** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM 10-QSB/A**

 

**(Amendment No. 1)**

** **

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

 

**Commission File Number 0-33295**

 

**MEDICALCV,INC.**

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

 

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

 

**9725 SouthRobert Trail**

**Inver GroveHeights, Minnesota 55077**

**(651)452-3000**

(Address of Principal Executive Offices and Issuer’sTelephone Number)

 

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

 

Yes ý  No o

 

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

 

TransitionalSmall Business Disclosure Format (check one)  o Yes  ý No

 

 

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# **ExplanatoryNote**

 

MedicalCV, Inc. (the “Company”) is filing this Amendment No. 1 to itsQuarterly Report on Form 10-QSB for the fiscal quarter ended October 31, 2003,originally filed December 15, 2003 (“Form 10-QSB”), solely to amend specificitems of the Form 10-QSB to reflect changes in classification of certain itemsin the Company’s statement of operations.

 

The Company changed the classification of certain expenditurespreviously classified as sales and marketing expenses, to a reduction in netsales. These expenditures consist of payments made to internationaldistributors for assistance in marketing the Company’s products that arerequired to be reported as a reduction in net sales pursuant to application ofthe Consensus for EITF Issue 01-9, “Accounting for Consideration Given by aVendor to a Customer (Including a Reseller of the Vendor’s Products)”.  The revision resulted in a reduction in netsales and sales and marketing expense, and a corresponding reduction in grossprofit and total operating expense.

 

The Company also changed the classification of income from inventoriesreturned from two former international distributors, which had previously beenreported as a reduction of cost of goods sold rather than as a reduction ofgeneral and administrative expenses. The revision resulted in an increase to cost of goods sold, a reductionin gross profit and a reduction in general and administrative expenses.

 

Thefinancial statements for three and six month periods ended October 31, 2003 and2002, have been restated to give effect to these changes inclassification.  See Note 11 to theConsolidated Financial Statements.  Thechanges in classification had no effect on the Company’s loss from operationsor net loss, nor any effect on the consolidated balance sheet, statement ofshareholders’ equity (deficit) or statement of cash flows.  This Amendment No. 1 amends only portions ofthe Form 10-QSB; the remainder of the Form 10-QSB is unchanged and is notreproduced in this Amendment No. 1. This Amendment No. 1 does not reflect events occurring after theoriginal filing of the Form 10-QSB.

 

ThisAmendment No. 1 contains changes to the following disclosures:

 

Part I – Item 1. Consolidated Financial Statements (Unaudited)

 

Part I – Item 2. Managements Discussion and Analysis or Plan of Operation

 

Part I – Item 3. Controls and Procedures

 

2

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**TABLE OFCONTENTS**

 
| PART I             |   | FINANCIAL INFORMATION |   |
|--------------------|--------|-----------------------|--------|
|               |   |                  |   |   |   |
|               |   | ITEM 1                |   | Financial Statements |   |
|               |   |                  |   | Consolidated Balance Sheet  at October 31, 2003 (unaudited) and April 30, 2003 |   |
|               |   |                  |   | Consolidated  Statement of Operations for the three and six-month periods ended  October 31, 2003 (unaudited) and October 31, 2002  (unaudited) |   |
|               |   |                  |   | Consolidated  Statement of Cash Flows for the six-month periods ended  October 31, 2003 (unaudited) and October 31, 2002  (unaudited) |   |
|               |   |                  |   | Notes to  Consolidated Financial Statements |   |
|               |   | ITEM 2                |   | Management’s Discussion and  Analysis or Plan of Operation |   |
|               |   | ITEM 3                |   | Controls and Procedures |   |
|               |   |                  |   |   |   |
| SIGNATURES         |   |                  |   |
| INDEX TO  EXHIBITS |   |                  |   |

 

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** **

**PART I**

 

**ITEM 1**** ****FINANCIAL****STATEMENTS**

** **

**MEDICALCV, INC.**

 

**Consolidated Balance Sheet**

 
|                                                                                                                              |   | **October  31,  2003** |      | **April 30,  2003** |   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|-----------|---------------------|--------|
|                                                                                                                              |   | **(unaudited)**        |      |                |   |
| **ASSETS**                                                                                                                        |   |                   |      |                |   |
| Current assets:                                                                                                                   |   |                   |      |                |   |
| Cash and cash equivalents                                                                                                         |   | $                      | 75,221    |                | $      | 184,227 |   |
| Trade and accounts receivable, net                                                                                                |   | 1,280,589              |      | 1,472,995           |   |
| Inventories                                                                                                                       |   | 2,758,704              |      | 2,782,613           |   |
| Prepaid expenses and other assets                                                                                                 |   | 149,827                |      | 183,856             |   |
| Total current assets                                                                                                              |   | 4,264,341              |      | 4,623,691           |   |
|                                                                                                                              |   |                   |      |                |   |
| Property, plant and equipment, net                                                                                                |   | 1,210,934              |      | 1,368,240           |   |
| Deferred financing costs, net                                                                                                     |   | 150,705                |      | 62,989              |   |
| Total assets                                                                                                                      |   | $                      | 5,625,980 |                | $      | 6,054,920 |   |
|                                                                                                                              |   |                   |      |                |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY  (DEFICIT)**                                                                          |   |                   |      |                |   |
| Current liabilities:                                                                                                              |   |                   |      |                |   |
| Short-term debt with related parties                                                                                              |   | $                      | 2,511,570 |                | $      | 943,333 |   |
| Current portion of related party lease  obligations                                                                               |   | 284,257                |      | 273,843             |   |
| Current portion of capital lease  obligations                                                                                     |   | 14,990                 |      | 42,069              |   |
| Accounts payable                                                                                                                  |   | 1,086,534              |      | 895,405             |   |
| Accrued expenses                                                                                                                  |   | 294,024                |      | 813,539             |   |
| Total current liabilities                                                                                                         |   | 4,191,375              |      | 2,968,189           |   |
|                                                                                                                              |   |                   |      |                |   |
| Related party lease obligations, less  current portion                                                                            |   | 3,312,233              |      | 3,472,661           |   |
| Total liabilities                                                                                                                 |   | 7,503,608              |      | 6,440,850           |   |
|                                                                                                                              |   |                   |      |                |   |
| Shareholders’ equity (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; 7,995,070 and 7,843,834 shares issued and outstanding,  respectively |   | 79,950                 |      | 78,438              |   |
| Additional paid-in capital                                                                                                        |   | 17,485,687             |      | 16,613,337          |   |
| Deferred stock-based compensation                                                                                                 |   | (3,297                 | )         | (4,610              | )      |
| Accumulated deficit                                                                                                               |   | (19,439,968            | )         | (17,073,095         | )      |
| Total shareholders’ equity (deficit)                                                                                         |   | (1,877,628             | )         | (385,930            | )      |
| Total liabilities and shareholders’ equity  (deficit)                                                                        |   | $                      | 5,625,980 |                | $      | 6,054,920 |   |

 

The accompanying notes are an integralpart of these financial statements.

 

4

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**MEDICALCV, INC.**

 

**ConsolidatedStatement of Operations**

**(unaudited)**

 
|                                                           |   | **Three  Months Ended October 31,** |       | **Six Months  Ended October 31,** |   |
|----------------------------------------------------------------|--------|-------------------------------------|------------|-----------------------------------|--------|
|                                                           |   | **2003  Restated  (Note 11)**       |       | **2002  Restated  (Note 11)**     |   | **2003  Restated  (Note 11)** |   | **2002  Restated  (Note 11)** |   |
| Net sales                                                      |   | $                                   | 807,532    |                              | $      | 371,664 |   | $ | 1,707,761 |   | $ | 1,068,048 |   |
| Cost of goods sold                                             |   | 426,189                             |       | 391,657                           |   | 923,292 |   | 961,526 |   |
| Gross profit                                                   |   | 381,343                             |       | (19,993                           | )      | 784,469 |   | 106,522 |   |
| Operating expenses:                                            |   |                                |       |                              |   |   |   |   |   |
| Sales and marketing                                            |   | 505,274                             |       | 599,158                           |   | 1,106,012 |   | 1,232,797 |   |
| General and administrative                                     |   | 624,142                             |       | 553,778                           |   | 1,181,065 |   | 999,369 |   |
| Engineering and regulatory                                     |   | 200,688                             |       | 300,554                           |   | 404,682 |   | 501,671 |   |
| Total operating expenses                                       |   | 1,330,104                           |       | 1,453,490                         |   | 2,691,759 |   | 2,733,837 |   |
| Loss from operations                                           |   | (948,761                            | )          | (1,473,483                        | )      | (1,907,290 | ) | (2,627,315 | ) |
| Other (expense) income:                                        |   |                                |       |                              |   |   |   |   |   |
| Interest expense                                               |   | (303,009                            | )          | (38,643                           | )      | (459,255 | ) | (77,623 | ) |
| Interest income                                                |   |                                |       | 1,642                             |   | 4,993 |   | 12,661 |   |
| Other (expense) income                                         |   | 5,860                               |       | 10,157                            |   | (5,321 | ) | 26,084 |   |
| Total other expense                                            |   | (297,149                            | )          | (26,844                           | )      | (459,583 | ) | (38,878 | ) |
|                                                           |   |                                |       |                              |   |   |   |   |   |
| Net loss                                                       |   | $                                   | (1,245,910 | )                                 | $      | (1,500,327 | ) | $ | (2,366,873 | ) | $ | (2,666,193 | ) |
| Basic and diluted net loss per share                           |   | $                                   | (.16       | )                                 | $      | (.19 | ) | $ | (.30 | ) | $ | (.33 | ) |
|                                                           |   |                                |       |                              |   |   |   |   |   |
| Shares used in computing basic and diluted  net loss per share |   | 7,906,825                           |       | 7,843,834                         |   | 7,915,306 |   | 7,843,834 |   |

 

The accompanying notes are an integral partof these financial statements.

 

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** **

**MEDICALCV,INC.**

** **

**ConsolidatedStatement of Cash Flows**

(unaudited)

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

 

The accompanying notes are an integral part of these financialstatements.

 

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**MEDICALCV, INC.**

 

**Notes toConsolidated Financial Statements**

 

**(1)****          ****Basis of Financial Statement Presentation**

 

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

 

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

 

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

 

**(2)****          ****Going Concern**

 

TheCompany’s consolidated financial statements for the quarter endedOctober 31, 2003, have been prepared on a going concern basis, whichcontemplates the realization of assets and settlement of liabilities andcommitments in the normal course of business. The Company has sustained losses and negative cash flows from operationsin recent years and expects these conditions to continue for the foreseeablefuture.  At October 31, 2003, theCompany had an accumulated deficit of $19,439,968 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 currentlyseeking other sources of financing to fund its operations and working capitalrequirements.  If the Company is unableto obtain sources of additional funds beginning in January 2004, it willbe required to significantly revise its business plans and drastically reduceoperating expenditures such that it may not be able to develop or enhance itsproducts, gain market share in the United States or respond to competitivepressures or unanticipated requirements, which could seriously harm itsbusiness, financial position and results of operations.  These financial statements do not includeany adjustments that might result from the outcome of this uncertainty.

 

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

 

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

 

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

 

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

 

7

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wouldhave been adjusted to the pro forma amounts indicated below:

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

 

**(4)****          ****Net Loss Per Share**

 

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

 

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

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

 

**(6)****          ****Short-term Debt**

 

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

 

OnJuly 8, 2003, the Company also issued $1.0 million of term debt to PeterL. Hauser (“Hauser”), a principal shareholder. The Company borrowed $1.0 million under this bridge financing during thequarter ended July 31, 2003.  Thedebt, which is collateralized by substantially all of our assets pursuant toour intercreditor agreement with PKM, bears interest at a rate of 10.0 percentper year and is due on June 30, 2004. In connection with the

 

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termdebt, the Company also issued a warrant with a ten-year term to purchase380,357 shares of the Company’s common stock at an exercise price of $0.70 pershare.  The allocated fair value of thenewly issued warrant was $281,706 and is accounted for as a discount on theborrowings under the bridge debt.  Thisdiscount, which is presented as a reduction of the face value of the debt onthe consolidated balance sheet is being amortized as interest expense over thetwelve-month term of the debt.  As ofOctober 31, 2003, the unamortized balance of the discount was$187,806.  In addition, the Companyincurred direct financing costs of $71,772, which are included in other assetsand are being amortized as expenses over the twelve-month term of the debt.

 

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

 

**(7)****          ****Segment Information**

 

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

 

Thefollowing table summarizes net sales by geographic area:

 
|          |   | **Three  Months Ended October 31,** |        | **Six Months  Ended October 31,** |   |
|---------------|--------|-------------------------------------|-------------|-----------------------------------|--------|
|          |   | **2003  Restated  (Note 11)**       |        | **2002  Restated  (Note 11)**     |   | **2003  Restated  (Note 11)** |   | **2002  Restated  (Note 11)** |   |
| Europe        |   | $                                   | 413,218     |                              | $      | 212,189 |   | $ | 860,088 |   | $ | 543,104 |   |
| South Asia    |   | 121,600                             |        | 99,190                            |   | 198,400 |   | 223,290 |   |
| Middle East   |   | 112,067                             |        | 46,950                            |   | 254,521 |   | 212,917 |   |
| Far East      |   | 0                                   |        | (25,125                           | )      | 53,180 |   | 17,702 |   |
| United States |   | 106,100                             |        | 37,950                            |   | 286,800 |   | 63,050 |   |
| Other         |   | 54,547                              |        | 510                               |   | 54,772 |   | 7,985 |   |
|          |   |                                |        |                              |   |   |   |   |   |
| **TOTALS**    |   | **$**                               | **807,532** | ** **                        | **$**  | **371,664** | ** ** | **$** | **1,707,761** | ** ** | **$** | **1,068,048** | ** ** |

 

**(8)****           Atrial FibrillationTechnology Purchase Agreement**

 

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

 

**(9)****           Return of Inventory**

 

During the quarter ended July 31, 2002, the Company obtainedinventories from two former international distributors.  The heart valves were sold to thesecustomers during fiscal year 2000 and the first half of fiscal year 2001.  Due to financial difficulties experienced bythese distributors, the Company provided allowances for the remaininguncollected accounts receivable balances in fiscal years 2001 and 2002.  The Company did not anticipate the return ofthese products at the time the uncollectible accounts were established.  Upon obtaining title to the heart valvesfrom these former distributors during the quarter ended July 31, 2002, theCompany increased its inventories and recorded a recovery of its priorprovision for doubtful accounts which reduced its general and administrativecosts by $92,000 representing the cost of the returned inventories. Asdescribed in Note 11, the Company had previously reported the return ofinventory as a reduction of cost of goods sold and has restated its financialstatements for the six month period ended October 31, 2002 to change theclassification to a reduction of general and administrative expenses.

 

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**(10****)****        ****Subsequent Events**

 

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

 

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

 

**(11)****        ****Restatement**

 

The Company has restated its financial statements for the three andsix-month periods ended October 31, 2003 and 2002, to change the classificationof marketing support expenditures, which had previously been reported as salesand marketing expense rather than a reduction in net sales pursuant toapplication of the Consensus for Emerging Issues Task Force No. 01-09,“Accounting for Consideration Given by a Vendor to a Customer (Including aReseller of the Vendor’s Products).” The effect of this change in classification is to decrease net sales,gross profit and sales and marketing expenses by corresponding amounts for allperiods presented.

 

The Company has also restated its financialstatements for the six month period ended October 31, 2002 to change theclassification of income from inventories returned from two formerinternational distributors, which had previously been reported as a reductionof cost of goods sold rather than as a reduction of general and administrativeexpenses (see Note 9).  The effect ofthis change in classification is to increase cost of goods sold, decrease grossprofit and decrease general and administrative expenses by $92,000 for the sixmonth period ended October 31, 2002.

 

The changes in classifications described inthe above two paragraphs had no effect on the Company’s loss from operations ornet loss, nor any effect on the Company’s consolidated balance sheet, statementof changes in stockholders’ equity (deficit) or statement of cash flows.  The table below summarizes the aggregateeffect of theses changes in classifications.

 
|                     |   | **Three  Months Ended October 31,** |    |
|--------------------------|--------|-------------------------------------|---------|
|                     |   | **2003**                            |    | **2002** |   |
|                     |   | **As  reported**                    |    | **As  restated** |   | **As  reported** |   | **As  restated** |   |
|                     |   |                                |    |   |   |   |   |   |   |
| Net sales                |   | $                                   | 887,225 |   | $ | 807,532 |   | $ | 425,769 |   | $ | 371,664 |   |
| Gross profit             |   | 461,036                             |    | 381,343 |   | 34,112 |   | (19,993 | ) |
|                     |   |                                |    |   |   |   |   |   |   |
| Operating expenses:      |   |                                |    |   |   |   |   |   |   |
| Sales and marketing      |   | 584,967                             |    | 505,274 |   | 653,263 |   | 599,158 |   |
| Total operating expenses |   | 1,409,797                           |    | 1,330,104 |   | 1,507,595 |   | 1,453,490 |   |
|                          |        |                                     |         |  |  |  |  |  |  |  |  |  |  |

 

10

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|                       |   | **Six Months  Ended October 31,** |      |
|----------------------------|--------|-----------------------------------|-----------|
|                       |   | **2003**                          |      | **2002** |   |
|                       |   | **As  reported**                  |      | **As  restated** |   | **As  reported** |   | **As  restated** |   |
|                       |   |                              |      |   |   |   |   |   |   |
| Net sales                  |   | $                                 | 1,981,804 |   | $ | 1,707,761 |   | $ | 1,244,101 |   | $ | 1,068,048 |   |
| Cost of goods sold         |   | n/a                               |      | n/a |   | 869,526 |   | 961,526 |   |
| Gross profit               |   | 1,058,512                         |      | 784,469 |   | 374,575 |   | 106,522 |   |
|                       |   |                              |      |   |   |   |   |   |   |
| Operating expenses:        |   |                              |      |   |   |   |   |   |   |
| Sales and marketing        |   | 1,380,055                         |      | 1,106,012 |   | 1,408,850 |   | 1,232,797 |   |
| General and administrative |   | n/a                               |      | n/a |   | 1,091,369 |   | 999,369 |   |
| Total operating expenses   |   | 2,965,802                         |      | 2,691,759 |   | 3,001,890 |   | 2,733,837 |   |
|                            |        |                                   |           |  |  |  |  |  |  |  |  |  |  |

 

----

n/a – not applicable

 

11

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

 

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

 

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

 

**Overview**

 

We are acardiothoracic surgery device manufacturer. Our primary products are mechanicalheart valves known as the Omnicarbon® Series 3000 and Series 4000, which wemanufacture and market.  Our heart valves are used to treat heartfailure caused by the aging process, heart diseases, prosthetic heart valvefailure and congenital defects.  Todate, we have distributed the Omnicarbon 3000 and 4000 heart valves primarilyin Europe, South Asia, the Middle East and the Far East.  In fiscal year 2003, we derived 62 percent of our net sales fromEurope.  As an innovator of heart valvetechnology, we have more than 33 years of experience in developing, manufacturing andmarketing five generations of heart valves, and we have sold approximately141,000 heart valves worldwide.

 

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

 

The worldwide heart valve market is dynamic and highlycompetitive.  In addition, technologyand competitive offerings, such as new tissue heart valves, place increasedpressure on us as we seek to increase our market share and revenue.  For more information regarding these risks,you should review our Cautionary Statement.

 

InSeptember 2003, we entered into an agreement with LightWave Ablation Systems,Inc. to purchase technology for the treatment of atrial fibrillation.  We believe this technology adds an importantgrowth platform to our portfolio of products for the cardiothoracic surgeon.

 

We have restated our financial information to reflect changes inclassification of certain items in the Company’s Statement of Operations foreach of the three and six month periods ended October 31, 2003 and 2002.

 

We have changed the classification of certain expenditures previouslyclassified as sales and marketing expenses to a reduction in net sales. Theseexpenditures consist of payments made to international distributors forassistance in marketing our products that are required to be reported as areduction in net sales pursuant to application of the Consensus for EITF Issue01-9 “Accounting for Consideration Given by a Vendor to a Customer (Including aReseller of the Vendor’s Products)”. The changes in these classifications decreased net sales, gross profit,sales and marketing expense and total operating expenses by correspondingamounts.

 

12

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We have also changed the classification of income from inventoriesreturned from two former international distributors, which had previously beenreported as a reduction of cost of goods sold rather than as a reduction ofgeneral and administrative expenses. The change in classification increased cost of goods sold, decreasedgross profit and decreased general and administrative expenses by $92,000 forthe six month period ended October 31, 2002.

 

The changes in classifications had no effect on our loss fromoperations or net loss, nor any effect on the consolidated balance sheet,statement of shareholders’ equity (deficit) or cash flows.  See Note 11 to the Consolidated FinancialStatements.

 

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

 

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

 
|                        |   | **Three  Months Ended October 31,** |   | **Six Months  Ended October 31,** |   |
|-----------------------------|--------|-------------------------------------|--------|-----------------------------------|--------|
|                        |   | **2003  Restated (1)**              |   | **2002  Restated (1)**            |   | **2003  Restated (1)** |   | **2002  Restated (1)** |   |
| Net sales                   |   | 100.0                               | %      | 100.0                             | %      | 100.0 | % | 100.0 | % |
| Cost of goods  sold         |   | 52.8                                |   | 105.4                             | %      | 54.1 | % | 90.0 | % |
|                        |   |                                |   |                              |   |   |   |   |   |
| Gross profit  (loss)        |   | 47.2                                | %      | (5.4                              | )%     | 45.9 | % | 10.0 | % |
|                        |   |                                |   |                              |   |   |   |   |   |
| Operating  expenses:        |   |                                |   |                              |   |   |   |   |   |
|                        |   |                                |   |                              |   |   |   |   |   |
| Sales and  marketing        |   | 62.5                                | %      | 161.2                             | %      | 64.7 | % | 115.4 | % |
| General and  administrative |   | 77.3                                | %      | 149.0                             | %      | 69.2 | % | 93.6 | % |
| Engineering  and regulatory |   | 24.9                                | %      | 80.9                              | %      | 23.7 | % | 47.0 | % |
|                        |   |                                |   |                              |   |   |   |   |   |
| Total  operating expenses   |   | 164.7                               | %      | 391.1                             | %      | 157.6 | % | 256.0 | % |
|                        |   |                                |   |                              |   |   |   |   |   |
| Loss from  operations       |   | (117.5                              | )%     | (396.5                            | )%     | (111.7 | )% | (246.0 | )% |
|                        |   |                                |   |                              |   |   |   |   |   |
| Other income  (expense):    |   |                                |   |                              |   |   |   |   |   |
|                        |   |                                |   |                              |   |   |   |   |   |
| Interest  expense           |   | (37.5                               | )%     | (10.4                             | )%     | (26.9 | )% | (7.2 | ) |
| Interest  income            |   | —                              | %      | 0.4                               | %      | 0.3 | % | 1.2 | % |
| Other income                |   | .7                                  | %      | 2.7                               | %      | (0.3 | )% | 2.4 | % |
|                        |   |                                |   |                              |   |   |   |   |   |
| Total other  expense        |   | (36.8                               | )%     | (7.3                              | )%     | (26.9 | )% | (3.6 | )% |
|                        |   |                                |   |                              |   |   |   |   |   |
| Net loss                    |   | (154.3                              | )%     | (403.8                            | )%     | (138.6 | )% | (249.6 | )% |

 

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(1) — As described in Note 11 to our consolidatedfinancial statements, we restated our financial statements for the three andsix month periods ended October 31, 2003 and 2002 to change the classificationof certain expenditures previouslyclassified as sales and marketing expenses to a reduction in net sales and tochange the classification of income from inventories returned from two formerinternational distributors previously classified as a reduction of cost ofgoods sold to a reduction of general and administrative expenses

 

**CriticalAccounting Policies**

 

Fordiscussion of critical accounting policies and estimates, see our Annual Reporton Form 10-KSB for the fiscal year ended April 30, 2003.

 

**Results ofOperations**

 

*Net Sales*.  Net sales in the second quarter of fiscal year 2004increased to $807,532 from $371,664 in the second quarter of the prior year.  Net sales in the six-month period ended October 31,2003, increased to $1,707,761 from $1,068,048 in the same period one yearago.  The increases were attributableprimarily to higher Omnicarbon unit sales in Europe, the Middle East and theU.S.

 

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

 

*Gross Profit.*  Gross profit (loss) as a percentage of net sales increased to 47.2 percent in the second quarterof fiscal year 2004 from a negative 5.4percent in the second quarter of theprior year.  Fiscalyear-to-date gross profit margins in 2004 were 45.9 percent compared to 10.0percent in the same period last fiscal year. Gross profit margins in the current quarter and year-to-date periodswere positively impacted by lower fixed costs per unit on higher sales volume,a favorable sales mix in international markets due to a higher proportion ofsales being generated in countries where prices charged are higher, and highergross margin sales in the U.S.  Grossprofit margins for the three and six-month periods ended October 31, 2002, werenegatively impacted by the following items; a reserve totaling $51,543 wasbooked to adjust the inventory valuation of our blood filter products, whichwas being phased out.  Also, due toinefficiencies in manufacturing, we incurred $36,822 in scrap expense.  Ourstrategy is to obtain FDA approval of our proprietary pyrolytic carbon manufacturing process in orderto market the Omnicarbon 4000 in the U.S. Due to its lower manufacturing cost, we believe the Omnicarbon 4000 willgenerate significantly higher gross profit margins when sold in the U.S. thanthe Omnicarbon 3000 heart valve.

 

*Sales andMarketing*.  Sales andmarketing expenses in the secondquarter of fiscal year 2004 were $505,274or 62.5 percent of net sales compared to $599,158 or 161.2 percent of net sales in the second quarterof the prior year.  For the six-month period endedOctober 31, 2003, sales and marketing expenses totaled $1,106,012 or 64.7percent of net sales, compared to $1,232,797 or 115.4 percent of net sales inthe same period last fiscal year.  The decrease in spending related to a more focused Omnicarbon marketing effort in the U.S. and internationalmarkets.  We believe wecan establish a competitive position in the U.S. and leverage this positioninto other areas of cardiothoracic surgery. Our overall marketingstrategy is to promote the clinical results of the Omnicarbon heart valve andthe technical strengths of our company in designing and manufacturingmechanical heart valves.

 

*General andAdministrative*.  General andadministrative expenses for the second quarter of fiscal year 2004 were $624,142 or 77.3 percent of net sales, compared to $553,778 or 149.0 percent of net sales in the same period oneyear ago.  For the six-month period endedOctober 31, 2003, general and administrative expenses totaled $1,181,065 or69.2 percent of net sales, compared to $999,369 or 93.6 percent of net sales inthe same period last year.  The increasesfor the quarter andyear-to-date periods were primarily attributable tocertain non-cash stock-based incentives associated with strengthening the executive managementstaff and board of directors.

 

*Engineering andRegulatory*.  Engineering andregulatory expenses for the secondquarterof fiscalyear 2004 were $200,688 or 24.9 percent of net sales compared to $300,554 or 80.9 percent of net sales in the second quarter ofthe prior fiscal year. For the six-month period ended October 31, 2003,engineering and regulatory expenses totaled $404,682 or 23.7 percent, comparedto $501,671 or 47.0 percent of net sales in the same period last year.  Thesecond quarter of last fiscal year included non-recurringexpenses associated with the purchase and development of the Northrup UniversalHeart Valve Repair SystemTM and IMA AccessTM Retractor Device.

 

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

 

*Income TaxProvision*.  In light of ourrecent history of operating losses, we recorded a valuation allowance to fullyoffset our deferred tax assets in fiscal year 2000.  We have continued to provide a full valuation allowance through the second quarter of fiscal year 2004 due to the current uncertainty aboutgenerating the future taxableincome necessary to realize our deferred tax assets.

 

*Loss fromOperations*.  As of October31,2003, we had anaccumulated deficit of $19,439,968.  We have incurredlosses in each of the last six fiscal years. Since 1994, we have invested in developing a bileaflet heart valve, aproprietary pyrolytic carbon coating process and obtaining premarket approvalfrom the FDA to market our Omnicarbon 3000 heart valve in the U.S.  Our strategy has been to invest intechnology to better position ourselves competitively once FDA

 

14

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premarket approval was obtained. We expect tocontinue to generate operating lossesinto fiscal year 2005 because of anticipated spending necessary to market the Omnicarbon3000 heart valve in the U.S., to establish and maintain a strong marketing organizationfor domestic and foreign markets and our continuing investment inresearch and development.

 

**Liquidity and Capital Resources**

 

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

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

 

Net cash used in operating activities decreased$476,077 to $1,936,361 in the six-month periodended October 31, 2003, from $2,412,438 in the six-month period ended October 31, 2002. The use of cash in operations in the six-month periods of both fiscalyears 2004 and 2003 was primarily due to net losses of $2,366,873 and$2,666,193, respectively.  The decreasein the use of cash in operations in fiscal year 2004 relative to fiscal year2003 was due principally to anincrease in accrued expenses and amortization combined with a decrease ininventories.  The increase in accruedexpenses was a function of the timing of when we paid certain costs.  The decrease in inventories in fiscal year2004 reflected the results of our concerted efforts to more closely control ourinventory levels combined with lower manufacturing costs.

 

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

 

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

 

Throughoutfiscal year 2003 and in the first six months of fiscal year 2004, we enteredinto a number of financing transactions to provide funds necessary to meet our workingcapital and capital expenditure needs and to meet other obligations.  These financing activities consisted of thefollowing:

 

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

 

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

 

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

 

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

 

15

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

 

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

 

OnJuly 8, 2003, under the terms of a bridge financing transaction, weestablished a one-year $1.0 million of term debt with PKM.  The line, which requires the payment ofinterest at a rate of 10.0 percent per year, matures on May 27, 2004, andis collateralized by substantially all of our assets.  As additional consideration for the financing, we issued to PKM aten-year warrants for the purchase of 380,357 shares of our common stock at anexercise price of $0.70 per share with terms and conditions that includeweighted-average anti-dilution rights. We agreed to extend the term of 700,000 previously issued warrants fromfive years to ten years.  The allocatedfair value of the warrants issued prior to July 31, 2003, and theincremental value of the existing warrants was $383,361, and was accounted foras a discount on the borrowings under the bridge debt.  This discount, which is presented as areduction of the face value of the debt on the consolidated balance sheet, isbeing amortized as interest expense over the eleven-month term of thedebt.  We also agreed to modify thesewarrants to conform to the terms of the warrants issued as part of this bridgedebt financing.

 

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

 

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

 

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

 

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

 

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

 

•      increased sales levels of our core products and new products are notachieved;

 

•      operating losses exceed our projections;

 

•      our manufacturing and developmentcosts or estimates prove to be inaccurate;

 

16

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•      we determine to acquire, license or develop additional technologies;

 

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

 

•      we make acquisitions.

 

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

 

Theterms of any equity financing are expected to be highly dilutive to ourexisting security holders.  Thedelisting of our securities from the Nasdaq SmallCap Market that occurred inMarch 2003 will negatively affect our ability to raise capital.  Ifwe are unable to obtain adequate financing on acceptable terms, we will be unable tocontinue operations.  Unless the level of U.S. market acceptance ofour heart valves increases and the FDA approves our pyrolytic carbon process,we anticipate that we will continue to depend upon cash provided by financingactivities to address our working capital requirements.  By broadening our portfolio ofcardiothoracic surgery products, we hope to reduce our dependence on sales ofheart valves and reduce our reliance upon financing transactions, which may notbe available to us.  We cannot, however,assure you that our efforts to diversify our product offerings will:

 

•      be attainable;

 

•      be profitable;

 

•      reduce our reliance upon financing transactions; or

 

•      enable us to continue operations.

 

**Commitments andContingent Liabilities**

 

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

 

*UROPACE*.  In July 1995, we established a wholly owned subsidiary, UROPACE, Inc., tocommercialize technology fortreating female urinary incontinence.  On November 1, 2000, we completed the spin-off ofUROPACE to our existing shareholders. The separation was effected by transferring from our company to UROPACEall assets, tangible and intangible, relating to the development of femaleurinary incontinence technology.  Ourshareholders of record on September 15, 2000, received one share of common stock of UROPACE for each6.882 shares of our common stock they held on that date.  The assets transferred to UROPACE had no bookvalue at November 1,2000, and the operations of UROPACE before the spin-off had no revenues andminimal expenses during fiscal year 2000 and fiscal year 2001.  As a part of this spin-off, we agreed toloan UROPACE up to $356,250 at a variable interest rate.  Principal and interest on the note will bepayable in installments equal to 5 percent of UROPACE’s future annual net sales until the noteand interest is paid in full.  At October 31,2003, we had loaned UROPACE $235,000,none of which had been repaid.  Due to the

 

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development stage of UROPACE and the uncertainty associated withthe collection of these borrowings, we established a reserve for the entire balance of the loan in the prior year. The corresponding expense wasincluded in other (expense) incomein the Consolidated Statement of Operations.

 

*Related Party LeaseObligation. *On April 4, 2003, we sold our corporateheadquarters, manufacturing facility and surrounding land in Inver Grove Heights,Minnesota to PKM.  In connection withthe transaction, we received total consideration of $3.84 million consisting of(i) $1.0 million in cash, (ii) PKM’s assumption of our $2.5 million outstandingindebtedness to Associated Bank which eliminated our indebtedness to AssociatedBank, and (iii) PKM’s assumption of our promissory note with Dakota ElectricAssociation and land special assessments payable to Dakota County aggregating$336,105.

 

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

 

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

 

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

 

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

 

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

 

*Atrial Fibrillation Technology Purchase Agreement. *We entered into an agreement with LightWave Ablation Systems, Inc.(LightWave) in September 2003 to purchase technology for the treatment ofatrial fibrillation. We issued 15,000 shares of common stock and made aninitial payment of $10,000 to LightWave Ablation Systems, Inc. for theworldwide distribution rights for the technology to treat atrial fibrillation.Pursuant to terms of the agreement, additional cash payments may be made andwarrants to purchase shares of our common stock may be issued to LightWave inthe event that LightWave meets certain development and marketing milestones,including obtaining a CE Mark, completion of a FDA 510(k) filing and thecompany meeting certain revenue milestones.

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

 

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(1)           Future paymentsinclude interest due.

 

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**Qualitative and Quantitative Disclosuresabout Market Risk**

 

We develop our products in the U.S. and market our productsglobally.  Because we continue to deriveour revenue primarily from sources outside of the U.S., our financial resultscould be affected by many factors, such as changes in currency exchange ratesor weak economic conditions in foreign markets.  Substantially all of our sales are denominated in U.S.dollars.  A strengthening of the U.S.dollar could make our products less competitive in foreign markets.  We do not currently participate in anycurrency hedging activities to mitigate this risk.  We assess the need to use financial instruments to hedge our exchangerate exposure on an ongoing basis.  In addition, we continuallyevaluate selling prices and billing currencies to monitor our exchange rateexposure.  Our interest income and expenses are sensitive to changes in thegeneral level of U.S. interest rates.  Based on thecurrent nature and levels of our investments and debt, however, we believe thatwe currently have no material market risk exposure.

 

Our general investing policy is to limit market and credit riskand the risk of principal loss.  Allliquid investments with original maturities of three months or less areconsidered to be cash equivalents.

 

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**ITEM 3****                  ****CONTROLS AND PROCEDURES**

 

Wemaintain a system of disclosure controls and procedures that is designed toprovide reasonable assurance that information, which is required to bedisclosed, is accumulated and communicated to management timely.  As of the end of the period covered by thisreport, we carried out an evaluation under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures pursuant to Exchange Act Rule13a-15.  In connection with its reviewof our financial statements for the quarter ended January 31, 2004,PricewaterhouseCoopers LLP informed our audit committee that there was amaterial weakness in our internal controls. Specifically, PricewaterhouseCoopers LLP identified a significantdeficiency in the design and operation of internal controls relating todocumenting and reporting international distribution marketing expenditures andrelated reimbursement.  We initiatedprocedures and reporting to document and support customer marketing expenses toremedy this deficiency in the future. Except for that deficiency, based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures are effective in timely alerting them to materialinformation relating to our company required to be disclosed in our periodicfilings with the SEC.

 

During our most recent fiscal quarter, there hasbeen no change in our internal control over financial reporting (as defined inRule 13a-15(f) or 15d-15(f) under the Exchange Act) that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

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**SIGNATURES**

 

Inaccordance with the requirements of the Exchange Act, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

 
|                       | MedicalCV,  Inc. |
|----------------------------|------------------|
|                       |             |   |
|                       |             |   |
| Date:  March 22, 2004 | By               | /s/  Blair P. Mowery |   |
|                       |             | Blair  P. Mowery |
|                       |             | President  and Chief Executive Officer |
|                       |             |   |
| Date:  March 22, 2004 | By               | /s/  John H. Jungbauer |   |
|                       |             | John  H. Jungbauer |
|                       |             | Chief  Financial Officer |

 

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**INDEX TO EXHIBITS**

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

 

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* Previously filed.

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