**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

**FORM 10-QSB**

| **x**                                               |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-----------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------|
| ** **                                          |   | ** **                                                                                              |
| **FOR THE QUARTERLY PERIOD ENDED JANUARY 31, 2007** |
| ** **                                          |   | ** **                                                                                              |
| **o**                                               |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission File Number 000-33295**

**MedicalCV, Inc.**

(Exact Name of Small Business Issuer as Specified inIts 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 Executive Offices and Issuer’sTelephone Number, including Area Code)

Checkwhether the issuer:  (1) filed all reports required to be filed bySection 13 or 15(d) of the Exchange Act during the past 12 months (orsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90 days.

Yes  x  No  o

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act).

Yes  o  No  x

As ofMarch 6, 2007, the issuer had outstanding 9,837,224 shares of common stock,$0.01 par value.

Transitional SmallBusiness Disclosure Format (check one)  o  Yes  x  No

 

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**TABLE OF CONTENTS**
| PART I        |   | FINANCIAL INFORMATION |
|--------------------|--------|-----------------------|
|               |   |                  |
|               |   | ITEM 1                |   | Condensed  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  5               |   | Other Information |
|               |   | ITEM 6                |   | Exhibits |
|               |
| SIGNATURES         |
| INDEX  TO EXHIBITS |

 

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**PART I**

**FINANCIALINFORMATION**

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

**MEDICALCV, INC.**

**CONDENSED BALANCE SHEETS**
| ** **                                                                                                                                                       | ** ** | **January 31,** | ** ** | **April 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|--------------------|------------|
| ** **                                                                                                                                                       | ** ** | **2007**             | ** ** | **2006**           | ** ** |
| ** **                                                                                                                                                       | ** ** | **(unaudited)**      | ** ** | ** **         | ** ** |
| **ASSETS**                                                                                                                                                       | ** ** | ** **           | ** ** | ** **         | ** ** |
| CURRENT ASSETS                                                                                                                                                   |       |                 |       |               |       |
| Cash and cash  equivalents                                                                                                                                       |       | $                    | 3,685,114  |               | $          | 10,351,570 |   |
| Accounts  receivable                                                                                                                                             |       | 3,525                |       | —             |       |
| Prepaid expenses  and other current assets                                                                                                                       |       | 186,541              |       | 242,975            |       |
| Current assets  of discontinued operations                                                                                                                       |       | 89,782               |       | 89,782             |       |
| TOTAL CURRENT  ASSETS                                                                                                                                            |       | 3,964,962            |       | 10,684,327         |       |
|                                                                                                                                                             |       |                 |       |               |       |
| PROPERTY, PLANT AND  EQUIPMENT, net                                                                                                                              |       | 803,528              |       | 740,010            |       |
| DEFERRED FINANCING  COSTS, net                                                                                                                                   |       | 45,479               |       | 50,942             |       |
| OTHER NON-CURRENT  ASSETS                                                                                                                                        |       | 86,530               |       | 23,400             |       |
| NON-CURRENT ASSETS OF  DISCONTINUED OPERATIONS                                                                                                                   |       | 19,986               |       | 87,323             |       |
| TOTAL ASSETS                                                                                                                                                     |       | $                    | 4,920,485  |               | $          | 11,586,002 |   |
|                                                                                                                                                             |       |                 |       |               |       |
| **LIABILITIES,  CONVERTIBLE PREFERRED STOCK AND  SHAREHOLDERS’  EQUITY**                                                                               | ** ** | ** **           | ** ** | ** **         | ** ** |
| ** **                                                                                                                                                       | ** ** | ** **           | ** ** | ** **         | ** ** |
| CURRENT LIABILITIES                                                                                                                                              |       |                 |       |               |       |
| Accounts payable                                                                                                                                                 |       | $                    | 369,486    |               | $          | 605,313 |   |
| Current portion  of related party lease obligation                                                                                                               |       | 331,576              |       | 322,586            |       |
| Accrued expenses                                                                                                                                                 |       | 394,972              |       | 377,507            |       |
| TOTAL CURRENT  LIABILITIES                                                                                                                                       |       | 1,096,034            |       | 1,305,406          |       |
| RELATED PARTY LEASE  OBLIGATION, less current portion                                                                                                            |       | 2,292,414            |       | 2,542,233          |       |
| TOTAL  LIABILITIES                                                                                                                                               |       | 3,388,448            |       | 3,847,639          |       |
|                                                                                                                                                             |       |                 |       |               |       |
| COMMITMENTS AND  CONTINGENCIES                                                                                                                                   |       |                 |       |               |       |
|                                                                                                                                                             |       |                 |       |               |       |
| 5% SERIES A REDEEMABLE  CONVERTIBLE PREFERRED STOCK;  $.01 par value; stated value $10,000 per share; 1,900 shares authorized; no  shares issued and outstanding |       | —               |       | —             |       |
|                                                                                                                                                             |       |                 |       |               |       |
| SHAREHOLDERS’ EQUITY                                                                                                                                        |       |                 |       |               |       |
| Preferred stock;  $.01 par value; 998,100 shares authorized; no shares issued and outstanding                                                                    |       | —               |       | —             |       |
| Common stock;  $.01 par value; 24,000,000 shares authorized; 9,837,224 and 9,122,946 shares  issued and outstanding                                              |       | 98,372               |       | 91,229             |       |
| Additional  paid-in capital                                                                                                                                      |       | 58,644,577           |       | 55,088,734         |       |
| Deferred  stock-based compensation                                                                                                                               |       | —               |       | (98,512            | )          |
| Accumulated  deficit                                                                                                                                             |       | (57,210,912          | )          | (47,343,088        | )          |
| TOTAL SHAREHOLDERS’  EQUITY                                                                                                                                 |       | 1,532,037            |       | 7,738,363          |       |
| TOTAL LIABILITIES,  CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY                                                                                    |       | $                    | 4,920,485  |               | $          | 11,586,002 |   |

 

See notes to condensed financial statements.

2

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**MEDICALCV, INC.**

**CONDENSEDSTATEMENTS OF OPERATIONS**

**(UNAUDITED)**
| ** **                                                                               | ** ** | **Three months ended January 31,** | ** ** | **Nine months ended January 31,** | ** ** |
|------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                               | ** ** | **2007**                                               | ** ** | **2006**                                              | ** ** | **2007** | ** ** | **2006** | ** ** |
| SALES                                                                                    |       | $                                                      | 11,200     |                                                  | $          | — |   | $ | 11,200 |   | $ | — |   |
| COST OF GOODS  SOLD                                                                      |       | 1,596                                                  |       | —                                                |       | 1,596 |   | — |   |
| GROSS PROFIT                                                                             |       | 9,604                                                  |       | —                                                |       | 9,604 |   | — |   |
|                                                                                     |       |                                                   |       |                                                  |       |   |   |   |   |
| OPERATING  EXPENSES                                                                      |       |                                                   |       |                                                  |       |   |   |   |   |
| Sales and marketing                                                                      |       | 361,824                                                |       | 295,742                                               |       | 1,158,698 |   | 429,576 |   |
| General and administrative                                                               |       | 899,799                                                |       | 840,155                                               |       | 3,657,007 |   | 2,324,735 |   |
| Research and development                                                                 |       | 1,456,710                                              |       | 707,630                                               |       | 5,199,361 |   | 1,900,305 |   |
| TOTAL OPERATING EXPENSES                                                                 |       | 2,718,333                                              |       | 1,843,527                                             |       | 10,015,066 |   | 4,654,616 |   |
| LOSS FROM  OPERATIONS                                                                    |       | (2,708,729                                             | )          | (1,843,527                                            | )          | (10,005,462 | ) | (4,654,616 | ) |
|                                                                                     |       |                                                   |       |                                                  |       |   |   |   |   |
| OTHER INCOME  (EXPENSE)                                                                  |       |                                                   |       |                                                  |       |   |   |   |   |
| Interest income                                                                          |       | 65,737                                                 |       | 97,362                                                |       | 247,108 |   | 243,392 |   |
| Interest expense                                                                         |       | (27,234                                                | )          | (28,776                                               | )          | (94,241 | ) | (128,855 | ) |
| Other income (expense)                                                                   |       | 883                                                    |       | (1,404                                                | )          | 20,608 |   | (5,008 | ) |
| Decrease in fair value of putable warrants                                               |       | —                                                 |       | 9,273,355                                             |       | — |   | 16,549,457 |   |
| TOTAL OTHER INCOME (EXPENSE)                                                             |       | 39,386                                                 |       | 9,340,537                                             |       | 173,475 |   | 16,658,986 |   |
|                                                                                     |       |                                                   |       |                                                  |       |   |   |   |   |
| (LOSS) INCOME  FROM CONTINUING OPERATIONS                                                |       | (2,669,343                                             | )          | 7,497,010                                             |       | (9,831,987 | ) | 12,004,370 |   |
| (LOSS) INCOME  FROM DISCONTINUED OPERATIONS                                              |       | (22,445                                                | )          | 92,755                                                |       | (35,837 | ) | (56,895 | ) |
| NET (LOSS)  INCOME                                                                       |       | $                                                      | (2,691,788 | )                                                     | $          | 7,589,765 |   | $ | (9,867,824 | ) | $ | 11,947,475 |   |
|                                                                                     |       |                                                   |       |                                                  |       |   |   |   |   |
| NET LOSS TO  COMMON SHAREHOLDERS                                                         |       |                                                   |       |                                                  |       |   |   |   |   |
| Net (loss) income                                                                        |       | $                                                      | (2,691,788 | )                                                     | $          | 7,589,765 |   | $ | (9,867,824 | ) | $ | 11,947,475 |   |
| Inducement to acquire redeemable convertible  preferred stock                            |       |                                                   |       | (13,579,979                                           | )          |   |   | (13,579,979 | ) |
| Redeemable convertible preferred stock cash  dividends                                   |       | —                                                 |       | (146,851                                              | )          | — |   | (588,542 | ) |
| NET LOSS TO COMMON SHAREHOLDERS                                                          |       | $                                                      | (2,691,788 | )                                                     | $          | (6,137,065 | ) | $ | (9,867,824 | ) | $ | (2,221,046 | ) |
|                                                                                     |       |                                                   |       |                                                  |       |   |   |   |   |
| NET LOSS PER  COMMON SHARE – CONTINUING OPERATIONS,  AFTER PREFERRED DIVIDENDS |       |                                                   |       |                                                  |       |   |   |   |   |
| Basic                                                                                    |       | $                                                      | (0.27      | )                                                     | $          | (1.54 | ) | $ | (1.05 | ) | $ | (1.03 | ) |
| Diluted                                                                                  |       | (0.27                                                  | )          | (2.64                                                 | )          | (1.05 | ) | (4.05 | ) |
|                                                                                     |       |                                                   |       |                                                  |       |   |   |   |   |
| NET (LOSS)  EARNINGS PER COMMON SHARE – DISCONTINUED OPERATIONS                     |       |                                                   |       |                                                  |       |   |   |   |   |
| Basic                                                                                    |       | $                                                      | (0.00      | )                                                     | $          | 0.02 |   | $ | (0.00 | ) | $ | (0.03 | ) |
| Diluted                                                                                  |       | (0.00                                                  | )          | 0.02                                                  |       | (0.00 | ) | (0.01 | ) |
|                                                                                     |       |                                                   |       |                                                  |       |   |   |   |   |
| NET LOSS PER  COMMON SHARE                                                               |       |                                                   |       |                                                  |       |   |   |   |   |
| Basic                                                                                    |       | $                                                      | (0.27      | )                                                     | $          | (1.52 | ) | $ | (1.05 | ) | $ | (1.06 | ) |
| Diluted                                                                                  |       | (0.27                                                  | )          | (2.62                                                 | )          | (1.05 | ) | (4.06 | ) |
|                                                                                     |       |                                                   |       |                                                  |       |   |   |   |   |
| WEIGHTED AVERAGE  COMMON SHARES OUTSTANDING                                              |       |                                                   |       |                                                  |       |   |   |   |   |
| Basic                                                                                    |       | 9,837,224                                              |       | 4,044,549                                             |       | 9,410,206 |   | 2,096,057 |   |
| Diluted                                                                                  |       | 9,837,224                                              |       | 5,878,972                                             |       | 9,410,206 |   | 4,620,092 |   |

 

See notes to condensed financial statements.

3

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**MEDICALCV,INC.**

**CONDENSEDSTATEMENTS OF CASH FLOWS**

**(UNAUDITED)**
| ** **                                                                                       | ** ** | **Nine months ended January 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2007**                                              | ** ** | **2006** | ** ** |
| OPERATING  ACTIVITIES                                                                            |       |                                                  |       |   |   |
| Net (loss) income                                                                                |       | $                                                     | (9,867,824 | ) | $ | 11,947,475 |   |
| Adjustments to reconcile net (loss) income to net  cash used by operating activities:            |       |                                                  |       |   |   |
| Decrease in fair value of putable warrants                                                       |       | —                                                |       | (16,549,457 | ) |
| Depreciation and amortization                                                                    |       | 140,367                                               |       | 171,395 |   |
| Gain from the sales of property, plant and equipment                                             |       | (45,973                                               | )          | (137,647 | ) |
| Stock-based compensation                                                                         |       | 1,456,427                                             |       | 22,889 |   |
| Warrant expense related to technology purchase  agreement                                        |       | 15,300                                                |       | — |   |
| Provision for doubtful accounts                                                                  |       | —                                                |       | 23,935 |   |
| Changes in operating assets and liabilities:                                                     |       |                                                  |       |   |   |
| Accounts receivable                                                                              |       | (3,525                                                | )          | 557,291 |   |
| Inventories                                                                                      |       | —                                                |       | 228,665 |   |
| Prepaid expenses and other assets                                                                |       | 60,641                                                |       | 68,190 |   |
| Accounts payable                                                                                 |       | (235,827                                              | )          | (70,704 | ) |
| Accrued expenses                                                                                 |       | 17,465                                                |       | 30,544 |   |
| NET CASH USED BY OPERATING ACTIVITIES                                                            |       | (8,462,949                                            | )          | (3,707,424 | ) |
| INVESTING  ACTIVITIES                                                                            |       |                                                  |       |   |   |
| Purchases of property, plant and equipment                                                       |       | (203,117                                              | )          | (322,498 | ) |
| Proceeds from the sales of property, plant and  equipment                                        |       | 50,668                                                |       | 341,757 |   |
| NET CASH (USED) PROVIDED BY INVESTING ACTIVITIES                                                 |       | (152,449                                              | )          | 19,259 |   |
| FINANCING  ACTIVITIES                                                                            |       |                                                  |       |   |   |
| Principal payments under related party lease  obligation                                         |       | (240,829                                              | )          | (194,793 | ) |
| Payments of fractional share interests                                                           |       | (229                                                  | )          | — |   |
| Proceeds from issuance of common stock and warrants,  net of offering costs                      |       | 2,190,000                                             |       | — |   |
| Proceeds from exercise of warrants, net of costs                                                 |       | —                                                |       | 6,435,140 |   |
| Proceeds from exercise of stock options                                                          |       | —                                                |       | 660 |   |
| Preferred stock cash dividends                                                                   |       | —                                                |       | (588,542 | ) |
| NET CASH PROVIDED BY FINANCING ACTIVITIES                                                        |       | 1,948,942                                             |       | 5,652,465 |   |
| NET (DECREASE)  INCREASE IN CASH AND CASH EQUIVALENTS                                            |       | (6,666,456                                            | )          | 1,964,300 |   |
|                                                                                             |       |                                                  |       |   |   |
| CASH AND CASH  EQUIVALENTS                                                                       |       |                                                  |       |   |   |
| Beginning of year                                                                                |       | 10,351,570                                            |       | 10,637,796 |   |
| End of period                                                                                    |       | $                                                     | 3,685,114  |   | $ | 12,602,096 |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION                                                |       |                                                  |       |   |   |
| Cash paid for interest                                                                           |       | $                                                     | 94,241     |   | $ | 128,855 |   |
|                                                                                             |       |                                                  |       |   |   |
| NON-CASH  INVESTING AND FINANCING ACTIVITIES                                                     |       |                                                  |       |   |   |
| Inducement to  acquire redeemable convertible preferred stock                                    |       | —                                                |       | $ | 13,579,979 |   |
| Reduction of fair value  of putable warrants upon exercise of warrants and removal of put option |       | —                                                |       | $ | 11,443,152 |   |

 

See notes to condensed financial statements.

4

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**MEDICALCV, INC.**

**Notes to Condensed FinancialStatements**

**1.             Basis ofFinancial Statement Presentation**

Theaccompanying unaudited condensed financial statements included herein have beenprepared 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 (“SEC”).  Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted pursuant to such rules andregulations.  These interim financial statements should be read in conjunctionwith the financial statements and the notes thereto included in the Company’sAnnual Report on Form 10-KSB for the fiscal year ended April 30,2006.

Thebalance sheet as of January 31, 2007, the statements of operations for thethree and nine months ended January 31, 2007 and 2006, and the statements ofcash flows for the nine months ended January 31, 2007 and 2006 include, inthe opinion of management, all adjustments, consisting solely of normalrecurring adjustments, necessary for a fair presentation of the financialresults for the respective interim periods and are not necessarily indicativeof results of operations to be expected for the entire fiscal year endingApril 30, 2007.

**2.             GoingConcern**

TheCompany’s financial statements as of and for the nine months ended January 31,2007 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 in the foreseeable future.  At January 31, 2007, the Companyhad an accumulated deficit of $57,210,912.  The level of cash required foroperations during the remaining quarter of fiscal year 2007 is difficult topredict, and management anticipates that development and the introduction ofits new product will require additional capital.  These matters raisesubstantial doubt about the Company’s ability to continue as a going concern. Management intends to seek additional debt or equity financing as it continuesto develop and launch its new product.  However, the Company may not beable to obtain such financing on acceptable terms or at all.  If theCompany is unable to obtain such additional financing, it will be required tosignificantly revise its business plan and drastically reduce operatingexpenditures such that it may not be able to develop or enhance its product,gain market share, or respond to competitive pressures or unanticipatedrequirements, which could seriously harm its business, financial position andresults of operations.  The financial statements do not include anyadjustments that might result from the outcome of this uncertainty.

5

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**3.             Net Lossper Common Share**

Basicnet loss per common share was computed by dividing the net loss to commonshareholders by the weighted average number of common shares outstanding. Diluted net loss per common share reflects the potential dilution that couldoccur if holders of warrants and options that are not anti-dilutive converttheir holdings into common stock.  Diluted net loss per common share doesnot differ from basic net loss per common share in the three and nine monthsended January 31, 2007 due to the loss from continuing operations which wouldcause the potentially dilutive shares to be anti-dilutive.  Certainwarrants outstanding during the three and nine months ended January 31, 2006were potentially dilutive and considered to be common stock equivalents. The net loss to common shareholders for the three and nine months ended January31, 2006 was adjusted for the decrease in fair value of putable warrants andthe weighted average number of shares used for the basic net loss per sharecomputation was increased by the shares issuable under the warrants as follows:
| ** **                                                                       | ** ** | **For the Periods Ended January 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **Three Months**                                          | ** ** | **Nine Months** | ** ** |
| ** **                                                                       | ** ** | **2007**                                                       | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** |
| Numerator:                                                                       |       |                                                           |       |   |   |   |   |   |   |
| Net loss to  common shareholders for basic net loss per common share             |       | $                                                              | (2,691,788 | ) | $ | (6,137,065 | ) | $ | (9,867,824 | ) | $ | (2,221,046 | ) |
| Effect of  dilutive securities – decrease in fair value of putable warrants |       | —                                                         |       | (9,273,355 | ) | — |   | (16,549,457 | ) |
| Net loss to common  shareholders for diluted loss per common share               |       | $                                                              | (2,691,788 | ) | $ | (15,410,420 | ) | $ | (9,867,824 | ) | $ | (18,770,503 | ) |

 
| ** **                                                                     | ** ** | **For the Periods Ended January 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **Three Months**                                          | ** ** | **Nine Months** | ** ** |
| ** **                                                                     | ** ** | **2007**                                                       | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** |
| Denominator:                                                                   |       |                                                           |       |   |   |   |   |   |   |
| Weighted average  shares outstanding for basic net loss per common share       |       | 9,837,224                                                      |       | 4,044,549 |   | 9,410,206 |   | 2,096,057 |   |
| Effect of  dilutive securities – shares issuable under warrant agreements |       | —                                                         |       | 1,834,423 |   | — |   | 2,524,035 |   |
| Weighted average shares  outstanding for diluted net loss per common share     |       | 9,837,224                                                      |       | 5,878,972 |   | 9,410,206 |   | 4,620,092 |   |

 

Optionsand warrants outstanding to purchase 2,218,010 and 1,889,671 shares of commonstock were excluded from the computation for the three months ended January 31,2007 and 2006, respectively, because they were anti-dilutive.  Options andwarrants outstanding to purchase 2,166,073 and 1,822,114 shares of common stockwere excluded from the computation for the nine months ended January 31, 2007and 2006, respectively, because they were anti-dilutive.

6

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**4.             Stock-BasedCompensation**

On May1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”)No. 123R (revised 2004), *Share-BasedPayment,*and elected the modified prospective application transitionmethod.  SFAS No. 123R is a revision of SFAS No. 123, *Accounting for Stock-Based Compensation*,and supersedes Accounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees*,and its related guidance.  As required by SFAS No. 123R, the Companyrecognizes compensation expense during the service period of stock-based awardsthat are granted, modified, repurchased, or cancelled after May 1, 2006 usingthe grant-date fair value of the award.  In addition, compensation expenseis recognized for the remaining service period of awards granted prior to, butnot yet vested as of May 1, 2006, based on the grant-date fair value of theaward.  In accordance with the modified prospective application transitionmethod of SFAS No. 123R, prior period results were not restated. Incremental compensation cost for a modification of the terms or conditions ofan award is measured by comparing the fair value of the modified award with thefair value of the award immediately before the modification.  The Companyhas also implemented the SEC interpretations in Staff Accounting Bulletin (“SAB”)No. 107, *Share-Based Payments,*inconnection with the adoption of SFAS No. 123R.

*Stock-Based Compensation Expense*

Stock-basedcompensation expense is classified in the same expense lines as cashcompensation in accordance with SAB No. 107.  Stock-based compensationexpense included in the statement of operations as a result of adopting SFASNo. 123R is as follows:  
| ** **                                                                         | ** ** | **Three months  ended January 31, 2007** | ** ** | **Nine months  ended January 31, 2007** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| Sales and  marketing                                                               |       | $                                                            | 23,260     |                                                        | $          | 68,632 |   |
| General and  administrative                                                        |       | 242,426                                                      |       | 1,019,494                                                   |       |
| Research and  development (1)                                                      |       | 126,531                                                      |       | 368,301                                                     |       |
| Total  stock-based compensation                                                    |       | $                                                            | 392,217    |                                                        | $          | 1,456,427 |   |
|                                                                               |       |                                                         |       |                                                        |       |
| Impact of adopting SFAS  No. 123R on reported basic and diluted net loss per share |       | $                                                            | (0.04      | )                                                           | $          | (0.15 | ) |

 

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(1)Includes $17,231 and $48,712 of stock-based compensation expense related tostock options granted under the Company’s Amended and Restated 2001 EquityIncentive Plan to non-employees serving on the Company’s scientific advisoryboard in the three and nine months ended January 31, 2007, respectively.

TheCompany recognizes compensation expense for stock-based awards on astraight-line basis over the requisite service period of the award.  Theamount of stock-based compensation recognized is based on the value of theportions of the awards that are ultimately expected to vest.  SFAS No.123R requires forfeitures to be estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates.  Compensation expense for the vested portion of stock-basedawards is not reversed if an award expires unexercised or if an award isforfeited due to employee termination. No compensation cost is recognized for unvested awards that employeesforfeit because the requisite service is not rendered.  Previouslyrecognized compensation cost is not reversed if an employee stock option forwhich the requisite service has been rendered expires unexercised.  TheCompany uses historical forfeitures and employee turnover to estimate thenumber of options that will actually vest.  The Company reevaluates thisestimate periodically and adjusts the forfeiture rate on a prospective basis asnecessary.

7

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As ofJanuary 31, 2007, there was $3,385,417 of total unrecognized stock-basedcompensation cost and the Company expects that cost to be recognized over aweighted-average recognition period of 2.4 years.

Priorto the adoption of SFAS No. 123R, the Company accounted for stock optionsgranted to employees using the intrinsic value method under the guidance of APBNo. 25, and provided pro forma disclosure as required by SFAS No. 123. Under the intrinsic value method of accounting, no compensation expense isrecognized in the statement of operations when the exercise price of theemployee stock option award equals or is greater than the market price of theunderlying common stock at the date of grant, and the measurement date of theoption grant is certain.  The measurement date is certain when the date ofgrant is fixed and determinable.  Compensation cost for employee stockoptions is measured as the excess, if any, of the quoted market price of thestock at the date of grant over the amount that the employee is required to payfor the stock.

Stock-basedcompensation cost of $22,889 was recognized in the statement of operations forthe three and nine months ended January 31, 2006 related to non-employeeconsultants serving on the scientific advisory board.  Stock options granted had an exercise priceequal to the market value of the underlying common stock of the Company at thedate of grant.

Inaccordance with the modified prospective application transition method of SFASNo. 123R, financial results for prior periods have not been restated.  Forpurposes of the pro forma disclosures required by SFAS No. 123, the Company amortizedthe grant-date fair value of employee stock options over the vesting period andaccounted for forfeitures as they occurred.  The following tableillustrates the effect on net loss and net loss per share as if the Company hadrecorded compensation expense for employee stock options under the fair valuebased method for the three and nine months ended January 31, 2006:  
| ** **                                                                                   | ** ** | **Three months  ended January 31, 2006** | ** ** | **Nine months  ended January 31, 2006** | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| Net loss to  common shareholders – as reported                                          |       | $                                                            | (6,137,065 | )                                                           | $          | (2,221,046 | ) |
| Add: Stock-based  compensation included in net loss                                          |       | 22,889                                                       |       | 22,889                                                      |       |
| Less:  Stock-based compensation determined under the fair value based method for all  awards |       | (556,098                                                     | )          | (1,359,375                                                  | )          |
| Net loss to  common shareholders – pro forma                                            |       | $                                                            | (6,670,274 | )                                                           | $          | (3,557,532 | ) |
|                                                                                         |       |                                                         |       |                                                        |       |
| Basic net loss  per common share                                                             |       |                                                         |       |                                                        |       |
| As reported                                                                                  |       | $                                                            | (1.52      | )                                                           | $          | (1.06 | ) |
| Pro forma                                                                                    |       | (1.65                                                        | )          | (1.70                                                       | )          |
|                                                                                         |       |                                                         |       |                                                        |       |
| Diluted net loss  per common share                                                           |       |                                                         |       |                                                        |       |
| As reported                                                                                  |       | $                                                            | (2.62      | )                                                           | $          | (4.06 | ) |
| Pro forma                                                                                    |       | (2.71                                                        | )          | (4.35                                                       | )          |

 

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*Stock Option Activity*

AtJanuary 31, 2007, 354,807 shares remain available for grant under the Company’sfive authorized stock option plans.  Of the 913,283 options outstanding atJanuary 31, 2007, 513,715 have been issued outside of the Company’s authorizedplans.  Generally, the exercise price of an option is set at the closingmarket price of the Company’s common stock on the grant date.  Optionstypically vest over four years and have a maximum contractual term of tenyears.  Certain option awards provide for accelerated vesting if there isa change in control.

Thefollowing table summarizes information about stock options for the nine monthsended January 31, 2007:

|                                                          | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted Average  Remaining  Contractual Term  (in years)** | ** ** | **Aggregate  Intrinsic  Value (1)** | ** ** |
|----------------------------------------------------------|------------|-------------|------------|----------------------------------------|------------|------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| Outstanding,  April 30, 2006                             |       | 903,253     |       | $                                      | 9.70       |                                                                         |       |                                     |       |   |
| Granted                                                  |       | 146,229     |       | 7.66                                   |       |                                                                         |       |                                     |       |
| Forfeited/Expired                                        |       | (99,947     | )          | 10.23                                  |       |                                                                         |       |                                     |       |
| Outstanding,  July 31, 2006                              |       | 949,535     |       | 9.33                                   |       |                                                                         |       |                                     |       |
| Granted                                                  |       | 26,000      |       | 4.05                                   |       |                                                                         |       |                                     |       |
| Forfeited/Expired                                        |       | (48,098     | )          | 10.22                                  |       |                                                                         |       |                                     |       |
| Outstanding,  October 31, 2006                           |       | 927,437     |       | 9.13                                   |       |                                                                         |       |                                     |       |
| Granted                                                  |       | 17,500      |       | 3.00                                   |       |                                                                         |       |                                     |       |
| Forfeited/Expired                                        |       | (31,654     | )          | 15.98                                  |       |                                                                         |       |                                     |       |
| Outstanding,  January 31, 2007                           |       | 913,283     |       | 8.78                                   |       | 6.6                                                                          |       | $                                        | —     |   |
| Vested and  expected to vest, January 31, 2007 |       | 775,695     |       | 8.83                                   |       | 6.5                                                                          |       | $                                        | —     |   |
| Exercisable,  January 31, 2007                           |       | 356,979     |       | 9.43                                   |       | 6.1                                                                          |       | $                                        | —     |   |
|                                                          |            |             |            |                                        |            |                                                                              |            |                                          |            |  |  |

 

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(1)This disclosure excludes those options that have no intrinsic value (i.e. thoseoptions that are out-of-the-money using the closing market price of the Company’scommon stock on January 31, 2007 of $2.55 per share).

On May10, 2006, the Company awarded non-qualified stock options for the purchase of5,000 shares of common stock to each of the Company’s six non-employeedirectors.  These options vested immediately, are exercisable at $10.50per share, and expire on May 10, 2016.  In addition, the Company awarded anon-qualified stock option for the purchase of 25,000 shares of common stock tothe Vice President, Marketing.  This option vests over 4 years, is exercisableat $10.50 per share, and expires on May 10, 2016.

On June21, 2006, the Company awarded a non-qualified stock option for the purchase of91,229 shares of common stock to the Vice President, Finance and ChiefFinancial Officer.  This option vests over 4 years, is exercisable at$5.95 per share, and expires on June 21, 2016.

OnOctober 19, 2006, the Company awarded non-qualified stock options for thepurchase of 5,000 shares of common stock to each of the Company’s fivenon-employee directors. The options vest in 1 year, are exercisable at $4.05per share, and expire on October 19, 2016.

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OnJanuary 15, 2007, the Company awarded non-qualified stock options for thepurchase of 5,000 shares of common stock under the Company’s Amended andRestated 2001 Equity Incentive Plan to each of the Company’s two directorselected on January 15, 2007.  Inaddition, the Company awarded non-qualified stock options for the purchase of3,750 shares of common stock under the Company’s 2005 Director Stock OptionPlan to each of the Company’s two directors elected on January 15, 2007.  These options vest in 1 year, are exercisableat $3.00 per share, and expire on January 15, 2017.

Netcash proceeds from the exercise of stock options for 375 shares of common stockwere $1,125 in the nine months ended January 31, 2006.  The aggregateintrinsic value of the options exercised (the amount by which the market priceof the stock on date of exercise exceeded the market price of the stock on thedate of grant) was $2,063 during the nine months ended January 31, 2006. Due to the Company’s tax position, no tax benefit was recognized as a result ofoption exercises.  There were no stock options exercised during the threeand nine months ended January 31, 2007 and three months ended January 31,2006.  The Company issues new shares for stock options exercised.

*Stock Option Valuation*

TheCompany uses the Black-Scholes-Merton formula to estimate the grant date fairvalue of its stock options using the following assumptions:
| ** **                              | ** ** | **Three months ended January 31,** | ** ** | **Nine months ended January 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                              | ** ** | **2007**                                               | ** ** | **2006**                                              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Options granted                         |       | 17,500                                                 |       | 24,250                                                |       | 189,729 |   | 107,846 |   |
| Weighted average  exercise price        |       | $                                                      | 3.00       |                                                  | $          | 8.40 |   | $ | 6.74 |   | $ | 7.62 |   |
| Weighted average  grant-date fair value |       | $                                                      | 2.42       |                                                  | $          | 8.15 |   | $ | 5.49 |   | $ | 7.40 |   |
| Expected  dividend rate (1)             |       | 0                                                      | %          | 0                                                     | %          | 0 | % | 0 | % |
| Risk free  interest rate (2)            |       | 4.8                                                    | %          | 4.2                                                   | %          | 4.8 to 5.1 | % | 4.2 | % |
| Expected term  (3)                      |       | 5.5 years                                              |       | 4.0 to 10.0 years                                     |       | 5.0 to 6.3 years |   | 4.0 to 10.0 years |   |
| Expected  volatility (4)                |       | 104.2                                                  | %          | 136.0                                                 | %          | 104.2 to 111.2 | % | 136.0 | % |
| Weighted-average  volatility            |       | 104.2                                                  | %          | 136.0                                                 | %          | 110.0 | % | 136.0 | % |

 

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**(1)  Expected dividend rate** — TheCompany has not historically paid a cash dividend to common shareholders anddoes not expect to pay dividends in the future.  Therefore, the Companyhas assumed an expected dividend rate of zero.

**(2)  Risk free interest rate** — For stockoption grants in fiscal year 2007, the Company used yield rates on U.S.Treasury securities for a period approximating the expected term of the award. For stock option grants in fiscal year 2006, the rate was based on the U.S.Treasury interest rate for the term consistent with the maturity of the option.

**(3)  Expected term** – Due to thelimited number of stock options exercised historically, the Company has electedto use the “simplified” method for estimating the expected terms of optionsgranted in fiscal year 2007 as allowed under SAB 107.  Under thisapproach, the expected term was calculated by taking the average of the vestingterm and the original contract term.  In fiscal year 2006, the Companyused the contractual life of the option as the expected term.

**(4)  Expected volatility** – For stockoption grants in fiscal year 2007, the Company used at least three years ofhistorical monthly price observations to estimate volatility.  For stockoption grants in fiscal year 2006, the Company used weekly price observationsbeginning in August 2003, the date of acquisition of certain technology used incontinuing operations.

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**5.             Shareholders’Equity**

**Reverse Stock Split**

On May31, 2006, the Company effected a reverse stock split pursuant to which everyten shares of common stock and every ten shares of preferred stock werecombined into one share of common stock and one share of preferred stock,respectively, without any change in the par value of the shares.  Theauthorized capital stock was reduced in a like manner.  No fractionalshares were issued as a result of the reverse split, and $229 has been paid forfractional share interests.  The reverse split was approved by the Company’sboard of directors without shareholder approval in accordance with therequirements of Minnesota law.  Historical share data presented hereingives retroactive effect to this reverse stock split.

**Registration Statement for Public Offering of Common Stock**

OnAugust 8, 2006, the Company requested withdrawal of its registration statementon Form SB-2 originally filed with the SEC on May 19, 2006 related to a proposedpublic offering of common stock.  Due to unsettled conditions in theequity markets, the Company decided not to pursue a public offering at thattime.

**Private Placement of Common Stock and Warrants**

OnOctober 13, 2006, pursuant to the terms of a securities purchase agreement, theCompany issued 714,286 shares of common stock and warrants for the purchase ofan aggregate of 178,571 shares of common stock to accredited investors. Gross proceeds of $2,500,000 from the private placement were reduced by offeringcosts of $310,000 resulting in $2,190,000 of net proceeds.  The warrantsare exercisable for five years at an exercise price of $4.365 per share,subject to basic, and for 9 months, full-ratchet anti-dilution adjustments.

Inconnection with the securities purchase agreement, the Company granted theinvestors a 12-month right of participation in subsequent financings.  TheCompany agreed not to create or authorize any senior securities or undertake areverse or forward stock split or reclassification, without the consent of thepurchasers of a majority of the shares, for 18 months.  The Company alsoagreed not to enter into any variable rate transactions for 18 months.

Inaddition, the Company entered into a registration rights agreement whichrequired the Company to file a registration statement to register for resalethe shares of common stock issued in this transaction and the shares of commonstock issuable upon exercise of the warrants.  The Company filed suchregistration statement on November 17, 2006 and it was declared effective onNovember 30, 2006.

If theregistration statement ceases to be effective for more than an aggregate of 75calendar days in any 12-month period, the Company has agreed to pay each holderan amount as liquidated damages equal to 1.5% of the aggregate investmentamount then held by the holder of the shares purchased pursuant to thesecurities purchase agreement and on each monthly anniversary of the failure toeffect such registration, provided however that such liquidated damages willnot exceed 10% of the aggregate purchase price paid by all holders.  TheCompany is required to use its commercially reasonable efforts to keep theregistration statement effective until all registered securities covered by theregistration statement have been sold or may be sold without volumerestrictions pursuant to Rule 144(k).  Given the Company’s recent historyof maintaining the effectiveness of its registration statements, an accrual forliquidated damages is not necessary.

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Inaddition, if the registration statement permitting the resale of the sharesissuable upon the exercise of the warrants is required to be effective but isnot then effective or the prospectus forming a part thereof is not thenavailable for the resale of the shares, then each warrant allows the holder toconvert the warrants into common stock without any cash consideration inexchange for the surrender of the remaining shares of common stock otherwisepurchasable upon the exercise of the warrant.

**Warrants**

TheCompany had warrants outstanding to purchase 1,288,638 shares of the Company’scommon stock at prices ranging from $3.25 to $29.50 per share at January 31,2007.  The warrants expire at various dates through March 2015.  

|                                                | ** ** | **Warrants** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|------------------------------------------------|------------|--------------|------------|----------------------------------------|------------|
| Outstanding,  April 30, 2006 and July 31, 2006 |       | 1,168,498    |       | $                                      | 11.24      |   |
| Granted                                        |       | 178,571      |       | 4.37                                   |       |
| Impact of anti-dilution features               |       | 6,569        |       | 0.07                                   |       |
| Forfeited/Expired                              |       | (50,000      | )          | 65.00                                  |       |
| Outstanding,  October 31, 2006                 |       | 1,303,638    |       | 8.18                                   |       |
| Forfeited/Expired                              |       | (15,000      | )          | 67.50                                  |       |
| Outstanding, January  31, 2007 (1)             |       | 1,288,638    |       | 7.49                                   |       |
|                                                |            |              |            |                                        |            |  |

 

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(1)  TheCompany is obligated to issue warrants for the purchase of 5,000 shares ofcommon stock to LightWave Ablation Systems, Inc. (“LightWave”) in connectionwith milestone achievements.  Thewarrants to be issued have a 7-year term and an exercise price of $14.60 pershare.  Warrant expense of $15,300 hasbeen recorded in the three and nine months ended January 31, 2007 in connectionwith these warrants.

**6.             EmploymentAgreements**

**Current Vice President, Finance and Chief Financial Officer**

In May2006, the Company entered into an employment agreement with Eapen Chacko, whojoined the Company on June 21, 2006, as Vice President, Finance and ChiefFinancial Officer.  Mr. Chacko assumed the roles of principal financialofficer and principal accounting officer effective at the close of business onJuly 31, 2006.  Mr. Chacko receives an annual base salary of $200,000 andis eligible to receive performance-based cash bonuses.  The employmentagreement provides that a severance payment will be made if the employment isterminated by the Company without cause, or by the employee for good reason,including, but not limited to, a reduction of the employee’s compensation; a reductionof authority and responsibility; a relocation of place of employment; or abreach of the employment agreement by the Company.  The severance paymentwould be six months of base salary and, if at the end of such six-month period,Mr. Chacko is not employed or engaged as an independent contractor, the Companywould pay him up to an additional six months of base salary until he isemployed or engaged as an independent contractor.  In addition to paymentsof base salary, the Company has agreed to pay or reimburse Mr. Chacko formedical (COBRA) benefits for the periods covered by the severancepayments.  In addition, Mr. Chacko has agreed to certain nondisclosure andinvention provisions and certain noncompetition and nonrecruitment provisionsduring the term of employment and for a period of one year after termination ofemployment.

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**Former Vice President, Finance and Chief Financial Officer**

InApril 2006, the Company entered into an amendment to the employment agreement(the “First Amendment”) with John H. Jungbauer, then the Company’s VicePresident, Finance and Chief Financial Officer, to reflect the mutual decisionreached concerning Mr. Jungbauer’s departure from the Company.  Mr.Jungbauer’s employment ceased effective at the close of business on July 31,2006.  A severance payment of $100,000 was paid on July 31, 2006 and anadditional $100,000 was paid to Mr. Jungbauer on January 2, 2007.  Inaddition to these severance payments, the Company has agreed to pay orreimburse Mr. Jungbauer for medical (COBRA) benefits.  The Companyrecorded an expense of $94,291 in the first quarter of fiscal year 2007 and$131,793 in fiscal year 2006 related to the severance payments, related payrolltaxes, and medical benefits.

Inconnection with the First Amendment, the Company agreed to amend Mr. Jungbauer’sstock option agreements to provide that his options, to the extent vested onthe termination date, would be exercisable for a period of twelve monthsfollowing the termination of Mr. Jungbauer’s employment.  The originalterms of Mr. Jungbauer’s stock option agreements for the purchase of 144,012shares of the Company’s common stock provided that he had three monthsfollowing termination of employment to exercise the vested portions.  TheCompany accounted for the modification in accordance with the provisions of APBNo. 25 and recorded stock-based compensation expense of $87,353 in fiscal year2006 to reflect the intrinsic value of the excess of the market price of theCompany’s common stock at the date of modification over the exercise price ofthe vested stock options.

In July2006, the Company entered into a second amendment to the employment agreement(the “Second Amendment”) with Mr. Jungbauer to retroactively rescind theprovision in the First Amendment that provided Mr. Jungbauer twelve monthsfollowing termination of employment to exercise the vested portions of hisstock options and revert to the original terms of the stock option agreementsthat provided Mr. Jungbauer three months following termination of employment toexercise the vested portions thereof.  Options held by Mr. Jungbauer topurchase 44,065 shares of the Company’s common stock had vested as of July 31,2006.  The Company accounted for the subsequent modification of theexercise period in fiscal year 2007 in accordance with the provisions of SFASNo. 123R.  Accordingly, no incremental compensation was recorded in fiscalyear 2007 as the fair value of the modified stock option agreements was lessthan the fair value immediately before the modification.  Mr. Jungbauer’soptions expired unexercised on October 31, 2006.

**Summary of Severance Activity**
| Balance as of  April 30, 2005                                |   | $        | 24,834 |   |
|--------------------------------------------------------------|--------|----------|--------|--------|
| Severance  charges in fiscal year 2006                       |   | 172,175  |   |
| Cash usage in  fiscal year 2006                              |   | (65,216  | )      |
| Balance as of  April 30, 2006                                |   | 131,793  |   |
| Severance  charges in the first quarter of fiscal year 2007  |   | 94,291   |   |
| Cash usage in  the first quarter of fiscal year 2007         |   | (100,000 | )      |
| Balance as of  July 31, 2006                                 |   | 126,084  |   |
| Severance  charges in the second quarter of fiscal year 2007 |   | —   |   |
| Cash usage in  the second quarter of fiscal year 2007        |   | (5,958   | )      |
| Balance as of  October 31, 2006                              |   | 120,126  |   |
| Severance  charges in the third quarter of fiscal year 2007  |   | —   |   |
| Cash usage in  the third quarter of fiscal year 2007         |   | (112,285 | )      |
| Balance as of January  31, 2007                              |   | $        | 7,841  |   |

 

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**7.****                                           Litigation**

OnMarch 10, 2006, J Giordano Securities LLC (d/b/a J Giordano SecuritiesGroup) (“JGSG”) filed suit against the Company in U.S. District Court for theDistrict of Connecticut. JGSG, which acted as a private placement agent for theCompany in connection with sales of the Company’s securities to privateinvestors in April 2005, asserts claims for breach of contract, unjustenrichment and quantum meruit. JGSG contends it is owed certain fees as aresult of “follow on transactions” executed by investors identified by JGSG,pursuant to the engagement agreement, as amended, between the Company and JGSGor, in the alternative, that it should be awarded such fees on an equitablebasis. In particular, JGSG originally claimed that the exercise of outstandingwarrants for the purchase of common stock by certain JGSG-identified investorsand the Company’s purchase of outstanding shares of 5% Series A RedeemableConvertible Preferred Stock from certain JGSG-identified investors inDecember 2005 and January 2006 entitled JGSG to damages no less than$1,431,769. JGSG originally sought (a) $279,191 in cash commissions,(b) warrants for the purchase of 85,905 shares at $3.25 per share,(c) lost profits of $751,669 on the argument that JGSG would haveexercised the foregoing warrant and sold 85,905 shares on December 30,2005, at a price of $12.00 per share, and (d) $400,909 in cash commissionsthe Company paid C.E. Unterberg, Towbin, LLC (“CEUT”).

OnSeptember 22, 2006, the Company asserted a counterclaim against JGSG forfraud and breach of contract based upon JGSG’s misrepresentations to induce theCompany to enter the engagement agreement and JGSG’s failure to perform itspromised services thereunder. The Company seeks damages of (a) the $30,000retainer and $543,000 cash paid to JGSG; (b) the value of the Company’swarrants for 114,600 shares of common stock issued to JGSG; (c) the$445,328 fee and $27,016 expense reimbursement that the Company paid CEUT forits advisory services in December 2005 and January 2006; (d) the$3.7 million cash the Company did not obtain on investor warrant exercises dueto the reduced warrant exercise price the Company was required to accept duringthose months; and (e) the value of the additional 1.9 million shares ofcommon stock the Company was required to issue to effectuate the preferredstock purchase during those months. As a result, the Company counterclaims inexcess of $5.0 million.

OnNovember 20, 2006, JGSG filed an amended statement of claim. JGSG addednew claims for additional compensation based upon the issuance of additionalcommon stock to preferred stock holders in the alleged “follow-on transactions,”the Company’s alleged failure to timely file a resale registration statementfor JGSG, and for additional compensation based upon the October 2006private placement. JGSG currently seeks alleged damages of $3,346,565 asfollows: (a) $279,191 in cash commissions; (b) warrants for thepurchase of 85,905 shares at $3.25 per share; (c) lost profits of $751,669on the argument that JGSG would have exercised the foregoing warrant and sold85,905 shares on December 30, 2005, at a price of $12.00 per share;(d) $249,690 in cash pursuant to the alleged failure to timely file theresale registration statement for JGSG; (e) $6,726 in liquidated damagesbased upon the Company’s alleged failure to timely file the resale registrationstatement for JGSG; (f) $556,214 in cash commissions that JGSG claims itwas entitled to based upon preferred stock holders’ receipt of additionalcommon stock in the alleged “follow-on transactions”; (g) warrants for thepurchase of 171,142 shares at $3.25 per share; (h) lost profits of$952,166 on the argument that JGSG would have exercised the foregoing warrantand sold 171,142 shares on January 3, 2006, at a price of $11.00 pershare; (i) $400,909 in cash commissions the Company paid to CEUT; and(j) $150,000 based upon the fee the Company paid to CEUT for theOctober 2006 private placement. JGSG also seeks reimbursement for reasonableexpenses, interest, costs and attorneys’ fees. The U.S. District Court for theDistrict of Connecticut has referred the matter to NASD arbitration. TheCompany believes that JGSG’s lawsuit is without merit and intends to vigorouslydefend itself.

Giventhe nature of arbitration, it is reasonably possible that the Company may beexpected to pay certain amounts in connection with this claim.  As of January 31, 2007, the Company has notrecorded an accrual for this matter since the amount to be paid, if any, cannotbe reasonably estimated.

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**8.             DiscontinuedOperations**

OnNovember 17, 2004, the Company’s board of directors authorized managementto cease production of heart valves but to continue marketing the valves whileexploring the merits of possible strategic alternatives for the heart valvebusiness, including, but not limited to, a joint venture with another party orthe sale of the business.  Following exploration of a number ofalternatives, management concluded in April 2005 that an orderly windingup of the valve business was the Company’s best alternative.  OnApril 6, 2005, the Company’s board authorized management to discontinuesales and marketing of heart valves effective April 30, 2005, and to seeka buyer for the related production equipment.

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

*The following discussion contains various forward-lookingstatements within the meaning of Section 21E of the Exchange Act. Although we believe that, in making any such statement, our expectations arebased on reasonable assumptions, any such statement may be influenced byfactors that could cause actual outcomes and results to be materially differentfrom those projected.  When used in the following discussion, the words “anticipates,”“believes,” “expects,” “intends,” “plans,” “estimates” and similar expressions,as they relate to us or our management, are intended to identify suchforward-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 actualresults to differ materially from those anticipated, certain of which arebeyond our control, are set forth in this document and in our CautionaryStatement which appears as Exhibit 99 to this report.*

*Our actual results, performance or achievements could differmaterially from those expressed in, or implied by, forward-lookingstatements.  Accordingly, we cannot be certain that any of the eventsanticipated by forward-looking statements will occur or, if any of them dooccur, what impact they will have on us.  We caution you to keep in mindthe 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.  We do not undertake to update any forward-lookingstatement.*

**Overview**

We area medical device company that develops, manufactures and sells surgicalablation systems that utilize a laser energy technology platform to createprecise lesions, or scars, on cardiac and soft tissues.

OurATRILAZETM Surgical Ablation System (“ATRILAZE System”), which has U.S. Food andDrug Administration (“FDA”) 510(k) clearance for ablating soft tissue toinclude cardiac tissue, delivers laser energy via a hand-held wand for cardiactissue ablation.  The ATRILAZE System hasbeen utilized in concomitant open-heart and, by some cardiothoracic surgeons,in minimally invasive cardiac surgery procedures.  Physicians see precise cardiac ablation as apotentially effective way to address cardiac arrhythmias, including atrialfibrillation (“AF”), in certain patients. AF is the most commonly occurring cardiac arrhythmia.  It reduces cardiac output, is a majorprecursor to congestive heart failure and is associated with an increasedincidence of stroke.

OurSOLARTM Surgical Ablation System (“SOLAR System”), which is the subject of thepending FDA 510(k) clearance, delivers laser energy via an automated track toablate soft tissue in various surgical settings.  Commensurate with the launch of the SOLARSystem, we plan to commence work with our scientific advisory board to designand implement a protocol to collect clinical data to support a subsequentregulatory submission to obtain a specific clearance of the SOLAR System forcardiac tissue ablation.  We alsoanticipate the development of a clinical protocol for an Investigational DeviceExemption (“IDE”) study of the SOLAR System for the specific treatment ofAF.  As of January 31, 2007, no medicaldevice in the United States had FDA approved labeling for the treatment of AF.

Ourcompany was incorporated in Minnesota on March 30, 1992, under the name CVDynamics, Inc.  In April 1992, we acquired all of the tangible andintangible assets of Omnicor, Inc.  Omnicor resulted from the corporateand financial restructuring of a predecessor company called MedicalIncorporated, which was organized in 1971 to develop and market theLillehei-Kaster heart valve, licensed from the University of Minnesota.

UntilNovember 2004, we developed and marketed mechanical heart valves known as theOmnicarbon® 3000 and 4000 heart valves.  In November 2004, after anexhaustive evaluation of the heart valve business, we discontinued all heartvalve related production.  In April 2005, we announced that ourefforts to find a buyer for the heart valve business had been unsuccessful andthat we would stop selling heart valves and were exiting the heart valvebusiness.  At that time, we also determined to direct all of our resourcesto the development and introduction of our laser energy technology platform fortissue ablation.

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**Critical Accounting Policies and Estimates**

Forfurther discussion of our critical accounting policies and estimates, see ourAnnual Report on Form 10-KSB for the fiscal year ended April 30,2006.  Also, see Note 4 in Part I, Item 1 “Condensed Financial Statements”for additional information.

*RevenueRecognition.*  Wegenerate revenue from the sales of single-use medical devices.  We consider revenue to be realized orrealizable and earned when all of the following criteria are met:  there is a written sales invoice specifyingthe terms and conditions; the price is fixed; collection of the resultingreceivable is probable; title has transferred; and there are no remainingperformance obligations.  There is noright of return unless the product is defective, damaged, or does not performaccording to technical specifications.

**Recent Accounting Pronouncements**

InNovember 2004, the Financial Accounting Standards Board (“FASB”) issued SFASNo. 151, *Inventory Costs – An Amendment ofARB No. 43, Chapter 4*(“SFASNo. 151”)*. *SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, “InventoryPricing,” to clarify the accounting for abnormal amounts of idle facilityexpense, freight, handling costs, and wasted material (spoilage).  Among other provisions, the new rule requiresthat items such as idle facility expense, excessive spoilage, double freight,and rehandling costs be recognized as current-period charges if they meet thecriterion of “so abnormal” as stated in ARB No. 43.  Additionally, SFAS No. 151 requires that theallocation of fixed production overhead to the costs of conversion be based onthe normal capacity of the production facilities.  SFAS No. 151 is effective for inventory costsincurred during fiscal years beginning after June 15, 2005.  The adoption of SFAS No. 151 on May 1, 2006did not have a material impact on our financial statements.

In June2006, the FASB issued Interpretation No. 48 (“FIN 48”), *Accounting for Uncertainty in Income Taxes – aninterpretation of FASB Statement No. 109*.  FIN 48 prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return, and provides guidance on derecognition, classification, interestand penalties, accounting in interim periods, disclosure, and transition.  FIN 48 is effective for fiscal years beginningafter December 15, 2006.  We do notanticipate the adoption of FIN 48 on May 1, 2007 to have a material impact onour financial statements due to our tax loss carryforwards and relatedvaluation allowance.

In September 2006, the FASB issuedSFAS No. 157, *Fair ValueMeasurements*, which defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles, and expandsdisclosures about fair value measurements.  SFAS No. 157 is effective forfinancial statements issued for fiscal years beginning after November 15, 2007,and interim periods within those fiscal years. We do not anticipate the adoption of SFAS No. 157 on May 1, 2008 to havea material impact on our financial statements.

In September 2006, the SEC issued SAB No. 108, *Considering the Effects of Prior Year MisstatementsWhen Quantifying Misstatements in Current Year Financial Statements*,which provides interpretive guidance on how the effects of the carryover orreversal of prior year misstatements should be considered in quantifying a currentyear misstatement. The SEC staff believes that registrants should quantifyerrors using both a balance sheet and an income statement approach and evaluatewhether either approach results in quantifying a misstatement that, when allrelevant quantitative and qualitative factors are considered, ismaterial.  This pronouncement is effective for fiscal years ending afterNovember 15, 2006.  We do not anticipate the adoption of SAB No. 108 tohave a material impact on our financial statements.

In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities –Including an amendment of FASB Statement No. 115*, which permitsentities to choose to measure many financial instruments and certain otheritems at fair value.  SFAS No. 159 iseffective as of the beginning of an entity’s first fiscal year that beginsafter November 15, 2007.  We do notanticipate the adoption of SFAS No. 159 on May 1, 2008 to have a materialimpact on our financial statements.

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**Results of Operations for the Three Months Ended January 31,2007 and 2006**

*Sales*.   Historical sales of our ATRILAZE System wererecorded as a reduction of research and development expenses since the primarypurpose of offering the device was to obtain clinical research information toassist in the development of the SOLAR System. In November 2006, we determined that there exists an opportunity to sellthe ATRILAZE System as a stand-alone device and as a potentially complementaryproduct to the SOLAR System after its introduction.  Since November 29, 2005, the date of thefirst sale, we have sold $62,200 of our ATRILAZE System single-usedevices.  Sales of the ATRILAZE Systemwere $11,200 in the three months ended January 31, 2007. Sales of the SOLARSystem product are not expected until we receive a FDA 510(k) clearance on suchproduct and we conduct the commercial launch of such product.

*Cost of Goods Sold*.  As a result of ourprior strategy not to promote the sales of the ATRILAZE System, we recorded thehistorical cost of the ATRILAZE System inventory as a research and developmentexpense since, at that time, it was believed to have no future economicvalue.  As a result, the cost of goodssold in the three months ended January 31, 2007 excluded the historical cost ofthe ATRILAZE System inventory since it was previously expensed in fiscal year2006.  The cost of goods sold in thethree months ended January 31, 2007 consisted of the six percent royalty toLightWave and an estimate of the sales and use tax to be assessed by state andlocal tax authorities.

*Sales and Marketing*.  Sales andmarketing expenses increased from $295,742 in the three months ended January31, 2006 to $361,824 in the three months ended January 31, 2007.  The$66,082 increase was primarily caused by increases in headcount and travel andentertainment expenses as a result of expanding our sales and marketing effortsin preparation for launch of our SOLAR System.  The three months endedJanuary 31, 2007 included $23,260 in employee stock-based compensation expenseas a result of SFAS No. 123R.

*General and Administrative*.  Generaland administrative expenses increased from $840,155 in the three months endedJanuary 31, 2006 to $899,799 in the three months ended January 31, 2007. The three months ended January 31, 2007 included $222,996 in employeestock-based compensation expense and $19,430 in director stock-basedcompensation expense as a result of SFAS No. 123R.

*Research and Development.*  Researchand development expenses increased from $707,630 in the three months endedJanuary 31, 2006 to $1,456,710 in the three months ended January 31,2007.  The $749,080 increase was primarily due to development of our SOLARSystem.  During the three months ended January 31, 2007, we incurred$338,247 and $90,000 in external development costs for our controller and laserdevices, respectively.  These twocomponents represent the capital equipment portion of the SOLAR System.  The three months ended January 31, 2007included $109,300 in employee stock-based compensation expense as a result ofSFAS No. 123R and $17,231 in stock-based compensation expense related tonon-employees serving on our scientific advisory board.

*Other Income (Expense)*.  Other income(expense) in the three months ended January 31, 2006 included a $9,273,355reduction in the fair value of the putable warrants issued in connection with1,803 shares of 5% Series A redeemable convertible preferred stock issued onApril 1, 2005 discussed more fully in Note 9 of the financial statementsincluded in our Annual Report on Form 10-KSB for the fiscal year ended April30, 2006.

*Discontinued Operations.*  The lossfrom discontinued operations in the three months ended January 31, 2007consisted primarily of the amortization of a prepaid insurance policy relatedto the heart valve business.  The income from discontinued operations inthe three months ended January 31, 2006 consisted primarily of a $137,647 gainfrom the sale of fixed assets partially offset by amortization of a prepaidinsurance policy related to the heart valve business.

*Dividends on Preferred Stock. *Duringthe three months ended January 31, 2006, we repurchased outstanding shares ofredeemable convertible preferred stock pursuant to our preferred stockacquisition plan.  Our acquisition ofredeemable convertible preferred stock in consideration of the issuance of3,077 shares of common stock per share of redeemable convertible preferredstock resulted in a non-cash dividend of $13,579,979.  In addition, cash dividends of $146,851 werepaid on the redeemable convertible preferred stock during the three monthsended January 31, 2006.  Refer to Note 9of our financial statements included in our Annual Report on Form 10-KSB forthe fiscal year ended April 30, 2006 for additional information.

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*Income Tax Provision*.  We have noincome tax provision in the three months ended January 31, 2007 and 2006 due tothe net operating losses generated for income tax reporting purposes.  Wehave established a valuation allowance to fully offset tax assets due to theuncertainty about our ability to generate the future taxable income necessaryto realize these deferred tax assets, particularly in light of our history ofsignificant operating losses.  In addition, future utilization ofavailable net operating loss carryforwards may be limited under InternalRevenue Code Section 382 as a result of changes in ownership that have or mayresult from the issuance of common stock, redeemable convertible preferredstock or common stock options and warrants.

**Results of Operations for the Nine Months Ended January 31,2007 and 2006**

*Sales*.   Historical sales of our ATRILAZE System wererecorded as a reduction of research and development expenses since the primarypurpose of offering the device was to obtain clinical research information toassist in the development of the SOLAR System. In November 2006, we determined that there exists an opportunity to sellthe ATRILAZE System as a stand-alone device and as a potentially complementaryproduct to the SOLAR System after its introduction.  Since November 29, 2005, the date of thefirst sale, we have sold $62,200 of our ATRILAZE System single-use devices.  We have recognized $11,200 of ATRILAZE Systemsales as revenue in the nine months ended January 31, 2007. Sales of the SOLARSystem product are not expected until we receive a FDA 510(k) clearance on suchproduct and we conduct the commercial launch of such product.

*Cost of Goods Sold*.  As a result of ourprior strategy not to promote the sales of the ATRILAZE System, we recorded thehistorical cost of the ATRILAZE System inventory as a research and developmentexpense since, at that time, it was believed to have no future economicvalue.  As a result, the cost of goodssold in the nine months ended January 31, 2007 excluded the historical cost ofthe ATRILAZE System inventory since it was previously expensed in fiscal year2006.  The cost of goods sold in the ninemonths ended January 31, 2007 consisted of the six percent royalty to LightWaveand an estimate of the sales and use tax to be assessed by state and local taxauthorities.

*Sales and Marketing*.  Sales and marketingexpenses increased from $429,576 in the nine months ended January 31, 2006 to$1,158,698 in the nine months ended January 31, 2007.  The $729,122increase was primarily due to expanding our sales and marketing efforts inpreparation for launch of our SOLAR System.  The significant components ofthe increase in sales and marketing expenses in the nine months ended January31, 2007 included $313,730 in additional payroll and related costs, $152,796 inadditional travel and entertainment, and $65,000 in relocation costs.  The nine months ended January 31, 2007included $68,632 in employee stock-based compensation expense as a result ofSFAS No. 123R.

*General and Administrative*.  Generaland administrative expenses increased from $2,324,735 in the nine months endedJanuary 31, 2006 to $3,657,007 in the nine months ended January 31, 2007. The $1,332,272 increase was primarily due to the adoption of SFAS No.123R.  The nine months ended January 31, 2007 included $654,618 inemployee stock-based compensation expense and $364,876 in director stock-basedcompensation expense as a result of SFAS No. 123R.  In addition, weincurred increases of $103,227 in legal services, $52,466 in accountingservices, and $183,665 in document preparation and filing services relatedprimarily to a proposed public offering of our common stock that wesubsequently decided not to pursue.

*Research and Development.*  Researchand development expenses increased from $1,900,305 in the nine months endedJanuary 31, 2006 to $5,199,361 in the nine months ended January 31, 2007. The $3,299,056 increase was primarily due to development of our SOLARSystem.  During the nine months ended January 31, 2007, we incurred$1,609,403 in external development of our controller component of the system, $465,886in external development of our laser component of the system, and $617,035 inmaterials, supplies, and temporary labor to build pre-clinical SOLAR Systemprototypes to be tested as part of the development process.  The ninemonths ended January 31, 2007 included $319,589 in employee stock-basedcompensation expense as a result of SFAS No. 123R and $48,712 in stock-basedcompensation expense related to non-employees serving on our scientificadvisory board.

*Other Income (Expense)*.  Other income(expense) in the nine months ended January 31, 2006 included a $16,549,457reduction in the fair value of the putable warrants issued in connection with1,803 shares of 5% Series A redeemable convertible preferred stock issued onApril 1, 2005 discussed more fully in Note 9 of the financial statementsincluded in our Annual Report on Form 10-KSB for the fiscal year ended April30, 2006.

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*Discontinued Operations.*  The lossfrom discontinued operations in the nine months ended January 31, 2007consisted primarily of $67,337 in amortization of a prepaid insurance policyrelated to the heart valve business partially offset by $31,500 in the gain onthe sale of fixed assets.  The loss from discontinued operations in thenine months ended January 31, 2006 included revenue of $338,333, cost of goodssold of $441,302, insurance expense of $67,338, and bad debt expense of$24,235, and a $137,647 gain from the sale of fixed assets.

*Dividends on Preferred Stock. *Duringthe nine months ended January 31, 2006, we repurchased outstanding shares ofredeemable convertible preferred stock pursuant to our preferred stockacquisition plan.  Our acquisition ofredeemable convertible preferred stock in consideration of the issuance of3,077 shares of common stock per share of redeemable convertible preferredstock resulted in a non-cash dividend of $13,579,979.  In addition, cash dividends of $588,542 werepaid on the redeemable convertible preferred stock during the nine months endedJanuary 31, 2006.  Refer to Note 9 of ourfinancial statements included in our Annual Report on Form 10-KSB for thefiscal year ended April 30, 2006 for additional information.

*Income Tax Provision*.  We have noincome tax provision in the nine months ended January 31, 2007 and 2006 due tothe net operating losses generated for income tax reporting purposes.  Wehave established a valuation allowance to fully offset tax assets due to theuncertainty about our ability to generate the future taxable income necessaryto realize these deferred tax assets, particularly in light of our history ofsignificant operating losses.  In addition, future utilization ofavailable net operating loss carryforwards may be limited under InternalRevenue Code Section 382 as a result of changes in ownership that have or mayresult from the issuance of common stock, redeemable convertible preferredstock or common stock options and warrants.

**Liquidity and Capital Resources**

Cashand cash equivalents decreased from $10,351,570 at April 30, 2006 to $3,685,114at January 31, 2007 due to the following:
| ** **                                 | ** ** | **Nine months   ended  January 31, 2007** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------------------|------------|
| Net cash used by  operating activities     |       | $                                                             | (8,462,949 | ) |
| Net cash used by  investing activities     |       | (152,449                                                      | )          |
| Net cash  provided by financing activities |       | 1,948,942                                                     |       |
| Net decrease in cash  and cash equivalents |       | $                                                             | (6,666,456 | ) |

 

*Operating Activities. *The net cashused by operating activities of $8,462,949 in the nine months ended January 31,2007 resulted primarily from the net loss of $9,867,824 partially offset bynon-cash charges of $1,456,427 related to stock-based compensation.  Thenet cash used by operating activities of $3,707,424 in the nine months endedJanuary 31, 2006 resulted primarily from the net income of $11,947,475 lessnon-cash charges of $16,549,457 related to the change in fair value of putablewarrants.

*Investing Activities. *The net cashused by investing activities of $152,449 in the nine months ended January 31,2007 resulted from purchases of property, plant and equipment of $203,117 lesscash proceeds from the sales of property, plant and equipment of $50,668. The net cash provided by investing activities of $19,259 in the nine monthsended January 31, 2006 resulted from proceeds of $341,757 from the sales ofproperty, plant and equipment less purchases of property, plant and equipmentof $322,498.

*Financing Activities. *The net cashprovided by financing activities of $1,948,942 in the nine months ended January31, 2007 resulted primarily from the $2,190,000 in net cash proceeds obtainedfrom the October 13, 2006 private placement (described below) partially offsetby principal payments required by the related party lease obligation.  Thenet cash provided by financing activities of $5,652,465 in the nine monthsended January 31, 2006 resulted primarily from the $6,435,140 in net cashproceeds obtained from the exercise of warrants partially offset by redeemableconvertible preferred stock cash dividends and principal payments required bythe related party lease obligation.

OnOctober 13, 2006, pursuant to the terms of a securities purchase agreement, weissued 714,286 shares of common stock and warrants for the purchase of anaggregate of 178,571 shares of common stock to accredited investors. Gross

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proceedsof $2,500,000 from the private placement were reduced by offering costs of $310,000resulting in $2,190,000 of net proceeds.  The warrants are exercisable forfive years at an exercise price of $4.365 per share, subject to basic, and for9 months, full-ratchet anti-dilution adjustments.

Inconnection with the securities purchase agreement, we granted the investors a12-month right of participation in subsequent financings.  We agreed notto create or authorize any senior securities or undertake a reverse or forwardstock split or reclassification, without the consent of the purchasers of amajority of the shares, for 18 months.  We also agreed not to enter intoany variable rate transactions for 18 months.

Inaddition, we entered into a registration rights agreement which required us tofile a registration statement to register for resale the shares of common stockissued in this transaction and the shares of common stock issuable uponexercise of the warrants.  We filed such registration statement onNovember 17, 2006 and it was declared effective on November 30, 2006.

If theregistration statement ceases to be effective for more than an aggregate of 75calendar days in any 12-month period, we have agreed to pay each holder anamount as liquidated damages equal to 1.5% of the aggregate investment amountthen held by the holder of the shares purchased pursuant to the securitiespurchase agreement and on each monthly anniversary of the failure to effectsuch registration, provided however that such liquidated damages will notexceed 10% of the aggregate purchase price paid by all holders.  We arerequired to use our commercially reasonable efforts to keep the registrationstatement effective until all registered securities covered by the registrationstatement have been sold or may be sold without volume restrictions pursuant toRule 144(k).  Given the Company’s recent history of maintaining theeffectiveness of its registration statements, an accrual for liquidated damagesis not necessary.

Inaddition, if the registration statement permitting the resale of the sharesissuable upon the exercise of the warrants is required to be effective but isnot then effective or the prospectus forming a part thereof is not thenavailable for the resale of the shares, then each warrant allows the holder toconvert the warrants into common stock without any cash consideration inexchange for the surrender of the remaining shares of common stock otherwisepurchasable upon the exercise of the warrant.

We haveentered into a number of other financing transactions to provide fundsnecessary to meet our working capital and capital expenditure needs and to meetother obligations.  Details of these activities are contained in ourAnnual Report on Form 10-KSB for the fiscal year ended April 30, 2006.

Weexpect to continue to incur operating losses and negative operating cash flowas we support the continued development and commercial launch of our SOLARSystem.  We did not have any clinical-ready SOLAR System inventory atJanuary 31, 2007.  Once we have built, qualified, and releasedclinical-ready SOLAR System inventory, and have obtained 510(k) clearance, weanticipate that we will require several additional weeks to place the capitalequipment in hospitals and train physicians on the use of our SOLAR Systembefore we can complete the commercial launch of such product.  We do notexpect to generate material sales of the SOLAR System until fiscal year 2008,at the earliest.  However, we anticipate that our sales and marketing,general and administrative and research and development expenses will continueto constitute a material use of our cash resources.  In fact, our ongoingproduct development work, as well as our manufacturing process designenhancements, made while seeking FDA 510(k) clearance have contributed toincreased research and development costs.  The actual amounts and timingof our expenditures will vary significantly depending upon the progress of ourproduct development and the availability of financing.  Our cash balanceof $3,685,114 at January 31, 2007 is expected to last through our fiscal yearending April 30, 2007.  

Giventhe insufficiency of our existing capital resources, we will require additionalfinancing to continue operations, to complete the planned launch of ourSOLAR System, and to achieve our long-term goal of providing a surgicalablation treatment option for atrial fibrillation.  Because we arenot generating measurable cash flow from operations, we will be required toraise additional funds through public or private sales of equity securities orthe incurrence of indebtedness.  If financing is not available to us, wewill be required to cease operating.  Our ability to fund continued operationswill depend on the availability of equity and debt financing, which willbe affected by prevailing economic conditions in the medical deviceindustry and financial, business and other factors, some of which arebeyond our control. We cannot assure you that we will obtain financing onfavorable terms or at all.  If we elect to raise additional capitalthrough the issuance and sale of equity securities, the sales may be at pricesbelow the market price of our stock, and our shareholders may suffer significantdilution.  Debt financing, if available, may involve significant cashpayment obligations, covenants and financial ratios that restrict our abilityto operate and grow our business, and would cause us to incur additionalinterest expense and financing costs.

Ourcapital requirements may vary depending upon the timing and the success of theimplementation of our business plan, regulatory, technological and competitivedevelopments, or if:

·              significant sales of our productsare not achieved;

·              operating losses exceed ourexpectations;

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

·              we acquire, license or developadditional technologies.

Wecannot, however, assure you that our efforts to implement our business strategywill:

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·              be attainable;

·              be profitable;

·              reduce our reliance upon financingtransactions; or

·              enable us to continue operations.

**Commitments and Contingent Liabilities**

*Related Party Lease Obligation. * OnApril 4, 2003, we sold our corporate headquarters, manufacturing facilityand surrounding land in Inver Grove Heights, Minnesota, to PKM Properties, LLC(“PKM”), an entity controlled by Paul K. Miller.  Mr. Miller is one of ourdirectors and one of the largest beneficial owners of our securities.  Inconnection with the transaction, we received total consideration of $3,836,105consisting of (1) $1,000,000 in cash, (2) PKM’s assumption of our$2,500,000 outstanding indebtedness to Associated Bank, and (3) PKM’sassumption of our promissory note with Dakota Electric Association and landspecial assessments payable to Dakota County aggregating $336,105.

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 initialterm with options for us to extend the lease up to ten additional years. Under certain conditions, we also have an option to purchase the building atthe end of the initial ten-year term at the fair value at that time.  Wealso pay maintenance and operating costs, utilities and real estate taxes underthe lease.  In addition, the lease makes it our responsibility for anyconstruction costs deemed necessary or required by the landlord in connectionwith the relocation or removal of the private septic system and/or drain fieldas well as costs associated with responding to any release of hazardousmaterials at the property.

*LightWave Technology Purchase Agreement. *In August 2003, we entered into a technology purchase agreement withLightWave and its principals, one of whom became an employee of our company,relating to the acquisition of LightWave’s interests in technology consistingof a catheter/probe containing elements of optical fiber, coolant passages andother features for the purpose of delivering laser energy to the epicardialsurface of the heart for treatment of atrial fibrillation.  We paidLightWave an initial standstill payment consisting of 1,500 shares of ourcommon stock, $10,000 upon closing and an additional $30,000 to LightWave ininstallments in 2004 and 2005.  An additional $125,000 was paid toLightWave in January 2006.  We will be obligated to pay an additional$385,000 within 45 days following our achievement of $1,500,000 of cumulativegross sales of disposable products.  In addition, at closing, duringfiscal year 2004, we issued to LightWave a warrant for the purchase of 2,500shares of common stock at $14.60 per share and, during fiscal year 2005, awarrant for the purchase of 2,500 shares of common stock at $14.60 per shareupon receiving an FDA 510(k) clearance.  In addition, we are obligated,but have not, issued a warrant for the purchase of 2,500 shares of common stockdue to the receipt of a U.S. utility patent covering the product and a warrantfor the purchase of 2,500 shares of common stock due to the first commercialsale of the product.

FollowingNovember 29, 2005, the date of the first commercial sale of the ATRILAZE System,we have agreed to make payments to LightWave for ten years equal to six percentof net sales of the LightWave product in countries in which we obtain patentprotection, including the United States of America, and four percent of netsales of the LightWave product in territories in which there is no patentprotection.  The payments are due within 60 days following each fiscalquarter.  Commencing with the second yearfollowing our first commercial sale on November 29, 2005, we have agreed tomake minimum annual payments as follows:

| Year Following First Commercial Sale | ** ** | **Minimum Annual  Payment** | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|
| November 29,  2007                                       |       | $                                | 50,000     |   |
| November 29,  2008                                       |       | 75,000                           |       |
| November 29,  2009                                       |       | 100,000                          |       |
| November 29,  2010                                       |       | 200,000                          |       |
| November 29,  2011                                       |       | 300,000                          |       |
| November 29,  2012                                       |       | 350,000                          |       |
| November 29,  2013                                       |       | 350,000                          |       |
| November 29,  2014                                       |       | 400,000                          |       |
| November 29,  2015                                       |       | 500,000                          |       |
| Total minimum  payments                                  |       | $                                | 2,325,000  |   |

 

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LightWaveand two of its principals have agreed to certain noncompetition obligations,nondisclosure obligations, and certain obligations to assign new developmentsor inventions relating to the acquired technology to our company.  Weagreed to use our reasonable commercial efforts to commercialize the technologywithin three years following the acquisition of the technology from LightWave.

If wefail in any year to pay minimum annual payments, we may be obligated to grantLightWave a nonexclusive right to use the technology acquired from LightWave,or pay LightWave the difference between payments actually made and minimumpayments due for a given year.  If wedetermine to discontinue the development or marketing of the product, we wouldhave no further obligation to pay amounts due to LightWave.  However, LightWave may, upon written request,obtain from us a license to use the intellectual property or, at our option, wemay assign the rights in the intellectual property to LightWave.

*Operating Lease.*  We have anoperating lease for a certain piece of office equipment, which expires infiscal year 2011.  At the end of the initial lease term, we have theoption to purchase the equipment at the fair market value, renew the lease, orreturn the equipment.

*Product Liability Contingency.*  InMarch 2005, we became aware that a patient who was utilizing our heartvalve had died.  We have not received any claims related to this matterbut believe that any such claim would be covered by our existing liabilityinsurance.  Based upon the expectation that insurance will cover the costof any claims after our payment of the deductible, we do not expect theultimate resolution of this matter to have a material effect on our business,financial condition, operating results or cash flows.

*Severance Contingencies.*  Employmentagreements with seven officers as of January 31, 2007 contain a provision forlump sum payments of up to twelve months severance if the officer is terminatedwithout cause by us or for good reason by the officer (as defined in theagreements).

Thefollowing table summarizes our contractual obligations as of January 31, 2007,excluding product liability contingencies and severance contingencies , asdescribed above:
| ** **                                            | ** ** | **Payments Due By Period** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------|------------|
| **Summary of Contractual Obligations** | ** ** | **TOTAL**                                 | ** ** | **Less than One   Year** | ** ** | **Two to Three   Years** | ** ** | **Four or More   Years** | ** ** |
| Related Party Lease Obligation(1)      |       | $                                         | 2,589,456  |   | $ | 430,904 |   | $ | 869,437 |   | $ | 1,289,115 |   |
| LightWave Minimum  Payments (2)                       |       | 2,325,000                                 |       | 50,000 |   | 175,000 |   | 2,100,000 |   |
| Operating Lease                                       |       | 18,432                                    |       | 5,530 |   | 11,059 |   | 1,843 |   |
| Total Contractual  Obligations                        |       | $                                         | 4,932,888  |   | $ | 486,434 |   | $ | 1,055,496 |   | $ | 3,390,958 |   |

 

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(1)                                      Futurepayments include interest due.

(2)                                      Excludesan additional $385,000 payable within 45 days following our achievement of$1,500,000 of cumulative gross sales of disposable products.

**Qualitative and Quantitative Disclosures about Market Risk**

We arefocusing substantially all of our resources on the development and introductionof our SOLAR System.  Sales of our SOLAR System are not expected until aFDA 510(k) clearance is obtained and we complete the commercial launch of suchproduct.  We expect that any sales willbe in the United States denominated in U.S. dollars.  Our interest incomeand expenses are sensitive to changes in the general level of U.S. interestrates, particularly since our investments are in short-term instruments. At January 31, 2007, we held a majority of our cash in a money marketaccount.  Based on the current nature and levels of our investments webelieve that we currently have no material market risk exposure.

Ourgeneral investing policy is to limit market and credit risk and the risk ofprincipal loss.  All liquid investments with maturities of three months orless are considered to be cash equivalents.

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**ITEM 3   CONTROLS ANDPROCEDURES**

**Evaluation of Disclosure Controls and Procedures**

Wemaintain disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”)) that are designed to ensure that information required to be disclosed byus in the reports we file or submit under the Exchange Act is recorded,processed, summarized, and reported, within the time periods specified in theSecurities and Exchange Commission’s rules and forms, and that such informationis accumulated and communicated to our management, including our principalexecutive officer and principal financial officer, to allow timely decisionsregarding required disclosure.

Ourmanagement, with the participation of our Chief Executive Officer and ChiefFinancial Officer, evaluated the effectiveness of our Company’s disclosurecontrols and procedures as of the end of the period covered in this QuarterlyReport on Form 10-QSB.  Based on this evaluation and because of thematerial weakness described below, our Chief Executive Officer and ChiefFinancial Officer have concluded that our disclosure controls and procedureswere not effective as of the end of the period covered in this Quarterly Reporton Form 10-QSB.  To address the material weakness described below, we haveexpanded our disclosure controls and procedures to include additional analysisand other procedures over the preparation of the financial statements includedin this report.  Accordingly, our management has concluded that thefinancial statements included in this report fairly present in all materialrespects our financial position, results of operations and cash flows for theperiods presented in conformity with accounting principles generally acceptedin the United States of America.

**Material Weakness in Internal Control Over FinancialReporting**

Amaterial weakness is a control deficiency or a combination of control deficienciesthat result in more than a remote likelihood that a material misstatement ofthe annual or interim financial statements will not be prevented ordetected.  Our management has concluded that, as of January 31, 2007 andApril 30, 2006, we did not maintain effective controls over the preparation,review, presentation and disclosure of our financial statements. Additionally, this control deficiency could result in a misstatement of thepresentation and disclosure of our statement of operations that would result ina material misstatement in our annual or interim financial statements thatwould not be prevented or detected.  Accordingly, management determinedthat this control deficiency constitutes a material weakness in our internalcontrol over financial reporting as of January 31, 2007 and April 30, 2006.

**Changes in Internal Control Over Financial Reporting**

Therewas no change in our internal control over financial reporting, other thanthose noted below, that occurred during our quarter ended January 31, 2007 thathas materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

**Plan for Remediation of Material Weakness**

We havedeveloped a plan to address the above-referenced material weakness that includesadding additional professional accounting personnel.  In April 2006, wehired a full-time controller with national public accounting firmexperience.  We will continue to assess the adequacy and appropriatenessof our financial staff and adjust accordingly as changes in our businesswarrant.  Although we are not certain when the material weakness will beremediated, we will need a period of time over which to demonstrate that thesecontrols are functioning appropriately to conclude that we have adequatelyremediated it.  We may be unable toachieve appropriate segregation of duties required for effective internalcontrol over financial reporting until we are able to increase the size of ourfinance department beyond its present level. We currently lack the resourcesnecessary to expand such staffing.

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**PART II**

**OTHERINFORMATION**

**ITEM 1   LEGAL PROCEEDINGS**

On March 10, 2006, J Giordano Securities LLC(d/b/a J Giordano Securities Group) (“JGSG”) filed suit against our company inU.S. District Court for the District of Connecticut. JGSG, which acted as aprivate placement agent for our company in connection with sales of oursecurities to private investors in April 2005, asserts claims for breachof contract, unjust enrichment and quantum meruit. JGSG contends it is owedcertain fees as a result of “follow on transactions” executed by investorsidentified by JGSG, pursuant to the engagement agreement, as amended, betweenus and JGSG or, in the alternative, that it should be awarded such fees on anequitable basis. In particular, JGSG originally claimed that the exercise ofoutstanding warrants for the purchase of common stock by certainJGSG-identified investors and our purchase of outstanding shares of 5%Series A Redeemable Convertible Preferred Stock from certainJGSG-identified investors in December 2005 and January 2006 entitledJGSG to damages no less than $1,431,769. JGSG originally sought(a) $279,191 in cash commissions, (b) warrants for the purchase of85,905 shares at $3.25 per share, (c) lost profits of $751,669 on theargument that JGSG would have exercised the foregoing warrant and sold 85,905shares on December 30, 2005, at a price of $12.00 per share, and(d) $400,909 in cash commissions we paid C.E. Unterberg, Towbin, LLC (“CEUT”).

On September 22, 2006, we asserted a counterclaimagainst JGSG for fraud and breach of contract based upon JGSG’smisrepresentations to induce us to enter the engagement agreement and JGSG’sfailure to perform its promised services thereunder. We seek damages of(a) the $30,000 retainer and $543,000 cash paid to JGSG; (b) thevalue of our warrants for 114,600 shares of common stock issued to JGSG;(c) the $445,328 fee and $27,016 expense reimbursement that we paid CEUTfor its advisory services in December 2005 and January 2006;(d) the $3.7 million cash we did not obtain on investor warrant exercisesdue to the reduced warrant exercise price we were required to accept duringthose months; and (e) the value of the additional 1.9 million shares ofcommon stock we were required to issue to effectuate the preferred stockpurchase during those months. As a result, we counterclaim in excess of $5.0million.

On November 20, 2006, JGSG filed an amendedstatement of claim. JGSG added new claims for additional compensation basedupon the issuance of additional common stock to preferred stock holders in thealleged “follow-on transactions,” our alleged failure to timely file a resaleregistration statement for JGSG, and for additional compensation based upon ourOctober 2006 private placement. JGSG currently seeks alleged damages of$3,346,565 as follows: (a) $279,191 in cash commissions; (b) warrantsfor the purchase of 85,905 shares at $3.25 per share; (c) lost profits of$751,669 on the argument that JGSG would have exercised the foregoing warrantand sold 85,905 shares on December 30, 2005, at a price of $12.00 pershare; (d) $249,690 in cash pursuant to the alleged failure to timely filethe resale registration statement for JGSG; (e) $6,726 in liquidateddamages based upon our alleged failure to timely file the resale registrationstatement for JGSG; (f) $556,214 in cash commissions that JGSG claims itwas entitled to based upon preferred stock holders’ receipt of additionalcommon stock in the alleged “follow-on transactions”; (g) warrants for thepurchase of 171,142 shares at $3.25 per share; (h) lost profits of$952,166 on the argument that JGSG would have exercised the foregoing warrantand sold 171,142 shares on January 3, 2006, at a price of $11.00 pershare; (i) $400,909 in cash commissions we paid to CEUT; and(j) $150,000 based upon the fee we paid to CEUT for our October 2006private placement. JGSG also seeks reimbursement for reasonable expenses,interest, costs and attorneys’ fees. The U.S. District Court for the Districtof Connecticut has referred the matter to NASD arbitration. We believe thatJGSG’s lawsuit is without merit and intend to vigorously defend ourselves.

Given the nature of arbitration, it is reasonablypossible that we may be expected to pay certain amounts in connection with thisclaim.  As of January 31, 2007, we havenot recorded an accrual for this matter since the amount to be paid, if any,cannot be reasonably estimated.

**ITEM 5   OTHER INFORMATION**

We are filing herewith aCautionary Statement pursuant to the Private Securities Litigation Reform Actof 1995 for use as a readily available written document to which reference maybe made in connection with forward-looking statements, as defined in suchact.  Such Cautionary Statement, which appears as Exhibit 99 to thisreport, is incorporated by reference in response to this Item 5.

**ITEM 6   EXHIBITS**

See “Index to Exhibits.”

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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  15, 2007 | By                   | /s/ Marc P. Flores |   |
|                       |                 | Marc P. Flores |
|                       |                 | President and Chief Executive Officer |
|                       |                 |   |
|                       | By                   | /s/ Eapen Chacko |   |
|                       |                 | Eapen Chacko |
|                       |                 | Vice President, Finance and  Chief Financial Officer |
|                            |                      |  |  |  |

 

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**INDEX TOEXHIBITS**
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                             |
|-----------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                        |
| 3.1             |       | Restated Articles of Incorporation of the  Registrant, as Amended (incorporated by reference to Amendment No. 1 to our  Registration Statement on Form SB-2, filed on June 6, 2006 (File No.  333-134315)). |
|            |       |                                                                                                                                                                                                        |
| 3.2             |       | Bylaws of the Registrant (incorporated by reference  to our Registration Statement on Form SB-2, filed on August 31, 2001 (File  No. 333-68884)).                                                           |
|            |       |                                                                                                                                                                                                        |
| 4.1             |       | Reference is made to Exhibits 3.1 and 3.2.                                                                                                                                                                  |
|            |       |                                                                                                                                                                                                        |
| 4.2             |       | Specimen Common Stock Certificate (incorporated by  reference to Amendment No. 1 to our Registration Statement on Form SB-2,  filed on June 6, 2006 (File No. 333-134315)).                                 |
|            |       |                                                                                                                                                                                                        |
| 10              |       | Production Services Agreement between MedicalCV,  Inc. and Minnetronix, Inc., dated December 6, 2006.                                                                                                       |
|            |       |                                                                                                                                                                                                        |
| 31.1            |       | Chief Executive Officer Certification pursuant to  Exchange Act Rule 13a-14(a).                                                                                                                        |
|            |       |                                                                                                                                                                                                        |
| 31.2            |       | Chief Financial Officer Certification pursuant to  Exchange Act Rule 13a-14(a).                                                                                                                        |
|            |       |                                                                                                                                                                                                        |
| 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.                                                                                                                             |
|            |       |                                                                                                                                                                                                        |
| 99              |       | Cautionary Statement.                                                                                                                                                                                       |

 

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