<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 [Fee Requires]
            For the fiscal year ended December 31, 1996

            [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
            SECURITIES EXCHANGE ACT OF 1934 [No fee required]
            For the Transition period from ________ to _______

                         Commission File Number: 0-28424

                            CARDIOGENESIS CORPORATION
             (Exact name of registrant as specified in its charter)

           Delaware                                          77-0352469
-------------------------------                         --------------------
(State or other jurisdiction of                            (I.R.S. employer
incorporation or organization)                            identification No.)


                               540 OAKMEAD PARKWAY
                           SUNNYVALE, CALIFORNIA 94086
          (Address of principal executive offices, including zip code)



                                 (408) 328-8500
              (Registrant's telephone number, including area code)


Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
                   COMMON STOCK, $0.001 PAR VALUE PER SHARE
                                (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 Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K. [ ]

   As of February 28, 1997, there were 12,004,113 shares of the Registrant's
Common Stock outstanding, and the aggregate market value of such share held by
non-affiliates of the Registrant (based upon the closing sale price of such
shares on the Nasdaq National Market on February 28, 1997) was approximately
$183,063,000. Shares of Common Stock held by each executive officer and director
and be each entity affiliated with such persons have been excluded from such
calculation in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.

                       DOCUMENTS INCORPORATED BY REFERENCE

   Certain sections of the Registrant's definitive Proxy Statement for the 1997
Annual Stockholders Meeting to be held on May 28, 1997 are incorporated by
reference in Part III of this Form 10-K to the extent stated herein.
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                                TABLE OF CONTENTS

PART I
ITEM 1.   Business....................................................     3
ITEM 2.   Properties..................................................    17
ITEM 3.   Legal Proceedings...........................................    17
ITEM 4.   Submission of Matters to a Vote of Security Holders.........    17

PART II
ITEM 5.   Market for Registrant's Common Equity and Related
          Stockholder Matters.........................................    18
ITEM 6.   Selected Financial Data.....................................    18
ITEM 7.   Management's Discussion and Analysis of Financial Condition
          and Results of Operations...................................    19
ITEM 8.   Financial Statements and Supplementary Data.................    31
ITEM 9.   Changes in and Disagreements With Accountants on Accounting
          and Financial Disclosure....................................    50

PART III
ITEM 10.  Directors and Executives Officers of the Registrant.........    50
ITEM 11.  Executive Compensation......................................    50
ITEM 12.  Security Ownership of Certain Beneficial Owners and
          Management..................................................    50
ITEM 13.  Certain Relationships and Related Transactions..............    50

PART IV
ITEM 14.  Exhibits, Financial Statement Schedules and Reports on
          Form 8-K....................................................    51
SIGNATURES............................................................    55



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PART I

ITEM 1.  BUSINESS

   This Report contains forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934, as amended. These forward-looking
statements involve a number of risks and uncertainties, including the factors
described throughout this Report, particularly the section entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Factors." The actual results the Company achieves may differ
materially from any forward-looking statements due to such risks and
uncertainties. The Company has identified by an asterisk (*) various sentences
within this Report which contain such forward-looking statements, and words such
as "believes", "anticipates", "expects", "intends" and similar expressions are
intended to identify forward-looking statements, but are not the exclusive means
of identifying such statements. The Company undertakes no obligation to revise
any forward-looking statements to reflect events or circumstances that may arise
after the date of this Report. Readers are urged to carefully review and
consider the various disclosures made by the Company in this Report that attempt
to advise interested parties of the risks and factors that may affect the
Company's business.

GENERAL

   CardioGenesis is developing proprietary probe and catheter systems to perform
both surgical and catheter-based percutaneous transmyocardial revascularization
("TMR"). TMR is used to treat patients with severe coronary artery disease
("CAD") who suffer from recurrent debilitating chest pain. Unlike coronary
artery bypass graft ("CABG") surgery and percutaneous transluminal coronary
angioplasty ("PTCA"), which are used to bypass, reopen or widen blocked or
narrowed arteries, TMR involves the use of laser energy, delivered through
probes and catheters, to create typically between 15 and 30 channels in the
oxygen-starved regions of the heart muscle. Clinical studies of TMR to treat
severe angina at some of the world's leading medical centers have demonstrated
improvements in clinical symptoms and have reported reductions in the frequency
of repeated diagnostic procedures and hospitalizations. While the mechanism of
the potential clinical benefit of TMR is currently unproven, and additional
clinical and mechanism investigations are ongoing, the Company believes the
reported benefits of TMR are associated with angiogenesis, the formation of new
blood vessels.

   The Company is currently developing three TMR systems, based upon its
patented technology, for use by cardiothoracic surgeons and interventional
cardiologists to treat patients with severe CAD. The Company's intraoperative
TMR ("ITMR(TM)") System and thoracoscopic TMR ("TTMR(TM)") System use an
epicardial approach (i.e., creating channels from outside the heart into the
left ventricle) and its percutaneous myocardial revascularization ("PMR(TM)")
System uses an endocardial approach (i.e., creating channels from inside the
left ventricle partially through the myocardium).

   The Company's objective is to establish TMR as a conventional therapy to
treat CAD and to become the worldwide market leader of TMR systems. *To
establish CardioGenesis as the leading provider of TMR systems, the Company
intends to continue to conduct clinical trials at, and focus its marketing
efforts on, high volume, prestigious cardiovascular centers. The Company's
clinical efforts have been focused on patients with severe angina for whom
existing therapies cannot be used ("no-option" patients). *However, the Company
plans to conduct clinical trials to broaden the applications for its TMR systems
to cover multiple indications, including use as an adjunct to other
interventional therapies, such as CABG and PTCA. *The Company intends to build
upon its domestic and international intellectual property position, particularly
its issued percutaneous and intraoperative TMR method patents. *The Company
seeks to rapidly establish a large installed base of its TMR systems in key
international markets, emerging secondary markets, and, following approval, in
the United States,


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thereby creating an opportunity for a recurring revenue stream from the sale of
its disposable probes and catheters. To help achieve this goal, the Company has
entered into an exclusive international distribution agreement with Boston
Scientific Corporation ("BSC"), a worldwide leader in medical devices. *The
Company believes this agreement, which grants BSC exclusive rights and
responsibilities for sales and distribution of the full range of the Company's
TMR products in all international markets, is the approach needed to capitalize
on the market potential of TMR therapy and the Company's TMR probes and
catheters. *Additionally, the Company intends to invest significant resources to
enhance its understanding of the TMR mechanism to enable it to further develop
its products and to promote widespread adoption of TMR in the medical community.

CARDIOGENESIS TMR APPROACHES AND MARKETS

   The Company's proprietary TMR systems are designed to create channels either
(i) epicardially (i.e., from outside the heart into the left ventricle) or (ii)
endocardially (i.e., from inside the left ventricle partially through the
myocardium). The Company's ITMR System and TTMR System use an epicardial
approach and its PMR System uses an endocardial approach.

   ITMR. In an intraoperative TMR procedure, the heart is exposed by a
cardiothoracic surgeon through either a thoracotomy (incision through the chest
wall) or a sternotomy (incision through the sternum), and the Company's ITMR
probe is applied directly onto the myocardium delivering laser energy to create
channels into the left ventricle. The Company initiated Phase I feasibility
clinical trials with the ITMR System in "no-option" patients in November 1995.
In June 1996, the Company received approval from the U.S. Food and Drug
Administration ("FDA") to expand its multi-center ITMR clinical trial to a Phase
II, prospective, randomized clinical trial in "no-option" patients. In addition,
the Company is conducting clinical studies of the ITMR System as an adjunct to
CABG. See "-- Clinical Trials."

   PMR. The Company's PMR System is designed to be used by an interventional
cardiologist in a cardiac catheterization laboratory. In this procedure, the
cardiologist accesses the heart by inserting a fiber optic equipped catheter
system into the femoral artery at the groin and then advancing it through the
aorta into the left ventricle. Once in the ventricle, the fiber optic catheter
is guided to the ischemic areas of the endocardial wall surface to create
channels partially through the wall of the heart. *The Company believes PMR, as
a catheter-based procedure, is less invasive, less traumatic, and more
cost-effective than other TMR approaches. In November 1996, the Company
initiated clinical testing in Europe of its PMR System in "no-option" patients.
See "-- Clinical Trials."

   TTMR. In a thoracoscopic TMR procedure, a TTMR probe is used by a
cardiothoracic surgeon in combination with endoscopic instruments to access and
visualize the heart. Through these endoscopic instruments, the TTMR probe is
maneuvered and placed on the beating heart delivering laser energy to create
channels into the left ventricle. The Company is testing its TTMR System on a
limited preclinical basis.

   *The Company believes the approaches discussed above may be used for a number
of CAD indications. However, none of the Company's TMR systems has received FDA
approval, and there can be no assurance any of these approaches will receive FDA
approval for any of the indications discussed below or will be accepted by the
medical community as viable methods for the treatment of CAD. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Risk
Factors -- No Assurance of Obtaining Required Regulatory Approvals to Market
Products in the United States; Significant Time Before Submission of Any PMA."


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POTENTIAL INDICATIONS

   The Company believes the three approaches it is developing could be used to
address a range of indications for TMR and estimates each year there are more
than 500,000 patients in the United States and other key markets who could
potentially benefit from TMR therapy.

   "No-option". TMR is currently being studied as a treatment for patients with
severe CAD not treatable by PTCA, CABG or other interventional therapies. These
patients have severe diffuse multivessel CAD and may have undergone multiple
prior cardiac procedures. *The Company believes all of its TMR systems could be
used in the treatment of "no-option" patients.

   Adjunct to CABG. TMR is also currently being studied in combination with
CABG, in cases where the patient has one or more areas of the heart afflicted by
severe CAD that cannot be adequately bypassed. In these cases, the coronary
arteries that can be bypassed are grafted, while other areas that are ischemic
and not suitable for bypass are treated with TMR. *The Company believes its ITMR
and TTMR Systems could address this potential indication.

   Adjunct to PTCA. *The Company believes its proprietary PMR System may be used
in combination with a PTCA procedure, where there is evidence of severely
ischemic regions of the heart not amenable to treatment with PTCA alone. In this
situation, the Company's PMR System would be used to treat the regions of the
heart where PTCA is not effective.

   No Company has yet received approval from the FDA to market TMR systems in
the United States for any indication. None of the Company's TMR systems has been
proven to be safe or efficacious nor has the Company received regulatory
approval to market its TMR systems in the United States. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Risk
Factors -- Early Stage of Clinical Trials; No Assurance of Safety or Efficacy"
and "-- No Assurance of Obtaining Required Regulatory Approvals to Market
Products in the United States; Significant Time Before Submission of Any PMA."

PRODUCTS

   The Company's TMR systems include disposable fiber optic probes and catheters
for transmitting laser energy to the myocardium, a Holmium YAG ("Ho:YAG") laser
unit, and an electrocardiogram ("ECG") monitor, which are described below.

   Disposable Fiber Optic Probes and Catheters. The proprietary probes used in
the Company's ITMR and TTMR Systems and the proprietary catheters used in the
Company's PMR System are flexible, fiber-optic based devices for positioning and
transmitting laser energy to create channels through the wall of the heart. The
tip of the probe includes a proprietary lens apparatus that creates the
appropriate laser energy distribution to allow for progressive, controlled
penetration of the myocardium. A highly flexible optical fiber, encased within a
protective fiber jacket, transmits energy to the lens from the laser. The probes
and catheters are designed as disposable single-use devices. Additionally, the
catheter system permits steering within the ventricle to guide the optical
system to the appropriate areas of the heart wall.

   Ho:YAG Laser. The Company's TMR systems incorporate a proprietary Ho:YAG
laser specifically designed for TMR applications. *The Company believes the
Ho:YAG laser is optimally suited for TMR procedures because of: (i) its tissue
ablation characteristics; (ii) its ability to deliver treatment energy through a
fiber optic device, thereby allowing percutaneous applications; (iii) its
reliability; and (iv) its ability to be manufactured cost-effectively. The
Company's current laser is a portable unit, weighing approximately 140 pounds,
which delivers pulsed infrared radiation.


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   ECG Monitor. The Company's TMR systems include a commercially available,
microprocessor-controlled ECG monitor and a proprietary software algorithm. This
ECG monitor provides the means for timing the Company's laser to the patient's
cardiac electrical activity. *Based on early research sponsored by the Company
and conducted at a major academic institution, the Company believes timing the
laser to the patient's cardiac electrical activity may be a significant factor
in minimizing the occurrence of arrhythmias.

   The Company's TMR systems are designed to offer the following advantages:

   Flexible System Design. The Company's TMR systems are designed to deliver
laser energy in a progressive, controlled manner through a fiber optic probe or
catheter, providing the Company with a technology adaptable for multiple
approaches and indications.

   Price/Performance. The Company has designed its TMR systems to be
cost-effective, enabling flexibility in the pricing of its laser systems and
disposable probes and catheters. *The Company hopes that this flexibility will
enable it to offer superior price/performance to its customers.

   Size and Portability. The Company's current TMR systems weigh approximately
140 pounds, are portable and do not occupy a significant amount of space in an
operating room or cardiac catheterization laboratory.

   Reliability. The Ho:YAG laser used in the Company's TMR systems is a solid
state laser designed for reliability, thereby minimizing maintenance costs. The
Company's TMR systems are also designed to meet and withstand the rigors of
shipment, installation, repeated use, and relocation within the hospital
environment.

   In July 1996, the Company received the CE Mark approval to market its ITMR
System in the European Community. The CE Mark is awarded to companies whose
products meet the essential requirements of the European Medical Device
Directive ("MDD") and provides the regulatory approval necessary for
commercialization in the European Community. In October 1996 at the European
Association of Cardio-Thoracic Surgery's annual meeting in Prague, Czech
Republic, the Company commercially launched the ITMR System in Europe.

   The Company is not currently developing any products outside the field of
TMR. Consequently, the Company is dependent on the successful development and
commercialization of the Company's TMR systems. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Risk Factors --
Dependence on TMR Product Line; Rapid Technological Change."

MARKETING, SALES AND DISTRIBUTION

   The Company's marketing strategy is designed to generate broad market
acceptance of the TMR procedure based on demonstrated clinical efficacy and
cost-effectiveness. The Company's strategy includes developing and maintaining
close working relationships with key cardiothoracic surgeons and interventional
cardiologists who practice at major cardiac care centers. *The Company seeks to
rapidly establish a large installed base of its TMR systems in key international
markets, emerging secondary markets, and, following approval, in the United
States, thereby creating an opportunity for a recurring revenue stream from the
sale of its disposable probes and catheters.

   *The Company expects that education and awareness will be a key component of
its marketing and sales effort for its TMR probe and catheter systems. *The
Company intends to support rigorous clinical research designed to support the
safety, efficacy and potential benefits of its TMR systems. *In addition, to
increase awareness of its TMR systems, the Company intends to encourage the
presentation of the

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results of this research by the research investigators at major national and
international medical symposia and the publication of clinical and scientific
reports of such results in major peer-reviewed publications.

   *In the United States, the Company intends to market its products, if
approved by the FDA, with a direct sales organization. The Company has deployed
a U.S. sales force. However, additional resources will be required to develop a
sales force capable of effectively commercializing the Company's TMR systems in
the U.S. Failure to build an effective sales and marketing organization could
have a material adverse effect on the Company's business, financial condition
and results of operations.

   To effectively address the international markets, the Company has entered
into an exclusive international distribution agreement with BSC, a worldwide
leader in medical devices. *The Company believes this agreement, which grants
BSC exclusive rights and responsibilities for sales and distribution of the full
range of its TMR products in all international markets, is the approach needed
to capitalize on the market potential of TMR therapy and the Company's TMR
probes and catheters. *This strategic relationship should favorably position the
Company in the increasingly competitive TMR technology environment and should
help the Company to address new marketing challenges.

   Until such time, if ever, as the FDA approves the Company's TMR systems for
marketing in the United States, the Company anticipates it will derive its
revenues primarily from BSC as the Company's exclusive international
distributor. The agreement with BSC will not allow the Company to control
international end-market prices and might not result in the same level of sales
and marketing efforts as would be the case using a direct sales force. BSC has
certain rights to terminate the agreement with the Company which, if exercised,
would require the Company to make alternative arrangements for the sale of its
products internationally, and could have a material adverse effect on the
Company's business, financial condition and results of operations. Even if FDA
approval is obtained, the Company expects international sales will continue to
account for a significant portion of the Company's total revenues. As a result,
most of the Company's revenues until such approval is obtained, and a
significant portion of the Company's revenues thereafter, will be subject to the
risks associated with international sales. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Risk Factors --
Reliance on a Third Party for All International Sales" and "-- Need to Comply
with International Government Regulation."

CLINICAL TRIALS

   The Company is conducting three clinical trials with its ITMR System. In
October 1995, the Company initiated a Phase I feasibility study of the ITMR
System in "no-option" patients. The follow-up evaluations of the "no-option"
patients enrolled in the feasibility study continues. In July 1996, the Company
received approval from the FDA under an Investigational Device Exemption ("IDE")
to expand its multi-center ITMR clinical trial to a Phase II, prospective,
randomized, multi-center clinical trial in up to 150 "no-option" patients at up
to 20 clinical sites. In this study, patients are randomly assigned
("randomized") either to treatment with the ITMR System plus continued use of
standard medications or to the continued use of standard medications alone. This
Phase II clinical trial was designed to generate the data necessary to establish
the safety and efficacy of the Company's ITMR System, to provide information
about the extent to which TMR improves the patient's quality of life, and to
provide information for purposes of establishing reimbursement for TMR. In
August 1996, the Company launched an additional prospective, randomized,
multi-center clinical study under an FDA authorized IDE to evaluate the ITMR
therapy as an adjunct to CABG surgery in up to 500 patients at up to 25 clinical
sites.

   In November 1996, the Company initiated clinical testing in Europe of its PMR
System in "no-option" patients. *The Company intends to submit an application to
the FDA to initiate Phase I/II clinical studies, under an IDE, of its PMR System
in the U.S.


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   *Due to the severity of the underlying illnesses of the patients in this
population, the Company expects the use of its TMR systems to be accompanied by
a certain level of patient morbidity and mortality. There can be no assurance
any clinical investigations the Company conducts will be completed or, if
completed, will provide sufficient safety and effectiveness data and information
to support a PMA application and to obtain FDA marketing approval. See
"-- Government Regulation."

MANUFACTURING

  General

   The Company's manufacturing activities conducted at its facility in
Sunnyvale, California, consist of assembly and testing of the fiber optic probe
and catheter systems used for the TMR procedures. The Company has developed
various proprietary processes used to manufacture its probes and catheters.
Recently, the Company's manufacturing activities have increased to support the
demand from commercial sales in Europe and to continue to provide probes and
catheters for use in the various clinical trials and laboratory testing. The
Company uses third party suppliers to manufacture the Ho:YAG laser and ECG
monitor included in its TMR systems and for other services and operations
including sterilization of its products.

   The Company's facilities include a controlled environment room where most
assembly operations are performed. The Company has complied with various
international regulatory requirements including meeting ISO 9001/EN 46001 and
MDD requirements and has obtained a CE Mark approval to market the ITMR System
in Europe. Before the FDA will approve a PMA application, it will inspect the
manufacturing facilities and processes for compliance with FDA regulations. The
Company's manufacturing facilities have not yet been inspected by the FDA. In
the event additional manufacturing sites are added or manufacturing processes
are changed, such new facilities and processes are also subject to regulatory
inspection for compliance with United States and international regulations. See
"-- Government Regulation."

  Suppliers

   Two major components used in the Company's TMR systems, the Ho:YAG laser and
the ECG monitor, are currently available from a sole source. In addition,
several other components used in the Company's TMR systems are purchased by the
Company from a single supplier. The Company periodically conducts assessments of
alternative vendors for various components used in its TMR systems. However, the
qualification of additional or replacement vendors for certain components is a
lengthy process. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Risk Factors -- Dependence on Sole
Suppliers," and "-- No Assurance of Obtaining Required Regulatory Approvals to
Market Products in the United States; Significant Time Before Submission of Any
PMA."

   The Ho:YAG laser currently used in the Company's TMR systems is manufactured
by New Star Lasers pursuant to an OEM Supply Agreement (the "OEM Agreement").
Under this OEM Agreement and a related Research and Development Agreement, the
Company has funded the research and development of a laser designed to meet the
Company's specifications, and the Company has exclusive rights to sell or
otherwise distribute the laser on a worldwide basis either incorporated into the
Company's products or on a stand-alone basis. The OEM Agreement contains a
manufacturing license in favor of the Company effective upon certain events. The
laser vendor has the exclusive right under the OEM Agreement to manufacture and
supply the laser to the Company, subject to the right of the Company to obtain
second sources under certain circumstances. The OEM Agreement prohibits the
laser vendor from selling or otherwise distributing the laser to any third party
unless approved in advance in


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<PAGE>   9
writing by the Company. During the term of the OEM Agreement and for a period of
one year thereafter, the laser vendor is prohibited from making a laser, or any
major subassembly of a laser, that is the same as or functionally equivalent to
the Company's laser for use competitive with that of the Company.

PATENTS AND PROPRIETARY RIGHTS

   The Company relies on a combination of patent, trade secret, copyright and
trademark laws and contractual restrictions to establish and protect proprietary
rights in its TMR systems.

   The Company holds six patents in the United States. One of the Company's
United States patents is directed to its method of PMR, where a flexible lasing
apparatus is inserted through a patient's vascular system into the heart and
laser energy is applied to the inner wall of the heart creating channels in the
myocardium. The Company also holds a United States patent which is directed to
its method of ITMR and TTMR, where a flexible optical fiber system is inserted
into a patient's chest cavity and laser energy is applied to the outer wall of
the heart creating channels through the heart muscle. These patents expire in
the year 2012. The Company also has two patents, which expire in the year 2009,
one directed to a specialized lens and means for securing the lens to an optical
fiber to provide a desirable energy emission pattern and one related to a system
for detecting broken optical fibers. The Company also has a patent which expires
in the year 2013 relating to a reinforced optical fiber system. The Company has
thirteen United States patent applications pending and intends to file
additional patent applications on various features of its TMR systems in the
future. The Company has four international patent applications pending and
intends to file additional international patent applications corresponding to
most of the pending United States patent applications. However, there can be no
assurance additional patents will issue with respect to any currently pending or
future patent application.

   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. Certain of the Company's competitors and potential
competitors have obtained United States patents covering technology that could
be used for certain TMR procedures, and there can be no assurance such
competitors, potential competitors or others have not filed and do not hold
international patents covering other TMR technology. In February 1995, the
Company received a letter from PLC Medical Systems, Inc. ("PLC") advising the
Company of the existence of certain of PLC's patents, including one entitled
Heart-Synchronized Pulsed Laser System ("PLC Patent"). This letter requested an
assessment by the Company of its activities in this area. *The Company believes,
based on its review of the PLC Patent and opinions of counsel, that the
Company's TMR systems do not infringe such PLC Patent. In 1996, the Company
initiated a suit against PLC seeking a judgment that the PLC Patent is invalid
and unenforceable. PLC has counterclaimed against the Company for patent
infringement. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Risk Factors -- Risk of Infringement; Patents and
Proprietary Technology."

RESEARCH AND DEVELOPMENT

   The Company's research and development efforts to date have been focused on
development of the Company's ITMR, PMR and TTMR Systems. The Company is
committed to enhancing the medical community's knowledge and acceptance of TMR
for the treatment of severe angina. *The Company intends to continue its basic
research of the TMR mechanism and to focus on the expansion of the indications
and approaches for using its TMR systems, in particular its PMR System. *In
addition, the Company will continue to address improvements in the devices that
are a part of the TMR systems, including improvements which may reduce the cost
of its TMR systems. *Based on its research, the Company believes the reported
reduction in chest pain, improvement in exercise tolerance, and apparent
long-term increase in myocardial blood flow may be associated with the formation
of new blood vessels,


                                      -9-
<PAGE>   10
or angiogenesis. Product research and development will require substantial
expenditures and has inherent risks, and there can be no assurance the Company
will be successful in identifying products for which demand exists or in
developing products that have the characteristics necessary to treat particular
indications, or that any new products introduced will receive regulatory
approval or be commercially successful. Total research and development expenses
were approximately $7.1 million, $4.0 million, and $1.4 million for the years
ended December 31, 1996, 1995 and 1994, respectively.

   Research and development work related to TMR is being carried out at Columbia
University ("Columbia") pursuant to an agreement that has been extended into
1999. Under this agreement, the Company has a worldwide exclusive license to any
patents that issue in connection with the research conducted. The license also
includes a paid up, exclusive worldwide license to use and disclose (subject to
certain nondisclosure requirements) information, data and know-how relating to
the subject matter of the research and the Company's products resulting from the
research. The license may become nonexclusive, at the election of Columbia, if
the Company fails to use reasonable efforts to develop and market the products
resulting from the research for commercial sale and distribution throughout the
world. The license also contains certain most-favored licensing provisions in
the event that the license becomes nonexclusive. The agreement provides for the
payment of certain royalties by the Company to Columbia based on its net
revenues from products to the extent such products include the patented
technology developed by Columbia under the agreement, including sales made under
an IDE. These royalties are offset by funds advanced by the Company and prior
sponsors to fund the research of Columbia. The Company is not required to pay
royalties to Columbia under the agreement until certain conditions are met.

COMPETITION

   Competition in the market for the treatment of CAD, in the medical device
industry generally, and in the TMR market in particular, is intense and is
expected to increase. The Company competes primarily with other producers of TMR
systems, including PLC, Eclipse Surgical Technologies, Inc. ("Eclipse"), and
U.S. Surgical Corporation ("U.S. Surgical"). Some of the Company's competitors
and many of its potential competitors have substantially greater name
recognition and capital resources than does the Company and also may have
greater resources and expertise in the areas of research and development,
obtaining regulatory approvals, manufacturing and marketing. The TMR market is
characterized by rapid technical innovation. There can be no assurance the
Company's competitors will not succeed in developing TMR products or procedures
that are more effective or more effectively marketed than products marketed by
the Company or that render the Company's technology obsolete. Additionally, even
if the Company's products provide performance comparable to competing products,
there can be no assurance the Company will be able to obtain necessary
regulatory approvals to compete against competitors in terms of manufacturing,
marketing and sales. Certain companies, including PLC, Eclipse, and U.S.
Surgical, currently are in Phase II clinical trials of products and procedures
involving TMR that compete with those offered by the Company, and received
regulatory approvals in Europe to begin commercially marketing their various TMR
products. Earlier entrants in the market in a therapeutic area often obtain and
maintain greater market share than later entrants.

   *The Company believes the primary competitive factors in the market for TMR
systems include clinical performance, product safety and reliability,
availability of third-party reimbursement, product design specifically for TMR
use, product quality, ease of use, price of systems and disposable components,
customer service, and company reputation. In addition, the length of time
required for products to be developed and receive regulatory approval and the
ability to use patents or other proprietary rights to prevent sales by
competitors are also important competitive factors. *The Company believes it
competes favorably with respect to these factors, although certain competitors
are at a more advanced stage in the clinical trial and regulatory approval
processes. There can be no assurance the Company will be able to continue to
compete successfully in the future.


                                      -10-
<PAGE>   11
   Many of the medical indications that may be treatable with TMR are currently
being treated by drug therapies or surgery and other interventional therapies,
including CABG and PTCA. A number of these therapies are widely accepted in the
medical community, have a long history of use and continue to be enhanced
rapidly. There is no assurance procedures using TMR will be able to replace or
augment such established treatments or that clinical research will support the
use of TMR. Additionally, new surgical procedures and new drug therapies are
being developed to treat CAD. These new procedures and drug therapies could be
more effective, safer or more cost-effective than TMR. The inability of TMR to
replace or augment existing therapies or to be more effective, safer or more
cost-effective than new therapies could have a material adverse effect on the
Company's business, financial condition and results of operations.

GOVERNMENT REGULATION

  United States

   The Company's TMR systems and accessories are regulated in the United States
as medical devices. As such, the Company is subject to extensive regulation by
the FDA and state and local authorities including the California Department of
Health Services ("CDHS"). Pursuant to the Federal Food, Drug, and Cosmetic Act
("FDC Act") and the regulations promulgated thereunder, the FDA regulates the
pre-clinical and clinical testing, manufacture, labeling, distribution, sale,
marketing, advertising 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, refusal of the government to grant PMA approval under Section 515 of
the FDC Act or premarket notification clearance under Section 510(k) of the FDC
Act ("510(k)"), withdrawal of marketing clearances or approvals, a
recommendation by the FDA that the Company not be permitted to enter into
government contracts and criminal prosecution. In certain circumstances, the FDA
also has the authority to order recall, repair, replacement or refund of the
cost of a device manufactured or distributed by the Company. To date, none of
the Company's products has been approved for sale in the United States. FDA
approval of a PMA will be required before the Company's TMR systems can be
marketed in the United States.

   In the United States, medical devices are classified as Class I, II or III on
the basis of the controls deemed by the FDA to be necessary to reasonably assure
their safety and effectiveness. Class I devices are subject to general controls
(e.g., labeling, premarket notification and adherence to FDA-mandated current
good manufacturing practice ("GMP") requirements), and Class II devices are
subject to general controls and special controls (e.g., performance standards,
postmarket surveillance, patient registries and FDA guidelines). Generally,
Class III devices are those that must receive premarket approval by the FDA to
assure their safety and effectiveness (e.g., life-sustaining, life-supporting
and implantable devices, or new devices which have been found not to be
substantially equivalent to legally marketed devices). Class III devices usually
require clinical testing and FDA approval prior to marketing and distribution.
The Company's TMR systems are Class III devices.

   Before a new medical device can be introduced into the market, the
manufacturer generally must obtain FDA clearance of a 510(k) or approval of a
PMA under Section 515 of the FDC Act. A PMA application is required if a
proposed device is not substantially equivalent to a legally marketed Class I or
Class II device, or if it is a Class III device for which the FDA has called for
PMAs. A PMA must be supported by valid scientific evidence that typically
includes extensive data, including biocompability data, preclinical study data
(e.g., bench testing, laboratory and animal studies) and clinical study 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


                                      -11-
<PAGE>   12
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 sponsors and all
reviewing IRBs conclude that the device presents a "nonsignificant risk" to the
patient, a sponsor may begin clinical trials after obtaining approval for the
study protocol by one or more of the appropriate IRBs, without the need for FDA
approval of the study protocol. Sponsors of clinical trials are permitted under
the FDA's regulations to sell those devices distributed in the course of the
clinical 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 FDA has the
authority to re-evaluate, alter, suspend or terminate clinical testing based on
its assessment of data collected throughout the trials.

   The PMA must also contain 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, promotional labeling and materials concerning training
methods (if any). Upon submission of a PMA, the FDA makes a threshold
determination regarding whether the application is sufficiently complete to
permit filing for 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. An FDA review of a PMA
generally takes one to three years from the date the PMA is accepted for filing,
but may take significantly longer if the FDA requests additional information and
any major amendments to the PMA are filed. The review time is often
significantly extended by the FDA's 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
regarding whether the device should be approved. The FDA is not bound by the
recommendations of the advisory panel. Toward the end of the PMA review process,
the FDA generally will conduct an inspection of the manufacturer's facilities to
ensure that the facilities are in compliance with the applicable GMP
requirements and may also conduct a bioresearch monitoring inspection to ensure
the integrity and scientific validity of the clinical data.

   If the FDA's evaluations of both the PMA and the manufacturing facilities are
favorable, the FDA will issue either an approval letter or an "approvable
letter" containing a number of conditions that must be met in order to secure
approval of the PMA. When and if those conditions have been fulfilled to the
satisfaction of the FDA, the agency will issue an order approving the PMA,
authorizing commercial marketing of the device for certain indications. If the
FDA's evaluation of the PMA or manufacturing facilities is not favorable, the
FDA will deny approval of the PMA or issue a "not approvable letter." The FDA
may also determine that additional pre-clinical or clinical trials are
necessary, in which case approval of the PMA could be delayed for up to several
years while additional pre-clinical or clinical trials are conducted and
submitted in an amendment to the PMA. The PMA process can be expensive,
uncertain and lengthy, and a number of devices for which FDA approval has been
sought by other companies have never been approved for marketing.

   Any products manufactured or distributed by the Company pursuant to the IDE
or subsequent FDA clearances or approvals are subject to pervasive and
continuing regulatory oversight by the FDA, including record-keeping
requirements and reporting of adverse experiences with the use of the device.
Device manufacturers are required to register their establishments and list
their devices with the FDA and certain state agencies and are subject to
periodic inspections. The FDC Act requires medical devices be manufactured in
accordance with the FDA's current GMP regulations. These regulations require,
among other things, the manufacturing process be regulated and controlled by the
use of written


                                      -12-
<PAGE>   13
procedures and the ability to produce devices which meet the manufacturer's
specifications be validated by extensive and detailed testing of every aspect of
the process. They also require investigation of any deficiencies in the
manufacturing process or in the products produced and detailed record keeping.
Manufacturing facilities are subject to FDA and CDHS inspection on a periodic
basis to monitor compliance with GMP requirements. If violations of the
applicable regulations are noted during FDA and CDHS inspections of the
Company's, or its subcontractors' manufacturing facilities, the FDA and CDHS
can, among other things, prohibit further manufacturing, distribution and sale
of the Company's devices until the violations are cured. The FDA has proposed
changes to the GMP regulations that will, among other things, require design
controls and maintenance of service records, which, when effective in June 1997,
will likely increase the cost of complying with GMP requirements. Other
applicable requirements include the FDA's medical device reporting regulation,
which requires that the Company provide information to the FDA on deaths or
serious injuries alleged to have been associated with the use of its marketed
devices, as well as product malfunctions that would likely cause or contribute
to a death or serious injury if the malfunction were to recur.

   Labeling, advertising and promotion activities for investigational and
marketed devices are subject to scrutiny by the FDA and, in certain instances,
by the Federal Trade Commission. The FDA enforces statutory prohibitions against
promoting and marketing of products for unapproved uses. The Company and its
products are also subject to a variety of state laws and regulations in those
states or localities where its products are or will be marketed. Any applicable
state or local regulations may hinder the Company's ability to market its
products in those states or localities. The Company is also 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.
Compliance with such laws and regulations now or in the future could require
substantial expenditures by the Company.

   Changes in existing requirements or interpretations (on which regulations
heavily depend) or adoption of new requirements or policies could adversely
affect the ability of the Company to comply with regulatory requirements.
Compliance with such laws and regulations now or in the future could require
substantial expenditures by the Company. Failure to comply with regulatory
requirements, or an increase in the cost of compliance, could have a material
adverse effect on the Company's business, financial condition and results of
operations.

   In addition to the requirements for medical devices in general, the FDA
places additional regulations, in the form of performance standards, upon the
manufacture of medical laser products. The Company's laser system is
self-certified by the manufacturer for conformity to these performance
standards. The Company is required to file with the FDA initial and annual
reports of production quantities with respect to its laser. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Risk
Factors -- No Assurance of Obtaining Required Regulatory Approvals to Market
Products in the United States; Significant Time Before Submission of Any PMA"
and "-- Need to Comply with United States Manufacturing Standards; Limited
Manufacturing Experience."

  International

   For the Company to market its TMR systems in European and certain other
foreign countries, the Company must obtain certain regulatory approvals and
clearances and otherwise comply with extensive regulations regarding product
safety, 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. In July 1996, the Company
received the CE Mark approval to market its ITMR System in the European
Community. The CE Mark is awarded to companies whose products meet the essential
requirements of the European MDD and provides the regulatory approval necessary
for commercialization. *The Company may rely in some circumstances on its
exclusive international


                                      -13-
<PAGE>   14
distributor, BSC, for the receipt of premarket approvals and compliance with
clinical trial requirements in certain countries where the Company intends to
market its TMR products. Any enforcement action by regulatory authorities with
respect to past or future regulatory noncompliance 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 the FDA approval, and the requirements
may differ. In addition, there may be foreign regulatory barriers other than
premarket approval. The FDA must approve exports of devices that require a PMA
but are not yet approved domestically, unless they are approved for sale by any
member country of the European Union and the other "listed" countries, including
Australia, Canada, Israel, Japan, New Zealand, Switzerland and South Africa, in
which case they can be exported for sale to any country without prior FDA
approval. In addition, an unapproved device may be exported without prior FDA
approval to the listed countries for investigational use in accordance with the
laws of those countries. To obtain FDA export approval when required, the
Company must provide the FDA with data and information to demonstrate that the
device: (1) is not contrary to public health and safety; and (2) has the
approval of the country to which it is intended for export. To allow the FDA to
determine that export of a device is not contrary to public health and safety,
the Company is required to submit basic data regarding the safety of the device
unless the device is the subject of an FDA-approved IDE and it will be marketed
or used for clinical trials in the importing country for the same intended use,
or at least two IRBs in the United States have determined that the device is a
nonsignificant risk device and the device will be marketed or used for clinical
trials in the importing country for the same intended use. The Company also must
submit a letter to the FDA from the foreign country approving importation of the
device.

   To sell its products within the European Economic Area, consisting of the
countries of the European Union and Norway and Iceland (the "EEA"), the Company
is required to meet the requirements of the MDD and to affix CE marking on its
products to attest to such compliance. To comply, the Company's products must
meet the "essential requirements," as defined under the MDD, relating to safety
and performance and the Company must successfully undergo verification of its
regulatory compliance ("conformity assessment") by a "notified body" selected by
the Company. Under MDD, the Company's TMR systems are in Class III, the highest
risk class, and therefore are subject to the most rigorous controls. In addition
to having to comply with the requirements of any particular country, the
authorities have the right under the MDD to prohibit a particular investigation
and impose specific conditions.

   Since the Company obtained the CE Mark approval for its ITMR system, it is
now subject to continued supervision by the notified body and will be required
to report any serious adverse incidents to the appropriate authorities. The
Company also will be required to comply with additional national requirements
that are outside the scope of the MDD. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Risk Factors -- Need to
Comply with International Government Regulation."

THIRD-PARTY REIMBURSEMENT

   In the United States, hospitals, physicians and other health care providers
that purchase medical devices generally rely on third-party payors, principally
Medicare, Medicaid, private health insurance plans, health maintenance
organizations, and other sources of reimbursement for health care costs
("Third-Party Payors"), to reimburse all or part of the cost of the procedure in
which the medical device is being used.

   Third-party reimbursement has generally been available in the United States
for cardiovascular surgery and interventional cardiology procedures using
devices that have received FDA approval for marketing. *Although the Company
does not anticipate receiving reimbursements for its ITMR Systems


                                      -14-
<PAGE>   15
from Medicare during its clinical trials, the Company does intend to seek
reimbursement from other Third-Party Payors. There can be no assurance, however,
that such reimbursement will be available. A failure by physicians to receive
what they consider to be adequate reimbursement for the TMR procedures in which
the Company's products are used could have a material adverse effect on the
Company's business, financial condition and results of operations. In addition,
failure to receive international reimbursement approvals could have a material
adverse effect on market acceptance of the Company's products in the
international markets in which such approvals are sought. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Risk
Factors -- Uncertain Availability of Third-Party Reimbursement."

PRODUCT LIABILITY AND INSURANCE

   The Company's business exposes the Company to potential product liability
risks or product recalls inherent in the design, development, manufacture and
marketing of medical devices. The Company could be subject to product liability
claims in the event the use of the Company's TMR systems is alleged to have
caused adverse effects on a patient or such products are believed to be
defective. The Company's products are designed to be used in life-threatening
situations where there is a high risk of serious injury or death. Such risks
will continue to exist with respect to those products that may in the future
receive regulatory clearance for commercial sale. The failure to comply with the
FDA's GMP or other regulations could have a material adverse effect on the
ability of the Company to defend against product liability lawsuits. Although
the Company has not experienced any product liability claims to date, any such
claims could have a material adverse effect on the Company's business, financial
condition and results of operations. There can be no assurance the Company's
product liability insurance, with coverage limits of $5 million per occurrence
and in the aggregate and additional coverage limits of DM1 million per person
and DM50 million in the aggregate for the use of the Company's TMR systems in
Germany, will be adequate for any future product liability problems or that such
insurance coverage will continue to be available on commercially reasonable
terms or at all. Particularly given that TMR is not well understood and the lack
of data regarding the clinical safety and efficacy of the Company's TMR systems,
there can be no assurance such coverage limits would be adequate to protect the
Company from liabilities it might incur in connection with the development,
manufacture and sale of its products. In addition, the Company may require
increased product liability coverage if any products are commercialized. Product
liability insurance is expensive and in the future may not be available to the
Company on acceptable terms, if at all. A successful product liability claim or
series of claims brought against the Company in excess of its insurance coverage
could have a material and adverse effect on the Company's business, financial
condition and results of operations.

EMPLOYEES

   As of February 28, 1997, the Company had a total of 57 employees, including
13 in research and development, 12 in operations, 10 in clinical and regulatory
affairs, 6 in quality assurance, 9 in sales and marketing and 7 in finance and
administration. In addition, the Company has consulting and other contract
arrangements. The Company believes the success of its business will depend, in
significant part, on its ability to attract and retain qualified personnel. None
of the Company's employees is represented by a collective bargaining agreement
and the Company has not experienced any work stoppage. The Company considers its
relations with its employees to be good. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Risk Factors --
Dependence on Management, Other Key Personnel and Scientific Advisors."

SCIENTIFIC ADVISORY BOARD

   The Company has a Scientific Advisory Board consisting primarily of leading
physicians and scientists in the field of CAD. Scientific Advisory Board members
consult regularly with the engineers,


                                      -15-
<PAGE>   16
physicians and scientists at the Company and advise the Company on the
specification and design of the Company's products and clinical trials. The
members of the Scientific Advisory Board are prominent scholars in their field
and, as a result, may serve as consultants to a variety of companies. Because
the members of the Company's Scientific Advisory Board may have consulting or
advisory positions with companies that may be competitors of the Company, each
member of the Scientific Advisory Board has entered into a confidentiality
arrangement with the Company. The Company compensates certain members of its
Scientific Advisory Board for participating in meetings of the Board or for
performing other services for the Company. The Company's Scientific Advisory
Board includes:

<TABLE>
<CAPTION>
  Name                                    Occupation/Title
  ----                                    ----------------
<S>                                       <C>
  Robert W. Anderson, M.D...........     David C. Sabiston Professor and Chairman,
                                         Department of Surgery, Duke University
                                         Medical Center

  Donald S. Baim, M.D...............     Chief, Interventional Cardiology Section,
                                         Cardiovascular Division, Beth Israel
                                         Hospital; Professor of Medicine, Harvard
                                         Medical School

  Daniel Burkhoff, M.D., Ph.D.......     Director of Cardiac Physiology Laboratory,
                                         Columbia Presbyterian Medical Center;
                                         Assistant Professor of Medicine, Columbia
                                         University

  James L. Cox, M.D.................     Evarts A. Graham Professor of Surgery,
                                         Chief, Division of Cardiothoracic Surgery,
                                         Washington University School of Medicine

  Pascal Goldschmidt, M.D., Ph.D....     Associate Professor of Medicine and Cell
                                         Biology and Anatomy; Co-Director,
                                         Ciccarone Center for the Prevention of
                                         Heart Disease; Co-Director, Thrombosis
                                         Center; Director, Bernard Vascular Biology
                                         Laboratory; Johns Hopkins University

  Keith L. March, M.D., Ph.D........     Associate Professor of Medicine, Krannert
                                         Institute of Cardiology, Indiana
                                         University Medical Center

  Patrick W. Serruys, M.D., Ph.D....     Professor of Interventional Cardiology,
                                         Erasmus University; Research Director of
                                         the Catheterization Laboratory,
                                         Thoraxcenter, University Hospital
                                         Dijkzigt, Rotterdam, The Netherlands

  Craig R. Smith, M.D...............     Chief, Division of Cardiothoracic Surgery,
                                         Columbia Presbyterian Medical Center;
                                         Associate Professor of Surgery, Columbia
                                         University

  Sharon Tomsen, M.D................     Associate Professor, Surgical Oncology and
                                         Anatomic Pathology; Program Director,
                                         Laser Biology Research Program, University
                                         of Texas M.D.  Anderson Cancer Center;
                                         Adjunct Associate Professor, Biomedical
                                         Engineering Program, University of Texas,
                                         Austin

  Ellis F. Unger, M.D...............     Senior Investigator, Physiology and
                                         Pharmacology Section, Cardiology Branch,
                                         National Heart, Lung, and Blood Institute,
                                         National Institutes of Health
</TABLE>

                                      -16-
<PAGE>   17
ITEM 2.  PROPERTIES

   The Company currently maintains its primary offices, research laboratories
and manufacturing and warehouse operations in an approximately 19,000 square
foot facility in Sunnyvale, California. These premises are leased pursuant to an
agreement which expires in October 1999. *The Company believes this facility
will be adequate for its operations through at least 1997, including a
significant increase in manufacturing volume.

ITEM 3.  LEGAL PROCEEDINGS

   In September 1996, the Company filed a declaratory judgment action in the
United States District Court for the Northern District of California against
PLC. The action seeks a determination that PLC's United States Patent No.
5,125,926 entitled Heart-Synchronized Pulsed Laser System (the "PLC Patent") is
invalid and not infringed. PLC has counterclaimed against the Company for
infringement of the PLC Patent. The case is in the early stages of discovery.
The Company intends to pursue its claims vigorously and to defend against PLC's
claim.

   In January 1997, the Company filed an Opposition to a European Patent owned
by PLC that corresponds to the PLC Patent. The Opposition seeks to have the
European Patent declared invalid. The Company believes it has meritorious
positions with respect to the invalidity of the European Patent and intends to
pursue the Opposition proceeding vigorously.

   The prosecution and defense of intellectual property suits and related legal
and administrative proceedings are costly and time consuming. The question of
patent infringement involves complex legal and factual issues and there can be
no assurance any conclusion reached by the Company regarding infringement will
be consistent with the resolution of any such issues by a court or
administrative body. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Risk Factors -- Risk of Infringement;
Patents and Proprietary Technology."


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

      - none -


                                      -17-
<PAGE>   18
Part II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

      The Company's Common Stock has been traded on the Nasdaq National Market
under the symbol "CGCP" since the Company's initial public offering on May 21,
1996. The following table sets forth, for the periods indicated, the range of
high and low closing sale prices for the Company's Common stock as reported by
Nasdaq:

<TABLE>
<CAPTION>
                                         High         Low
                                         ----         ---
<S>                                    <C>          <C>

   1996
   Second Quarter (from May 21, 1996)   $23.25      $  12.75
   Third Quarter                        $15.00      $   8.75
   Fourth Quarter                       $15.00      $10.5156
</TABLE>

   On February 28, 1997, there were approximately 71 holders of record of the
Company's Common Stock.

   The Company has never declared or paid any cash dividends on its Common
Stock, and does not anticipate paying any cash dividends in the foreseeable
future.

ITEM 6.  SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                      Period from
                                                     September 23,
                                                     1993 (Date of
                                                     Inception) to           Year Ended December 31
                                                      December 31,     ----------------------------------
                                                         1993          1994            1995          1996
                                                     -------------     ----            ----          ----
<S>                                                  <C>               <C>             <C>         <C>
                                                            (in thousands, except per share data)
Statement of Operations Data:
Sales ..........................................                                                   $ 3,959
Cost of sales ..................................                                                     2,866
                                                                                                   -------
  Gross profit .................................                                                     1,093
                                                                                                   -------
Operating expenses:
  Research and development .....................      $    85        $ 1,423        $  3,967         7,140
  General and administrative ...................           21            559           1,178         2,622
  Sales and marketing ..........................           --             --             336         2,417
  Write-off of acquired in-process
    research and development ...................          750             --              --            --
                                                      -------        -------         -------       -------
      Operating expenses .......................          856          1,982           5,481        12,179
                                                      -------        -------         -------       -------
      Operating loss ...........................         (856)        (1,982)         (5,481)      (11,086)
Interest income ................................            3            198             182         2,286
                                                      -------        -------         -------       -------
      Net loss .................................      $  (853)       $(1,784)        $(5,299)      $(8,800)
                                                      =======        =======         =======       =======

Net loss per share..............................      $ (0.20)       $ (0.42)        $ (1.25)      $ (0.97)
                                                      =======        =======         =======       =======
Shares used in computing net loss per share(1)..        4,229          4,229           4,229         9,056
                                                      =======        =======         =======       =======
</TABLE>

<TABLE>
<CAPTION>
                                                                           December 31
                                                     ----------------------------------------------------
                                                       1993            1994           1995         1996
                                                       ----            ----           ----         ----
<S>                                                  <C>            <C>            <C>            <C>
                                                                           (in thousands)
Balance Sheet Data:
Cash, cash equivalents and
  available-for-sale securities.................      $ 1,113        $ 5,324        $ 14,036       $58,208
Working capital ................................        1,120          5,321          14,192        57,324
Total assets ...................................        1,127          5,885          16,223        64,297
Redeemable convertible preferred stock .........        1,979          8,457          22,390            --
Total stockholders' equity (deficit)  ..........         (852)        (2,636)         (7,831)       61,395
</TABLE>

   (1)See Note 1 of Notes to Consolidateed Financial Statements.


                                      -18-
<PAGE>   19
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

OVERVIEW

   Since its inception, CardioGenesis has been primarily engaged in the design,
development, and marketing of its transmyocardial revascularization (TMR)
systems. The Company has only a limited operating history and experienced
significant operating losses since its inception. The Company incurred a net
loss of $8.8 million in 1996. The development and potential commercialization of
the Company's products will require significant research and development,
regulatory, sales and marketing, manufacturing and other expenditures.
*Operating losses are expected to continue at least through 1997 as the Company
continues to perform research and development, to fund clinical trials in
support of regulatory and reimbursement approvals, and to expand its marketing
and sales activities in the U.S. and internationally by supporting Boston
Scientific Corporation (BSC). There can be no assurance the Company's TMR
systems will ever generate significant revenues or the Company will achieve or
sustain profitability.

   The research, manufacture, sale and distribution of medical devices such as
the Company's TMR systems are subject to numerous regulations imposed by
governmental authorities, principally the Food and Drug Administration (FDA) and
corresponding state and foreign agencies. The regulatory process is lengthy,
expensive and uncertain. FDA approval of a Pre-market Approval (PMA) application
is required before any TMR system can be marketed in the United States. Securing
FDA approvals and clearances will require submission to the FDA of extensive
clinical data and technical information. Also, many foreign governments and the
European Union also have review processes for medical devices. In July 1996, the
Company received the CE Mark approval to market its ITMR System in the European
Community. The CE Mark is awarded to companies whose products meet the essential
requirements of the European Medical Device Directive (MDD) and provides the
regulatory approval necessary for commercialization. The Company will be subject
to continued supervision by regulators and will be required to report any
serious adverse incidents to the appropriate authorities. The Company also will
be required to comply with additional national requirements that are outside the
scope of the MDD. *The Company plans to continue to seek regulatory approvals to
allow for marketing and distribution of its products in international markets.

   The Company commenced clinical trials of its intraoperative TMR (ITMR(TM))
System in October 1995 and began clinical trials of its percutaneous myocardial
revascularization (PMR(TM)) System in November 1996. Clinical trials of the
Company's thoracoscopic TMR (TTMR(TM)) System have not commenced. In July 1996,
the Company began a Phase II clinical trial under an investigational device
exemption (IDE) that allowed a prospective, randomized, multi-center clinical
trial of its ITMR System in "no-option" patients with severe CAD. In August
1996, the Company received an IDE from the FDA and has begun a major clinical
study of its ITMR System used as an adjunctive therapy to coronary artery bypass
graft (CABG) surgery in patients with severe angina who are only partially
treatable by CABG. Substantial additional clinical testing of the Company's TMR
systems is required.

   The Company recorded sales for the first time in 1996 which totaled
approximately $4.0 million. In 1996, the Company sold or placed fifty ITMR
Systems to commercial customers in Europe and to clinical trial sites in both
the U.S. and Europe. The Company recognizes product revenues upon shipment of
its products to customers and fulfillment of acceptance terms, if any, and when
no significant contractual obligations remain outstanding. Deferred revenue
consists of shipments that have been made which are subject to limited rights of
return or other contingencies. *The Company anticipates its revenues from
product sales over the next several years will be primarily derived from
international sales by BSC. *Any such international sales will be subject to a
number of risks, including foreign currency


                                      -19-
<PAGE>   20
fluctuations, economic or political instability, foreign tax laws, shipping
delays, various tariffs and trade regulations and restrictions and foreign
medical regulations, any of which could have a significant impact on the
Company's revenues.

   *Results of the Company's operations have varied and are expected to
fluctuate significantly from quarter to quarter depending on numerous factors,
including: (i) demand for the Company's products, new product introductions by
the Company or its competitors or transitions to new products; (ii) the timing
of orders and shipments; (iii) the degree of acceptance of TMR therapy by the
medical community; (iv) competition, including pricing pressures; (v) the timing
of regulatory and third-party reimbursement approvals; (vi) expansion of the
Company's manufacturing capacity and the Company's ability to manufacture its
products efficiently; (vii) the timing of research and development expenses,
including clinical trial-related expenditures and (viii) seasonal factors
affecting the number of procedures performed. *Due to such fluctuations in
operating results, period-to-period comparisons of the Company's operating
results are not necessarily meaningful and should not be relied upon as
indicators of likely future performance.

RESULTS OF OPERATIONS

  Years Ended December 31, 1996, 1995, and 1994

   Sales.   Sales were recognized for the first time in 1996.  Sales of the
Company's ITMR System for commercial use in Europe and for use at clinical
trial sites in both the U.S.  and Europe totaled approximately $4.0 million
for the year ended December 31, 1996.

   Cost of Sales. Cost of sales for the year ended December 31, 1996 was
approximately $2.9 million, or 72% of sales. *As fixed costs of production are
distributed over greater unit volumes, cost of sales as a percentage of sales
should decrease. *However, no assurance can be given that demand for the
Company's products will grow sufficiently to require increased levels of
production.

   Research and Development Expenses. Research and development expenses
increased $3.2 million to $7.1 million for 1996 from $4.0 million for 1995 and
increased $2.5 million from $1.4 million for 1994. The increase in 1996 was
primarily due to the initiation of three additional clinical trials, two with
the Company's ITMR System and one with the PMR System. Also, the Company
continued to invest in mechanism research in the field of TMR. The increase in
research and development expenses in 1995 as compared to 1994 was primarily
attributable to the development of the Company's TMR systems. In particular,
significant expenses were incurred in 1995 for contract development by third
parties and for the development of prototype products and processes. *The
Company expects research and development expenses to continue to increase
throughout 1997 as the Company continues to enroll patients in its ongoing
clinical trials, initiates additional clinical trials, and continues to invest
in TMR mechanism research.

   General and Administrative Expenses. General and administrative expenses
increased $1.4 million to $2.6 million for 1996 from $1.2 million for 1995 and
increased $619,000 in 1995 from $559,000 for 1994. The increase in 1996 was due
to increased finance and administration personnel costs to support the Company's
growth and comply with additional infrastructure requirements associated with
being a public company, increased legal fees associated with entering into
research and development agreements and the exclusive international distribution
agreement with BSC, legal fees related to the initiation of a suit by the
Company against PLC Medical Systems, Inc. (PLC) seeking a judgment that a PLC
patent is invalid and unenforceable, increased property, general liability, and
product liability insurance costs, public and investor relations program costs,
and establishment of a reserve for doubtful accounts. The increase in general
and administrative expenses in 1995 as compared to 1994 was primarily a result
of


                                      -20-
<PAGE>   21
increased general and administrative personnel. *General and administrative
expenses should continue to increase in 1997 but at a substantially reduced rate
of growth.

   Sales and Marketing Expenses. Sales and marketing expenses increased $2.1
million to $2.4 million for 1996 from $336,000 for 1995. The Company did not
incur sales and marketing expenses prior to 1995. The increase in 1996 was due
to preparing for and launching the Company's ITMR System in Europe, adding
marketing staff, implementing outreach programs at clinical sites to provide
information to both physicians and patients, and hiring a senior sales and
marketing executive. The 1995 expenses related to the planning of the initial
distribution of the Company's products and initial sales and marketing
activities. *Sales and marketing expenses should continue to increase in 1997 as
the Company increases the size of the direct sales force in the U.S. and
supports the sales and marketing activities of BSC.

   Interest Income. Interest income increased $2.1 million to $2.3 million for
1996 from $182,000 for 1995 and remained relatively constant at approximately
$200,000 for 1995 and 1994. The increase in 1996 is due to the investment of the
proceeds from the Company's initial public offering of Common Stock in May 1996
of approximately $54.5 million, net of issuance costs.

   Deferred Compensation Expense. The Company recorded deferred compensation
expense of approximately $1.4 million and $874,000 with respect to options to
purchase Common Stock granted and Preferred Stock issued during 1996 and 1995,
respectively. These amounts are being amortized over the vesting period of the
options, which is generally four years. The Company recognized compensation
expense of $849,000 and $104,000 for 1996 and 1995, respectively. No deferred
compensation expenses were recorded in 1994.

LIQUIDITY AND CAPITAL RESOURCES

   The Company has funded its operations since inception primarily through the
private sale of capital stock and interest income on proceeds from private
financings as well as from its initial public offering in May 1996. Through
December 31, 1996, the Company had raised approximately $77.2 million from the
sale of stock, net of issuance costs.

   Net cash used in the Company's operations was $9.2 million, $5.0 million, and
$1.7 million for the years ended December 31, 1996, 1995, and 1994,
respectively. The increases in net cash used in the Company's operations were
primarily a result of higher research and development, general and
administrative, and sales and marketing activities. The Company's acquisition of
property and equipment was $1.7 million, $175,000, and $517,000 for the years
ended December 31, 1996, 1995, and 1994, respectively. The increase in capital
expenditures for 1996 was primarily due to relocating the Company's facilities
to Sunnyvale, California and to providing equipment for the new employees hired
during the year. *The Company expects a similar level of capital expenditures in
1997.

   At December 31, 1996, the Company had cash, cash equivalents and
available-for-sale securities, of $58.2 million. *The Company plans to finance
its operations and capital needs principally from the cash, cash equivalents and
available-for-sale securities, and, to the extent available, from bank and lease
financing and believes these sources of cash will be sufficient to fund its
operations at least through 1998. However, the Company's future liquidity and
capital requirements will depend upon numerous factors, including the level of
sales generated by BSC in major and emerging international markets; market
acceptance of, and demand for the Company's products; the Company's clinical
research and product development programs; the receipt of, and the time required
to obtain, regulatory clearances and approvals; the resources the Company
devotes to the development, manufacture and marketing of its products; the
resources required to hire and develop a direct sales force in the United
States, and to expand manufacturing capacity; facilities requirements; and other
factors. *Although the Company


                                      -21-
<PAGE>   22
believes the current levels of cash, cash equivalents, and available-for-sale
securities, together with cash generated from operations, will provide adequate
funding for its operations and capital requirements through at least 1998, the
Company may be required to raise additional funds through public or private debt
or equity financings, collaborative relationships, bank facilities or other
arrangements. *There can be no assurance the Company will not require additional
funding sooner or that such additional funding, if needed, will be available on
terms attractive to the Company, or at all. *Any additional equity financing may
be dilutive to stockholders, and debt financing, if available, may involve
restrictive covenants.

   As of December 31, 1996, the Company had federal and California net operating
loss carryforwards of approximately $13.8 million and $1.6 million,
respectively. The federal and California net operating loss carryforwards will
expire at various dates by the years 2011 and 2001, respectively, if not
utilized. Utilization of net operating loss carryforwards is subject to certain
limitations under Section 382 of the Internal Revenue Code of 1986, as amended,
where certain changes occur in the stock ownership of a company. *These annual
limitations may result in expiration of net operating loss carryforwards before
they can be fully utilized.

RISK FACTORS

  Reliance on a Third Party for All International Sales

   Until such time, if ever, as the FDA approves the Company's TMR systems for
marketing in the United States, the Company anticipates it will derive its
revenues primarily from BSC as the Company's exclusive international
distributor. The agreement with BSC will not allow the Company to control
international end-market prices and might not result in the same level of sales
and marketing efforts as would be the case using a direct sales force. BSC has
certain rights to terminate the agreement with the Company which, if exercised,
would require the Company to make alternative arrangements for the sale of its
products internationally, and could have a material adverse effect on the
Company's business, financial condition and results of operations. Even if FDA
approval is obtained, the Company expects international sales will continue to
account for a significant portion of the Company's total revenues. As a result,
most of the Company's revenues until such approval is obtained, and a
significant portion of the Company's revenues thereafter, will be subject to the
risks associated with international sales, including foreign currency
fluctuations, economic or political instability, foreign tax laws, shipping
delays, various tariffs and trade regulations and restrictions and foreign
medical regulations, any of which could have a significant impact on the
Company's revenues. Future imposition of, or significant increases in the level
of, customs duties, export quotas or other trade restrictions, could have a
material adverse effect on the Company's business, financial condition and
results of operations. The international nature of the Company's business also
subjects it and BSC to laws and regulations of the international jurisdictions
in which they operate or in which the Company's products may be sold. The
regulation of medical devices in a number of such jurisdictions, particularly in
the EEA, continues to develop and there can be no assurance new laws or
regulations will not have an adverse effect on the Company's business, financial
condition and results of operations. The Company has four pending international
patent applications and has been issued no international patents to date. While
the Company intends to file patent applications in various European countries,
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.

  Uncertainty of Clinical Adoption of TMR; Need for Increased Understanding
of TMR Mechanism

   Although TMR therapy using lasers has been in development since the 1980s,
TMR remains experimental and has not achieved broad clinical adoption. The
Company is unable to predict whether or at what rate and how broadly TMR will be
adopted by the medical community.


                                      -22-
<PAGE>   23
   Physician endorsements will be essential for clinical adoption of TMR. Even
if the clinical efficacy of TMR is established, physicians may elect not to
recommend TMR for any number of reasons. The reasons why TMR may effectively
treat CAD are not well understood. Although the Company intends to use research,
development and clinical efforts to enhance knowledge of the physiological
effects of TMR, there can be no assurance such understanding will be achieved on
a timely basis, or at all. Failure to gain a thorough understanding of the
physiological effects of TMR, and to disseminate such understanding within the
medical community, could adversely effect the clinical adoption of TMR.

   Clinical adoption of TMR will also depend upon the Company's ability to
facilitate training of cardiothoracic surgeons and interventional cardiologists
in TMR therapy, and the willingness of such physicians to adopt such procedures.
Patient acceptance of the procedure will depend in part upon physician
recommendations as well as other factors, including the degree of invasiveness,
the effectiveness of the procedure, and the rate and severity of complications
associated with the procedure as compared to other procedures. Even if TMR is
clinically adopted, physicians may elect not to recommend the procedure unless
acceptable reimbursement from health care payors is available. Failure of TMR,
for whatever reason, to achieve significant clinical adoption or failure of the
Company's TMR systems to achieve any significant market acceptance would have a
material adverse effect on the Company's business, financial condition and
results of operations. See " -- Uncertain Availability of Third-Party
Reimbursement."

  Early Stage of Clinical Trials; No Assurance of Safety or Efficacy

   The Company's ITMR and PMR Systems are at an early stage of clinical testing,
and there can be no assurance regarding the clinical safety or efficacy of
either of these systems. The Company has not begun clinical trials of its TTMR
Systems and there can be no assurance this system will be approved for clinical
trials. Clinical trials of the Company's TMR systems will require dedication by
the Company of substantial financial and management resources, and completing
such trials will take several years. There can be no assurance any of the
Company's TMR systems will prove to be safe or effective. If the Company's TMR
systems do not prove to be safe and effective in clinical trials or if the
Company is otherwise unable to commercialize its TMR systems successfully, the
Company's business, financial condition, and results of operations would be
materially and adversely affected and could result in the cessation of the
Company's business.

  Dependence on TMR Product Line; Rapid Technological Change

   The Company is not currently developing any products other than its TMR
systems. Consequently, the Company is dependent on the successful development
and commercialization of the Company's TMR systems. Unfavorable clinical trial
results, failure to obtain regulatory approvals in a timely manner, or at all,
or failure to gain widespread market acceptance for any of the Company's TMR
systems would have a material adverse effect on the Company's business,
financial condition and results of operations and cessation of the Company's
business could occur.

   The medical device industry is characterized by rapid and significant
technological change. Therefore, the Company's future success will depend in
large part on the Company's ability to continue to respond to such changes, as
well as to expand the indications and applications for which its products are
used, through the timely development and successful introduction of enhanced and
new versions of its TMR systems. Product research and development will require
substantial expenditures and will be subject to inherent risks, and there can be
no assurance the Company will be successful in identifying products for which
demand exists or in developing products that have the characteristics necessary
to treat particular indications, or that any new product introduced will receive
regulatory approval or will be commercially successful.


                                      -23-
<PAGE>   24
  No Assurance of Obtaining Required Regulatory Approvals to Market Products
in the United States; Significant Time Before Submission of Any PMA

   To date, none of the Company's products has been approved for sale in the
United States. Prior to receiving regulatory approval for marketing in the
United States, medical devices such as the Company's products are subject to
rigorous preclinical and clinical testing mandated by the FDA and, to a lesser
extent, by state regulatory authorities, such as the California Department of
Health Services ("CDHS"). The process of obtaining and maintaining requisite
regulatory approvals is lengthy, expensive and uncertain. The IDE/PMA process
generally takes several years or longer to complete and is expensive. Moreover,
regulatory approvals, if granted, may include significant limitations on the
indicated uses for which a product may be marketed. FDA enforcement policy
strictly prohibits the marketing of approved medical devices for unapproved
uses.

   The Company's TMR systems will require approval of a PMA by the FDA before
such products can be marketed in the United States. The Company has received FDA
approval of three IDEs for its ITMR System. All three clinical trials: a
feasibility study of ITMR; a Phase II prospective, randomized, multi-center
study of ITMR; and a study of ITMR therapy as an adjunct to CABG, have begun.
The Company has not submitted an application to the FDA for an IDE for its PMR
System or TTMR System. FDA regulations subject sponsors of IDEs to certain
requirements, including proper monitoring of clinical investigations, selection
of qualified investigators, record keeping, reporting of unanticipated adverse
device events and submission of periodic progress reports. The FDA also has the
authority to inspect premises where devices are held and to inspect and copy all
records pertaining to an investigation. In addition, a sponsor is prohibited
from promoting or commercializing a device prior to receiving PMA approval.
There can be no assurance any 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 any of the Company's products will ever be approved for sale in the
United States. Additionally, there can be no assurance required United States
regulatory filings will be made in a timely manner, approvals to commence future
clinical trials will be received, clinical trials will commence or be concluded
in the time frames anticipated by the Company, any such clinical trials will be
successful or the Company will be able to obtain regulatory approvals on a
timely basis, or at all, to market its products. Delays in initiating or
completing clinical trials or in the receipt of regulatory approval of the
Company's products, the failure to obtain regulatory approvals for such
products, significant limitations in the indicated uses for which such products
may be marketed or substantial costs incurred in obtaining such approvals would
have a material adverse effect on the Company's business, financial condition
and results of operations and cessation of the Company's business could occur.

   In January 1996, the Company reported to the FDA the existence of an error in
the software incorporated into the Holmium:YAG (Ho:YAG) laser included in its
TMR systems. The Company's laser manufacturer had determined that, under certain
circumstances, the laser could be fired even though its control panel indicated
it was in the "stand-by" mode. The Company initiated a voluntary field
correction of the lasers, categorized as a Class II recall by the FDA, and the
software error has been corrected. FDA defines a Class II recall as one in which
use of, or exposure to, the product may cause temporary or medically adverse
health consequences or where the probability of serious adverse health
consequences is remote. The FDA has acknowledged the correction of the software
error and the completion of the related field activities. However, there can be
no assurance the Company will not experience future product defects,
malfunctions, manufacturing difficulties or recalls related to the Ho:YAG laser
or any other component used in the Company's TMR systems. Any of such
occurrences could cause delay in regulatory approvals or adversely affect
acceptance of the Company's products and could have a material adverse effect on
the Company's business, financial condition and results of operations.


                                      -24-
<PAGE>   25
  Need to Comply with International Government Regulation

   International sales of medical devices often are subject to regulatory
requirements in foreign countries. The regulatory review process varies from
country to country. The Company's products are subject to pre-market approval in
the European Union and subject to other regulatory requirements in those and
other countries. In addition, the regulation of medical devices continues to
change. Any enforcement action by regulatory authorities with respect to past or
future regulatory noncompliance 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 required for FDA approval, and the requirements may
differ. In addition, there may be foreign regulatory barriers other than
pre-market approval. The FDA must approve exports of devices that require a PMA
but are not yet approved domestically, unless they are approved for sale by any
member country of the European Union and the other "listed" countries, including
Australia, Canada, Israel, Japan, New Zealand, Switzerland and South Africa, in
which case they can be exported for sale to any country without prior FDA
approval. In addition, an unapproved device may be exported without prior FDA
approval to the listed countries for investigational use in accordance with the
laws of those countries.

   To sell its ITMR Systems within the European Economic Area, consisting of the
countries of the European Union and Norway and Iceland (the "EEA"), the Company
has received approval to affix CE markings on its products to attest its
compliance with the requirements of the Medical Devices Directive of the EEA
(the "MDD"). The Company will be subject to continued supervision and will be
required to report any serious adverse incidents to the appropriate authorities.
The Company also will be required to comply with additional national
requirements that are outside the scope of the MDD. In addition, the Company has
received ISO 9001/EN 46001 certification, which was required to meet the CE Mark
certification prerequisites. The Company has not received CE Mark certification
for the sale of its other systems in the EEA. There can be no assurance the
Company will be able to achieve or maintain the compliance required for CE
marking on all or any of its products or it will be able to produce its products
profitably and in a timely manner while complying with the requirements of the
MDD and other regulatory requirements.

   Failure to comply with applicable regulatory requirements can result in
fines, injunctions, civil penalties, recalls or seizures of products, total or
partial suspensions of production, refusals by foreign governments to permit
product sales and criminal prosecution. Furthermore, changes in existing
regulations or adoption of new regulations or policies could prevent the Company
from obtaining, or affect the timing of, future regulatory approvals or
clearances. There can be no assurance the Company will be able to obtain
necessary regulatory clearances or approvals on a timely basis or at all or it
will not be required to incur significant costs in obtaining or maintaining such
foreign regulatory approvals. Delays in receipt of, or failure to receive, such
approvals or clearances, the loss of previously obtained approvals or clearances
or the 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.

  Risk of Infringement; Patents and Proprietary Technology

   The Company is dependent in large part on its ability to obtain patent
protection for its products and processes, to preserve its trade secrets and
proprietary technology, and to operate without infringing upon the patents or
proprietary rights of third parties. The medical device industry has been
characterized by extensive litigation regarding patents and other intellectual
property rights, and companies in the medical device industry have employed
intellectual property litigation to gain a competitive advantage. Certain of the
Company's competitors and potential competitors have obtained United States
patents covering technology that could be used for certain TMR procedures, and
there can be no assurance such


                                      -25-
<PAGE>   26
competitors, potential competitors or others have not filed and do not hold
international patents covering other TMR technology. No assurance can be given
that any such international patents would be interpreted the same as any
counterpart United States patents.

   From time to time, the Company has been contacted by various third parties
requesting the Company review and consider the applicability of certain patents
to the Company's technology. In particular, in February 1995, the Company
received a letter from PLC Systems, Inc. (PLC) advising the Company of the
existence of certain of PLC's patents, including one entitled Heart-Synchronized
Pulsed Laser System (PLC Patent). This letter requested an assessment by the
Company of its activities in this area. The Company believes, based on its
review of the PLC Patent and an opinion of its counsel, the Company's TMR
systems do not infringe such PLC Patent. In 1996, the Company initiated a suit
against PLC seeking a judgment that the PLC Patent is invalid and unenforceable.
PLC has counterclaimed against the Company for patent infringement.

   While the Company periodically reviews the scope of its patents and other
relevant patents of which it is aware, the question of patent infringement
involves complex legal and factual issues and there can be no assurance any
conclusion reached by the Company regarding infringement will be consistent with
the resolution of any such issues by a court. Further, there can be no assurance
the Company will not become subject to patent infringement claims or litigation
or interference proceedings declared by the United States Patent and Trademark
Office ("USPTO") to determine the priority of inventions.

   The defense and prosecution of intellectual property suits, USPTO
interference proceedings and related legal and administrative proceedings are
both costly and time-consuming. Further litigation may be necessary to enforce
patents issued to the Company, to protect trade secrets or know-how owned by the
Company or to determine the enforceability, scope and validity of the
proprietary rights of others. Any litigation 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
such litigation or interference proceedings could subject the Company to
significant liabilities to third parties, require the Company to seek licenses
from third parties, prevent the Company from selling its products in certain
markets or at all, or require the Company to modify its products. Although
patent and intellectual property disputes regarding medical devices are often
settled through licensing and similar arrangements, costs associated with such
arrangements may be substantial and could include ongoing royalties.
Furthermore, there can be no assurance the necessary licenses 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 validity and breadth of claims in medical technology patents involve
complex legal and factual questions and, therefore, may be highly uncertain. No
assurance can be given that any issued patent or patents based on pending patent
applications or any future patent application will exclude competitors or
provide competitive advantages to the Company, that any of the Company's patents
in which it has licensed rights 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 or licensed by the Company. Furthermore, there can be no
assurance others have not developed or will not develop similar products,
duplicate any of the Company's products or design around any patents issued to
or licensed by the Company or that may be issued in the future to the Company.
Since patent applications in the United States are maintained in secrecy until
patents issue, the Company also cannot be certain others did not first file
applications for inventions covered by the Company's pending patent
applications, nor can the Company be certain it will not infringe any patents
that may issue to others on such applications.


                                      -26-
<PAGE>   27
   The U.S. patent laws were recently amended to exempt physicians, other health
care professionals, and affiliated entities from infringement liability for
medical and surgical procedures performed on patients. The Company cannot
predict whether this amendment might have a material adverse effect on the
Company's ability to protect its proprietary methods and procedures.

   The Company typically requires its employees, consultants and advisors to
execute confidentiality and assignment of inventions agreements in connection
with their employment, consulting or advisory relations with the Company. There
can be no assurance, however, that these agreements will not be breached or that
the Company will have adequate remedies for any breach. Furthermore, no
assurance can be given that competitors will not independently develop
substantially equivalent proprietary information and techniques or otherwise
gain access to the Company's proprietary technology, or that the Company can
meaningfully protect its rights in unpatented proprietary technology.

  Highly Competitive Markets; Risk of Alternative Therapies

   Competition in the market for the treatment of CAD, in the medical device
industry generally, and in the TMR market in particular, is intense and is
expected to increase. The Company competes primarily with other producers of TMR
systems, including PLC, Eclipse, and U.S. Surgical. Some of the Company's
competitors and many of its potential competitors have substantially greater
name recognition and capital resources than does the Company and also may have
greater resources and expertise in the areas of research and development,
obtaining regulatory approvals, manufacturing and marketing. The TMR market is
characterized by rapid technical innovation. There can be no assurance the
Company's competitors will not succeed in developing TMR products or procedures
that are more effective or more effectively marketed than products marketed by
the Company or that render the Company's technology obsolete. Additionally, even
if the Company's products provide performance comparable to competing products,
there can be no assurance the Company will be able to obtain necessary
regulatory approvals to compete against competitors in terms of manufacturing,
marketing and sales. Certain companies, including PLC, Eclipse, and U.S.
Surgical, currently are in Phase II clinical trials of products and procedures
involving TMR that compete with those offered by the Company, and received
regulatory approvals in Europe to begin commercially marketing their various TMR
products before the Company. Earlier entrants in the market in a therapeutic
area often obtain and maintain greater market share than later entrants.

   There can be no assurance the Company will be able to continue to compete
successfully in the future. The Company believes the primary competitive factors
in the market for TMR systems include clinical performance, product safety and
reliability, availability of third-party reimbursement, product design
specifically for TMR use, product quality, ease of use, price, customer service
and company reputation. In addition, the length of time required for products to
be developed and receive regulatory approval and the ability to use patents or
other proprietary rights to prevent sales by competitors are also important
competitive factors.

   Many of the medical indications that may be treatable with TMR are currently
being treated by drug therapies or surgery and other interventional therapies,
including CABG and PTCA. A number of these therapies are widely accepted in the
medical community, have a long history of use and continue to be enhanced
rapidly. There is no assurance procedures using TMR will be able to replace or
augment such established treatments or that clinical research will support the
use of TMR. Additionally, new surgical procedures and new drug therapies are
being developed to treat CAD. These new procedures and drug therapies could be
more effective, safer or more cost-effective than TMR. The inability of TMR to
replace or augment existing therapies or to be more effective, safer or more
cost-effective than new therapies could have a material adverse effect on the
Company's business, financial condition and results of operations.


                                      -27-
<PAGE>   28
  Uncertain Availability of Third-Party Reimbursement

   In the United States, hospitals, physicians and other health care providers
that purchase medical devices generally rely on third-party payors, principally
Medicare, Medicaid, private health insurance plans, health maintenance
organizations and other sources of reimbursement for health care costs
("Third-Party Payors"), to reimburse all or part of the cost of the procedure in
which the medical device is being used. Few individuals are able to pay directly
for the costs associated with the use of the Company's products. Certain
Third-Party Payors such as Medicare determine whether to provide coverage for a
particular procedure and then reimburse hospitals for inpatient medical services
at a prospectively fixed rate based on the diagnosis related group ("DRG") to
which the case is assigned. DRG assignment is based on the diagnosis of the
patient and the procedures performed. The fixed rate of reimbursement
established by Medicare is independent of the hospital's cost incurred for the
specific case and the specific devices used. Medicare and other Third-Party
Payors are increasingly scrutinizing whether to cover new products and the level
of reimbursement for covered products. The Company intends to work with
government officials to secure a DRG assignment for its TMR systems that would
provide hospitals with appropriate payment. A failure to secure approval of a
DRG that adequately reflects the costs associated with use of the Company's TMR
system could have a material adverse effect on its business, financial condition
and results of operations.

   *Although the Company does not anticipate receiving reimbursements for its
ITMR Systems from Medicare during its clinical trials, the Company does intend
to seek reimbursement from other Third-Party Payors. There can be no assurance,
however, that such reimbursement will be available.

   Third-Party Payors that do not use prospectively fixed payments increasingly
use other cost-containment processes that may pose administrative hurdles to the
use of the Company's products. In addition, Third-Party Payors may deny
reimbursement if they determine the device used in a treatment is unnecessary,
inappropriate, experimental, used for a non-approved indication or not
cost-effective. Potential purchasers must determine the clinical benefits of the
Company's TMR systems justify the additional cost or the additional effort
required to obtain prior authorization or coverage and the uncertainty of
actually obtaining such authorization or coverage.

   Physician services are reimbursed by Medicare based on a physician fee
schedule as coded under the CPT-4 coding system. There is no assurance the codes
that will be used for submitting claims for TMR procedures using the Company's
products will result in Medicare payment levels that physicians consider to be
adequate. These codes and their associated weights are used by many other
Third-Party Payors in addition to Medicare. A failure by physicians to receive
what they consider to be adequate reimbursement for the TMR procedures in which
the Company's products are used could have a material adverse effect on the
Company's business, financial condition, and results of operations.

   If the Company obtains the necessary foreign regulatory registrations or
approvals, market acceptance of the Company's products in international markets
would be dependent, in part, upon the availability of reimbursement within
prevailing health care payment systems. Reimbursement and health care payment
systems in international markets vary significantly by country, and include both
government sponsored health care and private insurance. Although the Company
intends to seek international reimbursement approvals, there can be no assurance
any such approvals will be obtained in a timely manner, if at all. Failure to
receive international reimbursement approvals could have a material adverse
effect on market acceptance of the Company's products in the international
markets in which such approvals are sought.

   The Company believes the overall escalating cost of medical products and
services has led, and will continue to lead, to increased pressures on the
health care industry, both foreign and domestic, to reduce the cost of products
and services, including products offered by the Company. There can be no
assurance in either United States or international markets that third-party
reimbursement and coverage will be


                                      -28-
<PAGE>   29
available or adequate, that current reimbursement amounts will not be decreased
in the future or that future legislation, regulation or reimbursement policies
of Third-Party Payors will not otherwise adversely affect the demand for the
Company's products or its ability to sell its products on a profitable basis.
The unavailability of Third-Party Payor coverage or the inadequacy of
reimbursement could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, fundamental reforms
in the healthcare industry in the United States and Europe continue to be
considered, although the Company cannot predict whether or when any healthcare
reform proposals will be adopted and what impact such proposals might have.

  Dependence on Sole Suppliers

   Two of the major components used in the Company's TMR systems, the Ho:YAG
laser and the ECG monitor, are currently available only from sole sources. In
addition, several other components used in the Company's TMR systems are
purchased by the Company from a single supplier. The Company periodically
conducts assessments of alternative vendors for various components used in its
TMR systems. However, the qualification of additional or replacement vendors for
certain components is a lengthy process. In addition, if the Company were to
retain different suppliers of the laser or ECG monitor, the Company would need
to obtain approval from the FDA in an IDE or PMA amendment (if the IDE or PMA
were still under review) or an IDE or PMA supplement (if the IDE or PMA were
already approved). There can be no assurance such approval would be obtained on
a timely basis, if at all. Although the FDA is required by law to complete its
review of a PMA or PMA supplement within 180 days, the FDA may take a
significantly longer period of time to complete its review. Any significant
interruption in the supply of components used in the Company's TMR systems would
have a material adverse effect on the Company's ability to manufacture its
products and, therefore, a material adverse effect on its business, financial
condition and results of operations. In particular, if the Company had to obtain
an alternative source for the manufacture of some or all of its lasers or had to
manufacture its own lasers, the Company would experience significant delays in
the manufacture of its products, which would have a material adverse effect on
its business, financial condition and results of operations.

   Certain of the Company's suppliers, including the manufacturer of its laser,
could have difficulty expanding their manufacturing capacity to meet the
Company's needs if demand for the Company's TMR systems were to increase rapidly
or significantly. In addition, any defect or malfunction in the laser or other
products provided by the Company's suppliers could cause delay in regulatory
approvals or adversely affect acceptance of the Company's products. There can be
no assurance materials obtained from outside suppliers will continue to be
available in adequate quantities or that the Company will be able to locate
alternative suppliers on a timely basis. The failure to obtain sufficient
quantities of lasers or component materials would have a material adverse effect
on the Company's business, financial condition and results of operations.

   The supplier of the Company's Ho:YAG laser is a small company, almost all of
whose revenues are derived from sales to the Company. The Company purchases
lasers from this supplier pursuant to an OEM Supply Agreement. With the
exception of this agreement, the Company generally operates on a purchase order
basis with most of its suppliers, including the manufacturer of the ECG monitor
used in its TMR systems. Vendors that supply products to the Company on a
purchase order basis are not obligated to make available any minimum number of
units for purchase by the Company and could at any time determine to cease the
supply and production of such components, which could have a material adverse
effect on the Company's business, financial condition and results of operations.

  Dependence on Management, Other Key Personnel and Scientific Advisors

   The Company's ability to operate successfully depends in significant part
upon the continued service of certain key scientific, technical, managerial and
finance personnel and the Company's continuing


                                      -29-
<PAGE>   30
ability to attract and retain additional highly qualified personnel. In order to
support market development and sales in the future and augment its long term
competitive position, the Company anticipates it will be required to make
significant additions of personnel in manufacturing, research and development
and sales and marketing. Competition for such personnel is intense, and there
can be no assurance the Company can attract or retain highly qualified
scientific, technical, manufacturing, sales and marketing and finance personnel
in the future. The loss of key personnel or the inability to hire or retain
qualified personnel could have a material adverse effect upon the Company's
business, financial condition and results of operations. In addition, many
employees of the Company, including a number of its key scientific, technical
and managerial personnel, are subject to the terms of confidentiality agreements
with respect to proprietary information of their former employers. The failure
of these employees to comply with the terms of their agreements with, or other
obligations to, such former employers could result in assertion of claims
against the Company and such employees, which, if successful, could restrict
their role with the Company and have a material adverse effect on the Company's
business, financial condition and results of operations.

   The Company has established a Scientific Advisory Board including experts in
cardiac surgery, interventional cardiology, cardiology and basic science.
Members of the Scientific Advisory Board consult with the Company regarding
research and development efforts at the Company but are employed elsewhere on a
full-time basis. As a result, they can only spend a limited amount of time on
the Company's affairs and there can be no assurance the members of the Company's
Scientific Advisory Board will continue to serve in such capacity.

  Need to Comply with United States Manufacturing Standards; Limited
Manufacturing Experience

   The Company has limited experience in manufacturing its products.
Manufacturers often encounter difficulties in increasing production, including
problems involving production yields, adequate supplies of components, quality
control and assurance (including failure to comply with good manufacturing
practices ("GMP") regulations, international quality standards and other
regulatory requirements) and shortages of qualified personnel. Difficulties
experienced by the Company in manufacturing scale-up could have a material
adverse effect on its business, financial condition and results of operations.
There can be no assurance the Company will be successful in increasing
manufacturing capacity or it will not experience manufacturing difficulties or
product recalls in the future.

   Under current law, if the Company markets its devices or manufactures
finished devices in the United States, it will be required to demonstrate
compliance with the FDA's current GMP regulations. In addition, the FDA will
inspect the Company's manufacturing facilities on a regular basis to determine
such compliance. The FDA could determine the Company's export of components is
not in compliance with the FDC Act or the FDA's regulations or policies and
prohibit exports in the future. Failure to comply with applicable FDA or other
regulatory requirements can result in fines, injunctions, civil penalties,
recalls or seizures of products, total or partial suspensions of production and
criminal prosecutions. The FDA has recently promulgated new GMP regulations. To
date, the Company has no experience dealing with the new regulations.

  Product Liability Risk; Possible Insufficiency of Insurance

   The Company's business exposes the Company to potential product liability
risks or product recalls that are inherent in the design, development,
manufacture and marketing of medical devices. The Company could be subject to
product liability claims in the event the use of the Company's TMR systems is
alleged to have caused adverse effects on a patient or such products are
believed to be defective. The Company's products are designed to be used in
life-threatening situations where there is a high risk of serious injury or
death. Such risks will continue to exist with respect to those products that may
in the future receive regulatory clearance for commercial sale. The failure to
comply with the FDA's GMP or


                                      -30-
<PAGE>   31
other regulations could have a material adverse effect on the ability of the
Company to defend against product liability lawsuits. Although the Company has
not experienced any product liability claims to date, any such claims could have
a material adverse effect on the Company's business, financial condition and
results of operations. There can be no assurance the Company's product liability
insurance, with coverage limits of $5 million per occurrence and in the
aggregate and additional coverage limits of DM1 million per person and DM50
million in the aggregate for use of the Company's TMR systems in Germany, will
be adequate for any future product liability problems or that such insurance
coverage will continue to be available on commercially reasonable terms or at
all. Particularly given that TMR is not well understood and the lack of data
regarding the clinical safety and efficacy of the Company's TMR systems, there
can be no assurance such coverage limits would be adequate to protect the
Company from liabilities it might incur in connection with the development,
manufacture and sale of its products. In addition, the Company may require
increased product liability coverage if any products are commercialized. Product
liability insurance is expensive and in the future may not be available to the
Company on acceptable terms, if at all. A successful product liability claim or
series of claims brought against the Company in excess of its insurance coverage
could have a material and adverse effect on the Company's business, financial
condition and results of operations.


ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

    Index to Consolidated Financial Statements                             Page

      Report of Coopers & Lybrand L.L.P., Independent Accountants.......    33
      Consolidated Balance Sheets as of December 31, 1996 and 1995......    34
      Consolidated Statements of Operations for the three years ended
        December 31, 1996...............................................    35
      Consolidated Statements of Stockholders' Equity (Deficit) for the
        three years ended December 31, 1996.............................    36
      Consolidated Statements of Cash Flows for the three years ended
        December 31, 1996...............................................    37
      Notes to Consolidated Financial Statements........................    38

    Financial Statement Schedule

      The following financial statement schedule of the Company for the three
years ended December 31, 1996 is filed as part of this Form 10-K and should be
read in conjunction with the Consolidated Financial Statements, and related
notes thereto, of the Company.

      Report of Independent Accountants on Financial Statement Schedule ..  53

      Schedule II - Valuation and Qualifying Accounts....................   54

      All other schedules are omitted because they are not applicable or the
required information is shown in the consolidated financial statements or notes
thereto.




                                      -31-
<PAGE>   32
                           CARDIOGENESIS CORPORATION
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


                                   ----------





<TABLE>
<CAPTION>
                                                                       Page
                                                                       ----
<S>                                                                     <C>
Report of Independent Accountants...................................    33

Consolidated Balance Sheets.........................................    34

Consolidated Statements of Operations...............................    35

Consolidated Statements of Stockholders' Equity (Deficit)...........    36

Consolidated Statements of Cash Flows...............................    37

Notes to Consolidated Financial Statements..........................    38
</TABLE>



                                      -32-

<PAGE>   33


                        REPORT OF INDEPENDENT ACCOUNTANTS



To the Board of Directors and Stockholders
of CardioGenesis Corporation:

We have audited the accompanying consolidated balance sheets of CardioGenesis
Corporation as of December 31, 1996 and 1995, and the related consolidated
statements of operations, stockholders' equity (deficit) and cash flows for each
of the three years in the period ended December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements 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 CardioGenesis
Corporation as of December 31, 1996 and 1995, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles.


                                        Coopers & Lybrand L.L.P.


San Jose, California
January 29, 1997


                                      -33-
<PAGE>   34

                           CARDIOGENESIS CORPORATION
                           CONSOLIDATED BALANCE SHEETS
                      (in thousands, except per share data)

                                     -------



<TABLE>
<CAPTION>
                                                                           December 31
                                                                      ----------------------
                                  ASSETS                                 1996         1995
                                                                      --------      --------
<S>                                                                     <C>            <C>
Current assets:
   Cash and cash equivalents                                          $  2,080      $  4,150
   Available-for-sale securities                                        53,626         9,887
   Accounts receivable, net of allowance for doubtful accounts of
       $225 in 1996                                                      2,024           870
   Inventories                                                           1,108           625
   Interest receivable                                                     934           102
   Prepaids and other                                                      454           223
                                                                      --------      --------

           Total current assets                                         60,226        15,857

Property and equipment, net                                              1,546           330
Available-for-sale securities, noncurrent                                2,502
Other assets                                                                23            36
                                                                      --------      --------

              Total assets                                            $ 64,297      $ 16,223
                                                                      ========      ========

                               LIABILITIES

Current liabilities:
   Accounts payable                                                   $    237      $    520
   Short-term note payable                                                 215
   Accrued expenses                                                      1,528           133
   Accrued compensation                                                    552           141
   Deferred revenue                                                        370           870
                                                                      --------      --------

           Total liabilities                                             2,902         1,664
                                                                      --------      --------

Commitments (Note 5)

                  REDEEMABLE CONVERTIBLE PREFERRED STOCK

Series A, no par value:
   Authorized:  none in 1996 and  1,640 shares in 1995;
   Issued and outstanding:  none in 1996 and 1,640 shares in 1995           -          1,979
   (Liquidation and redemption value: $2,000)

Series B, no par value:
   Authorized:  none in 1996 and 2,669 shares in 1995;
   Issued and outstanding:  none in 1996 and 2,669 shares in 1995           -          6,477
   (Liquidation and redemption value: $6,509)

Series C, $0.001 par value:
   Authorized:  4,274 shares in 1996 and 4,223 shares in 1995;
   Issued and outstanding:  none in 1996 and 4,175 shares in 1995          -          13,934
   (Liquidation and redemption value: $14,250)
                                                                      --------      --------

           Total redeemable convertible preferred stock                    -          22,390
                                                                      --------      --------

                      STOCKHOLDERS' EQUITY (DEFICIT)

Common stock, $0.001 par value:
   Authorized:  40,000 shares in 1996 and 14,155 shares in 1995
   Issued and outstanding:  11,967 share in 1996 and none in 1995           12
Additional paid-in capital                                              79,450           874
Deferred compensation                                                   (1,328)         (770)
Accumulated deficit                                                    (16,735)       (7,935)
Cumulative foreign exchange translation adjustments                         (4)
                                                                      --------      --------

           Total stockholders' equity  (deficit)                        61,395        (7,831)
                                                                      --------      --------

              Total liabilities, redeemable preferred stock and
                 stockholders' equity (deficit)                       $ 64,297      $ 16,223
                                                                      ========      ========
</TABLE>



  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                      -34-
<PAGE>   35

                           CARDIOGENESIS CORPORATION
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      (in thousands, except per share data)

                                     -------



<TABLE>
<CAPTION>
                                                       Year Ended December 31
                                                ----------------------------------
                                                  1996          1995         1994
                                                --------      -------      -------
<S>                                             <C>           <C>          <C>
Sales                                           $  3,959

Cost of sales                                      2,866
                                                --------

        Gross profit                               1,093
                                                --------

Operating expenses:

   Research and development                        7,140      $ 3,967      $ 1,423

   General and administrative                      2,622        1,178          559

   Sales and marketing                             2,417          336
                                                --------      -------      -------

        Total operating expenses                  12,179        5,481        1,982
                                                --------      -------      -------

           Operating loss                        (11,086)      (5,481)      (1,982)

Interest income                                    2,286          182          198
                                                --------      -------      -------

              Net loss                          $ (8,800)     $(5,299)     $(1,784)
                                                ========      =======      =======

Net loss per share                              $  (0.97)     $ (1.25)     $ (0.42)
                                                ========      =======      =======
Shares used in computing net loss per share        9,056        4,229        4,229
                                                ========      =======      =======
</TABLE>



  The accompanying notes are an integral part of these consolidated financial
                                  statements.


                                      -35-
<PAGE>   36

                           CARDIOGENESIS CORPORATION
            CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                                (in thousands)

                                     -------

<TABLE>
<CAPTION>
                                                                                                               Cumulative
                                                                                                                 Foreign
                                                     Common Stock         Additional                             Currency
                                                   ----------------         Paid-In    Deferred   Accumulated  Translation
                                                   Shares    Amount         Capital  Compensation   Deficit    Adjustments  Total
                                                   ------    ------       ---------  ------------ -----------  -----------  -----
<S>                                                 <C>        <C>         <C>          <C>          <C>          <C>     <C>
Balances, December 31, 1993                                                                          $   (852)            $  (852)
   Net loss                                                                                            (1,784)             (1,784)
                                                                                                     --------             -------
Balances, December 31, 1994                                                                            (2,636)             (2,636)
   Deferred compensation related to issuance
       of preferred stock and grants of
       stock options                                                       $    874      $  (874)                               -
   Amortization of deferred compensation                                                     104                              104
   Net loss                                                                                            (5,299)             (5,299)
                                                                           --------     --------     --------             -------
Balances, December 31, 1995                                                     874         (770)      (7,935)             (7,831)
   Deferred compensation related to
       issuance of preferred shares and grants
       of stock options                                                       1,407       (1,407)                               -
   Amortization of deferred compensation                                                     849                              849
   Issuance of common shares upon exercise of
       stock options and stock grants                  409                       75                                            75
   Conversion of preferred stock to
       common stock                                  8,558     $     9       22,622                                        22,631
   Issuance of common stock in IPO, net of
       issuance costs of $5,533                      3,000           3       54,472                                        54,475
   Net loss                                                                                            (8,800)             (8,800)
   Foreign currency translation adjustment                                                                        $(4)         (4)
                                                    ------     -------     --------     --------     --------     ---     -------

Balances, December 31, 1996                         11,967     $    12     $ 79,450     $ (1,328)    $(16,735)    $(4)    $61,395
                                                    ======     =======     ========     ========     ========     ===     =======
</TABLE>




  The accompanying notes are an integral part of these consolidated financial
                                  statements.



                                      -36-
<PAGE>   37
                           CARDIOGENESIS CORPORATION
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)

                                     -------

<TABLE>
<CAPTION>
                                                                               Year Ended December 31
                                                                        -----------------------------------
                                                                           1996         1995         1994
                                                                        ---------     --------     --------
<S>                                                                     <C>           <C>          <C>
Cash flows from operating activities:
   Net loss                                                             $  (8,800)    $ (5,299)    $ (1,784)
   Adjustments to reconcile net loss to net cash
       used in operating activities:
      Depreciation and amortization                                           310          114           40
      Amortization of deferred compensation                                   849          104
      Disposal of property and equipment                                      152          215
      Other                                                                    (4)
      Changes in assets and liabilities:
        Accounts receivable                                                (1,154)        (870)
        Inventories                                                          (483)        (625)
        Interest receivable                                                  (832)        (102)
        Prepaids and other current assets                                    (231)        (161)         (59)
        Accounts payable                                                     (283)         475           45
        Accrued expenses                                                    1,395          126            7
        Accrued compensation                                                  411          129           13
        Deferred revenue                                                     (500)         870
                                                                        ---------     --------     --------
           Net cash used in operating activities                           (9,170)      (5,024)      (1,738)
                                                                        ---------     --------     --------

Cash flows from investing activities:
   Purchase of available-for-sale securities                             (200,922)     (30,235)      (7,159)
   Maturities of available-for-sale securities                            154,681       23,869        3,637
   Acquisition of property and equipment                                   (1,678)        (175)        (517)
   (Increase) decrease in other assets                                         13          (21)         (11)
                                                                        ---------     --------     --------
           Net cash used in investing activities                          (47,906)      (6,562)      (4,050)
                                                                        ---------     --------     --------

Cash flows from financing activities:
   Proceeds from note payable                                                 215
   Proceeds from issuance of preferred stock, net of issuance costs           241       13,934        6,477
   Proceeds from the issuance of common stock, net of issuance costs
                                                                           54,550
                                                                        ---------     --------     --------

           Net cash provided by financing activities                       55,006       13,934        6,477
                                                                        ---------     --------     --------

Net increase (decrease) in cash and cash equivalents                       (2,070)       2,348          689

Cash and cash equivalents, beginning of year                                4,150        1,802        1,113
                                                                        ---------     --------     --------

Cash and cash equivalents, end of year                                  $   2,080     $  4,150     $  1,802
                                                                        =========     ========     ========

SUPPLEMENTAL CASH FLOW INFORMATION:
   Conversion of redeemable preferred stock into common in
       connection with the Company's IPO                                $ 22,631
                                                                        ========
</TABLE>



  The accompanying notes are an integral part of these consolidated financial
                                  statements.



                                      -37-

<PAGE>   38
                           CARDIOGENESIS CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                     -------



1.   Summary of Significant Accounting Policies:

         BUSINESS:

         The Company was incorporated in September 1993 to conduct research,
         develop and manufacture cardiovascular surgical devices, including
         disposable systems, to perform both surgical and catheter based
         percutaneous transmyocardial revascularization. Since its inception,
         the Company has devoted substantially all of its efforts to developing
         products and bringing them to market, raising capital and recruiting
         personnel. The Company's principal operations commenced during 1996 at
         which time it emerged from the development stage.

         In the course of its development activities, the Company has sustained
         operating losses and expects such losses to continue at least through
         1997. The Company will finance its operations primarily through its
         cash, cash equivalents and available-for-sale securities, together with
         existing credit facilities and future revenues. There can be no
         assurance that the Company will not require additional funding and
         should this prove necessary, the Company may sell additional shares of
         its common or preferred stock through private placement or further
         public offerings.

         In May 1996, the Company completed its Initial Public Offering (IPO)
         selling 3,000,000 shares of its common stock with net proceeds of $54.5
         million.

         BASIS OF CONSOLIDATION:

         The consolidated financial statements include the accounts of
         CardioGenesis Corporation and its wholly owned subsidiary after all
         intercompany balances and transactions have been eliminated.

         USE OF ESTIMATES:

         The preparation of financial statements in conformity with generally
         accepted accounting principles requires management to make estimates
         and assumptions that affect the reported amounts of assets and
         liabilities and disclosure of contingent assets and liabilities at the
         date of the financial statements and the reported amounts of revenues
         and expenses during the reporting period. Actual results could differ
         from those estimates.




                                   Continued

                                      -38-


<PAGE>   39
9
                           CARDIOGENESIS CORPORATION
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                     -------




1.   Summary of Significant Accounting Policies, continued:


         CONCENTRATION OF CREDIT RISK AND OTHER RISKS AND UNCERTAINTIES:

         The majority of the Company's cash, cash equivalents and
         available-for-sale securities are invested in deposits with a major
         bank in the United States. Deposits in this bank may exceed the amount
         of insurance provided on such deposits.

         Sales to both international and domestic customers are generally made
         on open credit terms. Management performs ongoing credit evaluations of
         the Company's customers and maintains an allowance for potential credit
         losses when needed, but historically has not experienced any
         significant losses related to individual customers or group of
         customers in any particular geographic area.

         The Company's products require approval of the Food and Drug
         Administration (FDA) or other international regulatory agencies prior
         to commercialized sales. The Company cannot be assured that its
         products will receive this regulatory approval. During 1996, the
         Company received approval to market its ITMR system in the European
         Community. If the Company was denied regulatory approval or approval
         was delayed, it would have a material adverse impact on the Company.

         The Company purchases all of its lasers from a single supplier. The
         Company has an agreement with the supplier regarding exclusivity and
         meeting the Company's unit requirements. Management believes that other
         suppliers could be found to manufacture lasers to the Company's
         specifications with relatively consistent pricing. Management believes
         however, that there would be a significant delay if the Company was
         required to change suppliers and that this would have a material
         adverse impact on the Company.

         The Company purchases all of its ECG monitors from a single supplier.
         Management believes that other producers could be found to supply ECG
         monitors to the Company's specifications with relatively consistent
         pricing. Management believes that there would be minimal delay if the
         Company was required to change suppliers. If the Company experienced
         delays in locating a new supplier of ECG monitors, it would have a
         material adverse impact on the Company.

         Export sales totaled approximately $2.0 million for 1996.

         The Company operates in an industry which experiences rapid
         technological changes, which may render inventories maintained by the
         Company obsolete.


                                   Continued

                                      -39-

<PAGE>   40
                           CARDIOGENESIS CORPORATION
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                     -------


 1.  Summary of Significant Accounting Policies, continued:

         CASH AND CASH EQUIVALENTS:

         The Company considers all highly liquid investments purchased with an
         original maturity of three months or less from the date of purchase and
         money market funds to be cash equivalents.

         AVAILABLE-FOR-SALE SECURITIES:

         All investments are classified as available-for-sale and therefore are
         carried at fair market value. Unrealized gains and losses on such
         securities, when material, are reported as a separate component of
         stockholders' equity. Realized gains and losses on sales of all such
         securities are reported in earnings and computed using the specific
         identification cost method. Unrealized gains and losses were not
         material for the years ended December 31, 1996 and 1995.

         INVENTORIES:

         Inventories are stated at the lower of cost (determined on a first-in,
         first-out basis) or market.

         PROPERTY AND EQUIPMENT:

         Property and equipment are recorded at cost and depreciated using the
         straight-line method over the estimated useful lives of the respective
         assets, generally two to seven years. Amortization of leasehold
         improvements is provided on a straight-line basis over the estimated
         useful life of the related asset or the lease term, whichever is
         shorter. Maintenance and repairs are charged to operations as incurred.

         REVENUE RECOGNITION:

         The Company recognizes product sales upon shipment of product to the
         customer and fulfillment of acceptance terms, if any, and when no
         significant contractual obligations remain outstanding.

         RESEARCH AND DEVELOPMENT EXPENDITURES:

         Research and development expenditures are charged to operations as
         incurred.


                                   Continued

                                      -40-
<PAGE>   41
                           CARDIOGENESIS CORPORATION
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                     -------


1.   Summary of Significant Accounting Policies, continued:

         INCOME TAXES:

         Income taxes are accounted for under the liability method. Deferred tax
         assets and liabilities are recognized for the future tax consequences
         attributable to differences between the financial statement carrying
         amounts of existing assets and liabilities and their respective tax
         basis. Deferred tax assets and liabilities are measured using enacted
         tax rates expected to apply to taxable income in the years in which
         those temporary differences are expected to be recovered or settled.
         Valuation allowances are established when necessary to reduce deferred
         tax assets to the amounts expected to be realized.

         NET LOSS PER SHARE:

         The net loss per share is computed using the weighted average number of
         shares of common stock outstanding and dilutive common stock
         equivalents. Common stock equivalents consist of stock options,
         warrants and preferred stock. Pursuant to the Securities and Exchange
         Commission Staff Accounting Bulletins, common and common equivalent
         shares issued at prices below the public offering price during the 12
         months immediately preceding the initial filing date have been included
         in the calculations as if they were outstanding for all periods
         presented, prior to the effective date of the offering (using the
         treasury stock method).

         RECLASSIFICATIONS:

         Certain amounts in the financial statements have been reclassified to
         conform with the current year's presentation. The reclassifications had
         no impact on previously reported net losses.


2.   Available-for-Sale Securities:

         At December 31, 1996, available-for-sale securities consisted of
         corporate obligations and obligations of federal government agencies
         held by a major bank, bearing interest at rates ranging from 5.25% to
         5.99% per annum, and maturing from January 27, 1997, through February
         9, 1998. The maturities of the available-for-sale securities do not
         exceed two years.


                                   Continued

                                      -41-

<PAGE>   42
                           CARDIOGENESIS CORPORATION
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                     -------

2.   Available-for-Sale Securities, continued:

         The carrying and fair value of available-for-sale securities at
         December 31, are as follows (in thousands):

<TABLE>
<CAPTION>
                                              1996                 1995
                                      -------------------   -----------------
                                      Carrying      Fair    Carrying   Fair
                                        Value      Value      Value    Value
                                      --------    -------   --------   ------
         <S>                           <C>        <C>        <C>       <C>
         U.S. Government securities    $26,446    $26,446    $5,570    $5,570
         Corporate obligations          29,682     29,682     4,317     4,317
                                       -------    -------    ------    ------
                                       $56,128    $56,128    $9,887    $9,887
                                       =======    =======    ======    ======
</TABLE>


3.   Inventories:

         Inventories consisted of the following (in thousands):

<TABLE>
<CAPTION>
                                      December 31
                                    ---------------
                                     1996      1995
                                    ------    -----
<S>                                 <C>       <C>
         Raw materials              $   20    $ 73
         Finished goods              1,088     552
                                    ------    ----
                                    $1,108    $625
                                    ======    ====
</TABLE>

4.   Property and Equipment:

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

<TABLE>
<CAPTION>
                                                December 31
                                              --------------
                                               1996     1995
                                              ------    ----
<S>                                           <C>       <C>
         Computer equipment                   $  403    $130
         Laboratory equipment                    430      72
         Furniture and equipment                 447     189
         Leasehold improvements                  731      94
                                              ------    ----
                                               2,011     485
         Less accumulated depreciation and
             amortization                        465     155
                                              ------    ----
                                              $1,546    $330
                                              ======    ====
</TABLE>


                                   Continued

                                      -42-
<PAGE>   43
                           CARDIOGENESIS CORPORATION
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                     -------


5.   Commitments:

         FACILITY LEASE:

         The Company leases its Sunnyvale, California facility under a
         noncancelable operating lease expiring in October 1999. In addition to
         monthly rent, the lease is subject to additional payments for utilities
         and other costs above the base amounts. The Company has the option to
         extend the term of this lease for an additional five years upon all of
         the same terms and conditions except base rent.

         Future minimum lease payments are as follows at December 31, 1996 (in
         thousands):

<TABLE>
               <S>                <C>
               1997               $191
               1998                191
               1999                160
                                  ----
                                  $542
                                  ====
</TABLE>

         Rent expense for the years ended December 31, 1996, 1995 and 1994 was
         $229,000, $65,000 and $45,000, respectively.

         RESEARCH AGREEMENT:

         The Company, in its acquisition of technology in 1993, assumed certain
         obligations under an ongoing research and development agreement with
         Columbia University (Columbia). The agreement provides for a license
         fee of $1.5 million to be paid to Columbia on the date the technology
         licensed under the agreement meets all the following conditions:
         marketing approval from the FDA; issuance of a United States patent for
         the product; and demonstration of the manufacturability of the product.
         The Company must pay a royalty to Columbia of 1.4% of all net revenues
         from sales of the products subject to the license beginning twelve
         months preceding the issuance of the first United States patent. A
         royalty of 50% is required for all sublicense revenue. The agreement
         allows for cumulative research payments under the agreement to be
         deducted from future royalty payments required. Previous payments under
         the agreement made by the Company and the assignor to Columbia which
         would reduce future royalties for product sales have been expensed, as
         incurred, as research and development expenses.



                                   Continued

                                      -43-


<PAGE>   44
                           CARDIOGENESIS CORPORATION
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                     -------




         The Company has agreements to pay consultants and institutions $369,000
         for various research and development efforts in 1997.


6.   Redeemable Convertible Preferred Stock:

     Prior to the effective date of the Company's Initial Public Offering
     (IPO), the Company had outstanding mandatorily redeemable convertible
     preferred stock. The preferred stock automatically converted into
     common stock upon the completion of the IPO.


7.   Stockholders' Equity:

         COMMON STOCK:

         At December 31, 1996, the Company had 40 million shares of common stock
         authorized. In April 1996, the Company reincorporated in the State of
         Delaware. The financial statements have been retroactively adjusted to
         reflect the reincorporation. In April 1996, the Company had a 4.1-for-5
         reverse stock split of the Company's common and preferred stock. The
         financial statements have been retroactively restated to give effect to
         the split.

         EMPLOYEE STOCK PURCHASE PLAN:

         In April 1996, the Board of Directors adopted the 1996 Employee Stock
         Purchase Plan and reserved 123,000 shares of common stock for issuance
         under the Plan. The Plan provides for consecutive 24 month offering
         periods. Each offering period is comprised of four six month purchase
         periods. Shares are purchased through employees' payroll deductions at
         exercise prices equal to 85% of the lesser of the fair market value of
         the Company's common stock at either the first day of the applicable
         offering period or the last day of the respective purchase period. No
         shares had been issued under this plan as of December 31, 1996.

         STOCK OPTION PLANS:

         In November 1993, the Company established the 1993 Equity Incentive
         Plan (the 1993 Plan) that, as amended in 1995, authorized the Board of
         Directors to grant 1,640,000 incentive and nonstatutory stock options
         to employees, officers, directors and consultants of the Company. The
         Plan expires in 2003.

         In April 1996, the Company adopted the 1996 Equity Incentive Plan (the
         1996 Plan) and reserved 820,000 shares for issuance under this plan.
         Additionally in April 1996, the Company adopted the 1996 Directors
         Stock Option Plan and reserved 98,000 shares for issuance under this
         plan. These Plans expire in 2006.


                                   Continued

                                      -44-

<PAGE>   45
                           CARDIOGENESIS CORPORATION
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                     -------



7.   Stockholders' Equity, continued:

         STOCK OPTION PLANS, continued:

         Under the Plans, options must be granted at not less than the fair
         market value at the date of grant as determined by the Board of
         Directors, or committee thereof, except for options granted to a person
         owning greater than 10% of the total combined voting power of all
         classes of stock of the Company, for which the exercise price of the
         options must be not less than 110% of the fair market value at the time
         of grant as determined by the Board of Directors or committee thereof
         and nonstatutory stock options, for which the exercise price of the
         options must not be less than 85% of the fair market value at the time
         of grant as determined by the Board of Directors or committee thereof.
         The Board, or committee thereof, has the authority to set the term of
         the options (no longer than ten years from the date of grant, five
         years for greater than 10% owners of voting stock). Under the Plans,
         options generally vest at a rate of 25% annually after the vesting
         commencement date.

         Activity under the Plans is set forth below (in thousands, except per
         share data):

<TABLE>
<CAPTION>
                                                               Options Outstanding
                                              Shares  --------------------------------------
                                             Available   Number      Price
                                               for         of         Per
                                              Grant      Shares      Share            Total
                                              -----   ---------  ---------------  ----------

<S>                                            <C>         <C>     <C>               <C>
Balances, December 31, 1993                    144         266       $0.12           $    32
   Additional shares reserved by
       plan amendment                          861
   Options granted                            (265)         265    $0.12-$0.24            50
                                              -----       -----                      -------

Balances, December 31, 1994                    740         531     $0.12-$0.24            82
   Additional shares reserved by
       plan amendment                          369
   Options granted                            (813)         813    $0.24-$0.61           233
   Options canceled                              8           (8)      $0.24               (2)
                                              -----       -----                      -------

Balances, December 31, 1995                    304        1,336    $0.12-$0.61           313
   Additional shares reserved by
       plan amendment                          918
   Options granted                            (646)         646    $0.61-$14.50        5,161
   Options canceled                             75          (75)   $0.12-$14.50         (648)
   Options exercised                                       (409)    $0.12-$1.83          (75)
                                              -----       -----                      -------

Balances, December 31, 1996                    651        1,498    $0.12-$14.50      $ 4,751
                                              =====       =====                      =======
</TABLE>


                                   Continued

                                      -45-

<PAGE>   46
                           CARDIOGENESIS CORPORATION
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                     -------

7.   Stockholders' Equity, continued:

         STOCK OPTION PLANS, continued:

         The options outstanding and currently exercisable by exercise price at
         December 31, 1996 are as follows (in thousands, except per share data):

<TABLE>
<CAPTION>
                                                                    Options Currently
                        Options Outstanding                             Exercisable
   ---------------------------------------------------------      ----------------------
                                     Weighted
                                      Average       Weighted                    Weighted
                                     Remaining       Average                    Average
     Exercise           Number      Contractual     Exercise        Number      Exercise
      Prices         Outstanding       Life           Price       Exercisable    Price
   ------------      -----------    -----------     --------      -----------   --------
   <S>                   <C>           <C>            <C>            <C>         <C>
   $0.12-$ 0.24          821           8.10          $ 0.22          334         $ 0.19
   $0.61-$ 0.61          186           9.01          $ 0.61           40         $ 0.61
   $1.83-$ 1.83          150           9.17          $ 1.83           24         $ 1.83
   $9.75-$14.50          341           9.70          $12.24           25         $13.08
</TABLE>

         At December 31, 1996, options to purchase 423,000 shares were
         exercisable at an average exercise price of $1.07 per share and
         2,149,000 shares of common stock are reserved in the event of options
         exercised.


         Deferred compensation to be recognized as a result of stock options
         granted and preferred stock issued during 1996 and 1995 totaled $1.4
         million and $874,000, respectively. Amortization of deferred
         compensation is generally over a vesting period of four years, with
         compensation expense recognized in the period ended December 31, 1996
         and 1995 of $849,000 and $104,000, respectively.

                                   Continued

                                      -46-

<PAGE>   47
                           CARDIOGENESIS CORPORATION
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                     -------




7.   Stockholders' Equity, continued:

         PRO FORMA COMPENSATION EXPENSE:

         The Company has adopted the disclosure-only provisions of Statement of
         Financial Accounting Standards No. 123 (SFAS No. 123), "Accounting for
         Stock-Based Compensation." Accordingly, no compensation cost has been
         recognized for the Plans (including the Employee Stock Purchase Plan).
         Had compensation cost for the Plans been determined based on the fair
         value at the grant date for awards in 1996 and 1995 consistent with the
         provisions of SFAS No. 123, the Company's net loss and net loss per
         share would have been reduced to the pro forma amounts indicated below
         (in thousands, except per share data):


<TABLE>
<CAPTION>
                                                                            Year Ended
                                                                            December 31
                                                                         -----------------
                                                                          1996       1995
                                                                         -------   -------
<S>                                                                      <C>       <C>
         Net loss - as reported                                          $(8,800)  $(5,299)
                                                                         ======    =======
         Net loss - pro forma                                            $(9,258)  $(5,318)
                                                                         ======    =======
         Net loss per share - as reported                                $ (0.97)  $ (1.25)
                                                                         ======    =======
         Net loss per share - pro forma                                  $ (1.02)  $ (1.26)
                                                                         ======    =======
</TABLE>

         The fair value of each option grant is estimated on the date of grant
         using the minimum value method (prior to the IPO) and the Black-Scholes
         method (subsequent to the IPO) with the following weighted average
         assumptions by subgroup:

<TABLE>
<CAPTION>
                                                   Group A            Group B
                                                   -------            -------
         <S>                                       <C>                <C>
         Risk-free interest rate                      5.12%              5.12%
         Expected life                                4.21               3.29
         Expected dividends                        $     -            $    -
         Expected volatility                        0.7045             0.7045
</TABLE>


                                   Continued

                                      -47-

<PAGE>   48
                           CARDIOGENESIS CORPORATION
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                     -------


         The weighted average expected life was calculated based on the vesting
         period and the exercise behavior of each subgroup. Group A represents
         higher paid employees, while, Group B represents lower paid employees.
         The risk-free interest rate was calculated in accordance with the grant
         date and expected life calculated for each subgroup.

 8   Income Taxes:

     At December 31, the components of deferred tax assets are as follows
     (in thousands):

<TABLE>
<CAPTION>
                                                     1996          1995
                                                   -------       -------
<S>                                                <C>           <C>
         Intangible assets                         $    40       $   274
         Depreciation and amortization                   6             9
         Tax credits                                   229           128
         Accrued expenses and other                    219            58
         Capitalized research and development          628           342
         Deferred revenue                              111           184
         Net operating loss carryforwards            4,779         2,202
                                                   -------       -------

         Net deferred tax assets                     6,012         3,197
         Less valuation allowance                   (6,012)       (3,197)
                                                   -------       -------

                                                   $     -       $     -
                                                   =======       =======
</TABLE>

      The Company had federal and state net operating loss carryforwards of
      approximately $13.8 million and $1.6 million, respectively, at December
      31, 1996, available to offset future regular and alternative minimum
      taxable income. The Company's federal and state net operating loss
      carryforwards will expire by the years 2011 and 2001, respectively.

      The Tax Reform Act of 1986 substantially changed the rules relative to net
      operating loss carryforwards in the event of an "ownership change" of a
      corporation. Future changes in ownership may result in limitations on the
      annual utilization of net operating loss carryforwards.


9.   Related Party Transactions:

     The Company paid $159,000, $178,000 and $95,000 for consulting fees to
     certain stockholders during the years ended December 31, 1996, 1995 and
     1994, respectively.


                                      -48-
<PAGE>   49
                           CARDIOGENESIS CORPORATION
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                     -------



     The Company paid $37,000 and $130,000 to a company controlled by a former
     president of the Company for interim management services and office space,
     during the years ended December 31, 1995 and 1994, respectively.


                                      -49-


<PAGE>   50
ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURE

      - none -

PART III

ITEM 10.   DIRECTORS AND EXECUTIVES OFFICERS OF THE REGISTRANT

   The information required by this item with respect to the directors of the
Company is incorporated by reference from the definitive proxy statement for the
Company's 1997 annual meeting of stockholders to be filed with the Commission
pursuant to Regulation 14A not later than 120 days after the end of the fiscal
year covered by this report (the "Proxy Statement") under the caption "Proposal
No. 1-Election of Directors." The information relating to the executive officers
of the Company is incorporated by reference from the Proxy Statement under the
caption "Executive Officers."

   Information required by this item with respect to compliance with Section
16(a) of the Securities Exchange Act of 1934 is incorporated by reference from
the Proxy Statement under the caption "Section 16(a) Beneficial Ownership
Reporting Compliance."

ITEM 11. EXECUTIVE COMPENSATION

   The information required by this item is incorporated by reference from
the Proxy Statement under the captions "Executive Compensation," "Proposal
No. 1-Election of Directors-Director Compensation," and "Compensation
Committee Interlocks and Insider Participation."

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

   The information required by this item is incorporated by reference from the
Proxy Statement under the caption "Security Ownership of Certain Beneficial
Owners and Management."

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

   The information required by this item is incorporated by reference from the
Proxy Statement under the caption "Certain Relationships and Related
Transactions."


                                      -50-
<PAGE>   51
PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
         FORM 8-K

      (a)   The following documents are files as part of this Form:

                                                                         Page
                                                                         ----

            1.   Financial Statements

            The Consolidated Financial Statements, notes thereto, and
            Independent Accountant's Report thereon are included in Part II,
            Item 8 of this
            Form 10-K.

            2.   Financial Statement Schedule

            The Financial Statement Schedule is included in Part II, Item 8 of
            this Form 10-K.

            3.   Exhibits

            The following exhibits are filed or incorporated by reference as
            part of this Form 10-K:

              EXHIBIT
              NUMBER                         EXHIBIT TITLE
              ------                         -------------

                3.01     Restated Certificate of Incorporation
                3.02     Registrant's Bylaws.(1)
                4.01     Form of Specimen Certificate for Registrant's Common
                         Stock.(2)
                4.02     Registrant's Second Restated Investors' Rights
                         Agreement, dated as of December 5, 1995 as
                         amended.(2)
               10.01     Registrant's 1993 Equity Incentive Plan and related
                         documents.(2)*
               10.02     Registrant's 1996 Equity Incentive Plan and related
                         documents.(2)*
               10.03     Registrant's 1996 Directors Stock Option Plan and
                         related documents.(2)*
               10.04     Registrant's 1996 Employee Stock Purchase Plan and
                         related documents.(2)*
               10.05     Standard Industrial/Commercial Multi-Tenant Lease,
                         dated December 18, 1995, by and between Registrant
                         and De La Cruz Enterprises.(2)
               10.06     Koll Business Center Lease, dated July 13, 1994, by
                         and between Registrant and Fujita California
                         Partners III.(2)
               10.07     Form of Indemnity Agreement.(2)*
               10.08     Agreement, dated August 1, 1991, by and among the
                         Trustees of Columbia University in the City of New
                         York, Eli Lilly and Company and Advanced
                         Cardiovascular Systems, Inc. and related
                         documents.(2)(3)
               10.09     OEM Supply Agreement, dated May 31, 1995, by and
                         between Registrant and New Star Lasers as
                         amended.(2)(3)
               10.10     Research and Development Agreement, dated June 1,
                         1995, by and between Registrant and New Star
                         Lasers.(2)(3)
               10.11     Product Documentation, Approval, Manufacturing and
                         Supply Agreement, dated January 2, 1996, by and
                         between Registrant and Indigo Medical GmbH.(2)(3)
               10.12     Series A Preferred Stock Purchase Agreement, dated
                         November 23, 1993, by and among Registrant and various
                         investors and material exhibits thereto.(2)(3)(4)


                                      -51-
<PAGE>   52
              EXHIBIT
              NUMBER                         EXHIBIT TITLE
              ------                         -------------

               10.13     Series B Preferred Stock Purchase Agreement, dated June
                         9, 1994, by and among Registrant and various investors
                         and material exhibits thereto.(2)(4)
               10.14     Series C Preferred Stock Purchase Agreement, dated
                         December 5, 1995, by and among Registrant and various
                         investors and material exhibits thereto.(2)(4)
               10.15     Consulting Agreement, dated March 1, 1996, by and
                         between Registrant and Michael Aita.(2)(3)*
               10.16     Employment Terms Letter, dated November 23, 1993,
                         issued by the Company to Michael Aita.(2)*
               10.17     Consulting Agreement, dated November 23, 1993, by
                         and among Registrant, Carl J. Simpson and Advanced
                         Cardiovascular Systems, Inc. as amended.(2)*
               10.18     Letter Agreement, dated November 23, 1993, by and
                         between Registrant and Advanced Cardiovascular
                         Systems, Inc.(2)
               11.01     Statement regarding computation of per share
                         earnings.
               21.01     Subsidiary of Registrant.
               23.01     Consent of Coopers & Lybrand, L.L.P., independent
                         accountants.
               27.01     Financial Data Schedule.
----------
*   Management contract or compensatory arrangement.

   (1)  Incorporated by reference to Exhibit 3.04 to Registrant's Registration
        Statement on Form SB-2 (No. 333-3752-LA), declared effective on May 21,
        1996 (the "Form SB-2").

   (2)  Incorporated by reference to the Exhibit of the same number to the
        Form SB-2.

   (3)  Confidential treatment has been granted with respect to certain portions
        of this agreement. Such portions have been omitted from this filing and
        have been filed separately with the Securities and Exchange Commission.

   (4)  Certain exhibits to the agreement have been omitted because they are not
        material, but will be furnished supplementally to the Securities and
        Exchange Commission upon its request.

(b) Reports on Form 8-K
    None

(c) Exhibits
    See Item 14(a) above.

(d) Financial Statement Schedule
    See Item 14(a) above.


                                      -52-
<PAGE>   53
        REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE


   In connection with our audits of the consolidated financial statements of
CardioGenesis Corporation as of December 31, 1996 and 1995, and for each of the
three years in the period ended December 31, 1996, which financial statements
are included in this Annual Report on Form 10-K, we have also audited the
financial statement schedule listed in Item 8 herein.

   In our opinion, the financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly, in all
material respects, the information required to be included therein.




                                            Coopers & Lybrand L.L.P.

   San Jose, California
   January 29, 1997



                                      -53-
<PAGE>   54
                                                                    SCHEDULE II

                           CARDIOGENESIS CORPORATION
                       VALUATION AND QUALIFYING ACCOUNTS
                                 (in thousands)

<TABLE>
<CAPTION>
                                                Balance at
                                                Beginning       Charged to                      Balance at
                                                of the          Costs and                       End of the
                 Description                    Period          Expenses        Deductions      Period
                 -----------                    ----------      -----------     ----------      ----------
<S>                                             <C>             <C>             <C>             <C>
Balance for the year ended December 31, 1994:
 Allowance for doubtful accounts receivable     $ 0                                             $    0
Balance for the year ended December 31, 1995:
 Allowance for doubtful accounts receivable     $ 0                                             $    0
Balance for the year ended December 31, 1996:
 Allowance for doubtful accounts receivable     $ 0             $ 225                   --      $    0

</TABLE>



                                     -54-

<PAGE>   55
SIGNATURES

   Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.


                                          CARDIOGENESIS CORPORATION


                                          By: /s/ ALLEN W. HILL
                                             -------------------------
                                                  Allen W. Hill
                                          President and Chief Executive Officer

Date:  March 27, 1997


   Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
         Signature                       Title                                Date
         ---------                       -----                                ----
<S>                                   <C>                                  <C>
/s/  ALLEN W.  HILL                 President, Chief Executive              March 27, 1997
-------------------------------     Officer and a Director
      Allen W. Hill                 (Principal Executive Officer)



 /s/  RICHARD P.  POWERS            Chief Financial Officer,                March 27, 1997
-------------------------------     Vice President of Finance
    Richard P. Powers               and Administration and Secretary
                                    (Principal Financial Officer and
                                    Principal Accounting Officer)


/s/  DAVID B.  APFELBERG            Director                                March 27, 1997
-------------------------------
     David B. Apfelberg

/s/  JACK M.  GILL                  Director                                March 27, 1997
-------------------------------
        Jack M. Gill

/s/  DAVID C.  HULL, JR.            Director                                March 27, 1997
-------------------------------
        David C. Hull, Jr.

 /s/  THOMAS D.  KILEY              Director                                March 27, 1997
-------------------------------
       Thomas D. Kiley

/s/ F. THOMAS (JAY) WATKINS III
-------------------------------
    F.  Thomas (Jay) Watkins III   Director                                 March 27, 1997
</TABLE>


                                      -55-
<PAGE>   56
                                INDEX TO EXHIBITS

               EXHIBIT
               NUMBER                         EXHIBIT TITLE
               ------                         -------------

                3.01     Restated Certificate of Incorporation
                3.02     Registrant's Bylaws.(1)
                4.01     Form of Specimen Certificate for Registrant's Common
                         Stock.(2)
                4.02     Registrant's Second Restated Investors' Rights
                         Agreement, dated as of December 5, 1995 as
                         amended.(2)
               10.01     Registrant's 1993 Equity Incentive Plan and related
                         documents.(2)*
               10.02     Registrant's 1996 Equity Incentive Plan and related
                         documents.(2)*
               10.03     Registrant's 1996 Directors Stock Option Plan and
                         related documents.(2)*
               10.04     Registrant's 1996 Employee Stock Purchase Plan and
                         related documents.(2)*
               10.05     Standard Industrial/Commercial Multi-Tenant Lease,
                         dated December 18, 1995, by and between Registrant
                         and De La Cruz Enterprises.(2)
               10.06     Koll Business Center Lease, dated July 13, 1994, by
                         and between Registrant and Fujita California
                         Partners III.(2)
               10.07     Form of Indemnity Agreement.(2)*
               10.08     Agreement, dated August 1, 1991, by and among the
                         Trustees of Columbia University in the City of New
                         York, Eli Lilly and Company and Advanced
                         Cardiovascular Systems, Inc. and related
                         documents.(2)(3)
               10.09     OEM Supply Agreement, dated May 31, 1995, by and
                         between Registrant and New Star Lasers as
                         amended.(2)(3)
               10.10     Research and Development Agreement, dated June 1,
                         1995, by and between Registrant and New Star
                         Lasers.(2)(3)
               10.11     Product Documentation, Approval, Manufacturing and
                         Supply Agreement, dated January 2, 1996, by and
                         between Registrant and Indigo Medical GmbH.(2)(3)
               10.12     Series A Preferred Stock Purchase Agreement, dated
                         November 23, 1993, by and among Registrant and various
                         investors and material exhibits thereto.(2)(3)(4)
               10.13     Series B Preferred Stock Purchase Agreement, dated June
                         9, 1994, by and among Registrant and various investors
                         and material exhibits thereto.(2)(4)
               10.14     Series C Preferred Stock Purchase Agreement, dated
                         December 5, 1995, by and among Registrant and various
                         investors and material exhibits thereto.(2)(4)
               10.15     Consulting Agreement, dated March 1, 1996, by and
                         between Registrant and Michael Aita.(2)(3)*
               10.16     Employment Terms Letter, dated November 23, 1993,
                         issued by the Company to Michael Aita.(2)*
               10.17     Consulting Agreement, dated November 23, 1993, by
                         and among Registrant, Carl J. Simpson and Advanced
                         Cardiovascular Systems, Inc. as amended.(2)*
               10.18     Letter Agreement, dated November 23, 1993, by and
                         between Registrant and Advanced Cardiovascular
                         Systems, Inc.(2)
               11.01     Statement regarding computation of per share
                         earnings.
               21.01     Subsidiary of Registrant.
               23.01     Consent of Coopers & Lybrand, L.L.P., independent
                         accountants.
               27.01     Financial Data Schedule.

   ----------

   *  Management contract or compensatory arrangement.

 (1)   Incorporated by reference to Exhibit 3.04 to Registrant's Registration
       Statement on Form SB-2 (No. 333-3752-LA), declared effective on May 21,
       1996 (the "Form SB-2").

 (2)   Incorporated by reference to the Exhibit of the same number to the Form
       SB-2.



<PAGE>   57
 (3)   Confidential treatment has been granted with respect to certain portions
       of this agreement. Such portions have been omitted from this filing and
       have been filed separately with the Securities and Exchange Commission.

 (4)   Certain exhibits to the agreement have been omitted because they are not
       material, but will be furnished supplementally to the Securities and
       Exchange Commission upon its request.