<PAGE>   1
 
================================================================================
 
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------
 
                                   FORM 10-K
(MARK ONE)
 
[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
      ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 1997 OR
 
[ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(D) OF THE SECURITIES
      EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
                              TO                         .
 
                       COMMISSION FILE NUMBER: 000-28372
 
                          CARDIAC PATHWAYS CORPORATION
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                             <C>
                    DELAWARE                                       77-0278793
        (State or other jurisdiction of                         (I.R.S. Employer
         incorporation or organization)                      Identification Number)
   995 BENECIA AVENUE, SUNNYVALE, CALIFORNIA                         94086
    (Address of principal executive office)                        (zip code)
</TABLE>
 
       Registrant's telephone number, including area code: (408) 737-0505
 
        SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
                         Common Stock, $.001 par value
                Preferred Share Purchase Rights, $.001 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 [ ]
 
     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 by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
 
     The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the closing sale price of the Common Stock on August
20, 1997 as reported on the Nasdaq National Market, was approximately
$44,113,361. 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 in that such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes.
 
     As of August 20, 1997, the registrant had outstanding 9,529,718 shares of
Common Stock.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
     The Registrant has incorporated by reference into Part III of this Form
10-K portions of its Proxy Statement for the Annual Meeting of Stockholders to
be held October 14, 1997.
================================================================================
<PAGE>   2
 
                                     PART I
 
ITEM 1. BUSINESS
 
               SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
     Certain statements in this Report constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995 (the
"Reform Act"). Such forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause the actual results, performance
or achievements of the Company, or industry results, to be materially different
from any future results, performance or achievements expressed or implied by
such forward-looking statements. Such factors include, among other things, the
following: the Company's history of losses and uncertainty of profitability;
that those products which have not previously received regulatory clearance for
commercial sale will prove to be safe and efficacious in clinical trials; the
uncertainty as to whether the Company's products and systems will receive
approval for commercial sale from United States and international regulatory
authorities in a timely manner, if at all; the uncertainty of market acceptance
of the Company's products and systems; the Company's dependence on development
and introduction of new products; the Company's lack of sales, marketing and
distribution experience; the risks associated with manufacturing of the
Company's products; the Company's highly competitive industry and rapid
technological change within the Company's industry; the uncertainty of patent
and proprietary technology protection and reliance on technology licensed from
third parties; changes in, or failure to comply with, government regulation; the
uncertainty of third party reimbursement for procedures performed using the
Company's products; the potential fluctuations in the Company's annual and/or
quarterly results; the Company's dependence on retention and attraction of key
employees; general economic and business conditions; and other factors
referenced in this Report.
 
OVERVIEW
 
     Cardiac Pathways Corporation (the "Company") was organized in 1991 as a
California Corporation and completed a reincorporation in Delaware prior to its
initial public offering in June 1996. The Company designs, develops and
manufactures minimally invasive systems to diagnose and treat cardiac
tachyarrhythmias (abnormally rapid heart rhythms) which, if untreated, can cause
palpitations, fainting and sudden cardiac arrest (a fatal heart rhythm). The
Company is developing products designed to provide integrated system solutions
for the successful diagnosis and treatment of ventricular tachycardia and atrial
fibrillation, two of the most serious and prevalent types of abnormally rapid
heart rhythms. The Company's products consist of systems for diagnostic mapping,
or locating the source of the tachyarrhythmia within the heart, and for
performing ablation treatment, a nonsurgical, minimally invasive technique for
neutralizing heart tissue responsible for starting or maintaining a dangerous
heart rhythm. Current mapping and ablation procedures can take many hours to
complete. The Company believes its systems will substantially shorten mapping
and ablation procedure time and provide safe and more effective treatments of
ventricular tachycardia and atrial fibrillation than other current forms of
therapy. The Company's strategy is to establish its Ventricular Tachycardia
Ablation System, Arrhythmia Mapping Systems and Atrial Fibrillation Ablation
System as the preferred means for the diagnosis and treatment of ventricular
tachycardia and atrial fibrillation.
 
     The Company has generated only limited revenues from sales of
supraventricular tachycardia and diagnostic catheters in certain markets. The
Company does not have any experience in manufacturing, marketing or selling in
commercial quantities its products for diagnosis and treatment of ventricular
tachycardia and atrial fibrillation. There can be no assurance that the
Company's development efforts will result in commercially available products for
diagnosis and treatment of ventricular tachycardia and atrial fibrillation, that
any such product will prove to be safe and efficacious in clinical trials, that
required regulatory approvals will be obtained in a timely manner, or at all, or
that the Company will be successful in introducing any such product. Any
commercialization of the Company's products will require substantial
development, clinical, regulatory, manufacturing, sales and marketing and other
expenditures. The Company expects its operating losses to continue through at
least the end of calendar 1999 as it continues to expend substantial funds for
clinical trials in support of regulatory approvals, expansion of research and
development activities,
 
                                        1
<PAGE>   3
 
establishment of commercial-scale manufacturing capabilities and expansion of
sales and marketing activities. There can be no assurance that any of the
Company's potential products for diagnosis and treatment of ventricular
tachycardia and atrial fibrillation will be successfully commercialized or that
the Company will achieve significant revenues from either international or
domestic sales. In addition, there can be no assurance that the Company will
achieve or sustain profitability in the future.
 
BACKGROUND
 
     The heart consists of four chambers: the ventricles, the lower two
chambers, and the atria, the upper two chambers. A healthy heart at rest beats
between 60 to 100 times per minute and pumps over 1,800 gallons of blood per
day. A normal heartbeat is the coordinated contraction of each of the heart's
chambers resulting from the conduction of organized electrical signals generated
by the heart's natural pacemaker, the sinoatrial node ("SA node"). The SA node,
located in the right atrium, initiates the heartbeat by generating an electrical
signal that causes the atria to contract and helps to fill the ventricles, the
heart's primary pumping chambers. Once spread throughout the atria, the
electrical activity of the SA node conducts an electrical signal to the
atrioventricular node ("AV node"). The AV node serves as a delay timer and
electrical signal conductor, allowing the atria to complete their contraction
thus filling the ventricles with blood, then facilitating the organized spread
of the electrical signal to the ventricles, causing them to contract and
distribute deoxygenated blood to the lungs from the right ventricle and freshly
oxygenated blood to the rest of the body from the left ventricle.
 
     When defects compromise the normal conduction of this electrical activity,
the pumping rhythm of the heart can be affected, resulting in cardiac
arrhythmias (abnormal heart rhythms). Cardiac arrhythmias have numerous causes,
including congenital defects, tissue damage due to heart attacks or
arteriosclerosis (the deposition of fatty substances in the inner layer of the
arteries) and other diseases, that accelerate, delay or redirect the
transmission of electrical activity, thereby disrupting the normal coordinated
contractions of the chambers. During a cardiac arrhythmia, the heart beats
either too slowly or too rapidly. Cardiac arrhythmias characterized by an
abnormally slow heart rate, usually defined as a rate lower than 60 beats per
minute, are generally treated by implantation of a pacemaker that delivers
electrical impulses to increase the heart rate. Cardiac arrhythmias
characterized by an abnormally high rate of more than 100 beats per minute are
known as cardiac tachyarrhythmias. The following diagrams illustrate the four
chambers of the heart and a typical location of electrical signals associated
with ventricular tachycardia and atrial fibrillation in the heart's chambers.
 
                                        2
<PAGE>   4
 
<TABLE>
<S>                                           <C>
              THE FOUR CHAMBERS                            TYPICAL LOCATION OF
                 OF THE HEART                            ATRIAL FIBRILLATION AND
                                                         VENTRICULAR TACHYCARDIA
</TABLE>
 
[Description: Graphic of two views of the heart with (i) showing four chambers
 of the heart, highlighting the SA node, the right atrium, the AV node, the
 right ventricle, the left atrium and left ventricle and (ii) highlighting the
 areas of the heart where atrial fibrillation and ventricular tachycardia 
 occur.]

  Ventricular Tachycardia
 
     Disease Characteristics. Ventricular tachycardia is a life-threatening
condition characterized by the ventricles beating at an abnormally rapid rate,
significantly interfering with the pumping of oxygenated blood throughout the
body. When the ventricles beat at an abnormally rapid rate, they lack sufficient
time to fill with blood prior to each contraction. As a result, less blood is
pumped out of the heart and less oxygen is carried to the tissues and organs of
the body. This lack of oxygen can cause dizziness, loss of consciousness and
sudden cardiac arrest. Individuals with ventricular tachycardia are at risk of
imminent death due to the unpredictable nature of ventricular tachycardia. Most
ventricular tachycardias result from myocardial infarctions (heart attacks)
caused by coronary artery disease. When a myocardial infarction occurs due to a
blockage in one or more coronary arteries, a portion of the heart muscle (most
often in the left ventricle) dies. After the portion of the left ventricle heart
muscle that was served by the blocked artery dies, an irregular border
consisting of intermixed healthy and scar tissue forms. Ventricular tachycardias
typically originate at this irregular border of healthy and scar tissue.
 
     Disease Incidence. Each year more than 300,000 people in the United States
experience a sudden cardiac arrest episode. Of these, approximately 50,000
individuals survive primarily through emergency defibrillation. These survivors
are at risk for ventricular tachycardia or another sudden cardiac arrest
episode. The Company believes that over 100,000 individuals who have never had a
sudden cardiac arrest episode are diagnosed each year with symptomatic
ventricular tachycardia. In addition, the American Heart Association estimates
that approximately 1.5 million individuals suffer myocardial infarctions
annually in the United States, of which, approximately 1.0 million survive.
Approximately 30% of the survivors of a myocardial infarction are at risk of
suffering an episode of ventricular tachycardia within one year of surviving the
myocardial infarction. If safe and cost-effective diagnosis and treatment were
available, these individuals would be candidates for early diagnosis and
treatment of ventricular tachycardia.
 
                                        3
<PAGE>   5
 
     Current Therapies. The currently prescribed therapies for ventricular
tachycardia are not curative and in many instances have undesirable side
effects. Antiarrhythmic drugs have been the most common treatment of ventricular
tachycardia. In 1989, a major multi-center randomized trial evaluating the
antiarrhythmic capabilities of several different drugs indicated that these
drugs in many instances, actually induced the ventricular tachycardias they were
designed to prevent. Furthermore, toxic side effects, including pulmonary
fibrosis, corneal micro deposits and liver dysfunction, often prevent patients
from long-term usage of these drugs. The automatic implantable cardioverter
defibrillator ("ICD") has also become a standard therapy in the treatment of
ventricular tachycardia. The cost of an ICD system averages $25,000 and total
costs associated with the implant including hospitalization average $55,000. The
ICD detects and stops an arrhythmia once it has started by pacing or by applying
high energy pulses, but does not cure the ventricular tachycardia or remove the
arrhythmia-causing tissue. Significant side effects that result from the ICD
include pain associated with high energy defibrillation pulses, physical
discomfort at the implant site, adverse psychological effects from dependence
upon the device for life saving intervention and a risk of infection. Many ICD
patients also receive antiarrhythmic drug therapy in an attempt to minimize the
frequency of ventricular tachycardia episodes. An infrequently used procedure to
treat ventricular tachycardia is open heart surgery, where a highly trained
cardiovascular surgeon removes the arrhythmia causing tissue.
 
     While not a mainstay therapy, single point radiofrequency catheter ablation
for ventricular tachycardia is being performed throughout the United States and
Western Europe. Currently, mapping and ablation of ventricular tachycardia is a
slow and tedious process because physicians are able to evaluate only a single
point in the heart at a time. Ventricular tachycardia can best be treated when
the patient is actually experiencing an episode of arrhythmia, which must be
induced and carefully monitored by the physician. In the vast majority of
individuals suffering from ventricular tachycardia, single point mapping
techniques are not effective because of the rapid rate of the ventricular
tachycardia. A patient with rapid rate ventricular tachycardia cannot be left in
this unstable heart rhythm for a sufficient length of time to identify the
origins of the ventricular tachycardia. Another limiting factor of ventricular
tachycardia ablation has been the inability of current catheters to generate a
lesion that is deep enough to effectively ablate the thick ventricular scar
tissue that results from a previous myocardial infarction.
 
  Atrial Fibrillation
 
     Disease Characteristics. Atrial fibrillation is a condition in which the
regular pumping function of the atria is replaced by a disorganized, ineffective
quivering caused by chaotic conduction of electrical signals through the upper
chambers of the heart. Atrial fibrillation is often associated with other forms
of cardiovascular disease, including congestive heart failure, rheumatic heart
disease, coronary artery disease, left ventricular hypertrophy, cardiomyopathy
or hypertension. The progression of atrial fibrillation varies among
individuals. Initial episodes of atrial fibrillation are generally symptomatic,
intermittent (paroxysmal) episodes. Certain individuals suffer recurring
episodes of atrial fibrillation that progress to a chronic state. Although not
immediately life threatening, atrial fibrillation may cause up to a 30%
reduction in cardiac output and a reduction in cerebral blood flow during the
fibrillation episode, resulting in shortness of breath, fainting, fatigue and
reduced exercise capacity. Ventricular rates can also rise dangerously high when
the chaotic signals of the atria are conducted to these lower chambers of the
heart. More seriously, since the atria provide minimal pumping function during
atrial fibrillation, blood pools in the chambers, which can lead to the
formation of blood clots. Blood clots in the left atrium can dislodge and travel
to the brain resulting in stroke. Considered for years to be a benign disorder,
atrial fibrillation is now recognized as placing affected patients at a
significantly increased risk for stroke. The American Heart Association
estimates that 75,000 strokes per year in the United States (approximately 25%
of all strokes) are related to atrial fibrillation, with published reports of up
to 70% of such patients dying or suffering significant neurologic deficit. The
mortality rate of patients with atrial fibrillation associated stroke is high in
relation to other causes of stroke, with a reported 23% of these patients dying
within 30 days of the stroke, compared to only 8% of stroke patients who do not
have atrial fibrillation. Moreover, based upon studies estimating the average
lifetime cost for a stroke patient, the Company estimates an annual cost to the
United States health care system for the estimated 75,000 strokes related to
atrial fibrillation of in excess of $7.4 billion.
 
                                        4
<PAGE>   6
 
     Disease Incidence. Atrial fibrillation affects up to 4% of the United
States population over the age of 60 years. The National Center for Health
Statistics reported that atrial fibrillation was the primary diagnosis for
130,000 emergency room visits and 227,000 hospitalizations in the United States
in 1992, more hospitalizations than any other cardiac arrhythmia. In addition,
there were approximately 1.4 million hospital discharges in which atrial
fibrillation was a listed diagnosis and more than 1.5 million outpatient visits
by individuals who have atrial fibrillation as a primary diagnosis.
 
     Current Therapies. Currently, the only curative treatment for atrial
fibrillation is a rarely performed open heart surgical procedure (the surgical
maze procedure) in which the surgeon makes several incisions in the right and
left atria creating scar tissue to electrically isolate portions of the atria.
This open heart surgical procedure is complex, costly and associated with high
morbidity and mortality and therefore only used in extreme cases. There are a
limited number of patients for whom a reversible cause for atrial fibrillation
can be readily identified (for example patients with hyperthyroidism, alcoholism
or diabetes) and in whom atrial fibrillation does not recur once the cause has
been alleviated. Goals for managing patients with atrial fibrillation are to
restore and maintain the normal atrial rhythm and pumping function, control the
ventricular rate and prevent stroke. None of the commonly prescribed alternative
therapeutic options is curative and most have undesirable side effects.
Antiarrhythmic drugs, which control the ventricular rate during atrial
fibrillation, increase the risk of the patient developing life-threatening
ventricular arrhythmias. In addition, the rate of recurrence of atrial
fibrillation in patients using antiarrhythmic drugs is high, with trials
reporting as many as 60% of the patients failing to sustain normal heart rhythm
for one year. Side effects can include nausea, diarrhea, difficulty in
urinating, thyroid dysfunction, pulmonary fibrosis and liver dysfunction.
Anticoagulation drugs are generally recommended for use in concert with
antiarrhythmic drugs to reduce the risk of stroke. Anticoagulation therapy
requires attentive and frequent patient follow-up, generally including monthly
prothrombin time testing (an indicator of the blood's ability to form clots) and
dose adjustments to prevent hemorrhage complications.
 
     Internal electrical cardioversion, in which an implantable atrial
defibrillator automatically detects the onset of atrial fibrillation and
delivers low-energy shocks, has recently been introduced as a method to convert
atrial fibrillation to normal heart rhythm. Clinical trials of this proposed
treatment are in their early stages. A recent study indicated that initial
conversion rates are near 85%. However, reversion rates to atrial fibrillation
are high, and the automatic implantable atrial defibrillator is not a curative
therapy. In addition, the level of patient discomfort is often unacceptable.
 
     Less invasive treatments of atrial fibrillation include permanent
destruction of the AV node by catheter ablation accompanied by implantation of a
pacemaker, a procedure generally reserved for symptomatic individuals
experiencing prolonged or chronic episodes of atrial fibrillation where control
of the ventricular rate is the primary objective. The procedure ensures a
regular, controlled ventricular rate and improved cardiac output (with enhanced
quality of life), but the risks of stroke remain, and the atrial contribution to
cardiac output is not restored since the atria continue to fibrillate. In
addition, the patient becomes dependent upon the pacemaker to maintain an
adequate heart rate, and failure of the pacemaker can result in sudden loss of
consciousness or death. Several institutions in Europe and the United States
have undertaken procedures in which conventional radiofrequency ablation
catheters are dragged along the inside surface of the right and/or left atrium,
applying radiofrequency energy to electrically isolate portions of the atria
with scar tissue. However, it has been difficult to create a continuous line of
block to electrically isolate portions of the atria using conventional
radiofrequency catheters. In addition, although results achieved for atrial
fibrillation ablation at St. Francis Hospital in Tulsa, Oklahoma have been
encouraging, the mean time of this center's ablation procedures has been
approximately 10 hours.
 
  Supraventricular Tachycardia
 
     Supraventricular tachycardias affect ventricular rate from an origin above
the ventricles. During in-utero development, incomplete separation of the top
and bottom chambers of the heart leaves small muscle bundles that can rapidly
conduct electrical signals between chambers, resulting in a rapid heart rhythm.
The most common types of supraventricular tachycardias are Wolff-Parkinson-White
("WPW") syndrome and Atrioventricular Nodal Reentrant Tachycardia ("AVNRT"). WPW
syndrome involves a congenital remnant of
 
                                        5
<PAGE>   7
 
muscle tissue, an accessory pathway, between the atria and ventricles that can
very rapidly conduct electrical signals between the top and bottom chambers of
the heart. AVNRT, primarily a congenital condition, is characterized by a
circuit of conductive tissue between a part of the AV node and either the atria
or the ventricles. This circuit, like that of WPW syndrome, can conduct the
electrical signals from the AV node rapidly, leading to a symptomatic
tachycardia.
 
     These two common types of supraventricular tachycardias are readily
treatable using standard radiofrequency catheter ablation techniques. Since its
introduction in 1986, the success of radiofrequency catheter ablation has led to
a rapid decrease in the existing untreated population of patients with WPW
syndrome and AVNRT types of supraventricular tachycardia, antiarrhythmic drug
therapy is also a prescribed treatment. Antiarrhythmic drugs do not successfully
control the supraventricular tachycardia in many patients and often result in
undesirable side effects. Given the low morbidity and mortality, and high
success rate associated with radiofrequency catheter ablation, the Company
believes that this curative procedure has become the treatment of choice for WPW
syndrome and AVNRT.
 
THE CARDIAC PATHWAYS SOLUTION
 
     The Company is developing products to provide a comprehensive solution for
the successful diagnosis and treatment of ventricular tachycardia and atrial
fibrillation. The Company's systems are designed to allow the
electrophysiologist to perform high resolution mapping, which facilitates
location of cardiac tachyarrhythmias and assesses the effectiveness of the
minimally invasive ablation treatment. Current mapping and ablation procedures
can take many hours to complete. The Company believes its systems will
substantially shorten mapping and ablation procedure time and provide safe and
more effective treatments than other forms of therapy. The Company has also
developed and is currently marketing products for the diagnosis and treatment of
supraventricular tachycardia. The following are features and benefits of the
core technologies used in the Company's products.
 
     High Resolution Mapping for Ventricular Tachycardia. The Company's
Arrhythmia Mapping System for ventricular tachycardia utilizes a patented,
basket-shaped, multi-site, high resolution device which is placed in the
ventricle with a minimally invasive procedure, similar to a conventional heart
catheterization. This device is designed to allow the electrophysiologist to
quickly locate high rate ventricular tachycardia at multiple sites, thus
providing a significant improvement over currently used single point mapping
techniques. The Company believes that this ability to locate the source of the
ventricular tachycardia will enable a large population of patients to receive
successful treatment using the Company's Ventricular Tachycardia Ablation
System. Currently, these patients have no reliable minimally invasive means to
locate their high rate ventricular tachycardia.
 
     Cooled Ablation for Ventricular Tachycardia. The Company's Ventricular
Tachycardia Ablation System utilizes a patented electrode-cooling catheter that
allows the electrophysiologist to deliver greater energy levels than existing
technologies to the site that is causing the ventricular tachycardia without a
significant risk of producing charred blood particles that could lead to stroke.
The Company believes that the ability to make deeper and wider lesions enables
more effective treatment.
 
     Linear Lesion Ablation for Atrial Fibrillation. The Company's Atrial
Fibrillation Ablation System utilizes a proprietary, non-metallic conformable
electrode device that conforms to the irregular surface in the atrium and
delivers radiofrequency energy for lesion creation through a conductive fluid
medium. With this technology, the electrophysiologist is able to create an
unbroken transmural lesion in the atrium causing disruption of the electrical
wavefronts associated with atrial fibrillation. The Company believes ablation
procedures utilizing this technology will be more effective and significantly
less time consuming than other types of catheter ablation techniques and as
effective as the surgical maze procedure, which currently is the only curative
treatment.
 
     High Resolution Mapping for Atrial Fibrillation. The Company's Arrhythmia
Mapping System for atrial fibrillation utilizes a basket-shaped, multi-site,
high resolution device similar to that used in its Arrhythmia Mapping System for
ventricular tachycardia, but which has been designed to conform to the atria.
This technology provides high resolution, multi-site, simultaneous mapping and
is designed to be used to
 
                                        6
<PAGE>   8
 
quickly locate the source of the arrhythmia and to quickly assess the
effectiveness of the ablation treatment. The Company believes this approach will
significantly shorten the length of ablation procedures.
 
STRATEGY
 
     The Company's strategy is to establish its Ventricular Tachycardia Ablation
System, Arrhythmia Mapping Systems and Atrial Fibrillation Ablation System as
the preferred means for the diagnosis and treatment of ventricular tachycardia
and atrial fibrillation. The following are the key elements of the Company's
strategy:
 
     Demonstrate clinical efficacy and safety of the Company's mapping and
ablation systems leading to commercialization. The Company expects to market its
systems in the United States and internationally. Successful clinical trials
leading to regulatory approval are critical for market acceptance of the
Company's systems. The Company has established scientifically rigorous clinical
studies to assess the efficacy and safety of its Arrhythmia Mapping System for
use in the left ventricle and right atrium, and its Ventricular Tachycardia
Ablation System. In addition, the Company has applied for regulatory approval
relating to a clinical study for its Atrial Fibrillation Ablation System. The
results of these trials will be used to seek FDA regulatory approval to market
its mapping and ablation systems in the United States. The Company also intends
to seek regulatory approval to market these products internationally. See
"-- Clinical Trials."
 
     Build upon relationships with electrophysiologists. The Company has
developed strong relationships with prominent electrophysiologists worldwide who
have been involved and will continue to be involved in the Company's clinical
and product development. The Company intends to continue to build these
substantial relationships through clinical investigator meetings, participation
in physician-run symposia and meetings to discuss clinical issues and
treatments. The Company's strategy is to leverage these relationships with
leading electrophysiologists to gain market acceptance of its products in the
United States and internationally. The Company believes there are approximately
600 board certified electrophysiologists practicing in the United States.
 
     Provide integrated system solutions for diagnosing and treating Ventricular
Tachycardia and Atrial Fibrillation. The Company's mapping baskets and
integrated mapping computer system are designed to quickly identify the source
of an arrhythmia. The Company's catheters, including its cooled ablation and
linear lesion catheters, and integrated radiofrequency generator and
programmable fluid pump are designed to provide safe, effective ablation of the
heart tissue. The Company believes that its integrated systems approach provides
solutions for diagnosing and treating a significant portion of the patients who
suffer from ventricular tachycardia and atrial fibrillation. The Company also
believes its integrated systems solution offers advantages over other products.
All of the Company's products are designed to work together and thereby
eliminate incompatibility problems that may arise from using products from
several vendors. This makes the products easier to use, shortens procedure times
and increases the efficiency of the treatment. In addition, the Company plans to
be a single source provider of complete mapping and ablation systems, thereby
making its products more cost-effective.
 
     Maintain technological leadership and achieve market leadership. The
Company's goal is to be a market leader in the commercialization of integrated
systems to diagnose and treat ventricular tachycardia and atrial fibrillation.
The Company believes that its technological innovations have overcome the
principal obstacles to the development of such systems. In addition, the
Company's goal is to be a leading provider of these integrated systems and the
Company intends to continue to invest significant resources to enhance its
technological position and to increase market acceptance of its products.
 
     Protect and enhance proprietary position. The Company currently holds
issued and allowed patents and has pending patents covering a number of
fundamental aspects of the Company's Ventricular Tachycardia Ablation System,
Arrhythmia Mapping Systems and Atrial Fibrillation Ablation System. The Company
owns 36 United States issued patents and eight foreign issued patents. The
Company owns an exclusive field-of-use license on one United States issued
patent and licenses to 15 United States issued patents. In addition, the Company
has 22 United States pending patent applications, of which three are licensed,
and six have been allowed by the United States Patent and Trademark Office
(including one assigned re-issue patent
 
                                        7
<PAGE>   9
 
application). The Company has also filed 34 corresponding foreign patent
applications that are currently pending in Europe, Japan, Australia and Canada,
of which 10 have been published and are pending issuance. Three of the pending
foreign patent applications are PCT applications, with Europe, Japan, Australia
and Canada as designated countries for filing at the national phase. The Company
intends to continue to pursue its patent filing strategy and to vigorously
defend its intellectual property position against infringement.
 
PRODUCTS AND SYSTEMS
 
     The Company's product line is designed to provide an integrated systems
solution to the mapping and ablation of cardiac arrhythmias. The Company has
focused its product development and clinical applications on systems that
diagnose and treat ventricular tachycardia and atrial fibrillation. The
following table summarizes products that have been released and those that are
currently under development:
 
<TABLE>
<CAPTION>
             PRODUCTS                     DESCRIPTION                  STATUS(1)(2)
    ---------------------------   ---------------------------   ---------------------------
    <S>                           <C>                           <C>
    VENTRICULAR TACHYCARDIA
      CATHETERS
    Mercator Left Ventricular     A high density mapping        IDE feasibility study
      Mapping Basket              catheter and associated       completed in May 1997. IDE
                                  catheter deployment guide     supplemental submission in
                                  used to assess electrical     July 1997 for PMA or 510(k)
                                  conduction throughout the     approval process.
                                  left ventricle.
    Local Sector Mapping Basket   Variation of the Mercator     IDE supplemental submission
                                  Left Ventricular Mapping      in July 1997 for PMA or
                                  Basket that focuses mapping   510(k) approval process.
                                  electrodes in a sector or
                                  region of the left
                                  ventricle.
    Chilli Cooled Ablation        An ablation catheter that     Approved IDE June 1995;
      Catheter                    includes lumens to cool the   currently in clinical trial
                                  catheter tip during radio     for PMA approval process.
                                  frequency energy delivery.
    ATRIAL FIBRILLATION
      CATHETERS
    Nexus Linear Lesion           An ablation catheter used     Feasibility study completed
      Catheter                    to make long lesions in the   for right atrium in April
                                  atria.                        1997. Planned IDE
                                                                supplemental submission in
                                                                September 1997 for PMA
                                                                approval process for atrial
                                                                flutter.
    Mercator Atrial Mapping       A high density mapping        Approved IDE for right
      Basket                      catheter used to assess       atrium in June 1996 for
                                  atrial arrhythmias.           510(k) clearance process.
    SUPRAVENTRICULAR
      TACHYCARDIA/DIAGNOSTIC
      CATHETERS
    Radii Mapping and Ablation    A family of deflectable       Available in international
      Catheters                   catheters for mapping and     markets.
                                  ablation of
                                  supraventricular
                                  tachycardia.
    Trio/Ensemble Diagnostic      A set of three, uniquely      510(k) submitted by Arrow
      Catheters                   small multielectrode          International, Inc.
                                  catheters and a               ("Arrow") and cleared in
                                  triple-lumen guide catheter   December 1995. Available in
                                  for use in diagnostic         the United States and
                                  electrophysiology             international markets.
                                  procedures.
</TABLE>
 
                                        8
<PAGE>   10
 
<TABLE>
<CAPTION>
             PRODUCTS                     DESCRIPTION                  STATUS(1)(2)
    ---------------------------   ---------------------------   ---------------------------
    <S>                           <C>                           <C>
    HIGH RESOLUTION MAPPING
      EQUIPMENT
    Model 8100/8300 Arrhythmia    An integrated mapping         510(k) cleared in August
      Mapping System for basic    computer system that          1997. Available in the
      diagnostic                  analyzes and displays data    United States and certain
      electrophysiology studies   from single point catheters   international markets.
                                  to map electrical activity
                                  within the heart for basic
                                  diagnostic
                                  electrophysiology lab
                                  procedures.
    Model 8100/8300 Arrhythmia    An integrated mapping         IDE supplement submitted in
      Mapping System              computer system that          July 1997 for
                                  analyzes and displays data    approval-route clinical
                                  from high density mapping     study when used in the
                                  catheters; designed to be     ventricles. Approval-route
                                  used with Mercator Left       clinical study in progress
                                  Ventricular Mapping           when used in the right
                                  Baskets, Mercator Atrial      atrium.
                                  Mapping Baskets and Local
                                  Sector Mapping Baskets.
    ABLATION EQUIPMENT
    Model 8002 Radiofrequency     An integrated                 Approved with Nexus Linear
      Generator and Integrated    radiofrequency generator      Lesion Catheter in
      Fluid Pump                  energy source and fluid       September 1996.
                                  pump for cooled ablation
                                  applications.
    Model 8004 Radiofrequency     Adds to functionality and     Approved IDE with Chilli
      Generator and Integrated    ease of use of the Model      Ablation Cooled Catheter in
      Fluid Pump                  8002 for further pump         September 1995. Planned
                                  integration and for           software upgrade in the
                                  printing of ablation data.    first half of 1998 will
                                                                make the system compatible
                                                                for use with the Nexus
                                                                Linear Lesion catheter.
</TABLE>
 
---------------
(1) The status column includes the Company's current estimates of the planned
    submission time periods of IDEs for certain of the Company's products. These
    estimates are forward-looking statements that involve risks and
    uncertainties. The actual submission times could differ materially from
    those anticipated in these forward-looking statements as a result of certain
    factors, including the Company's success in completing any remaining
    development of the products, the efficacy and safety of the products in
    laboratory testing and the other factors set forth elsewhere in this report.
 
(2) At the earliest, the Company does not anticipate filing a PMA application
    for any system for at least the next six months, and does not anticipate
    receiving a PMA for any such system until at least one to two years after
    such PMA application is accepted for filing, if at all. See " -- Government
    Regulation."
 
                                        9
<PAGE>   11
 
     The following table sets forth the Company's current and planned systems
for mapping and ablation of ventricular tachycardia and atrial fibrillation and
their component catheters and equipment.
 
                            VENTRICULAR TACHYCARDIA
 
ARRHYTHMIA MAPPING SYSTEM
 
     - Mercator Left Ventricular Mapping Basket or Mercator Local Sector Mapping
       Basket
 
     - Model 8100/8300 Arrhythmia Mapping System
 
VENTRICULAR TACHYCARDIA ABLATION SYSTEM
 
     - Chilli Cooled Ablation Catheter
 
     - Models 8002 and 8004 Radiofrequency Generator and Integrated Fluid Pump
 
                              ATRIAL FIBRILLATION
 
ARRHYTHMIA MAPPING SYSTEM
 
     - Mercator Atrial Mapping Basket
 
     - Model 8100/8300 Arrhythmia Mapping System
 
ATRIAL FIBRILLATION ABLATION SYSTEM
 
     - Nexus Linear Lesion Catheter
 
     - Models 8002 and 8004 Radiofrequency Generator and Integrated Fluid Pump
 
  Ventricular Tachycardia Catheters
 
     The Company's ventricular tachycardia catheters, which consists of the
Chilli Cooled Ablation Catheter and Mercator Left Ventricular Mapping Basket,
currently in clinical trials, and the Local Sector Mapping Basket, currently in
the process of being approved for clinical trials, are designed to allow the
physician to locate the source of the ventricular tachycardia and perform an
ablation treatment that can reach wide and deep within the heart tissue to
successfully treat the patient's ventricular tachycardia.
 
     Mercator Left Ventricular Mapping Basket. The Mercator Left Ventricular
Mapping Basket is a high density 64-electrode, three dimensional basket for use
in left ventricular diagnostic electrophysiology procedures. Based on the
Company's proprietary high-density electrode mapping technology, this basket-
shaped mapping catheter has eight highly flexible electrode-carrying arms that
allow the basket to conform to the shape of the left ventricular chamber. This
design enables mapping with electrodes in contact with the heart tissue. Various
basket sizes have been designed for optimal fit in ventricular tachycardia
patients. The Company believes that the Mercator Left Ventricular Mapping Basket
will reduce procedure time and allow the mapping of a given ventricular
tachycardia rhythm using a single cardiac cycle (a single heartbeat).
Ventricular tachycardia can best be diagnosed while the patient is actually
experiencing an episode of tachyarrhythmia, which must be carefully monitored by
the physician. Current single point mapping techniques are often not appropriate
because the patient cannot be left in the unstable heart rhythm for a sufficient
length of time to determine the origins of the ventricular tachycardia. The
Mercator Left Ventricular Mapping Basket is designed to allow rapid mapping of a
large portion of the left ventricle. The Mercator Left Ventricular Mapping
Basket captures, within a few seconds, a large amount of electrical conduction
information that is useful in identifying appropriate sites for ablation. All
ventricular mapping baskets are intended for single use due to the inability of
the catheter's biocompatible, anti-coagulation coating to withstand
resterilization.
 
     The Mercator Left Ventricular Mapping Basket is combined with the Company's
Model 8100/8300 Arrhythmia Mapping System to form the Company's Arrhythmia
Mapping System for diagnostic mapping of ventricular tachycardia. This system
captures the conduction activity in the left ventricle and displays the
information, allowing the physician to evaluate and manipulate the data to
determine the source of the ventricular tachycardia and the appropriate location
for ablation. The Company believes that the Mercator
 
                                       10
<PAGE>   12
 
Left Ventricular Mapping Basket will also be usable with existing computerized
electrophysiology signal display systems after appropriate interface connections
have been implemented.
 
     Local Sector Mapping Basket. The Company has developed the first generation
Local Sector Mapping Basket, a variation of the Mercator Left Ventricular
Mapping Basket. This device clusters the electrode-carrying arms together,
providing a one-sided grouping of 40 electrodes. This product is designed to
allow the electrophysiologist to focus the electrodes of the mapping basket in
the specific region or sector of the left ventricle believed to be the locus of
the patient's ventricular tachycardia. Focusing the electrodes in a limited area
increases the amount and usefulness of the data collected for the specific
target area. Use of the Local Sector Mapping Basket would allow the
electrophysiologist to concentrate on the ventricular septal wall, the location
of the heart where the vast majority of ventricular tachycardias occur. The
Local Sector Mapping Basket is designed to be used with the Model 8100/8300
Arrhythmia Mapping System for diagnostic mapping of ventricular tachycardia. The
Local Sector Mapping Basket is intended for single use due to the inability of
the catheter's biocompatible, anticoagulation coating to withstand
resterilization.
 
     Chilli Cooled Ablation Catheter. The Chilli Cooled Ablation Catheter is a
minimally invasive device designed to treat ventricular tachycardia using
radiofrequency energy ablation to create lesions in the ventricle. Although
leading electrophysiologists have recently begun to use radiofrequency ablation
to treat ventricular tachycardia, excessive heating of the tissue and the
ablation electrode often limits the level of energy delivered and therefore the
success of the treatment. Incorporating a closed system of fluid circulation,
the Chilli Cooled Ablation Catheter allows circulating fluid to cool the
catheter ablation electrode during delivery of radiofrequency energy. A
programmable pump injects fluid into a catheter lumen that circulates the fluid
to the tip electrode and back to the fluid pump. The circulation of fluid draws
heat away from the metal electrode and from the electrode-to-tissue interface,
which the Company believes will allow the delivery of higher radiofrequency
energy power levels without excessive heating. Higher power levels allow for
creation of wider and deeper lesions than those created with lower power levels,
increasing the likelihood of a successful ablation. The Chilli Cooled Ablation
Catheter will be labeled for single use due to its closed system of fluid
circulation through catheter lumens.
 
  Atrial Fibrillation Catheters
 
     The Company is currently developing catheters to allow the physician to
treat atrial fibrillation. The Nexus Linear Lesion Catheter is designed to
create long lesions in the atria and the Atrial Mapping Basket is designed to
map the atria to assess the effectiveness of the ablation treatment.
 
     Nexus Linear Lesion Catheter. Currently, the only curative treatment for
atrial fibrillation is the surgical maze procedure in which the surgeon makes
several incisions in the right and left atria creating scar tissue to
electrically isolate portions of the atria. The Company designed the Nexus
Linear Lesion Catheter to enable a minimally invasive ablation procedure to
treat atrial fibrillation in the right atrium. A smaller version of the Nexus
Catheter (Nexus 2), featuring an optimized electrode design and improved
handling characteristics has been designed. The new catheter will be evaluated
for the treatment of atrial flutter in the right atrium, followed by studies of
its use in treating atrial fibrillation, primarily in the left atrium. The
Company believes that the Nexus Linear Lesion Catheter, through the use of a
conductive fluid medium for radiofrequency energy delivery, will produce a
homogenous lesion that will create a continuous line of block through the
tissue, creating lesions similar to those created with the surgical maze
procedure. The unique design of the Nexus Linear Lesion Catheter mounts several
electrodes together and provides a highly adjustable deployment system. This
novel deployment technique provides specific directional tissue contact for the
conformable electrode and a self-stabilizing support structure. A non-metallic
electrode allows the Nexus Linear Lesion Catheter to conform to irregular
surfaces in the endocardium and efficiently deliver radiofrequency energy for
ablating heart tissue. The Company believes that these features will
substantially reduce ablation procedure time compared to other current catheter
based treatments. As a result of the non-metallic electrode design, the Nexus
Linear Lesion Catheter will be a single-use catheter.
 
     The Nexus Linear Lesion Catheter will be used with the Company's Model 8002
Radiofrequency Generator and Integrated Fluid Pump. The Atrial Fibrillation
Ablation System will combine the unique features to be included in the Nexus
Linear Lesion Catheter with an instrument that incorporates the widely
 
                                       11
<PAGE>   13
 
accepted radiofrequency energy method for creating lesions in the heart tissue
and a programmable pump for fluid delivery during the ablation.
 
     Mercator Atrial Mapping Basket. The Mercator Atrial Mapping Basket is a
high density, 64-electrode basket that the Company believes will be useful in
atrial electrophysiology studies. This mapping catheter is based on the same
technology as the Mercator Left Ventricular Mapping Basket and has similar
design characteristics. The use of the Company's proprietary technology for
constructing high density electrode arms was leveraged in this design, and the
arm shapes were designed specifically with consideration for the anatomy of
human atria. A range of basket sizes has been developed to account for
variations in size and shape of human atria. Initially the Company has focused
its product development efforts on a mapping basket for the right atrium. The
Company believes that a mapping system for the atria will be important in
reducing the procedure time and assessing the effectiveness of ablation
procedures for treating the patient's atrial fibrillation. The Mercator Atrial
Mapping Basket is intended for single use due to the inability of the catheter's
biocompatible, anticoagulation coating to withstand resterilization.
 
     The Mercator Atrial Mapping Basket is combined with the Company's Model
8100/8300 Arrhythmia Mapping System to form the Company's Arrhythmia Mapping
System for diagnostic mapping of complex atrial tachyarrhythmias including
atrial fibrillation. This system captures the conduction activity in the atrium
and displays the information allowing the physician to evaluate and manipulate
the data to determine the source of atrial fibrillation. The Company believes
that the mapping catheter will also be compatible with existing computerized
electrophysiology signal display systems after appropriate interface connections
have been implemented.
 
  Supraventricular Tachycardia and Diagnostic Catheters
 
     The Company's Trio/Ensemble diagnostic catheters and Radii supraventricular
tachycardia mapping and ablation catheters, currently sold commercially, are
used for electrophysiological diagnostic mapping and ablation of
supraventricular tachycardia. These catheters employ single point mapping and
ablation techniques that are effective methods of locating the appropriate
ablation site for curing supraventricular tachycardia.
 
     Trio/Ensemble Diagnostic Catheters. Many diagnostic electrophysiological
studies are performed with placement of multi-electrode catheters in three or
four locations of the right heart chambers. The placement of these diagnostic
catheters provides the electrophysiologist with an overall tool to assess
electrical conduction between the atria and the ventricle. The Company believes
the Ensemble catheter is the world's smallest general purpose electrophysiology
diagnostic catheter. The Ensemble is available with five curve shapes to assist
placement of the catheters in different locations within the heart. The
Trio/Ensemble diagnostic catheters allow the placement of three diagnostic
catheters through a single patient introduction site rather than a separate
introduction site for each catheter, reducing patient preparation time,
lessening patient trauma and facilitating the electrophysiology study to be
performed on an outpatient basis. The FDA granted 510(k) clearance for the
Trio/Ensemble diagnostic catheter to Arrow in December 1995. Arrow distributes
the product in the United States and Arrow and a limited number of other
distributors market the Trio/Ensemble in certain international markets. The
Trio/Ensemble diagnostic catheters currently have list prices ranging from $150
to $250, depending upon configurations and distribution territory.
 
     Radii Mapping and Ablation Catheters. The Company's Radii family of
supraventricular tachycardia mapping and ablation catheters is similar to
catheters widely used in conjunction with ablation procedures. Each catheter has
a deflectable, steerable shaft that can be used with single-point mapping
techniques to locate potential arrhythmia sites prior to application of
radiofrequency energy to ablate the tissue. Unlike ventricular tachycardia,
single-point mapping techniques are appropriate for supraventricular tachycardia
because the arrhythmia can be induced and maintained in the patient for a
sufficient length of time to identify the origins of the supraventricular
tachycardia without threatening the patient's life. The radius of the
deflectable curve may be adjusted by the clinician. This feature allows small
catheter tip movements and slight curve changes that are necessary to reach
different anatomical sites. Some Radii models contain a temperature sensor
embedded into the ablation electrode to provide additional information about the
performance of the radiofrequency energy delivery. The Company believes that the
Radii is compatible with competing models of radiofrequency generators for use
in supraventricular tachycardia ablation procedures. The Radii supraventricular
tachycardia mapping and ablation catheters are distributed internationally by
 
                                       12
<PAGE>   14
 
distributors. Commercialization of the Radii family of catheters in the United
States would require full PMA regulatory approval and the related devotion of
substantial financial and management resources. As a result, the Company
currently does not intend to sell these products domestically. The Radii
supraventricular tachycardia mapping and ablation catheters have list prices
ranging from $600 to $800, depending upon model and distribution territory.
 
  High Resolution Mapping Equipment
 
     Electrophysiologists use dedicated signal amplifier systems to diagnose
information gathered during an electrophysiology study. Typical systems amplify
the signals recorded from the heart, convert these signals into digital
information and permanently store the digital information. A printer provides
paper display of signals for analysis by the electrophysiologist and medical
records storage. Currently, some electrophysiologists still rely on older analog
amplifier systems that merely display signals on a monitor and print them on a
paper strip chart recorder for medical records storage. These systems force the
electrophysiologist to perform a tedious process of manual measurement of the
signals printed on paper. More modern systems, while utilizing computerized
technology, are limited in their ability to support high resolution mapping
devices such as the Company's Mercator Left Ventricular Mapping Basket.
 
     The Model 8100/8300 Arrhythmia Mapping System records, amplifies and
displays the unique electrical activity recorded from catheter electrodes that
have been passed into the heart. The Arrhythmia Mapping System has been designed
to function as a signal amplifier system to be used in basic diagnostic
electrophysiology studies with single point catheters. The system also supports
complex mapping catheters by offering software that intuitively displays
information abstracted from the timing information in the electrical signals
using a type of color display known as an isochronal map. The isochronal maps
represent those parts of the heart's left ventricle that contract at the same
time by using the same color. With this technique, color indicates when parts of
the heart contract relative to each other. Colors provide rapid visual
indication of a segment of the heart that could be a source of the tachycardia.
 
     The Company's Model 8100/8300 Arrhythmia Mapping System (the "Model
8100/8300") received 510(k) clearance from the FDA in August 1997 for basic
diagnostic electrophysiology studies. The Company has begun marketing such
system commercially in the United States. However, there can be no assurance
that such system will gain any significant degree of market acceptance among
physicians, patients and health care payors. The Company believes that
physicians' acceptance of procedures performed using the Company's Model
8100/8300 will be essential for market acceptance of such system. Even though
the clinical efficacy of such system has been established, electrophysiologists,
cardiologists and other physicians may elect not to recommend the use of the
Model 8100/8300 for any number of reasons. The Company believes that, as with
any novel medical technology, there will be a significant learning process
involved for physicians to become proficient. Broad use of such system will
require training of electrophysiologists, and the time required to complete such
training could adversely affect market acceptance. Failure of such product to
achieve significant market acceptance would have a material adverse effect on
the Company's business, financial condition and results of operations. Moreover,
the Company has limited experience in manufacturing commercial volumes of its
products. Even if the Model 8100/8300 achieves market acceptance, if the Company
is unable to manufacture sufficient quantities of such product to satisfy
customer demand, the Company's business, financial condition and results of
operations would be materially adversely affected.
 
  Ablation Equipment
 
     Radiofrequency energy is the most common energy source used in catheter
ablation procedures. When radiofrequency energy is passed through heart tissue,
the tissue resists the flow of electricity, generating heat in a process known
as resistive heating. Resistive heating destroys the cardiac tissue in contact
with the catheter. The treatment of many arrhythmias requires that ablation
produce large, deep lesions. However, when the tissue becomes too hot from
resistive heating, heat conducts back from within the tissue to the catheter
electrode tip causing the formation of charred blood particles. This inhibits
the flow of electricity to the heart tissue and the depth of the lesion that can
be produced. In addition, this overheating poses a risk as the removal of the
catheter from the heart can dislodge charred blood particles that can travel
through the arteries exiting the heart into the brain, causing a stroke.
 
                                       13
<PAGE>   15
 
     Cooled ablation addresses these shortcomings of radiofrequency energy
ablation. By cooling the catheter tip, the Company believes heat is removed from
the electrode-to-tissue interface, allowing more energy to be delivered to the
heart without blood coagulating on the catheter tip, resulting in what the
Company believes are larger and deeper lesions created in a safer manner. The
Model 8002 Radiofrequency Generator and Integrated Fluid Pump incorporates the
widely accepted radiofrequency energy method for creating endocardial lesions
with a programmable fluid pump for fluid delivery during ablation. The Company
believes this is the only radiofrequency generator featuring an integrated fluid
pump for catheter electrode cooling. Software design limits the radiofrequency
energy output to a maximum of 50 watts, a level of energy delivery believed to
be both safe and sufficiently strong to produce an effective lesion. The Model
8004 Radiofrequency Generator and Integrated Fluid Pump adds functionality to
the Model 8002, including additional pump integration and printing of ablation
data.
 
     The Company's Ventricular Tachycardia Ablation System, Arrhythmia Mapping
Systems and Atrial Fibrillation Ablation System will require additional
development and clinical trials and regulatory approvals before they can be
marketed in the United States and internationally. At the earliest, the Company
does not anticipate filing a pre-market approval ("PMA") application for any
system for at least six months, and does not anticipate receiving a PMA for any
such system until at least one to two years after such PMA application is
accepted for filing, if at all. The Company will not generate any significant
revenue in the United States from the sale of such products, including the
recently obtained clearance under Section 510(k) ("510(k)") of the Food Drug and
Cosmetics Act of 1938, as amended (the "FDC Act") for the Model 8100/8300
Arrhythmia Mapping System for basic electrophysiology studies, until such time,
if ever, as its Ventricular Tachycardia Ablation System, Arrhythmia Mapping
Systems or Atrial Fibrillation Ablation System obtain clearance or approval from
the United States Food and Drug Administration (the "FDA"). There can be no
assurance that the Company's development efforts will be successful or that the
Ventricular Tachycardia Ablation System, Arrhythmia Mapping Systems or Atrial
Fibrillation Ablation System or any other product developed by the Company will
be safe or effective, approved by appropriate regulatory and reimbursement
authorities, capable of being manufactured in commercial quantities at
acceptable costs or successfully marketed. Furthermore, because the Ventricular
Tachycardia Ablation System, Arrhythmia Mapping Systems and Atrial Fibrillation
Ablation System represent the Company's sole near-term product focus, the
Company could be required to cease operations if these systems are not
successfully commercialized.
 
     There can be no assurance that the Company's Ventricular Tachycardia
Ablation System, Arrhythmia Mapping Systems or Atrial Fibrillation Ablation
System or the component catheters and equipment will gain any significant degree
of market acceptance among physicians, patients and health care payors. Even if
clinical trials demonstrate safety and efficacy and necessary regulatory and
reimbursement approvals are obtained. The Company believes that physicians'
acceptance of procedures performed using the Company's systems will be essential
for market acceptance of its systems. Physicians will not recommend that
procedures be performed using the Company's systems until such time, if at all,
as clinical data or other factors demonstrate the efficacy of such procedures as
compared to conventional drug, surgical and other treatments. Even if the
clinical efficacy of procedures using the Company's systems is established,
electrophysiologists, cardiologists and other physicians may elect not to
recommend the procedures for any number of other reasons. The Company believes
that, as with any novel medical procedure, there will be a significant learning
process involved for physicians to become proficient. Broad use of the Company's
systems will require training of physicians, and the time required to complete
such training could adversely affect market acceptance. Failure of the Company's
products to achieve significant market acceptance would have a material adverse
effect on the Company's business, financial condition and results of operations.
 
CLINICAL TRIALS
 
     The Company is currently conducting a clinical trial of the Chilli Cooled
Ablation Catheter and the Models 8002 and 8004 Radiofrequency Generator and
Integrated Fluid Pump, the products that together form the Company's Ventricular
Tachycardia Ablation System. In May 1997, the Company completed an IDE
feasibility study of the Mercator Left Ventricular Mapping Basket and the Model
8100/8300 Arrhythmia Mapping System, the products that together form the
Company's Arrhythmia Mapping System for diagnostic mapping of ventricular
tachycardia and has filed an IDE supplemental submission in July 1997 for the
Local
 
                                       14
<PAGE>   16
 
Sector Mapping Basket, a variation of the Mercator Left Ventricular Mapping
Basket. The Company is currently conducting a clinical trial of the Mercator
Atrial Mapping Basket and the Model 8100/8300 Arrhythmia Mapping System, the
products that together form the Company's Arrhythmia Mapping System for
diagnostic mapping of the right atrium. In April 1997, the Company completed a
feasibility study of the Nexus Linear Lesion Catheter and Model 8002
Radiofrequency Generator and Integrated Fluid Pump, the products that together
form the Company's Atrial Fibrillation Ablation System.
 
     Ventricular Tachycardia Ablation System. The Company initiated a clinical
trial for the Ventricular Tachycardia Ablation System in the United States and
Europe in November 1995 under an IDE approved by the FDA. The clinical trials
are being conducted at a maximum of 15 clinical sites and will involve a maximum
of 200 patients using the Ventricular Tachycardia Ablation System. Pursuant to
the IDE, the FDA will evaluate the safety and efficacy of the Ventricular
Tachycardia Ablation System. The primary endpoint of the clinical trial is
clinical recurrence of ventricular tachycardia in patients randomized to receive
ablation treatment versus patients in the control group receiving antiarrhythmic
drugs. The required post-treatment follow-up prior to submission of a PMA will
be 30 days for safety. However, the Company may be required to follow up with
each patient up to 24 months after the PMA filing. The Company anticipates that
this clinical trial will not be completed prior to early calendar 1998. At the
conclusion of the clinical trial, the Company plans to file a PMA application
for approval to market the Ventricular Tachycardia Ablation System and its
component catheters and equipment in the United States.
 
     As of May 15, 1997, the FDA no longer required randomization, and all
patients enrolled have been able to receive ablation initially. This
modification to the protocol has resulted in more rapid enrollment into the
clinical trial. As of August 18, 1997, 133 patients had been enrolled in the
trial; 75 patients randomized to ablation, 26 patients nonrandomized to
ablation, and 32 patients randomized to control of which 17 patients have
subsequently received ablation therapy due to VT recurrence. In addition, 23
patients have received ablation therapy under a compassionate use protocol. An
interim data analysis of acute and long-term success was performed as of May 31,
1997, comparing patients randomized to ablation to patients randomized to
control. Acute success of ablation therapy, defined as eradication of all
mappable VT at the end of the ablation procedure, was attained in 74% of
patients. The incidence of major adverse events associated with the procedure
has been approximately 9%.
 
     Arrhythmia Mapping System for Ventricular Tachycardia. In January 1996, the
Company received FDA approval to conduct an IDE feasibility study to evaluate
the safety of the Arrhythmia Mapping System for diagnostic mapping of
ventricular tachycardia. The feasibility study was conducted at three clinical
sites in the United States and Europe and involved a total of 13 patients. The
purpose of the clinical trial was to evaluate and test the success of the
deployment of the Mercator Left Ventricular Mapping Basket into the ventricle,
the fit of the catheter and the system's ability to accurately map the
electrical signals of the left ventricle. In addition, 14 patients were studied
in Europe outside of the IDE in a similar protocol. There was no thrombus
formation on any mapping basket used in the 27 studies. Of the 27 patients
evaluated, one patient developed asymptomatic aortic regurgitation, one patient
had a transient ischemic attack, and two patients developed pericardial
effusions associated with the procedure. In July 1997, the Company submitted an
IDE supplement to support commercialization of two types of baskets; the
Mercator Left Ventricular Mapping basket, the full chamber "global" basket
evaluated in the feasibility study, as well as a smaller, partial chamber high
density local sector basket. This study will enable the use of both ventricular
mapping baskets with the Ventricular Tachycardia Ablation System simultaneously.
Ventricular mapping should enable the treatment of high rate ventricular
tachycardia, which is more common than slow rate ventricular tachycardia which
is the only type amenable to ablation therapy using current techniques. It is
anticipated that this study will be continued in November, 1997, at 10 sites to
enroll a total of 75 patients.
 
     Arrhythmia Mapping System for Atrial Fibrillation. In June 1996, the
Company received IDE approval by the FDA to conduct a clinical trial of the
Mercator Atrial Mapping Basket for the right atrium and Arrhythmia Mapping
System for complex atrial tachyarrhythmias including atrial fibrillation. The
clinical trial is being conducted at seven clinical sites in the United States
and one in Europe. The purpose of this clinical trial is to demonstrate the
equivalency of the Right Mercator Atrial Mapping Basket and the Arrhythmia
Mapping System to commercially available mapping catheters. As of August 18,
1997, the
 
                                       15
<PAGE>   17
 
Mercator Atrial Mapping Basket was evaluated in 44 patients. There was no
thrombus formation on any mapping basket used in the 44 studies. The Company
anticipates submission of a 510(k) application for approval by the end of 1997.
 
     The Company has also tested the Mercator Atrial Mapping Basket outside of
the U.S. IDE at two European sites. As of August 18, 1997, the Mercator Atrial
Mapping Basket was safely deployed and fit properly in the right atrium in six
European patients. In addition, the Mercator Atrial Mapping Basket for the left
atrium was also tested in one of the patients. None of the patients in the U.S.
and Europe had complications as a result of the Mercator Atrial Mapping Basket
and Arrhythmia Mapping System.
 
     Atrial Fibrillation Ablation System. The Company received FDA approval of
an IDE feasibility study to evaluate the safety of the Atrial Fibrillation
Ablation System in August 1996. The purpose of the IDE feasibility study for the
Atrial Fibrillation Ablation System was to assess the safety and performance in
creating continuous linear lesions. The feasibility testing was completed with
10 patients undergoing testing.
 
     The Company also tested the Nexus Linear Lesion Catheter in two patients in
Europe. As of August 18, 1997, the Nexus Linear Lesion Catheter was used in a
total of 12 patients. The purpose of the clinical test was to verify that a
linear lesion could be made in a location in the atrium anticipated to eliminate
atrial fibrillation. In a majority of the patients undergoing ablation, linear
lesions were created in the right atrium either with the Nexus Linear Lesion
Catheter alone or with commercial ablation catheter supplementation. One patient
developed a pericardial effusion attributed to perforation by a commercial
diagnostic (nonablation) catheter. No other complications occurred.
 
     The Nexus Linear Lesion Catheter was modified to improve the ability to
create linear lesions minimizing the need for commercial ablation catheter
supplementation. The modifications include the addition of active deflection to
facilitate tissue contact. It is anticipated that an IDE supplement will be
submitted by October 1997 to support commercialization of the Nexus Linear
Lesion Catheter in the right atrium to treat atrial flutter. Atrial flutter is
an abnormal heart rhythm now commonly treated using catheter ablation, requiring
the creation of a two to four centimeter linear lesion in the right atrium. The
study is expected to begin in early calendar 1998 involving 100 patients at 12
investigative sites.
 
     The Company anticipates the submission of an IDE for use of the modified
Nexus Linear Lesion Catheter in the left atrium for the treatment of atrial
fibrillation in November 1997.
 
     The Ventricular Tachycardia Ablation System, Arrhythmia Mapping System for
diagnostic mapping of ventricular tachycardia and Arrhythmia Mapping System for
diagnostic mapping of the right atrium are in various stages of clinical
testing. Clinical data obtained to date are insufficient to demonstrate the
safety and efficacy of these products under applicable FDA regulatory
guidelines. There can be no assurance that any of the Company's products will
prove to be safe and effective in clinical trials under applicable United States
or international regulatory guidelines or that additional modifications to the
Company's products will not be necessary. In addition, the clinical trials may
identify significant technical or other obstacles to be overcome prior to
obtaining necessary regulatory or reimbursement approvals. In addition, the
ablation catheter and ablation equipment that together form the Company's Atrial
Fibrillation Ablation System are still under development. There can be no
assurance that the Company will be successful in completing development of the
atrial fibrillation product and submitting the appropriate IDEs or that the FDA
will permit the Company to undertake clinical trials of the atrial fibrillation
product. If the Ventricular Tachycardia Ablation System, Arrhythmia Mapping
Systems and Atrial Fibrillation Ablation System and their component catheters
and equipment do not prove to be safe and effective in clinical trials or if the
Company is otherwise unable to commercialize these products successfully, the
Company's business, financial condition and results of operations will be
materially adversely affected. In addition, because ablation treatment of these
cardiac arrhythmias is a relatively new and to date untested treatment, the
long-term effects of radiofrequency ablation on patients are unknown. As a
result, the long-term success of ablation therapy in treating ventricular
tachycardia and atrial fibrillation will not be known for several years.
 
                                       16
<PAGE>   18
 
MARKETING AND DISTRIBUTION
 
     The Company markets its Trio/Ensemble diagnostic catheters and Radii
supraventricular tachycardia mapping and ablation catheters internationally
through established distributors of specialty cardiovascular products. The
Company's agreement with Arrow provides distribution rights for the
Trio/Ensemble diagnostic catheters throughout the world except for the
territories of Japan and southern Europe. For distribution of the Company's
Radii supraventricular tachycardia mapping and ablation catheters, the Company
has agreements with distributors in Canada, Europe, Japan and the Pacific Rim.
Sales to Japan Lifeline Company, Ltd. ("Japan Lifeline"), the Company's
distributor in Japan, Arrow, and Sorin, S.p.A. ("Sorin"), the Company's
distributor in southern Europe, accounted for 66%, 17% and 13%, respectively, of
the Company's net sales in fiscal 1997. Sales to Japan Lifeline, Arrow, and
Sorin accounted for 54%, 33% and 13%, respectively, of the Company's net sales
in fiscal 1996 and 15%, 0% and 57%, respectively, in fiscal 1995. International
sales accounted for 82%, 67% and 100% of the Company's net sales in fiscal 1997,
1996 and 1995, respectively.
 
     The Company generally operates under written distribution agreements that
grant exclusive rights to sell the Company's products within a defined
territory. These agreements generally grant the Company the right to terminate
the distributor for cause (which includes failure to satisfy specified minimum
performance obligations) or the failure of the distributor to obtain required
governmental approvals to distribute the Company's products in the territory.
These distributors also market medical products of other companies, although the
Company has obtained covenants from its distributors granting the Company rights
to terminate given distribution agreements with distributors that market medical
devices that compete directly with those of the Company. Distributors typically
purchase the Company's products at a discount to list price and resell the
products to hospitals and physicians. Sales to international distributors are
usually denominated in United States dollars. The end-user price is determined
by the distributor and varies from country to country.
 
     The Company currently has only a limited sales and marketing organization.
The Company's Vice President, International and Technical Marketing manages
distributor relationships throughout the world. The Company recently obtained
510(k) clearance for the Model 8100/8300 Arrhythmia Mapping System for basic
electrophysiology studies. The Company is currently in the process of hiring one
U.S. sales representative and one field application engineer to market and sell
this equipment in the United States. In addition the Company intends to leverage
its existing field clinical engineers' and specialists' technical expertise to
support the Arrhythmia Mapping System revenue related installations. There can
be no assurance that electrophysiologists will accept the Arrhythmia Mapping
System on a commercial basis. Failure of such system to gain market acceptance
would have a material adverse effect upon the Company's business, financial
condition and results of operations. If FDA clearances or approvals are received
for the Company's ventricular tachycardia or atrial fibrillation products, the
Company intends to market its products primarily through a direct sales force in
the United States and indirect sales channels internationally. The Company
believes that the concentrated nature of the market of practicing
electrophysiologists in the United States will allow it to address this market
with a small, targeted sales force. The Company believes that fewer than 200 of
the leading electrophysiology centers account for approximately two-thirds of
the electrophysiological procedures performed for ventricular tachycardia. The
Company's existing distributors in Japan and southern Europe for the
Trio/Ensemble diagnostic catheters and Radii supraventricular tachycardia
mapping and ablation catheters have the right to elect to become the exclusive
distributors of the ventricular tachycardia and atrial fibrillation products in
their respective territories.
 
     The Company expects to expand its sales and marketing efforts to include
marketing managers and clinical specialists to assist in the sales and marketing
efforts. The Company's marketing and sales strategy in the United States will
involve the use of a combination of sales representatives directly employed by
the Company and field clinical engineers to provide technical expertise. The
role of the sales representative will be to demonstrate the use of the Company's
products while educating physicians as to the clinical benefits of catheter
ablation for atrial fibrillation and ventricular tachycardia, using marketing
techniques similar to those commonly employed in the cardiovascular device
industry. The role of the field clinical engineer will be to provide
installations of the Company's systems and provide training to physicians and
their staff on appropriate operation of the Company's equipment. The Company
also intends to establish a resource to provide physicians with relevant
clinical information regarding the Company's products. The Company believes that
 
                                       17
<PAGE>   19
 
this combination of sales representatives and field clinical engineers will
provide an appropriate balance of professional selling skills while maintaining
an appropriate level of technical expertise in the field.
 
     A key element of the Company's marketing strategy has been to develop
relationships with prominent academic physicians who have a history of research
and publications in peer reviewed literature on ablation for ventricular
tachycardia and atrial fibrillation. The Company's strategy is to leverage off
these relationships with leading electrophysiologists to gain market acceptance
of its products in the United States and internationally. The Company believes
there are approximately 600 board certified electrophysiologists practicing in
the United States. These physicians have been involved and will continue to be
involved in the Company's clinical and product development efforts. The Company
intends to continue to build these relationships through clinical investigator
meetings, participation in physician-run symposia and meetings to discuss
clinical issues and treatments. Because of the sub-specialty nature of
electrophysiology, electrophysiologists with high patient volume are found in
referral centers usually associated with major academic medical centers in large
urban population centers. These electrophysiologists have been identified by the
Company as potential prospects and will be the object of concentrated sales
efforts in the future if the Company's ventricular tachycardia or atrial
fibrillation products receive regulatory approvals.
 
     Establishing a marketing and sales capability sufficient to support sales
in commercial quantities will require substantial efforts and require
significant management and financial resources. There can be no assurance that
the Company will be able to build such a marketing staff or sales force, that
establishing such a marketing staff or sales force will be cost-effective or
that the Company's sales and marketing efforts will be successful. If the
Company is successful in obtaining the necessary regulatory approvals for its
ventricular tachycardia and atrial fibrillation products in international
markets, it expects to establish a sales and marketing capability in those
markets primarily through distributors. The Company is currently in discussions
with its distributor in France, U.K., Spain and Portugal to terminate the
relationship for strategic reasons. There can be no assurance that the Company
will be able to enter into agreements with desired distributors on a timely
basis or at all, or that such distributors will devote adequate resources to
selling the Company's products. Failure to establish appropriate distribution
relationships could have a material adverse effect upon the Company's business,
financial condition and results of operations.
 
     The Company currently sells its Radii supraventricular tachycardia mapping
and ablation catheters, Trio/Ensemble diagnostic catheters and Arrhythmia
Mapping Systems through distributors in certain international markets. All sales
of the Company's products to date have been denominated in U.S. dollars. In
addition, the Company plans to market its ventricular tachycardia and atrial
fibrillation products in international markets, subject to receipt of required
regulatory approvals. Changes in overseas economic conditions, currency exchange
rates, foreign tax laws, or tariffs or other trade regulations could have a
material adverse effect on the Company's ability to market its products
internationally and therefore on its business, financial condition and results
of operations.
 
STRATEGIC RELATIONSHIPS
 
     The Company intends to pursue strategic relationships with corporations and
research institutions with respect to the research, development, international
regulatory approval, manufacturing and marketing of certain of its products. In
March 1995, the Company formed a strategic relationship with Arrow, a
manufacturer of medical products for critical care medicine, interventional
cardiology and radiology. The relationship included Arrow's equity investment of
$9.1 million in the Company. The Company and Arrow entered into agreements
pursuant to which the Company granted to Arrow certain manufacturing and
distribution rights to the Trio/Ensemble diagnostic catheters and Radii
supraventricular tachycardia mapping and ablation catheters. Subsequently, the
Company and Arrow terminated the manufacturing and distribution agreement
related to the Radii product. Although the Company intends to pursue additional
strategic relationships in the future, there can be no assurance that the
Company will be successful in establishing or maintaining any such relationships
or that any such relationship will be successful. See "-- Marketing and
Distribution."
 
                                       18
<PAGE>   20
 
RESEARCH AND DEVELOPMENT
 
     Substantially all of the Company's research and development activities are
performed internally by the Company's team of research scientists, engineers and
technicians. The Company's research and development team is generally divided
into three groups. The Systems and Software Group, consisting of 15 persons as
of June 30, 1997, is responsible for all development activities related to the
Company's ablation and mapping equipment. The Catheter Development Group,
consisting of 16 persons at June 30, 1997, is responsible for all development
activities related to ablation and mapping catheters. The Company's primary
research and development programs involve completing development of the Atrial
Fibrillation Ablation System and developing improvements to the Ventricular
Tachycardia Mapping System, including new mapping and ablation catheter
configurations and new versions of the mapping and ablation equipment and
related software in order to increase the efficacy of the procedures, increase
manufacturing reliability and reduce component and manufacturing costs.
 
     Research and development expenses for fiscal 1997, 1996 and 1995 were $11.8
million, $6.8 million and $5.7 million, respectively. The Company intends to
continue to make significant investments in research and development.
 
MANUFACTURING
 
     The Company has a 14,000 square feet manufacturing facility consisting of
approximately 9,000 square feet for catheter manufacturing, and systems assembly
and testing, and approximately 5,000 square feet of manufacturing support area
at its facilities in Sunnyvale, California. The Company currently manufactures
its catheters and systems in limited quantities for laboratory testing, United
States clinical trials, international clinical trials and, in the case of its
Radii supraventricular tachycardia mapping and ablation catheters, Trio/Ensemble
diagnostic catheters and Arrhythmia Mapping Systems, limited commercial sales.
The manufacture of catheters is a complex operation involving a number of
separate processes and components. Each catheter is assembled and individually
tested by the Company prior to sterilization in accordance with FDA
requirements. The manufacturing process for the mapping and ablation equipment
consists primarily of assembly of purchased components and testing operations.
 
     The Company is currently encountering low yields, vendor shortages and
other significant production inefficiencies in the manufacture of its Mercator
Left Ventricular Mapping Basket and Mercator Atrial Mapping Basket. Although the
Company is taking appropriate steps to address these yield and other production
inefficiencies, there can be no assurance that such improvements will be
achieved. Failure to obtain acceptable yields in the manufacture of such
products will adversely affect the ability of the Company to expand its mapping
system clinical sites and commence commercialization of this product in
international markets within the next three months.
 
     Components and raw materials are purchased from various qualified suppliers
and subjected to stringent quality specifications. The Company conducts quality
audits of suppliers and is establishing a vendor certification program. A number
of the components are provided by sole source suppliers. For certain of these
components, there are relatively few alternative sources of supply, and
establishing additional or replacement vendors for such components could not be
accomplished quickly. The Company plans to qualify additional suppliers if and
as future production volumes increase. Because of the long lead time for some
components that are currently available from a single source, a vendor's
inability to supply such components in a timely manner could have a material
adverse effect on the Company's ability to manufacture the mapping basket,
mapping equipment and ablation equipment and therefore on its business,
financial condition and ability to market its products as currently
contemplated.
 
     The Company has no experience manufacturing its products in the volumes
that will be necessary for the Company to achieve significant commercial sales,
and there can be no assurance that reliable, high-volume manufacturing capacity
can be established or maintained at commercially reasonable costs. If the
Company receives FDA clearance or approval for its products, it will need to
expend significant capital resources and develop manufacturing expertise to
establish large-scale manufacturing capabilities. Manufacturers often encounter
difficulties in scaling up production of new products, including problems
involving production yields,
 
                                       19
<PAGE>   21
 
quality control and assurance, component supply shortages, shortages of
qualified personnel, compliance with FDA regulations, and the need for further
FDA approval of new manufacturing processes. In addition, the Company believes
that substantial cost reductions in its manufacturing operations will be
required for it to commercialize its catheters and systems on a profitable
basis. Any inability of the Company to establish and maintain large-scale
manufacturing capabilities would have a material adverse effect on the Company's
business, financial condition and results of operations.
 
     The Company's manufacturing facilities are subject to periodic inspection
by regulatory authorities, and its operations must undergo Quality System (the
successor to current Good Manufacturing Practice regulations) compliance
inspections conducted by the FDA. To date, the Company's facilities and
manufacturing processes have not undergone any such inspections. The Company
will be required to comply with Quality System requirements in order to produce
products for sale in the United States and with ISO 9001/EN46001 standards in
order to produce products for sale in Europe. The Company has been recommended
for ISO 9001/EN46001 certification by its European Notified Body and anticipates
final certification by the end of September 1997. Any failure of the Company to
comply with Quality System or ISO 9001/EN46001 standards may result in the
Company being required to take corrective actions, such as modification of its
policies and procedures. The State of California also requires that the Company
obtain a license to manufacture medical devices. The Company has applied for a
device manufacturing license from the California Department of Health Services
("CDHS"), however, the Company has not yet received an inspection by the CDHS
which is required before a license can be issued. If the Company is unable to
maintain such a license, it would be unable to manufacture or ship any product,
which inability would have a material adverse effect on the Company's business,
financial condition and results of operations.
 
PATENTS AND PROPRIETARY RIGHTS
 
     The Company's success will depend in part on its ability to obtain patent
and copyright protection for its products and processes, to preserve its trade
secrets and to operate without infringing or violating the proprietary rights of
third parties. The Company's strategy is to actively pursue patent protection in
the United States and foreign jurisdictions for technology that it believes to
be proprietary and that offers a potential competitive advantage for its
products. The Company holds issued and allowed Patents covering a number of
fundamental aspects of the Company's Ventricular Tachycardia Ablation System,
Arrhythmia Mapping Systems and Atrial Fibrillation Ablation System. The Company
owns 36 United States issued patents and eight foreign issued patents. The
Company owns an exclusive field-of-use license on one United States issued
patent and licenses to 15 United States issued patents. In addition, the Company
has 22 United States pending patent applications, of which three are licensed,
and six have been allowed by the United States Patent and Trademark Office (the
"USTPO") (including one assigned re-issue patent application). The Company has
also filed 34 corresponding foreign patent applications that are currently
pending in Europe, Japan, Australia and Canada, of which 10 have been published
and are pending issuance. Three of the pending foreign patent applications are
PCT applications, with Europe, Japan, Australia and Canada as designated
countries for filing at the national phase. The Company's patents and patent
applications relate to a number of aspects of the Company's technology,
including the technology related to the Company's basket approach to diagnostic
mapping, the integration of mapping and ablation in a single device, the cooled
ablation catheters, bend location and radius adjustment in the ablation
catheters and the multipart introducer. The Company intends to file additional
patent applications to seek protection for other proprietary aspects of its
technology in the future. The patent positions of medical device companies,
including those of the Company, are uncertain and involve complex and evolving
legal and factual questions. The coverage sought in a patent application either
can be denied or significantly reduced before or after the patent is issued.
Consequently, there can be no assurance that any patents from pending patent
applications or from any future patent application will be issued, that the
scope of any patent protection will exclude competitors or provide competitive
advantages to the Company, that any of the Company's patents will be held valid
if subsequently challenged or that others will not claim rights in or ownership
of the patents and other proprietary rights held by the Company. Since patent
applications are secret until patents are issued in the United States or
corresponding applications are published in international countries, and since
publication of discoveries in the scientific or patent literature often lags
behind actual discoveries, the Company cannot be certain that it was the first
to make the inventions
 
                                       20
<PAGE>   22
 
covered by each of its pending patent applications or that it was the first to
file patent applications for such inventions. In addition, there can be no
assurance that competitors, many of which have substantial resources and have
made substantial investments in competing technologies, will not seek to apply
for and obtain patents that will prevent, limit or interfere with the Company's
ability to make, use or sell its products either in the United States or in
international markets. Further, the laws of certain foreign countries do not
protect the Company's intellectual property rights to the same extent as do the
laws of the United States. Litigation or regulatory proceedings, which could
result in substantial cost and uncertainty to the Company may also be necessary
to enforce patent or other intellectual property rights of the Company or to
determine the scope and validity of other parties' proprietary rights. There can
be no assurance that the Company will have the financial resources to defend its
patents from infringement or claims of invalidity.
 
     The Company also relies on licensed technology from others for certain
components of its mapping and ablation systems. The Company relies on an
exclusive royalty-bearing license for the use of patents relating to a device
for ablating atrial fibrillation. The license will convert into a fully paid
nonexclusive license on the later of ten years from the first commercial sale of
products based on the patents or the expiration date of the last-to-expire
licensed patent. The Company obtained the rights to its biocompatible coating
material through a nonexclusive royalty bearing license that will terminate upon
the later of ten years from the first commercial sale of catheters treated with
the coating material or the expiration of the last-to-expire licensed patent.
The license can also be terminated if the Company does not begin commercial
sales of catheters using the biocompatible coating by July 1998.
 
     In addition to patents, the Company relies on trade secrets and proprietary
know-how to compete, which it seeks to protect, in part, through appropriate
confidentiality and proprietary information agreements. These agreements
generally provide that all confidential information developed or made known to
individuals by the Company during the course of the relationship with the
Company is to be kept confidential and not disclosed to third parties, except in
specific circumstances. The agreements also generally provide that all
inventions conceived by the individual in the course of rendering service to the
Company shall be the exclusive property of the Company. There can be no
assurance that proprietary information or confidentiality agreements with
employees, consultants and others will not be breached, that the Company will
have adequate remedies for any breach, or that the Company's trade secrets will
not otherwise become known to or independently developed by competitors.
 
     The medical device industry has been characterized by extensive litigation
regarding patents and other intellectual property rights, and companies in the
medical device industry have employed intellectual property litigation to gain a
competitive advantage. There can be no assurance that the Company will not
become subject to patent infringement claims or litigation in a court of law, or
interference proceedings declared by the USPTO to determine the priority of
inventions or an opposition to a patent grant in a foreign jurisdiction. The
defense and prosecution of intellectual property suits, USPTO interference or
opposition proceedings and related legal and administrative proceedings are both
costly and time-consuming. Any litigation, opposition or interference
proceedings will result in substantial expense to the Company and significant
diversion of effort by the Company's technical and management personnel. An
adverse determination in litigation or interference proceedings to which the
Company may become a party could subject the Company to significant liabilities
to third parties, require disputed rights to be licensed from third parties or
require the Company to cease using such technology. Although patent and
intellectual property disputes in the medical device area have often been
settled through licensing or similar arrangements, costs associated with such
arrangements may be substantial and could include ongoing royalties.
Furthermore, there can be no assurance that necessary licenses from others would
be available to the Company on satisfactory terms, if at all. Adverse
determinations in a judicial or administrative proceeding or failure to obtain
necessary licenses could prevent the Company from manufacturing and selling its
products, which would have a material adverse effect on the Company's business,
financial condition and results of operations. The Company is aware of certain
patents owned or licensed by others and relating to cardiac catheters and
cardiac monitoring. Certain enhancements of the Company's products are still in
the design and pre-clinical testing phase. Depending on the ultimate design
specifications and results of pre-clinical testing of these enhancements there
can be no assurance that the Company would be able to obtain a license to such
patents or that a court would find that such patents are
 
                                       21
<PAGE>   23
 
either not infringed by such enhancements or are invalid. Further, there can be
no assurance that owners or licensees of these patents will not attempt to
enforce their patent rights against the Company in a patent infringement suit or
other legal proceeding, regardless of the likely outcome of such suit or
proceeding.
 
COMPETITION
 
     At present, the Company considers its primary competition to be companies
involved in current, more established therapies for the treatment of ventricular
tachycardia and atrial fibrillation, including drugs, external electrical
cardioversion and defibrillation, implantable defibrillators, ablation
accompanied by pacemaker implantation, and open-heart surgery. In addition,
several competitors are also developing new approaches and new products for the
treatment and mapping of ventricular tachycardia and atrial fibrillation,
including ablation systems using ultrasound, microwave, laser and cryoablation
technologies and mapping systems using contact mapping, single-point spacial
mapping and non-contact, multisite electrical mapping technologies. Many of the
Company's competitors have an established presence in the field of
interventional cardiology and electrophysiology, including Boston Scientific
Corporation, C.R. Bard, Inc., Johnson & Johnson through its Cordis Division and
Medtronic, Inc. Many of these competitors have substantially greater financial
and other resources than the Company, including larger research and development
staffs and more experience and capabilities in conducting research and
development activities, testing products in clinical trials, obtaining
regulatory approvals, and manufacturing, marketing and distributing products.
There can be no assurance that the Company will succeed in developing and
marketing technologies and products that are more clinically efficacious and
cost-effective than the more established treatments or the new approaches and
products developed and marketed by its competitors. Furthermore, there can be no
assurance that the Company will succeed in developing new technologies and
products that are available prior to its competitors' products. The failure of
the Company to demonstrate the efficacy and cost-effective advantages of its
products over those of its competitors or the failure to develop new
technologies and products before its competitors could have a material adverse
effect on the Company's business, financial condition and results of operations.
 
     The Company believes that the primary competitive factors in the market for
cardiac ablation and mapping devices are safety, efficacy, ease of use and
price. In addition, the length of time required for products to be developed and
to receive regulatory and, in some cases, reimbursement approval is an important
competitive factor. The medical device industry is characterized by rapid and
significant technological change. Accordingly, the Company's success will depend
in part on its ability to respond quickly to medical and technological changes
through the development and introduction of new products. Product development
involves a high degree of risk and there can be no assurance that the Company's
new product development efforts will result in any commercially successful
products. The Company believes it competes favorably with respect to these
factors, although there is no assurance that it will be able to continue to do
so.
 
GOVERNMENT REGULATION
 
  United States
 
     Clinical testing, manufacture and sale of the Company's products are
subject to regulation by numerous governmental authorities, principally the FDA
and corresponding state and foreign regulatory agencies. Pursuant to the FDC
Act, the FDA regulates the clinical testing, manufacture, labeling, distribution
and promotion of medical devices. Noncompliance with applicable requirements can
result in, among other things, fines, injunctions, civil penalties, recall or
seizure of products, total or partial suspension of production, failure of the
government to grant premarket clearance or premarket approval for devices,
withdrawal of marketing approvals, a recommendation by the FDA that the Company
not be permitted to enter into government contracts and criminal prosecution.
The FDA also has the authority to request repair, replacement or refund of the
cost of any device manufactured or distributed by the Company.
 
     In the United States, medical devices are classified into one of three
classes, Class I, II or III, on the basis of the controls deemed by the FDA to
be necessary to reasonably ensure their safety and effectiveness. Class I
devices are subject to general controls (e.g., labeling, premarket notification
and adherence to current Good Manufacturing Practice regulations). Class II
devices are subject to general controls and to special
 
                                       22
<PAGE>   24
 
controls (e.g., performance standards, postmarket surveillance, patient
registries, and FDA guidelines). Generally, Class III devices (e.g.,
life-sustaining, life-supporting and implantable devices, or new devices which
have not been found substantially equivalent to legally marketed devices), are
those that require clinical testing to assure safety and effectiveness and FDA
approval prior to marketing and distribution.
 
     Before a new device can be introduced into the market, the manufacturer
must generally obtain marketing clearance through a premarket notification under
Section 510(k) of the FDC Act or an approval of a PMA application under Section
515 of the FDC Act. A 510(k) clearance typically will be granted if the
submitted information establishes that the proposed device is "substantially
equivalent" to a legally marketed Class I or II medical device or to a Class III
medical device for which the FDA has not called for a PMA (i.e., a predicate
device). A 510(k) notification must contain information to support a claim of
substantial equivalence, which may include laboratory test results or the
results of clinical studies of the device in humans. Commercial distribution of
a device for which a 510(k) clearance is required can only begin after the FDA
issues an order finding the device to be "substantially equivalent" to a
predicate device. The FDA recently has been requiring a more rigorous
demonstration of substantial equivalence than in the past and is more likely to
require the submission of human clinical trial data. Based upon industry and FDA
publications, the Company believes that it generally takes from four to twelve
months from the date of submission to obtain a 510(k) clearance, but it may take
longer. The FDA may determine that a proposed device is not substantially
equivalent to a legally marketed device, or that additional information is
needed before a substantial equivalence determination can be made. A "not
substantially equivalent" determination, or a request for additional
information, could delay the market introduction of new products that fall into
this category.
 
     For any devices that are cleared through the 510(k) process, modifications
or enhancements that could significantly affect safety or effectiveness, or
constitute a major change in the intended use of the device, will require new
510(k) submissions. The FDA granted 510(k) clearance to Arrow in December 1995
for Trio/Ensemble diagnostic Catheters and Arrow distributes the product in the
United States and internationally. In addition the FDA granted 510(k) clearance
to the Company in August 1997 for the Model 8100/8300 Arrhythmia Mapping System
for basic diagnostic electrophysiology studies.
 
     If the Company cannot establish that a proposed device is substantially
equivalent to a legally marketed predicate device, the Company must seek
premarket approval of the proposed device from the FDA through the submission of
a PMA application. A PMA application must be supported by valid scientific
evidence that typically includes extensive data, including preclinical and
clinical trial data, to demonstrate the safety and efficacy of the device. If
human clinical trials of a device are required and the device presents a
"significant risk," the sponsor of the trial (usually the manufacturer or the
distributor of the device) is required to file an IDE application with the FDA
prior to commencing human clinical trials. The IDE application must be supported
by data, typically including the results of animal and laboratory testing. If
the IDE application is approved by the FDA and one or more appropriate
institutional review boards ("IRBs"), human clinical trials may begin at a
specific number of investigational sites with a specific number of patients, as
approved by the FDA. If the device presents a "nonsignificant risk" to the
patient, a sponsor may begin the clinical trial after obtaining approval for the
study by one or more appropriate IRBs without the need for FDA approval.
Sponsors of clinical trials are permitted to sell investigational devices
distributed in the course of the study provided such compensation does not
exceed recovery of the costs of manufacture, research, development and handling.
An IDE supplement must be submitted to and approved by the FDA before a sponsor
or an investigator may make a change to the investigational plan that may affect
its scientific soundness or the rights, safety or welfare of human subjects.
 
     The Company initiated a clinical trial for the Ventricular Tachycardia
Ablation System in the United States and Europe in November 1995 under an IDE
approved by the FDA. Although the Company is currently conducting clinical
trials with the device, there can be no assurance that such trials will be
completed, or if completed, that such trials will provide sufficient safety and
effectiveness data and information to support a PMA application and to obtain
FDA marketing approval. The Company initiated a clinical trial for the
Arrhythmia Mapping System for diagnostic mapping of the right atrium in June
1996 under an IDE approved by the FDA. Although the Company is currently
conducting clinical trials with the device, there can be no assurance that such
trials will be completed, or if completed, that such trials will provide
sufficient safety
 
                                       23
<PAGE>   25
 
and effectiveness data and information to support 510(k) marketing approval. In
January 1996, the Company received FDA approval to conduct an IDE feasibility
study to evaluate the safety of the Arrhythmia Mapping System for diagnostic
mapping of ventricular tachycardia which has been completed. In June 1996, the
Company received an IDE supplement approval to the feasibility study relating to
a slight modification to the deployment system of the Arrhythmia Mapping System
for ventricular tachycardia in response to a complication noted in the
evaluation of a patient enrolled in the feasibility study. The IDE feasibility
study for the diagnostic mapping of ventricular tachycardia was completed in May
1997. See "-- Clinical Trials -- Arrhythmia Mapping System for Ventricular
Tachycardia." An IDE feasibility study is a limited investigation that is
intended to provide data on the device's form, function and feasibility for
diagnosis or therapeutic use. IDE applications for feasibility studies vary in
scope, but typically will include one investigator at one site with a limited
number of subjects, usually consisting of ten or less. Data from the IDE
feasibility study will not be considered by the FDA as pivotal evidence of
safety and effectiveness, but rather as a basis to finalize and confirm the
device's design and determine its potential for further development. There can
be no assurance that any IDE feasibility study that the Company proposes will be
approved by the FDA, will be completed or, if completed, will provide sufficient
data and information to support additional clinical investigations of the type
necessary to obtain FDA marketing clearance or approval. There can be no
assurance that the Company will be able to obtain necessary regulatory approvals
on a timely basis or at all, and delays in receipt of or failure to receive such
approvals, the loss of previously received approvals, or failure to comply with
existing or future regulatory requirements would have a material adverse effect
on the Company's business, financial condition and results of operations.
 
     The Company's current estimates of planned submission time periods of IDEs
for certain of the Company's products are set out above in "Products and
Systems" and involve risks and uncertainties. The actual submission times could
differ materially from those anticipated as a result of certain factors,
including the Company's success in completing any remaining development of the
products, the efficacy and safety of the products in laboratory testing and the
other factors set forth elsewhere in this report. The PMA application must
contain the results of clinical trials, the results of all relevant bench tests,
laboratory and animal studies, a complete description of the device and its
components, and a detailed description of the methods, facilities and controls
used to manufacture the device. In addition, the submission must include the
proposed labeling, advertising literature and training methods (if required).
Upon receipt of a PMA application, the FDA makes a threshold determination as to
whether the application is sufficiently complete to permit a substantive review.
If the FDA determines that the PMA application is sufficiently complete to
permit a substantive review, the FDA will accept the application for filing.
Once the submission is accepted for filing, the FDA begins an in-depth review of
the PMA application. Although under the FDC Act, the FDA is required to complete
its review of a PMA within 180 days, the agency may take a significantly longer
period of time to complete its review. Based upon industry and FDA publications,
the Company believes that an FDA review of a PMA application generally takes one
to three years from the date the PMA application is accepted for filing, but may
take significantly longer. The review time can be significantly extended by the
FDA asking for more information or clarification of information already provided
in the submission. During the review period, an advisory committee, typically a
panel of clinicians, will likely be convened to review and evaluate the
application and provide recommendations to the FDA as to whether the device
should be approved. The FDA is not bound by the recommendations of the advisory
panel. Toward the end of the PMA application review process, the FDA generally
will conduct an inspection of the manufacturer's facilities to ensure that the
facilities are in compliance with applicable Quality System requirements.
 
     If the FDA's evaluations of both the PMA application and the manufacturing
facilities are favorable, the FDA typically issues an "approvable letter," which
usually contains a number of conditions that must be met in order to secure
final approval of the PMA application. When and if those conditions have been
fulfilled to the satisfaction of the FDA, the agency will issue a PMA,
authorizing commercial distribution of the device for certain indications. If
the FDA evaluation of the PMA application or manufacturing facilities is not
favorable, the FDA will deny approval of the PMA application or issue a "not
approvable" letter. The FDA may also determine that additional clinical trials
are necessary, in which case the PMA may be delayed for several years while
additional clinical trials are conducted and submitted in an amendment to the
PMA
 
                                       24
<PAGE>   26
 
application. The PMA process can be expensive, uncertain and lengthy. A number
of devices for which FDA approval has been sought by other companies have never
been approved for marketing.
 
     Modifications to a device that is the subject of an approved PMA, its
labeling, or manufacturing process may require approval by the FDA of PMA
supplements or new PMAs. Supplements to a PMA often require the submission of
the same type of information required for an initial PMA, except that the
supplement is generally limited to that information needed to support the
proposed change from the product covered by the original PMA.
 
     Any devices manufactured or distributed by the Company pursuant to FDA
clearance or approvals are subject to pervasive and continuing regulation by FDA
and certain state agencies, including record keeping requirements and reporting
of adverse experiences with the use of the device. Labeling and promotional
activities are subject to scrutiny by FDA and, in certain circumstances, by the
Federal Trade Commission. Current FDA enforcement policy prohibits the marketing
of approved medical devices for unapproved uses.
 
     Manufacturers of medical devices intended for distribution in the United
States are required to adhere to applicable regulations setting forth detailed
Quality System requirements, which include testing, control and documentation
requirements to register their establishments with the FDA; and to submit device
listing information regarding the devices marketed in the United States.
Manufacturers must also comply with Medical Device Reporting ("MDR")
requirements that a firm report to FDA any incident in which its product may
have caused or contributed to a death or serious injury, or in which its product
malfunctioned and, if the malfunction were to recur, it would be likely to cause
or contribute to a death or serious injury.
 
     The Company has applied for a device manufacturing license from the CDHS;
however, the Company has not yet received an inspection by the state agency,
which is required before a license can be issued. The Company is subject to
routine inspection by FDA and the CDHS for compliance with Quality System
requirements, MDR requirements, and other applicable regulations. The Company
has not yet been inspected by the FDA or the CDHS. FDA has implemented the
Quality System regulations, including design control requirements, which will
likely increase the cost of compliance with Quality System requirements. Changes
in existing requirements or adoption of new requirements could have a material
adverse effect on the Company's business, financial condition, and results of
operation. There can be no assurance that the Company will not incur significant
costs to comply with laws and regulations in the future or that laws and
regulations will not have a material adverse effect upon the Company's business,
financial condition or results of operation.
 
     Labeling and promotional activities are subject to scrutiny by the FDA and,
in certain circumstances, by the Federal Trade Commission ("FTC"). FDA
enforcement policy strictly prohibits the marketing of FDA cleared or approved
medical devices for unapproved or "off-label" uses. The Company also is subject
to numerous federal, state and local laws relating to such matters as safe
working conditions, manufacturing practices, environmental protection, fire
hazard control and disposal of hazardous or potentially hazardous substances.
There can be no assurance that the Company will not be required to incur
significant costs to comply with such laws and regulations in the future or that
such laws or regulations will not have a material adverse effect upon the
Company's ability to do business.
 
     In summary, the process of obtaining a PMA and other required regulatory
approvals can be expensive, uncertain, and lengthy, and there can be no
assurance that the Company will ever obtain such approvals. At the earliest, the
Company does not anticipate filing a PMA application for any system for at least
six months, and does not anticipate receiving a PMA for any such system until at
least one to two years after such PMA application is accepted for filing, if at
all. There can be no assurance that the FDA will act favorably or quickly on any
of the Company's submissions to the FDA. Significant difficulties and costs may
be encountered by the Company in its efforts to obtain FDA clearance that could
delay or preclude the Company from selling its products in the United States.
Furthermore, there can be no assurance that the FDA will not request additional
data or require that the Company conduct further clinical studies, causing the
Company to incur substantial cost and delay. In addition, there can be no
assurance that the FDA will not impose strict labeling requirements, onerous
operator training requirements or other requirements as a condition of its PMA
approval, any of which could limit the Company's ability to market its systems.
FDA enforcement policy strictly prohibits the marketing of FDA cleared or
approved medical devices for unapproved uses. Further, if a
 
                                       25
<PAGE>   27
 
company wishes to modify a product after FDA approval of a PMA, including
changes in indications or other modifications that could affect safety or
efficacy, additional clearances or approvals will be required from the FDA.
Failure to receive or delays in receipt of FDA clearances or approvals,
including the need for additional clinical trials or data as a prerequisite to
clearance or approval, or any FDA conditions that limit the ability of the
Company to market its systems, could have a material adverse effect on the
Company's business, financial condition and results of operations.
 
  International
 
     In order for the Company to market its products in Europe and certain other
foreign jurisdictions, the Company must obtain required regulatory approvals and
clearances and otherwise comply with extensive regulations regarding safety and
manufacturing processes and quality. These regulations, including the
requirements for approvals or clearance to market and the time required for
regulatory review, vary from country to country. There can be no assurance that
the Company will obtain regulatory approvals in such countries or that it will
not be required to incur significant costs in obtaining or maintaining its
foreign regulatory approvals. Delays in receipt of approvals to market the
Company's products, failure to receive these approvals or future loss of
previously received approvals could have a material adverse effect on the
Company's business, financial condition and results of operations.
 
     The time required to obtain approval for sale in foreign countries may be
longer or shorter than that required for FDA approval, and the requirements may
differ. Export sales of investigational devices that are subject to PMA or IDE
requirements and have not received FDA marketing approval generally may be
subject to FDA export permit requirements depending upon, among other things,
the purpose of the export (investigational or commercial), the country to which
the device is intended for export, and whether the device has valid marketing
authorization in a country listed in the FDA Export Reform & Enforcement Act of
1996. In order to obtain such a permit, the Company must provide the FDA with
documentation from the medical device regulatory authority of the country in
which the study is to be conducted or the purchaser is located, stating that the
device has the approval of the country. In addition, the FDA must find that the
exportation of the device is not contrary to the public health and safety of the
country in order for the Company to obtain the permit. The Company is in the
process of obtaining the necessary approvals or initiating clinical trials in
the United Kingdom, Germany, France, Canada, Australia, and Asia.
 
     The European Union has promulgated rules which require that medical
products receive by June 12, 1998 the right to affix the CE Mark, an
international symbol of adherence to quality assurance standards and compliance
with applicable European medical device directives, Quality Systems
certification is one of the CE Mark requirements. The Company has been
recommended for ISO 9001/EN46001 certification of its manufacturing facility in
Sunnyvale, California by its European Notified Body. Final certification is
expected by the end of September 1997. While the Company intends to satisfy the
requisite policies and procedures that will permit it to receive the CE Mark
Certification, there can be no assurance that the Company will be successful in
meeting the European certification requirements and failure to receive the right
to affix the CE mark will prohibit the Company from selling its products in
member countries of the European Union. See "-- Manufacturing."
 
THIRD-PARTY REIMBURSEMENT AND UNCERTAINTY RELATED TO HEALTH CARE REFORM
 
     In the United States, health care providers, including hospitals and
physicians, that purchase medical products for treatment of their patients,
generally rely on third-party payors, principally federal Medicare, state
Medicaid and private health insurance plans, to reimburse all or a part of the
costs and fees associated with the procedures performed using these products.
The Company's success will be dependent upon, among other things, the ability of
health care providers to obtain satisfactory reimbursement from third-party
payors for medical procedures in which the Company's products are used.
Third-party payors may deny reimbursement if they determine that a prescribed
device has not received appropriate regulatory clearances or approvals, is not
used in accordance with cost-effective treatment methods as determined by the
payor, or is experimental, unnecessary or inappropriate. If FDA clearance or
approval is received, third-party reimbursement would also depend upon decisions
by HCFA for Medicare, as well as by individual health maintenance
 
                                       26
<PAGE>   28
 
organizations, private insurers and other payors. Government agencies, private
insurers and other payors determine whether to provide coverage for a particular
procedure and reimburse health care providers for medical treatment at a fixed
rate based on the diagnosis-related group ("DRG") established by the United
States HCFA. The fixed rate of reimbursement is based on the procedure
performed, and is unrelated to the specific type of number of devices used in a
procedure. If a procedure is not covered by a DRG, payors may deny
reimbursement. The Company intends to obtain an appropriate Medicare DRG
assignment by HCFA for procedures performed using its devices. As part of this
process, during clinical trials the Company will collect economic data regarding
resources expended in performing procedures with the devices. The Company will
use these data to document differences in resource use between procedures
performed with the Company's devices and procedures currently categorized under
existing DRGS. The Company intends to meet with HCFA policy staff to request and
support development of appropriate hospital payment policies for the procedures
performed using the Company's devices. In addition, the Company may also collect
resource use data regarding physician services to support establishment of
appropriate fee schedules by third-party payors. The Company believes these
efforts will also support reimbursement among private payors.
 
     In addition, Medicare traditionally has considered items or services
involving devices that have not been approved or cleared for marketing by FDA to
be precluded from Medicare coverage. However, under a new policy which has been
in effect since November 1, 1995, Medicare coverage will not be precluded for
items and related services involving devices that have been classified by FDA as
"non-experimental/investigational" (Category B) devices and that are furnished
in accordance with the FDA-approved IDE governing clinical trials. Even with
items or services involving Category B devices, however, Medicare coverage may
be denied if any other coverage requirements are not met, for example if the
treatment is not medically needed for the specific patient. In June 1995, the
FDA assigned the IDE covering the clinical trial for the Ventricular Tachycardia
Ablation System to Category B and in January 1996, assigned the IDE covering the
clinical trial for the Arrhythmia Mapping System for ventricular tachycardia to
Category B and in June 1996 assigned the IDE covering the clinical trial for the
Arrhythmia Mapping System for atrial fibrillation to Category B. Furthermore, in
September 1996, the FDA assigned the IDE for the Atrial Fibrillation Ablation
System to Category B. There can be no assurance that the Company's systems will
be covered when they are used in clinical trials and, if covered, whether the
payment amounts for their use will be considered to be adequate by hospitals and
physicians. If the devices are not covered or the payments are considered to be
inadequate, the Company may need to bear additional costs to sponsor such
trials, and such costs could have a material adverse effect on the Company's
business, financial condition and results of operation.
 
     Capital costs for medical equipment purchased by hospitals are currently
reimbursed separately from DRG payments. Recent federal legislation reduced
capital cost reimbursements under the Medicare capital cost pass-through system.
Such legislation required that the aggregate amount of reimbursements in fiscal
years 1992 through 1995 be reduced by approximately 10% per year. Such
reductions have had an adverse impact on reimbursements to hospitals for the
capital cost of equipment such as the system components of the Company's
products. There can be no assurance that similar legislation will not be enacted
in the future and, if enacted, that such legislation would not have a material
adverse effect on the Company's business, financial condition and results of
operations.
 
     Reimbursement systems in international markets vary significantly by
country and by region within some countries, and reimbursement approvals must be
obtained on a country-by-country basis. Many international markets have
government managed health care systems that control reimbursement for new
products and procedures. In most markets, there are private insurance systems as
well as government managed systems. Market acceptance of the Company's products
will depend on the availability and level of reimbursement in international
markets targeted by the Company. There can be no assurance that the Company will
obtain reimbursement in any country within a particular time, for a particular
time, for a particular amount, or at all.
 
     Regardless of the type of reimbursement system, the Company believes that
physician advocacy of the Company's products will be required to obtain
reimbursement. The Company believes that less invasive procedures generally
provide less costly overall therapies as compared to conventional drug, surgery
and other treatments. In addition, the Company believes that a patient's
underlying arrhythmia will typically not recur after treatment with the
Company's procedures. The Company anticipates that hospital administrators and
 
                                       27
<PAGE>   29
 
physicians would justify the use of the Company's products by the attendant cost
savings and clinical benefits that the Company believes would be derived from
the use of its products. However, there can be no assurance that this will be
the case. There can be no assurance that reimbursement for the Company's
products will be available in the United States or in international markets
under either government or private reimbursement systems, or that physicians
will support and advocate reimbursement for procedures using the Company's
products. Failure by hospitals and other users of the Company's products to
obtain reimbursement from third party payors, or changes in government and
private third-party payors' policies toward reimbursement for procedures
employing the Company's products, would have a material adverse effect on the
Company's business, financial condition and results of operations. Moreover, the
Company is unable to predict what additional legislation or regulation, if any,
relating to the health care industry or third-party coverage and reimbursement
may be enacted in the future, or what effect such legislation or regulation
would have on the Company.
 
     Political, economic and regulatory influences are subjecting the health
care industry in the United States to fundamental change. The Company
anticipates that Congress, state legislatures and the private sector will
continue to review and assess alternative health care delivery and payment
systems. Potential approaches that have been considered include mandated basic
health care benefits, controls on health care spending through limitations on
the growth of private health insurance premiums and Medicare and Medicaid
spending, the creation of large insurance purchasing groups, price controls and
other fundamental changes to the health care delivery system. Legislative debate
is expected to continue in the future, and market forces are expected to demand
reduced costs. The Company cannot predict what impact the adoption of any
federal or state health care reform measures, future private sector reform or
market forces may have on its business.
 
PRODUCT LIABILITY AND INSURANCE
 
     The development, manufacture and sale of medical products entail
significant risk of product liability claims and product failure claims. The
Company has conducted only limited clinical trials and does not yet have, and
will not have for a number of years, sufficient clinical data to allow the
Company to measure the risk of such claims with respect to its products. The
Company faces an inherent business risk of financial exposure to product
liability claims in the event that the use of its products results in personal
injury or death. The Company also faces the possibility that defects in the
design or manufacture of the Company's products might necessitate a product
recall. There can be no assurance that the Company will not experience losses
due to product liability claims or recalls in the future. The Company currently
maintains product liability insurance with coverage limits of $5.0 million per
occurrence and $7.0 million annually in the aggregate and there can be no
assurance that the coverage limits of the Company's insurance policies will be
adequate. In addition, the Company will require increased product liability
coverage if any potential products are successfully commercialized. Such
insurance is expensive, difficult to obtain and may not be available in the
future on acceptable terms, or at all. Any claims against the Company,
regardless of their merit or eventual outcome, could have a material adverse
effect upon the Company's business, financial condition and results of
operations.
 
EMPLOYEES
 
     As of June 30, 1997, the Company had 112 employees, 40 of whom were engaged
directly in research, development, regulatory and clinical activities, 57 in
manufacturing and quality assurance activities and 15 in marketing, sales, and
administrative activities. No employee of the Company is covered by collective
bargaining agreements, and the Company believes that its relationship with its
employees is good.
 
     The Company's ability to operate successfully depends in significant part
upon the continued service of certain key scientific, technical, clinical,
regulatory and managerial personnel, and its continuing ability to attract and
retain additional highly qualified scientific, technical, clinical, regulatory
and managerial personnel. Competition for such personnel is intense, and there
can be no assurance that the Company can retain such personnel or that it can
attract or retain other highly qualified scientific, technical, clinical,
regulatory and managerial personnel in the future, including key sales and
marketing personnel. The loss of key personnel or the inability to hire and
retain qualified personnel could have a material adverse effect upon the
Company's business, financial condition and results of operations.
 
                                       28
<PAGE>   30
 
     In addition, in order to complete clinical trials in progress, prepare
additional products for clinical trials, and develop future products, the
Company believes that it will be required to expand its operations, particularly
in the areas of research and development, manufacturing and sales and marketing.
As the Company expands its operations in these areas, such expansion will likely
result in new and increased responsibilities for management personnel and place
significant strain upon the Company's management, operating and financial
systems and resources. To accommodate any such growth and compete effectively,
the Company will be required to implement and improve information systems,
procedures, and controls, and to expand, train, motivate and manage its work
force. The Company's future success will depend to a significant extent on the
ability of its current and future management personnel to operate effectively,
both independently and as a group. There can be no assurance that the Company's
personnel, systems, procedures and controls will be adequate to support the
Company's future operations. Any failure to implement and improve the Company's
operational, financial and management systems or, to expand, train, motivate or
manage employees as required by future growth, if any, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
 
ITEM 2. PROPERTIES
 
     The Company leases approximately 36,000 square feet in Sunnyvale,
California, approximately 6,000 square feet of which was subleased to a
third-party through March 1997. The facility is leased through October 1998, at
which time the Company has an option to extend the lease for an additional
five-year term. The Company believes that this facility will be adequate to meet
its needs through fiscal 1998.
 
ITEM 3. LEGAL PROCEEDINGS
 
     The Company is not a party to any legal proceedings.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     Not applicable.
 
                      EXECUTIVE OFFICERS OF THE REGISTRANT
 
     The executive officers of the Company are as follows:
 
<TABLE>
<CAPTION>
                NAME              AGE                            POSITION
    ----------------------------  ---     -------------------------------------------------------
    <S>                           <C>     <C>
    William N. Starling.........  44      President, Chief Executive Officer and Chairman of the
                                          Board of Directors
    Earle L. Canty..............  45      Vice President, Regulatory Affairs and Quality
                                          Assurance
    Debra S. Echt, M.D..........  46      Vice President and Chief Medical Officer
    David W. Gryska.............  41      Vice President, Finance and Chief Financial Officer
    Mark L. Pomeranz............  36      Executive Vice President, Product Development
    Richard E. Riley............  42      Vice President, Product Development
    Donald J. Santel............  37      Vice President, International Sales and Technical
                                          Marketing
</TABLE>
 
     William N. Starling has been a Director of the Company since its inception.
Mr. Starling became President and Chief Executive Officer of the Company in
January 1992 and Chairman of the Board of Directors in January 1996. Prior to
joining the Company, Mr. Starling co-founded and was a director and a vice
president of Ventritex, Inc., a medical device company, from 1985 to 1991. From
1982 to 1985, Mr. Starling was the Director of Marketing of Advanced
Cardiovascular Systems, a division of Guidant, Inc. Mr. Starling serves on the
Board of Visitors of the University of North Carolina at Chapel Hill.
 
     Earle L. Canty has been Vice President, Regulatory Affairs and Quality
Assurance of the Company since April 1996. Prior to joining the Company, Mr.
Canty was Vice President, Regulatory Affairs and Quality Assurance at Symphonix
Devices, Inc., a medical device company, from September 1995 to March 1996.
 
                                       29
<PAGE>   31
 
From October 1994 to September 1995, Mr. Canty was the principal of Earle L.
Canty Medical Device Regulatory Affairs and Product Assurance Consulting. From
1987 to September 1994, Mr. Canty was the Vice President of Regulatory Affairs
and Quality Assurance at Ventritex, Inc., a medical device company.
 
     Debra S. Echt, M.D. has been Vice President and Chief Medical Officer of
the Company since September 1996. From July 1990 to August 1996, Dr. Echt was
Associate Professor of Medicine/Cardiology and Director of the Cardiac
Arrhythmia Section at Vanderbilt University. She held a concurrent position as a
member and consultant on the United States Food and Drug Administration's
Circulatory System Devices Advisory Panel from June 1991 to July 1996.
 
     David W. Gryska has been Vice President, Finance and Chief Financial
Officer of the Company since October 1993. From 1982 to September 1993, Mr.
Gryska was with Ernst & Young, LLP, as a partner from 1989 to September 1993.
 
     Mark L. Pomeranz has been Executive Vice President, Product Development of
the Company since January 1997. From May 1995 to January 1997, Mr. Pomeranz was
Vice President, Advanced Product Development of the Company. From October 1991
to May 1995, Mr. Pomeranz was Director of Catheter Engineering of the Company.
From 1989 to 1991, Mr. Pomeranz was a Project Manager at Cardiovascular Imaging
Systems, Inc., a medical device company. From 1986 to 1989, Mr. Pomeranz held
various senior engineering positions with MCM Laboratories, Baxter Healthcare
Corp. and Mallinckrodt Interventional Products.
 
     Richard E. Riley has been Vice President, Product Development of the
Company since July 1994. From July 1992 to July 1994, Mr. Riley was Vice
President, Software Development of the Company. From 1982 to June 1992, Mr.
Riley held various engineering positions, including Project Director with
Medtronic, Inc., a medical device company.
 
     Donald J. Santel has been Vice President, International Sales and Technical
Marketing of the Company since January 1995. From January 1992 to January 1995,
Mr. Santel was Vice President, Clinical Engineering of the Company. From 1982 to
1991, Mr. Santel was with Medtronic, Inc., a medical device company, most
recently as United States Marketing Product Manager.
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
     The Common Stock of the Company has been traded on the Nasdaq National
Market under the symbol CPWY since the Company's initial public offering on June
12, 1996. Prior to that time there was no public market for the Company's Common
Stock. The following table sets forth for the period indicated the high and low
sale prices of the Common Stock.
 
<TABLE>
<CAPTION>
                                                                   HIGH       LOW
                                                                   ----       ---
            <S>                                                    <C>        <C>
            FISCAL YEAR ENDED JUNE 30, 1996
            Fourth Quarter (from June 12, 1996)..................  $21  3/4   $12 5/8
 
            FISCAL YEAR ENDED JUNE 30, 1997
            First Quarter........................................  $17  1/2   $10 1/8
            Second Quarter.......................................  $13  1/4   $10 1/4
            Third Quarter........................................  $15  1/2   $ 7 /16
            Fourth Quarter.......................................  $12  1/4   $ 5 1/2
</TABLE>
 
     As of August 20, 1997, there were approximately 178 holders of record of
the Common Stock.
 
     The Company has never declared or paid cash dividends on its capital stock.
The Company currently expects to retain its future earnings for use in the
operation and expansion of its business and does not anticipate paying any cash
dividends in the foreseeable future.
 
                                       30
<PAGE>   32
 
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
 
     The data set forth below should be read in conjunction with the
consolidated financial statements and related notes attached to this Report on
Form 10-K as pages F-1 through F-19.
 
<TABLE>
<CAPTION>
                                                               YEAR ENDED JUNE 30,
                                               ---------------------------------------------------
                                                 1997       1996       1995       1994      1993
                                               --------   --------   --------   --------   -------
                                                      (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                            <C>        <C>        <C>        <C>        <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net sales....................................  $  2,409   $  1,684   $    115   $     --   $    --
Operating expenses:
  Manufacturing start-up and cost of goods
     sold....................................     2,508      2,408      2,520      1,432       202
  Research and development...................    11,756      6,819      5,666      5,103     2,494
  Selling, general and administrative........     3,147      1,981      1,745      1,152     1,021
                                               --------   --------   --------   --------   -------
          Total operating expenses...........    17,411     11,208      9,931      7,687     3,717
                                               --------   --------   --------   --------   -------
Loss from operations.........................   (15,002)    (9,524)    (9,816)    (7,687)   (3,717)
Other income (expense), net..................     2,136        155        156        257       232
                                               --------   --------   --------   --------   -------
Net loss.....................................  $(12,866)  $ (9,369)  $ (9,660)  $ (7,430)  $(3,485)
                                               ========   ========   ========   ========   =======
Net loss per share(1)........................  $  (1.37)
                                               ========
Shares used in computing net loss per
  share(1)...................................     9,379
                                               ========
Pro forma net loss per share(1)..............             $  (1.33)  $  (1.39)
                                                          ========   ========
Shares used in computing pro forma net loss
  per share(1)...............................                7,032      6,959
                                                          ========   ========
</TABLE>
 
<TABLE>
<CAPTION>
                                                                    JUNE 30,
                                               ---------------------------------------------------
                                                 1997     1996(2)      1995       1994      1993
                                               --------   --------   --------   --------   -------
                                                                 (IN THOUSANDS)
<S>                                            <C>        <C>        <C>        <C>        <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term
  investments................................  $ 41,567   $ 52,873   $ 11,652   $ 15,819   $ 5,475
Working capital..............................    39,511     52,028     10,632     14,861     5,099
Total assets.................................    46,655     57,188     15,139     17,777     6,212
Long-term liabilities, net of current
  portion....................................     9,077      8,877      5,978      5,050        --
Accumulated deficit..........................   (43,919)   (31,053)   (21,684)   (12,024)   (4,594)
Stockholders' equity.........................    33,992     46,051      7,440     11,483     5,826
</TABLE>
 
---------------
 
(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
    of shares used in computing net loss per share and pro forma net loss per
    share.
 
(2) The selected consolidated balance sheet data as of June 30, 1996 reflect the
    Company's initial public offering completed in June 1996.
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
     The following Management's Discussion and Analysis of Financial Condition
and Results of Operations contains forward-looking statements that involve risks
and uncertainties. The Company's actual results could differ materially from
those anticipated in these forward-looking statements as a result of certain
factors, that include, but are not limited to, the risks discussed in "Factors
That May Impact Future Operations" as well as those discussed in the following
"Overview" section. These forward looking statements include the statement in
the first paragraph of "Overview" relating to expectations of operating losses,
the statement in the second paragraph of "Overview" relating to anticipated
filing and approval time periods for PMA applications and the commercialization
of products that have received FDA manufacturing approval, the statements in the
third paragraph of "Overview" related to the manufacturing, marketing and
distribution of the Company's products, the statements in the last paragraph of
"Net Sales," the statements in the last sentence of the first paragraph
 
                                       31
<PAGE>   33
 
and the entire second paragraph of "Manufacturing Start-Up and Cost of Goods
Sold," the statements in the last sentence of each of the "Research and
Development" and "Selling, General and Administrative" paragraphs, the
statements regarding future capital expenditures in the third paragraph of
"Liquidity and Capital Resources" and the Company's forecast in the fourth
paragraph of "Liquidity and Capital Resources" of the period of time through
which its financial resources will be adequate to support its operations.
 
OVERVIEW
 
     The Company was founded in April 1991 and to date has engaged primarily in
researching, developing, testing and obtaining regulatory clearances for its
products. The Company has experienced significant operating losses since
inception and, as of June 30, 1997, had an accumulated deficit of approximately
$43.9 million. The Company has generated only limited revenues from sales of
Radii supraventricular tachycardia mapping and ablation catheters, Trio/Ensemble
diagnostic catheters, Mercator Mapping Baskets, Radiofrequency Generator Systems
and Arrhythmia Mapping Systems. The Company expects its operating losses to
continue through at least the end of calendar 1999 as it continues to expend
substantial funds for clinical trials in support of regulatory approvals,
expansion of research and development activities, establishment of
commercial-scale manufacturing capabilities and expansion of sales and marketing
activities.
 
     The Company believes that its Ventricular Tachycardia Ablation System,
Arrhythmia Mapping Systems and Atrial Fibrillation Ablation System and their
component catheters and equipment are currently the Company's only significant
potential products. The Ventricular Tachycardia Ablation System and Arrhythmia
Mapping System for diagnostic mapping of ventricular tachycardia are in the
early stages of clinical testing, and clinical data obtained to date are
insufficient to demonstrate the safety and efficacy of these products under
applicable FDA regulatory guidelines. In addition, the ablation catheter and
ablation equipment that together form the Atrial Fibrillation Ablation System
and the mapping catheter and mapping equipment that together form the Arrhythmia
Mapping System for atrial fibrillation are in the early stages of clinical
testing and will require further development. The design, manufacturing,
labeling, distribution and marketing of the Company's products are subject to
extensive and rigorous government regulation in the United States and certain
other countries where the process of obtaining required regulatory approvals is
lengthy, expensive and uncertain. In order for the Company to market the
Ventricular Tachycardia Ablation System, Arrhythmia Mapping Systems or Atrial
Fibrillation Ablation System and related catheters and equipment in the United
States, the Company must obtain clearance or approval from the FDA. At the
earliest, the Company does not anticipate filing a PMA application for any
system for at least six months, and does not anticipate receiving a PMA for any
such system until at least one to two years after such PMA application is
accepted for filing, if at all. The Company will not generate any significant
revenue in the United States until such time, if ever, as its Ventricular
Tachycardia Ablation System, Arrhythmia Mapping Systems or Atrial Fibrillation
Ablation System obtain clearance or approval from the FDA. Even if one or more
of the Company's products obtain FDA clearance or approval, there can be no
assurance that any of the Company's products for diagnosis and treatment of
ventricular tachycardia and atrial fibrillation will be successfully
commercialized or that the Company will achieve significant revenues from either
international or domestic sales. The FDA granted 510(k) clearance to the Company
in August 1997 for the Model 8100/8300 Arrhythmia Mapping System for basic
diagnostic electrophysiology studies. There can be no assurance that this system
will be successfully commercialized in the United States. See
"Business -- Clinical Trials" and "-- Factors That May Impact Future Operating
Results -- Clinical Trials" for a discussion of the status of the clinical
trials conducted to date for the Company's products.
 
     The Company does not have any experience in manufacturing, marketing or
selling its products for diagnosis and treatment of ventricular tachycardia and
atrial fibrillation in commercial quantities. If the Company receives FDA
clearance or approval for its products, it will need to expend significant
capital resources and develop manufacturing expertise to establish large-scale
manufacturing capabilities. Manufacturers often encounter difficulties in
scaling up production of new products, including problems involving production
yields, quality control and assurance, component supply shortages, shortages of
qualified personnel, compliance with FDA regulations, and the need for further
FDA approval of new manufacturing processes. In addition, if FDA clearances or
approvals are received, the Company intends to market its products primarily
 
                                       32
<PAGE>   34
 
through a direct sales force in the United States and indirect sales channels
internationally. Establishing a marketing and sales capability sufficient to
support sales in commercial quantities will require substantial efforts and
require significant management and financial resources.
 
RESULTS OF OPERATIONS
 
  Years Ended June 30, 1997 and 1996
 
     Net Sales. The Company's net sales to date have resulted primarily from
limited sales of Radii supraventricular tachycardia mapping and ablation
catheters, Trio/Ensemble diagnostic catheters, Mercator Mapping Baskets,
Radiofrequency Generator Systems and Arrhythmia Mapping Systems. Net sales
increased to $2.4 million for the year ended June 30, 1997 from $1.7 million in
the year ended June 30, 1996. The increase in net sales was due to higher
overall shipments of Trio/Ensemble catheters in Japan and the shipment of
Arrhythmia Mapping Systems to Japan and Europe during the year ended June 30,
1997, but such increase was offset in part by the non-recurrence of the sale of
Radiofrequency Generator Systems during the year ended June 30, 1996.
 
     In December 1995, the Company received $3.0 million pursuant to a royalty
agreement with Arrow. This amount was recorded as deferred royalty income and
will be amortized to income for those Trio/Ensemble catheters that Arrow
manufactures and sells. The royalty rate is 5% of the Trio/Ensemble catheter's
sales price. During the year ended June 30, 1997, Arrow started to manufacture
and sell Trio/Ensemble catheters subject to the agreement and the Company
recorded approximately $50,000 of royalty income. There was no royalty income
recorded for the year ended June 30, 1996.
 
     Manufacturing Start-Up and Cost of Goods Sold. Manufacturing start-up and
cost of goods sold primarily includes raw materials costs, catheter fabrication
costs, and system assembly and test costs. Cost of goods sold was $2.5 million
for the year ended June 30, 1997, resulting in a gross margin deficit of
approximately $99,000. For the year ended June 30, 1996, manufacturing start-up
and cost of goods sold was $2.4 million, resulting in a gross margin deficit of
approximately $724,000. The improvement in the gross margin deficit was
primarily attributable to higher sales volumes and the non-recurrence of certain
manufacturing start-up costs associated with the expansion of catheter
production capacity in fiscal 1996. The improvement in the gross margin deficit
was offset in part by increased compensation and associated costs for assembly,
quality control and engineering support personnel, and low production yields for
the Mercator Mapping Basket. The improvement in the gross margin deficit was
also aided by increased production and sales levels for Trio/Ensemble diagnostic
catheters and such increases have resulted in generally lower per unit
manufacturing costs. The Company expects future gross margins to fluctuate as
other products are commercialized.
 
     The Company is currently encountering low yields, vendor shortages and
other significant production inefficiencies in the manufacture of its Mercator
Mapping Basket catheters. Although the Company is taking appropriate steps to
address these yield and other production inefficiencies, there can be no
assurance that such improvements will be achieved. Failure to obtain acceptable
yields in the manufacture of such products will adversely affect the ability of
the Company to expand its mapping system clinical sites and commence
commercialization of this product in international markets for the next three
months.
 
     Research and Development. Research and development expenses include costs
associated with product research, clinical trials, prototype development,
obtaining regulatory approvals and costs associated with hiring regulatory,
clinical, research and engineering personnel. Research and development expenses
increased to $11.8 million for the year ended June 30, 1997 from $6.8 million
for the year ended June 30, 1996. This increase was primarily attributable to
increased costs associated with the hiring of additional engineering, regulatory
and clinical personnel, costs associated with conducting clinical trials,
increased prototype development costs, and increased costs related to the
manufacture and placement of Ventricular Tachycardia Ablation, Atrial
Fibrillation Ablation and Arrhythmia Mapping Systems and related catheter
products at clinical sites in the United States and Europe. The Company believes
that research and development expenditures will increase in the future as the
Company invests in product and process improvements related
 
                                       33
<PAGE>   35
 
to its ventricular tachycardia and atrial fibrillation products, expands
clinical research activities and increases its research and development efforts
related to new products and technologies.
 
     Selling, General and Administrative. Selling, general and administrative
expenses include compensation and benefits for sales, marketing, senior
management and administrative personnel, various legal and professional fees
including those in connection with obtaining patent protection, and costs of
trade shows. Selling, general and administrative expenses increased to $3.1
million for the year ended June 30, 1997 from $2.0 million for the year ended
June 30, 1996. The increase was primarily attributable to increased expenditures
for administrative personnel and services to support expanding international
sales and marketing activities, increased costs associated with expanded
participation in trade shows, increased professional fees related to the filing
and registration of the Company's patents, costs related to obtaining certain
insurance policies and costs related to the Company's internal computer network
and related administrative services. The Company anticipates that selling,
general and administrative expenses will increase in future periods as
additional personnel are added to support growing business operations in all
functional areas.
 
     Other Income (Expense), Net. Other income (expense), net increased to net
other income of $2.1 million for the year ended June 30, 1997 from net other
income of $155,000 for the year ended June 30, 1996. The net increase resulted
from a higher level of interest income earned on substantially higher cash, cash
equivalent and short-term investment balances following the closing of the
Company's initial public offering in June 1996, the net proceeds of which were
approximately $43.1 million.
 
     Net Loss. The Company's net loss increased to $12.9 million for the year
ended June 30, 1997 from $9.4 million for the year ended June 30, 1996. The
increase in the net loss primarily resulted from increased product development,
clinical research and selling, general and administrative expenses, but such
factors were offset in part by increased sales and interest income.
 
     Net Operating Loss and Research Tax Credit Carryforwards. As of June 30,
1997, the Company's reported net operating loss carryforwards were approximately
$38.0 million and $8.8 million for federal and state income tax purposes,
respectively. The Company's research tax credit carryforwards were approximately
$2.2 million. If not utilized, the net operating loss and credit carryforwards
will expire at various dates beginning in the years between 1998 through 2012.
Approximately $3.0 million of the federal net operating loss carryforward is
subject to an annual limitation on utilization of approximately $1.0 million due
to an ownership change as defined by the provisions of Internal Revenue Code
Section 382. In the event of additional ownership changes in the future as a
result of issuances or additional stock transfers, there could be further annual
limitations on the Company's ability to utilize its net operating loss and
credit carryforwards.
 
  Years Ended June 30, 1996 and 1995
 
     Net Sales. The Company's net sales during the years ended June 30, 1996 and
1995 resulted primarily from limited sales of the Trio/Ensemble diagnostic
catheters and Radii supraventricular tachycardia mapping and ablation catheters.
During the year ended June 30, 1996, the Company also sold a limited number of
Radiofrequency Generator Systems for use in clinical trials. The Company's net
sales increased to $1.7 million for the year ended June 30, 1996 from $115,000
for the year ended June 30, 1995. The increase in net sales was primarily
attributable to increased sales of the Trio/Ensemble and Radii catheters
following the establishment of distribution arrangements in certain European
markets and Japan.
 
     Manufacturing Start-Up and Cost of Goods Sold. For the years ended June 30,
1996 and 1995, the Company's manufacturing activities included pilot
manufacturing for catheters sold internationally and for catheters and ablation
and mapping equipment used in clinical trials. Manufacturing start-up and cost
of goods sold decreased slightly to $2.4 million for the year ended June 30,
1996 from $2.5 million for the year ended June 30, 1995. The slight decrease was
primarily attributable to the non-recurrence of manufacturing start-up costs
associated with the expansion of catheter and ablation and mapping equipment
production capacity, partially offset by increased compensation and associated
labor costs for assembly personnel and increased raw materials and supply costs
supporting higher production and sales levels.
 
                                       34
<PAGE>   36
 
     Research and Development. Research and development expenses increased to
$6.8 million for the year ended June 30, 1996 from $5.7 million for the year
ended June 30, 1995. This increase was primarily attributable to increased costs
associated with the hiring of additional engineering, regulatory and clinical
personnel, increased prototype development costs, increased costs related to the
manufacture and placement of Ventricular Tachycardia Ablation and Arrhythmia
Mapping Systems at clinical sites in the United States and Europe as clinical
trials commenced.
 
     Selling, General and Administrative. Selling, general and administrative
expenses increased to $2.0 million for the year ended June 30, 1996 from $1.7
million for the year ended June 30, 1995. The increase was primarily
attributable to increased expenditures for administrative personnel and services
to support expanding international sales and marketing activities, increased
costs associated with expanded participation in trade shows, increased
professional fees related to the filing and registration of the Company's
patents, and costs related to the Company's internal computer network and
related administrative services, partially offset by the termination of a
distributor arrangement and the non-recurrence of certain one-time costs related
to expansion of administrative and sales and marketing functions.
 
     Other Income (Expense), Net. Other income (expense), net decreased to net
other income of $155,000 for the year ended June 30, 1996 from net other income
of $157,000 for the year ended June 30, 1995. The net decrease resulted from
increased interest expense in connection with increased equipment lease
financing activity.
 
     Net Loss. The Company recognized net losses of $9.4 million and $9.7
million for the years ended June 30, 1996 and 1995, respectively.
 
     Impact of Adoption of New Accounting Standards. In February 1997, the
Financial Accounting Standards Board issued Statement of Financial Accounting
Standards No. 128 (FAS 128), "Earnings per Share," which the Company is required
to adopt on December 31, 1997. At that time, the Company will be required to
change the method currently used to compute earnings per share and to restate
all prior periods. Under the new requirements for calculating basic earnings per
share, the dilutive effect of stock options will be excluded. The Company has
studied the implications of FAS 128 and does not expect its adoption to have a
material impact on the Company's calculation of earnings per share.
 
     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (FAS 130), "Reporting Comprehensive
Income" which requires the reporting and presentation of comprehensive income
and its components in the financial statements. Comprehensive income reflects
certain items not currently reported in measuring net income such as changes in
value of available-for-sale securities and foreign currency translation
adjustments. FAS 130 will become effective for the Company's year ending June
30, 1999.
 
     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 (FAS 131), "Disclosures about Segments of
an Enterprise and Related Information" which supersedes the current segment
reporting requirements of Statement of Financial Accounting Standards No. 14
(FAS 14), "Financial Reporting for Segments of a Business Enterprise," as
amended. FAS 131 requires the reporting of certain financial and other
disclosures related to the Company's operating segments which are identified
using a "management approach." Operating segments are revenue-producing
components of the business for which separate financial information is produced
internally and are subject to evaluation by the chief operating decision maker
in the resource allocation process. FAS 131 will become effective for the
Company's year ending June 30, 1999.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Since inception, the Company has financed its operations through a
combination of private placements of equity securities yielding $33.5 million, a
private placement of debt securities yielding $4.5 million, equipment lease
financing arrangements yielding $3.2 million and a prepaid royalty arrangement
yielding $3.0 million. In addition, the Company closed its initial public
offering in June 1996 raising net proceeds of $43.1 million. As of June 30,
1997, the Company had $41.6 million in cash, cash equivalents and short-term
investments.
 
                                       35
<PAGE>   37
 
     Net cash used in operating activities was $10.2 million, $5.0 million and
$9.0 million for the years ended June 30, 1997, 1996 and 1995, respectively. For
such periods, net cash used in operating activities resulted primarily from net
losses. Net cash used in investing activities was $13.6 million and $18.5
million for the years ended June 30, 1997 and 1996, respectively, and net cash
provided by investing activities was $2.6 million for the year ended June 30,
1995. The cash used in investing activities was primarily attributable to the
purchase of short-term investments and the purchase of property and equipment.
The cash provided by investing activities was primarily attributable to
maturities of short-term investments. Net cash used in financing activities was
$311,000 for the year ended June 30, 1997, and net cash provided by financing
activities was $47.3 million and $5.2 million for the years ended June 30, 1996
and 1995, respectively. The net cash provided by financing activities was
primarily attributable to the private placement of preferred stock and the
closing of the Company's initial public offering during June 1996.
 
     As of June 30, 1997, the Company had capital equipment of $6.1 million,
less accumulated depreciation and amortization of $3.0 million, to support its
clinical, development, manufacturing and administrative activities. The Company
has financed $3.2 million from capital lease obligations through June 30, 1997.
The Company expects capital expenditures to increase over the next several years
as it expands facilities and acquires equipment to support the planned expansion
of manufacturing capabilities.
 
     The Company's future liquidity and capital requirements will depend upon
numerous factors, including the progress of the Company's product development
efforts, the progress of the Company's clinical trials, actions relating to
regulatory matters, the costs and timing of expansion of product development,
manufacturing, marketing and sales activities, the extent to which the Company's
products gain market acceptance, and competitive developments. Although the
Company believes that the proceeds from its initial public offering together
with the Company's current cash balances and cash generated from the future sale
of products will be sufficient to meet the Company's operating and capital
requirements through calendar 1998, there can be no assurance that the Company
will not require additional financing within this time frame.
 
     The factors described in the previous paragraph and elsewhere in this
Report will impact the Company's future capital requirements and the adequacy of
its available funds. The Company may be required to raise additional funds
through public or private financing, collaborative relationships or other
arrangements. There can be no assurance that such additional funding, if needed,
will be available on terms attractive to the Company, or at all. Furthermore,
any additional equity financing may be dilutive to stockholders, and debt
financing, if available, may involve restrictive covenants. Collaborative
arrangements, if necessary to raise additional funds, may require the Company to
relinquish its rights to certain of its technologies, products or marketing
territories. The failure of the Company to raise capital when needed could have
a material adverse effect on the Company's business, financial condition and
results of operations.
 
FACTORS THAT MAY IMPACT FUTURE OPERATIONS
 
  Limited Operating History; History of Losses and Expectation of Future Losses
 
     The Company was founded in 1991 and to date has engaged primarily in
researching, developing, testing and obtaining regulatory clearances for its
products. The Company has experienced significant operating losses since
inception. The Company's net loss for fiscal 1997 was $12.9 million. As of June
30, 1997, the Company had an accumulated deficit of $43.9 million. The Company
has generated only limited revenues from sales of its products and expects its
operating losses to continue through at least the end of calendar 1999 as it
continues to expend substantial funds for clinical trials in support of
regulatory approvals, expansion of research and development activities,
establishment of commercial scale manufacturing capabilities and expansion of
sales and marketing activities. There can be no assurance that any of the
Company's potential products for diagnosis and treatment of Ventricular
Tachycardia and Atrial Fibrillation will be successfully commercialized or that
the Company will achieve significant revenues from either international or
domestic sales. In addition, there can be no assurance that the Company will
achieve or sustain profitability in the future. The Company's results of
operations may fluctuate significantly from quarter to quarter or year to year
and will depend on numerous factors, including actions relating to regulatory
matters, progress of clinical trials, the extent to which the Company's products
gain market acceptance, the timing of scale-up of
 
                                       36
<PAGE>   38
 
manufacturing abilities, the timing of expansion of sales and marketing
activities and competition. See "Business -- Clinical Trials", "-- Competition",
" -- Government Regulation" and "-- Third Party Reimbursement and Uncertainty
Related to Health Care Reform."
 
  Clinical Trials
 
     The Ventricular Tachycardia Ablation System, Arrhythmia Mapping System for
diagnostic mapping of ventricular tachycardia and Arrhythmia Mapping System for
diagnostic mapping of the right atrium are in various stages of clinical
testing. Clinical data obtained to date are insufficient to demonstrate the
safety and efficacy of these products under applicable FDA regulatory
guidelines. There can be no assurance that any of the Company's products will
prove to be safe and effective in clinical trials under applicable United States
or international regulatory guidelines or that additional modifications to the
Company's products will not be necessary. In addition, the clinical trials may
identify significant technical or other obstacles to be overcome prior to
obtaining necessary regulatory or reimbursement approvals. In addition, the
ablation catheter and ablation equipment that together form the Company's Atrial
Fibrillation Ablation System are still under development. There can be no
assurance that the Company will be successful in completing development of the
atrial fibrillation product and submitting the appropriate IDEs or that the FDA
will permit the Company to undertake clinical trials of the atrial fibrillation
product. If the Ventricular Tachycardia Ablation System, Arrhythmia Mapping
Systems and Atrial Fibrillation Ablation System and their component catheters
and equipment do not prove to be safe and effective in clinical trials or if the
Company is otherwise unable to commercialize these products successfully, the
Company's business, financial condition and results of operations will be
materially adversely affected. In addition, because ablation treatment of these
cardiac arrhythmias is a relatively new and to date untested treatment, the
long-term effects of radiofrequency ablation on patients are unknown. As a
result, the long-term success of ablation therapy in treating ventricular
tachycardia and atrial fibrillation will not be known for several years. See
"Business -- Products and Systems" and "-- Clinical Trials."
 
     The Company is currently conducting a clinical trial of the Chilli Cooled
Ablation Catheter and the Models 8002 and 8004 Radiofrequency Generator and
Integrated Fluid Pump, the products that together form the Company's Ventricular
Tachycardia Ablation System. In May 1997, the Company completed an IDE
feasibility study of the Mercator Left Ventricular Mapping Basket and the Model
8100/8300 Arrhythmia Mapping System, the products that together form the
Company's Arrhythmia Mapping System for diagnostic mapping of ventricular
tachycardia and has filed an IDE supplemental submission in July 1997 for the
Local Sector Mapping Basket, a variation of the Mercator Left Ventricular
Mapping Basket. The Company is currently conducting a clinical trial of the
Mercator Atrial Mapping Basket and the Model 8100/8300 Arrhythmia Mapping
System, the products that together form the Company's Arrhythmia Mapping System
for diagnostic mapping of the right atrium. In April 1997, the Company completed
a feasibility study of the Nexus Linear Lesion Catheter and Model 8002
Radiofrequency Generator and Integrated Fluid Pump, the products that together
form the Company's Atrial Fibrillation Ablation System.
 
     Ventricular Tachycardia Ablation System. The Company initiated a clinical
trial for the Ventricular Tachycardia Ablation System in the United States and
Europe in November 1995 under an IDE approved by the FDA. The clinical trials
are being conducted at a maximum of 15 clinical sites and will involve a maximum
of 200 patients using the Ventricular Tachycardia Ablation System. Pursuant to
the IDE, the FDA will evaluate the safety and efficacy of the Ventricular
Tachycardia Ablation System. The primary endpoint of the clinical trial is
clinical recurrence of ventricular tachycardia in patients randomized to receive
ablation treatment versus patients in the control group receiving antiarrhythmic
drugs. The required post-treatment follow-up prior to submission of a PMA will
be 30 days for safety. However, the Company may be required to follow up with
each patient up to 24 months after the PMA filing. The Company anticipates that
this clinical trial will not be completed prior to early calendar 1998. At the
conclusion of the clinical trial, the Company plans to file a PMA application
for approval to market the Ventricular Tachycardia Ablation System and its
component catheters and equipment in the United States.
 
     As of May 15, 1997, the FDA no longer required randomization, and all
patients enrolled have been able to receive ablation initially. This
modification to the protocol has resulted in more rapid enrollment into the
 
                                       37
<PAGE>   39
 
clinical trial. As of August 18, 1997, 133 patients had been enrolled in the
trial; 75 patients randomized to ablation, 26 patients nonrandomized to
ablation, and 32 patients randomized to control of which 17 patients have
subsequently received ablation therapy due to VT recurrence. In addition, 23
patients have received ablation therapy under a compassionate use protocol. An
interim data analysis of acute and long-term success was performed as of May 31,
1997, comparing patients randomized to ablation to patients randomized to
control. Acute success of ablation therapy, defined as eradication of all
mappable VT at the end of the ablation procedure, was attained in 74% of
patients. The incidence of major adverse events associated with the procedure
has been approximately 9%.
 
     Arrhythmia Mapping System for Ventricular Tachycardia. In January 1996, the
Company received FDA approval to conduct an IDE feasibility study to evaluate
the safety of the Arrhythmia Mapping System for diagnostic mapping of
ventricular tachycardia. The feasibility study was conducted at three clinical
sites in the United States and Europe and involved a total of 13 patients. The
purpose of the clinical trial was to evaluate and test the success of the
deployment of the Mercator Left Ventricular Mapping Basket into the ventricle,
the fit of the catheter and the system's ability to accurately map the
electrical signals of the left ventricle. In addition, 14 patients were studied
in Europe outside of the IDE in a similar protocol. There was no thrombus
formation on any mapping basket used in the 27 studies. Of the 27 patients
evaluated, one patient developed asymptomatic aortic regurgitation, one patient
had a transient ischemic attack, and two patients developed pericardial
effusions associated with the procedure. In July 1997, the Company submitted an
IDE supplement to support commercialization of two types of baskets; the
Mercator Left Ventricular Mapping Basket, the full chamber "global" basket
evaluated in the feasibility study, as well as a smaller, partial chamber high
density local sector basket. This study will enable the use of both ventricular
mapping baskets with the Ventricular Tachycardia Ablation System simultaneously.
Ventricular mapping should enable the treatment of high rate ventricular
tachycardia, which is more common than slow rate ventricular tachycardia which
is the only type amenable to ablation therapy using current techniques. It is
anticipated that this study will be continued in November, 1997, at 10 sites to
enroll a total of 75 patients.
 
     Arrhythmia Mapping System for Atrial Fibrillation. In June 1996, the
Company received IDE approval by the FDA to conduct a clinical trial of the
Mercator Atrial Mapping Basket for the right atrium and Arrhythmia Mapping
System for complex atrial tachyarrhythmias including atrial fibrillation. The
clinical trial is being conducted at seven clinical sites in the United States
and one in Europe. The purpose of this clinical trial is to demonstrate the
equivalency of the Right Mercator Atrial Mapping Basket and the Arrhythmia
Mapping System to commercially available mapping catheters. As of August 18,
1997, the Mercator Atrial Mapping Basket was evaluated in 44 patients. There was
no thrombus formation on any mapping basket used in the 44 studies. The Company
anticipates submission of a 510(k) application for approval by the end of 1997.
 
     The Company has also tested the Mercator Atrial Mapping Basket outside of
the U.S. IDE at two European sites. As of August 18, 1997, the Mercator Atrial
Mapping Basket was safely deployed and fit properly in the right atrium in six
European patients. In addition, the Mercator Atrial Mapping Basket for the left
atrium was also tested in one of the patients. None of the patients in the U.S.
and Europe had complications as a result of the Mercator Atrial Mapping Basket
and Arrhythmia Mapping System.
 
     Atrial Fibrillation Ablation System. The Company received FDA approval of
an IDE feasibility study to evaluate the safety of the Atrial Fibrillation
Ablation System in August 1996. The purpose of the IDE feasibility study for the
Atrial Fibrillation Ablation System was to assess the safety and performance in
creating continuous linear lesions. The feasibility testing was completed with
10 patients undergoing testing.
 
     The Company also tested the Nexus Linear Lesion Catheter in two patients in
Europe. As of August 18, 1997, the Nexus Linear Lesion Catheter was used in a
total of 12 patients. The purpose of the clinical test was to verify that a
linear lesion could be made in a location in the atrium anticipated to eliminate
atrial fibrillation. In a majority of the patients undergoing ablation, linear
lesions were created in the right atrium either with the Nexus Linear Lesion
Catheter alone or with commercial ablation catheter supplementation. One patient
developed a pericardial effusion attributed to perforation by a commercial
diagnostic (non-ablation) catheter. No other complications occurred.
 
                                       38
<PAGE>   40
 
     The Nexus Linear Lesion Catheter was modified to improve the ability to
create linear lesions minimizing the need for commercial ablation catheter
supplementation. The modifications include the addition of active deflection to
facilitate tissue contact. It is anticipated that an IDE supplement will be
submitted by October 1997 to support commercialization of the Nexus Linear
Lesion Catheter in the right atrium to treat atrial flutter. Atrial flutter is
an abnormal heart rhythm now commonly treated using catheter ablation, requiring
the creation of a two to four centimeter linear lesion in the right atrium. The
study is expected to begin in early calendar 1998 involving 100 patients at 12
investigative sites.
 
     The Company anticipates the submission of an IDE for use of the modified
Nexus Linear Lesion Catheter in the left atrium for the treatment of atrial
fibrillation in November 1997.
 
     The Ventricular Tachycardia Ablation System, Arrhythmia Mapping System for
diagnostic mapping of ventricular tachycardia and Arrhythmia Mapping System for
diagnostic mapping of the right atrium are in various stages of clinical
testing. Clinical data obtained to date are insufficient to demonstrate the
safety and efficacy of these products under applicable FDA regulatory
guidelines. There can be no assurance that any of the Company's products will
prove to be safe and effective in clinical trials under applicable United States
or international regulatory guidelines or that additional modifications to the
Company's products will not be necessary. In addition, the clinical trials may
identify significant technical or other obstacles to be overcome prior to
obtaining necessary regulatory or reimbursement approvals. In addition, the
ablation catheter and ablation equipment that together form the Company's Atrial
Fibrillation Ablation System are still under development. There can be no
assurance that the Company will be successful in completing development of the
atrial fibrillation product and submitting the appropriate IDEs or that the FDA
will permit the Company to undertake clinical trials of the atrial fibrillation
product. If the Ventricular Tachycardia Ablation System, Arrhythmia Mapping
Systems and Atrial Fibrillation Ablation System and their component catheters
and equipment do not prove to be safe and effective in clinical trials or if the
Company is otherwise unable to commercialize these products successfully, the
Company's business, financial condition and results of operations will be
materially adversely affected. In addition, because ablation treatment of these
cardiac arrhythmias is a relatively new and to date untested treatment, the
long-term effects of radiofrequency ablation on patients are unknown. As a
result, the long-term success of ablation therapy in treating ventricular
tachycardia and atrial fibrillation will not be known for several years.
 
  Marketing and Distribution
 
     The Company currently has only a limited sales and marketing organization.
If FDA clearances or approvals are received for the Company's ventricular
tachycardia or atrial fibrillation products, the Company intends to market its
products primarily through a direct sales force in the United States and
indirect sales channels internationally.
 
     Establishing a marketing and sales capability sufficient to support sales
in commercial quantities will require substantial efforts and require
significant management and financial resources. There can be no assurance that
the Company will be able to build such a marketing staff or sales force, that
establishing such a marketing staff or sales force will be cost-effective or
that the Company's sales and marketing efforts will be successful. If the
Company is successful in obtaining the necessary regulatory approvals for its
ventricular tachycardia and atrial fibrillation products in international
markets, it expects to establish a sales and marketing capability in those
markets primarily through distributors. The Company is currently in discussions
with its distributor in France, U.K., Spain and Portugal to terminate the
relationship for strategic reasons. There can be no assurance that the Company
will be able to enter into agreements with desired distributors on a timely
basis or at all, or that such distributors will devote adequate resources to
selling the Company's products. Failure to establish appropriate distribution
relationships could have a material adverse effect upon the Company's business,
financial condition and results of operations. See "Business -- Marketing and
Distribution."
 
                                       39
<PAGE>   41
 
  Manufacturing
 
     Components and raw materials are purchased from various qualified suppliers
and subjected to stringent quality specifications. The Company conducts quality
audits of suppliers and is establishing a vendor certification program. A number
of components for the Company's products are provided by sole source suppliers.
For certain of these components, there are relatively few alternative sources of
supply, and establishing additional or replacement vendors for such components
could not be accomplished quickly. The Company plans to qualify additional
suppliers if and as future production volumes increase. Because of the long lead
time for some components that are currently available from a single source, a
vendor's inability to supply such components in a timely manner could have a
material adverse effect on the Company's ability to manufacture the mapping
basket, mapping equipment and ablation equipment and therefore on its business,
financial condition and ability to market its products as currently
contemplated.
 
     The Company has no experience manufacturing its products in the volumes
that will be necessary for the Company to achieve significant commercial sales,
and there can be no assurance that reliable, high-volume manufacturing capacity
can be established or maintained at commercially reasonable costs. If the
Company receives FDA clearance or approval for its products, it will need to
expend significant capital resources and develop manufacturing expertise to
establish large-scale manufacturing capabilities. Manufacturers often encounter
difficulties in scaling up production of new products, including problems
involving production yields, quality control and assurance, component supply
shortages, shortages of qualified personnel, compliance with FDA regulations,
and the need for further FDA approval of new manufacturing processes. In
addition, the Company believes that substantial cost reductions in its
manufacturing operations will be required for it to commercialize its catheters
and systems on a profitable basis. Any inability of the Company to establish and
maintain large-scale manufacturing capabilities would have a material adverse
effect on the Company's business, financial condition and results of operations.
 
     The Company's manufacturing facilities are subject to periodic inspection
by regulatory authorities, and its operations must undergo Quality System
compliance inspections conducted by the FDA. To date, the Company's facilities
and manufacturing processes have not undergone any such inspections. The Company
will be required to comply with Quality System requirements in order to produce
products for sale in the United States and with ISO 9001/EN46001 standards in
order to produce products for sale in Europe. The Company has been recommended
for ISO 9001/EN46001 certification by its European Notified Body and anticipates
final certification by the end of September 1997. Any failure of the Company to
comply with Quality System or ISO 9001/EN46001 standards may result in the
Company being required to take corrective actions, such as modification of its
policies and procedures. The State of California also requires that the Company
obtain a license to manufacture medical devices. The Company has applied for a
device manufacturing license from the CDHS, however, the Company has not yet
received an inspection by the CDHS which is required before a license can be
issued. If the Company is unable to maintain such a license, it would be unable
to manufacture or ship any product, which inability would have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Business -- Manufacturing."
 
  Patents and Proprietary Rights
 
     The Company's success will depend in part on its ability to obtain patent
and copyright protection for its products and processes, to preserve its trade
secrets and to operate without infringing or violating the proprietary rights of
third parties. The Company's strategy is to actively pursue patent protection in
the United States and foreign jurisdictions for technology that it believes to
be proprietary and that offers a potential competitive advantage for its
products. The Company holds issued and allowed Patents covering a number of
fundamental aspects of the Company's Ventricular Tachycardia Ablation System,
Arrhythmia Mapping Systems and Atrial Fibrillation Ablation System. The patent
positions of medical device companies, including those of the Company, are
uncertain and involve complex and evolving legal and factual questions. The
coverage sought in a patent application either can be denied or significantly
reduced before or after the patent is issued. Consequently, there can be no
assurance that any patents from pending patent applications or from any future
patent application will be issued, that the scope of any patent protection will
exclude competitors or
 
                                       40
<PAGE>   42
 
provide competitive advantages to the Company, that any of the Company's patents
will be held valid if subsequently challenged or that others will not claim
rights in or ownership of the patents and other proprietary rights held by the
Company. In addition, there can be no assurance that competitors, many of which
have substantial resources and have made substantial investments in competing
technologies, will not seek to apply for and obtain patents that will prevent,
limit or interfere with the Company's ability to make, use or sell its products
either in the United States or in international markets. Litigation or
regulatory proceedings, which could result in substantial cost and uncertainty
to the Company may also be necessary to enforce patent or other intellectual
property rights of the Company or to determine the scope and validity of other
parties' proprietary rights. There can be no assurance that the Company will
have the financial resources to defend its patents from infringement or claims
of invalidity.
 
     In addition to patents, the Company relies on trade secrets and proprietary
know-how to compete, which it seeks to protect, in part, through appropriate
confidentiality and proprietary information agreements. These agreements
generally provide that all confidential information developed or made known to
individuals by the Company during the course of the relationship with the
Company is to by kept confidential and not disclosed to third parties, except in
specific circumstances. The agreements also generally provide that all
inventions conceived by the individual in the course of rendering service to the
Company shall be the exclusive property of the Company. There can be no
assurance that proprietary information or confidentiality agreements with
employees, consultants and others will not be breached, that the Company will
have adequate remedies for any breach, or that the Company's trade secrets will
not otherwise become known to or independently developed by competitors.
 
     The medical device industry has been characterized by extensive litigation
regarding patents and other intellectual property rights, and companies in the
medical device industry have employed intellectual property litigation to gain a
competitive advantage. There can be no assurance that the Company will not
become subject to patent infringement claims or litigation in a court of law, or
interference proceedings declared by the USPTO to determine the priority of
inventions or an opposition to a patent grant in a foreign jurisdiction. The
defense and prosecution of intellectual property suits, USPTO interference or
opposition proceedings and related legal and administrative proceedings are both
costly and time-consuming. Any litigation, opposition or interference
proceedings will result in substantial expense to the Company and significant
diversion of effort by the Company's technical and management personnel. An
adverse determination in litigation or interference proceedings to which the
Company may become a party could subject the Company to significant liabilities
to third parties, require disputed rights to be licensed from third parties or
require the Company to cease using such technology. Although patent and
intellectual property disputes in the medical device area have often been
settled through licensing or similar arrangements, costs associated with such
arrangements may be substantial and could include ongoing royalties.
Furthermore, there can be no assurance that necessary licenses from others would
be available to the Company on satisfactory terms, if at all. Adverse
determinations in a judicial or administrative proceeding or failure to obtain
necessary licenses could prevent the Company from manufacturing and selling its
products, which would have a material adverse effect on the Company's business,
financial condition and results of operations. The Company is aware of certain
patents owned or licensed by others and relating to cardiac catheters and
cardiac monitoring. Certain enhancements of the Company's products are still in
the design and pre-clinical testing phase. Depending on the ultimate design
specifications and results of pre-clinical testing of these enhancements there
can be no assurance that the Company would be able to obtain a license to such
patents or that a court would find that such patents are either not infringed by
such enhancements or are invalid. Further, there can be no assurance that owners
or licensees of these patents will not attempt to enforce their patent rights
against the Company in a patent infringement suit or other legal proceeding,
regardless of the likely outcome of such suit or proceeding. See
"Business -- Patents and Proprietary Rights."
 
  Competition
 
     At present, the Company considers its primary competition to be companies
involved in current, more established therapies for the treatment of ventricular
tachycardia and atrial fibrillation, including drugs, external electrical
cardioversion and defibrillation, implantable defibrillators, ablation
accompanied by
 
                                       41
<PAGE>   43
 
pacemaker implantation, and open-heart surgery. In addition, several competitors
are also developing new approaches and new products for the treatment and
mapping of ventricular tachycardia and atrial fibrillation, including ablation
systems using ultrasound, microwave, laser and cryoablation technologies and
mapping systems using contact mapping, single-point spacial mapping and
non-contact, multisite electrical mapping technologies. Many of the Company's
competitors have an established presence in the field of interventional
cardiology and electrophysiology. Many competitors have substantially greater
financial and other resources than the Company, including larger research and
development staffs and more experience and capabilities in conducting research
and development activities, testing products in clinical trials, obtaining
regulatory approvals, and manufacturing marketing and distributing products.
There can be no assurance that the Company will succeed in developing and
marketing technologies and products that are more clinically efficacious and
cost effective than the more established treatments or the new approaches and
products developed and marketed by its competitors. Furthermore, there can be no
assurance that the Company will succeed in developing new technologies and
products that are available prior to its competitors' products. The failure of
the Company to demonstrate the efficacy and cost effective advantages of its
products over those of its competitors or the failure to develop new
technologies and products before its competitors could have a material adverse
effect on the Company's business, financial condition and results of operations.
 
     The Company believes that the primary competitive factors in the market for
cardiac ablation and mapping devices are safety, efficacy, ease of use and
price. In addition, the length of time required for products to be developed and
to receive regulatory and, in some cases, reimbursement approval is an important
competitive factor. The medical device industry is characterized by rapid and
significant technological change. Accordingly, the Company's success will depend
in part on its ability to respond quickly to medical and technological changes
through the development and introduction of new products. Product development
involves a high degree of risk and there can be no assurance that the Company's
new product development efforts will result in any commercially successful
products. The Company believes it competes favorably with respect to these
factors, although there is no assurance that it will be able to continue to do
so. See "Business -- Competition"
 
  Government Regulation
 
     UNITED STATES
 
     Clinical testing, manufacture and sale of the Company's products are
subject to regulation by numerous governmental authorities, principally the FDA
and corresponding state and foreign regulatory agencies. Pursuant to the FDC
Act, the FDA regulates the clinical testing, manufacture, labeling, distribution
and promotion of medical devices. Noncompliance with applicable requirements can
result in, among other things, fines, injunctions, civil penalties, recall or
seizure of products, total or partial suspension of production, failure of the
government to grant premarket clearance or premarket approval for devices,
withdrawal of marketing approvals, a recommendation by the FDA that the Company
not be permitted to enter into government contracts and criminal prosecution.
The FDA also has the authority to request repair, replacement or refund of the
cost of any device manufactured or distributed by the Company.
 
     Before a new device can be introduced into the market, the manufacturer
must generally obtain marketing clearance through a premarket notification under
510(k) or an approval of a PMA application under Section 515 of the FDC Act.
Commercial distribution of a device for which 510(k) clearance is required can
only begin after the FDA issues an order finding the device to be "substantially
equivalent" to a predicate device. If the Company cannot establish that a
proposed device is substantially equivalent to a legally marketed predicate
device, the Company must seek premarket approval of the proposed device from the
FDA through the submission of a PMA application.
 
     The process of obtaining a PMA and other required regulatory approvals can
be expensive, uncertain, and lengthy, and there can be no assurance that the
Company will ever obtain such approvals. At the earliest, the Company does not
anticipate filing a PMA application for any system for at least the next six
months, and does not anticipate receiving a PMA for any such system until at
least one to two years after such PMA application is accepted for filing, if at
all. There can be no assurance that the FDA will act favorably or quickly
 
                                       42
<PAGE>   44
 
on any of the Company's submissions to the FDA, and significant difficulties and
costs may be encountered by the Company in its efforts to obtain FDA clearance
that could delay or preclude the Company from selling its products in the United
States. Furthermore, there can be no assurance that the FDA will not request
additional data, require that the Company conduct further clinical studies,
causing the Company to incur substantial cost and delay. In addition, there can
be no assurance that the FDA will not impose strict labeling requirements,
onerous operator training requirements or other requirements as a condition of
its PMA approval, any of which could limit the Company's ability to market its
systems. Labeling and promotional activities are subject to scrutiny by the FDA
and, in certain circumstances, by the FTC. FDA enforcement policy strictly
prohibits the marketing of FDA cleared or approved medical devices for
unapproved uses. Further, if a company wishes to modify a product after FDA
approval of a PMA, including changes in indications or other modifications that
could affect safety or efficacy, additional clearances or approvals will be
required from the FDA. Failure to receive or delays in receipt of FDA clearances
or approvals, including the need for additional clinical trials or data as a
prerequisite to clearance or approval, or any FDA conditions that limit the
ability of the Company to market its systems, could have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Business -- Government Regulation."
 
     INTERNATIONAL
 
     The European Union has promulgated rules which require that medical
products receive by June 12, 1998 the right to affix the CE Mark, an
international symbol of adherence to quality assurance standards and compliance
with applicable European medical device directives. Quality Systems
certification is one of the CE Mark requirements. The Company has been
recommended for ISO 9001/EN46001 certification of its manufacturing facility in
Sunnyvale, California by its European Notified Body. Final certification is
expected by the end of September 1997. While the Company intends to satisfy the
requisite policies and procedures that will permit it to receive the CE Mark
Certification, there can be no assurance that the Company will be successful in
meeting the European certification requirements and failure to receive the right
to affix the CE mark will prohibit the Company from selling its products in
member countries of the European Union. See "Business -- Government Regulation."
 
     The time required to obtain approval for sale in foreign countries may be
longer or shorter than that required for FDA approval, and the requirements may
differ. Export sales of investigational devices that are subject to PMA or IDE
requirements and have not received FDA marketing approval generally may be
subject to FDA export permit requirements depending upon, among other things,
the purpose of the export (investigational or commercial), the country to which
the device is intended for export, and whether the device has valid marketing
authorization in a country listed in the FDA Export Reform & Enforcement Act of
1996. In order to obtain such a permit, the Company must provide the FDA with
documentation from the medical device regulatory authority of the country in
which the study is to be conducted or the purchaser is located, stating that the
device has the approval of the country. In addition, the FDA must find that the
exportation of the device is not contrary to the public health and safety of the
country in order for the Company to obtain the permit. The Company is in the
process of obtaining the necessary approvals or initiating clinical trials in
the United Kingdom, Germany, France, Canada, Australia, and Asia.
 
  Third-Party Reimbursement and Uncertainty Related to Health Care Reform
 
     In the United States, health care providers, including hospitals and
physicians, that purchase medical products for treatment of their patients,
generally rely on third-party payors, principally federal Medicare, state
Medicaid and private health insurance plans, to reimburse all or a part of the
costs and fees associated with the procedures performed using these products.
The Company's success will be dependent upon, among other things, the ability of
health care providers to obtain satisfactory reimbursement from third-party
payors for medical procedures in which the Company's products are used.
Third-party payors may deny reimbursement if they determine that a prescribed
device has not received appropriate regulatory clearances or approvals, is not
used in accordance with cost-effective treatment methods as determined by the
payor, or is experimental, unnecessary or inappropriate.
 
                                       43
<PAGE>   45
 
     Reimbursement systems in international markets vary significantly by county
and by region within some countries, and reimbursement approvals must be
obtained on a country-by-country basis. Many international markets have
government managed health care systems that control reimbursement for new
products and procedures. In most markets, there are private insurance systems as
well as government managed systems. Market acceptance of the Company's products
will depend on the availability and level of reimbursement in international
markets targeted by the Company. There can be no assurance that the Company will
obtain reimbursement in any country within a particular time, for a particular
time, for a particular amount, or at all.
 
     Regardless of the type of reimbursement system, the Company believes that
physician advocacy of the Company's products will be required to obtain
reimbursement. The Company believes that less invasive procedures generally
provide less costly overall therapies as compared to conventional drug, surgery
and other treatments. In addition, the Company believes that a patient's
underlying arrhythmia will typically not recur after treatment with the
Company's procedures. The Company anticipates that hospital administrators and
physicians would justify the use of the Company's products by the attendant cost
savings and clinical benefits that the Company believes would be derived from
the use of its products. However, there can be no assurance that this will be
the case. There can be no assurance that reimbursement for the Company's
products will be available in the United States or in international markets
under either government or private reimbursement systems, or that physicians
will support and advocate reimbursement for procedures using the Company's
products. Failure by hospitals and other users of the Company's products to
obtain reimbursement from third party payors, or changes in government and
private third-party payors' policies toward reimbursement for procedures
employing the Company's products, would have a material adverse effect on the
Company's business, financial condition and results of operations. Moreover, the
Company is unable to predict what additional legislation or regulation, if any,
relating to the health care industry or third-party coverage and reimbursement
may be enacted in the future, or what effect such legislation or regulation
would have on the Company.
 
  Product Liability and Insurance
 
     The development, manufacture and sale of medical products entail
significant risk of product liability claims and product failure claims. The
Company has conducted only limited clinical trials and does not yet have, and
will not have for a number of years, sufficient clinical data to allow the
Company to measure the risk of such claims with respect to its products. The
Company faces an inherent business risk of financial exposure to product
liability claims in the event that the use of its products results in personal
injury or death. The Company also faces the possibility that defects in the
design or manufacture of the Company's products might necessitate a product
recall. There can be no assurance that the Company will not experience losses
due to product liability claims or recalls in the future. In addition, the
Company will require increased product liability coverage if any potential
products are successfully commercialized. Such insurance is expensive, difficult
to obtain and may not be available in the future on acceptable terms, or at all.
Any claims against the Company, regardless of their merit or eventual outcome,
could have a material adverse effect upon the Company's business, financial
condition and results of operations. See "Business -- Product Liability and
Insurance."
 
  Employees
 
     The Company's ability to operate successfully depends in significant part
upon the continued service of certain key scientific, technical, clinical,
regulatory and managerial personnel, and its continuing ability to attract and
retain additional highly qualified scientific, technical, clinical, regulatory
and managerial personnel. Competition for such personnel is intense, and there
can be no assurance that the Company can retain such personnel or that it can
attract or retain other highly qualified scientific, technical, clinical,
regulatory and managerial personnel in the future, including key sales and
marketing personnel. The loss of key personnel or the inability to hire and
retain qualified personnel could have a material adverse effect upon the
Company's business, financial condition and results of operations.
 
     In addition, in order to complete clinical trials in progress, prepare
additional products for clinical trials, and develop future products, the
Company believes that it will be required to expand its operations,
 
                                       44
<PAGE>   46
 
particularly in the areas of research and development, manufacturing and sales
and marketing. As the Company expands its operations in these areas, such
expansion will likely result in new and increased responsibilities for
management personnel and place significant strain upon the Company's management,
operating and financial systems and resources. To accommodate any such growth
and compete effectively, the Company will be required to implement and improve
information systems, procedures, and controls, and to expand, train, motivate
and manage its work force. The Company's future success will depend to a
significant extent on the ability of its current and future management personnel
to operate effectively, both independently and as a group. There can be no
assurance that the Company's personnel, systems, procedures and controls will be
adequate to support the Company's future operations. Any failure to implement
and improve the Company's operational, financial and management systems or, to
expand, train, motivate or manage employees as required by future growth, if
any, could have a material adverse effect on the Company's business, financial
condition and results of operations.
 
  Issuance of Preferred Stock Could Delay or Prevent Corporate Takeover
 
     The Board of Directors has the authority to issue up to 5,000,000 shares of
undesignated Preferred Stock and to determine the rights, preferences,
privileges and restrictions of such shares without any further vote or action by
the stockholders. To date, the Board of Directors has designated 30,000 shares
as Series A Participating Preferred Stock in connection with the Company's
Stockholder Rights Plan. The issuance of Preferred Stock under certain
circumstances could have the effect of delaying or preventing a change in
control of the Company or otherwise adversely affecting the rights of the
holders of Common Stock.
 
     On April 22, 1997, pursuant to a Preferred Shares Rights Agreement (the
"Rights Agreement") between the Company and Norwest Bank Minnesota, N.A. (the
"Rights Agent"), the Company's Board of Directors declared a dividend of one
right (a "Right") to purchase 1/1000(th) a share of the Company's Series A
Participating Preferred Stock ("Series A Preferred") for each outstanding share
of Common Stock of the Company. The dividend was payable on May 23, 1997 to
stockholders of record as of the close of business on April 30, 1997 (the
"Record Date"). Each Right entitles the registered holder to purchase from the
Company 1/1000(th) of a share of Series A Preferred at an exercise price of $125
(the "Purchase Price"), subject to adjustment. The Rights approved by the Board
are designed to protect and maximize the value of the outstanding equity
interests in the Company in the event of an unsolicited attempt by an acquirer
to take over the Company, in a manner or on terms not approved by the Board of
Directors. The Rights have been declared by the Board in order to deter coercive
tactics, including a gradual accumulation of shares in the open market of a 15%
or greater position to be followed by a merger or a partial or two-tier tender
offer that does not treat all stockholders equally. The Rights should not
interfere with any merger or business combination approved by the Board of
Directors. However, the Rights may have the effect of rendering more difficult
or discouraging an acquisition of the Company deemed undesirable by the Board of
Directors. The Rights may cause substantial dilution to a person or group that
attempts to acquire the Company on terms or in a manner not approved by the
Company's Board of Directors, except pursuant to an offer conditioned upon the
negation, purchase or redemption of the Rights.
 
  Potential Volatility of Stock Price
 
     The market price of shares of Common Stock, like that of the common stock
of many medical products and high technology companies, has in the past been,
and is likely in the future to continue to be highly volatile. Factors such as
fluctuations in the Company's operating results, announcements of technological
innovations or new commercial products by the Company or competitors, government
regulation, changes in the current structure of the health care financing and
payment systems, developments in or disputes regarding patent or other
proprietary rights, economic and other external factors and general market
conditions may have a significant effect on the market price of the Common
Stock. Moreover, the stock market has from time to time experienced extreme
price and volume fluctuations which have particularly affected the market prices
for medical products and high technology companies and which have often been
unrelated to the operating performance of such companies. These broad market
fluctuations, as well as general economic, political and market conditions, may
adversely affect the market price of the Company's Common Stock. In the past,
 
                                       45
<PAGE>   47
 
following periods of volatility in the market price of a company's stock,
securities class action litigation has occurred against the issuing company.
There can be no assurance that such litigation will not occur in the future with
respect to the Company. Such litigation could result in substantial costs and a
diversion of management's attention and resources, which could have a material
adverse effect on the Company's business, operating results and financial
condition. Any adverse determination in such litigation could also subject the
Company to significant liabilities.
 
  Absence of Dividends
 
     The Company has not paid any cash dividends since inception and does not
anticipate paying cash dividends in the foreseeable future.
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
     The Company's financial statements and the report of independent auditors
appear on pages F-1 through F-19 of this Report.
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
 
     Not applicable.
 
                                    PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
     The information required by this item concerning the Company's directors is
incorporated by reference from the section captioned "Election of Directors"
contained in the Company's Proxy Statement related to the Annual Meeting of
Stockholders to be held October 14, 1997, to be filed by the Company with the
Securities and Exchange Commission within 120 days of the end of the Company's
fiscal year pursuant to General Instruction G(3) of Form 10-K (the "Proxy
Statement"). The information required by this item concerning executive officers
is set forth in Part I of this Report. The information required by this item
concerning compliance with Section 16(a) of the Exchange Act is incorporated by
reference from the section captioned "Section 16(a) Beneficial Ownership
Reporting Compliance" contained in the Proxy Statement.
 
ITEM 11. EXECUTIVE COMPENSATION
 
     The information required by this item is incorporated by reference from the
section captioned "Executive Compensation" contained in the Proxy Statement.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     The information required by this item is incorporated by reference from the
section captioned "Security Ownership of Certain Beneficial Owners and
Management" contained in the Proxy Statement.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     The information required by this item is incorporated by reference from the
sections captioned "Compensation Committee Interlocks and Insider Participation"
and "Certain Transactions With Management" contained in the Proxy Statement.
 
                                       46
<PAGE>   48
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
 
     (a)(1) Financial Statements
 
     The following financial statements are filed as part of this Report:
 
<TABLE>
<CAPTION>
                                                                                PAGE
                                                                                ----
        <S>                                                                     <C>
        Report of Ernst & Young LLP, Independent Auditors.....................  F-2
        Consolidated Balance Sheets...........................................  F-3
        Consolidated Statements of Operations.................................  F-4
        Consolidated Statements of Stockholders' Equity.......................  F-5
        Consolidated Statements of Cash Flows.................................  F-6
        Notes to Consolidated Financial Statements............................  F-7
</TABLE>
 
     (a)(2) Financial Statement Schedules
 
<TABLE>
        <S>                                                                     <C>
        II -- Valuation and Qualifying Accounts...............................  S-1
</TABLE>
 
     All other Schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable, and therefore have
been omitted.
 
     (a)(3) Exhibits
 
<TABLE>
        <S>           <C>
         3.1(1)       Restated Certificate of Incorporation of the Registrant.
         3.2(1)       Bylaws of Registrant.
         4.1(2)       Preferred Share Rights Agreement, dated April 22, 1997 between the
                      Registrant and Norwest Bank Minnesota, N.A.
        10.1(1)       Form of Indemnification Agreement between the Registrant and each of
                      its directors and officers.
        10.2(1)       1991 Stock Plan and form of Stock Option Agreement thereunder.
        10.3(1)       1996 Director Option Plan and form of Director Stock Option Agreement
                      thereunder.
        10.4(1)       1996 Employee Stock Purchase Plan and forms of agreement thereunder.
        10.5+(1)      OEM Agreement between Registrant and Liebel-Flarsheim Company dated
                      June 22, 1994.
        10.6+(1)      License Agreement between Registrant and BSI Corporation dated October
                      21, 1994.
        10.7(1)       Loan Agreement between the Registrant and Dideco S.p.A. dated June 23,
                      1994, as amended by Amendment to Loan Agreement dated June 22, 1995 and
                      Amendment No. 2 to Loan Agreement dated April 10, 1996.
        10.8+(1)      Exclusive License Agreement dated May 24, 1995.
        10.9(1)       Manufacturing and Supply Agreement between the Registrant and Arrow
                      International Inc. dated March 8, 1995.
        10.10(1)      Exclusive International Distributor Agreement between the Registrant
                      and Arrow International dated March 8, 1995.
        10.11(1)      Lease dated June 25, 1993 between the Registrant and Brock Properties.
        10.12(1)      Master Lease Agreement dated December 1, 1993 between the Registrant
                      and Linc Capital Management Services, Ltd, as amended.
</TABLE>
 
                                       47
<PAGE>   49
 
<TABLE>
        <S>           <C>
        10.13(1)      Shareholder Rights Agreement, as amended to date, dated June 13, 1995,
                      between the Registrant and certain holders of the Company's securities.
        10.14(1)      Consulting Agreement dated June 1, 1995 between the Registrant and Mir
                      Imran.
        11.1          Statement Regarding Computation of Net Loss Per Share.
        23.1          Consent of Ernst & Young LLP, Independent Auditors.
        24.1          Power of Attorney (see page 49).
        27.1          Financial Data Schedule
</TABLE>
 
---------------
 
 +  Confidential treatment has been granted for portions of these agreements.
    Omitted portions have been filed separately with the Commission.
 
(1) Incorporated by reference to exhibits filed with Registrant's Registration
    Statement on Form S-1 (Reg. No. 333-3616) as declared effective by the
    Commission on June 12, 1996.
 
(2) Incorporated by reference to exhibits filed with the Registrant's
    Registration Statement on Form 8-A (Reg. No. 000-28372) as declared
    effective by the Commission on May 22, 1997.
 
     (b)Reports on Form 8-K. The Company did not file any reports on Form 8-K
        during the quarter ended June 30, 1997.
 
     (c) Exhibits. See Item 14(a)(3) above.
 
     (d) Financial Statement Schedules. See Item 14(a)(2) above.
 
                                       48
<PAGE>   50
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this Report to
be signed on its behalf by the undersigned, thereunto duly authorized.
 
                                          CARDIAC PATHWAYS CORPORATION
 
                                          By:    /s/ WILLIAM N. STARLING
                                            ------------------------------------
                                                    William N. Starling
                                             President, Chief Executive Officer
                                                         and Director
 
Date: August 26, 1997
 
                               POWER OF ATTORNEY
 
     KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints William N. Starling and David W. Gryska,
and each of them, his true and lawful attorneys-in-fact and agents, each with
full power of substitution and resubstitution, to sign any and all amendments
(including post-effective amendments) to this Annual Report on Form 10-K and to
file the same, with all exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
connection therewith, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents, or their substitute or substitutes, or any of them, shall do or
cause to be done by virtue hereof.
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Report has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated:
 
<TABLE>
<CAPTION>
                   SIGNATURE                                TITLE                    DATE
-----------------------------------------------  ----------------------------  ----------------
<C>                                              <S>                           <C>
            /s/ WILLIAM N. STARLING              President, Chief Executive     August 26, 1997
-----------------------------------------------  Officer and Director
             (William N. Starling)               (Principal Executive
                                                 Officer)
 
              /s/ DAVID W. GRYSKA                Vice President of Finance      August 26, 1997
-----------------------------------------------  and Chief Financial Officer
               (David W. Gryska)                 (Principal Financial and
                                                 Accounting Officer)
 
         /s/ ANNETTE J. CAMPBELL-WHITE           Director                       August 26, 1997
-----------------------------------------------
          (Annette J. Campbell-White)
 
             /s/ MICHAEL L. EAGLE                Director                       August 26, 1997
-----------------------------------------------
              (Michael L. Eagle)
 
          /s/ THOMAS J. FOGARTY, M.D.            Director                       August 26, 1997
-----------------------------------------------
           (Thomas J. Fogarty, M.D.)
 
          /s/ JOSEPH P. ILVENTO, M.D.            Director                       August 26, 1997
-----------------------------------------------
           (Joseph P. Ilvento, M.D.)
 
           /s/ LAWRENCE G. MOHR, JR.             Director                       August 26, 1997
-----------------------------------------------
            (Lawrence G. Mohr, Jr.)
</TABLE>
 
                                       49
<PAGE>   51
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                                        PAGE
                                                                                        ----
<S>                                                                                     <C>
Report of Ernst & Young LLP, Independent Auditors.....................................  F-2
Consolidated Balance Sheets as of June 30, 1997 and 1996..............................  F-3
Consolidated Statements of Operations for the years ended June 30, 1997, 1996 and
  1995................................................................................  F-4
Consolidated Statements of Stockholders' Equity for the years ended June 30, 1997,
  1996 and 1995.......................................................................  F-5
Consolidated Statements of Cash Flows for the years ended June 30, 1997, 1996, and
  1995................................................................................  F-6
Notes to Consolidated Financial Statements............................................  F-7
</TABLE>
 
                                       F-1
<PAGE>   52
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors and Stockholders
Cardiac Pathways Corporation
 
     We have audited the accompanying consolidated balance sheets of Cardiac
Pathways Corporation as of June 30, 1997 and 1996, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended June 30, 1997. Our audits also included the
financial statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Cardiac
Pathways Corporation at June 30, 1997 and 1996, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended June 30, 1997, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material aspects the information set forth therein.
 
                                                           /s/ ERNST & YOUNG LLP
 
San Jose, California
July 30, 1997
 
                                       F-2
<PAGE>   53
 
                          CARDIAC PATHWAYS CORPORATION
 
                          CONSOLIDATED BALANCE SHEETS
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                             JUNE 30,
                                                                    ---------------------------
                                                                       1997            1996
                                                                    -----------     -----------
<S>                                                                 <C>             <C>
Current assets:
  Cash and cash equivalents.......................................  $ 5,091,426     $29,112,255
  Short-term investments..........................................   36,475,534      23,760,812
  Accounts receivable, net of allowance for doubtful accounts of
     $9,500 at June 30, 1997 and 1996.............................      168,828         398,997
  Receivable from related party...................................        1,552          21,725
  Inventories.....................................................      420,005         162,516
  Prepaid expenses................................................      411,758         234,339
  Notes receivable from related parties...........................           --         256,656
  Other current assets............................................      528,528         340,291
                                                                    -----------     -----------
          Total current assets....................................   43,097,631      54,287,591
Property and equipment, net.......................................    3,140,849       2,835,355
Notes receivable from related parties.............................      319,491           5,760
Deposits and other assets.........................................       97,283          59,188
                                                                    -----------     -----------
                                                                    $46,655,254     $57,187,894
                                                                    ===========     ===========
 
                             LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable................................................  $   788,384     $   511,386
  Accrued compensation and related benefits.......................      462,814         193,511
  Accrued clinical expenses.......................................      696,106         150,004
  Other accrued expenses..........................................      870,242         733,565
  Current obligations under capital leases........................      768,813         671,538
                                                                    -----------     -----------
          Total current liabilities...............................    3,586,359       2,260,004
Long-term obligations under capital leases........................      472,588         602,574
Deferred royalty income...........................................    2,950,473       3,000,000
Note payable......................................................    4,500,000       4,500,000
Interest payable on note..........................................    1,153,625         774,421
 
Commitments
Stockholders' equity:
  Preferred stock, $.001 par value; 5,000,000 shares authorized
     and none issued and outstanding at June 30, 1997 and 1996....           --              --
  Common stock, $.001 par value; 30,000,000 shares authorized;
     9,523,540 shares issued and outstanding at June 30, 1997 and
     9,269,332 at June 30, 1996...................................        9,524           9,270
  Additional paid-in capital......................................   79,089,193      77,656,634
  Receivables from stockholders...................................     (420,000)       (406,000)
  Accumulated deficit.............................................  (43,918,832)    (31,053,238)
  Deferred compensation...........................................     (767,676)       (155,771)
                                                                    -----------     -----------
          Total stockholders' equity..............................   33,992,209      46,050,895
                                                                    -----------     -----------
                                                                    $46,655,254     $57,187,894
                                                                    ===========     ===========
</TABLE>
 
                See Notes to Consolidated Financial Statements.
 
                                       F-3
<PAGE>   54
 
                          CARDIAC PATHWAYS CORPORATION
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                                                                   YEAR ENDED JUNE 30,
                                                         ----------------------------------------
                                                             1997          1996          1995
                                                         ------------   -----------   -----------
<S>                                                      <C>            <C>           <C>
Net sales..............................................  $  2,408,773   $ 1,684,107   $   115,316
Operating expenses:
  Manufacturing start-up and cost of goods sold........     2,507,375     2,407,655     2,519,785
  Research and development.............................    11,756,260     6,819,647     5,666,176
  Selling, general and administrative..................     3,147,311     1,981,309     1,745,556
                                                         ------------   -----------   -----------
          Total operating expenses.....................    17,410,946    11,208,611     9,931,517
                                                         ------------   -----------   -----------
Loss from operations...................................   (15,002,173)   (9,524,504)   (9,816,201)
Other income (expense):
  Interest income......................................     2,624,055       700,934       543,073
  Interest expense.....................................      (523,038)     (568,802)     (495,450)
  Other, net...........................................        35,562        23,208       109,035
                                                         ------------   -----------   -----------
          Total other income (expense).................     2,136,579       155,340       156,658
                                                         ------------   -----------   -----------
Net loss...............................................  $(12,865,594)  $(9,369,164)  $(9,659,543)
                                                         ============   ===========   ===========
Net loss per share.....................................  $      (1.37)
                                                         ============
Shares used in computing net loss per share............     9,379,000
                                                         ============
Pro forma net loss per share...........................                 $     (1.33)  $     (1.39)
                                                                        ===========   ===========
Shares used in computing pro forma net loss per
  share................................................                   7,032,000     6,959,000
                                                                        ===========   ===========
</TABLE>
 
                See Notes to Consolidated Financial Statements.
 
                                       F-4
<PAGE>   55
 
                          CARDIAC PATHWAYS CORPORATION
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
                        PREFERRED STOCK         COMMON STOCK      ADDITIONAL    RECEIVABLES
                      --------------------   ------------------     PAID-IN         FROM       ACCUMULATED      DEFERRED
                        SHARES     AMOUNT     SHARES     AMOUNT     CAPITAL     STOCKHOLDERS     DEFICIT      COMPENSATION
                      ----------   -------   ---------   ------   -----------   ------------   ------------   ------------
<S>                   <C>          <C>       <C>         <C>      <C>           <C>            <C>            <C>
Balance at June 30,
 1994...............   4,776,701     4,777     833,571     834     23,501,503            --     (12,024,531)           --
Issuance of Series F
  convertible
  preferred stock,
  less $38,257 in
  issuance costs....     373,001       373          --      --      5,556,370            --              --            --
Issuance of Series E
  preferred stock
  warrants..........          --        --          --      --          7,799            --              --            --
Issuance of common
  stock for
  technology and
  services..........          --        --       7,333       7         10,273            --              --            --
Issuance of
  nonqualified stock
  options for
  services..........          --        --          --      --         11,623            --              --            --
Exercise of options
  to purchase common
  stock.............          --        --      84,281      84         41,813       (11,000)             --            --
Net loss                      --        --          --      --             --            --      (9,659,543)           --
                      ----------   -------   ---------   ------   -----------     ---------    ------------     ---------
Balance at June 30,
  1995..............   5,149,702     5,150     925,185     925     29,129,381       (11,000)    (21,684,074)           --
Issuance of Series F
  convertible
  preferred stock,
  less $997 in
  issuance costs....     300,000       300          --      --      4,498,702            --              --            --
Issuance of Series F
  preferred stock
  warrants..........          --        --          --      --         33,000            --              --            --
Issuance of
  nonqualified stock
  options for
  services..........          --        --          --      --         34,131            --              --            --
Exercise of warrant
  to purchase common
  stock.............          --        --       6,667       7         57,993            --              --            --
Exercise of options
  to purchase common
  stock.............          --        --     387,778     388        576,887      (395,000)             --            --
Conversion of
  preferred stock to
  common stock......  (5,449,702)   (5,450)  5,449,702   5,450             --            --              --            --
Issuance of common
  stock in
  connection with
  initial public
  offering, less
  $1,037,725 in
  issuance costs....          --        --   2,500,000   2,500     43,134,775            --              --            --
Deferred
  compensation......          --        --          --      --        191,765            --              --      (191,765)
Amortization of
  deferred
  compensation......          --        --          --      --             --            --              --        35,994
Net loss............          --        --          --      --             --            --      (9,369,164)           --
                      ----------   -------   ---------   ------   -----------     ---------    ------------     ---------
Balance at June 30,
  1996..............          --        --   9,269,332   9,270     77,656,634      (406,000)    (31,053,238)     (155,771)
Issuance of
  nonqualified stock
  options for
  services..........          --        --          --      --         17,750            --              --            --
Exercise of options
  to purchase common
  stock.............          --        --     216,642     217        305,736       (14,000)             --            --
Issuance of common
  stock under
  employee stock
  purchase plan.....          --        --      37,566      37        253,573            --              --            --
Deferred
  compensation......          --        --          --      --        855,500            --              --      (855,500)
Amortization of
  deferred
  compensation......          --        --          --      --             --            --              --       243,595
Net loss............          --        --          --      --             --            --     (12,865,594)           --
                      ----------   -------   ---------   ------   -----------     ---------    ------------     ---------
Balance at June 30,
  1997..............          --   $    --   9,523,540   $9,524   $79,089,193    $ (420,000)   $(43,918,832)   $ (767,676)
                      ==========   =======   =========   ======   ===========     =========    ============     =========
 
<CAPTION>
                          TOTAL
                      STOCKHOLDERS'
                         EQUITY
                      -------------
<S>                   <C>
Balance at June 30,
 1994...............     11,482,583
Issuance of Series F
  convertible
  preferred stock,
  less $38,257 in
  issuance costs....      5,556,743
Issuance of Series E
  preferred stock
  warrants..........          7,799
Issuance of common
  stock for
  technology and
  services..........         10,280
Issuance of
  nonqualified stock
  options for
  services..........         11,623
Exercise of options
  to purchase common
  stock.............         30,897
Net loss                 (9,659,543)
                       ------------
Balance at June 30,
  1995..............      7,440,382
Issuance of Series F
  convertible
  preferred stock,
  less $997 in
  issuance costs....      4,499,002
Issuance of Series F
  preferred stock
  warrants..........         33,000
Issuance of
  nonqualified stock
  options for
  services..........         34,131
Exercise of warrant
  to purchase common
  stock.............         58,000
Exercise of options
  to purchase common
  stock.............        182,275
Conversion of
  preferred stock to
  common stock......             --
Issuance of common
  stock in
  connection with
  initial public
  offering, less
  $1,037,725 in
  issuance costs....     43,137,275
Deferred
  compensation......             --
Amortization of
  deferred
  compensation......         35,994
Net loss............     (9,369,164)
                       ------------
Balance at June 30,
  1996..............     46,050,895
Issuance of
  nonqualified stock
  options for
  services..........         17,750
Exercise of options
  to purchase common
  stock.............        291,953
Issuance of common
  stock under
  employee stock
  purchase plan.....        253,610
Deferred
  compensation......             --
Amortization of
  deferred
  compensation......        243,595
Net loss............    (12,865,594)
                       ------------
Balance at June 30,
  1997..............  $  33,992,209
                       ============
</TABLE>
 
                See Notes to Consolidated Financial Statements.
 
                                       F-5
<PAGE>   56
 
                          CARDIAC PATHWAYS CORPORATION
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                                  YEAR ENDED JUNE 30,
                                                       ------------------------------------------
                                                           1997           1996           1995
                                                       ------------   ------------   ------------
<S>                                                    <C>            <C>            <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss.............................................  $(12,865,594)  $ (9,369,164)  $ (9,659,543)
Adjustments to reconcile net loss to net cash used in
  operating activities:
  Depreciation and amortization......................     1,260,546        818,072        579,671
  Amortization of deferred compensation..............       243,595         35,994             --
  Loss on disposal of property and equipment.........            --         12,860             --
  Issuance of preferred stock warrants...............            --         33,000          7,799
  Issuance of nonqualified stock options for
     services........................................        17,750         34,131         11,623
  Issuance of common stock for technology and
     services........................................            --             --         10,280
Changes in operating assets and liabilities:
  Accounts receivable................................       230,169       (348,126)       (50,871)
  Receivable from related party......................        20,173        114,075       (120,800)
  Inventories........................................      (257,489)        49,177       (211,693)
  Prepaid expenses...................................      (177,419)       (93,266)       (26,330)
  Other current assets...............................      (188,237)      (179,336)        (4,583)
  Accounts payable...................................       276,998        (68,211)        70,142
  Accrued compensation and related benefits..........       269,303         94,856       (111,964)
  Accrued clinical expenses..........................       546,102        150,004             --
  Other accrued expenses.............................       136,677        252,210        148,931
  Interest payable on note...........................       379,204        399,656        374,765
  Deferred royalty income............................       (49,527)     3,000,000             --
                                                       -------------  -------------  -------------
Net cash used in operating activities................   (10,157,749)    (5,064,068)    (8,982,573)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of short-term investments..................   (54,509,722)   (27,761,202)   (11,920,680)
Maturities and sales of short-term investments.......    41,795,000     10,279,751     14,905,122
Purchase of property and equipment...................      (742,155)      (981,344)      (341,533)
(Increase) decrease in notes receivable..............       (57,075)         4,000        (21,334)
(Increase) in deposits and other assets..............       (38,095)       (47,298)       (12,381)
                                                       -------------  -------------  -------------
Net cash provided by (used in) investing
  activities.........................................   (13,552,047)   (18,506,093)     2,609,194
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from initial public offering, net...........            --     43,137,275             --
Principal payments under capital lease obligations...      (856,596)      (567,081)      (396,742)
Proceeds from sale of preferred stock................            --      4,499,002      5,556,743
Proceeds from sale of common stock...................       559,563        250,275         41,897
Notes receivable from stockholders...................       (14,000)       (10,000)       (11,000)
                                                       -------------  -------------  -------------
Net cash provided by (used in) financing
  activities.........................................      (311,033)    47,309,471      5,190,898
                                                       -------------  -------------  -------------
Net increase (decrease) in cash and cash
  equivalents........................................   (24,020,829)    23,739,310     (1,182,481)
Cash and cash equivalents at beginning of year.......    29,112,255      5,372,945      6,555,426
                                                       -------------  -------------  -------------
Cash and cash equivalents at end of year.............  $  5,091,426   $ 29,112,255   $  5,372,945
                                                       =============  =============  =============
</TABLE>
 
                See Notes to Consolidated Financial Statements.
 
                                       F-6
<PAGE>   57
 
                          CARDIAC PATHWAYS CORPORATION
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                 JUNE 30, 1997
 
 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Nature of Business
 
     Cardiac Pathways Corporation, a Delaware corporation (the "Company"),
designs, develops and manufactures minimally invasive systems to diagnose and
treat cardiac tachyarrhythmias.
 
  Basis of Presentation
 
     The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries, Cardiac Pathways B.V. and Cardiac
Pathways S.A. All significant intercompany accounts and transactions have been
eliminated.
 
  Use of Estimates
 
     The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
 
  Reincorporation and Reverse Stock Split
 
     In March 1996, the Company's Board of Directors authorized the
reincorporation of the Company in the state of Delaware and a 2-for-3 reverse
stock split. The reincorporation was effected in May 1996 following stockholder
approval. In June 1996, the Company completed its initial public offering of
2,500,000 shares of common stock at a price of $19.00 per share, raising net
proceeds of $43,137,000. Each share of the Company's outstanding convertible
preferred stock was automatically converted to a share of common stock during
the initial public offering. Effective upon the closing of the initial public
offering, the Company became authorized to issue 5,000,000 shares of $.001 par
value preferred stock and 30,000,000 shares of $.001 par value common stock (see
Note 4). All par value, share and per share amounts have been retroactively
adjusted to reflect the reverse stock split and the Company's reincorporation.
 
  Fair Value of Financial Instruments
 
     The carrying amounts reported in the balance sheet for cash and cash
equivalents and short-term investments approximate fair value. The fair value of
short-term investments is based on quoted market prices.
 
     The carrying amount of the Company's note payable approximates its fair
value. The fair value of the Company's note payable is estimated using
discounted cash flow analyses, based on the Company's current incremental
borrowing rate for similar types of borrowing arrangements.
 
  Concentrations of Credit Risk
 
     The Company is potentially subject to concentrations of credit risk with
respect to its cash investments and trade accounts receivable. The Company
invests its excess cash in a diversified portfolio of investment grade interest
bearing instruments. The Company is exposed to credit risk in the event of
default by the financial institutions or issuers of investments only to the
extent recorded on the balance sheet. To date, the Company has not experienced
any losses on its investments.
 
     The Company sells its products to distributors primarily in the United
States, Japan and Europe (see Note 10). The Company does not require collateral
and maintains reserves for estimated credit losses. To date, such losses have
been within management's expectations and have not been significant.
 
                                       F-7
<PAGE>   58
 
                          CARDIAC PATHWAYS CORPORATION
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                                 JUNE 30, 1997
 
  Cash, Cash Equivalents and Short-term Investments
 
     The Company considers all highly liquid investments with an original
maturity of three months or less when purchased to be cash equivalents. All
other liquid investments are classified as short-term investments and consist
primarily of U.S. government agency instruments, corporate obligations and money
market instruments.
 
     Management currently classifies the Company's investment portfolio as
held-to-maturity and available-for-sale. Available-for-sale securities are
carried at fair value with unrealized gains and losses reported as a separate
component of stockholders' equity. To date, the Company has not experienced any
significant unrealized gains or losses on available-for-sale securities and,
accordingly, no adjustments have been made to stockholders' equity.
 
     The cost of held-to-maturity securities is adjusted for the amortization of
premiums and the accretion of discounts to maturity. Such amortization of
premiums and accretion of discounts are included in interest income. At June 30,
1997 and 1996, these securities were valued at amortized cost, which
approximates fair value.
 
     The following is a summary of held-to-maturity and available-for-sale
securities at June 30, 1997:
 
<TABLE>
<CAPTION>
                                                               GROSS        GROSS
                                                AMORTIZED    UNREALIZED   UNREALIZED    ESTIMATED
                   DESCRIPTION                    COST         GAINS        LOSSES     FAIR VALUE
    -----------------------------------------  -----------   ----------   ----------   -----------
    <S>                                        <C>           <C>          <C>          <C>
    Held-to-maturity:
      U.S. government agency.................  $15,485,479    $  1,495     $  (9,079)  $15,477,895
      U.S. corporate obligations.............   20,329,767      12,511       (10,168)   20,332,110
    Available-for-sale:
      Auction rate preferred stock...........    2,100,000          --            --     2,100,000
      U.S. corporate obligations.............    1,055,206          --        (1,626)    1,053,580
                                               -----------     -------      --------   -----------
                                                38,970,452      14,006       (20,873)   38,963,585
    Amounts classified as cash equivalents...    2,494,918         139            --     2,495,057
                                               -----------     -------      --------   -----------
    Amounts included in short-term
      investments............................  $36,475,534    $ 13,867     $ (20,873)  $36,468,528
                                               ===========     =======      ========   ===========
</TABLE>
 
     There were no realized gains or losses as a result of the maturity or sale
of securities for the year ended June 30, 1997. The cost of securities sold is
based on the specific identification method. Held-to-maturity securities at June
30, 1997 mature at various dates through June 1998.
 
     The following is a summary of held-to-maturity and available-for-sale
securities at June 30, 1996:
 
<TABLE>
<CAPTION>
                                                               GROSS        GROSS
                                                AMORTIZED    UNREALIZED   UNREALIZED    ESTIMATED
                   DESCRIPTION                    COST         GAINS        LOSSES     FAIR VALUE
    -----------------------------------------  -----------   ----------   ----------   -----------
    <S>                                        <C>           <C>          <C>          <C>
    Held-to-maturity:
      U.S. government agency.................  $ 3,981,271    $     --     $    (404)  $ 3,980,867
      U.S. corporate obligations.............   19,748,126       3,008        (4,473)   19,746,661
    Available-for-sale:
      Auction rate preferred stock...........    5,000,000          --            --     5,000,000
                                               -----------     -------      --------   -----------
                                                28,729,397       3,008        (4,877)   28,727,528
    Amounts classified as cash equivalents...    4,968,585          70          (170)    4,968,485
                                               -----------     -------      --------   -----------
    Amounts included in short-term
      investments............................  $23,760,812    $  2,938     $  (4,707)  $23,759,043
                                               ===========     =======      ========   ===========
</TABLE>
 
                                       F-8
<PAGE>   59
 
                          CARDIAC PATHWAYS CORPORATION
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                                 JUNE 30, 1997
 
     There were no realized gains or losses as a result of the maturity or sale
of securities for the year ended June 30, 1996.
 
  Inventory
 
     Inventories are stated at the lower of cost (determined using the first-in,
first-out method) or market and consist of the following:
 
<TABLE>
<CAPTION>
                                                               JUNE 30,
                                                         ---------------------
                                                           1997         1996
                                                         --------     --------
                <S>                                      <C>          <C>
                Raw materials..........................  $252,349     $125,459
                Work-in-process........................    26,929           --
                Finished goods.........................   140,727       37,057
                                                         --------
                                                         $420,005     $162,516
                                                         ========
</TABLE>
 
  Property and Equipment
 
     Property and equipment, including equipment under capital leases, are
carried at cost less accumulated depreciation and amortization. Property and
equipment are depreciated using the straight-line method over estimated useful
lives of three to five years. Leasehold improvements are amortized using the
straight-line method over the shorter of the estimated useful life of the asset
or the remaining term of the lease. Depreciation expense includes amortization
of capital leases and leasehold improvements.
 
     Property and equipment consist of the following:
 
<TABLE>
<CAPTION>
                                                              JUNE 30,
                                                      -------------------------
                                                         1997           1996
                                                      ----------     ----------
                <S>                                   <C>            <C>
                Property and equipment:
                  Equipment.........................  $4,799,030     $3,472,535
                  Leasehold improvements............     274,307         83,047
                  Equipment-in-process..............   1,076,157      1,027,872
                                                      ----------     ----------
                                                       6,149,494      4,583,454
                Less accumulated depreciation and
                  amortization......................   3,008,645      1,748,099
                                                      ----------     ----------
                                                      $3,140,849     $2,835,355
                                                      ==========     ==========
</TABLE>
 
  Revenue Recognition
 
     Revenue from disposable products is recognized at the time of shipment.
Revenue from equipment is recognized upon shipment and the completion of certain
installation and acceptance criteria.
 
  Product Warranties
 
     The Company warrants its equipment for a period of one year. The Company
provides for estimated warranty costs concurrent with the recognition of
revenue.
 
  Royalty Income
 
     At June 30, 1997 and 1996, the Company had $2,950,473 and $3,000,000 of
deferred royalty income, respectively, related to one of its diagnostic catheter
systems (see Note 9). Income earned from this royalty agreement is recorded as a
component of net sales.
 
                                       F-9
<PAGE>   60
 
                          CARDIAC PATHWAYS CORPORATION
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                                 JUNE 30, 1997
 
  Research and Development Costs
 
     Research and development costs, which include clinical and regulatory
costs, are charged to expense as incurred.
 
  Foreign Currency Translation
 
     The functional currency of the Company's two foreign subsidiaries is the
U.S. dollar. Monetary assets and liabilities denominated in foreign currencies
are remeasured at the year-end exchange rate. Inventory, property, and other
nonmonetary assets and liabilities are remeasured at historical rates.
Adjustments resulting from these remeasurements are included in the results of
operations and have been immaterial to date.
 
  Net Loss Per Share
 
     Except as noted below, historical net loss per share is computed using the
weighted average number of shares of common stock outstanding. Common equivalent
shares from stock options and convertible preferred stock and warrants are
excluded from the computation as their effect is antidilutive, except that,
pursuant to the Securities and Exchange Commission Staff Accounting Bulletins,
common and common equivalent shares issued at prices substantially below the
public offering price during the twelve-month period prior to the filing of the
initial public offering have been included in the calculation as if they were
outstanding for all periods presented prior to the offering (using the treasury
stock method).
 
     Historical net loss per share information is as follows:
 
<TABLE>
<CAPTION>
                                                         YEAR ENDED JUNE 30,
                                                      -------------------------
                                                         1996           1995
                                                      ----------     ----------
                <S>                                   <C>            <C>
                Net loss per share................    $    (3.95)    $    (4.43)
                                                      ==========     ==========
                Shares used in computing net loss
                  per share.......................     2,375,000      2,182,000
                                                      ==========     ==========
</TABLE>
 
  Pro Forma Net Loss Per Share
 
     Pro forma net loss per share has been computed as described above and also
gives effect to the conversion of convertible preferred shares not included
above that automatically converted to common stock upon completion of the
Company's initial public offering (using the if-converted method) from the
original date of issuance.
 
  Stock-Based Compensation
 
     The Company accounts for its stock-based compensation arrangements using
the intrinsic-value method prescribed in Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" and accordingly, has adopted the
disclosure-only provisions of Statement of Financial Accounting Standards No.
123 (FAS 123), "Accounting for Stock-Based Compensation." These provisions
require the Company to disclose pro forma net loss and net loss per share
amounts as if compensation expense related to certain stock awards were
recognized based on the fair value accounting rules under FAS 123 (see Note 4).
 
  Reclassifications
 
     Certain reclassifications have been made to the prior years' financial
statements to conform to the June 30, 1997 presentation. Such reclassifications
had no effect on the results of operations or accumulated deficit.
 
                                      F-10
<PAGE>   61
 
                          CARDIAC PATHWAYS CORPORATION
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                                 JUNE 30, 1997
 
  Recent Pronouncements
 
     In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128 (FAS 128), "Earnings per Share," which
the Company will adopt on December 31, 1997. At that time, the Company will be
required to change the method currently used to compute earnings per share and
to restate all prior periods. Under the new requirements for calculating basic
earnings per share, the dilutive effect of stock options will be excluded. The
Company has studied the implications of FAS 128 and does not expect its adoption
to have a material impact on the Company's calculation of earnings per share.
 
     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (FAS 130), "Reporting Comprehensive
Income" which requires the reporting and presentation of comprehensive income
and its components in the financial statements. Comprehensive income reflects
certain items not currently reported in measuring net income such as changes in
value of available-for-sale securities and foreign currency translation
adjustments. FAS 130 will become effective for the Company's year ending June
30, 1999.
 
     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 (FAS 131), "Disclosures about Segments of
an Enterprise and Related Information" which supersedes the current segment
reporting requirements of Statement of Financial Accounting Standards No. 14
(FAS 14), "Financial Reporting for Segments of a Business Enterprise," as
amended. FAS 131 requires the reporting of certain financial and other
disclosures related to the Company's operating segments which are identified
using a "management approach." Operating segments are revenue-producing
components of the business for which separate financial information is produced
internally and are subject to evaluation by the chief operating decision maker
in the resource allocation process. FAS 131 will become effective for the
Company's year ending June 30, 1999.
 
 2. COMMITMENTS
 
     The Company leases facilities and equipment under noncancelable lease
agreements. Future minimum lease payments were as follows:
 
<TABLE>
<CAPTION>
                                                            JUNE 30, 1997
                                                       -----------------------
                                                        CAPITAL       OPERATING
                                                         LEASES        LEASES
                                                       ----------     --------
                 <S>                                   <C>            <C>
                 1998................................  $  853,890     $363,919
                 1999................................     418,834      129,511
                 2000................................      84,358        9,730
                                                       ----------     --------
                      Total minimum lease payments...   1,357,082     $503,160
                                                                      ========
                 Less amount representing interest...     115,681
                                                       ----------
                 Present value of minimum lease
                   payments..........................   1,241,401
                 Less current portion................     768,813
                                                       ----------
                 Long-term portion...................  $  472,588
                                                       ==========
</TABLE>
 
     The Company leases its facility under a noncancelable operating lease
agreement that extends through October 1998. Rent expense, net of sublease
income, was approximately, $322,000, $301,000, and $292,000 for the years ended
June 30, 1997, 1996 and 1995, respectively. Sublease income for the years ended
June 30, 1997, 1996 and 1995 was $45,000, $65,000 and $58,000, respectively. The
Company leases certain equipment under long-term leases, the terms of which
qualify as capital leases. Capital lease obligations are collateralized with
leased equipment.
 
                                      F-11
<PAGE>   62
 
                          CARDIAC PATHWAYS CORPORATION
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                                 JUNE 30, 1997
 
     The Company's equipment acquired under capital lease arrangements and
related accumulated amortization are as follows:
 
<TABLE>
<CAPTION>
                                                             JUNE 30,
                                                     -------------------------
                                                        1997           1996
                                                     ----------     ----------
                 <S>                                 <C>            <C>
                 Equipment at cost.................  $3,157,000     $2,333,000
                 Less accumulated amortization.....   1,779,000      1,109,000
                                                     ----------     ----------
                                                     $1,378,000     $1,224,000
                                                     ==========     ==========
</TABLE>
 
 3. NOTE PAYABLE
 
     At June 30, 1997, the Company had a $4,500,000 note payable due to a
European biomedical company. The note bears interest at the prime rate (8.50% at
June 30, 1997) as quoted in The Wall Street Journal, and all principal and
accrued interest are due on June 27, 1999.
 
     The note is immediately payable in the event the Company completes a
follow-on public offering pursuant to which the Company realizes more than
$5,000,000 or in the event the Company has positive cash flow from operations in
excess of $500,000 for any fiscal quarter. In addition, the note is immediately
payable upon the close of a merger, reorganization, or sale of substantially all
of the assets of the Company.
 
 4. STOCKHOLDERS' EQUITY
 
  Common Stock
 
     The Company is authorized to issue 30,000,000 shares of common stock, $.001
par value per share, of which a total of 9,523,540 shares were outstanding at
June 30, 1997. In June 1996, the Company completed its initial public offering
of 2,500,000 shares of common stock, raising net proceeds of approximately
$43,137,000. Upon completion of the offering, all of the preferred stock
outstanding automatically converted into 5,449,702 shares of common stock.
 
  Preferred Stock
 
     The Company is authorized to issue 5,000,000 shares of undesignated
preferred stock, $.001 par value per share. Preferred stock may be issued from
time to time in one or more series. The Board of Directors is authorized to
determine the rights, preferences, privileges, and restrictions granted to and
imposed upon any wholly unissued series of preferred stock and to fix the number
of shares of any series of preferred stock and the designation of any such
series without any vote or action by the Company's stockholders. At June 30,
1997 and 1996, the Company had no shares of preferred stock outstanding.
 
  Stock Warrants
 
     The Company has issued warrants to purchase common stock in connection with
various financing and lease agreements. The fair value of warrants issued in
connection with lease transactions was expensed as incurred. The following
warrants to purchase common stock were outstanding at June 30, 1997:
 
<TABLE>
<CAPTION>
                             PRICE
           RESERVED FOR       PER        AGGREGATE       EXPIRATION
SHARES       ISSUANCE        SHARE         PRICE            DATE
-------    ------------     --------     ----------     ------------
<S>        <C>              <C>          <C>            <C>
 19,999       19,999        $   8.70     $  173,991        June 2001
 76,972       76,972          13.125      1,010,258        June 2001
 11,000       11,000           15.00        165,000        June 2001
</TABLE>
 
                                      F-12
<PAGE>   63
 
                          CARDIAC PATHWAYS CORPORATION
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                                 JUNE 30, 1997
 
  Stock Option Plans
 
     In July 1991, the Board of Directors of the Company approved the Company's
1991 Stock Option Plan (the "Plan"). The Plan provides for the issuance of
incentive and nonstatutory options to employees, officers, and consultants of
the Company to acquire common stock of the Company. The Plan provides for the
granting of options for up to 1,887,030 shares of common stock of the Company.
The exercise price of incentive stock options granted under the Plan may not be
less than 100% (110% in the case of any options granted to a person who owns
more than 10% of the total combined voting power of all classes of stock of the
Company) of the fair market value of the common stock subject to the option on
the date of grant. Options granted under the Plan generally become exercisable
over a four-year period and generally expire ten years from the date of grant.
Expired options become available under the Plan. At June 30, 1997, a total of
1,132,550 shares of common stock has been reserved for issuance under the Plan.
 
     In September 1996 and April 1997, the Board of Directors authorized the
exchange of certain stock option grants at the then fair market values of the
Company's common stock. These exchanges were voluntary and open to all employees
holding options subsequent to certain dates. In September 1996, options to
purchase 28,651 shares of common stock at prices ranging from $12.75 to $15.00
per share were exchanged for options to purchase a like number of shares at
$12.00 per share. Under the September 1996 exchange, all previous vesting of the
related options was forfeited. In April 1997, options to purchase 154,628 shares
of common stock at prices ranging from $8.50 to $17.00 per share were exchanged
for options to purchase a like number of shares at $6.63 per share. Vesting
terms were not modified under the April 1997 exchange, however, no vested
options related to the exchange are exercisable for a period of 180 days
following the exchange.
 
     During the years ended June 30, 1997 and 1996, the Company recorded
deferred compensation of approximately $856,000 and $192,000, respectively,
representing the difference between the grant price and the fair value of the
Company's common stock for certain options granted during those years. The
deferred compensation is amortized over the period for which the related stock
options become exercisable, which is generally four years. Amortization of
deferred compensation was approximately $244,000 and $36,000 for the years ended
June 30, 1997 and 1996, respectively.
 
     In April 1996, the Company adopted the 1996 Director Option Plan (the
"Director Plan"). The Director Plan provides for the granting of options for up
to 20,000 shares of common stock of the Company. The option grants under the
Director Plan are automatic and non-discretionary, and the exercise price of the
options is 100% of the fair market value of the common stock on the grant date.
The Director Plan provides for an initial grant of options to purchase 13,000
shares of common stock to each new non-employee director. In addition, each
non-employee director will automatically be granted an option to purchase 700
shares of common stock annually. Options granted under the Director Plan become
exercisable over a four-year period and expire ten years from the date of grant.
At June 30, 1997, a total of 20,000 shares of common stock has been reserved for
issuance under the Director Plan.
 
     The fair value of option grants related to the above plans is estimated on
the date of grant using the Black-Scholes pricing model with the following
assumptions for the years ended June 30, 1997 and 1996:
 
<TABLE>
                <S>                                                <C>
                Risk-free interest rate..........................  6.02%
                Expected life....................................  3.49 years
                Expected volatility..............................  72.62%
                Dividend yield...................................  --
</TABLE>
 
                                      F-13
<PAGE>   64
 
                          CARDIAC PATHWAYS CORPORATION
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                                 JUNE 30, 1997
 
     The following is a summary of activity under the stock option plans:
 
<TABLE>
<CAPTION>
                                              1997                   1996                   1995
                                      --------------------   --------------------   --------------------
                                                  WEIGHTED               WEIGHTED               WEIGHTED
        YEAR ENDED JUNE 30,                       AVERAGE                AVERAGE                AVERAGE
------------------------------------              EXERCISE               EXERCISE               EXERCISE
           STOCK OPTIONS               SHARES      PRICE      SHARES      PRICE      SHARES      PRICE
------------------------------------  ---------   --------   ---------   --------   ---------   --------
<S>                                   <C>         <C>        <C>         <C>        <C>         <C>
Outstanding at July 1...............  1,045,172    $ 1.91    1,093,884    $ 0.85      819,478    $ 0.52
  Granted...........................    615,917    $ 8.16      379,408    $ 4.52      475,364    $ 1.38
  Exercised.........................   (216,642)   $ 1.41     (384,446)   $ 1.49      (84,281)   $ 0.54
  Canceled..........................   (416,685)   $ 7.43      (43,674)   $ 1.96     (116,677)   $ 0.99
                                      ---------              ---------              ---------
Outstanding at June 30..............  1,027,762    $ 3.52    1,045,172    $ 1.91    1,093,884    $ 0.85
                                      =========              =========              =========
Exercisable at June 30..............    454,390    $ 1.12      400,194    $ 0.94      477,726    $ 0.56
 
Weighted average fair value of
  options granted...................                $4.70                  $2.22
Shares available for grant..........    124,788                304,020                643,086
</TABLE>
 
     The following table summarizes information for outstanding and exercisable
options at June 30, 1997:
 
<TABLE>
<CAPTION>
                                     OPTIONS OUTSTANDING
                    -----------------------------------------------------           OPTIONS EXERCISABLE
                                    WEIGHTED AVERAGE                          --------------------------------
   RANGE OF           NUMBER           REMAINING         WEIGHTED AVERAGE       NUMBER        WEIGHTED AVERAGE
EXERCISE PRICES     OUTSTANDING     CONTRACTUAL LIFE      EXERCISE PRICE      OUTSTANDING      EXERCISE PRICE
---------------     -----------     ----------------     ----------------     -----------     ----------------
<S>                 <C>             <C>                  <C>                  <C>             <C>
$ 0.23 - $ 0.87        282,724            5.47                $ 0.54            263,856            $ 0.52
$ 1.32 - $ 3.30        314,693            7.51                $ 1.46            178,141            $ 1.42
$ 5.78 - $ 6.63        378,045            9.36                $ 6.51              7,254            $ 6.13
$ 7.75 - $15.00         52,300            9.57                $10.44              5,139            $14.06
                     ---------            ----                 -----            -------            ------
$  .23 - $15.00      1,027,762            7.73                $ 3.52            454,390            $ 1.12
</TABLE>
 
  Employee Stock Purchase Plan
 
     In April 1996, the Company adopted the 1996 Employee Stock Purchase Plan
(the "Purchase Plan"). The Purchase Plan provides for the purchase by employees
of up to 53,000 shares of the Company's common stock. The Purchase Plan provides
for consecutive, overlapping 24-month offering periods. Each offering period
consists of four semi-annual purchase periods and is designed to allow eligible
employees to purchase common stock through payroll deductions at a price equal
to 85% of the lesser of the fair market value of the Company's common stock on
the first day of the applicable offering period or the last day of the
respective purchase period. During the year ended June 30, 1997, a total of
37,566 shares were purchased under the Purchase Plan at prices of $5.53 and
$9.35 per share. There were no shares purchased during the year ended June 30,
1996. At June 30, 1997, there were 15,434 shares reserved for issuance under the
Purchase Plan.
 
     The estimated fair value of purchase rights under the Company's Employee
Stock Purchase Plan is determined using the Black-Scholes pricing model with the
following assumptions for the year ended June 30, 1997:
 
<TABLE>
                <S>                                                 <C>
                Risk-free interest rate...........................  5.41%
                Expected life.....................................  6 months
                Expected volatility...............................  72.62%
                Dividend yield....................................  --
</TABLE>
 
     For the year ended June 30, 1997, the weighted average fair value of
purchase rights under the plan was $3.87.
 
                                      F-14
<PAGE>   65
 
                          CARDIAC PATHWAYS CORPORATION
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                                 JUNE 30, 1997
 
  Pro Forma Compensation Expense
 
     The Company has adopted the disclosure-only provisions of FAS 123, and
accordingly, no compensation expense has been recorded for stock awards based on
the fair value method for the years ended June 30, 1997 and 1996. Had
compensation expense for the Company's stock plans been determined based on the
fair value methodology, the Company's net loss and net loss per share would have
been reported as the following pro forma amounts:
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED JUNE 30,
                                                   ----------------------------
                                                       1997            1996
                                                   ------------     -----------
                <S>                                <C>              <C>
                Net loss -- as reported..........  $(12,865,594)    $(9,369,164)
                Net loss -- pro forma............  $(14,094,538)    $(9,636,827)
                Net loss per share -- as
                  reported.......................  $      (1.37)    $     (1.33)
                Net loss per share -- pro
                  forma..........................  $      (1.50)    $     (1.37)
</TABLE>
 
     The above pro forma effects on the results of operations may not be
representative of the effects for future years as option grants typically vest
over several years and additional options are generally granted each year.
Furthermore, as FAS 123 applies only to options granted after July 1, 1995, the
pro forma effect will not be fully reflected until the year ended June 30, 1999.
 
  Stockholder Rights Plan
 
     In April 1997, the Board of Directors approved a stockholder rights plan
and declared a dividend of one preferred share purchase right (a "Right") for
each outstanding share of common stock of the Company to holders of record as of
April 30, 1997. Each Right will entitle stockholders to purchase 1/1000(th) of a
share of Series A participating preferred stock of the Company (a newly
designated series of preferred stock for which each 1/1000(th) of a share has
economic attributes and voting rights equivalent to those of one share of the
Company's common stock) at an exercise price of $125. The Rights only become
exercisable in certain limited circumstances involving acquisitions of or tender
offers for 15% or more of the Company's capital stock by another person or group
of persons. For a limited period of time after the announcement of any such
acquisition or offer, the Rights are redeemable at a price of $.01 per Right.
After becoming exercisable, each Right entitles its holder to purchase for $125
an amount of common stock of the Company, or in certain circumstances,
securities of the acquiror, having a then current market value equal to two
times the exercise price of the Right. The Rights expire on April 21, 2007.
 
 5. INCOME TAXES
 
     Due to operating losses and the inability to recognize an income tax
benefit therefrom, there was no provision for income taxes for the years ended
June 30, 1997, 1996 and 1995.
 
     As of June 30, 1997, the Company had net operating loss carryforwards for
federal and state income tax purposes of approximately $38,000,000 and
$8,800,000, respectively. In addition, the Company had research credit
carryforwards of approximately $2,200,000. The net operating loss and credit
carryforwards described above will expire at various dates beginning in the
years 1998 through 2012, if not utilized. Approximately $3,000,000 of the
federal net operating loss disclosed above is subject to an annual limitation on
utilization of approximately $1,000,000 due to the Section 382 ownership change
rules of the Internal Revenue Code.
 
                                      F-15
<PAGE>   66
 
                          CARDIAC PATHWAYS CORPORATION
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                                 JUNE 30, 1997
 
     Deferred income taxes reflect the net effects of tax carryforwards and
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax assets were as follows:
 
<TABLE>
<CAPTION>
                                                            JUNE 30,
                                                  -----------------------------
                                                      1997             1996
                                                  ------------     ------------
                <S>                               <C>              <C>
                Net operating loss
                  carryforwards...............    $ 13,400,000     $  9,100,000
                Capitalized research costs....       1,400,000          900,000
                Research credit
                  carryforwards...............       2,000,000        1,400,000
                Deferred revenue..............       1,100,000        1,200,000
                Other.........................         800,000          300,000
                                                  ------------     ------------
                  Subtotal....................      18,700,000       12,900,000
                Valuation allowance...........     (18,700,000)     (12,900,000)
                                                  ------------     ------------
                     Total deferred tax
                       asset..................    $         --     $         --
                                                  ============     ============
</TABLE>
 
     The increase in the valuation allowance was approximately $5,800,000 and
$3,600,000 for years ended June 30, 1997 and 1996, respectively.
 
 6. RISKS DUE TO CONCENTRATIONS
 
  Dependence on Systems
 
     The Company has been engaged primarily in researching, developing, testing
and obtaining regulatory clearances for the catheters and equipment that are
components of the Ventricular Tachycardia Ablation System, Arrhythmia Mapping
System and Atrial Fibrillation Ablation System. The Company believes that these
systems are currently the Company's only significant potential products and
these systems will require additional development, clinical trials and
regulatory approvals before they can be marketed in the United States and
internationally.
 
     There can be no assurance that the Company's development efforts will be
successful or that the systems or any other product developed by the Company
will be safe or effective, approved by appropriate regulatory and reimbursement
authorities, capable of being manufactured in commercial quantities at
acceptable costs or successfully marketed.
 
  Dependence on Key Suppliers
 
     The Company purchases certain key components of its products, including a
computer workstation, a fluid pump, certain integrated circuit components, flex
circuits and biocompatible coatings from sole, single or limited source
suppliers. Any significant component supply delay or interruption could require
the Company to qualify new sources of supply, if available, and could have a
material adverse effect on the Company's ability to manufacture its products.
 
 7. SUPPLEMENTAL CASH FLOW INFORMATION
 
<TABLE>
<CAPTION>
                                                  1997         1996          1995
                                                --------     --------     ----------
            <S>                                 <C>          <C>          <C>
            Capital lease obligations incurred
              to acquire equipment............  $823,885     $176,818     $1,319,064
            Issuance of note receivable in
              connection with stock option
              exercise........................  $     --     $385,000     $       --
            Cash paid for interest............  $143,887     $149,193     $  119,936
</TABLE>
 
                                      F-16
<PAGE>   67
 
                          CARDIAC PATHWAYS CORPORATION
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                                 JUNE 30, 1997
 
 8. NOTES RECEIVABLE
 
     In March 1996, the Company entered into an employment agreement with an
officer of the Company pursuant to which it loaned $385,000 to the officer at an
annual interest rate of 5.88%. The proceeds of the loan were used to exercise a
stock option granted to this officer in January 1996. The loan is due upon the
sale of the shares, or any portion thereof, underlying the option up to an
amount equal to fifty percent (50%) of the proceeds from such sale. The
outstanding balance of the note and accrued interest is due and payable on the
earlier of the termination of the officer's employment, or January 2001. In
December 1996, the Company loaned $197,450 to the officer at an annual interest
rate of 6.40% pursuant to the same employment agreement. The proceeds of the
loan were used to pay certain federal and state income taxes related to the
above stock option exercise. The loan is due upon the sale of the shares, or any
portion thereof, underlying the option up to an amount equal to fifty percent
(50%) of the proceeds from such sale. The outstanding balance of the note and
accrued interest is due and payable on the earlier of the termination of the
officer's employment, or December 2001.
 
     In fiscal 1993, the Company received a $200,000 promissory note from a
consultant and former director of the Company. The full recourse note had an
interest rate of 5.68% per annum, compounded annually, and was secured by
approximately 524,514 shares of the Company's common stock held by the
consultant. The principal and all accrued interest became payable upon the
effectiveness of the Company's initial public offering and was repaid in August
1996.
 
     The Company has made loans to employees and an officer in connection with
their relocation to the Company's geographic area. The aggregate outstanding
balance of these loans was $34,000 at June 30, 1997. These full recourse notes,
which are unsecured, may be forgiven at the end of four years and are charged to
expense in some circumstances. In addition, the Company has made full recourse
unsecured loans to certain officers and a director of the Company in the
aggregate amount of $151,000 at June 30, 1997 in connection with the purchase of
the Company's stock and certain federal and state income tax obligations arising
therefrom.
 
 9. RELATIONSHIP WITH ARROW INTERNATIONAL, INC.
 
     The Company entered into an agreement with Arrow International, Inc.
(Arrow) whereby the Company sold an aggregate of 606,667 shares of Series F
preferred stock (which automatically converted to common stock upon the closing
of the Company's initial public offering in June 1996) at $15.00 per share in
June 1995 and December 1995 for an aggregate purchase price of approximately
$9,100,000. In addition, Arrow acquired distribution and manufacturing rights
related to certain of the Company's diagnostic catheter products and the Company
received a $3,000,000 prepaid royalty from Arrow in December 1995. This amount
was recorded as deferred royalty income and will be amortized to income as the
catheter products are manufactured and sold by Arrow. The royalty rate is 5% of
the sales price of the related products. For the year ended June 30, 1997 the
Company recorded royalty income of approximately $50,000. There was no royalty
income recorded during the year ended June 30, 1996.
 
                                      F-17
<PAGE>   68
 
                          CARDIAC PATHWAYS CORPORATION
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                                 JUNE 30, 1997
 
10. INDUSTRY SEGMENT, CUSTOMER AND GEOGRAPHIC INFORMATION
 
     The Company operates in a single industry segment and revenues primarily
consist of product sales to three significant distributors in the United States,
Japan and Europe. The relative percentage of net sales for these distributors is
summarized as follows:
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED JUNE 30,
                                                     -----------------------
                                                     1997      1996      1995
                                                     ---       ---       ---
                <S>                                  <C>       <C>       <C>
                Distributor A......................  66%       54%       15%
                Distributor B......................  17%       33%       --%
                Distributor C......................  13%       13%       57%
</TABLE>
 
     All export and other foreign sales are denominated in U.S. dollars. Export
and other foreign sales to Japan and Europe represented 66% and 16%,
respectively, of the Company's net sales for the year ended June 30, 1997. For
the years ended June 30, 1996 and 1995, export and other foreign sales to Japan
were 54% and 15% of net sales, respectively, and export and other foreign sales
to Europe were 13% and 85% of net sales. Sales to unaffiliated customers from
the U.S. and the Company's European operations were approximately $2,024,000 and
$385,000, respectively, for the year ended June 30, 1997. Sales to unaffiliated
customers from the U.S. and the Company's European operations were approximately
$1,283,000 and $401,000, respectively, for the year ended June 30, 1996, and $0
and $115,000, respectively, for the year ended June 30, 1995. Identifiable
assets of the Company's two foreign subsidiaries are not significant.
 
11. RELATED PARTY TRANSACTIONS
 
     During the years ended June 30, 1997 and 1996, the Company entered into
certain transactions (described below) with Somnus Medical Technologies, Inc.
("Somnus"). There are two officers of the Company who have a direct financial
interest in Somnus. The Company had a sublease agreement with Somnus for
approximately 6,900 square feet. In addition, the Company had a shared services
and equipment rental agreement whereby the Company would provide, at the request
of Somnus, certain facilities and administrative support services, and would
rent certain office furniture and equipment to Somnus on a month-to-month basis.
Both agreements terminated on March 31, 1997. For the years ended June 30, 1997
and 1996, the Company recorded rental and related income under the agreements of
$96,000 and $22,000, respectively.
 
     During the years ended June 30, 1996 and 1995, the Company entered into
certain transactions (described below) with Intella Interventional Systems, Inc.
("Intella"). There are two members of the Board of Directors of the Company who
are on the Board of Directors of Intella, and one officer of the Company is also
on the Board of Directors of Intella. In addition, Intella and the Company have
certain common investor groups.
 
     The Company had a sublease agreement with Intella for approximately 6,300
square feet which terminated on September 30, 1995. Thereafter, Intella opted to
continue the sublease arrangement on a month-to-month basis through May 17,
1996, after which the sublease was terminated. For the years ended June 30, 1996
and 1995, the Company recorded rental income (inclusive of certain facilities
and related charges) from Intella of approximately $92,000 and $104,000,
respectively, under the sublease. In addition, the Company had a shared services
agreement with Intella whereby the Company and Intella shared the services of
certain employees of each company, and the Company provided Intella certain
engineering, and support services. The shared services agreement was on a
month-to-month basis, and for the years ended June 30, 1996 and 1995, the
Company recorded a net amount of $19,000 and $27,000 respectively, under the
shared services agreement after taking into consideration amounts due Intella.
For the years ended June 30, 1996 and 1995, the Company sold $0 and $33,000,
respectively, in raw materials and equipment, at cost to Intella.
 
                                      F-18
<PAGE>   69
 
                          CARDIAC PATHWAYS CORPORATION
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                                 JUNE 30, 1997
 
12. EMPLOYEE BENEFIT PLAN
 
     The Company has an employee 401(k) salary deferral plan that allows
voluntary contributions by all full-time employees. Eligible employees may
contribute from 1% to 15% of their respective compensation, subject to statutory
limitations, and the Company may match a percentage of employee contributions at
the discretion of the Board of Directors. The Company made matching
contributions to certain eligible employees in the plan of approximately
$27,000, $4,500 and $1,800 for the years ended June 30, 1997, 1996 and 1995,
respectively.
 
13. SUBSEQUENT EVENT (UNAUDITED)
 
     In August 1997, the Board of Directors approved increases in the number of
shares reserved for issuance under the Company's stock plans as follows; 380,000
shares under the 1991 Stock Option Plan, 20,000 shares under the 1996 Director
Option Plan and 70,000 shares under the 1996 Employee Stock Purchase Plan. These
increases are subject to stockholder approval at the 1997 Annual Meeting of
Stockholders.
 
                                      F-19
<PAGE>   70
 
                SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
 
<TABLE>
<CAPTION>
                                                             ADDITIONS
                                             BALANCE AT      CHARGED TO                    BALANCE AT
                                            BEGINNING OF     COSTS AND                       END OF
                 DESCRIPTIONS                  PERIOD         EXPENSES      DEDUCTIONS       PERIOD
    --------------------------------------  ------------     ----------     ----------     ----------
    <S>                                     <C>              <C>            <C>            <C>
    Allowance for Doubtful Accounts:
    June 30, 1995.........................     $   --          $9,500        $     --        $9,500
    June 30, 1996.........................      9,500           2,000          (2,000)        9,500
    June 30, 1997.........................      9,500              --              --         9,500
</TABLE>
 
                                       S-1
<PAGE>   71
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
                                                                                     SEQUENTIALLY
  EXHIBIT                                                                              NUMBERED
   NUMBER                                 DESCRIPTION                                    PAGE
  --------     ------------------------------------------------------------------    ------------
  <S>          <C>                                                                   <C>
   3.1(1)      Restated Certificate of Incorporation of the Registrant...........
   3.2(1)      Bylaws of Registrant..............................................
   4.1(2)      Preferred Share Rights Agreement, dated April 22, 1997 between the
               Registrant and Norwest Bank Minnesota, N.A........................
  10.1(1)      Form of Indemnification Agreement between the Registrant and each
               of its directors and officers.....................................
  10.2(1)      1991 Stock Plan and form of Stock Option Agreement thereunder.....
  10.3(1)      1996 Director Option Plan and form of Director Stock Option
               Agreement thereunder..............................................
  10.4(1)      1996 Employee Stock Purchase Plan and forms of agreement
               thereunder........................................................
  10.5+(1)     OEM Agreement between Registrant and Liebel-Flarsheim Company
               dated June 22, 1994...............................................
  10.6+(1)     License Agreement between Registrant and BSI Corporation dated
               October 21, 1994..................................................
  10.7(1)      Loan Agreement between the Registrant and Dideco S.p.A. dated June
               23, 1994, as amended by Amendment to Loan Agreement dated June 22,
               1995 and Amendment No. 2 to Loan Agreement dated April 10, 1996...
  10.8+(1)     Exclusive License Agreement dated May 24, 1995....................
  10.9(1)      Manufacturing and Supply Agreement between the Registrant and
               Arrow International Inc. dated March 8, 1995......................
  10.10(1)     Exclusive International Distributor Agreement between the
               Registrant and Arrow International dated March 8, 1995............
  10.11(1)     Lease dated June 25, 1993 between the Registrant and Brock
               Properties........................................................
  10.12(1)     Master Lease Agreement dated December 1, 1993 between the
               Registrant and Linc Capital Management Services, Ltd., as
               amended...........................................................
  10.13(1)     Shareholder Rights Agreement, as amended to date, dated June 13,
               1995, between the Registrant and certain holders of the Company's
               securities........................................................
  10.14(1)     Consulting Agreement dated June 1, 1995 between the Registrant and
               Mir Imran.........................................................
  11.1         Statement Regarding Computation of Net Loss Per Share.............
  23.1         Consent of Ernst & Young LLP, Independent Auditors................
  24.1         Power of Attorney (see page 49)...................................
  27.1         Financial Data Schedule...........................................
</TABLE>
 
---------------
 
 +  Confidential treatment has been granted for portions of these agreements.
    Omitted portions have been filed separately with the Commission.
 
(1) Incorporated by reference to exhibits filed with Registrant's Registration
    Statement on Form S-1 (Reg. No. 333-3616) as declared effective by the
    Commission on June 12, 1996.
 
(2) Incorporated by reference to exhibits filed with the Registrant's
    Registration Statement on Form 8-A (Reg. No. 000-28372) as declared
    effective by the Commission on May 22, 1997.