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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003
Commission file number: 0-28288   CardioGenesis Corporation  California
    
    77-0223740(State of incorporation)
    
    (I.R.S. Employer
Identification Number)
 26632 Towne Center Drive, Suite 320
Foothill Ranch, California 92610
(Address of principal executive offices) (714) 649-5000
(Registrants telephone number, including area code)   Securities registered
pursuantto Section 12(g) of the Act:
Common Stock, no par value
(Title of Class)   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 preceding 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 o Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrants knowledge, in definitive proxy or information
statements incorporated herein by reference in Part III of this Form 10-K or
any amendment to this Form
10-K.  o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2.) Yes o    No x The aggregate market value of the voting and non-voting stock held by
non-affiliates of the Registrant was approximately $33,654,144 as of
March 5, 2004, based upon the closing sale price reported for
that date of $1.07 on the
OTC Bulletin Board. Shares of Common Stock held by each officer and director
and by each person who owns 5% or more of the outstanding Common Stock have
been excluded because such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for any other purpose. Indicate the number of shares outstanding of each of the issuers classes
of common stock outstanding as of the latest practicable date. 37,859,108 shares
As of March 5, 2004




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INDEX TO FORM 10-K PagePART IItem 1.
    
    Business.
    
    
    1Item 2.
    
    Description of Property.
    
    
    19Item 3.
    
    Legal Proceedings.
    
    
    19Item 4.
    
    Submission of Matters to a Vote of Security Holders.
    
    
    19PART IIItem 5.
    
    Market for Registrants Shares and Related Shareholder Matters.
    
    
    20Item 6.
    
    Selected Consolidated Financial Data.
    
    
    21Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of
Operations.
    
    
    22Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk.
    
    
    28Item 8.
    
    Consolidated Financial Statements and Supplementary Data.
    
    
    29Item 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.
    
    
    29Item 9A.
    
    Controls and Procedures.
    
    
    29PART IIIItem 10.
    
    Directors and Executive Officers of the Registrant.
    
    
    30Item 11.
    
    Executive Compensation.
    
    
    30Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management.
    
    
    30Item 13.
    
    Certain Relationships and Related Transactions.
    
    
    30Item 14.
    
    Principal Accountant
Fees and Services.
    
    
    30PART IVItem 15.
    
    Exhibits, Financial Statement Schedule and Reports on Form 8-K.
    
    
    31Signatures
    
    
    
    
    34EXHIBIT 3.1.4EXHIBIT 3.2EXHIBIT 21.1EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1




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PART I 
 Item 1.Business. This Annual Report onForm 10-Kcontains forward-looking statements that
involve risks and uncertainties. The statements contained herein that are not
purely historical are forward-looking statements within the meaning of Section
27A of the Securities Act and Section 21E of the Exchange Act, including
without limitation statements regarding our expectations, beliefs, intentions
or strategies regarding the future. All forward-looking statements included in
this document or incorporated by reference herein are based on information
available to us on the date hereof, and we assume no obligation to update any
such forward-looking statements. Our actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including those set forth in Item 7 and elsewhere. General CardioGenesis Corporation, incorporated in California in 1989, designs,
develops and distributes laser-based surgical products and disposable
fiber-optic accessories for the treatment of advanced cardiovascular disease
through transmyocardial revascularization (TMR) and percutaneous transluminal
myocardial revascularization (PMR). TMR and PMR are recent laser-based heart
treatments in which channels are made in the heart muscle. Many
scientific experts believe these
procedures encourage new vessel formation, or angiogenesis. TMR is performed by
a cardiac surgeon through a small incision in the chest under general
anesthesia. PMR is performed by a cardiologist in a catheter-based procedure
which utilizes local anesthesia. Clinical studies have demonstrated a
significant reduction in angina and increase in exercise duration in patients
treated with TMR or PMR plus medications, when compared with patients who
received medications alone. We received CE Mark approval for our TMR system in May 1997 and our PMR
system in April 1998, which allows us to commercially distribute these products
within the European Community. The CE Marking is an international symbol of
adherence to quality assurance standards and compliance with applicable
European medical device directives. On February 11, 1999, we received final
approval from the Food and Drug Administration (FDA) for our TMR products for
treatment of stable patients with certain types of angina. Effective July 1,
1999, Centers for Medicare and Medicaid Services (CMS), formerly known as the
Health Care Financial Administration (HCFA) began to provide Medicare
coverage for any manufacturers TMR procedures. As a result, hospitals and
physicians are eligible to receive Medicare reimbursement for TMR equipment and
procedures for Medicare patients. We have completed pivotal clinical trials involving PMR, and study results
were submitted to the FDA in a Pre Market Approval (PMA application) in
December 1999 along with subsequent amendments. In July 2001, the FDA Advisory
Panel recommended against approval of PMR for public sale and use in the United
States. In February 2003, the FDA granted an independent panel review of our
pending PMA application for PMR by the Medical Devices Dispute Resolution Panel
(MDDRP). In July 2003, the FDA agreed to an alternative process in which
additional data in support of our PMA supplement for PMR could be submitted and
reviewed by the FDA in an interactive review process. The data was submitted
in August 2003 and the independent panel review by the MDDRP was cancelled. The
FDA agreed to reschedule the MDDRP hearing in the future if the dispute cannot
be resolved. The FDA has informed us that they believe the data
submitted in August 2003 in connection with the interactive
review process is still not adequate to support approval by the FDA
of our PMR system. We are currently scheduled to meet with the FDA in March 2004 as
part of the ongoing interactive review process. There can be no assurance,
however, that we will receive a favorable determination from the FDA. On March 17, 1999, we merged with the former CardioGenesis Corporation.
Under the terms of the combination, each share of the former CardioGenesis
common stock was converted into 0.8 of a share of our common stock, and the
former CardioGenesis has become a wholly owned subsidiary of ours. As a result
of the transaction, our outstanding shares increased by approximately 9.9
million shares. The transaction was structured to qualify as a tax-free
reorganization and has been accounted for as a pooling of interests.
Accordingly, the financial information included in this report has been
restated as if the combined entity existed for the 1999 period prior to the
merger. -1-




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Background According to the American Heart Association, cardiovascular disease is the
leading cause of death and disability in the U.S. Coronary artery disease is
the principal form of cardiovascular disease and is characterized by a
progressive narrowing of the coronary arteries which supply blood to the heart.
This narrowing process is usually due to atherosclerosis, which is the buildup
of fatty deposits, or plaque, on the inner lining of the arteries. Coronary
artery disease reduces the available supply of oxygenated blood to the heart
muscle, potentially resulting in severe chest pain known as angina, as well as
damage to the heart. Typically, the condition worsens over time and often leads
to heart attack and/or death. Based on standards promulgated by the Canadian Heart Association, angina
is typically classified into four classes, ranging from Class 1, in which
angina pain results only from strenuous exertion, to the most severe, Class 4,
in which the patient is unable to conduct any physical activity without angina
and angina may be present even at rest. The American Heart Association
estimates that more than six million Americans experience angina symptoms. The primary therapeutic options for treatment of coronary artery disease
are drug therapy, balloon angioplasty also known as percutaneous transluminal
coronary angioplasty or (PTCA), other interventional techniques which augment
or replace PTCA such as stent placement and atherectomy, and coronary artery
bypass grafting or (CABG). The objective of each of these approaches is to
increase blood flow through the coronary arteries to the heart. Drug therapy may be effective for mild cases of coronary artery disease
and angina either through medical effects on the arteries that improve blood
flow without reducing the plaque or by decreasing the rate of formation of
additional plaque (e.g., by reducing blood levels of cholesterol). Because of
the progressive nature of the disease, however, many patients with angina
ultimately undergo either PTCA or CABG. Introduced
in the early 1980s, PTCA is a less-invasive alternative to CABG in which a balloon-tipped catheter is inserted into an artery, typically near
the groin, and guided to the areas of blockage in the coronary arteries. The
balloon is then inflated and deflated at each blockage site, thereby rupturing
the blockage and stretching the vessel. Although the procedure is usually
successful in widening the blocked channel, the artery often re-narrows within
six months of the procedure, a process called restenosis, often necessitating
a repeat procedure. A variety of techniques for use in conjunction with PTCA
have been developed in an attempt to reduce the frequency of restenosis,
including stent placement and atherectomy. Stents are small metal frames
delivered to the area of blockage using a balloon catheter and deployed or
expanded within the coronary artery. The stent is a permanent implant intended
to keep the channel open. Atherectomy is a means of using mechanical, laser or
other techniques at the tip of a catheter to cut or grind away plaque. CABG is an open chest procedure developed in the 1960s in which conduit
vessels are taken from elsewhere in the body and grafted to the blocked
coronary arteries so that blood can bypass the blockage. CABG typically
requires the use of a heart-lung bypass machine to render the heart inactive
(to allow the surgeon to operate on a still, relatively bloodless heart) and
involves prolonged hospitalization and patient recovery periods. Accordingly,
it is generally reserved for patients with severe cases of coronary artery
disease or those who have previously failed to receive adequate relief of their
symptoms from PTCA or related techniques. Most bypass grafts fail within one to
fifteen years following the procedure. Repeating the surgery (re-do bypass
surgery) is possible, but is made more difficult because of scar tissue and
adhesions that typically form as a result of the first operation. Moreover, for
many patients CABG is inadvisable for various reasons, such as the severity of
the patients overall condition, the extent of coronary artery disease or the
small size of the blocked arteries. When these treatment options are exhausted, the patient is left with no
viable surgical or interventional alternative other than, in limited cases,
heart transplantation. Without a viable surgical alternative, the patient is
generally managed with drug therapy, often with significant lifestyle
limitations. TMR, which bears the CE Marking and has received FDA approval, and
PMR, which bears the CE Marking and for which we are continuing -2-




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to pursue FDA approval for use in the U.S., offer potential relief to a
large population of patients with severe cardiovascular disease. The TMR and PMR Procedures TMR is a surgical procedure performed on the beating or non-beating heart,
in which a laser device is used to create pathways through the myocardium
directly into the heart chamber. The pathways are intended to supply blood to
ischemic, or oxygen-deprived regions of the myocardium and reduce angina in the
patient. TMR can be performed using open chest surgery or minimally invasive
surgery through a small incision between the ribs. TMR offers end-stage cardiac
patients who have regions of ischemia not amenable to PTCA or CABG a means to
alleviate their symptoms and improve their quality of life. We have received
FDA approval for U.S. commercial distribution of our TMR laser system for
treatment of stable patients with angina (Canadian Cardiovascular Society Class
4) refractory to medical treatment and secondary to objectively demonstrated
coronary artery atherosclerosis and with a region of the myocardium with
reversible ischemia not amenable to direct coronary revascularization. PMR is an interventional procedure performed by a cardiologist. PMR is
based upon the same principles as TMR, but the procedure is much less invasive.
The procedure is performed under local anesthesia and the patient is treated
through a catheter inserted in the femoral artery at the top of the leg. A
laser transmitting catheter is threaded up into the heart chamber, where
channels are created in the inner portion of the myocardium (i.e. heart
muscle). PMR has received the CE Marking approving its use within the European
Union. See our discussion below under the caption Regulatory Status, for the
status of our PMA application with the FDA seeking approval of PMR for public
sale and use in the United States. Business Strategy Our objective is to become a recognized leader in the field of myocardial
revascularization, with TMR and PMR established as well-known and acceptable
therapies. Our strategies to achieve this goal are as follows:  Expand Market for our Products. We are seeking to expand market
awareness of our products among opinion leaders in the cardiovascular
field, the referring physician community and the targeted patient
population. In connection with the FDA approved TMR product, we have
prioritized our efforts in the U.S. on the top 600 hospitals that perform
the greatest number of cardiovascular procedures. We also currently
intend to expand our marketing efforts in Europe and to the rest of the
world through the establishment and expansion of direct international
sales and support organizations and third party distributors and agents.
In addition, we have developed a comprehensive training program to assist
physicians in acquiring the expertise necessary to utilize our TMR and PMR
products and procedures.  Demonstrate Clinical Utility of PMR. We are seeking to demonstrate
the clinical safety and effectiveness of PMR. We have completed a pivotal
clinical trial regarding PMR, and the study results were submitted to the
FDA in a PMA application in December 1999, along with subsequent
supplements. As discussed below under the caption Regulatory Status, the
FDA Advisory Panel recommended against approval of PMR for public sale and
use in the United States and further informed us that they believe
the data submitted in August 2003 in connection with the
interactive review process is still not adequate to support approval
by the FDA of our PMR system. We are currently scheduled to meet with the FDA
in March 2004 as part of the ongoing interactive review process of our PMA
application for PMR. We cannot assure you, however, that we will receive
a favorable determination from the FDA.  Leverage Proprietary Technology. We believe that our significant
expertise in laser and catheter-based systems for cardiovascular disease
and the proprietary technologies we have developed are important factors
in our efforts to demonstrate the safety and effectiveness of our TMR and
PMR procedures. We are seeking to develop additional proprietary
technologies for TMR, PMR and related procedures. We have over 100 foreign
and U.S. patents or allowed patent applications and more than 200 U.S. and
foreign patent applications pending relating to various aspects of TMR,
PMR and other cardiovascular therapies.   -3-




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Products and Technology TMR System Our
TMR system consists of a holmium laser console and a line of
fiber-optic, laser-based surgical tools. Each surgical tool utilizes an optical
fiber assembly to deliver laser energy from the source laser base unit to the
distal tip of the surgical handpiece or PMR catheter. The compact base unit
occupies a small amount of operating room floor space, operates on standard
220-volt power supply, and is light enough to move within the operating
room or among operating rooms in order to use operating room space efficiently.
Moreover, the flexible fiberoptic assembly used to deliver the laser energy to
the patient enables ready access to the patient and to various sites within the
heart. Our TMR system and related surgical procedures are designed to be used
without the requirement of the external systems utilized with certain
competitive TMR systems. For example, our TMR 2000 system does not require
electrocardiogram synchronization, which monitors the electrical output of the
heart and times the use of the laser to minimize electrical disruption of the
heart, or transesophageal echocardiography, which tests each application of the
laser to the myocardium during the TMR procedure to determine if the pathway
has penetrated through the myocardium into the heart chamber. Holmium
Laser. Our TMR 2000 laser base unit generates 2.1 micron
wavelength laser light by photoelectric excitation of a solid state holmium
crystal. The holmium laser, because it uses a solid state crystal as its
source, is compact, reliable and requires minimal maintenance. SoloGrip. The single use SoloGrip handpiece system contains multiple, fine
fiber-optic strands in a one millimeter diameter bundle. The flexible fiber
optic delivery system combined with the ergonomic handpiece provides access for
treating all regions of the left ventricle. The
SoloGrip fiber-optic delivery system has an easy to install connector
that screws into the laser base unit, and the device is pre-calibrated in the
factory so it requires no special preparation. PMR System Our PMR system is currently sold only outside the United States. The PMR
system consists of the PMR Laser and ECG Monitor. PMR Laser. Our holmium laser base unit generates 2.1 micron
wavelength laser light in the mid-infrared spectrum. It provides a reliable source
for laser energy with low maintenance. Axcis Catheter System. Our Axcis catheter system is an over-the-wire
system that consists of two components, the Axcis laser catheter and Axcis
aligning catheter. Our Axcis catheter system is designed to provide controlled
navigation and access to target regions of the left ventricle. The coaxial
Axcis laser catheter has an independent, extendible lens with radiopaque lens
markers which show the location and orientation of the tip for optimal contact
with the ventricle wall. The Axcis laser catheter also has nitinol petals at
the laser-lens tip which are designed for safe penetration of the endocardium
and to provide depth control. Regulatory Status United States. On February 11, 1999, we received approval from the FDA
for use of our TMR 2000 laser console and SoloGrip handpiece for treatment of
stable patients with angina (Canadian Cardiovascular Society Class 4)
refractory to other medical treatments and secondary to objectively
demonstrated coronary artery atherosclerosis and with a region of the
myocardium with reversible ischemia not amenable to direct coronary
revascularization. -4-




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We have completed pivotal clinical trials involving PMR and study results
were submitted to the FDA in a PMA application in December 1999 along with
subsequent amendments. The PMR study compares PMR to conventional medical
therapy in patients with no option for other treatment. In July 2001, the FDA
Advisory Panel recommended against approval of PMR for public sale and use in
the United States. In July 2003, the FDA agreed to an alternative process in
which additional data in support of our PMA supplement for PMR could be
submitted and reviewed by the FDA in an interactive review process. The data
was submitted in August 2003 and the independent panel review by the MDDRP was
cancelled. The FDA agreed to reschedule the MDDRP hearing in the future if the
dispute cannot be resolved. The FDA has informed us that they believe
the data submitted in August 2003 in connection with the
interactive review process is still not adequate to support approval
by the FDA of our PMR system. We are currently scheduled to meet with the FDA in
March 2004 as part of the ongoing interactive review process. We cannot assure
you, however, that we will receive a favorable determination from the FDA. European Union. We have obtained approval to affix the CE Marking to
substantially all of our products, which enables us to commercially distribute
our TMR and PMR products throughout the European Community. Sales and Marketing We
have received FDA approval for our surgical TMR laser system. In July
1999, the
Centers for Medicare and Medicaid Services announced its coverage
policy for TMR equipment and procedures. We are promoting market
awareness of our approved surgical products among opinion leaders in the
cardiovascular field and are recruiting physicians and hospitals to
use our TMR
products. In the United States, we currently offer a laser base unit at a current
end user list price of $355,000 per unit, and the disposable TMR handpiece (at
least one of which must be used with each TMR procedure) at an end user unit
list price of $3,300. In addition to sales of lasers to hospitals outright, in
an effort to accelerate market adoption of the TMR procedure, we developed a
program in which we loan lasers to hospitals in return for the
hospital purchasing a minimum number of handpieces at a premium over the list
price. Internationally, we sell our TMR and PMR products through a direct sales
and support organization and through distributors and agents. We currently
intend to expand our marketing efforts in Europe and to the rest of the world
through the establishment and expansion of direct international sales and
support organizations and third party distributors and agents. We can not
assure you, however, that we will be successful in increasing our international
sales. We have developed, in conjunction with several major hospitals using our
TMR or PMR products, a training program to assist physicians in acquiring the
expertise necessary to utilize our products and procedures. This program
includes a comprehensive one-day course including didactic training and
hands-on performance of TMR or PMR in vivo. To date over 1,200 cardiothoracic
surgeons have been trained on the CardioGenesis TMR system. We
exhibit our products at major meetings of cardiovascular medicine
practitioners. Evaluators of our products have made presentations at meetings
around the world, describing their results. Abstracts and articles have been
published in peer-reviewed publications and industry journals to present the
results of our clinical trials. Research and Development We believe that streamlining our research efforts and product offerings
is essential to our ability to stimulate growth and maintain our market
leadership position. Our ongoing research and product development efforts are
focused on the development of new and enhanced lasers and fiber-optic
handpieces for TMR and PMR applications. We believe our future success will depend, in part, upon the success of
our research and development programs. There can be no assurance that we will
realize financial benefit from these efforts or that products or technologies
developed by others will not render our products or technologies obsolete or
non-competitive. -5-




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Manufacturing We outsource the manufacturing and assembly of our TMR and PMR handpiece
systems to a single contract manufacturer. We believe that we have an
adequate supply of lasers to meet our expected demand for the next twelve
months. We are currently exploring manufacturing outsourcing options for the
TMR 2000 laser and currently expect to have production capacity by
the fourth
quarter of 2004. The PMR laser system is provided to us under a manufacturing
agreement with a laser manufacturing company. Certain components of our laser units and fiber-optic handpieces are
generally acquired from multiple sources. Other laser and fiber-optic
components and subassemblies are purchased from single sources. Although we
have identified alternative vendors, the qualification of additional or
replacement vendors for certain components or services is a lengthy process.
Any significant supply interruption would have a material adverse effect on the
ability to manufacture our products and, therefore, would harm our business. We
intend to continue to qualify multiple sources for components that are
presently single sourced. Competition We expect that the market for TMR and PMR, which is currently in the early
stages of development, will be competitive. At this point in time, we believe
that our only competitor is PLC Systems, Inc. (PLC) which markets
FDA-approved TMR products in the U.S. and abroad. Other competitors may also
enter the market, including large companies in the laser and cardiac surgery
markets. Many of these companies have or may have significantly greater
financial, research and development, marketing and other resources than we do. PLC is a publicly traded corporation which uses a CO2 laser and an
articulated mechanical arm in its TMR products. PLC obtained a Pre Market
Approval for TMR in 1998. PLC has received the CE Marking, which allows sales
of its products commercially in all European Union countries. PLC has been
issued patents for its apparatus and methods for TMR. Edwards Lifesciences, a
well known, publicly traded provider of products and technologies to treat
cardiovascular disease, has assumed full sales and marketing responsibility in
the U.S. for PLCs TMR Heart Laser 2 System and associated kits pursuant to a
co-marketing agreement between the two companies executed in January 2001.
Through its significantly greater financial and human resources, including a
well-established and extensive sales representative network, we believe Edwards
has the potential to market to a greater number of hospitals and doctors
than we currently can. We believe that the factors which will be critical to market success
include: the timing of receipt of requisite regulatory approvals, effectiveness
and ease of use of the TMR products and applications, breadth of product line,
system reliability, brand name recognition, effectiveness of distribution
channels and cost of capital equipment and disposable devices. TMR and PMR also compete with other methods for the treatment of
cardiovascular disease, including drug therapy, PTCA and CABG. Even with the
FDA approval of our TMR system in patients for whom other cardiovascular
treatments are not likely to provide relief, and when used in conjunction with
other treatments, we cannot assure you that our TMR or PMR products will be
accepted by cardiovascular professionals. Moreover, technological advances in other therapies for
cardiovascular disease such as pharmaceuticals or future innovations in cardiac
surgery techniques could make such other therapies more effective or lower in
cost than our TMR procedure and could render our technology obsolete. We cannot assure you that physicians will use our TMR procedure to replace or
supplement established treatments, or that our TMR procedure will be
competitive with current or future technologies. Such competition could harm
our business. Our TMR laser system and any other product developed by us that gains
regulatory approval will face competition for market acceptance and market
share. An important factor in such competition may be the timing of market
introduction of competitive products. Accordingly, the relative pace at which
we can develop products, complete clinical testing, achieve regulatory
approval, gain reimbursement acceptance and supply commercial quantities of the
product to the market are important competitive factors. In the event a
competitor is able to obtain -6-




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a PMA for its products prior to our doing so, we may not be able to
compete successfully. We may not be able to compete successfully against
current and future competitors even if we obtain a PMA prior to our
competitors. Government Regulation Laser-based surgical products and disposable fiber-optic accessories for
the treatment of advanced cardiovascular disease through TMR are considered
medical devices, and as such are subject to regulation in the U.S. by the FDA
and outside the U.S. by comparable international regulatory agencies. Our devices require the
rigorous PMA process for approval to market the product in the U.S. and must
bear the CE Marking for commercial distribution in the European Community. To obtain a Pre Market Approval (PMA) for a medical device, we must file
a PMA application that includes clinical data and the results of preclinical
and other testing sufficient to show that there is a reasonable assurance of
safety and effectiveness of the product for its intended use. To begin a
clinical study, an Investigational Device Exemption (IDE) must be obtained
and the study must be conducted in accordance with FDA regulations. An IDE
application must contain preclinical test data demonstrating the safety of the
product for human investigational use, information on manufacturing processes
and procedures, and proposed clinical protocols. If the FDA clears the IDE
application, human clinical trials may begin. The results obtained from these
trials are accumulated and, if satisfactory, are submitted to the FDA in
support of a PMA application. Prior to U.S. commercial distribution, premarket
approval is required from the FDA. In addition to the results of clinical
trials, the PMA application must include other information relevant to the
safety and effectiveness of the device, a description of the facilities and
controls used in the manufacturing of the device, and proposed labeling. By
law, the FDA has 180 days to review a PMA application. While the FDA has
responded to PMA applications within the allotted time frame, reviews more
often occur over a significantly longer period and may include requests for
additional information or extensive additional trials. There can be no
assurance that we will not be required to conduct additional trials which may
result in substantial costs and delays, nor can there be any assurance that a
PMA will be obtained for each product in a timely manner, if at all. In
addition, changes in existing regulations or the adoption of new regulations or
policies could prevent or delay regulatory approval of our products.
Furthermore, even if a PMA is granted, subsequent modifications of the approved
device or the manufacturing process may require a supplemental PMA or the
submission of a new PMA which could require substantial additional clinical
efficacy data and FDA review. After the FDA accepts a PMA application for
filing, and after FDA review of the application, a public meeting is frequently
held before an FDA advisory panel in which the PMA is reviewed and discussed.
The panel then issues a favorable or unfavorable recommendation to the FDA or
recommends approval with conditions. Although the FDA is not bound by the
panels recommendations, it tends to give such recommendations significant
weight. In February 1999, we received a PMA for our TMR laser system for use in
certain indications. As discussed above under the caption Regulatory
Status, the FDA Advisory Panel recommended against approval of
PMR for public sale and use in the United States and further informed
us that they believe the data submitted in August 2003 in
connection with the interactive review process is still not adequate
to support approval by the FDA of our PMR system. We are currently
scheduled to meet with the FDA in March 2004 as part of the
ongoing interactive review process of our PMA application for PMR. We
cannot assure you, however, that we will receive a favorable
determination from the FDA. Products manufactured or distributed by us pursuant to a PMA will be
subject to pervasive and continuing regulation by the FDA, including, among
other things, postmarket surveillance and adverse event reporting requirements.
Failure to comply with applicable regulatory requirements can result in, among
other things, warning letters, fines, suspensions or delays of approvals,
seizures or recalls of products, operating restrictions or criminal
prosecutions. The Federal Food, Drug and Cosmetic Act requires us to
manufacture our products in registered establishments and in accordance with
Good Manufacturing Practices (GMP) regulations and to list our devices with
the FDA. Furthermore, as a condition to receipt of a PMA, our facilities,
procedures and practices will be subject to additional pre-approval GMP
inspections and thereafter to ongoing, periodic GMP inspections by the FDA.
These GMP regulations impose certain procedural and documentation requirements
upon us with respect to manufacturing and quality assurance activities.
Labeling and promotional activities are subject to scrutiny by the FDA. Current
FDA enforcement policy prohibits the marketing of approved medical devices for
unapproved uses. Changes in existing regulatory requirements or adoption of new
requirements could harm our business. We may be required to incur significant
costs to comply with laws and regulations in the future and current or future
laws and regulations may harm our business. -7-




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We are also regulated by the FDA under the Radiation Control for Health
and Safety Act, which requires laser products to comply with performance
standards, including design and operation requirements, and manufacturers to
certify in product labeling and in reports to the FDA that our products comply
with all such standards. The law also requires laser manufacturers to file new
product and annual reports, maintain manufacturing, testing and sales records,
and report product defects. Various warning labels must be affixed and certain
protective devices installed, depending on the class of the product. In
addition, we are subject to California regulations governing the manufacture of
medical devices, including an annual licensing requirement. Our facilities are
subject to ongoing, periodic inspections by the FDA and California regulatory
authorities. Sales, manufacturing and further development of our TMR and PMR systems
also may be subject to additional federal regulations pertaining to export
controls and environmental and worker protection, as well as to state and local
health, safety and other regulations that vary by locality and which may
require obtaining additional permits. We cannot predict the impact of these
regulations on our business. Sales of medical devices outside of the U.S. are subject to foreign
regulatory requirements that vary widely by country. In addition, the FDA must
approve the export of devices to certain countries. To market in Europe, a
manufacturer must obtain the certifications necessary to affix to its products
the CE Marking. The CE Marking is an international symbol of adherence to
quality assurance standards and compliance with applicable European medical
device directives. In order to obtain and to maintain a CE Marking, a
manufacturer must be in compliance with appropriate ISO 9001 standards and
obtain certification of its quality assurance systems by a recognized European
Union notified body. However, certain individual countries within Europe
require further approval by their national regulatory agencies. We have
achieved International Standards Organization and European Union certification
for our manufacturing facility. In addition, we have completed CE mark
registration for all of our products in accordance with the implementation of
various medical device directives in the European Union. Failure to maintain
the right to affix the CE Marking or other requisite approvals could prohibit
us from selling our TMR and PMR products in member countries of the European
Union or elsewhere. Intellectual Property Matters Our success depends, in part, on our ability to obtain patent protection
for our products, preserve our trade secrets, and operate without infringing
the proprietary rights of others. Our policy is to seek to protect our
proprietary position by, among other methods, filing U.S. and foreign patent
applications related to our technology, inventions and improvements that are
important to the development of our business. We have over 100 U.S. and foreign
patents or allowed patent applications and more than 200 U.S. and foreign
patent applications pending relating to various aspects of TMR, PMR and other
cardiovascular therapies. Our patents or patent applications may be challenged,
invalidated or circumvented in the future or the rights granted may not provide
a competitive advantage. We intend to vigorously protect and defend our
intellectual property. We do not know if patent protection will continue to be
available for surgical methods in the future. Costly and time-consuming
litigation brought by us may be necessary to enforce our patents and to protect
our trade secrets and know-how, or to determine the enforceability, scope and
validity of the proprietary rights of others. We also rely upon trade secrets, technical know-how and continuing
technological innovation to develop and maintain our competitive position. We
typically require our employees, consultants and advisors to execute
confidentiality and assignment of inventions agreements in connection with
their employment, consulting, or advisory relationships with us. If
any of these agreements are breached, we may not have adequate
remedies available thereunder to protect our intellectual property or
we may incur substantial expenses enforcing our rights. Furthermore, our competitors may independently develop substantially
equivalent proprietary information and techniques or otherwise gain access to
our proprietary technology, or we may not be able to meaningfully protect our
rights in unpatented proprietary technology. The medical device industry in general, and the industry segment that
includes products for the treatment of cardiovascular disease in particular,
have been characterized by substantial competition and litigation regarding
patent and other intellectual property rights. In this regard, our competitors
have been issued a number of patents related to TMR and PMR. There can be no
assurance that claims or proceedings will not be initiated against us
by competitors or other third parties in the future. In
particular, the introduction in the United States market of our PMR
technology, should that occur, may create new exposures to claims of -8-




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infringement of third party
patents. Any such claims in the future, regardless of whether they
have merit, could be time-consuming and expensive to respond to and could
divert the attention of our technical and management personnel. We may be
involved in litigation to defend against claims of our infringement, to enforce
our patents, or to protect our trade secrets. If any relevant claims of third
party patents are upheld as valid and enforceable in any litigation or
administrative proceeding, we could be prevented from practicing the subject
matter claimed in such patents, or we could be required to obtain licenses from
the patent owners of each such patent or to redesign our products or processes
to avoid infringement. We cannot assure that our current and potential competitors and other
third parties have not filed or in the future will not file patent applications
for, or have not received or in the future will not receive, patents or obtain
additional proprietary rights that will prevent, limit or interfere with our
ability to make, use or sell our products either in the U.S. or
internationally. In the event we were to require licenses to patents issued to
third parties, such licenses may not be available or, if available, may not be
available on terms acceptable to us. In addition, we cannot assure
you that we would be successful in
any attempt to redesign our products or processes to avoid infringement or that
any such redesign could be accomplished in a cost-effective manner.
Accordingly, an adverse determination in a judicial or administrative
proceeding or failure to obtain necessary licenses could prevent us from
manufacturing and selling our products, which would harm our business. Third Party Reimbursement We
expect that sales volumes and prices of our products will continue to depend
significantly on the availability of reimbursement for surgical procedures
using our products from third party payors such as governmental programs,
private insurance and private health plans. Reimbursement is a significant
factor considered by hospitals in determining whether to acquire new equipment.
Reimbursement rates from third party payors vary depending on the third party
payor, the procedure performed and other factors. Moreover, third party payors,
including government programs, private insurance and private health plans, have
in recent years been instituting increasing cost containment measures designed
to limit payments made to healthcare providers by, among other measures,
reducing reimbursement rates, limiting services covered, negotiating
prospective or discounted contract pricing and carefully reviewing and
increasingly challenging the prices charged for medical products and services. Medicare reimburses hospitals on a prospectively determined fixed amount
for the costs associated with an in-patient hospitalization based on the
patients discharge diagnosis, and reimburses physicians on a prospectively
determined fixed amount based on the procedure performed, regardless of the
actual costs incurred by the hospital or physician in furnishing the care and
unrelated to the specific devices used in that procedure. Medicare and other
third party payors are increasingly scrutinizing whether to cover new products
and the level of reimbursement for covered products. In addition, Medicare
traditionally has considered items or services involving devices that have not
been approved or cleared for marketing by the FDA to be precluded from Medicare
coverage. In July 1999, Centers for Medicare and Medicaid Services began
coverage of FDA approved TMR systems for any manufacturers TMR procedures. In
October of 1999, CMS further clarified its coverage policy to include coverage
of TMR when performed as an adjunctive to CABG. In contrast to Medicare which covers a significant portion of the patients
who are candidates for TMR, private insurers and health plans each make any
individual decision whether or not to provide reimbursement for TMR
and, if so,
at what reimbursement level. We have limited experience to date ascertaining
the acceptability of our TMR procedures for reimbursement by private insurance
and private health plans. Private insurance and private health plans may not
approve reimbursement for TMR or PMR. The lack of private insurance and health
plans reimbursement may harm our business. Based on physician feedback, we
believe many private insurers are reimbursing hospitals and physicians when the
procedure is performed on non-Medicare patients. In May 2001, Blue Cross/Blue
Shields Technology Evaluation Center (TEC) assessed our therapy and
confirmed that both TMR and TMR used as an adjunct to bypass surgery, improves
net health outcomes. While TEC decisions are not binding, many Blue Cross/Blue
Shield plans and other third-party payers use the center as a benchmark and
adopt into policy those therapies that meet the TEC assessment. -9-




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In foreign markets, reimbursement is obtained from a variety of sources,
including governmental authorities, private health insurance plans and labor
unions. In most foreign countries, there are also private insurance systems
that may offer payments for alternative therapies. Although not as prevalent as
in the U.S., health maintenance organizations are emerging in certain European
countries. We may need to seek international reimbursement approvals, and we
may not be able to attain these approvals in a timely manner, if at all.
Failure to receive foreign reimbursement approvals could make market acceptance
of our products in the foreign markets in which such approvals are sought more
difficult. We believe that reimbursement in the future will be subject to increased
restrictions such as those described above, both in the U.S. and in foreign
markets. We also believe that the escalating cost of medical products and
services has led to and will continue to lead to increased pressures on the
healthcare industry, both foreign and domestic, to reduce the cost of products
and services, including products offered by us. Third party reimbursement and
coverage may not be available or adequate in U.S. or foreign markets, current
levels of reimbursement may be decreased in the future and future legislation,
regulation, or reimbursement policies of third party payors may reduce the
demand for our products or our ability to sell our products on a profitable
basis. Fundamental reforms in the healthcare industry in the U.S. and Europe
that could affect the availability of third party reimbursement continue to be
proposed, and we cannot predict the timing or effect of any such proposal. If
third party payor coverage or reimbursement is unavailable or inadequate, our
business may suffer. Product Liability and Insurance We maintain insurance against product liability claims in the amount of
$10 million per occurrence and $10 million in the aggregate. We may not be
able to obtain additional coverage or continue coverage in the amount desired
or on terms acceptable to us, and such coverage may not be adequate for
liabilities actually incurred. Any uninsured or underinsured claim brought
against us or any claim or product recall that results in a significant cost to
or adverse publicity against us could harm our business. Employees As of December 31, 2003 we had 31 employees, of which 18 employees were in
sales and marketing. None of our employees is covered by a collective
bargaining agreement and we have not experienced any work stoppages to date. Our
executive officers as of February 13, 2004 were as follows: Name
    
    Age
    
    PositionMichael J. Quinn
    
    
    60
    
    
    President, Chief Executive Officer,
Chairman of the Board and DirectorChristine G. Ocampo
    
    
    31
    
    
    Vice President, Chief Financial Officer,
Chief Accounting Officer, Treasurer and
SecretaryRichard P. Lanigan
    
    
    44
    
    
    Senior Vice President of MarketingHenry R. Rossell, Jr.
    
    
    48
    
    
    Senior Vice President, General Manager,
Atlantic Business Unit
 Michael J. Quinnhas served as our Chief Executive Officer, Chairman of
the Board and Director since October 2000 and also President from October 2000
to May 2002 and from November 2003 to the present. From November 1999 to September 2000, Mr. Quinn served as Chief
Executive Officer, President and a member of the Board of Directors for Premier
Laser Systems, a manufacturer of surgical and dental products. From January
1998 to November 1999, Mr. Quinn served as President and Chief Operating
Officer of Imagyn Medical Technologies, Inc., a manufacturer of minimally
invasive surgical specialty products. From 1995 through December 1997, Mr.
Quinn served as President and Chief Operating Officer of Fisher Scientific
Company. Prior to 1995, Mr. Quinn held senior - 10 -




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operating management positions at major healthcare organizations including
American Hospital Supply Corporation, Picker International, Cardinal Health
Group and Bergen Brunswig. Christine
G. Ocampohas served as our Vice President and Chief Financial
Officer, Chief Accounting Officer, Treasurer and Secretary since November 2003.
From 2001 to November 2003, Ms. Ocampo served in the role of Vice President and
Corporate Controller. She first joined the Company in April 1997 and spent
four years as our Accounting Manager. Prior to joining us, Ms. Ocampo held
a management position in Finance at Mills-Peninsula Health Systems in
Burlingame, CA, and spent three years as an Audit Senior for Ernst & Young LLP.
She graduated with a Bachelors of Science in Accounting from Seattle
University and became a licensed Certified Public Accountant in 1996. Richard P. Laniganhas been our Senior Vice President of Marketing since
November 2003. Prior to November 2003, Mr. Lanigan served in a variety of
different capacities. From March 2001 to October 2003, Mr. Lanigan was Vice
President of Government Affairs and Business Development. From March 2000 to
March 2001, Mr. Lanigan served as Vice President of Sales and
Marketing and from 1997 to 2000, he was the Director of Marketing.
From 1992 to 1997, Mr. Lanigan served in various positions, most recently
Marketing Manager, at Stryker Endoscopy. From 1987 to 1992, Mr. Lanigan served
in Manufacturing and Operations management at Raychem Corporation. From 1981 to
1987, he served in the U.S. Navy where he completed six years of service as
Lieutenant in the Supply Corps. Mr. Lanigan has a Bachelors of Arts in Finance
from Notre Dame and a Masters degree in Systems Management from the University
of Southern California. Henry R. Rossell, Jr.has been our Senior Vice President and General
Manager of the Atlantic Business Unit since January 2004. Prior to that, Mr.
Rossell served as our Senior Vice President of Worldwide Sales and Marketing
since January 2003. From 1999 to 2002, Mr. Rossell served as Senior
Vice-President, Sales and Marketing, Surgical Products Division at Imagyn
Medical Technologies, Inc. From 1998 to 1999, he served as Vice President of
the Education Services Group at Medascend, Inc. From 1994 to 1998, Mr. Rossell
served as Vice President of Sales at Deknatel Snowden-Pencer and at Genzyme
Surgical Products following the acquisition of Deknatel by Genzyme. Prior to
Genzyme, Mr. Rossell spent 17 years in several sales management positions at
Baxter Healthcare International where his most recently held position was Area
Vice President, Corporate Sales and Marketing. Mr. Rossell has a Bachelors of
Arts in History from Duke University. Risk Factors In addition to the other information included in this Form 10-K, the
following risk factors should be considered carefully in evaluating us and our
business. Our ability to maintain current operations is dependent upon sustaining
profitable operations or obtaining financing in the future. We have incurred significant losses since inception. For example, for the
fiscal years 2003, 2002 and 2001 we incurred net losses of $348,000, $530,000
and $10,247,000 respectively. We will have a continuing need for new infusions
of cash if we continue to incur losses in the future. We plan to
increase our revenues through increased direct sales and marketing efforts on existing products
and achieving regulatory approval for other products. If our direct sales and
marketing efforts are unsuccessful or we are unable to achieve regulatory
approval for our products, we will be unable to significantly increase our
revenues. We believe that if we are unable to generate sufficient funds from
sales or from debt or equity issuances to maintain our current expenditure
rate, it will be necessary to significantly reduce our operations, including
our sales and marketing efforts and research and development. If we are
required to significantly reduce our operations, our business will be harmed. We may be required to seek additional sources of financing, which could
include short-term debt, long-term debt or equity. Although in the past we
have been successful in obtaining financing, most recently through the private
placement of equity securities in January 2004, there is a risk that we may be
unsuccessful in obtaining financing in the future on terms acceptable
to us and that we will not have sufficient cash to fund our continued operations. - 11 -




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Our
revenues and operating income may be constrained:  
    
    if commercial
adoption of our TMR laser systems by healthcare providers in the
United States declines;  
    
    until such time, if ever, as we obtain FDA and other
regulatory approvals for our PMR laser systems; and  
    
    for an uncertain period of time after such approvals are obtained. We may fail to obtain required regulatory approvals in the United States
to market our PMR laser system. The FDA has not approved our PMR laser system for any application in the
United States. In July 2001, the FDA Advisory Panel recommended against
approval of PMR for public sale and use in the United States. In February
2003, the FDA granted an independent panel review of our pending PMA
application for PMR by the Medical Devices Dispute Resolution Panel (MDDRP).
In July 2003, the FDA agreed to an alternative process in which additional data
in support of our PMA supplement for PMR could be submitted and reviewed by the
FDA in an interactive review process. The data was submitted in August 2003
and the independent panel review by the MDDRP was cancelled. The FDA agreed to
reschedule the MDDRP hearing in the future if the dispute cannot be
resolved. The FDA has informed us that they believe the data
submitted in August 2003 in connection with the interactive
review process is still not adequate to support approval by the FDA
of our PMR system. We are currently scheduled to meet with the FDA in March 2004 as part of the
ongoing interactive review process. There can be no assurance, however, that
we will receive a favorable determination from the FDA. We will not be able to derive any revenue from the sale of our PMR system
in the United States until such time, if any, that the FDA approves the device.
Such inability to realize revenue from sales of our PMR device in the United
States may have an adverse effect on our results of operations. In the future, the FDA could restrict the current uses of our TMR product
and thereby restrict our ability to generate revenues. We
currently derive approximately 99% of our revenues from our TMR
product. The FDA has approved this product for sale and use by physicians in
the United States. At the request of the FDA, we are currently conducting
post-market surveillance of our TMR product. If we should fail to meet the
requirements mandated by the FDA or fail to complete our post-market
surveillance study in an acceptable time period, the FDA could withdraw its
approval for the sale and use of our TMR product by physicians in the United
States. Additionally, although we are not aware of any safety concerns during
our on-going post-market surveillance of our TMR product, if concerns over the
safety of our TMR product were to arise, the FDA could possibly restrict the
currently approved uses of our TMR product. In the future, if the FDA were to
withdraw its approval or restrict the range of uses for which our TMR product
can be used by physicians in the United States, such as restricting TMRs use
with the coronary artery bypass grafting procedure, either outcome could lead
to reduced or no sales of our TMR product in the United States and our business
could be materially and adversely affected. We must comply with FDA manufacturing standards or face fines or other
penalties including suspension of production. We are required to demonstrate compliance with the FDAs current good
manufacturing practices regulations if we market devices in the United States
or manufacture finished devices in the United States. The FDA inspects
manufacturing facilities on a regular basis to determine compliance. If we
fail to comply with applicable FDA or other regulatory requirements, we can be
subject to:  
    
    fines, injunctions, and civil penalties;  
    
    recalls or seizures of products;  
    
    total or partial suspensions of production; and - 12 -




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
    
    criminal prosecutions. The
impact on us of any such failure to comply would depend on
the impact of the remedy imposed on us. We may fail to comply with international regulatory requirements and could
be subject to regulatory delays, fines or other penalties. Regulatory requirements in foreign countries for international sales of
medical devices often vary from country to country. In addition, the FDA must
approve the export of devices to certain countries. The occurrence and related
impact of the following factors would harm our business:  
    
    delays in receipt of, or failure to receive, foreign regulatory approvals or clearances;
    
    the loss of previously obtained approvals or clearances; or
    
    the failure to comply with existing or future regulatory requirements. To market in Europe, a manufacturer must obtain the certifications
necessary to affix to its products the CE Marking. The CE Marking is an
international symbol of adherence to quality assurance standards and compliance
with applicable European medical device directives. In order to obtain and to
maintain a CE Marking, a manufacturer must be in compliance with the
appropriate quality assurance provisions of the International Standards
Organization and obtain certification of its quality assurance systems by a
recognized European Union notified body. However, certain individual countries
within Europe require further approval by their national regulatory agencies. We have completed CE Mark registration for all of our products in
accordance with the implementation of various medical device directives in the
European Union. Failure to maintain the right to affix the CE Marking or other
requisite approvals could prohibit us from selling our products in member
countries of the European Union or elsewhere. Any enforcement action by
international regulatory authorities with respect to past or future regulatory
noncompliance could cause our business to suffer. Noncompliance with
international regulatory requirements could result in enforcement action such
as prohibitions against us marketing our products in the European Union, which would
significantly reduce international revenue. We may not be able to successfully market our products if third party
reimbursement for the procedures performed with our products is not available
for our health care provider customers. Few individuals are able to pay directly for the costs associated with the
use of our products. In the United States, hospitals, physicians and other
healthcare providers that purchase medical devices generally rely on third
party payors, such as Medicare, to reimburse all or part of the cost of the
procedure in which the medical device is being used. Effective July 1, 1999,
the Centers for Medicare and Medicaid Services (CMS), formerly the Health
Care Financing Administration, commenced Medicare coverage for TMR systems for
any manufacturers TMR procedures. Hospitals and physicians are now eligible
to receive Medicare reimbursement covering 100% of the costs for TMR
procedures. If CMS were to materially reduce or terminate Medicare coverage
of TMR procedures, our business and results of operation would be harmed. As PMR has not been approved by the FDA, the CMS has not approved
reimbursement for PMR. If we obtain FDA approval for PMR in the future and CMS
does not in the provide reimbursement, our ability to successfully market and
sell our PMR products will be harmed. Even though Medicare beneficiaries appear to account for a majority of all
patients treated with the TMR procedure, the remaining patients are
beneficiaries of private insurance and private health plans. We have limited
experience to date with the acceptability of our TMR procedures for
reimbursement by private insurance and private health plans. If private
insurance and private health plans do not provide reimbursement, our business
will suffer. - 13 -




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If we obtain the necessary foreign regulatory registrations or approvals
for our products, market acceptance in international markets would be
dependent, in part, upon the availability of reimbursement within prevailing
healthcare payment systems. Reimbursement is a significant factor considered
by hospitals in determining whether to acquire new equipment. A hospital is
more inclined to purchase new equipment if third-party reimbursement can be
obtained. Reimbursement and health care payment systems in international
markets vary significantly by country. They include both government sponsored
health care and private insurance. Although we expect to seek international
reimbursement approvals, any such approvals may not be obtained in a timely
manner, if at all. Failure to receive international reimbursement approvals
could hurt market acceptance of our TMR and PMR products in the international
markets in which such approvals are sought, which would significantly reduce
international revenue. We
may not be able to meet future product demand on a timely basis and
may be subject to delays and interruptions to product shipments
because we depend on single source third party suppliers and
manufacturers. We
purchase certain critical products and components for lasers and
disposable handpieces from single sources. Moreover, we are currently
exploring manufacturing outsourcing options for the TMR 2000 laser. In
addition, we are vulnerable to delays and interruptions, for reasons
out of our control, because we outsource the manufacturing of our
products to third parties. We may experience harm to our business if
we cannot timely provide lasers to our customers or if our
outsourcing suppliers have difficulties supplying our needs for
products and components. In
addition, we do not have long-term supply contracts. As a result, our
sources are not obligated to continue to provide these critical
products or components to us. Although we have identified alternative
suppliers and manufacturers, a lengthy process would be required to
qualify them as additional or replacement suppliers or manufacturers.
Also, it is possible some of our suppliers or manufacturers could
have difficulty meeting our needs if demand for our TMR and PMR laser
systems were to increase rapidly or significantly. We believe that we
have an adequate supply of lasers to meet our expected demand for the
next twelve months and currently expect to have production capacity
for our TMR 2000 laser by the fourth quarter of 2004. However, if demand
for our TMR 2000 laser is greater than we currently anticipate and
there is a delay in obtaining production capacity, unless we are able
to obtain lasers originally placed through our loaned laser program
and no longer utilized by a hospital, we may not be able to meet the
demand for our TMR 2000 laser. In addition, any defect or malfunction
in the laser or other products provided by our suppliers and
manufacturers could cause delays in regulatory approvals or adversely
affect product acceptance. Further, we cannot predict:  · if materials and products obtained from outside
suppliers and manufacturers will always be available in adequate
quantities to meet our future needs; or· whether replacement suppliers and/or manufacturers can
be qualified on a timely basis if our current suppliers and/or
manufacturers are unable to meet our needs for any reason. Expansion of our business may put added pressure on our management and
operational infrastructure affecting our ability to meet any increased demand
for our products and possibly having an adverse effect on our operating
results. In 2001 we began a restructuring of our business in order, in part, to
bring our cost structure more in line with our revenues. As part of this
restructuring we significantly reduced our workforce. Growth in our business
may place a significant strain on our limited personnel, management, financial
systems and other resources. The evolving growth of our business presents
numerous risks and challenges, including:  · the dependence on the growth of the market for our TMR and PMR systems;· our ability to successfully and rapidly expand sales to potential customers in response to potentially increasing clinical adoption of the TMR procedure;· the costs associated with such growth, which are difficult to quantify, but could be significant;· domestic and international regulatory developments;· rapid technological change;· the highly competitive nature of the medical devices industry; and· the risk of entering emerging markets in which we have limited or no direct experience. To accommodate any such growth and compete effectively, we may need to
obtain additional funding to improve information systems, procedures and
controls and expand, train, motivate and manage our employees, and such funding
may not be available in sufficient quantities, if at all. If we are not able
to manage these activities and implement these strategies successfully to
expand to meet any increased demand, our operating results could suffer. Our operating results are expected to fluctuate and quarter-to-quarter
comparisons of our results may not indicate future performance. Our operating results have fluctuated significantly from
quarter-to-quarter and are expected to continue to fluctuate significantly from
quarter-to-quarter in future periods. We believe that quarter-to-quarter comparisons of our
operating results are not a good indication of our future performance. Due to
the emerging nature of the markets in which we compete, forecasting operating
results is difficult and unreliable. It is likely or possible that our
operating results for a future quarter will fall below the expectations of
public market analysts that may cover our stock and investors. When this
occurred in the past, the price of our common stock fell substantially, and if
this occurs in the future, the price of our common stock may fall again,
perhaps substantially. Our common stock is listed on the OTC Bulletin Board which may have an
unfavorable impact on our stock price and liquidity. Effective April 3, 2003 our common stock was delisted from The Nasdaq
SmallCap Market and became quoted on the OTC Bulletin Board on the same day.
The OTC Bulletin Board is a significantly more limited - 14 -




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market in comparison to the Nasdaq system. The listing of our shares on
the OTC Bulletin Board may result in a less liquid market available for
existing and potential stockholders to trade shares of our common stock, could
ultimately further depress the trading price of our common stock and could have
a long-term adverse impact on our ability to raise capital in the future. The trading prices of many high technology companies, and in particular
medical device companies, have been volatile which may result in large
fluctuations in the price of our common stock. The stock market has experienced significant price and volume fluctuations
that have particularly affected the trading prices of equity securities of many
high technology companies. These fluctuations have often been unrelated or
disproportionate to the operating performance of many of these companies. Any
negative change in the publics perception of medical device companies could
depress our stock price regardless of our operating results. The price of our common stock may fluctuate significantly, which may
result in losses for investors. The market price of our common stock has been and may continue to be
volatile. For example, during the 52-week period ended February 13, 2004, the
closing prices of our common stock as reported on Nasdaq and on the OTC
Bulletin Board ranged from a high of $1.92 per share to a low of
$0.24 per share. We expect our
stock price to be subject to fluctuations as a result of a variety of factors,
including factors beyond our control. These factors include:  
    
    actual or anticipated variations in our quarterly operating
results;  
    
    announcements of technological innovations or new products or
services by us or our competitors;  
    
    announcements relating to strategic relationships or acquisitions;  
    
    additions or terminations of coverage of our common stock by securities analysts;  
    
    statements by securities analysts regarding us or our industry;  
    
    conditions or trends in the medical device industry; and  
    
    changes in the economic performance and/or market valuations
of other medical device companies. The prices at which our common stock trades will affect our ability to
raise capital, which may have an adverse affect on our ability to fund our
operations. We face competition from products of our competitors which could limit
market acceptance of our products and render our products obsolete. The market for TMR laser systems is competitive. We currently compete
with PLC Systems, a publicly traded company which uses a CO2 laser and an
articulated mechanical arm in its TMR products. Edwards Lifesciences, a well
known, publicly traded provider of products and technologies to treat
cardiovascular disease, has assumed full sales and marketing responsibility in
the U.S. for PLCs TMR Heart Laser 2 System and associated kits pursuant to a
co-marketing agreement between the two companies executed in January 2001.
Through its significantly greater financial and human resources, including a
well-established and extensive sales representative network, we believe Edwards
has the potential to market to a greater number of hospitals and doctors that we
currently can. If PLC, or any new competitor, is more effective than
we are in developing
new products and procedures and marketing existing and future products similar
to ours, our business will suffer. The market for TMR laser systems is characterized by rapid technical
innovation. Our current or future competitors may succeed in developing TMR
products or procedures that:  
    
    are more effective than our products;  
    
    are more effectively marketed than our products; or  
    
    may render our products or technology obsolete. - 15 -




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If
we obtain the FDAs approval for our PMR laser system, we will face
competition for market acceptance and market share for that product. Our
ability to compete may depend in significant part on the timing of introduction
of competitive products into the market, and will be affected by the pace,
relative to competitors, at which we are able to:  
    
    develop products;
    
    complete clinical testing and regulatory approval processes;
    
    obtain third party reimbursement acceptance; and
    
    supply adequate quantities of the product to the market. Third party intellectual property rights may limit the development and
protection of our intellectual property, which could adversely affect our
competitive position. Our success is dependent in large part on our ability to:  
    
    obtain patent protection for our products and processes;  
    
    preserve our trade secrets and proprietary technology; and  
    
    operate without infringing upon the patents or proprietary rights of third parties. The
medical device industry has been characterized by extensive litigation
regarding patents and other intellectual property rights. Companies in the
medical device industry have employed intellectual property litigation to gain
a competitive advantage. Certain competitors and potential competitors of ours
have obtained United States patents covering technology that could be used for
certain TMR and PMR procedures. We do not know if such competitors, potential
competitors or others have filed and hold international patents covering other
TMR or PMR technology. In addition, international patents may not be
interpreted the same as any counterpart United States patents. While we periodically review the scope of our patents and other relevant
patents of which we are aware, the question of patent infringement involves
complex legal and factual issues. Any conclusion regarding infringement may
not be consistent with the resolution of any such issues by a court. Costly litigation may be necessary to protect intellectual property
rights. We may have to engage in time consuming and costly litigation to protect
our intellectual property rights or to determine the proprietary rights of
others. In addition, we may become subject to patent infringement claims or
litigation, or interference proceedings declared by the United States Patent
and Trademark Office to determine the priority of inventions. Defending and prosecuting intellectual property suits, United States
Patent and Trademark Office interference proceedings and related legal and
administrative proceedings are both costly and time-consuming. We may be
required to litigate further to:  
    
    enforce our issued patents;
    
    protect our trade secrets or know-how; or
    
    determine the enforceability, scope and validity of the proprietary rights of others. Any litigation or interference proceedings will result in substantial
expense and significant diversion of effort by technical and management
personnel. If the results of such litigation or interference proceedings are
adverse to us, then the results may:  
    
    subject us to significant liabilities to third parties;
    
    require us to seek licenses from third parties; - 16 -




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##### Table of Contents




    
    prevent us from selling our products in certain markets or at all; or
    
    require us to modify our products. Although patent and intellectual property disputes regarding medical
devices are often settled through licensing and similar arrangements, costs
associated with such arrangements may be substantial and could include ongoing
royalties. Furthermore, we may not be able to obtain the necessary licenses on
satisfactory terms, if at all. Adverse determinations in a judicial or administrative proceeding or
failure to obtain necessary licenses could prevent us from manufacturing and
selling our products. This would harm our business. The United States patent laws have been amended to exempt physicians,
other health care professionals, and affiliated entities from infringement
liability for medical and surgical procedures performed on patients. We are
not able to predict if this exemption will materially affect our ability to
protect our proprietary methods and procedures. We rely on patent and trade secret laws, which are complex and may be
difficult to enforce. The validity and breadth of claims in medical technology patents involve
complex legal and factual questions and, therefore, may be highly uncertain.
Issued patent or patents based on pending patent applications or any future
patent application may not exclude competitors or may not provide a competitive
advantage to us. In addition, patents issued or licensed to us may not be held
valid if subsequently challenged and others may claim rights in or ownership of
such patents. Furthermore, we cannot assure you that our competitors:  
    
    have not developed or will not develop similar products;  
    
    will not duplicate our products; or  
    
    will not design around any patents issued to or licensed by us. Because patent applications in the United States were historically
maintained in secrecy until the patents are issued, we cannot be certain that:  
    
    others did not first file applications for inventions covered by our pending patent applications; or
    
    we will not infringe any patents that may issue to others on such applications - 17 -




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We may suffer losses from product liability claims if our products cause
harm to patients. We are exposed to potential product liability claims and product recalls.
These risks are inherent in the design, development, manufacture and marketing
of medical devices. We could be subject to product liability claims if the use
of our TMR or PMR laser systems is alleged to have caused adverse effects on a
patient or such products are believed to be defective. Our products are
designed to be used in life-threatening situations where there is a high risk
of serious injury or death. We are not aware of any material side effects or
adverse events arising from the use of our TMR product. Though we are in the
process of responding to the FDAs Circulatory Devices Panels recent
recommendation against approval of our PMR product because of concerns over the
safety of the device and the data regarding adverse events in the clinical
trials, we believe there are no material side effects or adverse events arising
from the use of our PMR product. When being clinically investigated, it is not
uncommon for new surgical or interventional procedures to result in a higher
rate of complications in the treated population of patients as opposed to those
reported in the control group. In light of this, we believe that the
difference in the rates of complications between the treated groups and the
control groups in the clinical trials for our PMR product are not statistically
significant, which is why we believe that there are no material side effects or
material adverse events arising from the use of our PMR product. Any regulatory clearance for commercial sale of these products will not
remove these risks. Any failure to comply with the FDAs good manufacturing
practices or other regulations could hurt our ability to defend against product
liability lawsuits. Our insurance may be insufficient to cover product liability claims
against us. Our product liability insurance may not be adequate for any future product
liability problems or continue to be available on commercially reasonable
terms, or at all. If we were held liable for a product liability claim or series of claims
in excess of our insurance coverage, such liability could harm our business and
financial condition. We maintain insurance against product liability claims in
the amount of $10 million per occurrence and $10 million in the aggregate. We may require increased product liability coverage as sales of approved
products increase and as additional products are commercialized. Product
liability insurance is expensive and in the future may not be available on
acceptable terms, if at all. We depend heavily on key personnel and turnover of key employees and
senior management could harm our business. Our future business and results of operations depend in significant part
upon the continued contributions of our key technical and senior management
personnel. They also depend in significant part upon our ability to attract
and retain additional qualified management, technical, marketing and sales and
support personnel for our operations. If we lose a key employee or if a key
employee fails to perform in his or her current position, or if we are not able
to attract and retain skilled employees as needed, our business could suffer.
Significant turnover in our senior management could significantly deplete our
institutional knowledge held by our existing senior - 18 -




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##### Table of Contents



management team. For example, in November 2003,
our employment relationship with Darrell Eckstein, our former
President, Chief Operating Officer, Acting Chief Financial Officer, Chief
Accounting Officer, Treasurer and Secretary was terminated. We depend on the skills and abilities of these key employees in
managing the manufacturing, technical, marketing and sales aspects of our
business, any part of which could be harmed by further turnover. We sell our products internationally which subjects us to specific risks
of transacting business in foreign countries. In future quarters, international sales may become a significant portion
of our revenue if our products become more widely used outside of the United
States. Our international revenue is subject to the following risks, the
occurrence of any of which could harm our business:  
    
    foreign currency fluctuations;
    
    economic or political instability;
    
    foreign tax laws;
    
    shipping delays;
    
    various tariffs and trade regulations;
    
    restrictions and foreign medical regulations;
    
    customs duties, export quotas or other trade restrictions; and
    
    difficulty in protecting intellectual property rights. 
 Item 2.Description of Property. 
 Our headquarters, located in Foothill Ranch, California, are comprised of
12,533 square feet of leased space. The lease expires in October 2006. We believe
our facilities are adequate to meet our foreseeable requirements. There can be
no assurance that additional facilities will be available to us, if and when
needed, thereafter. 
 Item 3.Legal Proceedings. In November 2003, our employment relationship with Darrell Eckstein, our
former President, Chief Operating Officer, Acting Chief Financial Officer,
Chief Accounting Officer, Treasurer and Secretary was terminated. In
connection with his departure, Mr. Eckstein has made certain
breach of contract claims arising out his employment agreement with us, as well
as certain tort claims. Pursuant to the terms of Mr. Ecksteins employment
agreement, we have agreed to submit the matter to binding arbitration. We
believe Mr. Ecksteins claims are without merit and we intend to vigorously
defend against these claims. However, if Mr. Eckstein were to prevail on some
or all of his claims, we cannot assure you that such claims would not have a
material adverse effect on our financial condition, results of
operations or cash flows. 
 Item 4.Submission of Matters to a Vote of Security Holders. None. - 19 -




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PART II 
 Item 5.Market for Registrants Shares and Related Shareholder Matters. Our common stock is traded on the OTC Bulletin Board under the symbol
CGCP.OB. In 2002, our common stock was listed on the Nasdaq SmallCap Market and
Nasdaq National Market. For the periods indicated, the following table presents
the range of high and low sale prices for the common stock as reported by the
OTC Bulletin Board, Nasdaq National Market and Nasdaq SmallCap Market for the
respective market on which our common stock was listed during the quarter being
reported. 2002
    
    High
    
    LowFirst Quarter
    
    $
    1.25
    
    
    $
    0.65Second Quarter
    
    $
    1.20
    
    
    $
    0.67Third Quarter
    
    $
    0.99
    
    
    $
    0.56Fourth Quarter
    
    $
    0.93
    
    
    $
    0.25
 2003
    
    High
    
    LowFirst Quarter
    
    $
    0.66
    
    
    $
    0.22Second Quarter
    
    $
    0.85
    
    
    $
    0.24Third Quarter
    
    $
    1.49
    
    
    $
    0.72Fourth Quarter
    
    $
    1.92
    
    
    $
    0.70
 As
of December 31, 2003, shares of our common stock were held by 217
shareholders of record. We have never paid a cash dividend on our common stock and do not
anticipate paying any cash dividends in the foreseeable future, as we intend to
retain our earnings, if any, to generate increased growth and for general
corporate purposes. In connection with a Purchase and Security Agreement dated March 27, 2003,
we issued a revolving convertible promissory note providing for borrowings up to
$2,000,000 based upon eligible accounts receivable and a warrant to purchase up
to 275,000 shares of our common stock at exercise prices per share ranging from
$0.35 to $0.44. Prior to any borrowings under this arrangement, we
intend to cancel the note in the first quarter of 2004. The warrant is immediately exercisable at any time prior to March 27,
2008. The warrant was issued, in reliance upon the exemption from registration
provided by Section 4(2) and Rule 506 of the Securities Act of 1933, as amended
(the Securities Act). - 20 -




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##### Table of Contents



Item 6.Selected Consolidated Financial Data. The following selected consolidated statement of operations data for
fiscal years ended 2003, 2002 and 2001 and the consolidated balance sheet data
for 2003 and 2002 set forth below are derived from our consolidated financial
statements and are qualified by reference to our consolidated financial
statements included herein. The
selected consolidated statement of operations data for fiscal years
ended 2000 and 1999 and the consolidated balance sheet data for 2001, 2000 and 1999 have been
derived from our audited consolidated financial statements not included herein.
These historical results are not necessarily indicative of the results of
operations to be expected for any future period. As a result of our 1999
pooling of interest with the former CardioGenesis, all data prior to the
pooling has been restated as if the combined entity existed for the entire
period presented. Selected Consolidated Financial Data
(in thousands, except per share amounts) Years Ended December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(1)Consolidated Statement of Operations
Data:Net revenues
    
    $
    13,518
    
    
    $
    13,048
    
    
    $
    14,153
    
    
    $
    22,210
    
    
    $
    25,324Cost of revenues
    
    
    2,295
    
    
    
    2,935
    
    
    
    5,777
    
    
    
    10,055
    
    
    
    13,246Gross profit
    
    
    11,223
    
    
    
    10,113
    
    
    
    8,376
    
    
    
    12,155
    
    
    
    12,078Operating expenses:Research and development
    
    
    1,944
    
    
    
    657
    
    
    
    1,863
    
    
    
    5,065
    
    
    
    11,353Sales, general and administrative
    
    
    9,590
    
    
    
    12,297
    
    
    
    15,119
    
    
    
    22,009
    
    
    
    24,581Restructuring and merger-related costs
    
    
    
    
    
    
    
    
    
    
    1,033
    
    
    
    
    
    
    
    5,214Total operating expenses
    
    
    11,534
    
    
    
    12,954
    
    
    
    18,015
    
    
    
    27,074
    
    
    
    41,148Operating loss
    
    
    (311
    )
    
    
    (2,841
    )
    
    
    (9,639
    )
    
    
    (14,919
    )
    
    
    (29,070
    )Interest and other income (expense), net
    
    
    (37
    )
    
    
    2,311
    
    
    
    (608
    )
    
    
    310
    
    
    
    737Net loss
    
    $
    (348
    )
    
    $
    (530
    )
    
    $
    (10,247
    )
    
    $
    (14,609
    )
    
    $
    (28,333
    )Net loss per share  basic and diluted
    
    $
    (0.01
    )
    
    $
    (0.01
    )
    
    $
    (0.31
    )
    
    $
    (0.48
    )
    
    $
    (0.99
    )Shares used in per share calculation
    
    
    37,303
    
    
    
    36,911
    
    
    
    33,311
    
    
    
    30,166
    
    
    
    28,629Consolidated Balance Sheet Data:Cash, cash equivalents and marketable
securities
    
    $
    1,013
    
    
    $
    1,490
    
    
    $
    2,629
    
    
    $
    3,357
    
    
    $
    13,313Working capital
    
    
    2,001
    
    
    
    1,614
    
    
    
    1,048
    
    
    
    4,662
    
    
    
    10,031Total assets
    
    
    6,460
    
    
    
    7,755
    
    
    
    11,309
    
    
    
    16,965
    
    
    
    34,019Long-term debt, less current portion
    
    
    6
    
    
    
    1
    
    
    
    32
    
    
    
    405
    
    
    
    815Accumulated deficit
    
    
    (164,958
    )
    
    
    (164,610
    )
    
    
    (164,080
    )
    
    
    (153,833
    )
    
    
    (139,224
    )Total shareholders equity
    
    
    3,820
    
    
    
    3,711
    
    
    
    3,582
    
    
    
    7,974
    
    
    
    18,573
   (1)
    
    Cost of revenues includes $2.5 million of inventory write-offs and
upgrades associated with the March 1999 merger. - 21 -




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Item 7.Managements Discussion and Analysis of Financial Condition and Results of Operations. This Managements Discussion and Analysis of Financial Condition and
Results of Operations contains descriptions of our expectations regarding
future trends affecting our business. These forward-looking statements and
other forward-looking statements made elsewhere in this document are made in
reliance upon the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Please read the section below titled Factors Affecting
Future Results to review conditions which we believe could cause actual
results to differ materially from those contemplated by the forward-looking
statements. Forward-looking statements are identified by words such as
believes, anticipates, expects, intends, plans, will, may and
similar expressions. In addition, any statements that refer to our plans,
expectations, strategies or other characterizations of future events or
circumstances are forward-looking statements. Our business may have changed
since the date hereof and we undertake no obligation to update these forward
looking statements. The following discussion should be read in conjunction with financial
statements and notes thereto included in this Annual Report onForm 10-K. Overview CardioGenesis Corporation, formerly
known as Eclipse Surgical
Technologies, Inc., incorporated in California in
1989, designs, develops, manufactures and distributes laser-based surgical
products and disposable fiber-optic accessories for the treatment of advanced
cardiovascular disease through transmyocardial revascularization (TMR) and
percutaneous transluminal myocardial revascularization (PMR). On February 11, 1999, we received final approval from the FDA for our TMR
products for certain indications, and we are permitted to sell those
products in the U.S. on a commercial basis. We have also received the European
Conforming Mark (CE Mark) allowing the commercial sale of our TMR laser
systems and our PMR catheter system to customers in the European Community.
Effective July 1, 1999, Centers for Medicare and Medicaid Services (CMS)
began providing Medicare coverage for TMR. As a result, hospitals and
physicians are now eligible to receive Medicare reimbursement for TMR equipment
and procedures performed on Medicare recipients. We have completed pivotal clinical trials involving PMR and study results
were submitted to the FDA in a PMA application in December 1999 along with
subsequent amendments. The PMR study compares PMR to conventional medical
therapy in patients with no option for other treatment. In July 2001, the FDA
Advisory Panel recommended against approval of PMR for public sale and use in
the United States. In July 2003, the FDA agreed to an alternative process in
which additional data in support of our PMA supplement for PMR could be
submitted and reviewed by the FDA in an interactive review process. The data
was submitted in August 2003 and the independent panel review by the MDDRP was
cancelled. The FDA agreed to reschedule the MDDRP hearing in the future if the
dispute cannot be resolved. The FDA has informed us that they believe
the data submitted in August 2003 in connection with the interactive
review process is still not adequate to support approval by the FDA of
our PMR system. We are currently scheduled to meet with the FDA in
March 2004 as part of the ongoing interactive review process. There can be no
assurance, however, that we will receive a favorable determination from the
FDA. As of December 31, 2003, we had an accumulated deficit of $164,958,000. We
may continue to incur operating losses. The timing and amounts of our
expenditures will depend upon a number of factors, including the efforts
required to develop our sales and marketing organization, the timing of market
acceptance of our products and the status and timing of regulatory approvals. - 22 -




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Results of Operations Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 Net Revenues We generate our revenues primarily through the sale of our TMR laser base
units and related handpieces, and related services . Net revenues of
$13,518,000 for the year ended December 31, 2003 increased $470,000, or 4%,
when compared to net revenues of $13,048,000 for the year ended December 31,
2002. The increase in net revenues was due to an increase in domestic handpiece
and laser revenues of $268,000 and $286,000, respectively, offset by a decrease
in international handpiece and laser sales of $9,000 and $69,000, respectively. The increase in handpiece revenue is primarily related to a higher average
per unit selling price in 2003 as compared to 2002. In an effort to accelerate
market adoption of the TMR procedure, we developed a program pursuant to which
we loan lasers to hospitals in return for the hospital purchasing a minimum
number of handpieces at a premium over the list price. In the year ended
December 31, 2003, domestic handpiece revenue consisted of $2,649,000 in sales
to customers operating under our loaned laser program, of which $781,000 was
attributed to premiums associated with such sales. In the year ended December
31, 2002, domestic handpiece revenue consisted of $2,832,000 in sales of
product to customers operating under our loaned laser program, of which
$756,000 was attributed to premiums associated with such sales. In the years
ended December 31, 2003 and 2002, sales of product to customers not operating
under our loaned laser program were $6,387,000 and $5,937,000, respectively. For the year ended December 31, 2003, domestic laser sales increased by
$286,000 compared to the year ended December 31, 2002 primarily from a moderate
increase in the conversion of loaned lasers to outright sales. International
sales, accounting for approximately 3% of total sales for the year ended
December 31, 2003, decreased $78,000 from the prior year when international
sales accounted for 4% of total sales. The decrease in international sales
occurred primarily as a result of fewer handpiece sales resulting from
decreased sales and marketing efforts in the international market compared to
2002. Service and other revenue of $971,000 slightly decreased by $6,000 for
the year ended December 31, 2003 when compared to $977,000 for the year ended
December 31, 2002. Gross Profit Gross profit increased to 83% of net revenues for the year ended December
31, 2003 as compared to 78% of net revenues for the year ended December 31,
2002. Gross profit in absolute dollars increased by $1,110,000 to $11,223,000
for the year ended December 31, 2003, as compared to $10,113,000 for the year
ended December 31, 2002. The increase in gross profit as a percent of sales,
and in absolute terms, resulted from improved margins on lasers sold. These
margins improved primarily due to sales of lasers originally placed under our
laser loan program that were converted to outright sales. In addition, margins
on disposable handpieces increased due to improvements in manufacturing which
resulted in higher yields. Research and Development Research
and development expenditures of $1,944,000 increased $1,287,000
or 196% for the year ended December 31, 2003 when compared to $657,000 for the
year ended December 31, 2002. The increase in overall research and development
expense resulted primarily from an increase in costs for outside services of $463,000 related to the
PMR approval process. For the year ended December 31, 2003, a
reduction of $601,000 was recorded on accrued liabilities recorded in
prior years for estimated clinical trial obligations. This reduction
of accrued liabilities decreased $828,000 for the year ended
December 31, 2002 and contributed to the overall increase in
research and development expenditures. - 23 -




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Sales, General and Administrative Sales,
general and administrative expenditures of $9,590,000 decreased
$2,707,000 or 22% for the year ended December 31, 2003 when compared to
$12,297,000 for the year ended December 31, 2002. The decrease in expenses
resulted primarily from a decrease in employee expenses of $1,077,000
primarily related to reductions in our workforce. Additionally, outside services, advertising and marketing, training and
clinical research, and facilities and office expense decreased $564,000,
$396,000, $152,000, $118,000, respectively, due to overall cost cutting
efforts. Interest and Other Income (Expense), Net Interest and other income (expense), net is comprised of interest income,
interest expense and our former ownership interest in Microheart,
Inc., a
privately-held company (Microheart). Interest income of $7,000 decreased $32,000 or 82% for the year ended
December 31, 2003 when compared to $39,000 for the year ended December 31,
2002. This decrease was due to lower interest rates and lower investments in
cash equivalents. Interest
expense of $44,000 increased $31,000 or 238% for the year ended
December 31, 2003 when compared to $13,000 for the year ended December 31,
2002. This increase is primarily due to a higher level of financing
for equipment under capital lease and amortization of debt issue costs. A
gain on the sale of an investee of $2,285,000 for the year ended
December 31, 2002 resulted from the sale of our ownership
interest in Microheart in April 2002. Year Ended December 31, 2002 Compared to Year Ended December 31, 2001 Net Revenues Net revenues of $13,048,000 for the year ended December 31, 2002 decreased
$1,105,000, or 8%, when compared to net revenues of $14,153,000 for the year
ended December 31, 2001. The decrease in net revenues was due to a reduction in
domestic handpiece revenues of $1,810,000 and international sales of $547,000
offset by an increase in domestic laser sales of $761,000 and in service and
other revenue of $491,000. The decrease in handpiece revenue was primarily related to our then
current strategy of concentrating our sales resources on increasing procedure
volume in our existing installed base, which had the effect of reducing
handpiece revenues from loaned laser placements, when compared to the levels
attained in the year ended December 31, 2001. The decline in loaned laser
placements in 2002, when compared to the prior year, resulted in a
year-over-year reduction in the number of handpieces sold as each shipped laser
is normally accompanied by an order for handpieces. In the year ended December
31, 2002, domestic handpiece revenue consisted of $2,832,000 in sales to
customers operating under our loaned laser program, of which $756,000 was
attributed to premiums associated with such sales. In the year ended December
31, 2001, domestic handpiece revenue consisted of $4,677,000 in sales of
product to customers operating under our loaned laser program, of which
$1,424,000 was attributed to premiums associated with such sales. In the years
ended December 31, 2002 and 2001, sales of product to customers not operating
under our loaned laser program was $5,937,000 and $5,902,000, respectively. For the year ended December 31, 2002, domestic laser sales increased by
$761,000 compared to the year ended December 31, 2001 primarily from an
increase in sales of lasers that were previously on loan in our installed base.
International sales, accounting for approximately 4% of total sales for the
year ended December 31, 2002, decreased $547,000 from the prior year when
international sales accounted for 7% of total sales. This reduction in
international sales occurred primarily as a result of fewer handpiece sales due
to decreased shipments to distributors in the international market compared to
2001. Service and other revenue of $976,000 increased $491,000 for the year
ended December 31, 2002 when compared to $485,000 for the year ended December
31, 2001 due primarily to an increase in the number of service contracts sold. - 24 -




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Gross Profit Gross profit increased to 78% of net revenues for the year ended December
31, 2002 as compared to 59% of net revenues for the year ended December 31,
2001. Gross profit in absolute dollars increased by $1,737,000 to $10,113,000
for the year ended December 31, 2002, as compared to $8,376,000 for the year
ended December 31, 2001. The increase in gross profit as a percent of sales,
and in absolute terms, resulted from improved margins on lasers sold as well as
improved margins on disposable handpieces. We achieved these improved margins
through due to the outsourcing of disposables manufacturing which took place in
the second half of 2001. Research and Development Research and development expenditures of $657,000 decreased $1,206,000 or
65% for the year ended December 31, 2002 when compared to $1,863,000 for the
year ended December 31, 2001. While actual expenditures for research and
development remained fairly constant from 2001 to 2002, the decrease in overall
research and development expense resulted primarily from the effects of
recording a total of $1.3 million in reductions of accrued liabilities recorded
in prior years for estimated clinical trial obligations. Sales, General and Administrative Sales, general and administrative expenditures of $12,297,000 decreased
$2,822,000 or 19% for the year ended December 31, 2002 when compared to
$15,119,000 for the year ended December 31, 2001. The decrease in expenses
resulted primarily from a decrease in employee expenses of $1,956,000. We
achieved this decrease in expenses primarily related to reductions in our work
force and overall cost cutting efforts. Additionally, facilities and office
expenses decreased by $685,000 primarily as a result of the relocation of our
corporate headquarters which was completed in the third quarter of 2001. Restructuring and Merger-Related Costs During the year ended December, 31 2001, we recognized restructuring
charges of $1,303,000, which were partially offset by a change in estimate of
$270,000 in connection with merger-related costs that were incurred in 1999.
The 2001 restructuring charges related to the company-wide restructuring which
began in the second quarter of 2001. The restructuring included a reduction in
headcount, the closing of our facilities in Sunnyvale, California and the move
to a new facility located in Foothill Ranch, California. As a result of the
restructuring, 48 employees were identified to be terminated under the original
restructuring plan, primarily from the finance and manufacturing departments. The following table summarizes the restructuring activity (in thousands): Personnel and
    
    Lease and Other
    
    OtherSeverance
    
    Contractual
    
    MiscellaneousCosts
    
    Commitments
    
    Costs
    
    TotalProvisions
    
    $
    655
    
    
    $
    344
    
    
    $
    304
    
    
    $
    1,303Payments
    
    
    (655
    )
    
    
    (252
    )
    
    
    (176
    )
    
    
    (1,083
    )Non-cash
charges
    
    
    
    
    
    
    (52
    )
    
    
    (116
    )
    
    
    (168
    )Reserve balance as of December 31, 2001
    
    
    
    
    
    
    40
    
    
    
    12
    
    
    
    52Payments
    
    
    
    
    
    
    (40
    )
    
    
    
    
    
    
    (40
    )Non-cash
charges
    
    
    
    
    
    
    
    
    
    
    (12
    )
    
    
    (12
    )Reserve balance as of December 31, 2002
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
 - 25 -




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##### Table of Contents



Interest and Other Income (Expense), Net Interest and other income (expense), net is comprised of interest income,
interest expense and our ownership
interest in Microheart. Interest income of $39,000 decreased $23,000 or 37% for the year ended
December 31, 2002 when compared to $62,000 for the year ended December 31,
2001. This decrease was due to lower interest rates and lower investments in
cash equivalents. Interest expense of $13,000 decreased $5,000 or 28% for the year ended
December 31, 2002 when compared to $18,000 for the year ended December 31,
2001. This decrease reflected a lower level of debt outstanding. A gain on the sale of an investee of $2,285,000 for the year ended
December 31, 2002 was related to the sale of our ownership interest in
Microheart in April 2002. For the year ended December 31, 2001, the equity in
net loss of $652,000 represented our share of the net loss of Microheart, in
which our ownership was approximately 30% at the time the net loss was
recorded. Liquidity and Capital Resources Cash and cash equivalents were $1,013,000 at December 31, 2003 compared to
$1,490,000 at December 31, 2002, a decrease of $477,000. We used $680,000 of
cash for operating activities in the twelve months ended December 31, 2003
primarily to pay down accounts payable and accrued liabilities. Cash
used in investing activities during the twelve months ended
December 31, 2003 was $80,000. Cash provided by financing activities during the twelve
months ended December 31, 2003 was $358,000 due to proceeds from employee stock
option exercises and common stock purchased under the Employee Stock Purchase
Plan. In
March 2003, we entered into a Purchase and Security Agreement with a
private equity fund and entered into a revolving Convertible Note credit
facility (the Note) that matures on March 26, 2006. In conjunction with this
transaction, we issued warrants to acquire 275,000 shares of our
common stock. The warrants are
exercisable for five years from the date of grant at exercise prices ranging from $.35 to $.44 per
share. As of December 31, 2003, we had no outstanding borrowings
on the Note. We intend to cancel the Note in the first quarter of
2004. On
January 22, 2004, we sold 3,100,000 shares of common stock to private
investors for a total price of $2,700,000. We also issued warrants to purchase
3,100,000 additional shares of common stock at a price of $1.37 per share. The
warrants are immediately exercisable and have a term of five years. The
investors also have an option to purchase approximately 1,570,000 shares of
common stock at $1.00 per share for a period of six months following the
effective date of a related registration statement to be filed in connection with the
transaction. We agreed to file this registration statement covering the resale of
shares within 50 days of the closing date of the transaction. We have incurred significant losses for the last several years and at
December 31, 2003 we had an accumulated deficit of $164,958,000. Our ability
to maintain current operations is dependent upon achieving and maintaining
profitable operations or obtaining additional debt or equity financing. - 26 -




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##### Table of Contents



We also plan to continue our cost containment efforts by focusing on
sales, general and administrative expenses. We have significantly reduced our
cost of revenues, primarily due to the outsourcing of a significant portion of
our manufacturing which allows us to purchase products at lower costs. To
reduce operating expenses, we have focused our efforts on reducing headcount
and overall expenses in functions that are not essential to core and critical
activities. Currently, our primary goal is to maintain profitability. Our actions
have been guided by this initiative, and the resulting cost containment
measures have helped to conserve our cash. Our focus is upon core and critical
activities, thus operating expenses that are nonessential to our core
operations have been eliminated. We believe our cash balance as of December 31, 2003 and the proceeds from
our January 2004 sale of common stock will be sufficient to meet our capital
and operating requirements through the next 12 months. We believe that if
revenues from sales or new funds from debt or equity instruments are
insufficient to maintain the current expenditure rate, it will be necessary to
significantly reduce our operations until an appropriate solution is
implemented. We
will have a continuing need for new infusions of cash if we incur
losses in the future. We plan to increase our sales through increased
direct sales and marketing efforts on existing products and achieving
regulatory approval for other products. If our direct sales and
marketing efforts are unsuccessful or we are unable to achieve
regulatory approval for our products, we will be unable to
significantly increase our revenues. We believe that if we are unable
to generate sufficient funds from sales or from debt or equity
issuances to maintain our current expenditure rate, it will be
necessary to significantly reduce our operations. We may be required
to seek additional sources of financing, which could include
short-term debt, long-term debt or equity. There is a risk that we
may be unsuccessful in obtaining such financing and that we will not have
sufficient cash to fund our operations. We are currently scheduled to meet with the FDA in March 2004 as part of
the ongoing interactive review process for our PMR product. If we receive
approval from the FDA to sell our PMR product in the United States, we intended
to expend cash resources to educate potential customers and stimulate sales.
We currently anticipate that our cash and cash equivalents and currently
anticipated revenues combined with revenues from sales of our PMR products in
the United States, if approved by the FDA, will be adequate to fund the introduction of our PMR product
in the United States during 2004. However, if we experience unanticipated cash
expenditures or revenues from the sale of our current products decrease, we may
need to seek additional sources of funding, including debt or equity, in order
to finance the introduction of PMR product in the United States. We cannot
assure you, however, that we will receive a favorable determination from the
FDA. Payments due by period(In Thousands)Less than
    
    1-3
    
    3-5
    
    More thanContractual Obligations
    
    Total
    
    1 year
    
    years
    
    years
    
    5 yearsLong Term Debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Capital Lease Obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating Leases
    
    $
    1,006
    
    
    $
    350
    
    
    $
    656
    
    
    $
    
    
    
    $
    Purchase Obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other Long Term Liabilities Reflected on the
    Registrants Balance Sheet under GAAP
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    1,006
    
    
    $
    350
    
    
    $
    656
    
    
    $
    
    
    
    $
     - 27 -




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##### Table of Contents



Critical Accounting Policies and Estimates The preparation of financial statements in conformity with generally
accepted accounting principles requires our management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
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. Actual results could differ from those estimates. The
following presents a summary of our critical accounting policies,
defined as those policies we believe are: (i) the most important
to the portrayal of our financial condition and results of
operations, and (ii) that require our most difficult, subjective
or complex judgments, often as a result of the need to make estimates
about the effects of matters that are inherently uncertain. Revenue Recognition: We
recognize revenue on product sales upon receipt of a purchase order,
shipment of the products, the price is fixed or determinable and
collection of sales proceeds is reasonably assured. Where purchase orders allow
customers an acceptance period or other contingencies, revenue is recognized
upon the earlier of acceptance or removal of the contingency. Revenues from sales to distributors and agents are recognized upon
shipment when there is evidence that an arrangement exists, delivery has
occurred under the Companys standard FOB shipping point terms, the sales price is fixed or determinable and the ability to
collect sales proceeds is reasonably assured. The contracts regarding these
sales do not include any rights of return or price protection clauses. We frequently loan lasers to hospitals in return for the hospital
purchasing a minimum number of handpieces at a premium over the list price. The
loaned lasers are depreciated to cost of revenues over a useful life of 24
months. The revenue on the handpieces is recognized upon shipment at an amount
equal to the list price. The premium over the list price represents revenue
related to the use of the laser unit and is recognized ratably, generally over
the 24-month useful life of the placed lasers. Revenues from service contracts, rentals, and per procedure fees are
recognized upon performance or over the terms of the contract as appropriate. Accounts Receivable: We
regularly evaluate the collectability of accounts receivable based
upon our knowledge of customers and compliance with credit terms. The
allowance for doubtful accounts is adjusted based on such evaluation,
with a corresponding provision included in general and administrative
expenses. Inventories: Inventories
are stated at the lower of cost (principally standard cost, which
approximates actual cost on a first-in, first-out basis) or market
value. Income
Taxes: We
account for income taxes using the liability method under which
deferred tax assets or liabilities are calculated at the balance
sheet date using current tax laws and rates in effect for the year in
which the differences are expected to affect taxable income.
Valuation allowances are established, when necessary, to reduce
deferred tax assets to the amounts expected to be realized. 
 Item 7A.Quantitative
and Qualitative Disclosures About Market Risk. Quantitative Disclosures We are exposed to market risks inherent in our operations, primarily
related to interest rate risk and currency risk. These risks arise from
transactions and operations entered into in the normal course of business. We
do not use derivatives to alter the interest characteristics of our marketable
securities or our debt instruments. We have no holdings of derivative or
commodity instruments. Interest Rate Risk. We are subject to interest rate risks on cash and cash
equivalents and any future financing requirements. Our long-term debt at
December 31, 2003 consisted of an outstanding balance on a lease obligation. The following table presents the future principal cash flows or amounts
and related weighted average interest rates expected by year for our existing
cash and cash equivalents and long-term debt instruments: In Thousands
    
    2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Total Fair ValueAssetsCash, cash equivalents
    
    $
    1,013
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    1,013Weighted average interest rate
    
    
    1.0
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.0
    %LiabilitiesFixed Rate Debt
Lease obligation
    
    $
    7
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    7Weighted average interest rate
    
    
    6.8
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6.8
    %
 - 28 -




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##### Table of Contents

\

Qualitative Disclosures Interest Rate Risk. Our primary interest rate risk exposures relate to the
impact of interest rate movements on our ability to obtain adequate financing
to fund future operations. We manage interest rate risk on our outstanding long-term debts through
the use of fixed rate debt. Our management evaluates our financial position on
an ongoing basis. We do not hedge any balance sheet exposures and intercompany balances
against future movements in foreign exchange rates. The exposure related to
currency rate movements would not have a material impact on future net income
or cash flows. 
 Item 8.Consolidated Financial Statements and Supplementary Data. Quarterly
Results of Operations The
following table sets forth certain quarterly financial information
for the periods indicated. This information has been derived from
unaudited financial statements that, in the opinion of management,
have been prepared on the same basis as the audited information, and
includes all normal recurring adjustments necessary for a fair
presentation of such information. The results of operations for any
quarter are not necessarily indicative of the results to be expected
for any future periods. Three Months
Ended(In thousands, except per share data)2003
    
    2002March 31
    
    June 30
    
    Sept. 30
    
    Dec. 31
    
    March 31
    
    June 30
    
    Sept. 30
    
    Dec. 31Net revenues
    
    $
    3,422
    
    
    $
    3,090
    
    
    $
    3,594
    
    
    $
    3,412
    
    
    $
    3,158
    
    
    $
    3,010
    
    
    $
    3,210
    
    
    $
    3,670Gross profit
    
    
    2,800
    
    
    
    2,588
    
    
    
    2,973
    
    
    
    2,862
    
    
    
    2,332
    
    
    
    2,338
    
    
    
    2,515
    
    
    
    2,928Operating (loss) / income
    
    
    119
    
    
    
    (879
    )
    
    
    (121
    )
    
    
    570
    
    
    
    (1,246
    )
    
    
    (1,160
    )
    
    
    (581
    )
    
    
    146Net (loss) / income
    
    
    121
    
    
    
    (878
    )
    
    
    (129
    )
    
    
    538
    
    
    
    (1,239
    )
    
    
    1,137
    
    
    
    (576
    )
    
    
    148Net (loss) / income per share:Basic and diluted
    
    
    0.00
    
    
    
    (0.02
    )
    
    
    0.00
    
    
    
    0.01
    
    
    
    (0.03
    )
    
    
    0.03
    
    
    
    (0.02
    )
    
    
    0.00Weighted average shares
outstanding  Basic
    
    
    37,121
    
    
    
    37,136
    
    
    
    37,351
    
    
    
    37,597
    
    
    
    36,507
    
    
    
    36,979
    
    
    
    37,059
    
    
    
    37,090Weighted average shares
outstanding  Diluted
    
    
    37,145
    
    
    
    37,136
    
    
    
    37,351
    
    
    
    38,446
    
    
    
    36,507
    
    
    
    37,098
    
    
    
    37,059
    
    
    
    37,146
 See Item 15 below and the Index therein for a listing of the
consolidated financial statements and supplementary data filed as part of this
report. Recently Issued Accounting
Standards. In
May 2003, the Financial Accounting Standards Board (FASB)
issued SFAS 150,  Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and
Equity. SFAS 150 establishes standards for how an issuer
classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an
issuer classify a financial instrument that is within
its scope as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. This
Statement is effective for financial instruments entered into or
modified after May 31, 2003 (except for mandatorily redeemable
noncontrolling interests). For all instruments that existed prior to
May 31, 2003, the Standard is effective at the beginning of the
first interim period beginning after June 15, 2003 (except for
mandatorily redeemable noncontrolling interests). For mandatorily
redeemable noncontrolling interest, the FASB has deferred the
provisions of FAS 150 until further notice. The provisions of
SFAS 150 adopted thus far did not have a material effect on the
Companys financial statements and the adoption of the remaining
provision of SFAS 150 is not expected to have a material effect
on the Companys financial statements. In
December 2003, the FASB issued FASB Interpretation No. 46R,
Consolidation of Variable Interest Entities (FIN 46R).
FIN 46R requires the application of either FIN 46 or
FIN 46R by Public Entities to all Special Purpose Entities (SPE)
created prior to February 1, 2003 as of December 31, 2003
for calendar year-end companies. FIN 46R is applicable to all
non-SPEs created prior to February 1, 2003 at the end of the
first interim or annual period ending after March 15, 2004. For
all entities created subsequent to January 31, 2003,
Public Entities were required to apply the provisions of FIN 46.
The adoption of FIN 46 did not have a material impact to our
consolidated financial position, results of operations or cash flows.
The adoption of FIN 46R for SPEs did not have an impact on our
consolidated financial position, results of operations or cash
flows, and we do not believe the adoption of FIN 46R for
non-SPEs will have a material impact to our consolidated financial
position, results of operations or cash flows. In
 December 2003, the SEC issued Staff Accounting Bulletin
(SAB) No. 104, Revenue Recognition, SAB 104
codifies, revises and rescinds certain sections of
SAB No. 101 in order to make this interpretive guidance
consistent with current authoritative accounting and auditing guidance
and SEC rules and regulations. Accordingly, there is no impact to our
results of operations, financial position or cash flows as a result
of the issuance of SAB No. 104. 
 Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. 
 Item 9A.Controls and Procedures Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, we have
evaluated the effectiveness of our disclosure controls and procedures (as
such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended as of the end of the period
covered by this report, which we refer to as the Evaluation Date. Based on
such evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that, as of the Evaluation Date, our disclosure controls and
procedures are effective to provide reasonable assurance that information
required to be disclosed by us in our periodic reports under the Exchange Act
is recorded, processed, summarized and reported within the time periods
specified by the Securities and Exchange Commission rules and forms, and that
such information is accumulated and communicated to our management, including
our Chief Executive Officer and Chief Financial Officer, as appropriate, to
allow timely decisions regarding required disclosure. During the fiscal quarter ended December 31, 2003, no change in our
internal control over financial reporting occurred that materially affected, or
is reasonably likely to materially affect, our internal controls over financial
reporting. - 29 -




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##### Table of Contents



PART III 
 Item 10.Directors and Executive Officers of the Registrant. 
 Certain information required by Part III, Item 10 is omitted from this
Annual Report on Form 10-K because we will file a definitive proxy statement
within 120 days after the end of our fiscal year pursuant to Regulation 14A for
our 2004 Annual Meeting of Shareholders, and the information included in the
proxy statement is incorporated herein by reference. 
 Item 11.Executive Compensation. Certain of the information concerning our executive officers required by
this Item is contained in the section of Part I of this Annual Report on Form
10-K entitled Item 1. Business  Employees. The information concerning our directors and the remaining information
concerning our executive officers required by this item is incorporated by
reference to the information set forth under the similarly titled caption
contained in the proxy statement to be used by us in connection with our 2004
Annual Meeting of Shareholders. 
 Item 12.Security Ownership of Certain Beneficial Owners and Management. The information required by this item is incorporated by reference to the
information set forth under the similarly titled caption contained in the proxy
statement to be used by us in connection with our 2004 Annual Meeting of
Shareholders. 
 Item 13.Certain Relationships and Related Transactions. The information required by this item is incorporated by reference to the
information set forth under the similarly titled caption contained in the proxy
statement to be used by us in connection with our 2004 Annual Meeting of
Shareholders. 
 Item 14.Principal Accountant Fees and Services. The information required by this item is incorporated by reference to the
information set forth under the similarly titled caption contained in the proxy
statement to be used by us in connection with our 2004 Annual Meeting of
Shareholders. - 30 -




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##### Table of Contents



PART IV 
 Item 15.Exhibits, Financial Statement Schedule, and Reports on Form 8-K.  (a)(1)
    
    Financial Statements.The financial statements required to be filed by
Item 8 herewith are as follows: PageReport of
Independent Auditors
    
    
    35Consolidated Balance Sheets as of December 31, 2003 and 2002
    
    
    36Consolidated Statements of Operations and Comprehensive Loss for the years ended December
31, 2003, 2002 and 2001
    
    
    37Consolidated Statements of Shareholders Equity for the years ended December 31, 2003,
2002 and 2001
    
    
    38Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001
    
    
    39Notes to Consolidated Financial Statements
    
    
    40
  (2)
    
    Financial Statement Schedule. The
following financial statement schedule is filed herewith.Schedule II  Valuation and Qualifying Accounts
    
    
    52
  (3)
    
    Exhibits. The exhibits listed under Item 15(c) are filed or incorporated by reference herein.
  (b)
    
    Reports onForm 8-K. We filed a report on October 31, 2003 to announce preliminary
financial results for the third quarter and nine months ended September 30,
2003. We filed a report on November 21, 2003 to announce certain management
changes. We filed a report on November 25, 2003 to provide a then-current update on
the status of the Food and Drug Administrations review of our PMR product.  (c)
    
    Exhibits. The exhibits below are filed or incorporated herein by reference. Exhibit No.
    
    Description3.1.1 (1)
    
    Restated Articles of Incorporation, as filed with the California Secretary of State
on May 1, 19963.1.2 (2)
    
    Certificate of Amendment of Restated Articles of Incorporation, as filed with
California Secretary of State on July 18, 20013.1.3 (3)
    
    Certificate of Determination of Preferences of Series A Preferred Stock, as filed
with the California Secretary of State on August 23, 20013.1.4 (4)
    
    Certificate of Amendment of Restated Articles of Incorporation, as filed with the
California Secretary of State on January 23, 20043.2 (5)
    
    Amended and Restated Bylaws4.1 (6)
    
    Form of Common Stock Purchase Warrant issued in connection with Facilities Lease for
26632
 - 31 -




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##### Table of Contents



Exhibit No.
    
    DescriptionTowne Center Drive, Suite 320, Foothill Ranch, California4.2 (7)
    
    Second Amendment to Rights Agreement, dated as of January 21, 2004, between
CardioGenesis Corporation and EquiServe Trust Company, N.A., as Rights Agent4.3 (8)
    
    First Amendment to Rights Agreement, dated as of January 17, 2002, between
CardioGenesis Corporation and EquiServe Trust Company, N.A., as Rights Agent4.4 (9)
    
    Rights Agreement, dated as of August 17, 2001, between CardioGenesis Corporation and
EquiServe Trust Company, N.A., as Rights Agent4.5 (10)
    
    Share Purchase Agreement dated
April 10, 2002 between the CardioGenesis Corporation and the State of
Wisconsin Investment Board4.5 (11)
    
    Securities Purchase Agreement, dated as of January 21, 2004, by and among
CardioGenesis Corporation and each of the investors identified therein4.6 (12)
    
    Registration Rights Agreement, dated as of January 21, 2004, by and among
CardioGenesis Corporation and the investors identified therein4.7 (13)
    
    Form of Common Stock Purchase Warrant, dated January 21, 2004, having an exercise
price of $1.37 per share4.8 (14)
    
    Form of Common Stock Purchase Warrant, dated January 21, 2004, having an exercise
price of $1.00 per share10.1 (15)
    
    Form of Indemnification Agreement by and between the Company and each of its
officers and directors10.2 (16)
    
    Stock Option Plan, as restated June, 200310.3 (17)
    
    Directors Stock Option Plan, as restated June, 200310.4 (18)
    
    1996 Employee Stock Purchase Plan, as restated June, 200310.5 (19)
    
    Facilities Lease for 26632 Towne Center Dr., Suite 320, Foothill Ranch, California10.6 (20)
    
    401(k) Plan10.7 (21) 
    
    1993 Equity Incentive Plan of the former CardioGenesis Corporation10.8 (22) 
    
    1996 Equity Incentive Plan of the former CardioGenesis Corporation10.9 (23)
    
    Employment Agreement, dated June 1, 2002, between the Company and Darrell F. Eckstein10.10 (24)
    
    Employment Agreement, dated as of September 27, 2001, between the Company and
Michael J. Quinn10.11 (25)
    
    Amendment No. 1 to Employment Agreement, dated July 3, 2002, between the Company and
Michael J. Quinn21.1 (26)
    
    List of Subsidiaries23.1 (26)
    
    Consent of PricewaterhouseCoopers LLP24.1
    
    Power of Attorney (see page 34)31.1 (26)
    
    Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 200231.2 (26)
    
    Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 200232.1 (26)
    
    Certifications of the Chief Executive Officer and Chief Financial Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
  
 (1) Incorporated by reference to Exhibit 3.1 to the Registrants Registration
Statement on Form S-1/A (File No. 33-03770), filed on May 21, 1996 (2) Incorporated by reference to Exhibit 3.2 to the Registrants Quarterly
Report on Form 10-Q filed on August 14, 2001 (3) Incorporated by reference to Exhibit 4.2 to the Registrants Current Report
on Form 8-K filed on August 14, 2001 (4) Filed herewith (5) Filed herewith (6) Incorporated by reference to Exhibit 10.1 to the Registrants Quarterly
Report on Form 10-Q/A filed on August 16, 2001 - 32 -




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##### Table of Contents



(7) Incorporated by reference to Exhibit 4.1 to the Registrants Current Report
on Form 8-K filed January 22, 2004 (8) Incorporated by reference to Exhibit 4.1 to the Registrants Current Report
on Form 8-K filed January 18, 2002 (9) Incorporated by reference to Exhibit 4.1 to the Registrants Current Report
on Form 8-K filed August 20, 2001 (10) Incorporated by reference to Exhibit 4.2 to the Registrants Current
Report on Form 8-K filed April 12, 2002 (11) Incorporated by reference to Exhibit 4.4 to the Registrants Current
Report on Form 8-K filed January 22, 2004 (12) Incorporated by reference to Exhibit 4.5 to the Registrants Current
Report on Form 8-K filed January 22, 2004 (13) Incorporated by reference to Exhibit 4.6 to the Registrants Current
Report on Form 8-K filed January 22, 2004 (14) Incorporated by reference to Exhibit 4.7 to the Registrants Current
Report on Form 8-K filed January 22, 2004 (15) Incorporated by reference to the Companys Registration Statement on Form
S-1 (File No. 333-03770), as amended, filed on April 18, 1996 (16) Incorporated by reference to Exhibit 10.1 to the Registrants Registration
Statement on Form S-8 (File No. 333-106082) filed June 13, 2003 (17) Incorporated by reference to Exhibit 10.3 to the Registrants Registration
Statement on Form S-8 (File No. 333-106082) filed June 13, 2003 (18) Incorporated by reference to Exhibit 10.2 to the Registrants Registration
Statement on Form S-8 (File No. 333-106082) filed June 13, 2003 (19) Incorporated by reference to Exhibit 10.1 to the Registrants Quarterly
Report on Form 10-Q/A filed on August 16, 2001 (20) Incorporated by reference to the Companys Registration Statement on Form
S-1 (File No. 333-03770), as amended, filed on April 18, 1996 (21) Incorporated by reference to the former CardioGenesis Corporations Form
SB-2 (File No. 333-3752-LA), declared effective on May 21, 1996 (22) Incorporated by reference to Exhibit 4.1 to the former CardioGenesis
Corporations Registration Statement on Form S-8 (File No. 333-35095), filed on
September 8, 1997 (23) Incorporated by reference to Exhibit 10.12 to the Registrants Quarterly
Report on Form 10-Q filed on August 14, 2002 (24) Incorporated by reference to Exhibit 10.11 to the Registrants Annual
Report on Form 10-K filed on April 16, 2002 (25) Incorporated by reference to Exhibit 10.13 to the Registrants Quarterly
Report on Form 10-Q filed on August 14, 2002 (26) Filed herewith - 33 -




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or15(d)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. CARDIOGENESIS CORPORATIONDate:
March 10, 2004
    
    By:
    
    /s/ MICHAEL J. QUINNMichael J. QuinnPresident, Chief Executive Officer,Chairman of the Board and Director(Principal Executive Officer)
 Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the date indicated. KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints jointly and severally, Michael J. Quinn
and Christine G. Ocampo and each one of them, his attorneys-in-fact, each
with the power of substitution, for him in any and all capacities, to sign any
and all amendments to this Annual Report on Form 10-K and to file the same,
with exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his or her substitute or substitutes, may do or
cause to be done by virtue hereof. Signature
    
    Title
    
    Date/s/ MICHAEL J. QUINN
Michael J. Quinn
    
    President, Chief Executive Officer,
Chairman of the Board and Director
(Principal Executive Officer)
    
    March 10, 2004/s/        CHRISTINE G. OCAMPO
Christine G. Ocampo
    
    Vice President, Chief Financial Officer,Secretary and
Treasurer
(Principal Accounting and Financial Officer)
    
    March 10, 2004/s/            JOSEPH R. KLETZEL, II
Joseph R. Kletzel, II
    
    Director
    
    March 10, 2004/s/        ROBERT L. MORTENSEN
Robert L. Mortensen
    
    Director
    
    March 10, 2004/s/       MARVIN J. SLEPIAN, M.D.
Marvin J. Slepian, M.D.
    
    Director
    
    March 10, 2004/s/           ROBERT C. STRAUSS
Robert C. Strauss
    
    Director
    
    March 10, 2004/s/        KURT E. WEHBERG, M.D.
Kurt E. Wehberg, M.D.
    
    Director
    
    March 10, 2004
 - 34 -




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REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Shareholders of
CardioGenesis Corporation In our opinion, the accompanying consolidated financial statements listed
in the index appearing under Item 15(a)(1) on page 31 present fairly, in all
material respects, the financial position of CardioGenesis Corporation and its
subsidiaries (the Company) at December 31, 2003 and December 31, 2002, and
the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2003 in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the financial statement schedule listed in the index appearing
under Item 15(a)(2) on page 31 presents fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and the financial
statement schedule are the responsibility of the Companys management; our
responsibility is to express an opinion on these financial statements and the
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in
the United States of America, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP
Orange County, California
February 25, 2004 - 35 -




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##### Table of Contents



CARDIOGENESIS CORPORATION CONSOLIDATED BALANCE SHEETS
December 31, 2003 and 2002
(in thousands) ASSETS 2003
    
    2002Current assets:Cash and cash equivalents
    
    $
    1,013
    
    
    $
    1,490Accounts receivable, net of allowance for doubtful
accounts of $26 and $449 at December 31, 2003 and 2002, respectively
    
    
    1,830
    
    
    
    1,961Inventories, net of reserves of $373 and $361 at December 31, 2003
and 2002, respectively
    
    
    1,339
    
    
    
    1,632Prepaids and other current assets
    
    
    453
    
    
    
    574Total current assets
    
    
    4,635
    
    
    
    5,657Property and equipment, net
    
    
    408
    
    
    
    589Other assets
    
    
    1,417
    
    
    
    1,509Total assets
    
    $
    6,460
    
    
    $
    7,755LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    876
    
    
    $
    1,241Accrued liabilities
    
    
    1,159
    
    
    
    2,101Customer deposits
    
    
    25
    
    
    
    50Deferred revenue
    
    
    573
    
    
    
    621Current portion of capital lease obligation
    
    
    1
    
    
    
    30Total current liabilities
    
    
    2,634
    
    
    
    4,043Capital lease obligation, less current portion
    
    
    6
    
    
    
    1Total liabilities
    
    
    2,640
    
    
    
    4,044Commitments and contingencies (Note 9)Shareholders equity:Preferred stock:no par value; 6,600 shares authorized; none issued and outstanding;
    
    
    
    
    
    
    Common stock:no par value; 75,000 shares authorized; 37,859 and 37,121 shares issued and
outstanding at December 31, 2003 and 2002, respectively
    
    
    168,778
    
    
    
    168,321Accumulated deficit
    
    
    (164,958
    )
    
    
    (164,610
    )Total shareholders equity
    
    
    3,820
    
    
    
    3,711Total liabilities and shareholders equity
    
    $
    6,460
    
    
    $
    7,755
 The accompanying notes are an integral part of these consolidated financial statements - 36 -




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CARDIOGENESIS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
For the Years Ended December 31, 2003, 2002 and 2001
(in thousands, except per share amounts) 2003
    
    2002
    
    2001Net revenues
    
    $
    13,518
    
    
    $
    13,048
    
    
    $
    14,153Cost of revenues
    
    
    2,295
    
    
    
    2,935
    
    
    
    5,777Gross profit
    
    
    11,223
    
    
    
    10,113
    
    
    
    8,376Operating expenses:Research and development
    
    
    1,944
    
    
    
    657
    
    
    
    1,863Sales, general and administrative
    
    
    9,590
    
    
    
    12,297
    
    
    
    15,119Restructuring and merger-related costs.
    
    
    
    
    
    
    
    
    
    
    1,033Total operating expenses
    
    
    11,534
    
    
    
    12,954
    
    
    
    18,015Operating loss
    
    
    (311
    )
    
    
    (2,841
    )
    
    
    (9,639
    )Interest expense
    
    
    (44
    )
    
    
    (13
    )
    
    
    (18
    )Interest income
    
    
    7
    
    
    
    39
    
    
    
    62Equity in net loss of investee
    
    
    
    
    
    
    
    
    
    
    (652
    )Gain on sale of investee
    
    
    
    
    
    
    2,285
    
    
    
    Net loss
    
    
    (348
    )
    
    
    (530
    )
    
    
    (10,247
    )Other comprehensive loss, net of tax:Foreign currency translation adjustment
    
    
    
    
    
    
    88
    
    
    
    (23
    )Other comprehensive income (loss)
    
    
    
    
    
    
    88
    
    
    
    (23
    )Comprehensive loss
    
    $
    (348
    )
    
    $
    (442
    )
    
    $
    (10,270
    )Net loss per share:Basic and diluted
    
    $
    (0.01
    )
    
    $
    (0.01
    )
    
    $
    (0.31
    )Weighted average shares outstanding
    
    
    37,303
    
    
    
    36,911
    
    
    
    33,311
 The accompanying notes are an integral part of these consolidated financial statements - 37 -




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CARDIOGENESIS CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
For the Years Ended December 31, 2003, 2002 and 2001
(in thousands) Common Stock
    
    Deferred
    
    AccumulatedOtherComprehensiveIncome
    
    AccumulatedShares
    
    Amount
    
    Compensation
    
    (Loss)
    
    Deficit
    
    TotalBalances, December 31, 2000
    
    
    30,836
    
    
    $
    161,938
    
    
    $
    (66
    )
    
    $
    (65
    )
    
    $
    (153,833
    )
    
    $
    7,974Issuance of common stock pursuant to
exercise of options
    
    
    446
    
    
    
    719
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    719Issuance of common stock pursuant to
stock purchased under the Employee
Stock Purchase Plan
    
    
    105
    
    
    
    120
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    120Issuance of common stock purchase
warrants
    
    
    
    
    
    
    94
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    94Issuance of common stock for cash
    
    
    5,120
    
    
    
    4,884
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,884Deferred stock compensation
    
    
    
    
    
    
    (5
    )
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    61
    
    
    
    
    
    
    
    
    
    
    
    61Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (23
    )
    
    
    
    
    
    
    (23
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,247
    )
    
    
    (10,247
    )Balances, December 31, 2001
    
    
    36,507
    
    
    
    167,750
    
    
    
    
    
    
    
    (88
    )
    
    
    (164,080
    )
    
    
    3,582Issuance of common stock pursuant to
stock purchased under the Employee
Stock Purchase Plan
    
    
    114
    
    
    
    85
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    85Issuance of common stock for cash
    
    
    500
    
    
    
    486
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    486Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    88
    
    
    
    
    
    
    
    88Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (530
    )
    
    
    (530
    )Balances, December 31, 2002
    
    
    37,121
    
    
    
    168,321
    
    
    
    
    
    
    
    
    
    
    
    (164,610
    )
    
    
    3,711Issuance of common stock pursuant to
exercise of options
    
    
    607
    
    
    
    294
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    294Issuance of common stock pursuant to
stock purchased under the Employee
Stock Purchase Plan
    
    
    131
    
    
    
    88
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    88Issuance of common stock purchase
warrants
    
    
    
    
    
    
    75
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    75Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (348
    )
    
    
    (348
    )Balances, December 31, 2003
    
    
    37,859
    
    
    $
    168,778
    
    
    $
    
    
    
    $
    
    
    
    $
    (164,958
    )
    
    $
    3,820
 The accompanying notes are an integral part of these consolidated financial statements - 38 -




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##### Table of Contents



CARDIOGENESIS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2003, 2002 and 2001
(in thousands) 2003
    
    2002
    
    2001Cash flows from operating activities:Net loss
    
    $
    (348
    )
    
    $
    (530
    )
    
    $
    (10,247
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    261
    
    
    
    308
    
    
    
    450Gain from sale of equity investee
    
    
    
    
    
    
    (2,285
    )
    
    
    Loss from equity investee
    
    
    
    
    
    
    
    
    
    
    652Provision for doubtful accounts
    
    
    26
    
    
    
    335
    
    
    
    904Inventory reserves
    
    
    198
    
    
    
    854
    
    
    
    1,144Amortization of deferred compensation for options to consultants
    
    
    
    
    
    
    
    
    
    
    61Amortization of other assets
    
    
    195
    
    
    
    194
    
    
    
    211Amortization of debt issue costs
    
    
    44
    
    
    
    
    
    
    
    Accretion of long-term liability
    
    
    
    
    
    
    
    
    
    
    31Loss on disposal of property and equipment
    
    
    
    
    
    
    28
    
    
    
    4Reduction of clinical trial accrual
    
    
    (601
    )
    
    
    (1,282
    )
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    105
    
    
    
    34
    
    
    
    420Inventories
    
    
    95
    
    
    
    729
    
    
    
    1,041Prepaids and other current assets
    
    
    202
    
    
    
    619
    
    
    
    346Other receivables
    
    
    
    
    
    
    
    
    
    
    119Other assets
    
    
    (103
    )
    
    
    
    
    
    
    Accounts payable
    
    
    (365
    )
    
    
    (307
    )
    
    
    859Accrued liabilities
    
    
    (316
    )
    
    
    (1,084
    )
    
    
    (1,322
    )Current portion of long term liabilities
    
    
    
    
    
    
    (495
    )
    
    
    (5
    )Long term liabilities
    
    
    
    
    
    
    
    
    
    
    (370
    )Customer deposits
    
    
    (25
    )
    
    
    (4
    )
    
    
    (132
    )Deferred revenue
    
    
    (48
    )
    
    
    (310
    )
    
    
    (379
    )Net cash used in operating activities
    
    
    (680
    )
    
    
    (3,196
    )
    
    
    (6,213
    )Cash flows from investing activities:Proceeds from sale of equity in investee
    
    
    
    
    
    
    2,285
    
    
    
    Acquisition of property and equipment
    
    
    (80
    )
    
    
    (62
    )
    
    
    (269
    )Net cash provided by (used in) investing activities
    
    
    (80
    )
    
    
    2,223
    
    
    
    (269
    )Cash flows from financing activities:Net proceeds from issuance of common stock from exercise of options and
from
stock purchased under the Employee Stock Purchase Plan
    
    
    307
    
    
    
    85
    
    
    
    839Net proceeds from sale of common stock to private entities
    
    
    
    
    
    
    486
    
    
    
    4,884(Payments on) proceeds from short term borrowings
    
    
    
    
    
    
    (794
    )
    
    
    439Repayment of note payable
    
    
    
    
    
    
    
    
    
    
    (355
    )Repayments of capital lease obligations
    
    
    (24
    )
    
    
    (31
    )
    
    
    (30
    )Net cash (used in) provided by financing activities
    
    
    283
    
    
    
    (254
    )
    
    
    5,777Effect of exchange rates on cash and cash equivalents
    
    
    
    
    
    
    88
    
    
    
    (23
    )Net decrease in cash and cash equivalents
    
    
    (477
    )
    
    
    (1,139
    )
    
    
    (728
    )Cash and cash equivalents at beginning of year
    
    
    1,490
    
    
    
    2,629
    
    
    
    3,357Cash and cash equivalents at end of year
    
    $
    1,013
    
    
    $
    1,490
    
    
    $
    2,629Supplemental schedule of cash flow information:Interest paid
    
    $
    19
    
    
    $
    13
    
    
    $
    21Taxes paid
    
    $
    23
    
    
    $
    60
    
    
    $
    74Supplemental schedule of noncash investing and financing activities:Issuance of common stock purchase warrants
    
    $
    75
    
    
    $
    
    
    
    $
    94Deferred compensation
    
    $
    
    
    
    $
    
    
    
    $
    (5
    )
 The accompanying notes are an integral part of these consolidated financial statements - 39 -




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##### Table of Contents



CARDIOGENESIS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Nature of Operations: CardioGenesis Corporation (CardioGenesis or the Company), formerly
known as Eclipse Surgical Technologies, Inc., was founded in 1989 to develop,
manufacture and market surgical lasers and accessories for the treatment of
disease. Currently, CardioGenesis emphasis is on the development and
manufacture of products used for transmyocardial revascularization (TMR) and
percutaneous myocardial revascularization (PMR), which are cardiovascular
procedures. CardioGenesis markets its products for sale primarily in the U.S.,
Europe and Asia. CardioGenesis operates in a single segment. These financial statements contemplate the realization of assets and the
satisfaction of liabilities in the normal course of business. CardioGenesis has
sustained significant operating losses for the last several years and may
continue to incur losses through 2004. Management believes its cash balance as
of December 31, 2003 is sufficient to meet the Companys capital and operating
requirements for the next 12 months. (See Note 15). CardioGenesis may require additional financing in the future. There can be
no assurance that CardioGenesis will be able to obtain additional debt or
equity financing, if and when needed, on terms acceptable to the Company. Any
additional equity or debt financing may involve substantial dilution to
CardioGenesis stockholders, restrictive covenants or high interest costs. The
failure to raise needed funds on sufficiently favorable terms could have a
material adverse effect on the execution of the Companys business plan,
operating results and financial condition. CardioGenesis long term liquidity
also depends upon its ability to increase revenues from the sale of its
products and achieve profitability. The failure to achieve these goals could
have a material adverse effect on the execution of the Companys business plan,
operating results and financial condition. 2. Summary of Significant Accounting Policies: Basis of Presentation: On March 17, 1999, Eclipse Surgical Technologies, Inc. (Eclipse)
completed the acquisition of the former CardioGenesis Corporation pursuant to
the Agreement and Plan of Reorganization (the merger) dated as of October 21,
1998. The merger was accounted for using the pooling of interests method of
accounting for business combinations. The accompanying consolidated financial
statements include the accounts of the Company and its wholly-owned
subsidiaries. All significant intercompany transactions and balances have been
eliminated. Use of Estimates: The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
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. Actual results could differ from those estimates. - 40 -




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CARDIOGENESIS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. Summary of Significant Accounting Policies (continued): Cash and Cash Equivalents: All highly liquid instruments purchased with an original maturity of three
months or less are considered cash equivalents. Accounts Receivables: The Company regularly evaluates the collectability of accounts receivable
based upon its knowledge of customers and compliance with credit terms. The
allowance for doubtful accounts is adjusted based on such evaluation, with a
corresponding provision included in general and administrative expenses. Inventories: Inventories are stated at the lower of cost (principally standard cost,
which approximates actual cost on a first-in, first-out basis) or market value. Patent Expenses: Patent and patent related expenditures are expensed as general and
administrative expenses as incurred. Property and Equipment: Property and equipment are stated at cost and depreciated on a
straight-line basis over their estimated useful lives of two to seven years.
Assets acquired under capital leases are amortized over the shorter of their
estimated useful lives or the term of the related lease (generally three to
five years). Amortization of leasehold improvements is based on the
straight-line method over the shorter of the estimated useful life or the lease
term. Accounting for the Impairment or Disposal of Long-Lived Assets: CardioGenesis evaluates the recoverability of its long-lived assets in
accordance with Statement of Financial Accounting Standards No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144).
SFAS 144 requires recognition of the impairment of long-lived assets in the
event the net book value of such assets exceeds the future undiscounted cash
flows attributable to such assets. Fair Value of Financial Instruments: The carrying amounts of certain of CardioGenesis financial instruments
including cash equivalents, accounts receivable, accounts payable, accrued
liabilities and customer deposits approximate fair value due to their short
maturities. - 41 -




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CARDIOGENESIS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. Summary of Significant Accounting Policies (continued):: Revenue Recognition: CardioGenesis recognizes revenue on product sales upon receipt of a
purchase order, shipment of the products, the price is fixed or determinable
and collection of sales proceeds is reasonably assured. Where purchase orders
allow customers an acceptance period or other contingencies, revenue is
recognized upon the earlier of acceptance or removal of the contingency. Revenues from sales to distributors and agents are recognized upon
shipment when there is evidence that an arrangement exists, delivery has
occurred under the Companys standard FOB shipping point terms, the sales
price is fixed or determinable and the ability to collect sales proceeds is
reasonably assured. The contracts regarding these sales do not include any
rights of return or price protection clauses. CardioGenesis frequently loans lasers to hospitals in return for the
hospital purchasing a minimum number of handpieces at a premium over the list
price. The loaned lasers are depreciated to cost of revenues over a useful life
of 24 months. The revenue on the handpieces is recognized upon shipment at an
amount equal to the list price. The premium over the list price represents
revenue related to the use of the laser unit and is recognized ratably,
generally over the 24-month useful life of the placed lasers. Revenues from service contracts, rentals, and per procedure fees are
recognized upon performance or over the terms of the contract as appropriate. Shipping and Handling Costs and Revenues: All shipping and handling costs are expensed as incurred and are recorded
as a component of cost of sales. Charges for shipping and handling are included
as a component of revenue. Research and Development: Research and development expenses are charged to operations as incurred. Warranties: CardioGenesis laser products are generally sold with a one year warranty.
CardioGenesis provides for estimated future costs of repair or replacement
which are reflected in the accompanying financial statements. Advertising: CardioGenesis expenses all advertising as incurred. CardioGenesis
advertising expenses were $80,000, $221,000 and $137,000 for 2003, 2002, and
2001, respectively. Advertising expenses include fees for website design and
hosting, reprints from medical journals, promotional materials and sales
sheets. - 42 -




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##### Table of Contents



CARDIOGENESIS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. Summary of Significant Accounting Policies (continued): Income Taxes: CardioGenesis accounts for income taxes using the liability method under
which deferred tax assets or liabilities are calculated at the balance sheet
date using current tax laws and rates in effect for the year in which the
differences are expected to affect taxable income. Valuation allowances are
established, when necessary, to reduce deferred tax assets to the amounts
expected to be realized. Foreign Currency Translation: CardioGenesis international subsidiary, a foreign sales corporation
(FSC) uses its local currency as its functional currency. Assets and
liabilities are translated at exchange rates in effect at the balance sheet
date and income and expense accounts at average exchange rates during the year.
Resulting translation adjustments are recorded in accumulated other
comprehensive income/loss in shareholders equity. Transaction gains and losses
are included in the results of operations and have not been significant for all
periods presented. In 2003, the Company decided to discontinue this
FSC and at December 31, 2003 the only remaining asset is a
nominal cash balance. Stock-Based Compensation: CardioGenesis accounts for its stock-based compensation in accordance with
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees (APB 25). CardioGenesis has elected to adopt the disclosure only
provisions of Statement of Financial Accounting Standards No. 123, Accounting
for Stock-Based Compensation (SFAS 123), which requires pro forma
disclosures in the financial statements as if the measurement provisions of
SFAS 123 had been adopted. In addition, the Company has made the appropriate
disclosures as required under the Statement of Financial Accounting Standards
No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure. The Company has adopted the disclosure only provisions of SFAS 123 as
updated by FAS 148. CardioGenesis, however, continues to apply APB 25 and
related interpretations in accounting for its plans. Had compensation cost for
the Stock Option Plan, the Directors Stock Option Plan and the ESPP been
determined based on the fair value of the options at the grant date for awards
consistent with the provisions of SFAS 123, CardioGenesis net loss and net
loss per share would have increased to the pro forma amounts indicated below
(in thousands, except per share amounts): Year Ended December 31,2003
    
    2002
    
    2001Net loss as reported
    
    $
    (348
    )
    
    $
    (530
    )
    
    $
    (10,247
    )Stock-based employee compensation, net
of related tax
effects
    
    $
    (1,135
    )
    
    $
    (1,404
    )
    
    $
    (  1,362
    )Pro forma net loss
    
    $
    (1,483
    )
    
    $
    (1,934
    )
    
    $
    (11,609
    )Basic and diluted net loss per share as reported
    
    $
    (0.01
    )
    
    $
    (0.01
    )
    
    $
    (0.31
    )Pro forma basic and diluted net loss per share
    
    $
    (0.04
    )
    
    $
    (0.05
    )
    
    $
    (0.35
    )
 - 43 -




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##### Table of Contents



CARDIOGENESIS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. Summary of Significant Accounting Policies (continued): Stock-Based Compensation (continued): The above pro-forma disclosures are not necessarily representative of the
effects on reported net income (loss) for future years. The aggregate fair
value and weighted average fair value per share of options granted in the years
ended December 31, 2003, 2002 and 2001 were $651,000, $646,000 and $1,400,000,
and $0.33, $0.58 and
$1.53, respectively. The fair value of each option grant is estimated on the
date of grant using the Black-Scholes option pricing model with the following
weighted-average assumptions for grants in 2003, 2002 and 2001: December 31,2003
    
    2002
    
    2001Expected life of option
    
    7 years
    
    7 years
    
    7 yearsRisk-free interest rate
    
    
    3.68
    %
    
    
    4.04
    %
    
    
    5.26
    %Expected dividends
    
    
    
    
    
    
    
    
    
    
    Expected volatility
    
    
    151
    %
    
    
    75
    %
    
    
    100
    %
 The aggregate fair value and weighted average fair value per share of
purchase rights under the ESPP in fiscal years 2003, 2002 and 2001 was $55,000,
$56,000 and $61,000, and $0.43, $0.59 and $0.64, respectively.
The fair value for the purchase rights under the ESPP is estimated using the
Black-Scholes option pricing model, with the following assumptions for the
rights granted in 2003, 2002 and 2001: December 31,2003
    
    2002
    
    2001Expected life
    
    .5 years
    
    .5 years
    
    .5 yearsRisk-free interest rate
    
    
    3.68
    %
    
    
    4.04
    %
    
    
    5.26
    %Expected dividends
    
    
    
    
    
    
    
    
    
    
    Expected volatility
    
    
    151
    %
    
    
    152
    %
    
    
    193
    %
 CardioGenesis accounts for equity instruments issued to non-employees in
accordance with the provisions of SFAS 123 and Emerging Issues Task Force Issue
No. 96-18 Accounting for Equity Instruments with Variable Terms That Are
Issued for Consideration Other Than Employee Services under FASB Statement No.
123, Accounting for Stock-Based Compensation. Net Loss Per Share: Basic earnings per share (EPS) is computed by dividing the net loss by
the weighted average number of common shares outstanding for the period.
Diluted EPS is computed giving effect to all dilutive potential common shares
that were outstanding during the period. Dilutive potential common shares
consist of incremental shares issuable upon the exercise of stock options and
warrants using the treasury stock method. Options to purchase 4,070,000, 3,477,000, and 2,787,000 shares of common
stock were outstanding at December 31, 2003, 2002 and 2001, respectively. The
range of per share exercise prices for these options was $0.32-$12.6875 for
2003 and $0.563-$12.6875 for 2002 and 2001. Warrants to purchase 75,000 shares
of common stock at $1.63 per share were outstanding as of December 31, 2003,
2002 and 2001. Warrants to purchase 275,000 shares of common stock at prices
ranging from $.35 to $.44 per share were outstanding as of December 31, 2003.
None of the options and warrants were included in the calculation of diluted
EPS because their inclusion would have been anti-dilutive. Recently Issued Accounting
Standards: In
May 2003, the Financial Accounting Standards Board (FASB)
issued SFAS 150,  Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and
Equity. SFAS 150 establishes standards for how an issuer
classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an
issuer classify a financial instrument that is within
its scope as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. This
Statement is effective for financial instruments entered into or
modified after May 31, 2003 (except for mandatorily redeemable
noncontrolling interests). For all instruments that existed prior to
May 31, 2003, the Standard is effective at the beginning of the
first interim period beginning after June 15, 2003 (except for
mandatorily redeemable noncontrolling interests). For mandatorily
redeemable noncontrolling interest, the FASB has deferred the
provisions of FAS 150 until further notice. The provisions of
SFAS 150 adopted thus far did not have a material effect on the
Companys financial statements and the adoption of the remaining
provision of SFAS 150 is not expected to have a material effect
on the Companys financial statements. In
December 2003, the FASB issued FASB Interpretation No. 46R,
Consolidation of Variable Interest Entities (FIN 46R).
FIN 46R requires the application of either FIN 46 or
FIN 46R by Public Entities to all Special Purpose Entities (SPE)
created prior to February 1, 2003 as of December 31, 2003
for calendar year-end companies. FIN 46R is applicable to all
non-SPEs created prior to February 1, 2003 at the end of the
first interim or annual period ending after March 15, 2004. For
all entities created subsequent to January 31, 2003,
Public Entities were required to apply the provisions of FIN 46.
The adoption of FIN 46 did not have a material impact to our
consolidated financial position, results of operations or cash flows.
The adoption of FIN 46R for SPEs did not have an impact on our
consolidated financial position, results of operations or cash
flows, and we do not believe the adoption of FIN 46R for
non-SPEs will have a material impact to our consolidated financial
position, results of operations or cash flows. In
 December 2003, the SEC issued Staff Accounting Bulletin
(SAB) No. 104, Revenue Recognition, SAB 104
codifies, revises and rescinds certain sections of
SAB No. 101 in order to make this interpretive guidance
consistent with current authoritative accounting and auditing guidance
and SEC rules and regulations. Accordingly, there is no impact to our
results of operations, financial position or cash flows as a result
of the issuance of SAB No. 104. - 44 -




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##### Table of Contents



CARDIOGENESIS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. Restructuring Costs: During the year ended December 31, 2001, the Company recognized
restructuring charges of $1,303,000, which were partially offset by a change in
estimate of $270,000 in connection with merger-related costs that were incurred
in 1999. The restructuring included a reduction in headcount and the closing
of the Companys facilities in Sunnyvale, California. As a result of the
restructuring, 48 employees were identified to be terminated under the original
restructuring plan, primarily from the finance and manufacturing departments. The following table summarizes the restructuring activity and the
remaining restructuring reserve balance (in thousands): Personnel and
    
    Lease and Other
    
    OtherSeverance
    
    Contractual
    
    MiscellaneousCosts
    
    Commitments
    
    Costs
    
    TotalProvisions
    
    $
    655
    
    
    $
    344
    
    
    $
    304
    
    
    $
    1,303Payments
    
    
    (655
    )
    
    
    (252
    )
    
    
    (176
    )
    
    
    (1,083
    )Non-cash charges
    
    
    
    
    
    
    (52
    )
    
    
    (116
    )
    
    
    (168
    )Balance as of December 31, 2001
    
    
    
    
    
    
    40
    
    
    
    12
    
    
    
    52Payments
    
    
    
    
    
    
    (40
    )
    
    
    
    
    
    
    (40
    )Non-cash charges
    
    
    
    
    
    
    
    
    
    
    (12
    )
    
    
    (12
    )Balance as of December 31, 2002
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
 There is no remaining restructuring reserve balance at December 31, 2003
or December 31, 2002. 4. Inventories: Inventories consist of the following (in thousands): December 31,2003
    
    2002Raw materials
    
    $
    1,042
    
    
    $
    1,121Work in process
    
    
    159
    
    
    
    136Finished goods.
    
    
    511
    
    
    
    7361,712
    
    
    
    1,993Less reserves
    
    
    (373
    )
    
    
    (361
    )$
    1,339
    
    
    $
    1,632
 5. Property and Equipment: Property and equipment consists of the following (in thousands): December 31,2003
    
    2002Computers and equipment
    
    $
    2,733
    
    
    $
    2,677Manufacturing and demonstration equipment
    
    
    2,181
    
    
    
    2,177Leasehold improvements
    
    
    193
    
    
    
    1725,106
    
    
    
    5026Less accumulated depreciation and amortization
    
    
    (4,698
    )
    
    
    (4,437
    )$
    408
    
    
    $
    589
 - 45 -




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##### Table of Contents



CARDIOGENESIS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 5. Property and Equipment: CardioGenesis leases certain equipment under a capital lease which expired
in November 2003. Accordingly, capitalized equipment costs of $138,000, net of
accumulated amortization of $138,000 at December 31, 2003 is included in
computers and equipment. 6. Other Assets: On January 5, 1999, CardioGenesis entered into
an Agreement (the PLC agreement) with PLC Medical Systems, Inc. (PLC), which
granted CardioGenesis a non-exclusive worldwide use of certain PLC patents.
In return, CardioGenesis agreed to pay PLC a fee totaling $2,500,000 over an approximately forty-month period. The present value
of these payments of $2,300,000 was recorded as a prepaid asset,
included in other
assets, and is being amortized over the life of the underlying
patents. The Company has included the related amortization expense in
Sales, general and administrative expenses in the accompanying
Consolidated Statements of Operations and Comprehensive Loss. The
Company has recorded related accumulated amortization of $973,000 and
$778,000 as of December 31, 2003 and 2002, respectively. At December 31, 2001, CardioGenesis had a 30% ownership interest in
Microheart, Inc., formerly known as Microheart Holdings, Inc., (Microheart),
which was accounted for under the equity method. For the year ended December
31, 2001, CardioGenesis recorded an expense of $652,000 which represented
CardioGenesis equity in the losses incurred by Microheart. As of December 31,
2001 the investment in Microheart was fully written down. In the second quarter
of 2002, CardioGenesis recorded a gain of $2,285,000 resulting from the sale of
the Companys minority interest in Microheart. 7. Accrued Liabilities: Accrued liabilities consists of the following (in thousands): December 31,2003
    
    2002Accrued research support
    
    $
    152
    
    
    $
    753Accrued accounts payable and related expenses
    
    
    327
    
    
    
    557Accrued vacation
    
    
    203
    
    
    
    198Accrued commissions
    
    
    234
    
    
    
    276Accrued other
    
    
    243
    
    
    
    317$
    1,159
    
    
    $
    2,101
 8. Credit Facility: On March 27, 2003, the Company entered into a Purchase and Security Agreement with
a private equity fund and entered into a revolving Convertible Note credit
facility (the Note) that matures on March 26, 2006. The Note, which is
collateralized by substantially all of the Companys assets, provides for borrowings of up to $2,000,000 based
upon eligible accounts receivable. Advances under the Note will bear interest
at prime plus 3.35%. The Note includes a right of conversion into common stock
at a fixed conversion price of $.30 per share, subject to adjustment. In
conjunction with this transaction, the Company issued 275,000 five year warrants. The
warrants are exercisable for common stock at exercise prices ranging from $.35
to $.44 per share. As of December 31, 2003, the Companys borrowing capacity was
approximately $1,300,000 based on eligible accounts receivable and
there were no
outstanding borrowings on the Note. The Company intends to cancel the credit
facility in the first quarter of 2004. - 46 -




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##### Table of Contents



CARDIOGENESIS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. Commitments and Contingencies: CardioGenesis has entered into an operating lease for an office facility
with terms extending through October 2006. The minimum future rental payments
are as follows (in thousands): Year Ending December 31,2004
    
    $
    3502005
    
    
    3502006
    
    
    306$
    1,006
 Rent expense was approximately $547,000, $504,000 and $1,154,000 for the
years ended December 31, 2003, 2002 and 2001, respectively. In November 2003, the Companys employment relationship with Darrell
Eckstein, former President, Chief Operating Officer, Acting Chief Financial
Officer, Chief Accounting Officer, Treasurer and Secretary was terminated. In
connection with his departure from the Company, Mr. Eckstein has made certain
breach of contract claims arising out of his employment agreement with the
Company, as well as certain tort claims. Pursuant to the terms of Mr.
Ecksteins employment agreement, the Company has agreed to submit the matter to
binding arbitration. The Company believes Mr. Ecksteins claims are without
merit and intends to vigorously defend against these claims. However, if Mr.
Eckstein were to prevail on some or all of his claims, there can be no
assurance that such claims would not have a material adverse effect on the
Companys financial condition. 10. Shareholders Equity: Issuances of Common Stock: In March 2001, the Company sold 898,202 shares of common stock to a
private company. The sale was at a negotiated purchase price of $1.1133 per
share. In April 2002, December 2001 and April 2001, the Company sold 500,000,
2,222,225 and 2,000,000 shares, respectively, of common stock to a governmental
entity. The April 2002 and April 2001 sales were at a negotiated purchase
price of $1.00 per share and the December 2001 sale was at a negotiated
purchase price of $0.90 per share. Certain bylaws were amended as a condition
of these sales. In January 2004, CardioGenesis sold approximately 3,100,000 shares of
common stock to private investors for a total price of $2,700,000. (See Note
15). Warrants: During the year ended December 31, 2001, the Company issued warrants to
purchase 75,000 shares of common stock at a price of $1.63 per share in
connection with a facilities lease agreement executed in 2001. The warrants
were fair valued at $94,000 using the Black-Scholes pricing model and are being
amortized over the five-year lease term. For the years ended December 31, 2003
and 2002, the Company recorded amortization charges to rent expense of $19,000
per year in connection with these warrants. The warrants expire in May 2006 and
were outstanding at December 31, 2003. - 47 -




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##### Table of Contents



CARDIOGENESIS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. Shareholders Equity (continued): During the year ended December 31, 2003, the Company issued five-year
warrants to purchase 275,000 shares of common stock at exercise prices ranging
from $.35 to $.44 per share in connection with a Convertible Note credit
facility (See Note 8) with a private equity fund executed in March 2003. The warrants were
fair valued at $75,000 using the Black-Scholes pricing model and are being
amortized over the five-year term. For the year ended December 31, 2003, the
Company recorded amortization of $44,000 in connection with these warrants. The
warrants expire in March 2008 and were outstanding at December 31, 2003. During the year ended December 31, 2002, no warrants were issued. During
the years ended December 31, 2003, 2002 and 2001, no warrants were exercised. On January 22, 2004, CardioGenesis issued warrants to purchase
approximately 3,100,000 shares of common stock at a price of $1.37 per share.
The warrants are immediately exercisable and have a term of five years. The
investors also have an option to purchase approximately 1,570,000 shares of
common stock at $1.00 per share for a period of six months following the
effective date of the related registration statement. (See Note 15). Options Granted to Consultants: At December 31, 2002 and 2001, options for consultants to purchase a total
of 47,000 and 86,000 shares of common stock, respectively, at exercise prices
ranging from $.78 to $8.75 per share were outstanding. No options for
consultants were outstanding as of December 31, 2003. The termination of this
plan and terms under which stock options are exercised are the same as
CardioGenesis Stock Option Plan which is described below. CardioGenesis
recorded deferred stock compensation of $61,000 for the year ended December 31,
2001, related to these options. No deferred compensation was recorded in the
years ended December 31, 2003 and 2002. These options are included in the Stock
Option Plan disclosures below. Stock Option Plan: CardioGenesis maintains a Stock Option Plan, which includes the Employee
Program under which incentive and nonstatutory options may be granted to
employees and the Consultants Program, under which nonstatutory options may be
granted to consultants of the Company. As of December 31, 2003, CardioGenesis
had reserved a total of 8,600,000 shares of common stock for issuance under
this plan. Under the plan, options may be granted at not less than fair market
value (110% of fair market value for options granted to 10% shareholders), as
determined by the Board of Directors. Options generally vest over a period of
three years and
expire ten years from date of grant (five years for options granted to 10%
shareholders). No shares of common stock issued under the plan are subject to
repurchase. Directors Stock Option Plan: CardioGenesis maintains a Directors Stock Option Plan which provides for
the grant of nonstatutory options to directors who are not officers or
employees of the Company. As of December 31, 2003, CardioGenesis had reserved
575,000 shares of common stock for issuance under this plan. Under this plan,
options are granted at the trading price of the common stock at the date of
grant. Options generally vest over twelve to thirty-six months and expire ten
years from date of grant. No shares of common stock issued under the plan are
subject to repurchase. - 48 -




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##### Table of Contents



CARDIOGENESIS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. Shareholders Equity (continued): Employee Stock Purchase Plan: CardioGenesis maintains an Employee Stock Purchase Plan (ESPP), under
which 1,028,400 shares of common stock have been reserved for issuance.
CardioGenesis adopted the ESPP in April 1996. The purpose of the ESPP is to
provide eligible employees of CardioGenesis with a means of acquiring common
stock of CardioGenesis through payroll deductions. Eligible employees are
permitted to purchase common stock at 85% of the fair market value through
payroll deductions of up to 15% of an employees compensation, subject to
certain limitations. During fiscal years 2003, 2002 and 2001, approximately
131,000, 114,000 and 105,000 shares, respectively, were sold through the ESPP. Option activity under the Stock Option Plan and the Directors Stock Option
Plan is as follows (in thousands, except per share amounts): Outstanding OptionsShares Available
    
    Number
    
    Weighted AverageFor Grant
    
    of Shares
    
    Price per ShareBalance, December 31, 2000
    
    
    
    
    
    
    3,243
    
    
    $
    4.99Additional shares reserved
    
    
    500
    
    
    
    
    
    
    
    Options granted
    
    
    (2,075
    )
    
    
    2,075
    
    
    $
    1.61Options canceled
    
    
    2,085
    
    
    
    (2,085
    )
    
    $
    5.27Options exercised
    
    
    
    
    
    
    (446
    )
    
    $
    1.58Balance, December 31, 2001
    
    
    510
    
    
    
    2,787
    
    
    $
    2.42Additional shares reserved
    
    
    1,500
    
    
    
    
    
    
    
    Options granted
    
    
    (1,105
    )
    
    
    1,105
    
    
    $
    0.82Options canceled
    
    
    415
    
    
    
    (415
    )
    
    $
    3.86Balance, December 31, 2002
    
    
    1,320
    
    
    
    3,477
    
    
    $
    1.74Additional shares reserved
    
    
    1,500
    
    
    
    
    
    
    
    Options granted
    
    
    (2,034
    )
    
    
    2,034
    
    
    $
    0.52Options canceled
    
    
    834
    
    
    
    (834
    )
    
    $
    1.46Options exercised
    
    
    
    
    
    
    (607
    )
    
    $
    0.48Balance, December 31, 2003
    
    
    1,620
    
    
    
    4,070
    
    
    $
    1.37
 The following table summarizes information about the Companys stock
options outstanding and exercisable under the Stock Option Plan and the
Directors Stock Option Plan at December 31, 2003: Options Outstanding
    
    Options ExercisableWeighted AverageRemainingNumber
    
    Contractual Life
    
    Weighted Average
    
    Number
    
    Weighted AverageExercise Prices
    
    Outstanding
    
    (in Years)
    
    Exercise Price
    
    Exercisable
    
    Exercise Price(in thousands)
    
    
    
    
    
    
    
    
    
    (in thousands)$0.32-$0.37
    
    
    822
    
    
    
    9.12
    
    
    $
    0.32
    
    
    
    756
    
    
    $
    0.32$0.56-$0.83
    
    
    871
    
    
    
    8.80
    
    
    $
    0.70
    
    
    
    426
    
    
    $
    0.69$0.84-$1.00
    
    
    467
    
    
    
    8.30
    
    
    $
    0.89
    
    
    
    452
    
    
    $
    0.89$1.01-$1.16
    
    
    340
    
    
    
    8.11
    
    
    $
    1.03
    
    
    
    268
    
    
    $
    1.03$1.19-$1.44
    
    
    522
    
    
    
    7.67
    
    
    $
    1.26
    
    
    
    402
    
    
    $
    1.24$1.67-$1.75
    
    
    714
    
    
    
    5.18
    
    
    $
    1.69
    
    
    
    714
    
    
    $
    1.69$2.57-$6.06
    
    
    191
    
    
    
    6.74
    
    
    $
    3.51
    
    
    
    174
    
    
    $
    3.58$6.38-$12.69
    
    
    143
    
    
    
    4.42
    
    
    $
    9.75
    
    
    
    143
    
    
    $
    9.754,070
    
    
    
    8.01
    
    
    $
    1.37
    
    
    
    3,335
    
    
    $
    1.48
 - 49 -




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##### Table of Contents



CARDIOGENESIS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. Shareholders Equity (continued): The Companys stock options exercisable under the Stock Option Plan and
the Directors Stock Option Plan at December 31, 2003 and 2002 were 3,335,000
and 2,119,000 shares, respectively. 11. Employee Retirement Plan: CardioGenesis maintains a 401(k) plan for its employees. The plan allows
eligible employees to defer up to 15% of their earnings, not to exceed the
statutory amount per year on a pretax basis through contributions to the plan.
The plan provides for employer contributions at the discretion of the Board of
Directors. For the years ended December 31, 2003, 2002 and 2001, $85,000,
$93,000 and $110,000 of employer contributions were made to the plan,
respectively. 12. Segment Disclosures The Company operates in one segment. The principal markets for the
Companys products are in the United States of America. International sales
occur in Europe, the Middle East and Asia and amounted to $415,000, $494,000
and $1,000,000 for the years ended December 31, 2003, 2002 and 2001,
respectively. The international sales represent 3%, 4% and 7% of total sales
for the years ended December 31, 2003, 2002 and 2001, respectively. The
majority of international sales are denominated in US dollars. 13. Income Taxes: Significant components of CardioGenesis deferred tax assets are as
follows (in thousands): December 312003
    
    2002Net operating losses
    
    $
    55,741
    
    
    $
    56,042Credits
    
    
    4,362
    
    
    
    4,330Research and development
    
    
    525
    
    
    
    583Reserves
    
    
    379
    
    
    
    670Accrued liabilities
    
    
    516
    
    
    
    572Depreciation
    
    
    118
    
    
    
    263Net deferred tax asset
    
    
    61,641
    
    
    
    62,460Less valuation allowance
    
    
    (61,641
    )
    
    
    (62,460
    )Net deferred tax assets.
    
    $
    
    
    
    $
    
 The Company has established a valuation allowance to the extent of its
deferred tax assets because it was determined by management that it was more
likely than not at the balance sheet date that such deferred tax assets would
not be realized. At such time as it is determined that it is more likely than
not that the deferred tax assets are realizable, the valuation allowance will
be reduced. As of December 31, 2003, the Company had federal and state net operating
loss carryforwards of approximately $152,500,000 and $43,800,000, respectively,
to offset future taxable income. In addition, the Company had federal and state
credit carryforwards of approximately $2,562,000 and $1,578,000 available to
offset future tax liabilities. The Companys net operating loss carryforwards,
as well as federal credit carryforwards, will expire at various dates beginning
in 2003 through 2023, if not utilized. Research and experimentation credits
carry forward indefinitely for state purposes. The Company also has a
manufacturers investment credit for state purposes of approximately $222,000. -50-




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##### Table of Contents



CARDIOGENESIS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. Income Taxes: The Internal Revenue Code limits the use of net operating loss and tax
credit carryforwards in certain situations where changes occur in the stock
ownership of a company. The Company believes that the sale of common stock in
its initial public offering and the merger with CardioGenesis resulted in
changes in ownership which could restrict the utilization of the carryforwards. Income tax expense for each of the three years ended December 31, 2003 was
$800 per year. 14. Risks and Concentrations: CardioGenesis sells its products primarily to hospitals and other
healthcare providers in North America, Europe and Asia. CardioGenesis performs
ongoing credit evaluations of its customers and generally does not require
collateral. Although CardioGenesis maintains allowances for potential credit
losses that it believes to be adequate, a payment default on a significant sale
could materially and adversely affect its operating results and financial
condition. At December 31, 2003, two customers individually accounted for more
than 10% of gross accounts receivable. For the years ended December 31, 2003,
2002 and 2001, no customer individually accounted for 10% or more of net
revenues. Certain components of laser units and fiber-optic handpieces are generally
acquired from multiple sources. Other laser and fiber-optic components and
subassemblies are purchased from single sources. Although the Company has
identified alternative vendors, the qualification of additional or replacement
vendors for certain components or services is a lengthy process. Any
significant supply interruption would have a material adverse effect on the
Companys ability to manufacture its products and, therefore, would harm its
business. The Company intends to continue to qualify multiple sources for
components that are presently single sourced. 15. Subsequent Event: On January 22, 2004, CardioGenesis sold approximately 3,100,000 shares of
common stock at a price of $.86 per share to private investors for a total
price of $2,700,000. CardioGenesis also issued warrants to purchase 3,100,000
additional shares of common stock at a price of $1.37 per share. The warrants
are immediately exercisable and have a term of five years. The investors also
have the option in the form of a warrant to purchase approximately 1,570,000
shares of common stock at $1.00 per share for a period of six months following
the effective date of the related registration statement. The Company agreed
to file such registration statement covering the resale of shares within 50
days of the closing date of the transaction. -51-




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##### Table of Contents



CARDIOGENESIS CORPORATION SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS
(in thousands) Balance at Beginning
    
    
    
    
    
    
    
    
    
    Balance atof Period
    
    Additions (1)
    
    Deductions (2)
    
    End of PeriodAllowance for doubtful accounts:Year ended December 31, 2001Allowance for doubtful accounts.
    
    $
    796
    
    
    $
    904
    
    
    $
    346
    
    
    $
    1,354Year ended December 31, 2002Allowance for doubtful accounts.
    
    $
    1,354
    
    
    $
    335
    
    
    $
    1,240
    
    
    $
    449Year ended December 31, 2003Allowance for doubtful accounts.
    
    $
    449
    
    
    $
    26
    
    
    $
    449
    
    
    $
    26Inventory reserve:Year ended December 31, 2001Inventory reserve
    
    $
    2,180
    
    
    $
    1,144
    
    
    $
    2,078
    
    
    $
    1,246Year ended December 31, 2002Inventory reserve
    
    $
    1,246
    
    
    $
    854
    
    
    $
    1,739
    
    
    $
    361Year ended December 31, 2003Inventory reserve
    
    $
    361
    
    
    $
    198
    
    
    $
    186
    
    
    $
    373Warranty reserve:Year ended December 31, 2001Warranty reserve
    
    $
    158
    
    
    $
    28
    
    
    $
    170
    
    
    $
    16Year ended December 31, 2002Warranty reserve
    
    $
    16
    
    
    $
    35
    
    
    $
    34
    
    
    $
    17Year ended December 31, 2003Warranty reserve
    
    $
    17
    
    
    $
    46
    
    
    $
    34
    
    
    $
    29Valuation allowance:Year ended December 31, 2001Valuation allowance
    
    $
    59,415
    
    
    $
    4,516
    
    
    $
    
    
    
    $
    63,931Year ended December 31, 2002Valuation allowance
    
    $
    63,931
    
    
    $
    
    
    
    $
    1,471
    
    
    $
    62,460Year ended December 31, 2003Valuation allowance
    
    $
    62,460
    
    
    $
    
    
    
    $
    819
    
    
    $
    61,641
   (1)
    
    Charged to costs and expenses.(2)
    
    Amounts written off against the reserve. THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE YEARS
ENDED DECEMBER 31, 2003, 2002 AND 2001 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS. -52-




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##### Table of Contents



EXHIBIT INDEX Exhibit No.
    
    Description3.1.1 (1)
    
    Restated Articles of Incorporation, as filed with the California Secretary of State
on May 1, 19963.1.2 (2)
    
    Certificate of Amendment of Restated Articles of Incorporation, as filed with
California Secretary of State on July 18, 20013.1.3 (3)
    
    Certificate of Determination of Preferences of Series A Preferred Stock, as filed
with the California Secretary of State on August 23, 20013.1.4 (4)
    
    Certificate of Amendment of Restated Articles of Incorporation, as filed with the
California Secretary of State on January 23, 20043.2 (5)
    
    Amended and Restated Bylaws4.1 (6)
    
    Form of Common Stock Purchase Warrant issued in connection with Facilities Lease for
26632 Towne Center Drive, Suite 320, Foothill Ranch, California4.2 (7)
    
    Second Amendment to Rights Agreement, dated as of January 21, 2004, between
CardioGenesis Corporation and EquiServe Trust Company, N.A., as Rights Agent4.3 (8)
    
    First Amendment to Rights Agreement, dated as of January 17, 2002, between
CardioGenesis Corporation and EquiServe Trust Company, N.A., as Rights Agent4.4 (9)
    
    Rights Agreement, dated as of August 17, 2001, between CardioGenesis Corporation and
EquiServe Trust Company, N.A., as Rights Agent4.5 (10)
    
    Share Purchase Agreement dated
April 10, 2002 between CardioGenesis Corporation and the State of
Wisconsin Investment Board4.5 (11)
    
    Securities Purchase Agreement, dated as of January 21, 2004, by and among
CardioGenesis Corporation and each of the investors identified therein4.6 (12)
    
    Registration Rights Agreement, dated as of January 21, 2004, by and among
CardioGenesis Corporation and the investors identified therein4.7 (13)
    
    Form of Common Stock Purchase Warrant, dated January 21, 2004, having an exercise
price of $1.37 per share4.8 (14)
    
    Form of Common Stock Purchase Warrant, dated January 21, 2004, having an exercise
price of $1.00 per share10.1 (15)
    
    Form of Indemnification Agreement by and between the Company and each of its
officers and directors10.2 (16)
    
    Stock Option Plan, as restated June, 200310.3 (17)
    
    Directors Stock Option Plan, as restated June, 200310.4 (18)
    
    1996 Employee Stock Purchase Plan, as restated June, 200310.5 (19)
    
    Facilities Lease for 26632 Towne Center Dr., Suite 320, Foothill Ranch, California10.6 (20)
    
    401(k) Plan10.7 (21) 
    
    1993 Equity Incentive Plan of the former CardioGenesis Corporation10.8 (22) 
    
    1996 Equity Incentive Plan of the former CardioGenesis Corporation10.9 (23)
    
    Employment Agreement, dated June 1, 2002, between the Company and Darrell F. Eckstein10.10 (24)
    
    Employment Agreement, dated as of September 27, 2001, between the Company and
Michael J. Quinn10.11 (25)
    
    Amendment No. 1 to Employment Agreement, dated July 3, 2002, between the Company and
Michael J. Quinn21.1 (26)
    
    List of Subsidiaries23.1 (26)
    
    Consent of PricewaterhouseCoopers LLP24.1
    
    Power of Attorney (see page 34)31.1 (26)
    
    Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 200231.2 (26)
    
    Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 200232.1 (26)
    
    Certifications of the Chief Executive Officer and Chief Financial Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
   
    
    Management contract, compensatory plan or arrangement




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##### Table of Contents



(1)
    
    Incorporated by reference to Exhibit 3.1 to the Registrants Registration
Statement on Form S-1/A (File No. 33-03770), filed on May 21, 1996(2)
    
    Incorporated by reference to Exhibit 3.2 to the Registrants Quarterly
Report on Form 10-Q filed on August 14, 2001(3)
    
    Incorporated by reference to Exhibit 4.2 to the Registrants Current Report
on Form 8-K filed on August 14, 2001(4)
    
    Filed herewith(5)
    
    Filed herewith(6)
    
    Incorporated by reference to Exhibit 10.1 to the Registrants Quarterly
Report on Form 10-Q/A filed on August 16, 2001(7)
    
    Incorporated by reference to Exhibit 4.1 to the Registrants Current Report
on Form 8-K filed January 22, 2004(8)
    
    Incorporated by reference to Exhibit 4.1 to the Registrants Current Report
on Form 8-K filed January 18, 2002(9)
    
    Incorporated by reference to Exhibit 4.1 to the Registrants Current Report
on Form 8-K filed August 20, 2001(10)
    
    Incorporated by reference to Exhibit 4.2 to the Registrants Current
Report on Form 8-K filed April 12, 2002(11)
    
    Incorporated by reference to Exhibit 4.4 to the Registrants Current
Report on Form 8-K filed January 22, 2004(12)
    
    Incorporated by reference to Exhibit 4.5 to the Registrants Current
Report on Form 8-K filed January 22, 2004(13)
    
    Incorporated by reference to Exhibit 4.6 to the Registrants Current
Report on Form 8-K filed January 22, 2004(14)
    
    Incorporated by reference to Exhibit 4.7 to the Registrants Current
Report on Form 8-K filed January 22, 2004(15)
    
    Incorporated by reference to the Companys Registration Statement on Form
S-1 (File No. 333-03770), as amended, filed on April 18, 1996(16)
    
    Incorporated by reference to Exhibit 10.1 to the Registrants Registration
Statement on Form S-8 (File No. 333-106082) filed June 13, 2003(17)
    
    Incorporated by reference to Exhibit 10.3 to the Registrants Registration
Statement on Form S-8 (File No. 333-106082) filed June 13, 2003(18)
    
    Incorporated by reference to Exhibit 10.2 to the Registrants Registration
Statement on Form S-8 (File No. 333-106082) filed June 13, 2003(19)
    
    Incorporated by reference to Exhibit 10.1 to the Registrants Quarterly
Report on Form 10-Q/A filed on August 16, 2001(20)
    
    Incorporated by reference to the Companys Registration Statement on Form
S-1 (File No. 333-03770), as amended, filed on April 18, 1996(21)
    
    Incorporated by reference to the former CardioGenesis Corporations Form
SB-2 (File No. 333-3752-LA), declared effective on May 21, 1996(22)
    
    Incorporated by reference to Exhibit 4.1 to the former CardioGenesis
Corporations Registration Statement on Form S-8 (File No. 333-35095), filed on
September 8, 1997(23)
    
    Incorporated by reference to Exhibit 10.12 to the Registrants Quarterly
Report on Form 10-Q filed on August 14, 2002(24)
    
    Incorporated by reference to Exhibit 10.11 to the Registrants Annual
Report on Form 10-K filed on April 16, 2002(25)
    
    Incorporated by reference to Exhibit 10.13 to the Registrants Quarterly
Report on Form 10-Q filed on August 14, 2002(26)
    
    Filed herewith