UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549








FORM
10-Q




(Mark
One)




x
            
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


FOR THE
QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008




OR




o
            
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


FOR THE
TRANSITION PERIOD FROM ____________ TO ____________




COMMISSION
FILE NUMBER: 000-22419




CARDIMA,
INC.




(Exact
name of registrant as specified in its charter)




Delaware
            
            94-3177883(State
      or other jurisdiction of
              incorporation
      or organization)
            
            (I.R.S.
      Employer
              Identification
      Number)




47266
      Benicia Street,
              Fremont,
      CA  94538-7330(Address
      of principal executive offices) (Zip
Code)




Registrant’s
telephone number, including area code: (510) 354-0300





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
past 12 months (or for such 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  .




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See definition of “accelerated filer”, “large accelerated
filer”, “non-accelerated filer” and “smaller reporting company” in Rule 12b-2 of
the Exchange Act.




Large
      accelerated filer o
            Accelerated
      filer o
            Non-accelerated
      filer o
            Smaller
      reporting company x







Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2) of the Act. Yes  o No   x




There
were 124,930,172 shares of the registrant's common stock, par value $0.001,
issued and outstanding as of October 31, 2008.




1






CARDIMA, INC.




TABLE
OF CONTENTS




PART
I.  Financial Information







Description
              PageItem
      1.
              Financial
      Statements (unaudited)
              3Balance
      Sheets as of September 30, 2008 and December 31,
2007
              3Statements
      of Operations for the Three and Nine Months ended September 30, 2008 and
      2007
              4Statements
      of Cash Flows for the Nine Months ended September 30, 2008 and
      2007
              5Notes
      to Condensed Financial Statements
              6Item
      2.
              Management’s
      Discussion and Analysis and Results of Operations
              19Item
      3.
              Quantitative
      and Qualitative Disclosures About Market Risk
              23Item
      4.
              Controls
      and Procedures
              23





PART
II.  Other Information




Description
                PageItem
      1.
                Legal
      Proceedings
                25Item
      2.
                Unregistered
      Sales of Equity Securities and Use of Proceeds
                25Item
      3.
                Defaults
      Upon Senior Securities
                25Item
      4.
                Submission
      of Matters to a Vote of Security Holders
                25Item
      5.
                Other
      Information
                25Item
      6.
                Exhibits
                26Signatures
                
                26





2


PART I – FINANCIAL
INFORMATION





ITEM 1.  Financial
Statements


CARDIMA,
      INC.BALANCE
      SHEETS(In
      thousands, except shares and per share amounts)ASSETS
                
                September
      30, 2008
                
                
                December
      31, 2007Current
      assets:
                
                (Unaudited)
                
                
                (Note
      2)Cash
                
                $
                2,241
                
                
                $
                4,811Accounts
      receivable, net of allowances for doubtful
                  accounts
      of $185 and $77, respectively
                
                
                253
                
                
                
                183Short
      term investment
                
                
                50
                
                
                
                2,008Inventories,
      net
                
                
                1,090
                
                
                
                402Prepaid
      expenses
                
                
                990
                
                
                
                46Other
      current assets
                
                
                41
                
                
                
                131Total
      current assets
                
                
                4,665
                
                
                
                7,581Property
      and equipment, net
                
                
                816
                
                
                
                362Other
      assets
                
                
                61
                
                
                
                61TOTAL
      ASSETS
                
                $
                5,542
                
                
                $
                8,004LIABILITIES
      AND SHAREHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable
                
                $
                700
                
                
                $
                443Accrued
      liabilities
                
                
                1,120
                
                
                
                911Loans
      payable
                
                
                12
                
                
                
                10Capital
      leases - current portion
                
                
                24
                
                
                
                24Notes
      payable to related-party - current portion
                
                
                100
                
                
                
                175Total
      current liabilities
                
                
                1,956
                
                
                
                1,563Capital
      leases - net of current portion
                
                
                52
                
                
                
                7Notes
      payable to related-party - net of current portion
                
                
                44
                
                
                
                53TOTAL
      LIABILITIES
                
                
                2,052
                
                
                
                1,623Shareholders'
      Equity:Preferred
      stock, $0.001 par value, liquidation preference
                  of
      $0.10, 10,000,000 shares authorized, 5,000,000 issued
                  and
      outstanding
                
                
                500
                
                
                
                500Common
      stock, $0.001 par value, 300,000,000 shares authorized,
                  124,920,172
      and 116,316,311 shares issued and outstanding at
                  September
      30, 2008 and December 31, 2007, respectively
                
                
                125
                
                
                
                116Additional
      paid-in-capital
                
                
                189,316
                
                
                
                182,324Accumulated
      deficit
                
                
                (186,451
                )
                
                
                (176,559
                )Total
      Shareholders' Equity
                
                
                3,490
                
                
                
                6,381TOTAL
      LIABILITIES AND SHAREHOLDERS' EQUITY
                
                $
                5,542
                
                
                $
                8,004




See
accompanying notes to these condensed financial statements


3




CARDIMA,
      INC.STATEMENTS
      OF OPERATIONS(In
      thousands, except per share amounts)(unaudited)Three
      Months Ended September 30,2008
                  
                  2007Net
      sales
                  
                  $
                  391
                  
                  
                  $
                  311Cost
      of goods sold
                  
                  
                  838
                  
                  
                  
                  523Gross
      deficiency
                  
                  
                  (447
                  )
                  
                  
                  (212
                  )Operating
      expenses:Research
      and development
                  
                  
                  1,329
                  
                  
                  
                  388Selling,
      general and administrative
                  
                  
                  1,626
                  
                  
                  
                  859Total
      operating expenses
                  
                  
                  2,955
                  
                  
                  
                  1,247Operating
      loss
                  
                  
                  (3,402
                  )
                  
                  
                  (1,459
                  )Interest
      income and expense, net
                  
                  
                  20
                  
                  
                  
                  (3,075
                  )Other
      income / (expense)
                  
                  
                  (5
                  )
                  
                  
                  1,684Loss
      on debt extinguishment
                  
                  
                  -Total
      other income / (expense)
                  
                  
                  15
                  
                  
                  
                  (1,391
                  )Total
      pre-tax loss
                  
                  
                  (3,387
                  )
                  
                  
                  (2,850
                  )Income
      tax
                  
                  
                  -
                  
                  
                  
                  -Net
      loss
                  
                  $
                  (3,387
                  )
                  
                  $
                  (2,850
                  )Basic
      and diluted net loss per share
                  
                  $
                  (0.03
                  )
                  
                  $
                  (0.28
                  )Shares
      used in computing basic and diluted net loss per share
                  
                  
                  124,902
                  
                  
                  
                  10,288Nine
      Months Ended September 30,2008
                  
                  2007Net
      sales
                  
                  $
                  1,088
                  
                  
                  $
                  890Cost
      of goods sold
                  
                  
                  2,135
                  
                  
                  
                  1,478Gross
      deficiency
                  
                  
                  (1,047
                  )
                  
                  
                  (588
                  )Operating
      expenses:Research
      and development
                  
                  
                  3,440
                  
                  
                  
                  2,083Selling,
      general and administrative
                  
                  
                  5,497
                  
                  
                  
                  2,607Total
      operating expenses
                  
                  
                  8,937
                  
                  
                  
                  4,690Operating
      loss
                  
                  
                  (9,984
                  )
                  
                  
                  (5,278
                  )Interest
      income and expense, net
                  
                  
                  104
                  
                  
                  
                  (3,003
                  )Other
      income / (expense)
                  
                  
                  (11
                  )
                  
                  
                  2,188Excess
      shares liability
                  
                  
                  -
                  
                  
                  
                  (7,737
                  )Loss
      on debt extinguishment
                  
                  
                  -
                  
                  
                  
                  (15,182
                  )Total
      other income / (expense)
                  
                  
                  93
                  
                  
                  
                  (23,734
                  )Total
      pre-tax loss
                  
                  
                  (9,891
                  )
                  
                  
                  (29,012
                  )Income
      tax
                  
                  
                  1
                  
                  
                  
                  -Net
      loss
                  
                  $
                  (9,892
                  )
                  
                  $
                  (29,012
                  )Basic
      and diluted net loss per share
                  
                  $
                  (0.08
                  )
                  
                  $
                  (2.82
                  )Shares
      used in computing basic and diluted net loss per share
                  
                  
                  120,910
                  
                  
                  
                  10,288





See
accompanying notes to these condensed financial statements





4




CARDIMA,
      INC.STATEMENTS
      OF CASH FLOWS(In
      thousands)Nine
      Months Ended September 30,2008
                              
                              
                              2007CASH
      FLOWS FROM OPERATING ACTIVITIES:
                              
                              (Unaudited)Net
      loss
                              
                              $
                              (9,892
                              )
                              
                              $
                              (29,012
                              )Adjustments
      to reconcile net loss to net cash used in operating
activities
                                provided
      by operations:Depreciation
      and amortization
                              
                              
                              111
                              
                              
                              
                              69Non-cash
      stock-based compensation
                              
                              
                              989
                              
                              
                              
                              145Non-cash
      compensation
                              
                              
                              868Non-cash
      interest expense (income)
                              
                              
                              -
                              
                              
                              
                              298Disposal
      of assets
                              
                              
                              14
                              
                              
                              
                              -Loss
      on excess shares over authorized
                              
                              
                              -
                              
                              
                              
                              7,737Loss
      on debt extinguishment
                              
                              
                              -
                              
                              
                              
                              15,182Preferred
      shares issued for fees
                              
                              
                              -
                              
                              
                              
                              500Excess
      and obsolete inventory
                              
                              
                              -
                              
                              
                              
                              129Allowance
      for doubtful accounts
                              
                              
                              108
                              
                              
                              
                              26Changes
      in operating assets and liabilities:Accounts
      receivable
                              
                              
                              (177
                              )
                              
                              
                              223Inventories
                              
                              
                              (687
                              )
                              
                              
                              (284
                              )Prepaid
      and other assets
                              
                              
                              (855
                              )
                              
                              
                              (54
                              )Accounts
      payable, accrued compensation and other liabilities
                              
                              
                              464
                              
                              
                              
                              (145
                              )Accrued
      interest and fees
                              
                              
                              -
                              
                              
                              
                              2,973Excess
      share liability
                              
                              
                              -
                              
                              
                              
                              (2,886
                              )Net
      cash used in operating activities
                              
                              
                              (9,057
                              )
                              
                              
                              (5,099
                              )CASH
      FLOWS FROM INVESTING ACTIVITIESPurchase
      of short-term investment
                              
                              
                              (50
                              )
                              
                              
                              -Maturity
      of short-term investment
                              
                              
                              2,008Purchase
      of property and equipment
                              
                              
                              (500
                              )
                              
                              
                              (83
                              )Net
      cash provided by/(used in) investing activities
                              
                              
                              1,458
                              
                              
                              
                              (83
                              )CASH
      FLOWS FROM FINANCING ACTIVITIESPrincipal
      payments under capital leases and credit facility
                              
                              
                              (32
                              )
                              
                              
                              (25
                              )Payment
      to related party
                              
                              
                              (82
                              )
                              
                              
                              (4
                              )Net
      proceeds from loan financing
                              
                              
                              -
                              
                              
                              
                              4,720Net
      proceeds from sale of common stock
                              
                              
                              5,143
                              
                              
                              
                              36Net
      cash provided by financing activities
                              
                              
                              5,029
                              
                              
                              
                              4,727Change
      in cash and cash equivalents
                              
                              
                              (2,570
                              )
                              
                              
                              (455
                              )Beginning
      cash and cash equivalents
                              
                              
                              4,811
                              
                              
                              
                              942Ending
      cash and equivalents
                              
                              $
                              2,241
                              
                              
                              $
                              487SUPPLEMENTAL
      DISCLOSURE OF CASH FLOWS INFORMATIONCash
      paid for income taxes
                              
                              $
                              1
                              
                              
                              $
                              -Cash
      paid for interest
                              
                              $
                              21
                              
                              
                              $
                              11SUPPLEMENTAL
      SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIESConversion
      of debt to equity
                              
                              
                              
                              
                              
                              $
                              10,129Equipment
      acquired under capital lease arrangements
                              
                              $
                              79
                              
                              
                              $
                              -Issuance
      of preferred stock to pay for accrued fees
                              
                              $
                              -
                              
                              
                              $
                              500Debt
      extinguishment
                              
                              
                              
                              
                              
                              
                              15,182





See
accompanying notes to these condensed financial statements




5




CARDIMA,
INC.




NOTES
TO FINANCIAL STATEMENTS


SEPTEMBER
30, 2008


(Unaudited)





1.
            NATURE
      OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
  POLICIES




Cardima,
Inc., (“we”, “us”, “our”) was incorporated in the State of Delaware on November
12, 1992. We design, develop, manufacture and market minimally invasive,
single-use, micro-catheter systems for the mapping and ablation of the two most
common forms of cardiac arrhythmias: atrial fibrillation and ventricular
tachycardia. We have developed the PATHFINDER®,
TRACER® and
VUEPORT® Series
of diagnostic catheters, the NAVIPORT® Series
of guiding catheters, the REVELATION® Series
of ablation catheters, the Surgical Ablation System with its series of ablation
probes, and the INTELLITEMP® Energy
Management Device Series for RF (radiofrequency) energy management. These
devices are CE marked and/or received United States FDA 510(k)
clearance.  The REVELATION Series of ablation catheters with the
INTELLITEMP EP Energy Management Device was developed and marketed for the
treatment of atrial fibrillation (AF) with CE mark approval in Europe; it is not
yet commercially approved in the United States. We have licensed our
micro-catheter technology for use in the treatment of electrophysiological
diseases affecting areas other than the central nervous system from Target
Therapeutics. We sell our products worldwide through both direct sales and
distribution channels, with a substantial portion of our sales to international
customers.




2.
            BASIS
      OF PRESENTATION - INTERIM FINANCIAL
INFORMATION




The
accompanying unaudited interim financial statements included herein have been
prepared, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission ("SEC"). The financial statements and notes are
presented as permitted on Form 10-Q and do not contain information included in
our annual statements and notes. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to such rules and regulations, although we believe
that the disclosures are adequate to make the information presented not
misleading.





The
consolidated balance sheet at December 31, 2007 has been derived from the
audited consolidated financial statements at that date but does not include all
of the information and footnotes required by generally accepted accounting
principles for complete financial statements. It is suggested that these
condensed financial statements be read in conjunction with the December 31, 2007
audited financial statements and the accompanying notes thereto filed on our
annual report on Form-10KSB/A with the SEC on July 15, 2008. While we
believe the procedures followed in preparing these financial statements are
reasonable, the accuracy of the amounts are in some respects dependent upon the
facts that will exist, and procedures that will be accomplished by us later in
the year. These results are not necessarily indicative of the results to be
expected for the full year.




These
unaudited financial statements reflect all adjustments, including normal
recurring adjustments, which, in the opinion of management, are necessary to
present fairly the operations and cash flows for the periods
presented.





The
accompanying unaudited consolidated financial statements in this report have
been presented on the going concern basis which contemplates the realization of
assets and the satisfaction of liabilities in the normal course of business.
While we have obtained additional equity financing in December 2007 and May
2008, our viability as a going concern is dependent upon our ability to maintain
and increase profitable operations through increased sales and the higher profit
margins received from product sales. Historically, we have experienced
significant operating losses with corresponding reductions in working capital
and shareholders' equity. We do not currently have any external financing in
place to support operating cash flow requirements. However, historically, we
have been able to raise capital through the issuance of debt or equity to meet
working capital needs.  We obtained $5 million in additional capital
through an equity offering in May 2008.





To
address the going concern issue, we implemented financial and operational plans
to improve operating efficiencies, reduce overhead and reduce and eliminate cash
losses, and position ourselves for future profitable operations. We are reducing
our general and administrative expenses by streamlining our executive and
administrative support team.





3.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES





Adoption of New Accounting
Standards




There
have been no significant changes in our significant accounting policies during
the nine months ended September 30, 2008, compared to what was previously
disclosed in our Annual Report on 10-KSB/A for the year ended December 31,
2007.


6


USE OF
ESTIMATES




The
preparation of financial statements in conformity with GAAP requires us to make
estimates and judgments that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Significant estimates include the fair value of
stock-based compensation, the allowance for doubtful accounts inventory
reserves, and valuation allowance for deferred tax assets.  We base
our estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances. Actual results may differ
significantly from our estimates. In addition, any significant unanticipated
changes in any of our assumptions could have a material adverse effect on its
business, financial condition, and results of operations.




COMPREHENSIVE
LOSS





Comprehensive
loss consists of net loss and other gains and losses affecting stockholders’
equity that, under generally accepted accounting principles are excluded from
net loss in accordance with Statement of Financial Accounting Standards No. 130,
Reporting Comprehensive
Income.  We, however, do not have any components of other
comprehensive loss as defined by SFAS No. 130 and therefore, for the three and
nine months ended September 30, 2008 and 2007, comprehensive loss is equivalent
to our reported net loss.  Accordingly, a statement of comprehensive
loss is not presented.




STOCK-BASED
COMPENSATION




Since
January 1, 2006, we follow Statement of Financial Accounting Standard 123
(revised 2004), “Share-Based Payment” (“SFAS 123(R)”) which requires the
measurement and recognition of compensation expense for all share-based awards
made to employees and directors, including employee stock options and employee
stock purchases, based on estimated fair values. Also, the Securities and
Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB 107”)
relating to SFAS 123(R). We have applied the provisions of SAB 107 in our
adoption of SFAS 123(R). We adopted SFAS 123(R) using the modified prospective
transition method.




Stock
compensation expense recognized during the period is based on the value of
share-based awards that are expected to vest during the period. Stock
compensation expense recognized in our statements of operations for 2008
and 2007 includes compensation expense related to share-based awards granted
prior to January 1, 2006 that vested during the current period based on
grant date fair value estimated in accordance with the pro forma provisions of
SFAS 123. Stock compensation expense for the share-based awards granted
subsequent to January 1, 2006 is based on the grant date fair value
estimated in accordance with the provisions of SFAS 123(R). As stock
compensation expense recognized in the statement of operations is based on
awards ultimately expected to vest, it has been adjusted for estimated
forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of
grant and revised, if necessary, in subsequent periods if actual forfeitures
differ from those estimates.For the three and nine months ended September 30, 2008 and 2007, no
excess tax benefits were generated.




Our
determination of estimated fair value of share-based awards utilizes the
Black-Scholes option-pricing model. The Black-Scholes model is affected by our
stock price as well as assumptions regarding certain highly complex and
subjective variables. These variables include, but are not limited to; our
expected stock price volatility over the term of the awards and actual and
projected employee stock option exercise behaviors.




STOCK
WARRANTS ISSUED TO THIRD PARTIES





We
account for stock warrants issued to third parties, including customers, in
accordance with the provisions of the EITF Issue No. 96-18, Accounting for Equity Instruments
That Are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling Goods or Services, and EITF 01-9, Accounting for Consideration Given
by a Vendor to a Customer (Including a Reseller of the Vendor’s
Products). Under the provisions of EITF 96-18, because none of our
agreements have a disincentive for nonperformance, we record a charge for the
fair value of the portion of the warrants earned from the point in time when
vesting of the warrants becomes probable. Final determination of fair value of
the warrants occurs upon actual vesting. EITF 01-9 requires that the fair value
of certain types of warrants issued to customers be recorded as a reduction of
revenue to the extent of cumulative revenue recorded from that
customer.  We have not issued any warrants to customers in 2008 or
2007.


7




NET LOSS
PER COMMON SHARE




Net loss
per share has been computed using the weighted average number of shares of
common stock outstanding during the period.  We have excluded all
warrants and stock options from the computation of basic and diluted net loss
per share because all such securities are anti-dilutive for the periods
presented. Excluded common stock equivalent shares included the
following:




September30,2008
                        
                        
                        2007Warrants
                        
                        
                        9,261,086
                        
                        
                        
                        20,945,493Stock
      Options
                        
                        
                        9,616,193
                        
                        
                        
                        446,063Preferred
      Shares, common stock equivalent
                        
                        
                        1,000,000
                        
                        
                        
                        -Total
      Warrants, Options and Preferred Shares
                        
                        
                        19,877,279
                        
                        
                        
                        21,391,556





RECLASSIFICATIONS





Certain
prior year financial statement amounts have been reclassified to conform to the
current year presentation.  The reclassifications did not impact net
loss or stockholder’s equity.





4.
            RECENTLY
      ISSUED ACCOUNTING STANDARDS




Effective
January 1, 2008, we adopted SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities – including an amendment of FASB Statement No.
115.”  SFAS No. 159 allows an entity the irrevocable option to elect
fair value for the initial and subsequent measurement of certain financial
assets and liabilities under an instrument-by-instrument
election.  Subsequent measurements for the financial assets and
liabilities an entity elects to fair value will be recognized in the results of
operations.  SFAS No. 159 also establishes additional disclosure
requirements.  We did not elect the fair value option under SFAS No.
159 for any of our financial assets or liabilities upon adoption.  The
adoption of SFAS No. 159 did not have a material impact on our results of
operations or financial position.




In
September 2006, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements (SFAS
No. 157). SFAS No. 157 establishes a framework for measuring fair
value, clarifies the definition of fair value and requires additional
disclosures about fair-value measurements. In general, SFAS No. 157 applies
to fair value measurements that are already required or permitted by other
accounting standards and is expected to increase the consistency of those
measurements. SFAS No. 157, as issued, is effective for fiscal years
beginning after November 15, 2007. In February 2008, the FASB issued FASB
Staff Position (FSP) SFAS No. 157-2, Effective Date of FASB Statement No.
157 (FSP SFAS No. 157-2) which deferred the effective date of SFAS No.
157 for one year for certain nonfinancial assets and nonfinancial liabilities.
Accordingly, we adopted the required provisions of SFAS No. 157 at the beginning
of fiscal year 2008 and the remaining provisions will be adopted by us at the
beginning of fiscal year 2009. The 2008 fiscal year adoption did not result in a
material impact to our financial statements. We are currently evaluating the
impact of adopting the remaining parts of SFAS No. 157 in fiscal year 2009 in
accordance with FSP SFAS No. 157-2.




In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS
No. 141(R)). SFAS No. 141(R) amends SFAS No. 141, Business Combinations,and
provides revised guidance for recognizing and measuring identifiable assets and
goodwill acquired, liabilities assumed and any noncontrolling interest in the
acquiree. Some of the revised guidance of SFAS No. 141(R) includes initial
capitalization of acquired in-process research and development (IPR&D),
expensing transaction costs, expensing acquired restructuring costs and
recording contingent consideration payments at fair value with subsequent
adjustments recorded to net earnings. It also provides disclosure requirements
to enable users of the financial statements to evaluate the nature and financial
statement effects of the business combination. SFAS No. 141(R) is effective for
fiscal years beginning on or after December 15, 2008 and will be applied
prospectively to business combinations that are consummated after adoption of
SFAS No. 141(R).




In May
2008, the FASB issued FSP Accounting Principles Board (APB) Opinion No. 14-1,
Accounting for Convertible
Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial
Cash Settlement) (FSP APB No. 14-1). The FSP requires the proceeds from
the issuance of such convertible debt instruments to be allocated between a
liability and an equity component in a manner that reflects the entity’s
nonconvertible debt borrowing rate when interest expense is recognized in
subsequent periods. The resulting debt discount is amortized over the period the
convertible debt is expected to be outstanding as additional non-cash interest
expense. FSP APB No. 14-1 is effective in fiscal years beginning after December
15, 2008 and requires retrospective application to all prior periods presented.
We believe that the adoption of FSP APB No. 14-1 will not have a significant
impact on our results of operations, financial condition or
liquidity.





8




Other
recent accounting pronouncements issued by the FASB (including its Emerging
Issues Task Force ("EITF"), the American Institute of Certified Public
Accountants ("AICPA"), and the SEC did not or are not believed by us to have a
material impact on our present or future financial statements.




5.
            LIQUIDITY





The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. We have accumulated significant losses as we
have been developing our current and next generation products. We had recurring
losses and expect to report operating losses for fiscal year 2008. For the three
and nine months ended September 30, 2008, we reported net loss of $3.4 million
and $9.9 million, respectively, with cash used in operations amounting to $9.0
million for the nine months ended September 30, 2008. We believe that the
debt and equity financings from our existing shareholders and other third
parties, if necessary, will be sufficient to fund the anticipated operations
through December 2008. These financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset amounts or
the amounts and classification of liabilities that might be necessary should we
be unable to continue as a going concern for a reasonable period of
time.




Additionally,
we have taken action to reduce operating costs and have established
plans to increase the sales of our products and services. We intend to seek
financing to provide funds needed to increase liquidity, fund growth in revenues
and to implement our business plan. We intend to secure additional working
capital through debt or equity financings. Any additional equity financing could
dilute the equity interests of existing security holders. If adequate funds are
not available or are not available on acceptable terms, our ability to operate
our business and fund our operations could be materially and adversely affected.
No assurance can be given that we will be able to raise any additional
capital.





6.
            INVENTORIES





Inventories
are stated at the lower of cost or market.  Cost is based on actual
costs computed on a first-in, first-out basis.  Inventories consist of
the following (in thousands):





September
      30, 2008
                  
                  
                  December
      31, 2007Raw
      Materials
                  
                  $
                  646
                  
                  
                  $
                  611Work-In-Process
                  
                  
                  17
                  
                  
                  
                  23Finished
      Goods
                  
                  
                  620
                  
                  
                  
                  384Reserve
      for obsolescence
                  
                  
                  (193
                  )
                  
                  
                  (616
                  )$
                  1,090
                  
                  
                  $
                  402




Inventories
are reduced for excess and obsolete inventories. These write-downs are based on
our review of inventories on hand on a quarterly basis, compared to our
assumptions about future demand, market conditions and anticipated timing of the
release of next generation products. If actual conditions for future demand are
less favorable than those projected by us or if next generation products are
released earlier than anticipated, additional inventory write-downs may be
required. Obsolete products removed from gross inventory are physically
scrapped.





7.
            PROPERTY
      AND EQUIPMENT





Property
and equipment, including equipment under capital leases, are carried at cost
less accumulated depreciation and amortization.  Property and
equipment are depreciated using the straight-line method over the estimated
useful lives, generally three to five years.  Leasehold improvements
are amortized using the straight-line method over the shorter of the estimated
useful life of the asset or the remaining term of the
lease.  Depreciation expense includes amortization of capital leases
and leasehold improvements. Depreciation expense was $45,000 and $111,000 for
the three and nine months ended September 30, 2008, respectively, as compared to
$21,000 and $69,000 for the same periods in 2007, respectively.


9




Property
and equipment consist of the following (in thousands):





September
      30, 2008
                  
                  
                  December
      31, 2007Equipment
                  
                  $
                  2,665
                  
                  
                  $
                  2,230Leasehold
      improvements
                  
                  
                  343
                  
                  
                  
                  270$
                  3,008
                  
                  
                  $
                  2,500Less
      accumulated depreciation and amortization
                  
                  
                  (2,194
                  )
                  
                  
                  (2,138
                  )Property
      and equipment, net
                  
                  $
                  814
                  
                  
                  $
                  362Idle
      Equipment
                  
                  $
                  1,290
                  
                  
                  $
                  1,290Less
      accumulated depreciation and amortization
                  
                  
                  (1,290
                  )
                  
                  
                  (1,290
                  )Idle
      equipment, net
                  
                  $
                  0
                  
                  
                  $
                  0




8.
            RECENT
      FINANCING





In May
2008, the Company entered into a Subscription Agreement for the purchase of
Securities (the “ Subscription Agreement”) with various accredited investors
pursuant to which the Company sold in a private placement to these accredited
investors (a) 8,474,992 shares of the Company’s Common Stock, par value $0.001
per share, and (b) warrants to purchase, in aggregate, up to 1,271,247 shares of
the Company’s common stock, par value $0.001 at an exercise price of $0.65 per
share, for an aggregate purchase price of approximately $5.1
million.





9.
            RELATED
      PARTY TRANSACTIONS – APIX International
Ltd.





In
relation to the May 2008 private placement transaction described in Note 8, APIX
International Ltd. (“APIX”) acted as placement agent for the transaction. APIX
is owned by Robert Cheney, who is also our Chief Executive Office and a
Director. In consideration for the services provided, we have entered into an
agreement with APIX whereby we agreed to: (i) grant 1,500,000 warrants to
purchase shares of our Common Stock for a period of five years at an exercise
price of $0.60, having a fair value of $868,000 calculated based on the
Black-Scholes Option pricing model; and (ii) pay APIX an aggregate of $80,000 in
placement fees.





10.
            NOTE
      PAYABLE TO RELATED PARTIES





In
December 2006, a settlement agreement was reached in principle, pursuant to
which we would pay $295,000 to Mr. William Wheeler ($5,000 per month for 59
months). The liability is accounted for in accordance with APB 21 as discussed
in the footnote to the filing. The liability was recorded at the final date of
the settlement. We had netted $193,000 of the notes receivable, which was a home
loan made by us to Mr. Wheeler during the course of his employment and the note
payable, which is a payment of compensation related to Mr. Wheeler’s separation
from our company, in accordance with the underlying agreement that gave both
parties the right of offset in accordance with FASB Technical Bulletin 88-2
which provides the specific requirements for liabilities and receivables to be
offset. The technical bulletin has been superseded, but paragraph 4 of FIN 39
says that the guidance in the Technical Bulletin has been incorporated largely
without change. In accordance with the Accounting Principle Board (“APB”) No.
21, “Interest on Receivables and Payables”, the $295,000 note payable is
discounted at 10% (same as the interest rate on the current loan financing) and
the $193,000 note receivable is discounted at 6% (the original note’s interest
rate). The discounted value of the note payable and note receivable is $232,000
and $162,000, respectively. The net note payable balance amounted to $56,000 as
of September 30, 2008.





In
December 1997, we entered into a $300,000 note receivable agreement with Phillip
Radlick, a Director, and then President and Chief Executive Officer, to
facilitate the purchase of a principal residence in the San Francisco Bay Area.
The note bears interest at the minimum Applicable Federal Rate, and was due and
payable in a single lump sum forty-eight months from the note date. In August,
2001, our Board of Directors amended Mr. Radlick’s agreement to extend this loan
until the first of (i) the date that Mr. Radlick no longer serves as a member of
the Board of Directors, (ii) the date when Mr. Radlick sells his house and (iii)
December 16, 2005. As a security for the note, Mr. Radlick granted us a security
interest in his vested stock options. At December 16, 2005, Mr. Radlick informed
us that he was unable to repay the loan. At December 31, 2005, the balance of
the loan was approximately $357,000, including approximately $79,000 of accrued
interest. No interest accrual was made after December 31, 2004. The loan balance
was fully reserved as of the end of December 31, 2007. In the recently concluded
round of financing on December 17, 2007,  APIX, accepted for its services
rendered all rights, title and interest in a loan totaling $360,000, including
accrued interest, owed to us by Mr. Radlick, with a guarantee by us that the
minimum recoverable value of the loan is not less than $100,000.  In
the event the actual amount recovered is less than $100,000, we agree to pay to
APIX the amount of shortfall on or before December 18, 2008. As a result, we had
$100,000 in notes payable at September 30, 2008.




10




11.
            COMMITMENTS
      AND CONTINGENCIES





Commitments





We lease
facilities under an operating lease, which has been extended through May
2010.  We also lease certain equipment under non-cancelable capital
leases, which bear interest at the rate of 10% per annum. Following is a
schedule of future minimum lease payments under both operating and capital
leases at September 30, 2008 (in thousands):




Fiscal
      Year
                  
                  Operating
      Leases
                  
                  
                  Capital
      Leases2008
                  
                  $
                  265
                  
                  
                  $
                  82009
                  
                  
                  272
                  
                  
                  
                  312010
                  
                  
                  115
                  
                  
                  
                  312011
                  
                  
                  -
                  
                  
                  
                  18Total
      minimum lease payments
                  
                  $
                  652
                  
                  
                  $
                  88Less
      amounts representing interest
                  
                  
                  -
                  
                  
                  
                  (12
                  )Present
      value of net minimum lease payments
                  
                  $
                  652
                  
                  
                  $
                  76





Royalty
Agreement





On July
1, 2005, we entered into a royalty agreement with SurModics, Inc., a Minnesota
corporation (the “Agreement”). Pursuant to the terms of the Agreement, we have
non-exclusive use of licensed products and patents for products treated with
photoreactive polyvinylpyrrolidone copolymer and non-photoreactive
polyvinylpyrrolidone. During the term of the Agreement, we are required to pay
quarterly minimum royalty payments ranging from $7,500 through $15,000 for the
period from July 1, 2005 through December 31, 2009. The royalty fee will
increase gradually beginning January 1, 2010.  The royalty agreement
expires on the expiration of the last patent or 15 years from the licensed
product effective date, whichever is longer; however, the agreement may be
terminated earlier by either party by delivering written notice to the other
party.  Royalty payments to SurModics were $10,000 and $30,000 for the
three and nine months ended September 30, 2008, respectively, and $7,500 and
$22,500 for the three and nine months ended September 30, 2007,
respectively.





Consultant
Agreement





We have
entered into consulting agreements with several individuals.  The
agreements are typically for one year in length and define the scope of services
to be provided by the individuals.  The method of compensation for the
consultants is either cash or stock options, or combination of
both.





Contingencies





On August
31, 2007, our Board of Directors terminated the employment of our Chief
Executive Officer and Acting Chief Financial Officer, Gabriel
Vegh.  Mr. Vegh remained as a Director until September 8, 2008. We
determined that Mr. Vegh’s termination was “with cause” thus the severance
provision of his employment agreement did not apply. On March 3, 2008, we
received a letter from the law firm representing Mr. Gabriel Vegh in which
claims were made for damages for wrongful termination in violation of statutes,
breach of contract and related claims. We will defend ourselves vigorously
against Mr. Vegh’s claims.





On
October 31, 2007, we received a letter from the law firm representing our former
Director of Operations, Mr. Larry Stevens. Mr. Stevens claimed for damages for
wrongful termination in violation of public policy, breach of contract and
related claims.  We determined that Mr. Stevens’ termination was “with
cause” thus the severance provision of his employment agreement did not apply.
We will defend ourselves vigorously against Mr. Stevens’ claims.





In
addition, we are subject to numerous risks and uncertainties because of the
nature and status of our operations and could be subject to claims and legal
actions arising in the ordinary course of business. We maintain insurance
coverage for events in amounts that we deems appropriate. We believe that
uninsured losses, if any, will not be materially adverse to our financial
position or results of operations.





12.
            INCOME
      TAXES





Historically,
we have incurred net operating losses, or NOLs. Because of this history of net
operating losses, we do not currently believe that the future realization of the
tax benefit associated with these NOL carryforwards is more likely than not;
therefore, we have recorded a valuation allowance for the full amount of its net
deferred tax assets.  We will continue to evaluate the likelihood that
these tax benefits may be realized, and may reverse all or a portion of its
valuation allowance in the future if it is determined that realization of these
benefits is more likely than not.




11





Utilization
of the NOL carry forwards to offset future taxable income and tax, respectively,
may be subject to a substantial annual limitation due to ownership change
limitations that may have occurred previously or that could occur in the future
provided by Section 382 of the Internal Revenue Code of 1986, as amended (the
“Code”). In general, an ownership change, as defined by Section 382 of the Code,
results from transactions increasing the ownership of certain stockholders or
public groups in the stock of a corporation by more than 50 percentage points
over a three-year period.





We have
considered these factors in reaching our conclusion as to the valuation
allowance for financial reporting purposes. Accordingly, no benefit has been
recognized on the net loss as the realization of the net operating loss
carryforward cannot be assured.




13.  CONCENTRATIONS
OF RISK







To date,
product sales have been direct to customers in the United States and to
distributors primarily in Europe. The geographic distribution of net sales was
as follows (in thousands):





Three
      Months Ended September 30,
                    
                    
                    Nine
      Months Ended September 30,2008
                    
                    
                    2007
                    
                    
                    2008
                    
                    
                    2007United
      States
                    
                    $
                    344
                    
                    
                    
                    88
                    %
                    
                    $
                    228
                    
                    
                    
                    73
                    %
                    
                    $
                    806
                    
                    
                    
                    74
                    %
                    
                    $
                    703
                    
                    
                    
                    79
                    %Europe
                    
                    
                    48
                    
                    
                    
                    12
                    %
                    
                    
                    69
                    
                    
                    
                    22
                    %
                    
                    
                    282
                    
                    
                    
                    26
                    %
                    
                    
                    257
                    
                    
                    
                    29
                    %Asia/Pacific
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1
                    
                    
                    
                    0
                    %
                    
                    
                    (85
                    )
                    
                    
                    -10
                    %Others
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    14
                    
                    
                    
                    5
                    %
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    15
                    
                    
                    
                    2
                    %Total
      Net Sales
                    
                    $
                    392
                    
                    
                    
                    100
                    %
                    
                    $
                    311
                    
                    
                    
                    100
                    %
                    
                    $
                    1,089
                    
                    
                    
                    100
                    %
                    
                    $
                    890
                    
                    
                    
                    100
                    %





During
the first quarter of 2007, our Japanese distributor notified us of their failure
to maintain the legal documentation standard required to sell our PATHFINDER in
Japan.  As a result, we had no sales in Japan in 2007 and in the
first nine months of 2008. We have filed a “Shonin Application” to obtain
the necessary regulatory approval to re-start PATHFINDER sales in the Japanese
market. We understand that the reapplication process takes approximately twelve
to eighteen months.





Our
diagnostic product group, namely the Pathfinder family of micro-catheter
systems, accounted for 51% and 64% of net sales for the nine months ended
September 30, 2008 and 2007, respectively.





We
purchase certain key components of our products for which there are relatively
few alternative sources of supply including the hydrophilic coating for certain
of our micro-catheters, from sole or limited source supplies. Establishing
additional or replacement suppliers for any of the numerous components used in
our products, if required, may not be accomplished quickly and could involve
significant additional costs.  Any supply interruption from vendors or
failure of our products would limit our ability to manufacture our products and
would have a material adverse effect on our business, financial condition and
results of operations.





14.
            CASH
      AND CASH EQUIVALENTS





We
receive payments from our customers and deposit them in federally insured
financial institutions during our normal course of business.  As of
September 30, 2008, we had cash and cash equivalents of approximately of $2.2
million. During October 2008, the FDIC implemented a new temporary liquidity
program, which provides that all our cash and cash equivalents held in
non-interest bearing accounts is insured by the FDIC through December 31,
2009.





15.
            STOCK-BASED
      COMPENSATION





2007
Stock Option Plan





On
September 14, 2007, our Board of Directors adopted the 2007 Stock Option Plan
(the “2007 Stock Plan”). The 2007 Stock Plan authorizes the Board of Directors
or one or more of its members to grant options to purchase shares of our Company
to eligible individuals.  Eligible individuals may be employees,
non-employee members of the Board or the board of directors of any Parent or
Subsidiary, and consultants who provide valuable service to us or our Parent or
Subsidiary. Options to purchase Common Stock granted under the plan may be
incentive stock options or non-statutory stock options as determined by the
Board of Directors or its delegate. 30,000,000 shares of Common Stock were
reserved for issuance over the term of the 2007 Stock Plan.




12




Under the
plan in no event shall the option price per share be less than 85% of the fair
market value of a share of Common Stock on the date of the grant. In case of
incentive stock option, except options to 10% stockholders, the exercise price
of the option will not be less than 100% of the fair value of the Common Stock
at the grant date. Each option agreement specifies the term as to when the
option is to become exercisable. Standard options vest at a rate of at least 33%
of the underlying shares per year over 3 years and have a maximum term of 10
years. However, in no event shall an incentive stock option granted to a 10%
stockholder under the plan shall have a maximum term in excess of more than 5
years from the date of the grant, Any optionee (as determined under Section
424 (d) of the Internal Revenue Code) who owns more than 10% of the combined
voting power of all classes of outstanding stock of the Company, its Parent or
Subsidiary is not eligible for the grant unless the exercise price of the option
is at least 110% of the fair market value of the Common Stock on the date of the
grant.




2003
Stock Option Plan




On April
17, 2003, our Board of Directors adopted the 2003 Stock Option Plan (the “Stock
Plan”). The Stock Plan authorizes the Board of Directors or one or more of its
members to grant to employees, consultants and non-employee directors options to
purchase Common Stock of the Company. Options granted under the Stock Plan may
be incentive stock options or non-statutory stock options as determined by the
Board of Directors or its delegate.




Under the
Stock Plan, 820,000 shares of Common Stock were reserved for issuance. Under the
plan, any optionee who owns more than 10% of the combined voting power of all
classes of outstanding stock is not eligible for the grant of an incentive stock
option unless the exercise price of the option is at least 110% of the fair
market value of the Common Stock on the date of the grant.




Under the
Stock Plan, except 10% stockholders, the exercise price of incentive stock
option will not be less than 100% of the fair value of the Common Stock at the
grant date. Each option agreement specifies the term as to when the option is to
become exercisable. Standard option issuances are for grants with vesting
periods of four years with six months 12.5% cliff vesting and ratable monthly
vesting thereafter. However, in no event shall an incentive stock option granted
under the Stock Plan be exercisable more than 10 years from the date of the
grant, and in the case of 10% stockholders, no more than 5 years from the date
of the grant.





1993
Stock Option Plan




During
1993, our Board of Directors adopted the 1993 Stock Option Plan, as amended, and
reserved 765,069 shares of common stock for issuance under the plan. The plan
provides for both incentive and non-statutory stock options to be granted to
employees, directors and consultants. Exercisability, option price, fair value
and other terms are determined by the Board of Directors; however, the exercise
price of each incentive stock option shall be not less than 100% of the fair
market value of the stock issuable upon exercise of the option on the date the
option is granted. The exercise price of each non-statutory stock option shall
not be less than 85% of the fair market value of the stock subject to the option
on the date the option is granted. All options granted prior to the initial
public offering of shares were generally exercisable upon grant, but shares
received upon exercise prior to vesting are subject to repurchase upon the
stockholder’s termination of service to the Company. Subsequent to our initial
public offering, only fully vested shares are exercisable. Shares purchased upon
exercise of options generally vest at the rate of 12.5% after six months from
the date of grant, and monthly thereafter over the following 42 months. No
option shall have a maximum term in excess of ten years from the grant date and
no option granted to a 10% stockholder shall have a maximum term in excess of
five years from the grant date. The 1993 plan expired on June 10, 2003, and no
additional grants would be made under this plan.




1997
Directors' Stock Option Plan




In March
1997, the Board of Directors adopted the 1997 Directors’ Stock Option Plan and
reserved 90,000 shares of common stock for issuance. The plan provides for the
grant of non-statutory stock options to non-employee directors of the Company.
The 1997 plan expired in March 2007 and no additional grants would be made under
this plan.





Valuation
Assumptions





Forfeiture
rate is the estimated percentage of options granted that are expected to be
forfeited or cancelled on an annual basis before becoming fully vested. We
estimate the forfeiture rate based on past turnover data.




13





The
assumptions used for the three and nine months ended September 30, 2008 and 2007
and the resulting estimates of weighted-average fair value per share of options
granted and shares purchased during these periods were as follows:





Three months ended Sept 30,
                  
                  
                  Nine months ended Sept 30,2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007Employee
      stock options:Dividend
      yield
                  
                  
                  0.0
                  %
                  
                  
                  0.0
                  %
                  
                  
                  0.0
                  %
                  
                  
                  0.0
                  %Volatility
      factor
                  
                  
                  158.0
                  %
                  
                  
                  162.2
                  %
                  
                  
                  160.2
                  %
                  
                  
                  162.2
                  %Risk-free
      interest rate
                  
                  
                  3.8
                  %
                  
                  
                  4.3
                  %
                  
                  
                  3.7
                  %
                  
                  
                  4.3
                  %Expected
      term (years)
                  
                  
                  7
                  
                  
                  
                  7
                  
                  
                  
                  7
                  
                  
                  
                  7Weighted-average
      fair value
                    of
      options granted during the
                    periods
                  
                  $
                  1.61
                  
                  
                  $
                  0.44
                  
                  
                  $
                  1.29
                  
                  
                  $
                  0.44





In
estimating the expected term, we considered our historical stock option exercise
experience including forfeitures, our post vesting termination pattern and the
term of the options outstanding. The annual risk free rate of return was based
on the U.S. Treasury constant maturity rates with similar terms to the expected
term of the stock option awards. We based our determination of expected
volatility on our historical stock price volatility over the expected
term.




The stock
based compensation expense under SFAS123R that has been reported in general and
administrative expense in the statements of operations is as
follow:





Three months ended Sept 30,
                  
                  
                  Nine months ended Sept 30,2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007Stock
      based compensation
                  
                  $
                  319,000
                  
                  
                  $
                  34,000
                  
                  
                  $
                  736,000
                  
                  
                  $
                  142,000





For stock
subject to graded vesting, we have utilized the “straight-line” method for
allocating compensation cost by period. As of September 30, 2008, there was
$5.3 million of total unrecognized compensation cost related to non-vested stock
option awards which is expected to be recognized over a weighted-average period
of 2.9 years.  There were approximately 1,294,000 options that became
vested during the nine months ended September 30, 2008.





Since we
have a full valuation allowance for our deferred tax assets, there was no impact
to its cash flows related to excess tax benefits associated with the provisions
of Statement of Financial Accounting Standards, or SFAS, No. 123R, Share-Based
Payment.





14


The
following is a summary of stock option activity under all plans:




Outstanding
      Options
                  
                  
                  Average
      Exercise Price
                  
                  
                  Intrinsic
      ValueOption
      Plan
                  Status2007
                  Outstanding
      December 31, 2007
                  
                  
                  5,815,000
                  
                  
                  $
                  0.44
                  
                  
                  $
                  384,000Granted
                  
                  
                  4,690,000Exercised
                  
                  
                  -Cancelled/expired
                  
                  
                  (1,260,000
                  )Outstanding
      September 30, 2008
                  
                  
                  9,245,000
                  
                  
                  $
                  0.82
                  
                  
                  $
                  4,754,9502003
                  Outstanding
      December 31, 2007
                  
                  
                  81,425
                  
                  
                  $
                  3.17
                  
                  
                  
                  -Granted
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  (4,687
                  )
                  
                  
                  -
                  
                  
                  
                  -Cancelled/expired
      (1)
                  
                  
                  75,312
                  
                  
                  
                  
                  
                  
                  
                  -Outstanding
      September 30, 2008
                  
                  
                  152,050
                  
                  
                  $
                  5.20
                  
                  
                  $
                  46,6051993
                  Outstanding
      December 31, 2007
                  
                  
                  60,271
                  
                  
                  $
                  11.24
                  
                  
                  $
                  -Granted
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Cancelled/expired
      (1)
                  
                  
                  138,472
                  
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      September 30, 2008
                  
                  
                  198,743
                  
                  
                  $
                  11.24
                  
                  
                  $
                  -1997
      Director's Plan
                  Outstanding
      December 31, 2007
                  
                  
                  31,800
                  
                  
                  $
                  0.90
                  
                  
                  $
                  160Granted
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Cancelled/expired
                  
                  
                  (11,400
                  )
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      September 30, 2008
                  
                  
                  20,400
                  
                  
                  $
                  1.03
                  
                  
                  $
                  23,517





(1)
            Includes
      147,500 and 100,000 options under the 2003 and 1993 Directors plans that
      were reported as cancelled in the prior year. These options are still
      outstanding as of September 30,
2008.





During
the three months ended September 30, 2008, 4,687 options to purchase common
stock were exercised.


15





The
following is a summary of information relating to stock options outstanding and
exercisable by price range as of September 30, 2008:




Options
      Outstanding
                  
                  
                  Options
      ExercisableOption
      Plan
                  
                  Range
      of exercise prices
                  
                  
                  As
      of September 30, 2008
                  
                  
                  Weighted
      avg. remaining contractual life
                  
                  
                  Weighted
      avg. exercise price
                  
                  
                  As
      of September 30, 2008
                  
                  
                  Weighted
      avg. remaining contractual life
                  
                  
                  Weighted
      avg. exercise price2007
                  
                  $
                  0.41-$0.62
                  
                  
                  
                  6,465,000
                  
                  
                  
                  9.09
                  
                  
                  $
                  0.46
                  
                  
                  
                  1,597,515
                  
                  
                  
                  9.00
                  
                  
                  $
                  0.44$
                  1.25-$1.65
                  
                  
                  
                  500,000
                  
                  
                  
                  9.88
                  
                  
                  
                  1.45
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -$
                  1.69-$1.85
                  
                  
                  
                  2,280,000
                  
                  
                  
                  9.89
                  
                  
                  
                  1.70
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Total
                  
                  
                  
                  9,245,000
                  
                  
                  
                  9.33
                  
                  
                  $
                  0.82
                  
                  
                  
                  1,597,515
                  
                  
                  
                  9.00
                  
                  
                  $
                  0.442003
                  
                  $
                  0.55-$2.50
                  
                  
                  
                  78,075
                  
                  
                  
                  7.13
                  
                  
                  $
                  0.61
                  
                  
                  
                  65,008
                  
                  
                  
                  7.12
                  
                  
                  $
                  0.61$
                  3.50-$12.40
                  
                  
                  
                  73,975
                  
                  
                  
                  5.42
                  
                  
                  
                  10.04
                  
                  
                  
                  73,786
                  
                  
                  
                  5.42
                  
                  
                  
                  10.06Total
                  
                  
                  
                  152,050
                  
                  
                  
                  6.30
                  
                  
                  $
                  5.20
                  
                  
                  
                  138,794
                  
                  
                  
                  6.22
                  
                  
                  $
                  5.631993
                  
                  $
                  3.40-$10.30
                  
                  
                  
                  99,651
                  
                  
                  
                  3.78
                  
                  
                  $
                  7.96
                  
                  
                  
                  99,651
                  
                  
                  
                  3.78
                  
                  
                  $
                  7.96$
                  11.60-$25.60
                  
                  
                  
                  99,092
                  
                  
                  
                  2.75
                  
                  
                  
                  14.55
                  
                  
                  
                  99,092
                  
                  
                  
                  2.75
                  
                  
                  
                  14.55Total
                  
                  
                  
                  198,743
                  
                  
                  
                  3.27
                  
                  
                  $
                  11.24
                  
                  
                  
                  198,743
                  
                  
                  
                  3.27
                  
                  
                  $
                  11.241997
      Director's Plan
                  
                  $
                  0.50-$.70
                  
                  
                  
                  19,600
                  
                  
                  
                  7.73
                  
                  
                  $
                  0.66
                  
                  
                  
                  17,600
                  
                  
                  
                  7.77
                  
                  
                  $
                  0.68$
                  8.40-$14.50
                  
                  
                  
                  800
                  
                  
                  
                  4.17
                  
                  
                  
                  10.10
                  
                  
                  
                  800
                  
                  
                  
                  4.17
                  
                  
                  
                  10.10Total
                  
                  
                  
                  20,400
                  
                  
                  
                  7.59
                  
                  
                  $
                  1.03
                  
                  
                  
                  18,400
                  
                  
                  
                  7.62
                  
                  
                  $
                  1.09




Non-employee
Compensation




From time
to time we grant options to non-employees to purchase common stock at a specific
price with various vesting dates. The options are typically granted for services
rendered and/or specific milestone met. During the first nine months of 2008, we
granted 1,660,000 options to purchase shares of our common stock to
non-employees and recorded an expense of $253,000.  During 2007, we
approved a stock issuance in the amount of 29,000 (post-split) shares of common
stock to a third party for its services. A non-cash stock compensation expense
of $3,000 was recorded in 2007.





1997
Employee Stock Purchase Plan




In March
1997, the Board of Directors adopted the 1997 Employee Stock Purchase Plan (the
“Plan”), as amended, and reserved 2.5 million shares of common stock for
issuance. On June 28, 2007, the shareholders authorized to increase the number
of authorized shares of common stock issuable under the Plan to 3.5 million. The
purchase plan is intended to provide an opportunity for eligible employees and
our designated subsidiaries to acquire common stock on a favorable basis. The
purchase plan is implemented by a series of offering periods of twelve months
duration, with two consecutive purchase periods of six months in duration. New
offering periods commence on or about February 1 and August 1 of each year (or
at such other time or times as may be determined by the Board of Directors).
Through periodic payroll deductions, which may not exceed $25,000 per offering
period or 10% of any employee’s compensation, eligible employees may purchase
common stock at a price equal to the lower of: (i) 85% of the fair market value
of the common stock on the offering date; or (ii) 85% of the fair market value
of the common stock on the purchase date. During the January and July 2008
offerings, 124,182 shares of common stock were issued under the purchase plan.
As of September 30, 2008, there were 420,958 shares issued under the
Plan.





We
believe that under SFAS 123R (Paragraph 12) a plan is not compensatory if among
other things “any purchase discount from the market price does not exceed the
per-share amount of share issuance costs that would have been incurred to raise
a significant amount of capital by a public offering. A purchase discount of 5%
or less from the market price shall be considered to comply with this condition
without further justification. A purchase discount greater than 5% that cannot
be justified under this condition results in compensation cost for the entire
amount of the discount.” Additionally, we do not believe that in 2007 we are in
a position to raise significant amount of capital through a public offering.
Based on our recent cost of raising equity capital, we incurred costs of 37% and
16%. In both cases the cost exceeded the 15% discount given under this
plan. The plan was therefore considered non-compensatory. We understand that in
accordance with footnote 115 to SFAS 123R, if an entity justifies a purchase
discount in excess of 5 percent, it would be required to reassess that discount
at least annually and no later than the first share purchase offer during the
fiscal year. If upon reassessment that discount is not deemed justifiable,
subsequent grants using that discount would be compensatory. In August 2008, our
Board of Directors reviewed our stock-based compensation plans and decided to
terminate the 1997 Employee Stock Purchase Plan.




16




16.
            WARRANTS




In May
2008, we consummated a transaction whereby we entered into a series of
Subscription Agreements with certain accredited investors (collectively, the
“Investors”) providing for the sale by us to the Investors of (i) a total of
8,474,992 shares of our Common Stock (the “Shares”) and (ii) warrants (the
“Warrants”) to purchase an aggregate of 1,271,247 shares of our Common Stock at
an exercise price of $0.65 for the aggregate principal amount of $5.1
million.





APIX
acted as placement agent for the transaction. In consideration for the services
provided, we have entered into a Funding Agreement with APIX whereby we agreed
to: (i) grant 1.5 million warrants to purchase shares of our Common Stock for a
period of five years at an exercise price of $0.60; and (ii) reimburse APIX’s
expenses totaling $80,000.





The
warrants issued were accounted for under Financial Accounting Standards Board
Statement No. 123R, using the Black-Scholes option-pricing model (with similar
assumptions as those used for the option), which resulted in the recording of
$868,000 in compensation cost during the period ended June 30,
2008.





The
following table summarizes warrants for the years 2007 and 2008:





Outstanding WarrantsNumber
      of Warrant Shares
                  
                  
                  Exercise
      Price/ Warrant Share
                  
                  
                  Weighted
      Avg. Exercise PriceBalance
      as of 12/31/2006
                  
                  
                  7,579,353
                  
                  
                  $
                  0.60
      - $14.00
                  
                  
                  $
                  3.20Granted
      in 2007
                  
                  
                  19,860,000
                  
                  
                  $
                  0.30
      - $0.55
                  
                  
                  $
                  0.55Canceled
      in 2007
                  
                  
                  (537,359
                  )
                  
                  $
                  0.78
      - $13.40
                  
                  
                  $
                  10.60Exercised
      in 2007
                  
                  
                  (20,340,000
                  )
                  
                  $
                  0.40
                  
                  
                  $
                  0.40Balance
      as of 12/31/2007
                  
                  
                  6,561,994
                  
                  
                  $
                  0.55
      - $12.38
                  
                  
                  $
                  1.30Granted
      in 2008
                  
                  
                  2,771,247
                  
                  
                  $
                  0.65
                  
                  
                  $
                  0.65Canceled
      in 2008
                  
                  
                  (72,155
                  )
                  
                  $
                  7.79
      - $8.38
                  
                  
                  $
                  8.09Exercised
      in 2008
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  $
                  -Balance
      as of 9/30/2008
                  
                  
                  9,261,086
                  
                  
                  $
                  0.55
      - $12.38
                  
                  
                  $
                  0.91








The
following table summarizes information about warrants outstanding and
exercisable at September 30, 2008:





Range
      of Exercise Price
                        
                        
                        Number
      of Warrants Outstanding and Exercisable
                        
                        
                        Weighted
      Avg. Remaining Contractual Life (Yrs.)
                        
                        
                        Weighted
      Avg. Exercise Price$4.30
      - $10.98
                        
                        
                        
                        789,839
                        
                        
                        
                        1.0
                        
                        
                        $
                        4.57$0.55
                        
                        
                        
                        5,700,000
                        
                        
                        
                        4.2
                        
                        
                        $
                        0.55$0.60
      - $0.65
                        
                        
                        
                        2,771,247
                        
                        
                        
                        4.6
                        
                        
                        $
                        0.629,261,086





No
warrants were exercised during the three months end September 30, 2008 and
2007.





17.
            PREFERRED
      SHARES





On August
14, 2008, we signed a letter agreement with APIX that clarifies the terms of the
Series A Preferred Stock issued to APIX as originally understood by the parties,
as follows:




APIX, at
its sole discretion, may convert the five million Preferred Shares it owns
into 10,000,000 shares of our common stock, subject to adjustment in the
event of a stock split and other similar events affecting the number of issued
and outstanding common stock.  As a result of the ten for one reverse stock
that was effectuated on July 31, 2007, the Series A Preferred is currently
convertible into 1,000,000 shares of our common stock.  The Series A
Preferred votes together with the Common Stock and will continue to carry 28
votes for each share of Preferred Stock.  We are in the process of drafting
and filing an amended certificate of designation for the preferred stock to
reflect these clarifications.


17


ITEM
2. Management’s Discussion and Analysis and Results of Operations




Cautionary
Statement Regarding Forward-Looking Statements




The
information in this discussion may contain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. These forward-looking statements involve risks and uncertainties,
including statements regarding our capital needs, business strategy and
expectations. Any statements that are not of historical fact may be deemed
to be forward-looking statements. These forward-looking statements involve
substantial risks and uncertainties. In some cases you can identify
forward-looking statements by terminology such as “may,” “will,” “should,”
“expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,”
“potential,” or “continue”, the negative of the terms or other comparable
terminology. Unless the context otherwise requires, references in this Form 10-Q
to “we,” “us,” “our,” or the “Company” refer to Cardima, Inc. Forward-looking
statements in this Report may also include references to anticipated sales
volume and product margins, efforts aimed at establishing new or improving
existing relationships with customers, other business development activities,
anticipated financial performance, business prospects and similar matters.
Actual events or results may differ materially from the anticipated results
or other expectations expressed in the forward-looking statements. In evaluating
these statements, you should consider various factors, including the risks
included from time to time in other reports or registration statements filed
with the United States Securities and Exchange Commission. These factors
may cause our actual results to differ materially from any forward-looking
statements. We disclaim any obligation to publicly update these statements, or
disclose any difference between actual results and those reflected in these
statements.





Overview





Our
corporate strategy involves attaining certain key goals in three significant
areas: product commercialization, regulatory strategy, and manufacturing
capabilities. These areas are discussed in detail in the following
sections.




Product
Commercialization




We are
committed to the commercialization of our surgical and electrophysiological
products worldwide.  In order to attain this goal, we have and will
continue to add key marketing resources and personnel in the US and align
ourselves with independent sales organizations capable of representing our
products in other markets. In the second quarter of this year, we received
product registration approval from the State Food and Drug Administration in
China for the INTELLITEMP product.  In the third quarter, we received
product registration approval in Thailand for all of our products.




In the
immediate term, domestically, we are focusing our efforts on the
commercialization of our FDA 510K cleared Surgical Ablation
System.  In Europe, we are focusing in the near term on expanding the
number of commercial EP centers using our EP ablation products in select markets
including the United Kingdom and Germany.  In the first quarter of
2009 (dependent on CE mark approval) we will start to market our Surgical
Ablation System in the European Union.  Also in the same quarter, we
expect to obtain EP ablation product market approvals in China.  The
Chinese market is promising for us as it has a large population of untreated
patients, a significant body of trained electrophysiologists and cardiac
surgeons, and several cardiac centers that routinely perform both EP and
surgical ablations.  In the second half of 2009 (dependent on
regulatory approval),we
intend to re-enter the Japanese diagnostic market and are reviewing Japanese
regulatory requirements for our surgical and EP ablation
products.




As we
commercialize our products, we shall identify key opinion leaders to become
“product champions” and will certify certain leading cardiology programs as
Cardima “Centers of Excellence”.  We shall also continue to add
leading electrophysiologists and cardiac surgeons as consultants and advisors to
improve our products and the procedure designs.  We are also
identifying appropriate independent distributors that will be engaged to train,
support and distribute our products in key markets.




Regulatory
Strategy




We are
focused on attaining necessary regulatory approvals for the commercial sale of
our surgical and EP products worldwide. We have engaged the services of Sanjeev
Saksena MD, a cardiologist and trained electrophysiologist with a worldwide
reputation, to advise us in this process.  In
addition to Dr. Saksena, we have also engaged our Chief Medical Officer and
Director, Dr. Sung Chun and other specialist consultants, such as Dr. Abraham
Kocheril (University of Illinois, Chicago), to provide us with appropriate
advice.  To our knowledge, we remain the only company to date to have
completed a multi-center RF ablation trial and submitted our data for review to
an FDA panel for the indication of treating AF.  We continue to
interact with the FDA to resolve the final issues and data required to attain
market approval for the EP ablation product.




In
addition to the efforts with the FDA, we have filed, or are planning to file,
applications for product approvals in several countries, notably China and Japan
and the European Union.




Manufacturing
Capabilities




We have
focused on improving our ability to manufacture, in commercial quantities, high
quality reliable products.  The entire organization is committed to
providing the best surgical and EP products possible.  This has
entailed adding key individuals, improving design processes, adding test and
quality control measures above those required and implementing training and
support systems to ensure high levels of staff performance and product
quality.  Our team of professionals and our dedicated staff have made
great strides in achieving new manufacturing goals and standards in
2008.




18




The
research and development goals and achievements for the third quarter of 2008
included:





New
EP Handle




One of
our design policies is to constantly receive feedback from our end users so that
we can continuously improve our products. In the second quarter of 2008, we
received feedback from end-user physicians and finalized the design of a new
handle design for the EP products, including the REVELATION T-Flex and the
NAVIPORT. Significant progress has been achieved in this regard, including
developing manufacturing processes for this new handle. We will complete
verification and validation testing in the fourth quarter of 2008, and have
plans to introduce the new handle design into clinical usage in the first
quarter of 2009.  In a parallel process, all necessary regulatory updates
for these devices with the new handle will be submitted to the appropriate
notified bodies.  The new handle will afford significant improvements in
product performance and is expected to offer patients and physicians key
procedure improvements in ease of use and shorter procedure
times.





Enhancement
of REVELATION T-Flex 8 electrodes





Our
product development engineers have been evaluating ways to improve the
deflection performance of the REVELATION T-Flex with 8 electrodes, to address
ablation at specific anatomic regions of the heart, such as the cavo-tricuspid
isthmus.  This is an ongoing endeavor and pre-clinical testing leading
to clinical assessment will begin when these modifications are implemented in
production units.





INTELLITEMP




Over the
past several months, we have worked with a new strategic supplier and have been
successful in transferring the INTELLITEMP Energy Management Device (“EMD”) to
this new supplier. During the second quarter, manufacturing verification of the
surgical version of the INTELLITEMP EMD was completed, with system validation
occurring in late third quarter of 2008. After product validation, the units
will be available to our marketing staff and sales representatives for
commercial centers in the early fourth quarter.




We
continue to evaluate the INTELLITEMP design and have been developing the
specifications internally for the next version of this product.  The
goal is to develop specifications together with vendor input in the later part
of 2008.




Surgical
Ablation System




We have
implemented a number of product improvements and design changes to improve the
performance and safety of the Surgical Ablation System.  In addition,
earlier this year, our Product Development and Process Engineers made key
recommendations to the development of manufacturing processes that potentially
reduce the time needed to build Surgical Ablation Probes.  In the third
quarter of 2008, we also prototyped a longer version of the sheathed probe and
demonstrated invitroproof of
concept.




Going
forward, our product development team continues to review marketing feedback
from surgeons, and will develop product enhancements to fulfill user needs based
on this feedback.




Sales and
Marketing Priorities and achievements in the third quarter of 2008
included:




Resource
Management




We have
continued to follow our strategic sales and marketing plans as noted in our
previous report on Form 10-Q filed with the SEC on August 14,
2008.  Staffing for clinical site and case support for US surgical
procedures has been increased. Our marketing team has redesigned our Web
site to a state-of-the-art portal which allows patients, doctors and investors
to view a broad range of clinical and product information including company
milestones that have been met.  We are continuing to bolster our
resources and personnel in sales and marketing as well as customer
training/support throughout 2008.




Distribution
Partners




We
continue to review several potential distribution partners worldwide.
 Progress in this area is expected throughout the balance of
2008.  We anticipate strategic contracts will be in place prior to
registration approvals of products in all key
world markets.  This will be achieved in the fourth quarter of
2008 and throughout 2009.




19




Surgical
Ablation System




We will
continue to identify higher volume surgical ablation centers whose surgeons are
experienced in the techniques of ablation.  Some of these sites will
become Cardima Centers of Excellence and conduct peer-to peer physician
training. It is anticipated that this strategy will aid our U.S. commercial
efforts for surgical ablation, both open chest and minimally invasive,
throughout 2008 and 2009.




In
Europe, our sales executives are evaluating appropriate marketing partners in
the surgical field and are awaiting CE mark approval for the Surgical Ablation
Probe with Sheath to implement the European surgical sales
strategy.





EP
Ablation System




In the
field of electrophysiology, we are focusing on key European markets including
the United Kingdom and Germany.  We are in the process of selecting
marketing partners, training the field representatives and supporting customer
centers that will develop into EP Centers of Excellence.  These
Centers of Excellence will also conduct peer-to peer physician training; aiding
Cardima in EP sales and marketing efforts.




Developments
in China and Thailand




We are in
discussions with potential marketing partners for the China market to cover both
electrophysiology and surgical products.  We have also met with key
Chinese physicians and opinion leaders in the industry to prepare for an
appropriate market launch in China.  Furthermore, in June 2008, we
received approval from China’s State Food and Drug Administration to market the
INTELLITEMP Energy Management Device in the People’s Republic of China. We are
also awaiting registration in Thailand.




Risk
factors





For the
period between January 1, 2008 and September 30, 2008, we do not have any
material change to report from risk factors as previously disclosed in our Forms
10-KSB and 10-KSB/A for the period ended December 31, 2007.





Results
of Operations





NetSales




(unaudited,
      in thousands)Three
      months ended
                    
                    
                    Nine
      months endedNet
      sales
                    
                    Sept
      30, 2008
                    
                    
                    Sept
      30, 2007
                    
                    
                    Sept
      30, 2008
                    
                    
                    Sept
      30, 2007United
      States
                    
                    $
                    343
                    
                    
                    $
                    228
                    
                    
                    $
                    805
                    
                    
                    $
                    703Europe
                    
                    
                    48
                    
                    
                    
                    69
                    
                    
                    
                    282
                    
                    
                    
                    257Asia/Pacific
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1
                    
                    
                    
                    (85
                    )Other
                    
                    
                    -
                    
                    
                    
                    14
                    
                    
                    
                    -
                    
                    
                    
                    15Total
      net sales
                    
                    $
                    391
                    
                    
                    $
                    311
                    
                    
                    $
                    1,088
                    
                    
                    $
                    890





For three
months ended September 30, 2008, sales were $391,000 as compared to $311,000 for
the same period in 2007. Domestic sales increased slightly primarily due to the
initial shipments of our new surgical ablation products to our Centers of
Excellence. Net sales for the nine months ended September 30, 2008 were $1.1
million as compared to $890,000 for the same period in 2007.  During
the second quarter of 2007, our former Japanese distributor retuned $85,000
worth of our PATHFINDER products due to their failure to maintain the legal
documentation standard required to sell products in Japan. As the distributor no
longer had the right to sell our product, the goods were taken back and returned
to our inventory.  In October 2008, we have appointed Japan Lifeline
Co. Ltd. as our new distributor in Japan. Together with Japan Lifeline, we have
filed a “Shonin Application” to obtain the necessary regulatory approval to
re-start PATHFINDER sales in the Japanese market. During the reapplication
process, we may have limited or no sales in Japan.  We anticipate
resuming commercial sales to Japan in the second half of
2009.  However, there can be no assurance that we will be able to
resume sales by that time.




20


Cost
of Sales; gross margin deficiency




(unaudited,
      in thousands)Three
      months ended
                      
                      
                      Nine
      months endedSept
      30, 2008
                      
                      
                      Sept
      30, 2007
                      
                      
                      Sept
      30, 2008
                      
                      
                      Sept
      30, 2007Sales
                      
                      $
                      391
                      
                      
                      $
                      311
                      
                      
                      $
                      1,088
                      
                      
                      $
                      890Cost
      of sales
                      
                      
                      838
                      
                      
                      
                      523
                      
                      
                      
                      2,135
                      
                      
                      
                      1,478Gross
      margin deficiency
                      
                      $
                      (447
                      )
                      
                      $
                      (212
                      )
                      
                      $
                      (1,047
                      )
                      
                      $
                      (588
                      )


Cost of
goods sold primarily includes raw materials costs, catheter fabrication costs,
system assembly and testing costs, and manufacturing labor and overhead costs
for the units sold in the period. Cost of goods sold as a percentage to sales
for the three months ended September 30, 2008 increased to 214%, as compared to
168% for the same period in 2007. Cost of goods sold as a percentage to sales
for the nine months ended September 30, 2008 increased to 196%, as compared to
166% for the same period in 2007. The increase in cost of sales for the three
and nine months ended September 30, 2008 as compared to the same period in 2007
was primarily attributable to higher compensation costs of $321,000 and
$509,000, respectively, from increased headcount in anticipation of the
commercialization of the surgical line of products.  We expect the
cost of sales percentage to improve as sales volume increases.





Research
and Development Expenses




(unaudited,
      in thousands)Three
      months ended
                    
                    
                    Nine
      months endedSept
      30, 2008
                    
                    
                    Sept
      30, 2007
                    
                    
                    Sept
      30, 2008
                    
                    
                    Sept
      30, 2007Research
      and development
                    
                    $
                    1,329
                    
                    
                    $
                    388
                    
                    
                    $
                    3,440
                    
                    
                    $
                    2,083




Research
and development expenses include product development, clinical testing and
regulatory expenses. Research and development expenses for the three months
ended September 30, 2008 increased to $1.3 million from $388,000 for the same
period in 2007. The increase was primarily related to higher compensation
expenses of $320,000 due to head count increase to support the new product
commercialization initiative, recruiting expenses of $121,000, outside
consulting and other services of $295,000, legal expenses of $21,000 related to
patent applications and other supplies of $44,000.  Research and
development expenses for the nine months ended September 30, 2008 increased to
$3.4 million from $2.1 million for the same period in 2007. The increase was
mainly attributable to higher compensation expenses of $482,000 due to headcount
increase, recruiting expenses of $196,000, outside consulting and other services
of $321,000, and other supplies of 212,000.





Selling,
Marketing, General and Administrative Expenses




(unaudited,
      in thousands)Three
      months ended
                    
                    
                    Nine
      months endedSept
      30, 2008
                    
                    
                    Sept
      30, 2007
                    
                    
                    Sept
      30, 2008
                    
                    
                    Sept
      30, 2007Selling,
      general and administrative
                    
                    $
                    1,626
                    
                    
                    $
                    859
                    
                    
                    $
                    5,497
                    
                    
                    $
                    2,607


Selling,
marketing, general and administrative expenses for the three and nine months
ended September 30, 2008 increased to $1.6 million and $5.5 million,
respectively, from $859,000 and $2.6 million, respectively, for the same period
in 2007.





For the
three months ended September 30, 2008, selling and marketing expenses increased
by $174,000 as compared to the same period in 2007 due mostly to higher
compensation expense from increased headcount. For the nine months ended
September 30, 2008, selling and marketing expenses increased by $864,000 due
mainly to higher compensation expense of $492,000, outside consulting expenses
of $160,000, and travel and trade show expenses of $164,000.





General
and administrative expenses for the three months ended September 30, 2008
increased by $630,000 as compared to the same period in 2007 due chiefly to (i)
non-cash stock-based compensation expenses of $383,000, (ii) outside consulting
expenses of $92,000, (iii) provision for doubtful collections from our customers
of $46,000 and (iv) legal and accounting expenses related to the restatement of
our historical financial statements and the set up of the 2008 annual meeting of
the shareholders of $57,000. General and administrative expenses for the nine
months ended September 30, 2008 increased by $2.1 million largely due to (i)
non-cash stock-based compensation expenses of $844,000, (ii) legal and
accounting expenses of $155,000, (iii) travel related expenses of $91,000 and
(iv) non-cash compensation cost of $868,000, accounted for under the
Black-Scholes option-pricing model, for warrants granted to APIX in
consideration of their services provided in the arrangement of the funding
during the second quarter of 2008 of $5.1 million from accredited
investors.





We expect
general and administrative expenses to increase slightly in the next six months
in the area of consulting costs to help with the implementation of Sarbanes
Oxley internal controls.




21




Interest
Income and Expense, net




Interest
income for the three months ended September 30, 2008 was $20,000 as compared to
an interest expense of $3.1 million in the same period of 2007 resulted from an
adjustment of interest on the debt in 2007. Interest income for the nine months
ended September 30, 2008 was $104,000 as compare to an interest expense of $3.0
million for the same period of 2007 resulted from an adjustment of interest on
the debt in 2007.




Net
Loss




Net loss
for the three months ended September 30, 2008 was $3.4 million, as compared to a
net loss of $2.9 million reported in the same period of 2007, which included
charges from the correction of interest expense of $3.1 million associated with
the loan, offset in part by the adjustment of derivative liability related to
the fair value of warrant liability of $1.7 million.





Net loss
for the nine months ended September 30, 2008 was $9.9 million, as compared to a
net loss of $29.0 million reported in the same period of 2007. The net loss in
2007 included the charges from the recognition of the extinguishment of debt
treatment of $15.2 million, a charge of $7.7 million, recorded in the first
three months of 2007, arising from shares to settle convertible debt in excess
of corporate authority, and a correction of interest expense of $3.0 million,
offset in part by the adjustment of derivative liability related to the fair
value of the warrant liability of $2.2 million.





We
recorded a liability for the derivative instrument that resulted due to the
number of potential common stock shares plus outstanding shares that exceeded
the number of authorized common stock shares. At March 31, 2007, our authorized
shares were less than the outstanding shares plus potential shares from the
exercise of options, warrants, and convertible debt that were issued. The excess
potential shares were attributed to the additional funding received starting in
April 2006 from the issuance of convertible debt. We calculated the fair value
of these potential shares and recorded a corresponding liability of $7.7 million
based on the fair value of our common stock on March 31, 2007 and any change was
processed through a charge or gain in the statement of operations. In June 2007,
our shareholders voted for a reverse stock-split without a corresponding
decrease in the authorized number of shares authorized. As a result of this
action, we cured this liability as the authorized common shares now exceed all
outstanding common shares and potential common shares.




Liquidity
and Capital Resources




We had
cash and cash equivalents of approximately $2.2 million as of September 30, 2008
and $4.8 million as of December 31, 2007.  As of September 30, 2008,
we had positive working capital of $2.7 million and an accumulated deficit of
approximately $186.5 million.





Net cash
used in operating activities was approximately $9.0 million and $5.1 million for
the nine months ended September 30, 2008 and 2007, respectively, resulting
primarily from increased working capital needs and current period operating
expenses. Net cash used in investing activities included $500,000 related to the
capital expenditures of property and equipment, as compared to $83,000 used in
2007. We had $2.0 million cash in short term investments as of December 31,
2007, which was liquidated into to our cash accounts during the second quarter
of 2008 to support our operating expenses. Net cash provided by financing
activities in the first nine months of 2008 was $5.0 million primarily from a
private placement funding from qualified investors arranged by APIX, which also
provided $4.7 million loan financing in the same period of 2007.





Off-Balance
Sheet Arrangements





We have
no off-balance sheet arrangements





ITEM
3. Quantitative and Qualitative Disclosure About Market Risk





Not
applicable.





ITEM
4. Controls and Procedures





Evaluation
of Disclosure Controls and Procedures





Our
disclosure controls and procedures are designed to ensure that information
required to be disclosed in reports that we file or submit under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the rules and forms of the SEC. Our Chief Executive
Officer and Interim Corporate Controller have reviewed the effectiveness of our
“disclosure controls and procedures” (as defined in the Securities Exchange Act
of 1934 Rules 13a-14(c) and 15d-14(c)) during the period covered by this report
on Form 10-Q.  We had detected certain errors in the calculation and
disclosure of debt extinguishment and excess share liability as presented in our
previously issued Quarterly Reports on Form 10-Q for the periods ended March 31,
June 30, and September 30, 2006, March 31, June 30, and September 30, 2007 and
in the 2007 annual report on Form 10-KSB for the year ended December 31,
2007.




22





As
disclosed in Part I. ITEM 8A. CONTROLS AND PROCEDURES of our Annual Report on
Form 10-KSB/A for the year ended December 31, 2006 and our restatements to the
Quarterly Financial statements for the quarterly periods ended March 31, June
30, and September 30, 2006, March 31, June 30, and September 30, 2007 and ITEM
3A on form 10-KSB/A for the year ended December 31, 2007, we determined that
there were material weaknesses in our internal controls over financial reporting
in the areas of accounting for debt extinguishments and excess share
liability.




To
address these significant deficiencies and material weaknesses, we have taken
the following steps to improve our internal controls and procedures over
financial reporting:





·
            We
      have added additional staff to our financial department and have assigned
      to our CEO some of the duties of our previous interim CFO as of March
      2008.




·
            We
      have added three additional accounting staff in 2008 to allow for
      sufficient segregation of duties. We have hired an interim corporate
      controller, who has public company reporting
  experience.





·
            We
      initiated a plan to search and add personnel with technical accounting
      expertise in order to help us maintain effective disclosure controls and
      procedures as well as internal control over financial
      reporting.




·
            We
      are performing additional analyses, including but not limited to a
      detailed balance sheet and statement of operations analytical review that
      compared changes from the prior period's financial statements and analyzed
      all significant differences.




·
            We
      implemented new procedures during the first quarter of 2008 that require
      additional reviews by qualified third parties to perform detailed review
      of all non-recurring journal entries above a certain dollar threshold and
      also to review all journal entries.




·
            We
      have retained a consultant to analyze and update our written internal
      controls over financial reporting as
necessary.




Based
upon such evaluation and the steps taken by us to address the previously
reported significant deficiencies and material weaknesses, we have concluded
that, as of the end of the period covered by this report, our disclosure
controls and procedures are effective in ensuring that information required to
be disclosed in this filing is accumulated and communicated to management and is
recorded, processed, summarized and reported in a timely manner and in
accordance with Securities and Exchange Commission rules and regulations. We are
in the process of testing all of our controls. The testing of all controls has
not been completed as of the balance sheet date.




Internal Control
Over Financial Reporting.





Except
for the affirmative changes discussed above, there have been no changes in our
internal controls over financial reporting during the last quarterly period
covered by this Quarterly Report on Form 10-Q that have materially affected, or
are reasonably likely to materially affect, our internal control over financial
reporting.





We will
continue to monitor internal control over financial reporting and will modify or
implement if necessary, any additional controls or procedures that may be
required to ensure the continued integrity of our financial
statements





Limitations
on the Effectiveness of Controls





A control
system, no matter how well conceived and operated, can provide only reasonable,
not absolute, assurance that the objectives of the control system are met.
Because of the inherent limitations in all control systems, no evaluation of
controls can provide absolute assurance that all control issues and instances of
fraud, if any, within a company have been detected.  Our disclosure
controls and procedures are designed to provide reasonable assurance of
achieving our objectives.





23


PART
II - OTHER INFORMATION




ITEM
1.   Legal Proceedings





A
complaint was filed against us in the Superior Court in Alameda County,
California, on March 3, 2008 by Gabriel Vegh, one of our directors, and former
Chairman and Chief Executive Officer, for violation of statues, breach of
contract, bad faith, wrongful termination and damages. The action was commenced
in connection with our termination of Mr. Vegh in August 2007. We are in the
process of responding to the complaint and intend to defend ourselves
vigorously.





On
October 31, 2007, we received a letter from the law firm representing our former
Director of Operations, Larry Stevens in which claims were made for damages for
wrongful termination in violation of public policy, breach of contract and other
related claims.  We determined that Mr. Stevens’ termination was “with
cause” thus the severance provision of his employment agreement did not apply.
We will defend ourselves vigorously against Mr. Stevens’ claims.




ITEM
2.   Unregistered Sales of Equity Securities and Use of
Proceeds





None.





ITEM
3.   Defaults Upon Senior Securities





None.




ITEM
4.   Submission of Matters to a Vote of the Security
Holders





We held
our Annual Meeting of Shareholders on September 8, 2008. At the meeting, our
shareholders voted on the following three proposals and casted their votes as
follows:





Proposal
1: To elect the following nominees as directors:




Nominee
              For
              WithheldTony
      Shum
              256,804,463
              204,699Robert
      Cheney
              256,799,893
              209,269Eric
      Chan
              256,802,953
              206,209Sung
      Chun
              256,802,943
              206,219Richard
      Gaston
              256,801,653
              207,509Phillip
      Radlick
              256,801,289
              207,873





Proposal
2: To ratify the adoption of the 2007 Employee Option Plan for the issuance of
30,000,000 shares of common stock over the term of the option plan:





For
              Against
              Abstain251,250,187
              161,150
              5,996





Proposal
3: To ratify the appointment of PMB Helin Donovan, LLP as our independent
registered public accounting firm for the 2008 fiscal year:





For
              Against
              Abstain256,903,251
              94,804
              11,106





ITEM
5.   Other Information





On November
11, 2008, we executed a Loan Term Sheet and Loan Commitment letter (the
“Financing Documents”) with an accredited investor and shareholder of the
Company pursuant to which we will issue a secured promissory note (the
“Note”) in the principal amount of $6 million. The Note will bear interest at a
rate of 10% per year and matures on November 10, 2009. The Note will have
and be a general charge on all of our assets. Pursuant to the Financing
Documents, the final definitive loan agreement will be concluded within 45
days from the signing of the Financing Documents. We intend to use the
proceeds for general corporate purposes, including working capital and equipment
purchases.





24





ITEM
6.   Exhibits




31.1
            
            Certification
      of the Chief Executive Officer and Chief Financial Officer of
      Cardima, Inc., pursuant to Rule 13a-14(a) under the Securities Exchange
      Act of 1934.32.1
            
            Certification
      of the Chief Executive Officer and Chief
      Financial Officer of Cardima furnished pursuant to Section 1350
      of Chapter 63 of 18 U.S.C. as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.




..


CARDIMA,
INC.





SIGNATURE





Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.








CARDIMA,
      INC.November
      13, 2008
            By:
            /s/ Robert
      CheneyChief
      Executive Officer and Chief Financial Officer (Principal Executive and
      Financial and Accounting Officer)














25