an exercise price of $1.60 per share.  In connection with suchplacement, we issued our agent a five-year warrant to purchase 123,272 units atan exercise price of $1.8375 per unit, paid our agent cash commissions of$181,210 and paid our agent an expense allowance of $67,954.  Inconnection with such placement, we issued our finder a five-year warrant topurchase 190,378 units at an exercise price of $1.8375 per unit, paid ourfinder a finder’s fee of $140,928 and reimbursed our finder for expenses of$4,163.  The warrants underlying the unit warrants issued to the agent andthe finder are exercisable for a period of five-years at an exercise price of$1.8375 per share.

 

In December 2004 and January 2005, we issuedconvertible bridge notes totaling $425,000. The notes, which are due on May 31, 2005, bear interest at the rateof 10 percent per year and are convertible into securities to be issued in ournext equity financing, if any.  Within 10days of the consummation of our next equity financing, if any, each note holderwill be required to elect one of the following two alternatives:  (1) convert the entire unpaid principaland all accrued but unpaid interest under the note into equity securities soldby the Company in its next equity financing (“Next Shares”) at a price pershare equal to eighty percent (80%) of the issuance price of the Next Shares,and retain the warrants issued in connection with the convertible bridge notes,or (2) surrender the note and the warrants issued in connection with thebridge notes to us in exchange for the issuance of a number of Next Shares andany accompanying warrants issuable in connection with the Next Shares, equal tothe amount of such securities that could be purchased using the entire unpaidprincipal and all accrued but unpaid interest under the note.

 

In connection with issuance of the convertible bridgenotes, we issued to the note holders warrants to purchase up to 85,000 sharesof common stock.  The warrants, which have a five-year term,are exercisable at a price per share equal to the per share or per unit priceof equity securities sold in our next offering. However, such exercise price will not exceed $1.49 per share.  The warrants contain anti-dilutionprovisions.  The allocated fairvalue of the newly issued warrants was $79,030 and is accounted for as adiscount on the borrowings. This discount, which is presented as a reduction ofthe carrying value of the debt on the consolidated balance sheet is beingamortized as interest expense over the five-month term of the debt. As of January 31,2005, the unamortized balance of the discount was $63,224.

 

We expect that our operating losses and negative operating cash flowwill continue through fiscal year 2005 as we continue adding staff to supportthe development and launch of our atrial fibrillation technology.  Weanticipate that our sales and marketing and general and administrative expenseswill continue to constitute a material use of our cash resources.  Theactual amounts and timing of our capital expenditures will vary significantlydepending upon progress on our product development projects and theavailability of financing.

 

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

 

•                  operatinglosses exceed our projections;

 

•                  manufacturingand development costs exceed our estimates;

 

•                  wedetermine to acquire, license or develop additional technologies; or

 

•                  werequire additional technologies to complete projected product development.

 

Our capital requirements will also vary depending upon the amount, ifany, we receive from a transaction in which we exit from the heart valvebusiness.

 

By refocusing on cardiothoracic surgery products, we hope to improveour cash flow from operating activities and reduce our reliance upon financingtransactions, which may not be available to us.  We cannot, however,assure you that our efforts to enter the AF market will:

 

•                  beattainable;

 

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•                  beprofitable;

 

•                  reduceour reliance upon financing transactions; or

 

•                  enableus to continue operations.

 

Our ability to continue as a going concern depends upon our ability toobtain additional debt and/or equity financing.  Assuming there are nocash proceeds from the sale of the heart valve business or its assets, our planto fund the business is outlined as follows:

 

•                  SinceDecember 2004, we have been attempting to raise $10 million to $14 millionto fund the development of our AF product;

 

•                  Webelieve if we raise $10 million it will fund our operations through April 30,2006; and

 

•                  Webelieve if we raise $14 million it will fund our operations through October 2006.

 

In December 2004 and January 2005, we received $425,000 fromthe sale of convertible debentures. These debentures will convert to equity if we complete the $10 millionto $14 million financing described above.

 

In February 2005, we entered into the February 2005 DiscretionaryCredit agreement with PKM.  We borrowed$250,000 in February 2005 and expect to borrow the remaining $250,000under this agreement in March 2005. We are required to repay the entire $500,000 from this credit facilityif we sell more than $3 million in equity credit.

 

In addition to these cash requirements, we will require an additional$3.5 million in funding in order to repay notes payable to PKM and Hauser,which mature on June 30, 2005, unless the terms are otherwise extended orrestructured.

 

We expect to face substantial difficulty in raising funds in thecurrent market environment and we have no commitments at this time to providethe required financing.  If we obtain the foregoing financing, we believewe will have sufficient capital resources to operate and fund the growth of ourbusiness for fiscal year 2006.

 

The amount of capital needed for future periods is difficult toestimate and will be dependent on many factors, including the timing andsuccess of our introduction of our open-chest atrial fibrillation product anddevelopment costs related to our minimally invasive atrial fibrillationproducts.

 

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

 

**Commitments and Contingent Liabilities**

 

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

 

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

 

*Clinical Studies*. We entered into agreements with several large institutions to conduct clinicalstudies regarding certain aspects of our Omnicarbon heart valve’s clinicalperformance.  The agreements run through fiscal year 2006.  Ingeneral, recipients of clinical study payments are required to purchase ourproducts in order to complete their studies and collect and submit dataaccording to a study protocol.  As of January 31, 2005, we haveaccrued,

 

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but not paid, $10,300 for clinical study payments.

 

*Accrued Severance.*As part of the restructuring, we are making severance payments to formerofficers and employees.  As of January 31, 2005, our remainingobligations total $97,953.  We expect to complete making these severancepayments by August 2005.  (SeeFootnote 6 of the “Notes to Consolidated Financial Statements”.)

 

*AtrialFibrillation Technology Purchase Agreement*.  We enteredinto an agreement with LightWave Ablation Systems, Inc. (“LightWave”) in August 2003to purchase technology for the treatment of atrial fibrillation.  Weissued 15,000 shares of common stock and a warrant to purchase 25,000 shares ofcommon stock, and made an initial payment of $10,000 to LightWave for theworldwide technology distribution rights.  In April 2004, we paid LightWaveand additional $15,000 coincident with the filing of a 510(k) application withthe FDA pertaining to an application of the LightWave technology.  In December 2004, we issued a warrant topurchase 25,000 shares of common stock as a result of the U.S. Food and DrugAdministration’s grant of 510(k) market clearance for our AtriLazeTM SurgicalAblation System.  Pursuant to terms ofthe agreement, additional cash payments will be made and warrants to purchaseshares of our common stock may be issued to LightWave in the event that we meetcertain development and marketing milestones, including obtaining a CE Mark andissuance of a U.S. Patent.  Upon the first commercial sale in the U.S. orEurope utilizing the purchased technology, a payment of $125,000 will be dueand an additional $385,000 will be due when cumulative gross sales ofdisposable products utilizing the purchased technology reach $1,500,000. In addition, for a period of 10 years measured from the first commercial saleutilizing the purchased technology, we will make a payment totaling 2 to 6percent of net sales of disposable products.  Following the firstcommercial sale utilizing the purchased technology, the timing of which isindeterminable, minimum payments under this provision would total $2,325,000over nine years.

 

The following table summarizes our contractual obligations as of January 31,2005:

 
| **Summary  of Contractual  Obligations**               | ** ** | **Payments Due By Period** | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|
| ** **                                             | ** ** | **TOTAL**                  | ** ** | **Less than One Year** | ** ** | **Two to Three  Years** | ** ** | **Four or More  Years** | ** ** |
| Related Party  Lease Obligation (1)                    |       | $                          | 3,249,568  |   | $ | 384,000 |   | $ | 768,000 |   | $ | 2,097,568 |   |
| Clinical  Studies                                      |       | 10,300                     |       | 10,300 |   |   |   |   |   |
| Deferred  compensation                                 |       | 97,953                     |       | 97,953 |   |   |   |   |   |
| Atrial  Fibrillation Technology Purchase Agreement (2) |       | 15,000                     |       | 15,000 |   |   |   |   |   |
| Debt                                                   |       | 4,368,333                  |       | 4,368,333 |   |   |   |   |   |
| TOTAL  CONTRACTUAL OBLIGATIONS                         |       | $                          | 7,741,154  |   | $ | 4,875,586 |   | $ | 768,000 |   | $ | 2,097,568 |   |

 

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(1)                                  Futurepayments include interest due.

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

 

**Qualitative and Quantitative Disclosuresabout Market Risk**

 

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

 

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

 

17

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**ITEM 3****                                                        CONTROLSAND PROCEDURES**

 

We maintain a system of disclosure controls and procedures, as definedin Exchange Act Rule 13a-15(e) that is designed to providereasonable assurance that information, which is required to be disclosed, isaccumulated and communicated to management timely.  As of the end of theperiod 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-15b.  Based upon that evaluation, ourChief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures are effective in timely alerting them tomaterial information relating to our company required to be disclosed in ourperiodic filings with the SEC.

 

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

 

18

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**PART II**

 

**OTHERINFORMATION**

 

ITEM 1                                Legal Proceedings

 

As of March 15, 2005, the Company was not a party to any materiallitigation.

 

ITEM 2                                      UnregisteredSales of Equity Securities and Use of Proceeds

 

Not applicable.

 

ITEM 3                                Defaultsupon Senior Securities

 

Not applicable.

 

ITEM 4                                Submissionof Matters to a Vote of Security Holders

 

Not applicable.

 

ITEM 5                                Other Information

 

Not applicable.

 

ITEM 6                                Exhibits

 

See Index to Exhibits.

 

19

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**SIGNATURES**

 

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

 

 
|                            | MedicalCV, Inc. |
|---------------------------------|----------------------|
|                            |                 |
|                            |                 |
| Date:  March 17, 2005 | By                   | /s/ Marc P. Flores |   |
|                            |                 | Marc P. Flores |   |
|                            |                 | President and Chief Executive Officer |
|                            |                 |
| Date:  March 17, 2005 | By                   | /s/ John H. Jungbauer |   |
|                            |                 | John H. Jungbauer |   |
|                            |                 | Vice President, Finance and |   |
|                            |                 | Chief Financial Officer |   |

 

20

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**INDEX TO EXHIBITS**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                          |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                |       | October 2004 Discretionary Credit  Agreement by and between MedicalCV, Inc. and PKM Properties, LLC, dated October 29,  2004, effective November 17, 2004 (incorporated by reference to our  Current Report on Form 8-K filed on November 23, 2004 (File No. 000-33295)).                                                                                             |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.2                |       | October 2004 Credit Note issued by  MedicalCV, Inc. (maker) to PKM Properties, LLC (payee), dated October 29,  2004, effective November 17, 2004 (incorporated by reference to our  Current Report on Form 8-K filed on November 23, 2004 (File No. 000-33295)).                                                                                                      |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.3                |       | Intellectual Property Security Agreement by  and between PKM Properties, LLC (secured party) and MedicalCV, Inc.  (debtor), dated October 29, 2004, effective November 17, 2004  (incorporated by reference to our Current Report on Form 8-K filed  on November 23, 2004 (File No. 000-33295)).                                                                           |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.4                |       | Amendment No. 3 to First Amended and  Restated Subordination and Intercreditor Agreement by and between Peter L.  Hauser and PKM Properties, LLC, accepted and acknowledged by MedicalCV, Inc.,  dated October 29, 2004, effective November 17, 2004 (incorporated  by reference to our Current Report on Form 8-K filed on November 23,  2004 (File No. 000-33295)). |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.5                |       | Waiver Agreement by and between MedicalCV, Inc.  (borrower) and PKM Properties, LLC (lender), dated October 29, 2004,  effective November 17, 2004 (incorporated by reference to our Current  Report on Form 8-K filed on November 23, 2004 (File No. 000-33295)).                                                                                                         |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.6                |       | Warrant Agreement issued to PKM Properties,  LLC, dated November 17, 2004 (incorporated by reference to our Current  Report on Form 8-K filed on November 23, 2004 (File No. 000-33295)).                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.7                |       | Form of Bridge Note Purchase Agreement  (including form of convertible promissory note and form of common stock  purchase warrant), dated December 31, 2004 (incorporated by reference to  our Current Report on Form 8-K, filed on January 6, 2005  (File No. 000-33295)).                                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.8                |       | Warrant Agreement to purchase 25,000 shares  of common stock issued by the Registrant to LightWave Ablation Systems, Inc.,  dated December 1, 2004 (incorporated by reference to our Current Report  on Form 8-K/A, filed on February 10, 2005 (File No. 000-33295)).                                                                                                           |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.9                |       | February 2005 Discretionary Credit  Agreement by and between MedicalCV, Inc. and PKM Properties, LLC, dated February 16,  2005, effective March 3, 2005 (incorporated by reference or our Current  Report on Form 8-K/A, filed on March 9, 2005 (File No. 000-33295)).                                                                                                |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.10               |       | February 2005 Discretionary Credit  Note issued by MedicalCV, Inc. (maker) and PKM Properties, LLC (payee),  dated February 16, 2005, effective March 3, 2005 (incorporated by  reference or our Current Report on Form 8-K/A, filed on March 9,  2005 (File No. 000-33295)).                                                                                         |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.11               |       | Warrant Agreement issued to PKM Properties,  LLC, dated February 16, 2005, effective March 3, 2005,  (incorporated by reference or our Current Report on Form 8-K/A,  filed on March 9, 2005 (File No. 000-33295)).                                                                                                                                                             |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.12               |       | Amendment No. 4 to First Amended and  Restated Subordination and Intercreditor Agreement by and between Peter L.  Hauser and PKM Properties, LLC, accepted and acknowledged by MedicalCV, Inc.,  dated February 16, 2005, effective March 3, 2005 (incorporated by  reference or our Current Report on Form 8-K/A, filed on March 9,  2005 (File No. 000-33295)).     |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.13               |       | Form of Non-Qualified Stock Option  Agreement under the MedicalCV, Inc. 2001 Equity Incentive Plan.                                                                                                                                                                                                                                                                                                      |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.14               |       | Form of Non-Qualified Stock Option  Agreement under the MedicalCV, Inc. 1997 Stock Option Plan.                                                                                                                                                                                                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.15               |       | Form of Non-Qualified Stock Option  Agreement under the MedicalCV, Inc. 1993 Director Stock Option Plan.                                                                                                                                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.16               |       | Non-Qualified Stock Option Agreement issued  by the Registrant to Lawrence L. Horsch in the amount of 149,850 shares,  dated November 18, 2004.                                                                                                                                                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.17               |       | Non-Qualified Stock Option Agreement issued  by the Registrant to John H. Jungbauer in the amount of 68,584 shares, dated  November 18, 2004.                                                                                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.18               |       | Non-Qualified Stock Option Agreement issued  by the Registrant to John H. Jungbauer in the amount of 81,416 shares, dated  November 18, 2004.                                                                                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.19               |       | Non-Qualified Stock Option Agreement issued  by the Registrant to Lawrence L. Horsch in the amount of 62,050 shares, dated  January 19, 2005.                                                                                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 31.1                |       | Chief Executive Officer Certification  pursuant to Rule 13a-14.                                                                                                                                                                                                                                                                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 31.2                |       | Chief Financial Officer Certification  pursuant to Rule 13a-14.                                                                                                                                                                                                                                                                                                                                     |

 

21

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| 32.1   |   | Chief Executive Officer Certification  pursuant to 18 U.S.C. Section 1350. |
|--------|--------|---------------------------------------------------------------------------------|
|   |   |                                                                            |
| 32.2   |   | Chief Financial Officer Certification  pursuant to 18 U.S.C. Section 1350. |

 

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