UNITED STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549


FORM
10-K





[X]
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934


For the
fiscal year ended December 31, 2008





[
] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934


Commission file number:0-22419




CARDIMA, INC.


(Exact
name of registrant as specified in its charter)




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


47266
BENICIA STREET, FREMONT, CALIFORNIA 94538-7330


(Address
of Principal Executive Offices)





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





Securities
registered under Section 12(b) of the Exchange Act:




NONE





Securities
registered under Section 12(g) of the Exchange Act:


COMMON
STOCK, $0.001 PAR VALUE PER SHARE





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.


Yes [ ]
No [X]





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.


Yes [ ]
No [X]





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. Yes
[X] No [ ]





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (229.405 of this chapter) 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
or any amendment to this Form 10-K. [_]





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





Large
accelerated filer []      Accelerated Filer
[]       Non-accelerated filer  [
]      Smaller reporting company[x]





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




The
aggregate market value of the voting Common Stock held by non-affiliates of the
registrant, based upon the closing sale price of the Common Stock on June 30,
2008 was approximately $31,367,000.





As of
February 28, 2009, the Company had outstanding 143,754,906 shares of Common
Stock, $0.001 par value.






1








TABLE
OF CONTENTS




PART I
                                        
                                        Page No.Item
      1
                                        Business
                                        3Item
      1A
                                        Risk
      Factors
                                        17Item
      1B
                                        Unresolved Staff
      Comments
                                        25Item
      2
                                        Properties
                                        25Item
      3
                                        Legal
      Proceedings
                                        25Item
      4
                                        Submission of Matters
      to a Vote of Security Holders
                                        25PART IIItem
      5
                                        Market for the
      Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
                                        26Item
      6
                                        Selected Financial
      Data
                                        28Item
      7
                                        Management’s Discussion and
      Analysis of Financial Condition and Results of
      Operations
                                        28Item
      7A
                                        Quantitative and
      Qualitative Disclosures about Market Risk
                                        34Item
      8
                                        Financial
      Statements and Supplementary Data
                                        34Item
      9
                                        Changes in and
      Disagreements with Accountants on Accounting and Financial
      Disclosure
                                        59Item
      9A
                                        Controls and
      Procedures
                                        59Item
      9B
                                        Other
      Information
                                        60PART IIIItem
      10
                                        Directors, Executive
      Officers and Corporate Governance
                                        61Item
      11
                                        Executive
      Compensation
                                        62Item
      12
                                        Security Ownership of
      Certain Beneficial Owners and Management and Related Stockholder
      Matters
                                        65Item
      13
                                        Certain
      Relationships and Related Transactions, and DirectorIndependence
                                        66Item
      14
                                        Principal
      Accountant Fees and Services
                                        67PART IVItem
      15
                                        Exhibits and Financial
      Statement Schedules
                                        68SIGNATURES
                                        
                                        70









2






FORWARD-LOOKING
STATEMENTS





This annual report on Form
10-Kincludes
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, which we refer to in this annual report as the Exchange Act.
Forward-looking statements are not statements of historical fact but rather
reflect our current expectations, estimates and predictions about future results
and events. These statements may use words such as "anticipate," "believe,"
"estimate," "expect," "intend," "predict," "project" and similar expressions as
they relate to us or our management.Unless the context otherwise
requires, references in this annual report to “we,” “us,” “our,” or the
“Company” refer to Cardima, Inc.When we make forward-looking
statements, we are basing them on our management's beliefs and assumptions,
using information currently available to us. These forward-looking statements
are subject to risks, uncertainties and assumptions, including but not limited
to, risks, uncertainties and assumptions discussed in this annual report.
Factors that can cause or contribute to these differences include those
described under the headings "Risk Factors" and "Management Discussion and
Analysis and Plan of Operation." If one or more of these or other risks or
uncertainties materialize, or if our underlying assumptions prove to be
incorrect, actual results may vary materially from what we projected. All
subsequent written and oral forward-looking statements attributable to us or
individuals acting on our behalf are expressly qualified in their entirety by
this paragraph. You should specifically consider the factors identified in this
annual report, which would cause actual results to differ before making an
investment decision. We are under no duty to update any of the forward-looking
statements after the date of this annual report or to conform these statements
to actual results.




PART
I





ITEM
1.                      DESCRIPTION
OF BUSINESS





Overview




Cardima®is a medical device
company focused on the diagnosis and treatment of cardiac
arrhythmias.  Arrhythmias develop from abnormal electrical currents
within the heart, and can be associated with fast, slow and/or irregular
heartbeats.  Most arrhythmias are symptomatic, and some are associated
with significant morbidity and even mortality.  Our products have been
developed for the diagnosis and treatment of the two most common forms of
arrhythmias, atrial fibrillation (AF) and ventricular tachycardia (VT), with AF
being of most of our clinical and commercial efforts.




Our
products include the PATHFINDER®, TRACERTM
and REVELATION® Series
of diagnostic catheters, the VUEPORT® and
NAVIPORT® Series
of guiding catheters, the INTELLITEMP® Energy
Management Device and the Surgical Ablation System.  All of these
devices have received CE mark approval and U.S. Food and Drug Administration
(FDA) 510(k) clearance.  The REVELATION® Series
of ablation catheters with the INTELLITEMP® EP
Energy Management Device, developed for the treatment of atrial fibrillation
(AF), has received CE mark approval and is marketed in Europe.





PATHFINDER®,
TRACERTM, VUEPORT®,
NAVIPORT®,
REVELATION® and
INTELLITEMP® are our
registered trademarks.




The
PATHFINDERSeries
of microcatheters are small, flexible wire based devices. Their unique design
makes them the Go-To catheter for all difficult procedures when accessing and
mapping in the coronary sinus. The linear ablation systems for EP and Surgical
ablation deliver Controlled RF energy to create thin, continuous, linear,
transmural lesions.





Normal
Heart Rhythm




The heart
is an electromechanical pump that relies on self-generated electrical signals to
contract its muscle fibers and pump blood throughout the body. It is divided
into four chambers.  The two upper chambers, or atria, receive blood
from the lungs (RA) and body (LA), and the two lower chambers, or ventricles,
pump blood to the lungs (RV) and body (LV).   On average the
heart “beats” 72 times/minute.





The
heart's pumping action is controlled by its electrical conduction system within
the heart muscle tissue. This conduction system allows electrical signals to
propagate through the heart in a systematic and very organized way. These
specialized conduction cells are placed throughout the walls of the four
chambers of the heart. In a systematically timed sequence, this conduction
system carries electrical signals to the muscle cells throughout the heart. This
electrical conduction cycle results in a normal heartbeat that originates in the
right atrium, commencing in a specialized group of cells called the Sino-Atrial
node.




The
Sino-Atrial node is the heart's natural pacemaker, regularly discharging an
electrical signal that is responsible for setting the heart rate.  The
signal generated in the Sino Atrial node is propagated through the atrial tissue
until it reaches the Atrio-Ventricular node, located just above the ventricles.
A momentary delay of the signal provides enough time for the atria to fill the
ventricles with blood before the ventricles are signaled to
contract.






3






Once the
electrical signal exits the Atrio-Ventricular node, it is rapidly conducted down
the Bundle of His, a thin bundle of specialized cardiac muscle which conducts
the electrical signals from the right atrium to the ventricles, and is
distributed widely throughout both ventricles via the Purkinje Fibers, causing
the ventricles to contract in unison. Since the ventricles pump blood to the
lungs and the rest of the body, they consist of a much greater muscle mass than
the atria.  The left ventricle, in particular, is the stronger of the
two ventricles, generating higher pressure and working harder in order to pump
oxygenated blood through the entire body.





Arrhythmias





Arrhythmias
adversely affect the mechanical activities of the heart, have detrimental
physical effects and impair a person’s quality of life. Arrhythmias result in
insufficient blood flow, which may cause dizziness, inadequate function of
important organs in the body, stroke and even death. Arrhythmias have numerous
causes, including congenital defects and tissue damage from either heart attacks
or arteriosclerosis. There are two general types of arrhythmias: tachycardia, a
fast resting heart rate, and bradycardia, a slow resting heart
rate.  Tachycardias fall into one of two major categories: (i) atrial
tachycardia, which has its origin in the atria and (ii) ventricular tachycardia,
which has its origin in the wall of the ventricles.  Many arrhythmias
worsen over time.




Atrial
Fibrillation





Atrial
fibrillation, the most common form of atrial tachycardia, is characterized by
the irregular fluttering and/or very rapid beating of the atria resulting from
malfunctioning of the electrical conduction system in the walls of the atria.
During AF the regular pumping action of the atria is replaced by irregular,
disorganized and quivering spasms of atrial muscle tissue. Symptoms of AF
typically include a rapid and irregular heartbeat, palpitations, discomfort and
dizziness. This malfunction results in the failure of the atria to fill the
ventricles completely and, consequently, the failure of the heart to pump
adequate amounts of blood to the body. Once AF becomes symptomatic, it is
typically associated with significant morbidity related to reduced blood flow.
Often the greatest concern is that the reduced atrial contraction can lead to
blood pooling in the atria and cause the formation of blood
clots.  Blood clots in the left atrium can dislodge and travel through
the bloodstream to the brain, resulting in stroke or even death.




According
to the American Heart Association’s (AHA) Heart Disease and Stroke Statistics -
2004 Update, AF affects more than 2.2 (this number is larger now) million people
in the United States. The AHA statistics update also estimates that AF is
responsible for over 100,000 strokes each year in the United States,
representing a five-fold increase risk compared to people in normal
rhythm.  According to the Framingham Heart Study reported in
Circulation (medical journal), the lifetime risk for the development of AF in
men and women 40 years of age and older is 25%.





Traditional
AF treatments are primarily supportive and palliative and do not cure AF. The
most common are anti-arrhythmic and anticoagulant drugs. Anti-arrhythmic drugs
are typically used in an attempt to reduce the number of episodes of AF and/or
to reduce the duration of each individual episode. Anti-coagulants are used to
reduce the normal clotting mechanism of the blood, therefore reducing the
potential of creating blood clots and thus strokes.  Anti-arrhythmic
drug therapy often becomes less effective over time, with approximately half of
the patients developing resistance to the drugs. In addition, anti-arrhythmic
drugs have potentially severe side effects including pulmonary fibrosis,
impaired liver function, thyroid problems and the development of worse and even
life-threatening ventricular arrhythmias.





Another
palliative procedure for AF is external cardioversion, or the application of a
strong electrical current using an external defibrillator to attempt to shock
the heart back into normal sinus rhythm. This treatment only affects a single
episode of AF.  Another treatment is the deliberate destruction of the
atrio-ventricular node and subsequent implantation of a pacemaker. This is
typically considered a treatment of last resort for AF patients as it does not
cure or treat the AF itself, but rather allows rate control of the ventricles.
The patient still has AF. Also, the patient is dependent on the pacemaker for
life. Pacemakers are a device implanted into the chest, are battery-powered and
typically require replacement approximately every seven to ten
years.  Patients with pacemakers are usually required to continue with
chronic anticoagulant drug therapy to prevent clotting. Anticoagulant therapy
carries the risk of bleeding, including fatal brain hemorrhaging.





The only
curative therapy for AF used today is an open-heart operation commonly known as
the surgical "maze" procedure. In the maze procedure (described briefly in the
Overview section of this report) is usually done concomitantly with another
heart procedure such as a valve replacement or coronary artery bypass. The
surgeon makes a series of cuts in a specific “maze-like” formation through the
wall of the atrium with a scalpel, and then sutures these cuts back together.
The scars that result re-direct and contain the chaotic electrical impulses, and
channel the electrical signal emanating from the Sino-Atrial node, thereby
returning the heart to normal sinus rhythm. This open-heart operation is
traumatic to the patient, is very expensive, is associated with long hospital
stays and may require a three to six month recovery time. Although this approach
is not commonly used because it is limited to AF patients who also have some
other surgical need, it is generally considered highly effective in controlling
AF.





For
almost two decades thought leaders in electrophysiology and cardiac surgery have
worked to develop less invasive catheter approaches to cause scarring in the
heart which would treat AF as successfully as the surgical
Maze.  Various energy sources have been evaluated, and various “lesion
sets” in or on the heart have been tested. The most successful results to
date are obtained when most or all of the Cox-Maze lesions are
recreated.






4







If a
catheter procedure is to successfully mimic the maze procedure, it is necessary
to make various shaped lines, including straight, curvilinear and
circumferential lesions.  These lesions need to have adequate depth
into atrial tissue, and be continuous, leaving no gaps. Cardima’s ablation
systems for both inside and on top of the heart accomplish these goals. If a
catheter procedure is to successfully mimic the maze procedure, it is necessary
to make various shaped lines, including straight, curvilinear and
circumferential lesions. Therefore we developed the REVELATIONTx,
REVELATION T-Flex and REVELATION Helix respectively, to mimic these required
shapes.




Ventricular
Tachycardia





Ventricular
tachycardia is a life-threatening condition in which heartbeats are improperly
initiated from within the ventricular wall, bypassing the heart's normal
conduction system. A typical VT patient has experienced a myocardial infarction,
or heart attack, resulting in the formation of a ventricular scar electrical
instability.  During episodes of VT, the ventricles beat at such an
abnormally rapid rate that they are unable to fill completely with blood, thus
reducing the amount of oxygenated blood being pumped throughout the body. The
resulting reduction in the amount of oxygen transported to the tissues and
organs of the body can cause dizziness and loss of consciousness. VT can often
progress into ventricular fibrillation, an extremely irregular, chaotic and
ineffective spasming of the ventricles, resulting in sudden death.




According
to the AHA’s Heart Disease and Stroke Statistics - 2004 Update, few deaths are
statistically listed as being directly caused by ventricular tachycardia.
However, it is estimated that most of the approximately 340,000 sudden cardiac
deaths per year from coronary artery disease may be attributed to ventricular
fibrillation.




Limitations
of Current Catheter-Based Diagnosis and Therapy




The
potential medical benefits and cost efficiency of minimally invasive procedures
have encouraged electro-physiologists and surgeons to seek new, minimally
invasive techniques for the diagnosis and treatment of arrhythmias. In the case
of AF, electro-physiologists have experimented with a  technique,
often referred to as the "drag and burn procedure," in which conventional radio
frequency tip ablation catheters are dragged across the inside surface of an
atrium in an attempt to replicate a linear lesion similar to the surgical maze
procedure. Creating continuous, linear, trans-mural lesions to isolate portions
of the atria using standard tip catheters can be time consuming and
difficult.




We
maintain that the disadvantages of existing catheter-based approaches to treat
AF are attributable not to the minimally invasive approach of the procedure, but
rather to the existing catheter technology. The catheters currently used are
larger and stiffer than our products and most have a single electrode at the end
of the catheter designed to create an ablation at the tip only. This single
electrode catheter approach makes creating a solid or continuous line of scar
lesion difficult.




Cardima’s
Micro-catheter System Solution for Electrophysiologists




We
believe our micro-catheter-based systems have the potential to offer the
effectiveness of the open-heart surgical cure for AF (the “maze” procedure) but
with less trauma, fewer complications, reduced pain, shorter hospital stays and
lower procedure costs. In our quest to achieve those goals, we have designed
micro-catheter systems that we believe provide more extensive and safe access to
the arrhythmia-causing tissue.   All of our micro-catheter
systems are designed to offer the following perceived advantages over existing,
competitive catheters:




·Minimally
invasive approach.Our micro-catheter systems are designed to provide greater access simply
because they are smaller and more flexible than competitive technologies. Size
constraints prevent other EP systems from reaching some small vessels that our
micro-catheters can reach.  Our smaller surgical systems allow for
easy port access into the chest and on top of the heart. We believe that this
increased access results in decreased procedure time, shorter hospital stays,
lower procedure costs and fewer complications than the procedures currently in
use.




·Single
micro-catheter that can both map and ablate.We initially developed
micro-catheters for diagnosing arrhythmias. Our focus today is the refinement of
therapeutic micro-catheters, which we call the REVELATION series of
micro-catheters, capable of both mapping and ablating. Because our
micro-catheter systems can both map and ablate, we believe that it will be able
to decrease procedure times, improve treatment outcomes and enhance the overall
safety of the procedure.  Cardima is launching multicenter EP clinical
studies in Europe and in the US.  There will also be a focus on market
awareness and development through seminars, tradeshows, and site
visits.




·Enhanced access
to the vasculature of the heart.Our micro-catheters are
approximately one-third to one-fourth the size of standard electrophysiology
catheters, and incorporate what is called variable stiffness technology.
Variable stiffness technology involves our use of a tapered core guide wire as
the basic building block of each catheter. We then attach a highly flexible,
atraumatic tip to the leading end of each catheter. As a result of this variable
stiffness technology, our micro-catheters are more torqueable and flexible than
standard electrophysiology catheters and thus allow more extensive and less
traumatic access to the vasculature of the heart. This variable stiffness
technology also allows for our REVELATION series of mapping and ablation
catheters to conform to the contours of the heart wall, with the goal of
maintaining controlled, regular contact even in a fast-beating
heart.








5






·Less tissue
damage at safer power setting.Because our REVELATION
series ablation catheters are smaller, we create thinner lesion lines while
maintaining adequate depth of tissue penetration. This significant reduction in
surface tissue damage may be important in lesion formation in and around the
pulmonary veins where pulmonary vein stenosis, (or the narrowing of the lumen of
the pulmonary veins) after conventional ablation therapy is an
issue.  Our catheters also can create these lesions at lower power
settings because of the effect of current density emitted from our smaller
coiled electrodes. We believe that lower power has the potential to preserve
more cardiac tissue and therefore more cardiac function when compared to
conventional ablation.




·Reduced procedure
and radiation exposure times.We believe that the dual
functionality of our micro-catheter systems has the potential to reduce
procedure times and enhance safety. Since the electro-physiologists must use
x-rays to place and determine location of all catheters, faster procedures
equate to decreased cumulative x-ray exposure to patients, physicians and lab
personnel.





Cardima’s
Surgical Ablation System- A Solution for Cardiothoracic Surgeons




Cardiothoracic
surgeons continue to search for better options to treat atrial
fibrillation.  As the number of patients with AF increases, Cardima has an
opportunity to capture increased market share.  The features and benefits
of the Surgical Ablation System include physician control, patient feedback,
increased safety, and reduced procedure time and length of stay for the
patient. In the first quarter of 2008, we had a limited market release of
our surgical ablation system, which is based on the EP technology that
has used in over 450 documented clinical cases.  It can be used in
both open and closed-chest procedures.




·Physician
Control.The
Cardima Surgical System allows the physician to choose ablation length, ablation
time, lesion shape and placement.  Competitive devices do not give the
surgeon the flexibility of our system.





·Physician
Feedback.Our
system is also unique in the fact that it gives feedback directly to the
user.  Tissue temperature is monitored by two thermocouples adjacent
to each ablating electrode.  The thermocouples give direct feedback on
the temperature of the tissue surface that is being ablated.  There is
also a safety limit that is set.  This allows for an automatic shut
off of the device so as not to cause any charring.  Charring leaves a
“blackened” area and RF energy can no longer penetrate to achieve lesion
formation.  Without depth, the ablation will not be
complete.  Contact is also crucial to optimal lesion
formation.  Our Surgical System provides feedback for each electrode
that is being activated.  The user is aware when there is contact with
the tissue.  These readings allow the surgeon to reposition if needed
and maintain l contact throughout the ablation time.





·Safer Power
Settings and Feedback to the Physician.Because the Surgical
Probes are constructed with the same material and process as the EP catheters,
we create thinner lesion lines while maintaining depth of tissue penetration.
This reduction in surface tissue damage may be important in lesion formation
around the pulmonary veins where pulmonary vein stenosis, (or the narrowing of
the lumen of the pulmonary veins which restricts the flow of re-oxygenated blood
returning to the heart from the lungs) after conventional ablation therapy is an
issue. Our system also creates these lesions at lower power settings because of
the effect of higher current density emitted from our smaller coiled
electrodes.  We believe that lower power can potentially preserve more
cardiac tissue and therefore more cardiac function when compared to conventional
ablation.  The user receives feedback from the system on how much
power (W) is being emitted by each electrode.





·Added Patient
Safety.Our
Surgical Ablation systems feedback provides for additional patient
safety.  Additionally a protective shield around the electrodes
ensures only tissue in contact with the electrodes as selected by the surgeon
will be ablated.  The surrounding tissue is shielded, therefore
eliminating inadvertent ablation of non-cardiac tissue.





·Reduced procedure
time and hospital stay for the patient.We believe that the
procedure performed through two ports using a scope to visualize the access can
potentially reduce procedure time for the patient and makes this a viable
procedure for more patients who would not normally be able to have an open chest
procedure.  The heart does not have to be arrested and the patient can
go home after being monitored over night in the short stay unit.





REVELATION
Catheters





Our
REVELATION Series micro-catheter systems are designed to diagnose AF by
creating long, thin, continuous, linear, transmural lesions. A new model of the
REVELATION T-Flex, with an atraumatic ball-tip, available with 8 or 16
electrodes, received CE Mark approval in June 2005. Our REVELATION Helix
micro-catheter system is designed to diagnose and treat AF that originates from
the pulmonary veins, located in the left atria. The REVELATION Helix can both
diagnose and treat focal, or localized, AF. The REVELATION Helix makes
circumferential or partially circumferential scar patterns within the pulmonary
veins, on the ostia or outer base of the pulmonary veins, and on the outside
wall where the pulmonary veins enter the atria in order to contain AF causing
signals. A newer model, the REVELATION Helix STX received CE Mark approval in
the European Union from its European Notified Body Rheinisch Westphaelischer
Technischer Ueberwachungsverein e.V., (RWTUV) in 2003 to treat AF originating in
the pulmonary veins.








6







Curative
Approach for Ventricular Tachycardia





Our
PATHFINDER, PATHFINDER mini and TRACER diagnostic
micro-catheter systems for mapping VT are all designed for use inside the
vasculature of the heart wall, facilitating access to arrhythmia-causing tissue
through the venous system. We believe that at least half of the VT foci are
located in the intramyocardium and the epicardium, areas that are ineffectively
accessed using standard endocardial catheters or basket type catheters currently
in development. The intravascular approach to VT ablation should permit our
micro-catheters to be positioned in close proximity to the arrhythmia-causing
tissue, facilitating the creation of smaller, more focused lesions. We believe
that this approach has the potential to be more effective than standard
endocardial ablation procedures, with reduced destruction of surrounding healthy
tissue, thus maximizing and optimizing the normal function of the heart after
the procedure. We also believe that the smaller catheter sizes of our
ventricular systems may be particularly appealing to the pediatric market. We
are aware of at least one other epicardial mapping catheter in addition to the
PATHFINDER, PATHFINDER mini, and TRACER. We have temporary decided to focus our
efforts on our AF program and postpone our work on the therapeutic VT program.
These products are currently used to help localize placement of bi-ventricular
pacing leads via CS access.




Our
Business Strategy




Our
objective is to develop innovative products that provide safer and more
effective diagnosis and treatment of AF. We aim to commercialize all of our
REVELATION series of ablation products for the treatment of AF in the
electrophysiology market and to deliver a Controlled RF Surgical Ablation System
to Cardiothoracic surgeons.




Our
Controlled RF Surgical Ablation System a micro-catheter-based surgical probe
coupled with the INTELLITEMP, an RF energy management device, received 510(k)
clearance for use in the United States in January 2003. The FDA also awarded
510(k) clearance in May 2006 for a longer version of the surgical probe having
an integrated stabilization sheath.




Our
strategy incorporates the following key elements:




·Seek funding
necessary to continue operations.Due to our limited cash
resources, we plan to continue to seek additional funding. There can be no
assurance that we will receive additional funding or that funding can be
obtained on terms that are reasonable and acceptable to us.





·Continue Market
Launch and Clinical Studies.We are launching the technology on several
fronts.  In the US, our partnership with other companies and
distributors who have close relationships with Cardiothoracic surgeons will
be leveraged to initiate market development of the Surgical Ablation
System.  We intend to penetrate the market by selecting key sites and
developing them into Centers of Excellence (“COE”).  Once the COE are
established, we will be able to penetrate the market with post-approval data,
symposia presentations, major meeting/tradeshow strategies, and a registry
database. In 2008, we achieved our objective and established regional COE. These
centers will train new surgeons as we continue the launch of our Surgical
Program. The EP System is being launched in the UK and Germany.  Once
again we are developing the market by developing key COE.  Once the
COE are established, they will act as peer-to-peer training sites.  We
will continue to present at symposia and major meetings/tradeshows to establish
our clinical excellence in the Electrophysiology Field.  Multi-center
clinical studies are expected to begin in the UK and Germany followed by the
US.  The additional data gained from these studies will assist in
achieving FDA/PMA approval for the EP Ablation System.  We will also
be launching our technology in Asia, including China and Japan.  We
anticipate that funds will be needed to develop new markets, penetrate existing
markets, and continue clinical studies world-wide. There can be no assurance
that we will receive additional funding or that funding can be obtained on terms
that are reasonable and acceptable to us.





· Enhance
micro-catheter technology to address unmet clinical needs for both mapping and
ablation.We are
refining our micro-catheter systems to address new clinical needs by enhancing
current technology and developing new technology for endocardial access and a
treatment for AF.





·Provide
micro-catheter systems that lower the cost of treating electrophysiological
disorders.Our
micro-catheter systems are designed to reduce the average time required for AF
and the diagnostic and therapeutic procedures for VT. As a result, less time
should be spent in high cost electrophysiology laboratories, reducing the
overall cost of AF or VT treatments. The shorter procedure time that we believe
will result from the use of our micro-catheter systems should enable physicians
to perform a greater number of AF or VT procedures and reduce the overall cost
per procedure. In addition, we intend to use data derived from our clinical
studies to establish enhanced reimbursement for AF and VT procedures using our
micro-catheter systems. We believe that our micro-catheter systems will appeal
to patients and third-party payers seeking a cost-effective solution to the
diagnosis and treatment of AF and VT.





·Provide Surgical
Ablation System that lowers the cost of surgical ablation.Our Surgical Ablation System
is designed to reduce the average time required for cardiac tissue ablation. As
a result, less time should be spent in high cost operating rooms, and post
procedure hospital stay.  We believe that the shorter procedure time
will result in the physicians being able to perform a greater number of
procedures and reduce the overall cost per procedure. In addition, we intend to
use data derived from our post market data to establish enhanced
reimbursement.  We believe that our Surgical Ablation System will
appeal to patients and third-party payers seeking a cost-effective
solution.






7






·Accelerate
acceptance and adoption of our Ablation Systems by leading
physicians.We have formed
relationships with leading physicians and medical centers in the United States,
Europe, China, Thailand and Japan.  We believe that successful
acceptance and adoption of these systems by widely recognized experts in the
field of electrophysiology and cardiac surgery is an important step in the
overall market acceptance of our Systems. We intend to continue to work with
leading physicians and medical centers to demonstrate the safety and
effectiveness.  We hope this will allow us to establish broad market
acceptance of our products.  In addition, we intend to accelerate
physician education through additional training with our clinical investigators
and peer-reviewed publications.




Products




We are
currently focused on market development of the micro-catheter systems for the
diagnosis of AF and the Controlled RF Surgical Ablation System for the ablation
of cardiac tissue. These systems are designed to access both the right and left
atria.




Our micro-catheter
systems are designed to be used both endocardially and epicardially on the
atria, to diagnose and to replicate the surgical maze procedure through the
creation of long, thin, continuous, linear, lesions. The series of electrodes at
the distal end of each micro-catheter, depending on the particular product, may
both receive electrical signals for mapping, and, emit radio frequency energy
for ablation. In addition, these micro-catheter systems are smaller in diameter
and are designed to be more flexible than other existing electrophysiology
catheters, providing thinner, continuous linear lesions, and therefore cause
less destruction of tissue. Our micro-catheters are single use, disposable
products. We are designing our EP products to be used with existing
electrophysiology recording systems and radio frequency ablation generators. Our
ancillary products, including guiding catheters, electrical switch boxes and
connecting cables, support these micro-catheter systems.




Our
Surgical Ablation System is a CONTROLLED RF delivery system.  As
described previously, our management believes that user control, user feedback,
and added patient safety along with our patented technology make it stand out
from the competition.  The Probes incorporate irrigation, suction, and
illumination.  This aids placement and lesion depth.  The
small, flexible, design offers sole port-hole access, potentially decreasing
procedure time, patient hospital stay, and patient
discomfort.   .





The
following table describes our major products and their intended indications and
regulatory status:




Therapeutic
      Products
                
                Description
                
                Indication
                
                U.S.
      Regulatory Status(1)
                
                International
                  Regulatory
      Status(1)REVELATION
                  Mapping
      Catheter
                
                Eight-electrode
      micro-catheter designed to map in both right and left
      atria.
                
                Mapping
                
                510(k)
      (2) clearance
      obtained.
                
                Approved
      in the European Economic Area (CE Mark)(3) and
      Canada.REVELATION
      Tx
                
                Guidewire
      based eight-electrode micro-catheter system with tissue temperature
      sensors designed to map and create long, thin, continuous, linear,
      transmural lesions in the atrium.
                
                Mapping
      and Ablation
                
                No
      immediate plans
                
                Approved
      in the European Economic Area (CE Mark) and
CanadaREVELATION
      T-Flex
                
                Deflectable
      and steerable eight-and sixteen-electrode micro-catheter system with
      temperature sensors designed to map and create long, thin, continuous,
      linear, transmural lesions in the right atrium.
                
                Mapping
      and Ablation
                
                Seeking
      FDA approval to treat AF.  Currently in study trial design
      development.
                
                Approved
      in the European Economic Area (CE Mark) and
  Canada









8








REVELATIONHelix
            
            Helical
      shaped guide-wire eight-electrode micro-catheter system with temperature
      sensors designed to map and create circumferential, focal linear lesions
      in the pulmonary vein ostia of the left atrium.
            
            Mapping
      and Ablation
            
            No
      immediate plans
            
            Approved
      in the European Economic Area (CE Mark)REVELATION
      Helix STX
              
              
              
              
              
              
              
              Surgical
      Ablation
              System
              
              
              
              
              INTELLITEMP
              and
      INTELLITEMP EP Radio Frequency (RF) Energy Management
      Device
            
            Helical
      shaped guide-wire 16 -electrode micro-catheter system with temperature
      sensors and designed to map and create circumferential, focal linear
      lesions in larger pulmonary vein ostia of the left
      atrium.
              
              Single
      use Cardima Surgical Ablation Probe with INTELLITEMP Radio Frequency(RF)
      Energy Management Device
            
            Pacing
              Mapping
      and
              Ablation
              
              
              
              
              
              
              Ablation
      using radiofrequency energy
            
            No
      immediate plans
              
              
              
              
              
              
              
              
              510(k)
      clearance obtained.
            
            Probe
      is approved in European Economic Area (CE Mark),
      Thailand
              
              
              
              Approved
      in European Economic Area (CE Mark), ChinaDiagnostic
      ProductsPATHFINDER
            
            Guide-wire
      based multi-electrode micro-catheter system designed for accessing
      coronary sinus vasculature to locate arrhythmia-causing
      tissue.
            
            Mapping
            
            510(k)
      clearance obtained.
            
            Approved
      in the European Economic Area (CE Mark) Canada, Thailand and
      JapanPATHFINDER mini
            
            Smallest
      Cardima PATHFINDER® micro-catheter (1.5 French) designed to provide access
      to more distal and smaller coronary veins
            
            Mapping
            
            510(k)
      clearance obtained.
            
            Approved
      in the European Economic Area (CE Mark), Japan, Thailand and
      Canada





(1)
 The regulatory status of our micro-catheter systems reflects our current
status of regulatory submission or approvals in the United States, Europe Japan,
China and Thailand. See “—Government Regulation.” The actual submission times
could differ materially from those anticipated in these estimates as a result of
certain factors, including failure to complete development of micro-catheter
systems or to demonstrate safety or effectiveness in clinical studies, as well
as the other factors set forth under our “Management’s Discussion and Analysis
of Financial Condition and Results of Operations - Factors Affecting Future
Results” and elsewhere in this Annual Report on Form 10-K.




(2)
 510(k) clearance is granted when a product has been found by the Food and
Drug Administration to be substantially equivalent to other similar and legally
marketed devices and receives clearance for commercial distribution. A 510(k)
product usually requires less time to receive FDA approval to market than a
Class III PMA device.




(3)
 CE Mark means that a medical device is in substantial compliance with
provisions set forth under the jurisdiction of the Medical Device Directive
93/42/EC and national derivatives in any European Member State. The
affixed CE Mark allows commercial distribution throughout the European Economic
Area.






9






(4)  An
Investigational Device Exemption (IDE) is issued by the U.S. FDA to study the
safety and effectiveness of an unapproved investigational device in humans.
Approval to begin an IDE study is issued if the U.S. Food and Drug
Administration concludes that the device potentially offers benefits for public
health that outweigh the identified risk(s).




(5)
 PMA is the most stringent type of device marketing application required by
FDA. A PMA application is submitted to FDA to request approval to market, or to
continue to market, a Class III medical device. Unlike pre-market notification,
PMA approval is based on a determination by FDA that the PMA application
contains sufficient valid scientific evidence that provides reasonable assurance
that the device is safe and effective for its intended use(s).




In
addition to the major products listed above, our other products are (i)
Diagnostic products: TRACER; (ii) support products: VENAPORT, VUEPORT, and
NAVIPORT.




Research and New Product
Development





We
believe that, assuming we obtain the funding necessary to continue operations,
our future success will depend in large part on our ability to develop and
introduce clinically advanced diagnostic and therapeutic systems that are
effective, easy to use, safe and reliable. Our New Product Development
department focuses on the continued development and refinement of our existing
diagnostic devices, systems and procedures, as well as on the development of new
devices, systems and procedures for treating cardiac arrhythmias. While the
primary responsibility of the department is to develop new products and transfer
them to manufacturing, the department also performs applied research to improve
device performance during the earlier stages of product development. In late
2008, as part of gearing up for commercialization, Product Development and Pilot
Production Departments also became actively focused on projects to improve
product quality, increase production yields and decrease manufacturing
times.





Ongoing
R&D efforts are aimed at enhancing our suite of ablation devices and
ancillary tools for the EP as well as surgical arenas, as well as developments
leading to next generation products.




Research
and development expenses for the years ended December 31, 2008 and 2007, were
$4.4 million and $3.1 million, respectively.





Marketing
and Distribution





We have a
direct clinical sales team responsible for U.S. sales growth of our products,
including the surgical ablation system for AF and the Pathfinder diagnostic
catheters for mapping along with our series of guides.  We are
focusing our efforts on expanding our domestic customer base working with a
distribution network.  We believe that there are between 500 and 600
hospitals in the United States that perform electrophysiology procedures on a
routine basis. Further, we believe there are over 800 board certified
electro-physiologists practicing domestically.  There are 1,100
surgical centers that could be candidates for surgical AF ablation
programs.




Our
European sales presence includes our own global sales manager, one sales
consultant and distribution through third party distributors in key target
markets. These on-going European distributor relationships provide coverage in
France, the Mediterranean area, the United Kingdom, and Central and Eastern
Europe. We believe there are about 400 hospitals that perform electrophysiology
procedures and approximately 600 board certified electro-physiologists located
outside of the U.S.





Our
former distributor in Japan, Paramedic Co., Ltd., notified us in the first
quarter of 2007 of its failure to maintain the legal documentation standard
required to sell our PATHFINDER in Japan. As a result, we had no sales in Japan
during 2007 and 2008. We understand that the reapplication process takes
approximately twelve to eighteen months. In October 2008, we appointed Japan
Lifeline Co. Ltd. as our new distributor in Japan. Together with Japan Lifeline,
we filed a “Shonin Application” to obtain the necessary regulatory approval to
re-start PATHFINDER sales in the Japanese market.  During the
reapplication process, we may have no sales in Japan. We anticipate resuming
commercial sales in the second quarter of 2009. However, there can be no
assurance that we will be able to resume sales by that time.





In
August, 2008, we received approval from the Food and Drug Administration,
Ministry of Public Health, in Thailand, to market three main lines of products,
including the diagnostic products, the EP therapeutic REVELATION line of
products and the Surgical Ablation System.





In
October 2008, we established a new strategic surgical relationship and renewed
the electrophysiology sales and marketing contract with Biocore, a U.S. Eastern
regional sales agent specializing in sales and customer training and support for
Cardiac Devices. Biocore's staff will be directly supporting both surgical and
cardiac cath lab procedures, as well as assisting cardiac surgeons and
electrophysiologists with Cardima's solutions for patient care. Our management
believes that this relationship will strengthen Cardima's Surgical Program
commercial launch in the U.S.A. by leveraging the existing relationships Biocore
has with physicians and hospitals in the eastern United States.








10







In
November 2008, we engaged Peerless Medical Inc. as the distributor for the
Cardima Surgical Ablation System in the Midwestern United States, including the
St. Louis, Kansas City, Wichita, Topeka and Omaha markets. Peerless, which
enjoys strong relationships with leading cardiac surgeons in these territories,
will market Cardima's Surgical Ablation System and solutions for cardiac patient
care.





In
December 2008, we engaged Western Medical Inc. as a distributor for the Cardima
Surgical Ablation System and the EP Pathfinder line of diagnostic catheters in
the Southern California, Arizona and Nevada regions, including the Los Angeles,
San Diego, Las Vegas, Phoenix and Tucson markets. Western Medical has a
significant presence within the electrophysiology and surgical ablation
community in these regions. The marketing program commenced immediately with the
training of 35 Western Medical field sales representatives.





Manufacturing





We
fabricate certain proprietary components of our products and assemble, inspect,
test and package most into finished products. Designing and manufacturing our
products from raw materials allows us to maintain greater control of quality,
cost, and the ability to limit outside access to our proprietary technology.
Cardima is certified to the exacting standards of the ISO 13485 Quality System
Management requirement for Medical Devices.





We
believe our custom-designed, proprietary processing equipment and lean tool
techniques are important components of our manufacturing
strategy.  Our technological expertise includes, but is not limited
to, plastics extrusion, braiding, precision coil winding, materials surface
preparation, electronics, machining, and hydrophilic coating
applications.





As
we receive approval from regulatory agencies to market our products, we may need
to expend significant capital resources and develop additional manufacturing
capacity to establish large-scale manufacturing capabilities. Other challenges
include supplier based management, inventory supplies, and an adequately trained
employee pool, which could have a material adverse effect on our ability to
manufacture products and therefore on our business, financial condition and
ability to test or market our products on a timely basis.




Our
manufacturing facilities and operations are subject to periodic inspection from
various regulatory authorities, and must meet FDA, ISO, and PMDA Quality
Management System (QMS) compliance inspections, before we can market our
products. We have obtained ISO 13485 Quality Systems certification from TUV Nord
and have maintained the right to affix the CE Mark to certain electrophysiology
mapping and ablation catheters and accessories as well as electrosurgical units.
In 2008, we successfully passed the FDA Quality System Inspection Technique, (or
QSIT) Audit, of our Quality System, as well as passed a PMDA QMS inspection and
an ISO 13485 compliance inspection conducted by our applicable notified bodies.
Though successful in these inspections, there can be no assurance that our
manufacturing facilities will continue to meet such compliance audits and
maintain such compliance standards. See "Government Regulation."





Patents
and Proprietary Rights





Our
success will depend in part on our ability to obtain patent and copyright
protection for our products and processes, to preserve our trade secrets and to
operate without infringing or violating the proprietary rights of third parties.
Our strategy is to actively pursue patent protection in the United States and
key foreign jurisdictions for technology we believe to be proprietary and which
offers a potential competitive advantage for our products. We have filed and
intend to continue to file patent applications, both in the United States and
selected international markets, to seek protection for proprietary aspects of
our technology. We also license intellectual property from commercial entities
to obtain the rights to technology that is required for our research,
development and commercialization activities.





In 2007,
we were awarded an additional patent from the U.S. Patent and Trademark Office
for the INTELLITEMPEnergy Management Device.
 This device is used to control the delivery of radiofrequency (RF) energy
during ablation procedures in the EP and surgical markets.  The feedback
system incorporates both temperature and impedance from CARDIMA’s full line
of ablation microcatheters and surgical probes.  This patent reinforces the
uniqueness of the INTELLITEMP’s modular architecture that controls RF energy
delivery to any combination of up to 8 electrodes simultaneously along a linear
ablation catheter or surgical probe.  In comparison to standard “drag and
burn” ablation technologies, simultaneous ablation through multiple electrodes
of our linear ablation catheter or surgical probe controlled by the INTELLITEMP
shortens procedure time.  Furthermore, this process safely creates clean
lesions that have penetrating depth, with no gaps along the linear
trajectory.  The INTELLITEMP is marketed in the USA as part of the CARDIMA
Surgical Ablation System, and CE Marked in the EU for both surgical and
electrophysiology ablation applications.





As of
December 31, 2008, we are the assignee to 25 issued United States patents and 5
pending United States patent applications. We also have 24 patents in major
international markets that have been validated or granted, and 18 pending
foreign applications.





In
addition to patents and licenses, we also rely upon trade secrets, technical
know-how and continuing technical innovation to develop and maintain our
competitive position. We typically require our employees, consultants, and
advisors to execute confidentiality and assignment of invention agreements in
connection with their employment, consulting or advisory relationships with us.
There can be no assurance, however, that the agreements will not be breached or
that we 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
our proprietary knowledge, or that we can meaningfully protect our rights in
unpatented proprietary technology.






11







Competition





We
believe our primary competitors to be large companies who are engaged in the
development and marketing of existing catheter technology. Their treatments
include drugs, external electrical cardioversion and defibrillation, implantable
defibrillators, open-heart surgery and purposeful destruction of the
atrio-ventricular node, followed by implantation of a pacemaker. Several
competitors are also developing new approaches and new products for the mapping
and ablation of AF and VT. These approaches include mapping systems using
contact mapping, single-point spatial mapping and non-contact, multi-site
electrical mapping technologies and ablation systems using ultrasound,
microwave, laser and cryoablation technologies. In addition, companies are
developing surgical procedures that could potentially be used by physicians to
perform the surgical maze procedure in a minimally invasive manner. If any of
these new approaches or new products proves to be safe and effective, our
products could be rendered non-competitive or obsolete, which could have a
material adverse effect on our business, financial condition and results of
operations.





Many of
our competitors have an established presence in the field of interventional
cardiology and/or electrophysiology, including Boston Scientific, C.R. Bard,
Inc., St. Jude Medical, Inc. (through its Daig Division), Johnson &
Johnson/Biosense Webster, and Medtronic, Inc. These competitors have
substantially greater financial and other resources than we do, including larger
research and development staffs and more experience and greater capabilities in
conducting research and development activities, testing products in clinical
trials, obtaining regulatory approvals, and manufacturing, marketing and
distributing products.





Other
companies are developing proprietary systems for the diagnosis of cardiac
arrhythmias including Ablation Frontiers, Biosense Webster, Inc., a division of
Johnson & Johnson; Cardiac Pathways, Inc. and EP Technologies, divisions of
Boston Scientific; and Endocardial Solutions, Inc., a subsidiary of St. Jude
Medical, Inc. Other companies develop, market and sell alternative approaches to
the treatment of AF and VT, including Guidant, Medtronic, Inc., and St. Jude
Medical, Inc., which manufacture implantable defibrillators. There can be no
assurance that we will succeed in developing and marketing technologies and
products that are more clinically effective and cost-effective than the current
treatments, or the new approaches and products being developed and marketed by
our competitors. Furthermore, there can be no assurance that we will succeed in
developing new technologies and products that are available prior to our
competitors' products. Our failure to demonstrate the competitive advantages of
our products continues to have a material adverse effect on our business,
financial condition and results of operations.





In the
market for cardiac mapping and ablation devices, we believe that the primary
competitive factors are safety, clinical effectiveness, ease of use and overall
cost to the health care system. In addition, the length of time required for
products to be developed and to receive regulatory and, in some cases,
reimbursement approval is an important competitive factor. The medical device
industry is characterized by rapid and significant technological change.
Accordingly, our success will depend in part on our ability to respond quickly
to medical and technological changes through the development and introduction of
new products. Product development involves a high degree of risk and there can
be no assurance that our new product development efforts will result in any
commercially successful products. We believe our products that have received
regulatory approvals compete with respect to these factors, although there is no
assurance that we will be able to continue to do so. Our other products’
competitiveness will depend on further regulatory approvals, which are
inherently uncertain.





In the
surgical market, we believe we have advanced technology above and beyond our
competition.  However, because our competition has been available for
a longer period of time, and has an advantage in sales & marketing
resources, Cardima will need to overcome manpower and financial hurdles to
penetrate the market.  In the surgical market, patient safety, time,
and results are driving market approval/penetration.  We believe our
competitors lack the technology to continue market penetration once Cardima has
established centers of excellence, developed peer-to-peer training, and has post
market data to present at key meetings and symposia.  The major
competitors include Atricure, Boston Scientific, and
Medtronic.  Smaller startup companies include Estech and CTS
Medical.  Again, whether they use RF, unipolar or bipolar, or laser
energy, we believe they are unable to match the features and benefits of the
Cardima Surgical Ablation System.




Government
Regulation





The
pre-clinical and clinical testing, manufacturing, labeling, marketing and
distribution of our products are subject to extensive and rigorous government
regulation in the United States and other countries. Failure to comply with
applicable regulatory requirements can result in enforcement action by the FDA
or comparable foreign regulatory bodies including, among other things, fines,
injunctions, civil penalties, recall or seizure of products, refusal to grant
marketing clearances or approvals, withdrawal of marketing approvals and
criminal prosecution.






12






U.S.
Regulation





A medical
device may be marketed in the United States only with prior authorization from
the U.S. FDA. Devices classified by the FDA as posing less risk are placed
either in Class I or II. All Class II and some Class I devices require 510(k)
clearance from the FDA prior to marketing. Such clearance generally is granted
when submitted information establishes that a proposed device is "substantially
equivalent" in intended use and safety and effectiveness to a Class I or II
device already legally on the market or to a "pre-amendment" Class III device
(i.e., one that has been in commercial distribution since before May 28, 1976)
for which the FDA has not required a premarket approval, or PMA, application.
The FDA recently has been requiring a more rigorous demonstration of substantial
equivalence than in the past, including in some cases requiring clinical trial
data. During this process, the FDA may determine that it needs additional
information or that a proposed device is precluded from receiving clearance
because it is not “substantially equivalent” to a legally marketed Class I or II
device. After a device receives 510(k) clearance, any modification that could
significantly affect its safety or effectiveness, of which constitutes a major
change in its intended use, may require another 510(k) clearance or may be
classified as a Class III device. We believe that generally it takes
approximately 4 to 12 months from the date of submission to obtain 510(k)
clearance. The process may, however, take substantially longer, depending on the
circumstances, and there can be no assurance that 510(k) clearance will ever be
obtained.





To date,
we have received 510(k) clearances from the FDA for our PATHFINDER, PATHFINDER
mini and TRACER over-the-wire micro-catheter systems for mapping VT and
REVELATION micro-catheter system for mapping AF. In addition, we have received
510(k) clearance for our line of VENAPORT, VUEPORT and NAVIPORT guiding
catheters used to introduce electrophysiology catheters into the heart. We have
also received 510(k) clearances for a surgical probe, based on REVELATION
catheter technology, for the ablation of cardiac tissue during surgery, as well
as for a longer version of the surgical probe with an integrated stabilization
sheath.





A device
that does not qualify for Class I or II is placed in Class III, which is
reserved for devices classified by the FDA as posing greater risk, e.g.,
life-sustaining, life-supporting or implantable devices, or devices that are not
substantially equivalent to a legally marketed Class I or Class II device. A
Class III device generally must go through the PMA application process to
receive FDA approval. This process requires that the manufacturer establish the
safety and effectiveness of the device to the FDA's satisfaction. This requires
the manufacturer to provide extensive pre-clinical and clinical data,
information about the manufacture of the device and its components and
information about the labeling and promotional material. As part of the PMA
application process, the FDA may inspect the manufacturer's facilities for
compliance with the Quality System Regulations, which includes an extensive
review of design, manufacturing, and process controls, documentation and other
quality assurance procedures.





Upon
submission of the PMA application, the FDA determines if the application is
sufficiently complete to permit a substantive review, and, if so, the
application is accepted for filing. The FDA then commences an in-depth review of
the PMA application, which typically takes six months to a year, but may take
longer. The review time is often significantly extended as a result of the FDA
asking for more information or clarification of information already provided.
The FDA also may respond with a "not approvable" determination based on
deficiencies in the application and require additional clinical trials that are
often expensive and time consuming and can delay approval for months or even
years. Recently, the FDA has heightened its scrutiny of clinical trial data
submitted in support of PMA applications. In addition, the FDA may visit an
applicant’s facilities and/or its investigator’s sites to audit the clinical
data and/or the data collection process and procedures. Near the completion of
the PMA application process, an FDA advisory committee, typically a panel of
clinicians, will generally be convened to review the application and recommend
to the FDA whether, or upon what conditions, the device should be approved.
Although the FDA is not bound by the advisory panel decision, the panel's
recommendation is important to the FDA's overall decision-making process and the
panel’s recommendation is generally accepted.





If the
FDA's evaluation of the PMA application is favorable, the FDA typically issues
an "approvable letter" requiring the applicant's agreement to comply with
specific conditions (e.g., changes in labeling) or to supply specific additional
data (e.g., longer patient follow up) or information (e.g., submission of final
labeling) in order to secure final approval of the PMA application. Once the
approvable letter conditions are satisfied, the FDA will issue an Approval Order
for the approved indications, which can be more limited than those originally
sought by the manufacturer. The Approval Order can include post -approval
conditions that the FDA believes necessary to ensure the safety and
effectiveness of the device including, among other things, restrictions on
labeling, promotion, sale and distribution. Failure to comply with the
conditions of approval can result in enforcement action, including withdrawal of
the approval. The PMA application process can be expensive and lengthy, and no
assurance can be given that any of our PMA applications will ever be approved.
Even after obtaining approval, a new PMA application or PMA supplement is
generally required for any modification to the device, its labeling or its
manufacturing process.





We have
confirmed that our ablation products, including the REVELATION® Tx, REVELATION®
T-Flex and REVELATION® Helix for the treatment of certain arrhythmia conditions
will be designated as Class III devices requiring PMA approval. There can be no
assurance that a PMA application will be submitted for any such products or
that, once submitted, the PMA application will be accepted for filing, found
approvable, or, if found approvable, will not take longer than expected to
obtain, or will not include unfavorable restrictions.






13







A
clinical trial in support of a 510(k) submission or a PMA application often
requires an Investigational Device Exemption (IDE) application approved in
advance by the FDA to conduct a clinical trial .The IDE application must be
supported by appropriate data, such as animal and laboratory testing results.
Clinical trials may begin if the IDE application is approved by the FDA and by
the appropriate institutional review boards at the clinical trial sites. During
a clinical trial, we would be permitted to sell products used in the study for
an amount that does not exceed recovery of the costs of manufacture, research,
development and handling. Failure to adhere to regulatory requirements generally
applicable to clinical trials and to the conditions of an IDE could result in a
material adverse effect on us, including termination of the IDE and an inability
to obtain marketing clearance or approval for our products.




We
received FDA approval to conduct a pivotal Phase III clinical trial of our
REVELATION® Tx micro-catheter system for AF in August 2000. However, on May 28,
2004, we received a letter dated May 21, 2004, from the FDA, stating that our
PMA for the REVELATION Tx linear ablation micro-catheter system was not
approvable based on the requirements of applicable regulations. The FDA required
additional clinical data using a randomized clinical trial design. Along with
FDA dialogue, we are currently in the early stages of designing a new clinical
study trial for use to seek FDA marketing approval.





Any
devices manufactured or distributed by us pursuant to FDA clearances or
approvals will be subject to pervasive and continuing regulation by the FDA and
certain state agencies. We are subject to inspection by the FDA and the
California Department of Health Services and have to comply with various other
regulatory requirements that usually apply to medical devices marketed in the
United States. These regulatory requirements include, among others,
manufacturing and design control regulations, labeling, Medical Device Reporting
regulations which require that a manufacturer report to the FDA certain types of
adverse events involving its products, and the FDA's prohibitions against
promoting approved products for unapproved, or "off-label," uses. In addition,
Class II devices, such as our mapping products, can be subject to additional
special controls (e.g., performance standards, post-market surveillance, patient
registries, and FDA guidelines) that do not apply to Class I devices. Our
failure to comply with applicable regulatory requirements could result in
enforcement action by the FDA, which could have a material adverse effect on
us.





Unanticipated
changes in existing regulatory requirements, failure to comply with such
requirements or adoption of new requirements could have a material adverse
effect on us. We are also subject to numerous federal, state and local laws
relating to such matters as safe working conditions, good manufacturing
practices, environmental protection, fire hazard control and hazardous material
disposal. There can be no assurance we will not incur significant costs to
comply with such laws and regulations in the future or that such laws or
regulations will not have a material adverse effect upon our business, financial
condition and results of operations.





Foreign
Regulation





In order
for us to market our products in Europe and certain other foreign jurisdictions,
we must comply with extensive regulations in those jurisdictions regarding
safety, performance as well as product design and manufacturing processes. These
regulations, including the requirements for regulatory approval and the time
period required for regulatory review, vary from country to country. In
addition, there may be foreign regulatory barriers other than pre-market
approval. There can be no assurance we will obtain regulatory approvals or
clearances in such countries or that we will not be required to incur
significant costs in obtaining or maintaining our foreign regulatory approvals
or clearances. Under certain circumstances, FDA approval is required for us to
export our products. Delays in receipt of approvals to market our products,
failure to receive these approvals or loss of previously received approvals
could have a material adverse effect on our business, financial condition and
results of operations.





The
European Union has promulgated rules that require commercial medical products to
bear the CE Mark. The CE Mark is recognized by the European Union as a symbol of
adherence to strict quality systems requirements set forth in the ISO 13485
quality standards for medical devices, as well as compliance with 93/42/EEC, the
Medical Device Directive. The CE Mark allows us to market our products
throughout the European Economic Area. We received ISO 13485 Quality Systems
certification for our manufacturing facility in Fremont, California, which was
re-certified in January 2008. These certifications and repeated inspections are
required in order to continue to affix the CE Mark to our approved products in
Europe. In addition, ISO 13485 certification was obtained in March 2004 to
include electrosurgical generators and associated equipment.





We have
received regulatory approval to affix the CE Mark to our REVELATION, REVELATION
Tx, REVELATION T-Flex and REVELATION Helix micro-catheters for treatment of AF
as well as our PATHFINDER diagnostic family of micro-catheters. Failure to
receive regulatory approval to affix the CE Mark would prohibit us from selling
these products in member countries of the European Union.





In the
first quarter of 2007, our Japanese distributor notified us of its failure to
maintain the legal documentation standard required to sell our PATHFINDER in
Japan. As a result, we had no sales in Japan during 2007 and 2008. We understand
that the reapplication process takes approximately twelve to eighteen months. In
October 2008, we appointed Japan Lifeline Co. Ltd. as our new distributor in
Japan. Together with Japan Lifeline, we filed a “Shonin Application” to obtain
the necessary regulatory approval to re-start PATHFINDER sales in the Japanese
market.  During the reapplication process, we may have no sales in
Japan. We anticipate resuming commercial sales in the second quarter of 2009.
However, there can be no assurance that we will be able to resume sales by that
time.








14





In June
2008 we received regulatory approval from the SFDA and were granted a market
access license for the INTELLITEMP and it is the first multichannel
radiofrequency (RF) energy delivery device to receive approval for sale in
China. The Company was previously awarded an INTELLITEMP patent by the State
Intellectual Property Office in 2003.   Existing RF delivery
systems currently marketed in China can deliver energy to only one ablation
electrode at a time. The INTELLITEMP controls the delivery of RF energy for
effective multi-electrode linear ablation in Cardima's systems, namely, the EP
Ablation System and the Surgical Ablation System, both designed to treat atrial
fibrillation ("AF"). Other Cardima products pending China SFDA approval are the
EP ablation catheters and Surgical Ablation Probes.





A 2004
study from Peking University estimates that AF currently affects
approximately 10 million patients in China. Published scientific literature in
China shows that the percentage of hospital admissions for AF has increased at a
faster rate than for cardiovascular admissions generally. As in other countries,
the distribution of AF events in China progressively increases with age. China's
population of people over the age of 50 will be 332 million in 2010 and will
increase to 525 million by 2025, according to the International Institute for
Applied Systems Analysis. Studies also show that the incidence of stroke among
AF cases is high in China, yet it is difficult to enforce a drug regimen for
preventing stroke in this patient population. Therefore, it will be a
significant challenge for the public healthcare system in China to manage,
control and treat the growing numbers of AF patients. China is one of the
world's fastest growing medical markets and holds a high regard for medical
products manufactured in the United States and Europe.





In
August, 2008, we received approval from the Food and Drug Administration,
Ministry of Public Health, in Thailand, to market its three main lines of
products, including the diagnostic products, the EP therapeutic REVELATION line
of products and the Surgical Ablation System.





Third-Party
Reimbursement





In the
United States, health care providers, including hospitals and physicians, that
purchase medical products for treatment of their patients generally rely on
third-party payers, principally federal Medicare, state Medicaid and private
health insurance plans to reimburse all or a part of the costs and fees
associated with the procedures performed using these products. Our success will
be dependent upon, among other things, the ability of health care providers to
obtain satisfactory reimbursement from third-party payers for medical procedures
in which our products are used. Third-party payers may deny reimbursement if
they determine that a prescribed device has not received appropriate regulatory
clearances or approvals, is not used in accordance with cost-effective treatment
methods as determined by the payer, or is experimental, unnecessary,
inappropriate or used for a non-approved indication. If FDA clearance or
approval were received, third-party reimbursement would also depend upon
decisions by the United States Centers for Medicare & Medicaid Services
(CMS), as well as by individual health maintenance organizations, private
insurers and other payers. Government agencies, private insurers and other
payers determine whether to provide coverage for a particular procedure based on
its medical necessity for the patient in question. The federal Medicare program,
many state Medicaid programs and other payers reimburse health care providers
for medical treatment at a fixed rate based on, or adapted from the
diagnosis-related group established by the CMS. The fixed rate of reimbursement
is typically based on the patient's diagnosis and the procedure performed, but
may be related to the specific type or number of devices used in a procedure.
There can be no assurance that reimbursement for our products will be available
in sufficient amounts, if at all, or that future reimbursement policies of
payers will not adversely affect our ability to sell products on a profitable
basis.





In
addition, Medicare traditionally has considered items or services involving
devices that have not been approved or cleared for marketing by FDA to be
precluded from Medicare coverage. However, under a policy which has been in
effect since November 1, 1995, Medicare coverage will not be precluded for items
and related services involving devices that have been classified by FDA as
"non-experimental / investigational" (Category B) devices and that are furnished
in accordance with the FDA-approved IDE governing clinical trials. Even with
items or services involving Category B devices, however, Medicare coverage may
be denied if any other coverage requirements are not met, such as if the
treatment is not medically needed for the specific patient. There can be no
assurance that our products will be covered when they are used in clinical
trials and, if covered, whether the payment amounts for their use will be
considered to be adequate by hospitals and physicians. If the devices are not
covered or the payments are considered to be inadequate, we may need to bear
additional costs to sponsor such trials, and such costs could have a material
adverse effect on our business, financial condition and results of
operations.





There is
also new federal legislation that changed the traditional Medicare payment
system by creating a new visit-based payment system called ambulatory payment
classification (APC) groups, that establishes fixed payments for specific
medical procedures that are performed on an outpatient basis. If our products
increase the cost per procedure above the fixed rate under the ambulatory
payment classification groups system, market acceptance of such products could
be impaired, which would have a material adverse effect on our business,
financial condition and results of operations.





The U. S.
Congress had previously enacted and we received a “pass-through reimbursement
allowance category” in March 2001 on all U.S. approved diagnostic and guiding
catheter products including the PATHFINDER, REVELATION, TRACER, NAVIPORT,
VUEPORT and VENAPORT. Pass-through reimbursement allowed for the direct charge
of a specific product for reimbursement. The temporary category status expired
on December 31, 2002. The products now sell without the need for such
categorization.






15





Reimbursement
systems in international markets vary significantly by country and by region
within some countries, and reimbursement approvals must be obtained on a
country-by-country basis. Many international markets have government managed
health care systems that control reimbursement for new products and procedures.
In most markets, there are private insurance systems as well as
government-managed systems. Market acceptance of our products will depend on the
availability and level of reimbursement in international markets targeted by us.
There can be no assurance that we will obtain reimbursement in any country
within a particular time, for a particular time, for a particular amount, or at
all.





Regardless
of the type of reimbursement system, we believe that physician advocacy of our
products will be required to obtain reimbursement. We believe that less invasive
procedures generally provide less costly overall therapies as compared to
conventional drug, surgery and other treatments. In addition, we believe that a
patient's underlying arrhythmia should typically not recur after treatment with
procedures using our products. We anticipate that hospital administrators and
physicians would justify the use of our products by the attendant cost savings
and clinical benefits derived from the use of our products. However, there can
be no assurance this will be the case. There can be no assurance that
reimbursement for our products will be available in the United States or in
international markets under either government or private reimbursement systems,
or that physicians will support and advocate reimbursement for procedures using
our products. Failure by hospitals and other users of our products to obtain
reimbursement from third-party payers, or changes in government and private
third-party payers' policies toward reimbursement for procedures using our
products, would have a material adverse effect on our business, financial
condition and results of operations.




Product
Liability and Insurance





The
development, manufacture and sale of our micro-catheter systems expose us to an
inherent risk of product liability claims. Although we currently have general
liability insurance with coverage in the amount of $1.0 million per occurrence,
subject to a $2.0 million annual limitation, and product liability insurance
with coverage in the amount of $5.0 million per occurrence, subject to a $5.0
million annual limitation, there can be no assurance that such coverage will be
available to us in the future on reasonable terms, if at all. In addition, there
can be no assurance that all of the activities encompassed within our business
are or will be covered under our policies. Although all our guiding, diagnostic
and therapeutic products are labeled for single use only, we are aware that some
physicians are re-sterilizing and reusing such products. Moreover, despite
labeling our micro-catheters for diagnostic use only, we believe physicians are
using such mapping micro-catheters for ablation. Multiple use or "off-label" use
of our micro-catheters could subject us to increased exposure to product
liability claims, which could have a material adverse effect on our business,
financial condition and results of operations. We may require additional product
liability coverage if we significantly expand commercialization of our products.
Such additional coverage is expensive, difficult to obtain and may not be
available in the future on acceptable terms, if at all. Any claims or series of
claims against us, regardless of their merit or eventual outcome, could have a
material adverse effect on our business, financial condition and results of
operations.





Employees





At
December 31, 2008, we had 77 employees, of whom 73 were full-time employees and
4 were part-time employees. Out of the 73 full-time employees, 11 were engaged
directly in research and new product development, 6 in regulatory affairs,
quality assurance and clinical activities, 41 in manufacturing, 6 in sales and
marketing and 9 in finance and administration. We maintain compensation,
benefits, equity participation, and work environment policies intended to assist
in attracting and retaining qualified personnel. We believe the success of our
business will depend, in significant part, on ourability to attract and
retain such personnel. None of our employees is represented by a collective
bargaining agreement, nor have we experienced any work stoppage. We consider our
relations with our employees to be good.





Corporate
History and Website Information





We were
incorporated in Delaware in 1992. Our principal executive offices are located at
47266 Benicia Street, Fremont, California, 94538, and our main telephone number
is (510) 354-0300. Investors can obtain access to this annual report on
Form 10-K, our quarterly reports on Form 10-Q, our current reports on
Form 8-K and all amendments to these reports, free of charge, on our
website at http://www.cardima.com as soon as reasonably practicable after such
filings are electronically filed with the Securities and Exchange Commission or
SEC. The public may read and copy any material we file with the SEC at the SEC’s
Public Reference Room at 100 F Street, N.W., Washington, D.C., 20549.
The public may obtain information on the operations of the Public Reference Room
by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site,
http://www.sec.gov that contains reports, proxy and information statements and
other information regarding issuers that file electronically with the
SEC.





We have adopted a code of ethics, which
is part of our Code of Business Conduct and Ethics that applies to all of our
employees, including our principal executive officer, our principal financial
officer and our principal accounting officer. This code of ethics is posted on
our website at
http://www.cardima.com/about/compliance/principles-and-ethics.








16







ITEM
1A.            RISK
FACTORS





You
should carefully consider the following risk factors and the other information
included herein as well as the information included in other reports and filings
made with the SEC before investing in our common stock. If any of the following
risks actually occurs, our business, financial condition or results of
operations could be harmed. The trading price of our common stock could decline
due to any of these risks, and you may lose part or all of your
investment.





RISKS
RELATED TO OUR FINANCIAL RESULTS:





If
we fail to raise additional capital in the near future, our business will
fail.




We have
very limited cash resources and will need to raise additional capital in the
immediate future through public or private financings or other arrangements in
order to continue operations. If we are unable to do so, our business will fail.
Even assuming no increase in our cash utilization rate from recent months,
management estimates that our cash balance as of December 31, 2008 will be
sufficient to fund planned expenditures only for a limited period of time,
although the actual level of expenditures cannot be predicted with certainty and
it is possible that our cash balance may be exhausted sooner than currently
anticipated. There can be no assurance that additional capital will be available
to us when needed, if at all, or, if available, will be obtained on terms
attractive to us.





Our
financing arrangements contain, and, if we succeed in closing future financings,
those future financings will likely contain, terms which place substantial
restrictions on our ability to raise additional funds, such as anti-dilution
protection in the event of subsequent financings. We had negative cash flow from
operations for the twelve months ended December 31, 2008 of $12 million, and we
expect to continue to incur substantial negative cash flow from operations for
the foreseeable future. We may be required to expend greater than anticipated
funds if unforeseen difficulties arise in the course of completing the
development, approval and marketing of our products. Even if we raise capital in
the near term, our future cash needs may, at a minimum, cause us to delay, scale
back or eliminate some or all of our product research and development programs,
to limit the marketing of our products, or to license or sell to third parties
the rights to commercialize our products or technologies that we would otherwise
develop and market ourselves. Our failure to raise capital when needed would
likely cause us to cease our operations.




We have
financed our operations since inception primarily through the private placement
of equity securities, proceeds from our initial public offering in June 1997,
loan facilities and the sale of certain of our patents and other intellectual
property. Although our management recognizes the need to raise funds in the
immediate future, there can be no assurance that we will be successful in
consummating any fundraising transaction, or if we do consummate such a
transaction, that its terms and conditions will not require us to give investors
valuable rights with respect to our products or technology, warrants or other
valuable rights to purchase additional interests in our company, or be otherwise
unfavorable to us. Among other things, the agreements under which we issued some
of our existing securities include, and any securities that we may issue in the
future will likely include, terms that could impede our ability to raise
additional funds, such as terms requiring the consent of certain security
holders before we issue or register additional securities and anti-dilution
protection giving those holders the right to receive additional shares of our
common stock depending on the terms of our later financings. We may be required
to issue preferred stock, debt or other securities with rights and preferences
senior to the rights of holders of our common stock. In addition, the issuance
of additional securities will likely dilute the interests of existing common
stockholders, and could impose additional restrictions on how we operate and
finance our business.




We
have sold a limited number of our products, and we will continue to incur
substantial losses for the foreseeable future.




We have
sold only a limited number of our micro-catheter and surgical products. In
addition, we will continue to incur substantial losses into the foreseeable
future because of research and product development, clinical trials, regulatory
approval efforts and manufacturing, sales, marketing and other expenses as we
seek to obtain necessary approvals and bring our micro-catheters and surgical
products to market. Since our inception, we have experienced losses, and we
expect to experience substantial net losses into the foreseeable
future.




Our net
losses were approximately $13.7 million for the year ended December 31, 2008 and
approximately $42.6 million for the year ended December 31, 2007. As of December
31, 2008, our accumulated deficit was approximately $190.3 million. Our limited
sales history, and the fact that we have very limited cash resources, makes it
difficult to assess or predict our future results. We cannot be certain that we
will ever generate substantial revenue or achieve profitability. Our failure to
generate substantial revenues would harm our business.





Our
need to raise additional capital in the near future could have a dilutive effect
on your investment.




In order
to continue operations, we will need to raise additional capital. Subject to the
contractual restrictions described above, we may attempt to raise capital
through the public or private sale of our common stock or securities convertible
into or exercisable for our common stock.






17






If we
sell additional shares of our common stock or warrants, such sales will further
dilute the percentage of our equity that you own. In addition, our recent
private placement financings have involved the issuance of securities at a price
per share that represented a discount to the closing price of our common stock
and any future private placements will likely involve the issuance of securities
at a discount to prevailing market prices. Depending upon the price per share of
securities that we sell in the future, if any, your interest in us could be
further diluted by any adjustments to the number of shares and the applicable
exercise price required pursuant to the terms of the agreements under which we
previously issued securities. No assurance can be given that previous or future
investors, finders or placement agents will not claim that they are entitled to
additional anti-dilution adjustments or dispute the Company’s calculation of any
such adjustments. Any such claim or dispute could require us to incur material
costs and expenses regardless of the resolution and, if resolved unfavorably to
us, to effect dilutive securities issuances or adjustments to previously issued
securities. In addition, certain of our prior securities issuances have
included, and future financings may also include, provisions requiring us to
make additional payments to the investors if we fail to obtain or maintain the
effectiveness of SEC registration statements by specified dates or take other
specified action. Our ability to meet these requirements may depend on actions
by regulators and other third parties, over which we will have no control. These
provisions may require us to make payments or issue additional dilutive
securities, or could lead to costly and disruptive disputes.




We
must obtain governmental approvals or clearances before we can sell our
products.




Our
products are considered to be medical devices and are subject to regulation in
the United States and internationally. These regulations are wide ranging and
govern, among other things:





· Product
design and development;


·Product
testing;


·Product
labeling;


·Product
storage;


·Pre-market
clearance and approval;


·Advertising and
promotion; and


·Product sales and
distribution




Before we
can market any of our products in the United States or other countries, we must
demonstrate that our products are safe and effective and obtain approval or
clearance from the applicable governmental authorities. In the United States, we
must obtain from the FDA 510(k) pre-market notification clearance for devices
that are classified as Class II, or a PMA for devices classified as Class III,
such as REVELATION T-Flex, in order to market a product. Currently, the FDA
review process for 510(k) clearance requires approximately 120 days and PMA
application review process requires approximately six to twelve months or
longer. The PMA application review process is in addition to the time required
to conduct clinical trials demonstrating safety and effectiveness. However, the
timing of such processes can be uncertain and may involve significantly more
time than we may anticipate. We cannot guarantee either the timing or receipt of
regulatory approval or clearance for any of our products in development. The FDA
may request extensive clinical data to support either 510(k) clearance or a PMA.
The approval process, including any necessary clinical trials, can involve
substantial expense. No assurance can be given that we will ever be able to
obtain the necessary approvals for any of our products. Our failure to do so on
a timely basis would have a material adverse effect on our business, financial
condition and results of operations.




Even if
regulatory approvals are obtained, the applicable regulatory agencies may limit
the indications for which they approve or clear any of our products. Further,
the FDA or regulatory agencies in other countries may restrict or withdraw
approval or clearance of a product if additional information becomes available
to support such action. Delays in the approval or clearance process, limitation
of our labeling claims or denial of our applications or notifications would
cause our business to be materially and adversely affected.





None
of our ablation products for electrophysiology has received regulatory approval
in the United States. Our failure to receive these approvals will harm our
business.





To date,
although we received 510(k) clearance for the use of the Surgical Ablation
System (SAS) to ablate cardiac tissue, none of our electrophysiology products in
development for the ablation of AF or VT has received regulatory approval in the
United States. The SAS has received 510(k) clearance only for ablating cardiac
tissue and not for any other purpose or any specified treatment. If we cannot
gain U.S. regulatory approvals, our business will be materially harmed and we
may be unable to secure the funding needed to continue operations. Even if we
raise the funding necessary to continue operations, successfully develop our
ablation products and obtain the required regulatory approvals, we cannot be
certain that our ablation products and their associated procedures will
ultimately gain market acceptance. Because our sole product focus is to design
and market micro-catheter systems to map and ablate AF and VT, our failure to
obtain regulatory approval for and successfully commercialize these systems
would materially harm our business.




In the
United States, we are required to seek a PMA for AF treatment claims using our
ablation products, such as the REVELATION T-Flex micro-catheters, since they
have been classified as Class III devices. The process of obtaining a PMA is
expensive, lengthy and uncertain and requires clinical trials to demonstrate the
safety and effectiveness of the product.






18






Pre-clinical
and clinical trials are inherently unpredictable. If we do not successfully
conduct these trials, we may be unable to market or sell our
products.




Through
pre-clinical studies and clinical trials, we must demonstrate that our products
are safe and effective for their indicated uses. Results from pre-clinical
studies and early clinical trials may not allow us to predict results in
later-stage testing. No assurance can be given that, even if we are able to
conduct future clinical trials, those trials will demonstrate the safety and
effectiveness of any of our products or will result in regulatory approval to
market our products. We may never meet our development schedule for any of our
products in development. Even if a product is successfully developed and
clinically tested, we cannot be certain that it will be approved by the FDA or
other regulatory agency on a timely basis or at all. If the FDA does not approve
our products for commercial sales, our business will be harmed.




Current
or future clinical trials of our micro-catheter systems will require substantial
financial and management resources. In addition, the clinical trials may
identify significant technical or other obstacles that we will need to overcome
before obtaining the necessary regulatory approvals or market acceptance. Our
failure to complete our clinical trials, demonstrate product safety and clinical
effectiveness, or obtain regulatory approval for the use of our micro-catheter
system for the ablation of AF would have a material adverse effect on our
business, financial condition and results of operations.




Delays
in enrolling patients in our clinical trials could increase our expenses and
harm our business.




The rate
at which we may complete our pre-clinical and clinical trials is dependent upon,
among other things, the rate of patient enrollment. Patient enrollment depends
on many factors, including the size of the patient population, the nature of the
procedure, the proximity of patients’ residences to clinical sites, the
eligibility criteria for the study and impact of other clinical studies
competing for the same patient population and/or the same physicians’ time and
research efforts. Delays in planned patient enrollment may result in increased
costs and delays, which could cause our business results to suffer.




We
have limited sales and limited experience in the sale, marketing and
distribution of our products. Our failure to establish an effective direct or
indirect sales and marketing force will cause our revenues to
decline.





We have a
direct clinical sales team responsible for U.S. sales of our products, including
the surgical ablation system for AF and the Pathfinder diagnostic catheters for
mapping along with our series of guides.  We are focusing our efforts
on expanding our domestic customer base working with a distribution network.
Expanding our marketing and sales capability to support sales in commercial
quantities adequately will require substantial effort and require significant
management and financial resources. Our failure to establish an effective sales
and marketing force will prevent us from being able to generate significant
revenues from the sale of our products.





We
distribute our products internationally through third-party distribution
channels in key target markets. Our European sales presence includes our own
clinical research manager and a sales consultant. These on-going European
distributor relationships provide coverage in France, the Mediterranean area,
the United Kingdom, and Central and Eastern Europe. Building and managing a
larger remote sales force effectively, in Europe or elsewhere, would require
additional resources, time and expense, which could have a material adverse
effect on our business, financial condition and results of operations. We cannot
be certain that we will be able to build a successful European business. Failure
to do so would harm our business.




Currently,
international sales and marketing of our PATHFINDER, PATHFINDER mini, REVELATION
and TRACER micro-catheter systems are conducted through an exclusive distributor
in Europe and Japan.   Paramedic Co., Ltd., our distributor in
Japan, in the first quarter of 2007, notified us of its failure to maintain the
legal documentation standard required to sell our PATHFINDER® in Japan. As a
result, we had no sales in Japan during 2007. In October 2008, we appointed
Japan Lifeline Co. Ltd. as our new distributor in Japan Together with Japan
Lifeline, we filed a “Shonin Application” to obtain the necessary regulatory
approval to re-start PATHFINDER sales in the Japanese market.  During
the reapplication period, we may not have any sales in Japan. We anticipate
resuming commercial sales in the second quarter of 2009. However, there can be
no assurance that we will be able to resume sales by that time. Furthermore, we
cannot be certain that our distributors will be able to effectively market and
sell our products. In the past, we have terminated several distribution
arrangements in Europe because of the distributors’ failure to meet minimum
sales levels under those agreements. Our failure to establish and maintain
successful distribution relationships would harm our business.





We
rely on multiple third parties to conduct and collect data for the clinical
trials of our products. If we are unable to access this data or the FDA refuses
to accept the data in a filing, the commercialization of our products will be
delayed and our business will be harmed.




We often
rely on multiple third parties, such as hospitals and universities, to conduct
and collect data for our clinical trials. We depend on these third parties to
provide access to data and cooperate with us in completing regulatory filings
for the approval or clearance of our products. In order for the FDA and other
regulatory agencies to accept and rely on the data of a filing, the data
collection, analysis and summarization must meet certain standards. We cannot be
certain that the clinical data collected by the third parties meet the standards
of the FDA or other regulatory agencies. If we are unable to rely on the
clinical data collected by third parties, or if these third parties do not
perform their contractual obligations, the FDA or other regulatory agencies may
require us to gather additional clinical data. This could significantly delay
commercialization of our products, require us to spend additional capital on our
clinical trials and harm our business.






19







We
cannot assure the safety or effectiveness of our products.




To obtain
and maintain required regulatory approvals and secure the confidence of
physicians and others whose acceptance is needed for our products, we will need
to demonstrate that our products are safe and effective. We cannot assure you
that our products will be deemed safe and effective. Many of our products, such
as our surgical ablation system, which has begun to be used by cardiac surgeons
only recently, have not been used to a sufficient extent to permit us to predict
their safety and effectiveness. In addition, our products include components and
materials supplied by third parties, whose safety and reliability we cannot
guarantee. We have occasionally experienced quality issues with some elements of
our products, and we may face additional issues in the future. The perceived
safety and effectiveness of our products can also depend on their manner of use
by physicians and other third parties, which we cannot control. If safety and
effectiveness issues arise with any of our products in the future, we may incur
liabilities to third parties, lose any regulatory approvals for the applicable
product, or be required to redesign the product. These issues will reduce our
sales and increase our expenses, possibly substantially.




Our
products and their related procedures are novel to the market and will require
the special training of physicians. If the market does not accept our products
and procedures, our revenues will decline.




Our
micro-catheter systems represent novel approaches to diagnosing and treating AF
and VT and our SAS represents a novel approach to ablating cardiac tissue during
surgery. Acceptance of our products and procedures by physicians, patients and
health care payers will be necessary in order for us to be successful. If the
market does not accept our products and the procedures involved in their use,
our business would be harmed and our revenues would decline.





Our
products must be safe, effective and cost efficient in order for them to
effectively compete against more established treatments. If we cannot compete
with these treatments, our revenues will decline.




The
market for catheters to diagnose or treat AF and VT is highly competitive. Our
micro-catheter systems for the mapping and ablation of AF and VT are new
technologies. Safety, cost efficiency and effectiveness are the primary
competitive factors in this market. Other competitive factors include the length
of time required for products to be developed and receive regulatory approval
and, in some cases, reimbursement approval. Existing treatments with which we
must compete include:





·      Conventional
catheters using the “drag and burn” or “dot to dot” technique;


·      Anti-arrhythmic
and anti-coagulant drugs;


·      External
electrical shock to restore normal heart rhythms and
defibrillation;


·      Implantable
defibrillators;


·      Purposeful
destruction of the atrial-ventricular node followed by implantation of a
pacemaker; and


·      Open-heart
surgery known as the “maze” procedure




Physicians
will not recommend the use of our systems unless they can conclude that our
systems provide a safe, effective and cost-efficient alternative to current
technologies for the mapping and ablation of AF or VT. If our clinical data and
other studies do not show that our products are safe and effective, the FDA and
other regulators will not approve our products for sale. If our products are not
approved, we will not be able to enter the market and we will not be able to
generate revenues from their sale.




If
we do not comply with applicable domestic laws and regulations after obtaining
approvals or clearances, our business results may suffer.




After
initial regulatory approval or clearance of our products, we will continue to be
subject to extensive domestic regulatory requirements. Our failure to comply
with applicable regulatory requirements can result in enforcement actions by the
FDA, and other regulatory agencies, including, but not limited to:





·     
Fines;


·Injunctions;


·Recall or seizure of products;


·Withdrawal of marketing approvals or clearances;


·Refusal by the FDA to grant clearances or approvals;
and


·Civil and criminal penalties




We also
are required to demonstrate and maintain compliance with the FDA’s Quality
Systems Requirements for all of our products. The FDA enforces the QSR through
periodic inspections, including a pre-approval inspection for PMA products. The
QSR relates to product testing and quality assurance, as well as the maintenance
of records and documentation. If we do not, or any third-party manufacturer of
our products does not, comply with the QSR and cannot be brought into
compliance, we will be required to find alternative manufacturers. Identifying
and qualifying alternative manufacturers would likely be a long and difficult
process. We also are required to provide information to the FDA on deaths or
serious injuries alleged to have been associated with the use of our medical
devices, as well as product malfunctions that could contribute to death or
serious injury. If we fail to comply with these applicable regulations, we may
incur substantial business disruption, expenses, penalties, fines and other
liabilities and our business results and financial condition could
suffer.






20






If
we do not comply with foreign regulatory requirements to market our products
outside the United States, our business will be harmed.




Sales of
medical devices outside the United States are subject to international
regulatory requirements that vary from country to country. The time required for
approval varies from country to country and may be longer or shorter than the
time required in the United States. In order to market any of our products in
the member countries of the European Union, we are required to obtain CE Mark
certification. CE Mark certification is an international symbol of adherence to
quality assurance standards and compliance with the European Medical Device
Directives. We have received CE Mark certification to sell our PATHFINDER,
PATHFINDER mini, REVELATION, REVELATION Tx, REVELATION Helix, TRACER
micro-catheters  VUEPORT and NAVIPORT guiding catheters for mapping in
the European Union, and approval to sell some of our products in Canada. We
received CE Mark Clearance for the INTELLITEMP radio frequency energy management
devices during the first quarter of 2004.





We intend
to submit data in support of additional CE Mark applications. However, there can
be no assurance we will be successful in obtaining or maintaining the CE Mark
for any of our products, as the case may be. Failure to receive or maintain
approval to affix the CE Mark would prohibit us from selling these products in
member countries of the European Union, and would require significant delays in
obtaining individual country approvals. No assurance can be given that we will
ever obtain or maintain such approvals. If we do not receive or maintain these
approvals, our business could be harmed.




In the
first quarter of 2007, our Japanese distributor notified us of its failure to
maintain the legal documentation standard required to sell our PATHFINDER in
Japan. As a result, we had no sales in Japan during the first quarter of 2007.
We understand that the reapplication process takes approximately twelve to
eighteen months. In October 2008, we appointed Japan Lifeline Co. Ltd. as our
new distributor in Japan. Together with Japan Lifeline, we filed a “Shonin
Application” to obtain the necessary regulatory approval to re-start PATHFINDER
sales in the Japanese market.  During the reapplication process, we
may have no sales in Japan. We anticipate resuming commercial sales in 2009.
However, there can be no assurance that we will be able to resume sales by that
time.




Reuse
of our single-use products could cause our revenues to decline.




Although
we label all of our micro-catheter systems for single-use only, we are aware
that some physicians potentially may reuse these products. Reuse of our
micro-catheter systems could reduce revenues from product sales and could cause
our revenues to decline. In addition, such misuse of our products could result
in personal injury and death. See “Factors Affecting Future Results—we may face
product liability claims related to the use or misuse of our
products.”




Difficulties
presented by international factors could negatively affect our
business.




A
component of our strategy is to expand our international sales revenues. We
believe that we will face risks in doing business abroad that we do not face
domestically. Among the international risks we believe are most likely to affect
us are:





· Export
license requirements for our products;


·Exchange rate
fluctuations or currency controls;


·Changes in the
regulation of medical products by the European Union or other international
regulatory agencies;


·The difficulty in
managing a direct sales force from aboard;


·The financial
condition, expertise and performance of our international distributors and any
future international distributors;


·Domestic or
international trade restrictions; and


·Changes in
tariffs




Any of
these factors could damage our business results.




We
may be unable to successfully commercialize our micro-catheter or surgical
products, as the industry for them is highly competitive.





The
market for catheters to map and/or ablate AF and VT is highly competitive, as is
the market for surgical ablation products. Several of our competitors are
developing different approaches and products for these procedures. These
approaches include mapping systems using contact mapping, single-point spatial
mapping and non-contact, multi-site electrical mapping technologies, and
ablation systems using radio frequency, ultrasound, microwave, laser and
cryoblation technologies. Other companies are also developing surgical
procedures that could allow physicians to perform the open-heart surgical maze
procedure for the treatment of AF in a minimally invasive manner. If any of
these new approaches or products proves to be safe, effective and cost
effective, our products could be rendered non-competitive or obsolete, which
would harm our business.






21






Many of
our competitors have an established presence in the field of interventional
cardiology and electrophysiology, or the study of the electrical system of the
heart. These competitors include C.R. Bard, Inc., Medtronic, Inc., Boston
Scientific, through its EP Technologies and Cardiac Pathways divisions, Johnson
& Johnson, through its Biosense-Webster division and St. Jude Medical, Inc.,
through its Daig division. These competitors have substantially greater
financial and other resources than we do, including larger research and
development staffs and greater experience and capabilities in conducting
clinical trials, obtaining regulatory approvals, and manufacturing, marketing
and distributing products. In addition, other companies are developing
proprietary systems for the diagnosis and treatment of cardiac arrhythmias,
including Biosense-Webster, a division of Johnson & Johnson, and Endocardial
Solutions, Inc. Other companies are also developing, marketing and selling
alternative approaches for the treatment of AF and VT, including manufacturers
of implantable defibrillators such as Guidant Corporation, Medtronic, Inc. and
St. Jude Medical, Inc. We cannot be certain that we will succeed in developing
and marketing technologies and products that are safer, more clinically
effective and cost-effective than the more established treatments or the new
approaches and products being developed and marketed by our competitors.
Furthermore, there can be no assurance that we will succeed in developing new
technologies and products that will be available before those of our
competitors, particularly because of our financial position. Our failure to
demonstrate the competitive advantages and achieve market acceptance of our
products would significantly harm our business.





We
license portions of our product technology from potential competitors, and the
termination of any of these licenses would harm our business.




We rely
on license agreements for some of our product technology from potential
competitors. A license from Target Therapeutics, Inc., a subsidiary of Boston
Scientific Corporation, is the technological basis for our micro-catheter
systems for mapping and ablation. Boston Scientific Corporation currently has
research efforts in the field of electrophysiology that may compete with our
products. Under the Target Therapeutics license agreement we have an exclusive
license under specific issued United States patents. The exclusive license from
Target Therapeutics covers the diagnosis and treatment of electrophysiological
disorders in areas other than the central nervous system. In addition, we have
obtained a non-exclusive license to use Target Therapeutics’ technology,
provided we have made a substantial improvement of such technology, for the
diagnosis or treatment of diseases of the heart, other than by balloon
angioplasty. The license will terminate upon the expiration or invalidation of
all claims under the underlying patents. In addition, Target Therapeutics has
the right to terminate the license earlier if we fail to comply with various
commercialization, sublicensing, insurance, royalty, product liability,
indemnification, non-competition and other obligations. Furthermore, either
party can terminate the license if a material breach remains uncured for thirty
days or if either party ceases to be actively engaged in its present business
for a period of twelve months. We may lose the licensed rights in the event of
an assignment for the benefit of creditors or other bankruptcy or
insolvency-related event. The loss of our exclusive rights to the Target
Therapeutics-based micro-catheter technology would significantly harm our
business.





In
December 2000, we sold certain patents and related intellectual property
pertaining to intravascular sensing and signal detection to Medtronic, Inc.,
which currently has research efforts in the field of electrophysiology that may
compete with our products. We received a perpetual, worldwide license at no cost
from Medtronic to use these patents and related intellectual property in our
products for mapping and ablation of arrhythmia-causing tissue. In addition,
Medtronic agreed not to sublicense the patents within our field of use to any
non-affiliated party. We have also licensed a proprietary surface-coating
material from another vendor used on certain of our
micro-catheters.




We cannot
be certain that these licenses will continue to be available to us or will be
available to us on reasonable terms. The loss of or inability to maintain any of
these licenses could result in delays in commercial shipments until we could
internally develop or identify, license and integrate equivalent technology.
These delays would have a material adverse effect on our business, financial
condition and results of operations.




We
may not be able to commercialize our products under development if they infringe
existing patents or patents that have not yet issued.




We
believe that our patent applications and products do not interfere with existing
patents. However, we cannot be sure that relevant patents have not been issued
that could block our ability to obtain patents or commercialize our products.
Moreover, because U.S. patent applications are not a matter of public record, a
patent application could currently be on file that would prevent us from
obtaining a patent issuance. In addition, Congress recently amended the U.S.
patent laws to exempt physicians, other health care professionals and affiliated
entities from infringement liability for medical and surgical procedures
performed on patients. The issuance of any potentially competing patent could
harm our business.




We have
received in the past and expect to continue to receive letters from others
threatening to enforce patent or other intellectual rights against us. We cannot
be certain that we will not become subject to patent or intellectual property
infringement claims or litigation, interference proceedings in the U.S. Patent
and Trademark Office to determine the priority of inventions, or oppositions to
patent grants in foreign countries. Any such claim, litigation or proceeding,
regardless of the outcome, would likely require us to expend substantial defense
costs and would disrupt our business. An adverse determination in litigation,
interference or opposition proceedings could subject us to significant
liabilities to third parties, require us to cease using important technology
invalidate our intellectual property rights, or require us to license disputed
rights from third parties. However, we cannot be certain that any licenses will
be available to us on commercially reasonable terms or at all. Our inability to
obtain such a license could materially delay the commercialization of our
products, require us to expend substantial resources to design and develop
alternative to the disputed technology, and otherwise harm our business. Our
license with Target Therapeutics does not provide us with indemnification
against claims brought by third parties alleging infringement of patent rights.
Consequently, we would bear the liability resulting from such claims. We cannot
be certain that we will have the financial resources to protect and defend our
intellectual property; as such defense is often costly and time-consuming. Our
failure to protect our patent rights, trade secrets, know-how or other
intellectual property would harm our business.






22







The
United States patent laws exempt medical practitioners and related health care
entities from infringement liability for medical and surgical procedures in
certain circumstances. We cannot predict whether this exception might have a
material adverse effect on our ability to protect our proprietary methods and
procedures.





If
healthcare providers do not receive adequate reimbursement for procedures using
our products, the market may not accept our products and our revenues may
decline.




U.S.
healthcare providers, including hospitals and physicians, that purchase
micro-catheter products generally rely on third-party payers, principally
federal Medicare, state Medicaid and private health insurance plans, to
reimburse all or a part of the costs and fees associated with the procedures
performed using our products. The success of our products will depend upon the
ability of healthcare providers to obtain satisfactory reimbursement for medical
procedures in which our micro-catheter systems are used. If these healthcare
providers are unable to obtain reimbursement from third-party payers, the market
may not accept our products and our revenues may decline.




Third-party
payers may deny reimbursement if they determine that a prescribed
device:





· Has not
received appropriate regulatory clearances or approvals;


·Is not used in
accordance with cost-effective treatment methods as determined by the payor;
or


·Is experimental,
unnecessary or inappropriate





If we
receive FDA clearance or approval, third-party reimbursement also would depend
upon decisions by the United States Health Care Financing Administration for
Medicare, as well as by individual health maintenance organizations, private
insurers and other payors. Reimbursement systems in international markets vary
significantly by country and by region within some countries, and reimbursement
approvals may be obtained on a country-by-country basis. Many international
markets have government-managed health care systems that control reimbursement
for new devices and procedures. In most markets, there are private insurance
systems as well as government-managed systems. There can be no assurance
that:





· Reimbursement
for our products will be available domestically or internationally;


·If available,
that such reimbursement will be available in sufficient amounts in the United
States or in international markets under either government or private
reimbursement systems;


·Physicians will
support and advocate reimbursement for procedures using our
products





Failure
by hospitals and other users of our products to obtain reimbursement from
third-party payers or changes in government and private third-party payers’
policies toward reimbursement for procedures employing our products would harm
our business. Moreover, we are unable to predict what additional legislation or
regulation, if any, relating to the health care industry or third-party coverage
and reimbursement may be enacted in the future, or what effect such legislation
or regulation would have on our business.




We
cannot be certain that we will be able to manufacture our products in high
volumes at commercially reasonable costs.




We
currently manufacture our micro-catheter systems in limited quantities for U.S.
and international sales and for pre-clinical and clinical trials. However, we
have limited experience manufacturing our products in the amounts necessary to
achieve significant commercial sales. For example, we currently do not have the
ability to manufacture one of the components of our SAS in substantial
quantities. We expect that if U.S. sales of our PATHFINDER micro-catheter
products, our REVELATION micro-catheter products, or our SAS increase or if we
receive FDA clearance or approvals for other products, we will need to expend
significant capital resources and develop additional manufacturing capacity to
establish large-scale manufacturing capabilities. However, we could encounter
problems related to:





· Capacity
constraints;


·Production
yields;


·Quality control;
and


·Shortage of
qualified personnel




Such
problems could affect our ability to adequately scale-up production of our
products and fulfill customer orders on a timely basis, which could harm our
business.






23






Our
manufacturing facilities are subject to periodic inspection by regulatory
authorities. Our operations must either undergo QSR compliance inspections
conducted by the FDA or receive an FDA exemption from such compliance
inspections in order for the FDA to permit us to produce products for sale in
the United States. Our facilities and manufacturing processes are subject to
inspections from time to time by the FDA, the State of California and European
Notified Bodies. We have demonstrated compliance with ISO 13485quality
standards, as well as compliance with 93/42/EEC, the Medical Device Directive.
We comply with procedures to produce products for sale in Europe. Any failure by
us to comply with the QSR requirements or to maintain our compliance with ISO
13485s and 93/42/EEC, the Medical Device Directive, will require us to take
corrective actions, such as modification of our policies and procedures. In
addition, we may be required to cease all or part of our operations for some
period of time until we can demonstrate that appropriate steps have been taken
to comply with QSR or ISO 13485 standards. There can be no assurance that we
will be found in compliance with the QSR by regulatory authorities, or that we
will maintain compliance with ISO 13485 standards in future audits. Our failure
to comply with state or FDA QSR, maintain compliance with ISO 13485 standards,
or develop our manufacturing capability in compliance with such standards, would
have a material adverse effect on our business, financial condition and results
of operations.




Our
facilities and manufacturing processes have undergone a successful annual
surveillance audit by the European Notified Body in December 2004. We
successfully passed a pre PMA inspection by the FDA in January 2003. In March
2006, the FDA conducted a Quality System Inspection Technique, (or QSIT) Audit,
of our Quality System, which we successfully passed. There is no assurance that
our manufacturing facilities will continue to meet such compliance audits and
will maintain such compliance standards.




If
our sole-source suppliers are unable to meet our demands, our business results
will suffer.




We
purchase certain key components for some of our products, from sole, single or
limited source suppliers. For some of these components, there are relatively few
alternative sources of supply. Establishing additional or replacement suppliers
for any of the numerous components used in our products, if required, may not be
accomplished quickly and could involve significant additional costs. Any supply
interruption from vendors or failure to obtain alternative vendors for any of
the numerous components used to manufacture our products would limit our ability
to manufacture our products. Any such limitation on our ability to manufacture
our products would cause our business results to suffer.





We
may face product liability claims related to the use or misuse of our
products.




We face
an inherent business risk of product liability claims in the event that the use
or misuse of our products results in personal injury or death. We have received
claims of this type in the past and may receive additional claims in the future.
We cannot be certain, in particular after commercial introduction of our
products, that we will not experience losses due to product liability claims.
Although we currently have general liability and product liability insurance
coverage, this coverage is subject to per-occurrence and annual limitations, as
well as substantial deductibles. We cannot be certain that such coverage will be
adequate or continue to be available to us on reasonable terms, if at all. In
addition, there can be no assurance that all of the activities encompassed
within our business are or will be covered under our policies. Although we label
our micro-catheter products for single-use only, we are aware that some
physicians are re-using such products. Moreover, despite labeling our
micro-catheters for diagnostic use only, we believe that physicians are using
such mapping micro-catheters for ablation. Multiple use or “off-label” use of
our micro-catheters could subject us to increased exposure to product liability
claims, which could have a material adverse effect on our business, financial
condition and results of operations. We may require additional product liability
coverage if we significantly expand commercialization of our products. Such
additional coverage is expensive, difficult to obtain and may not be available
in the future on acceptable terms, if at all. Any claims or series of claims
against us, regardless of their merit or eventual outcome, could have a material
adverse effect on our business, financial condition and results of
operations.





We
are dependent upon our key personnel.




Our
ability to operate successfully depends in significant part upon the continued
service of certain key scientific, technical, clinical, regulatory and
managerial personnel, and our continuing ability to attract and retain
additional highly qualified personnel in these areas. Competition for such
personnel is intense, especially in the San Francisco Bay Area. We cannot be
certain that we can retain such personnel or that, if we are able to raise
additional capital in amounts sufficient to maintain and expand our operations,
we will be able to attract or retain other highly qualified scientific,
technical, clinical, regulatory and managerial personnel in the
future.




The
general economic downturn both in the US and worldwide may have a significant
impact on our financial condition and operating results.





In recent
months, worldwide economic conditions have deteriorated significantly in the
United States and other countries, and may remain depressed for the foreseeable
future. These conditions make it difficult for us to accurately forecast and
plan future business activities, and could cause us to slow or reduce spending
on our research and development activities. Furthermore, during challenging
economic times, we may face issues gaining timely access to financings or
capital infusion, which could result in an impairment of our ability to continue
our business activities. We cannot predict the timing, strength or duration of
any economic slowdown or subsequent economic recovery, worldwide, in the United
States, or in our industry. These and other economic factors could have a
material adverse effect on our financial condition and operating
results.





We
do not intend to pay cash dividends on our stock.




We have
never paid cash dividends on our capital stock and do not anticipate paying cash
dividends in the foreseeable future. Instead, we intend to retain future
earnings for reinvestment in our business.





We
may be adversely affected by regulatory requirements, tax requirements and The
Sarbanes-Oxley Act. We may not be able to implement Section 404 of the
Sarbanes-Oxley Act of 2002 on a timely basis and we had identified material
weakness in our system of internal controls.





We are
subject to numerous rules and regulations, including, but not limited to,
environmental and health and welfare benefit regulations as well as those
associated with being a public company as well as numerous federal, state, and
local tax rules and regulations. These rules and regulations and associated
interpretations may be changed by local, state or federal governments or
agencies. Changes in these regulations may result in a significant increase in
our compliance costs. Compliance with changes in rules and regulations could
require increases to our workforce, increased cost for services, compensation
and benefits, or investments in new or upgraded equipment. In addition, audits
and examinations of prior years may result in liabilities and additional
financial burdens.


24


We will
be subject to reporting on internal controls in accordance with Section 404
of The Sarbanes-Oxley Act for auditors attestation for fiscal years ending on or
after December 15, 2009. The Company is currently unable to predict the cost or
difficulties required to complete such certifications. We expect that we will
need to hire and/or engage additional personnel and incur incremental costs in
order to complete the work required by Section 404. We have in the past
discovered, and may in the future discover, areas of our internal controls that
need improvement. We may not be able to remediate these problems on a timely
basis. Additionally, upon completion of a Section 404 plan, we may not be able
to conclude that our internal controls are effective, or in the event that we
conclude that our internal controls are effective, our independent accountants
may disagree with our assessment and may issue a report that is qualified. Any
failure to implement required new or improved controls, or difficulties
encountered in their implementation, could harm our operating results or cause
us to fail to meet our reporting obligations.





Substantial
future sales of our common stock in the public market could cause our stock
price to fall.




Among
other factors contributing to the potential volatility of our stock price,
additional sales of our common stock in the public market or the perception that
such sales could occur could cause the market price of our common stock to
decline.




Delaware
law, our corporate charter and bylaws and our stockholder rights plan could
delay or discourage takeover attempts that stockholders may consider
favorable.




Provisions
in our certificate of incorporation and bylaws may have the effect of delaying
or preventing a change of control of our company. These provisions
include:





·
                        The
      ability of the Board of Directors to alter our bylaws without
      stockholders’ approval;·
                        The
      ability of the Board of Directors to issue, without stockholders’
      approval, up to five million shares of preferred stock with rights set by
      the Board of Directors, which rights could be senior to those of our
      common stock; and·
                        The
      elimination of the rights of stockholders to act by written
      consent





Each of
these provisions could discourage potential takeover attempts.




In May
2002, we adopted a stockholder rights plan and declared a dividend distribution
of one right for each outstanding share of common stock on May 21, 2002. Each
right, when exercisable, entitles the registered holder to purchase from us one
one-hundredth of a share of a new series of preferred stock on the terms stated
in our rights plan. The rights will generally separate from the common stock and
become exercisable if any person or group acquires or announces a tender offer
to acquire 15% or more of our outstanding common stock without the consent of
our board of directors. Because the rights may substantially dilute the stock
ownership of a person or group attempting to take us over without the approval
of our board of directors, our stockholder rights plan could make it more
difficult for a third party to acquire us (or a significant percentage of our
outstanding capital stock) without first negotiating with our board of
directors. In addition, we are governed by provisions of Delaware law that may
prohibit large stockholders, in particular those owning 15% or more of our
outstanding voting stock, from merging or combining with us.




These
provisions in our charter, bylaws and rights plan and under Delaware law could
discourage takeover attempts that our stockholders would otherwise favor, or
otherwise reduce the price that investors might be willing to pay for our common
stock in the future.




ITEM
1B.             UNRESOLVED
STAFF COMMENTS





None.





ITEM
2.                 DESCRIPTION
OF PROPERTY





We lease
a 29,000 square feet facility in Fremont, California. Our facility includes a
4,000 square feet clean-room, a machine shop for prototyping and tooling,
extrusion and braiding capability, wire grinding operations, general assembly,
test and inspection areas, and a materials area. Our amended facility lease
expires on May 31, 2010. We believe that we will be able to obtain additional
commercial space if needed.





ITEM
3.                 LEGAL
PROCEEDINGS




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





On
October 31, 2007, we received a letter from the law firm representing our former
Director of Operations, Larry Stevens in which claims were made against us for
damages due to wrongful termination in violation of public policy, breach of
contract and other related claims.  We determined that Mr. Stevens’
termination was “with cause” thus the severance provision of his employment
agreement did not apply. In February 2009, we reached an agreement with Mr.
Stevens to settle all disputes and release all claims against each
other.





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





Not
applicable.






25










PART
II





ITEM 5.
            MARKET
      FOR COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS AND ISSUER PURCHASES OF
      EQUITY SECURITIES





Market
for Common Equity





In
October 2005, our common stock resumed quotation on the Nasdaq Over-the-Counter
Bulletin Board under the symbol CADM.OB. Our common stock was quoted on the Pink
Sheets, Nasdaq SmallCap Market and Nasdaq National Market from May 2005 to
October 2005, June 2001 to May 2005 and June 1997 to June 2001 respectively. The
following table sets forth for the periods indicated the high and low sale
prices of our common stock.




YEAR
      ENDED DECEMBER 31, 2008
              
              High
              
              
              LowFirst
      Quarter
              
              $
              0.71
              
              
              $
              0.39Second
      Quarter
              
              
              2.14
              
              
              
              0.58Third
      Quarter
              
              
              1.88
              
              
              
              1.12Fourth
      Quarter
              
              
              1.73
              
              
              
              1.30YEAR
      ENDED DECEMBER 31, 2007First
      Quarter
              
              $
              1.80
              
              
              $
              0.50Second
      Quarter
              
              
              1.70
              
              
              
              0.40Third
      Quarter
              
              
              0.64
              
              
              
              0.50Fourth
      Quarter
              
              
              0.60
              
              
              
              0.41





Dividends





We have
not declared or paid any cash dividends on our common stock, and we currently
intend to retain future earnings, if any, to finance the expansion of our
business, and we do not expect to pay any cash dividends in the foreseeable
future. The decision whether to pay cash dividends on our common stock will be
made by our board of directors, in their discretion, and will depend on our
financial condition, operating results, capital requirements and other factors
that the board of directors considers significant. As of December 31, 2008,
we had approximately 86 shareholders of record, not including persons who hold
their shares through a nominee.





Recent
Sales of Unregistered Securities





In
December 2007, we entered into a series of Subscription Agreements (the
“Subscription Agreement”) with certain accredited investors (collectively, the
“Investors”) providing for the sale of (i) a total of 18 million shares of our
Common Stock in the aggregate principal amount of $9 million (the “Shares”)
and (ii) warrants (the “Warrants”) to purchase an aggregate of 2.7 million
shares of our Common Stock at an exercise price of $0.55 per share. At our
option, we may force the Holder to exercise the Warrant at a price per share
equal to $0.55 per share, provided that (i) our Common Stock is trading at a
price equal to or greater than $1.00 for a period of fifteen (15) consecutive
trading days ending on the date preceding the date we send a notice to the
Holder in which we announce our intention to force the exercise of the Warrants
and (ii) a registration statement is in effect with respect to the Warrant
Shares.  The Warrants have an expiration date of 5 years from the date
of issuance. Pursuant to the Subscription Agreement, we have agreed to use our
best efforts to secure effectiveness of, as soon as reasonably practicable after
the issuance and delivery of the Shares and Warrants, a registration statement
on Form SB-2, now S-1.




In May
2008, we entered into a series of Subscription Agreements (the “Subscription
Agreement”) with certain accredited investors (collectively, the “Investors”)
providing for the sale of (i) a total of 8,474,992 shares of our Common Stock in
the aggregate principal amount of $5.1 million (the “Shares”) and (ii)
warrants (the “Warrants”) to purchase an aggregate of 1,271,247 shares of our
Common Stock at an exercise price of $0.65 per share. At our option, we may
force the Holder to exercise the Warrant at a price per share equal to $0.65 per
share, provided that (i) our Common Stock is trading at a price equal to or
greater than $1.00 per share for a period of fifteen (15) consecutive trading
days ending on the date preceding the date we send a notice to the Holder in
which we announce our intention to force the exercise of the Warrants and (ii) a
registration statement is in effect with respect to the Warrant Shares. We
also issued 1,500,000 warrants to purchase shares of our common stock to Apix
International, Limited (“APIX”) at an exercise price of $0.60 per share. The
Warrants have an expiration date of 5 years from the date of issuance. Pursuant
to the Subscription Agreement, we have agreed to use our best efforts to secure
effectiveness of, as soon as reasonably practicable after the issuance and
delivery of the Shares and Warrants, a registration statement on Form SB-2, now
S-1.


26


On
February 28, 2009, we entered into a subscription agreement with an accredited
investor providing for the sale of (i) a total of 18,518,518 shares of our
Common Stock at a price equal to $1.08 per share, in the aggregate principal
amount of $20 million and (ii) warrants to purchase an aggregate of 5,555,555
shares of our Common Stock at an exercise price of $1.25 per share. At our
option, we may force the Holder to exercise the Warrant at a price per share
equal to $1.08, provided that (i) our Common Stock is trading at a price equal
to or greater than $1.58 per share for a period of fifteen (15) consecutive
trading days ending on the date preceding the date we send a notice to the
Holder in which we announce our intention to force the exercise of the Warrants
and (ii) a registration statement is in effect with respect to the Warrant
Shares. The Warrants have an expiration date of 5 years from the date of
issuance. Pursuant to the Subscription Agreement, we have agreed to use our best
efforts to secure effectiveness of, as soon as reasonably practicable after the
issuance and delivery of the Shares and Warrants, a registration statement on
Form SB-2, now S-1.  APIX acted as placement agent.  We
provided for up to $80,000 in expense reimbursements.




All of
the above offerings and sales were deemed to be exempt under rule 506 of
Regulation D and Section 4(2) and/or Regulation S of the Securities Act of 1933,
as amended. No advertising or general solicitation was employed in offering the
securities. The offerings and sales were made to a limited number of persons,
all of whom were accredited investors, business associates of the Company or
executive officers of the Company, and transfer was restricted by the Company in
accordance with the requirements of the Securities Act of 1933. In addition to
representations by the above-referenced persons, we have made independent
determinations that all of the above-referenced persons were accredited or
sophisticated investors, and that they were capable of analyzing the merits and
risks of their investment, and that they understood the speculative nature of
their investment. Furthermore, all of the above-referenced persons were provided
with access to our Securities and Exchange Commission filings.





Apix
International Limited





APIX is
an entity that is solely owned by Robert Cheney who is also the CEO, CFO and a
Director of our Company. Mr. Cheney was appointed as the CEO in June 2007. APIX
acted as agent for all of our recent financing activities.





Equity
Compensation Plans




The
following table summarizes information about our equity compensation plans as of
December 31, 2008.




Number
      of securities to be issued upon exercise of outstanding options and
      warrants
                    
                    
                    Weighted-average
      exercise price of outstanding options and warrants
                    
                    
                    Number
      of securities remaining available for future issuance under equity
      compensation plans (excluding securities reflected in second
      column)Equity
      compensation plans approved by Cardima stockholders
                    
                    
                    9,301,636
                    
                    
                    $
                    0.93
                    
                    
                    
                    21,365,971Total
                    
                    
                    9,301,636
                    
                    
                    
                    0.93
                    
                    
                    
                    21,365,971





Equity
compensation plans approved by our shareholders include our 1993, 1997, 2003 and
2007 Stock Option Plans.






27






ITEM
6.                      SELECTED
FINANCIAL DATA




In the
table below, we have presented certain selected financial data as of and for
each of the years in the five-year period ended December 31, 2008. The financial
data has been derived from our audited financial statements. This data should be
read in conjunction with Item 7, “Management’s Discussion and Analysis and
Results of Operations” and Item 8, Financial Statements and Supplementary Data”
of this Annual Report on Form 10-K.




Years
      Ended December 31,2008
                
                
                2007
                
                
                2006
                
                
                2005
                
                
                2004(in
      thousands, except per share data)Statement
      of Operations Data:Sales
                
                
                1,456
                
                
                
                1,157
                
                
                
                1,541
                
                
                
                1,859
                
                
                
                2,366Cost
      of sales
                
                
                2,481
                
                
                
                1,613
                
                
                
                2,023
                
                
                
                1,999
                
                
                
                2,608Gross
      deficiency
                
                
                (1,025
                )
                
                
                (456
                )
                
                
                (482
                )
                
                
                (140
                )
                
                
                (242
                )Operating
      expenses
                
                
                12,693
                
                
                
                8,294
                
                
                
                4,774
                
                
                
                6,891
                
                
                
                9,475Operating
      loss
                
                
                (13,718
                )
                
                
                (8,750
                )
                
                
                (5,256
                )
                
                
                (7,031
                )
                
                
                (9,717
                )Interest
      income (expense)
                
                
                115
                
                
                
                (865
                )
                
                
                (1,753
                )
                
                
                (1,297
                )
                
                
                4Other
      income (expenses)
                
                
                (121
                )
                
                
                17
                
                
                
                -
                
                
                
                -
                
                
                
                -Other
      non-cash expenses
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (33
                )Loss
      on debt extinguishment
                
                
                -
                
                
                
                (15,182
                )
                
                
                (2,256
                )
                
                
                -
                
                
                
                -Loss
      on excess shares over authorized
                
                
                -
                
                
                
                (7,737
                )
                
                
                (2,886
                )
                
                
                -
                
                
                
                -Loss
      on debt settlement
                
                
                -
                
                
                
                (10,129
                )
                
                
                -
                
                
                
                -
                
                
                
                -Income
      tax
                
                
                1
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Net
      loss
                
                
                (13,725
                )
                
                
                (42,646
                )
                
                
                (12,151
                )
                
                
                (8,328
                )
                
                
                (9,746
                )Basic
      and diluted net loss per share
                
                
                (0.11
                )
                
                
                (1.31
                )
                
                
                (1.19
                )
                
                
                (0.08
                )
                
                
                (0.11
                )Weighted
      average shares outstanding
                
                
                121,945
                
                
                
                32,442
                
                
                
                10,170
                
                
                
                101,408
                
                
                
                85,703Balance
      Sheet Data:Cash,
      cash equivalents and short-term investments
                
                
                5,375
                
                
                
                6,819
                
                
                
                942
                
                
                
                124
                
                
                
                3,854Working
      capital (deficit)
                
                
                (338
                )
                
                
                6,018
                
                
                
                (12,986
                )
                
                
                (4,088
                )
                
                
                4,158Total
      assets
                
                
                8,791
                
                
                
                8,004
                
                
                
                2,217
                
                
                
                1,746
                
                
                
                6,537Total
      current liabilities
                
                
                8,144
                
                
                
                1,563
                
                
                
                14,852
                
                
                
                5,481
                
                
                
                1,946Total
      liabilities
                
                
                8,230
                
                
                
                1,623
                
                
                
                14,936
                
                
                
                5,509
                
                
                
                1,998Total
      shareholders’ equity (deficit)
                
                
                561
                
                
                
                6,381
                
                
                
                (12,719
                )
                
                
                (3,763
                )
                
                
                4,539





ITEM
7.                      MANAGEMENT'S
DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS





The
following discussion of our financial condition and results of operations should
be read in conjunction with our financial statements and related notes, and the
other financial information included in Form 10-K. With respect to this
discussion, the terms “Cardima,” “Company,” “we,” “us,” and “our” refer to
Cardima, Inc. This discussion and analysis may contain forward-looking
statements as a result of many factors, including but not limited to those set
forth under “Risk Factors” and elsewhere in this Form 10-K.




OVERVIEW





Since
2001, our efforts have primarily focused on developing differentiated products
that diagnose and treat AF, including our REVELATION Tx micro-catheter for use
in the electrophysiology (EP) market, and our Surgical Ablation System (SAS) for
use in the surgical market.  Our EP products allow for the mapping
(diagnosis) and ablation (treatment) of the two most common forms of cardiac
arrhythmias: atrial fibrillation and ventricular tachycardia.





We have
experienced significant operating losses since inception.  We expect
that our operating losses will continue for the foreseeable future as we
continue to invest substantial resources in product development, pre-clinical
and clinical trials, seeking regulatory approval, sales and marketing and
manufacturing. Because our cash resources are extremely limited, we must raise
additional capital in the immediate future in order to continue to pursue FDA
approval for our REVELATION Tx micro-catheter system, or seek to sell or
otherwise consummate a strategic transaction involving our SAS or other
operations.





On April
19, 2007, the FDA’s Medical Devices Dispute Resolution Panel (MDDRP) recommended
to not approve our REVELATION Tx Microcatheter System’s PMA.  We will
consider our options regarding this decision in the U.S. In addition, we will
continue to market our next generation ablation EP systems, which include the
REVELATION T-Flex and the INTELLITEMP in the European Union and the rest of the
world where we are licensed to promote and sell these products.





Currently
our primary focus is to execute our business plan to generate revenue from our
surgical devices, which have FDA- approval in the United States and to increase
our EP diagnostic sales world-wide.  Moreover, we have signed up new
distributors in the United States to sell both our Surgical and EP Diagnostic
products. We will need to raise additional capital to implement our marketing
strategy relating to the sale of surgical devices.






28






In May
2008, we raised an aggregate principal amount of $5.1 million through the sale
of 8,474,992 shares of our Common Stock to certain accredited investors. We also
issued warrants to the investors to purchase shares of our Common Stock. (See
discussion of this transaction in “Recent Sales of Unregistered Securities in
Item 5 of Part II).





On
November 11, 2008, we executed a Loan Term Sheet and Loan Commitment letter (the
"Financing Documents") with an accredited investor and shareholder of our
company (the “Note Holder”) pursuant to which we will issue a secured
promissory note (the "Note") in the principal amount of $6 million (the
“Advance”).  The Note provided for interest at a rate of 10% per year
and a maturity date of November 10, 2009.  We agreed to grant the
Holder of the Note a general charge on all of our assets.





On
February 28, 2009, we raised an aggregate principal amount of $20.0 million
through the sale of 18,518,518 shares of our Common Stock to the Note Holder.
The Note Holder agreed to convert the Advance into shares and waive all accrued
interest.  We also issued warrants to purchase shares of our Common
Stock. (See discussion of this transaction in “Recent Sales of Unregistered
Securities in Item 5 of Part II).





We intend
to use the net proceeds of the offerings for general corporate purposes,
including working capital and equipment purchase.





Results
of Operations - Years Ended December 31, 2008 and 2007





The
following table set forth, for the periods indicated, our results of operations
expressed in dollar amounts and as percentage of total sales:





Year
      ended December 31,2008
                
                
                2007Amount
                
                
                %
      of Sales
                
                
                Amount
                
                
                %
      of Sales(dollar
      in thousands)Sales
                
                $
                1,456
                
                
                
                100.0
                %
                
                $
                1,157
                
                
                
                100.0
                %Cost
      of sales
                
                
                2,481
                
                
                
                170.4
                %
                
                
                1,613
                
                
                
                139.4
                %Gross
      deficiency
                
                
                (1,025
                )
                
                
                -70.4
                %
                
                
                (456
                )
                
                
                39.4
                %Operating
      expenses:Research
      and development
                
                
                4,381
                
                
                
                300.9
                %
                
                
                3,091
                
                
                
                267.2
                %Selling,
      general and administrative
                
                
                8,312
                
                
                
                570.9
                %
                
                
                5,203
                
                
                
                449.7
                %Total
      operating expenses
                
                
                12,693
                
                
                
                871.8
                %
                
                
                8,294
                
                
                
                716.9
                %Operating
      loss
                
                
                (13,718
                )
                
                
                -942.2
                %
                
                
                (8,750
                )
                
                
                -756.3
                %Other
      income (expense)Interest
      income and (expense), net
                
                
                115
                
                
                
                7.9
                %
                
                
                (865
                )
                
                
                -74.8
                %Other
      income (expense)
                
                
                (121
                )
                
                
                -8.3
                %
                
                
                17
                
                
                
                1.5
                %Loss
      on debt extinguishment
                
                
                -
                
                
                
                -
                
                
                
                (15,182
                )
                
                
                -1312.2
                %Loss
      on excess shares over authorized
                
                
                -
                
                
                
                -
                
                
                
                (7,737
                )
                
                
                -668.7
                %Loss
      on debt settlement
                
                
                -
                
                
                
                -
                
                
                
                (10,129
                )
                
                
                -875.4
                %Total
      other income (expense)
                
                
                (6
                )
                
                
                -0.4
                %
                
                
                (33,896
                )
                
                
                -2929.6
                %Total
      pre-tax loss
                
                
                (13,724
                )
                
                
                -942.6
                %
                
                
                (42,646
                )
                
                
                -3685.9
                %Income
      tax
                
                
                1
                
                
                
                0.1
                %
                
                
                -
                
                
                
                -Net
      loss
                
                $
                (13,725
                )
                
                
                -942.7
                %
                
                $
                (42,646
                )
                
                
                -3685.9
                %





Sales


Sales were
$1.5 million in 2008 as compared to $1.2 million in 2007 mostly due to increased
sales of our surgical ablation products to our domestic customers and
distributors.





We had no
sales to Japan during 2008 and 2007, as our former Japanese distributor failed
to maintain the legal documentation standard required to sell our PATHFINDER
products in Japan. In October 2008, we appointed Japan Lifeline Co. Ltd. as our
new distributor in Japan. Together with Japan Lifeline, we have filed a “Shonin
Application” to obtain the necessary regulatory approval to re-start PATHFINDER
sales in the Japanese market. During the reapplication process, we may have
limited or no sales in Japan. We anticipate resuming commercial sales in Japan
the second quarter of 2009. However, there can be no assurance that we will be
able to resume sales by that time.






29







Cost
of Sales; gross deficiency





Cost of goods
sold primarily includes raw material costs, catheter fabrication costs, system
assembly and testing costs, and manufacturing labor and overhead costs for the
units sold in the period. Cost of goods sold as a percentage to sales increased
to 170% in 2008 as compared to 139% in 2007 due mostly to higher compensation
costs of $878,000 from increased headcount in anticipation of the
commercialization of the surgical line of products as well as the positioning of
our PATHFINDER line of products in anticipation of shipments to Japan as soon as
the Shonin Application is approved, which is expected in early 2009. In the
fourth quarter of 2008, we had identified $261,000 of idle facility costs as
certain plant operating costs as a result of an extended period of production
down-time for maintenance of manufacturing equipment as well as down-time due to
FDA audits. We expect the cost of goods sold as a percentage of sales to improve
as sales volume increases.





Research
and Development Expenses





Research and
development expenses include product development, clinical testing and
regulatory expenses. Research and development expenses in 2008 increased by $1.3
million as compared to the expenses in 2007 primarily due to higher
compensation expense of $469,000 from increased headcount of 10 employees and
higher outside consulting expenses of $694,000.





Selling,
Marketing, General and Administrative Expenses





Selling,
general and administrative expenses increased by $3.1 million in 2008 as
compared to 2007 largely attributable to (i) non-cash stock-based compensation
expenses of $1.8 million, (ii) legal expenses of $442,000, (iii) compensation
and consulting expenses of $367,000, (iv) investor relations expenses of
$66,000, and (v) Sarbanes Oxley compliance expenses of $40,000, and (vi) offset
in part by lower cost of fund raising expenses of $361,000.





Other
income (expense)





Other income,
net of expense, in 2008 was $6,000 as compared to expenses of $33.9 million in
2007. The expenses in 2007 mainly included (i) charges from the recognition of
the extinguishment of debt treatment of $15.2 million, (ii) $7.7 million arising
from shares to settle convertible debt in excess of corporate authority, (iii) a
loss of $10.1 million on non-cash conversion of debt in to equity.





LIQUIDITY
AND CAPITAL RESOURCES




As of
December 31, 2008 and 2007, we had cash and cash equivalents of approximately
$5.3 million and $4.8 million, respectively.  Our short-term
investments were $50,000 and $2 million as of December 31, 2008 and 2007,
respectively.





Net cash
used in operating activities in 2008 was $11.9 million, an increase of $5.2
million over cash used in 2007. The cash used in 2008 was primarily due to
increased product development, outside consultants, clinical, personnel related
expenses.  We also increased inventory by $1.2 million in anticipation
of the sale of our PATHFINDER products in Japan once the necessary regulatory
approval is obtained, and for the commercialization of the surgical line of
products.





Net cash
provided by investing activities was $1.3 million in 2008 as compared to $2.2
million of cash used in investing activities in 2007.  The cash
provided in 2008 was primarily due to the maturity of short-term investments. We
continue to invest in capital expenditures primarily to acquire lab equipment,
computer hardware and software to support the growth of our business. Our
capital expenditures totaled $686,000 in 2008 as compared to $177,000 in
2007.





Recent
Financing Transactions





Net cash
provided by financing activities was $11.1 million in 2008 as compared to $12.7
million in 2007. We intend to use the net proceeds for general corporate
purposes, including working capital and equipment purchase. During
2007, we raised $9 million from the sale of our Common Stock and $3.7 million
from loan financing.




Historically, we have
funded our operations primarily with proceeds from issuances of preferred stock,
common stock, debt financing, and lease financing.





In May
2008, we raised an aggregate principal amount of $5.1 million through the sale
of 8,474,992 shares of our Common Stock to certain accredited investors. We also
issued warrants to the investors to purchase shares of our Common Stock. (See
discussion of this transaction in “Recent Sales of Unregistered Securities in
Item 5 of Part II).





On
November 11, 2008, we executed a Loan Term Sheet and Loan Commitment letter (the
"Financing Documents") with an accredited investor and shareholder of our
company (the “Note Holder”) pursuant to which we issued a secured promissory
note (the "Note") in the principal amount of $6 million (the
“Advance”).  The Note provided for interest at a rate of 10% per year
and a maturity date of November 10, 2009.  We agreed to grant the Note
Holder a general charge on all of our assets. (See discussion of this
transaction in “Recent Sales of Unregistered Securities in Item 5 of Part
II).






30







On
February 28, 2009, we raised an aggregate principal amount of $20.0 million
through the sale of 18,518,518 shares of our Common Stock to the Note Holder.
The Note Holder agreed to convert the Advance into shares and waive all accrued
interest.  We also issued warrants to purchase shares of our Common
Stock. (See discussion of this transaction in “Recent Sales of Unregistered
Securities in Item 5 of Part II).




We
believe our existing cash and cash equivalents and the additional capital raised
in 2009 will be sufficient to meet our anticipated cash needs for at least the
next twelve months. Our future working capital requirements will depend on many
factors, including the rates of our revenue growth, our introduction of new
features and complementary services for our products and services, and our
expansion of research and development and sales and marketing activities. To the
extent our cash and cash equivalents and cash flow from operating activities are
insufficient to fund our future activities, we may need to raise additional
funds through bank credit arrangements or public or private equity or debt
financings. We also may need to raise additional funds in the event we determine
in the future to effect one or more acquisitions of businesses, technologies and
products. If additional funding is required, we may not be able to obtain bank
credit arrangements or effect an equity or debt financing on terms acceptable to
us or at all.
  CRITICAL
ACCOUNTING POLICIES





Our
discussion and analysis of our financial condition and results of operations are
based on our financial statements, which have been prepared in accordance with
U.S. generally accepted accounting principles. The preparation of these
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities and expenses and related disclosure of
contingent assets and liabilities. We review our estimates on an ongoing basis.
We base our estimates on historical experience and on various other assumptions
that we believe to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities. Actual results may differ from these estimates under different
assumptions or conditions. While our significant accounting policies are
described in more detail in Note 1 to our financial statements, we believe the
following accounting policies to be critical to the judgments and estimates used
in the preparation of our financial statements:





Revenue Recognition. We
recognize revenue from two types of customers, end users and distributors.
Revenue is recognized in accordance with Staff Accounting Bulletin 104, “Revenue
Recognition in Financial Statements” when all of the following criteria are met:
persuasive evidence of an arrangement exists, shipment of the product has
occurred and title of products transferred at the point of shipment, payment of
the product is reasonably assured and no substantive obligations to the customer
remain. Revenue is presented net of discounts, allowances, and returns.
Customers are not entitled to any rights of product return. Payment terms are
either open trade credit or cash. We have distributors in Asia and Europe and we
record as revenue the wholesale price we charge our distributors. The
distributors assume the title and risk of loss at the shipping
point.




Research and Development.Research and development costs, which include clinical and regulatory
costs, are charged to expense as incurred.




Allowance for Notes Receivable
Loss. The reserve for doubtful notes represents management’s estimate of
principal and accrued interest losses as of the balance sheet date.
Determination of the reserve is inherently subjective, as it requires
significant estimates, including the amounts and timing of expected future cash
flows. Also, specific reserves are established in cases where management has
identified significant conditions or circumstances related to an individual’s
credit that we believe indicates the note is uncollectible. Note losses are
charged off against the reserve. Evaluations of the reserve balance are
conducted quarterly.





Allowance for Doubtful Accounts.We use the allowance method to account for uncollectible accounts
receivable. Our estimate is based on historical collection experience and a
review of the current status of accounts receivable. We review our accounts
receivable balances by customer for accounts greater than 90 days old and make a
determination regarding the collectability of the accounts based on specific
circumstances and the payment history that exists with such customers. We also
take into account our prior experience, the customer’s ability to pay and an
assessment of the current economic conditions in determining the net realizable
value of our receivables. We also review our allowances for doubtful accounts in
aggregate for adequacy following this assessment. Accordingly, we believe that
our allowances for doubtful accounts fairly represent the underlying
collectability risks associated with our accounts receivable.





Inventories. Inventory
consists of raw materials, work in progress, and finished goods. Inventory is
stated at the lower of cost or market using the first-in, first-out (“FIFO”)
method. Cost includes the acquisition cost of raw materials and components,
direct labor, and manufacturing overhead. We periodically review our inventory
for excess, obsolescence or quality issues. Should we conclude that we have
inventory for which we cannot recover our costs as a result of such review, we
would record a charge to cost of goods sold. We record write downs for excess
and obsolete inventory equal to the difference between the cost of inventory and
the estimated fair value based on assumptions about future product life-cycles,
product demand and market conditions.  If actual product life cycles,
product demand and market conditions are less favorable than those projected by
management, additional inventory write-downs may be required.  At the
point of the loss recognition, a new, lower-cost basis for that inventory is
established, and subsequent changes in facts and circumstances do not result in
the restoration or increase in that newly established cost basis.




Income Taxes.Income taxes are accounted
for under the asset and liability method. Deferred income tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement bases and the respective tax bases
of the assets and liabilities and operating loss and tax credit carry forwards.
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. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. Valuation allowances are established
when necessary to reduce deferred tax assets to the amount expected to be
realized, and have been provided for all periods presented.






31






Valuation of Derivative Financial
Instruments.We
adopted Financial Accounting Standards Board (“FASB”) Statement No. 133,
“Accounting for Derivative Instruments and Hedging Activities” which establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. All changes in fair value
are reported in other income or expense.




Stock-Based Compensation.We
adopted Financial Accounting Standards Board (“FASB”) Statement No. 123R,
“Share Based Payment,” on January 1, 2006. Prior to adoption, we disclosed such
expenses on a pro forma basis in the notes to our financial statements.
Assumptions used for 2008 and 2007 and the resulting estimates of
weighted-average fair value per share of options granted and shares purchased
during these periods were as follows:





2008
                
                
                2007Stock
      options:Dividend
      yield
                
                
                0.0%
                
                
                
                0.0%Volatility
      factor
                
                
                159.6%
                
                
                
                188.0%Risk-free
      interest rate
                
                
                3.6%
                
                
                
                4.3%Expected
      term (years)
                
                
                7
                
                
                
                7Weighted-average
      fair valueof
      options granted during theperiods
                
                $
                1.36
                
                
                $
                0.44





In
estimating the expected term, we considered our historical stock option exercise
experience including forfeitures, our post vesting termination pattern and the
term of the options outstanding. The annual risk free rate of return was based
on the U.S. Treasury constant maturity rates with similar terms to the expected
term of the stock option awards. We based our determination of expected
volatility on our historical stock price volatility over the expected
term. Forfeiture rate is the estimated percentage of options granted that
are expected to be forfeited or cancelled on an annual basis before becoming
fully vested. We estimate the forfeiture rate based on past turnover data and is
expected to be minimal.





RECENT
ACCOUNTING PRONOUNCEMENTS





In June
2007, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 06-11,
"Accounting for Income Tax
Benefits of Dividends on Share-Based Payment Awards." EITF Issue No 06-11
requires that tax benefits generated by dividends paid during the vesting period
on certain equity-classified share-based compensation awards be treated as
additional paid-in capital and included in a pool of excess tax benefits
available to absorb tax deficiencies from share-based payment awards. EITF Issue
No. 06-11 is effective beginning with the 2008 fiscal year. The adoption of
EITF Issue No. 06-11 did not have a significant impact on our financial
position, results of operations or cash flows.





Also in
June 2007, the FASB ratified EITF Issue No. 07-3, "Accounting for Advance Payments for
Goods or Services to Be Used in Future Research and Development
Activities." EITF 07-3 provides that nonrefundable advance payments made
for goods or services to be used in future research and development activities
should be deferred and capitalized until such time as the related goods or
services are delivered or are performed, at which point the amounts would be
recognized as an expense. This issue is effective for fiscal years beginning
after December 15, 2007.  The adoption of EITF 07-3 did not have a
material impact on our financial position and results of
operations.





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




In
September 2006, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements (SFAS
No. 157)”. SFAS No. 157 establishes a framework for measuring fair
value, clarifies the definition of fair value and requires additional
disclosures about fair-value measurements. In general, SFAS No. 157 applies
to fair value measurements that are already required or permitted by other
accounting standards and is expected to increase the consistency of those
measurements. SFAS No. 157, as issued, is effective for fiscal years
beginning after November 15, 2007. In February 2008, the FASB issued FASB
Staff Position (FSP) SFAS No. 157-2, Effective Date of FASB Statement No.
157 (FSP SFAS No. 157-2) which deferred the effective date of SFAS No.
157 for one year for certain nonfinancial assets and nonfinancial liabilities.
Accordingly, we adopted the required provisions of SFAS No. 157 at the beginning
of fiscal year 2008 and the remaining provisions will be adopted by us at the
beginning of fiscal year 2009. The 2008 fiscal year adoption did not result in a
material impact to our financial statements. In October 2008, the FASB issued
FSP 157-3, “Determining the
Fair Value of a Financial Asset when the Market of that Asset is not
Active”, or FSP 157-3. FSP 157-3 clarifies the application of SFAS 157 in
a market that is not active and provides an example to illustrate key
considerations in determining the fair value of a financial asset when the
market for that financial asset is not active. We are currently evaluating the
impact of adopting the remaining parts of SFAS No. 157 and FSP 157-3 in fiscal
year 2009.






32






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




In
December 2007, the FASB issued FAS No. 160, “Accounting for Noncontrolling
Interests.” FAS No. 160 clarifies the classification of noncontrolling
interests in consolidated statements of financial position and the accounting
for and reporting of transactions between the reporting entity and holders of
such noncontrolling interests. Under the standard, noncontrolling interests are
considered equity and should be reported as an element of consolidated equity,
and net income will encompass the total income of all consolidated subsidiaries
and there will be separate disclosure on the face of the income statement of the
attribution of that income between the controlling and noncontrolling interests.
FAS No. 160 is effective prospectively for fiscal years beginning after December
15, 2008. The adoption of FAS No. 160 did not have a significant impact on our
results of operations, financial condition or liquidity.





In March
2008, the FASB issued FAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities,” an amendment of FASB Statement No.
133 “Accounting for Derivative
Instruments and Hedging Activities”. FAS No. 161 requires entities to
provide greater transparency about how and why an entity uses derivative
instruments, how derivative instruments and related hedged items are accounted
for under FAS No. 133, and how derivative instruments and related hedged items
affect an entity’s financial position, results of operations, and cash flows.
The statement is effective for financial statements issues for fiscal years and
interim periods beginning after November 15, 2008, and is not expected to have a
significant impact on our results of operations, financial condition or
liquidity.





In May
2008, the FASB issued Financial Accounting Standard (“FAS”) No. 162, “The Hierarchy of Generally Accepted
Accounting Principles.” The statement is intended to improve financial
reporting by identifying a consistent hierarchy for selecting accounting
principles to be used in preparing financial statements that are prepared in
conformance with generally accepted accounting principles. Unlike Statement on
Auditing Standards (“SAS”) No. 69, “The Meaning of Present in Conformity
With GAAP,” FAS No. 162 is directed to the entity rather than the
auditor. The statement is effective 60 days following the SEC’s approval of the
Public Company Accounting Oversight Board (“PCAOB”) amendments to AU Section
411, “The Meaning of Present
Fairly in Conformity with GAAP,” and is not expected to have any impact
on our results of operations, financial condition or liquidity.





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





In June
2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff
Position (“FSP”) Emerging Issues Task Force (EITF) No. 03-6-1, “Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating
Securities.” Under the FSP, unvested share-based payment awards that
contain rights to receive nonforfeitable dividends (whether paid or unpaid) are
participating securities, and should be included in the two-class method of
computing earnings per share. The FSP is effective for fiscal years beginning
after December 15, 2008, and interim periods within those years, and is not
expected to have a significant impact on our results of operations, financial
condition or liquidity.






33







ITEM
7A.                QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





We are
exposed to various market risks, which include potential losses arising from
adverse changes in market rates and prices, such as foreign exchange
fluctuations and changes in interest rates. Since our distributors in the
Netherlands and England who distribute our products to the respective countries
and invoice in Euros and British Pounds, we have exposure to exchange rate
fluctuations between the Euro, British Pounds and the U.S. Dollar. Our
foreign-currency-based sales to these countries have been insignificant in 2008
and 2007; as a result, the effect of the foreign exchange fluctuations on our
financial results has not been significant.





ITEM
8.                    FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA





INDEX
TO FINANCIAL STATEMENTS





PageFinancial
      Statements:Report of Independent Registered Public
      Accounting Firm
                35Balance Sheets as of December 31, 2008 and
      2007
                36Statements of Operations for the years
      ended December 31, 2008 and 2007
                37Statements of Shareholders’
      Equity  for the years ended December 31, 2008 and
      2007
                38Statements of Cash Flows for the years ended December
      31, 2008 and 2007
                39Notes to Financial Statements
                40









34






REPORT OF PMB HELIN DONOVAN, LLP


INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM














The Board
of Directors and Stockholders


Cardima,
Inc.








We have
audited the accompanying balance sheets of Cardima, Inc. as of December 31, 2008
and 2007 and the related statements of operations, shareholders’ equity, and
cash flows for the years ended December 31, 2008 and 2007. 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 the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company has determined that it
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, 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 financial position of Cardima, Inc. at December 31, 2008
and 2007 and the results of its operations and its cash flows for the years
ended December 31, 2008 and 2007 in conformity with accounting principles
generally accepted in the United States of America.





/s/ PMB
Helin Donovan


San
Francisco, California




March 19,
2009














35







CARDIMA,
INC.


BALANCE SHEETS


(In
thousands, except share amounts)





December
      31,2008
                
                
                2007ASSETSCurrent
      assets:Cash
      and cash equivalents
                
                $
                5,325
                
                
                $
                4,811Accounts
      receivable, net of allowances for doubtful accounts of $187 and $77,
      respectively
                
                
                169
                
                
                
                183Short
      term investment
                
                
                50
                
                
                
                2,008Inventories,
      net
                
                
                1,566
                
                
                
                402Prepaid
      expenses
                
                
                687
                
                
                
                46Other
      current assets
                
                
                9
                
                
                
                131Total
      current assets
                
                
                7,806
                
                
                
                7,581Property
      and equipment, net of accumulated depreciation of $2,988 and $3,428 at
      December 31, 2008 and 2007, respectively
                
                
                924
                
                
                
                362Other
      assets
                
                
                61
                
                
                
                61TOTAL
      ASSETS
                
                $
                8,791
                
                
                $
                8,004LIABILITIES
      AND SHAREHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
                
                $
                418
                
                
                $
                443Accrued
      liabilities
                
                
                1,477
                
                
                
                911Deferred
      revenue
                
                
                112
                
                
                
                -Loans
      payable
                
                
                12
                
                
                
                10Capital
      leases – current portion
                
                
                25
                
                
                
                24Notes
      payable to related-party – current portion
                
                
                6,100
                
                
                
                175Total
      current liabilities
                
                
                8,144
                
                
                
                1,563Loans
      payable – net of current portion
                
                
                41
                
                
                
                53Capital
      leases – net of current portion
                
                
                45
                
                
                
                7TOTAL
      LIABILITIES
                
                
                8,230
                
                
                
                1,623Shareholders’
      Equity:Preferred
      stock, series A, $0.001 par value, liquidation preference of $0.10,
      10,000,000 shares authorized, 5,000,000 issued and
    outstanding
                
                
                500
                
                
                
                500Common
      stock, $0.001 par value, 300,000,000 shares authorized, 125,134,721 and
      116,316,311 shares issued and outstanding at December 31, 2008 and 2007,
      respectively
                
                
                125
                
                
                
                116Additional
      paid-in-capital
                
                
                190,220
                
                
                
                182,324Accumulated
      deficit
                
                
                (190,284
                )
                
                
                (176,559
                )Total
      shareholders’ equity
                
                
                561
                
                
                
                6,381TOTAL
      LIABILITIES AND SHAREHOLDERS’ EQUITY
                
                $
                8,791
                
                
                $
                8,004








The
accompanying notes are an integral part of these financial
statements








36






CARDIMA,
INC.


STATEMENTS OF OPERATIONS


(In
thousands, except per share amounts)





Year
      Ended December 31,2008
                  
                  
                  2007Net
      sales
                  
                  $
                  1,456
                  
                  
                  $
                  1,157Cost
      of goods sold
                  
                  
                  2,481
                  
                  
                  
                  1,613Gross
      deficiency
                  
                  
                  (1,025
                  )
                  
                  
                  (456
                  )Operating
      expensesResearch
      and development
                  
                  
                  4,381
                  
                  
                  
                  3,091Selling,
      general and administrative
                  
                  
                  8,312
                  
                  
                  
                  5,203Total
      operating expenses
                  
                  
                  12,693
                  
                  
                  
                  8,294Operating
      loss
                  
                  
                  (13,718
                  )
                  
                  
                  (8,750
                  )Other
      income (expense)Other
      income / (expense)
                  
                  
                  (121
                  )
                  
                  
                  17Interest
      income and (expense), net
                  
                  
                  115
                  
                  
                  
                  (865
                  )Loss
      on debt extinguishment
                  
                  
                  -
                  
                  
                  
                  (15,182
                  )Loss
      on excess shares over authorized
                  
                  
                  -
                  
                  
                  
                  (7,737
                  )Loss
      on debt settlement
                  
                  
                  -
                  
                  
                  
                  (10,129
                  )Total
      other income / (expense)
                  
                  
                  (6
                  )
                  
                  
                  (33,896
                  )Loss
      before income taxes
                  
                  
                  (13,724
                  )
                  
                  
                  (42,646
                  )Income
      taxes
                  
                  
                  1
                  
                  
                  
                  -Net
      loss
                  
                  $
                  (13,725
                  )
                  
                  $
                  (42,646
                  )Basic
      and diluted net loss per share
                  
                  $
                  (0.11
                  )
                  
                  $
                  (1.31
                  )Shares
      used in computing basic and diluted net loss per share
                  
                  
                  121,945
                  
                  
                  
                  32,442








The
accompanying notes are an integral part of these financial
statements








37











CARDIMA, INC.Statement of Shareholders’ Equity
      (deficit)For
      the years ended December 31, 2008 and 2007(In
      thousands)Convertible
      Preferred Stock Series A
                      
                      
                      Common
      Stock
                      
                      
                      Additional
                        Paid-In-Capital
                      
                      
                      
                      
                      
                      Total
      Shareholders’ Equity (deficit)Shares
                      
                      
                      Amount
                      
                      
                      Shares
                      
                      
                      Amount
                      
                      
                      
                      
                      Accumulated
      DeficitBalance
      at December 31, 2006
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      
                      10,235
                      
                      
                      $
                      9
                      
                      
                      $
                      121,185
                      
                      
                      $
                      (133,913
                      )
                      
                      $
                      (12,719
                      )Common
      stock issued under employee stock plans
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      75
                      
                      
                      
                      1
                      
                      
                      
                      34
                      
                      
                      
                      -
                      
                      
                      
                      35Common
      stock issued for services
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      6
                      
                      
                      
                      
                      
                      
                      
                      3
                      
                      
                      
                      -
                      
                      
                      
                      3Expense
      for vesting of stock options granted to employees and
      non-employees
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      488
                      
                      
                      
                      -
                      
                      
                      
                      488Relative
      fair value of warrants issued and beneficial conversion
      feature
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      12,073
                      
                      
                      
                      -
                      
                      
                      
                      12,073Warrants
      issued as compensation expense
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      1,234
                      
                      
                      
                      -
                      
                      
                      
                      1,234Conversion
      of Debt to Common stock and repurchase of warrants
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      88,000
                      
                      
                      
                      88
                      
                      
                      
                      27,702
                      
                      
                      
                      -
                      
                      
                      
                      27,790Sale
      of common stock
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      18,000
                      
                      
                      
                      18
                      
                      
                      
                      8,982
                      
                      
                      
                      -
                      
                      
                      
                      9,000Preferred
      Stock issued for fees
                      
                      
                      5,000
                      
                      
                      
                      500
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      500Reclassification
      of derivative liability for excess shares to paid-in
    capital
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      10,623
                      
                      
                      
                      -
                      
                      
                      
                      10,623Net
      Loss
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (42,646
                      )
                      
                      
                      (42,646
                      )Balance
      at December 31, 2007
                      
                      
                      5,000
                      
                      
                      $
                      500
                      
                      
                      
                      116,316
                      
                      
                      $
                      116
                      
                      
                      $
                      182,324
                      
                      
                      $
                      (176,559
                      )
                      
                      $
                      6,381Common
      stock issued under employee stock plans
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      343
                      
                      
                      
                      2
                      
                      
                      
                      160
                      
                      
                      
                      -
                      
                      
                      
                      162Expense
      for vesting of stock options granted to employees and
      non-employees
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      1,791
                      
                      
                      
                      -
                      
                      
                      
                      1,791Warrants
      issued as compensation expense
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      868
                      
                      
                      
                      -
                      
                      
                      
                      868Sale
      of common stock
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      8,475
                      
                      
                      
                      7
                      
                      
                      
                      5,077
                      
                      
                      
                      -
                      
                      
                      
                      5,084Net
      Loss
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (13,725
                      )
                      
                      
                      (13,725
                      )Balance
      at December 31, 2008
                      
                      
                      5,000
                      
                      
                      $
                      500
                      
                      
                      
                      125,134
                      
                      
                      $
                      125
                      
                      
                      $
                      190,220
                      
                      
                      $
                      (190,284
                      )
                      
                      $
                      561








The
accompanying notes are an integral part of these financial
statements








38







CARDIMA,
INC.


STATEMENTS OF CASH FLOWS


(In
thousands)




For
      the Years Ended December 31,2008
                  
                  
                  2007CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
                  
                  $
                  (13,725
                  )
                  
                  $
                  (42,646
                  )Adjustments
      to reconcile net loss to net cash used in operating
activities
                    provided
      by operations:Depreciation
      and amortization
                  
                  
                  190
                  
                  
                  
                  97Non-cash
      stock-based compensation
                  
                  
                  1,791
                  
                  
                  
                  491Non-cash
      compensation
                  
                  
                  868
                  
                  
                  
                  1,234Non-cash
      interest expense (income)
                  
                  
                  -
                  
                  
                  
                  649Loss
      on excess shares over authorized
                  
                  
                  -
                  
                  
                  
                  7,737Loss
      on debt extinguishment
                  
                  
                  -
                  
                  
                  
                  15,182Loss
      on debt settlement
                  
                  
                  -
                  
                  
                  
                  10,129Preferred
      shares issued for fees
                  
                  
                  -
                  
                  
                  
                  500Excess
      and obsolete inventory
                  
                  
                  -
                  
                  
                  
                  37Allowance
      for doubtful accounts
                  
                  
                  110
                  
                  
                  
                  63Changes
      in operating assets and liabilities:Accounts
      receivable
                  
                  
                  (96
                  )
                  
                  
                  168Inventories
                  
                  
                  (1,164
                  )
                  
                  
                  (116
                  )Prepaid
      and other assets
                  
                  
                  (519
                  )
                  
                  
                  18Accounts
      payable, accrued compensation and other liabilities
                  
                  
                  455
                  
                  
                  
                  (112
                  )Deferred
      revenue
                  
                  
                  112
                  
                  
                  
                  -Accrued
      interest and fees
                  
                  
                  83
                  
                  
                  
                  (111
                  )Net
      cash used in operating activities
                  
                  
                  (11,895
                  )
                  
                  
                  (6,680
                  )CASH
      FLOWS FROM INVESTING ACTIVITIESPurchase
      of short-term investment
                  
                  
                  (50
                  )
                  
                  
                  (2,008
                  )Maturity
      of short-term investment
                  
                  
                  2,008
                  
                  
                  
                  -Purchase
      of property and equipment
                  
                  
                  (686
                  )
                  
                  
                  (177
                  )Net
      cash provided by/(used in) investing activities
                  
                  
                  1,272
                  
                  
                  
                  (2,185
                  )CASH
      FLOWS FROM FINANCING ACTIVITIESPrincipal
      payments under capital leases and credit facility
                  
                  
                  (24
                  )
                  
                  
                  (15
                  )Proceeds
      from notes payable
                  
                  
                  5,990
                  
                  
                  
                  -Payments
      on notes payable
                  
                  
                  (75
                  )
                  
                  
                  (6
                  )Net
      proceeds from loan financing
                  
                  
                  -
                  
                  
                  
                  3,720Net
      proceeds from sale of common stock
                  
                  
                  5,246
                  
                  
                  
                  9,035Net
      cash provided by financing activities
                  
                  
                  11,137
                  
                  
                  
                  12,734Change
      in cash and cash equivalents
                  
                  
                  514
                  
                  
                  
                  3,869Beginning
      cash and cash equivalents
                  
                  
                  4,811
                  
                  
                  
                  942Ending
      cash and cash equivalents
                  
                  $
                  5,325
                  
                  
                  $
                  4,811SUPPLEMENTAL
      DISCLOSURE OF CASH FLOWS INFORMATIONCash
      paid for income taxes
                  
                  $
                  1
                  
                  
                  $
                  -Cash
      paid for interest
                  
                  $
                  28
                  
                  
                  $
                  10SUPPLEMENTAL
      SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIESConversion
      of debt to equity
                  
                  $
                  -
                  
                  
                  $
                  10,129Equipment
      acquired under capital lease arrangements
                  
                  $
                  79
                  
                  
                  $
                  -Issuance
      of preferred stock to pay for accrued fees
                  
                  $
                  -
                  
                  
                  $
                  500









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






39






CARDIMA,
INC.


Notes to Financial Statements


December
31, 2008







1.  Nature
of Business and Summary of Significant Accounting Policies




Nature
of Business




Cardima,
Inc., (“The Company”) was incorporated in the State of Delaware on November 12,
1992. We are a medical device company focused on the diagnosis and treatment of
cardiac arrhythmias.  Arrhythmias develop from abnormal electrical
currents within the heart, and can be associated with fast, slow and/or
irregular heartbeats.  Most arrhythmias are symptomatic, and some are
associated with significant morbidity and even mortality.  Our
products have been developed for the diagnosis and treatment of the two most
common forms of arrhythmias, atrial fibrillation (AF) and ventricular
tachycardia (VT), with AF being the focus of our clinical and commercial
efforts. We sell our products worldwide through distribution
channels.





Reverse
Stock split





Our Board
of Directors authorized a one-for-ten reverse stock split which became effective
on July 31, 2007 to shareholders of record. Based on approximately 102,354,679
pre-split shares of Common Stock issued and outstanding as of  June
30, 2007, the following table reflects a range of the approximate percentage
reduction in the outstanding shares of Common Stock and the approximate number
of shares of Common Stock that are outstanding as a result of the Reverse Stock
Split.




Reverse
                  Percentage
                  Post-splitStock Split
                  Reduction
                  Shares1
      for 10
                  90%
                  10,235,468




All
outstanding options, warrants, rights and convertible securities were
appropriately adjusted for the Reverse Stock Split automatically on the
effective date of the Reverse Stock Split. The Reverse Stock Split affects all
stockholders equally and does not affect any stockholder’s proportionate equity
interest in the Company except for those stockholders whose fractional shares
will be rounded up.




None of
the rights currently accruing to holders of the Common Stock, options or
warrants to purchase Common Stock or securities convertible into Common Stock
are affected by the Reverse Stock Split. Following the Reverse Stock Split, each
share of New Common Stock entitled the holder thereof to one vote per share and
is otherwise identical to one share of the Old Common Stock. The percentage
ownership of management, the number of stockholders or any aspect of our
business has not changed materially because of the Reverse Stock
Split.




All
references in the financial statements to the number of shares outstanding, per
share amounts, and stock option data of our common stock have been restated to
reflect the effect of the stock split for all periods presented.




Use
of Estimates




The
preparation of financial statements in conformity with generally accepted
accounting principles in the United States requires management to make estimates
and assumptions that affect the amounts of assets and liabilities, disclosures
of contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reported period. Actual
results could differ from those estimates and such differences could affect the
results of operations reported in future periods.





We make
estimates that affect reserves for allowance for doubtful accounts, inventory
reserves, deferred income tax assets, estimated useful lives of property and
equipment, accrued expenses, fair value of equity instruments and reserves for
any other commitments or contingencies.  Any adjustments applied to
estimates are recognized in the period in which such adjustments are
determined.





Revenue
Recognition




We
recognize revenue from two types of customers, end users and distributors.
Revenue is recognized in accordance with Staff Accounting Bulletin 104, “Revenue Recognition,” when
all of the following criteria are met: persuasive evidence of an arrangement
exists, shipment of the product has occurred and title of products transferred
at the point of shipment, payment of the product is reasonably assured and no
substantive obligations to the customer remain. Revenue is presented net of
discounts, allowances, and returns. Payment terms are either open trade credit
or cash. We generally allow the customers to return defective, damaged and in
certain cases expired products for credit. We have distributors in Asia and
Europe and we record as revenue the wholesale price we charge our distributors.
The distributors assume the title and the risk of loss at the shipping point.
The distributors do not have any price protection or return rights. We also have
agreements with group purchasing organizations to sell our products to
participating hospitals at negotiated prices. We recognize revenue from these
agreements following the same revenue recognition criteria discussed
above.








40







Comprehensive
Income




We
utilize Statement of Financial Accounting Standards (“SFAS”) No. 130,
“Reporting Comprehensive
Income.” This statement establishes standards for reporting comprehensive
income and its components in a financial statement. Comprehensive income as
defined includes all changes in equity (net assets) during a period from
non-owner sources. Examples of items to be included in comprehensive income,
which are excluded from net income, include foreign currency translation
adjustments, minimum pension liability adjustments, and unrealized gains and
losses on available-for-sale securities. Comprehensive income is not presented
in our financial statements since we did not have any changes in equity from
non-owner sources.





Inventories




Inventories
are stated at the lower of cost or market value.  Cost is determined
by the first-in, first-out method and market represents the estimated net
realizable value. We base our provisions for excess, obsolete or expired
inventory primarily on a percentage based on our aged category and on our
production levels. A significant change in the timing or level of demand for our
products as compared to forecasted amounts may result in recording additional
provisions for excess, obsolete or expired inventory in the future. The industry
in which we participate is characterized by rapid product development and
frequent new product introductions. Uncertain timing of next-generation product
approvals, variability in product launch strategies, product recalls and
variation in product utilization all affect the estimates related to excess and
obsolete inventory. If actual product life cycles, product demand and market
conditions are less favorable than those projected by management, additional
inventory write-downs may be required.  At the point of the loss
recognition, a new, lower-cost basis for that inventory is established, and
subsequent changes in facts and circumstances do not result in the restoration
or increase in that newly established cost basis.




Assets
Held as Leasehold Improvements




Assets
held as leasehold improvements are recorded at cost and included with property
and equipment. Amortization expense is computed using the straight-line method
over the shorter of the estimated useful lives of the assets or the period of
the related lease.





Cost
of Goods Sold





Cost of
goods sold primarily includes raw material costs, catheter fabrication costs,
system assembly, shipping and handling charges, testing costs and manufacturing
overhead.





Research
and Development




Research
and development costs, which include clinical and regulatory costs, are charged
to expense as incurred.




Impairment
of Long-Lived Assets




We assess
the impairment of our long-lived assets periodically in accordance with the
provisions of Statement of Financial Accounting Standards (“SFAS”) 144, “Accounting for the Impairment and
Disposal of Long-Lived Assets”.




We review
the carrying value of property and equipment for impairment whenever events and
circumstances indicate that the carrying value of an asset may not be
recoverable from the estimated future cash flows expected to result from its use
and eventual disposition. In cases where undiscounted expected future cash flows
are less than the carrying value, an impairment loss is recognized equal to an
amount by which the carrying value exceeds the fair value of assets. The factors
considered by management in performing this assessment include current operating
results, trends, and prospects, as well as the effects of obsolescence, demand,
competition, and other economic factors. During the year ended December 31,
2008, we believe that there has been no indicator of impairment.





Reclassification





Certain
reclassifications have been made to prior period amounts to conform to the
current year presentation.




Income
Taxes




We
utilize SFAS No. 109, “Accounting for Income Taxes,”
which requires the recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been included in the
financial statements or tax returns. Under this method, deferred income taxes
are recognized for the tax consequences in future years of differences between
the tax bases of assets and liabilities and their financial reporting amounts at
each year-end based on enacted tax laws and statutory tax rates applicable to
the periods in which the differences are expected to affect taxable income.
Valuation allowances are established, when necessary, to reduce deferred tax
assets to the amount expected to be realized.






41







In June
2006, the FASB issued FASB Interpretation No. (“FIN”) 48 “Accounting for Uncertainty in Income
Taxes, an interpretation of FASB Statement No. 109.” FIN 48
clarifies the accounting for uncertainty in income taxes. FIN 48 prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return. FIN 48 requires that a Company recognize in the financial statements
the impact of the tax position if that position will more likely than not be
sustained on audit, based on the technical merits of the position. FIN 48 also
provides guidance related to de-recognition, classification, interest and
penalties, accounting in interim periods and disclosure. If there are changes in
net assets as a result of application of FIN 48, these will be accounted for as
an adjustment to retained earnings. We determined that there was no impact as a
result of the adoption of FIN No. 48.




Stock
Based Compensation





On
January 1, 2006, we adopted SFAS 123 (revised 2004), Share-Based
Payment (“SFAS 123(R)”), which requires the measurement and recognition of
compensation expense for all share-based awards made to employees and directors,
including employee stock options and shares issued through its employee stock
purchase plan, based on estimated fair values. In March 2005, the Securities and
Exchange Commission issued Staff Accounting Bulletin 107 (“SAB 107”)
relating to SFAS 123(R). We have applied the provisions of SAB 107 in
its adoption of SFAS 123(R). We adopted SFAS 123(R) using the modified
prospective transition method, which requires the measurement and recognition of
compensation expense for all share-based awards made to employees, consultants,
directors, including employee non-qualified and incentive stock options, and
employee purchase rights under our Employee Stock Purchase Plan based on
estimated fair values beginning in 2006.





Stock
compensation expense recognized during the period is based on the value of
share-based awards that are expected to vest during the period. Stock
compensation expense recognized in our statements of operations include
compensation expense related to share-based awards granted prior to
January 1, 2006 that have vested based on the grant date fair value
estimated in accordance with the pro forma provisions of SFAS 123. Stock
compensation expense also includes compensation expense for the share-based
awards granted subsequent to January 1, 2006 based on the grant date fair
value estimated in accordance with the provisions of
SFAS 123(R).




We use
the Black-Scholes method to determine fair value of stock options
granted.  The Black-Scholes model requires the use of highly
subjective and complex assumptions which determine the fair value of share-based
awards, including the option’s expected term and the price volatility of the
underlying stock. Stock-based compensation expense is calculated based on the
fair market value of our stock on the date of grant.




Net
Loss per Share




The
Company utilizes SFAS No. 128, “Earnings per Share.” Basic
loss per share is computed by dividing loss available to common stockholders by
the weighted-average number of common shares outstanding. Diluted loss per share
is computed similar to basic loss per share except that the denominator is
increased to include the number of additional common shares that would have been
outstanding if the potential common shares had been issued and if the additional
common shares were dilutive. Common equivalent shares are excluded from the
computation if their effect is anti-dilutive. Our common share equivalents
consist of stock options, warrants, and convertible preferred
shares.





The
following outstanding anti-dilutive securities are not included in the
calculation of diluted net loss per share attributable to common
stockholders:





2008
                
                
                2007Options
      to purchase common stock
                
                
                9,301,636
                
                
                
                5,988,496Warrants
      to purchase common stock
                
                
                9,228,656
                
                
                
                6,561,994Convertible
      preferred shares
                
                
                1,000,000
                
                
                
                1,000,000Total
                
                
                19,530,292
                
                
                
                13,550,490





The
following table presents the calculation of basic and diluted net loss per
share: (in thousands, except per share amounts)




2008
                
                
                2007Net
      loss available to common shareholders
                
                $
                (13,725
                )
                
                $
                (42,646
                )Weighted
      average common shares outstanding
                
                
                121,945
                
                
                
                32,442Basic
      and diluted net loss per share available to common
      shareholders
                
                $
                (0.11
                )
                
                $
                (1.31
                )










42






Cash
and Cash Equivalents




Cash and
cash equivalents include all cash balances and highly liquid investments with an
initial maturity of three months or less. We place our temporary cash
investments with high credit quality financial institutions. In October 2008,
the Federal Deposit Insurance Corporation announced the Term Policy Liquidity
Guarantee Program which provides deposit insurance for funds in non-interest
bearing transaction deposit accounts. As of December 31, 2008, we had cash and
cash equivalents of $5.3 million.





Accounts
Receivables and Allowance for Doubtful Accounts




Trade
accounts receivable are stated at the amount we expect to collect. We recognize
allowances for doubtful accounts for estimated losses resulting from the
inability of our customers to make required payments. We use the allowance
method to account for uncollectible accounts receivable. Our estimate is based
on historical collection experience and a review of the current status of
accounts receivable. We review our accounts receivable balances by customer for
accounts greater than 90 days old and make a determination regarding the
collectability of the accounts based on specific circumstances and the payment
history that exists with such customers. We also take into account our prior
experience, the customer’s ability to pay and an assessment of the current
economic conditions in determining the net realizable value of our receivables.
We also review allowance for doubtful accounts in aggregate for adequacy
following this assessment. Accordingly, we believe that our allowance for
doubtful accounts fairly represent the underlying collectability risks
associated with our accounts receivable. For the period ended December 31,
2008 and 2007, we established an allowance for doubtful accounts of $187,000 and
$77,000, respectively.





Short-Term
Investments





Short-term
investments consist of certificates of deposit with maturities of less than a
year.





Property
and Equipment





Property
and equipment are stated at cost less accumulated depreciation and amortization.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets. Equipment held under capital leases is classified as
capital assets and amortized using the straight line method over the term of the
lease or the estimated useful life, whichever is shorter. Minor replacements,
maintenance, and repairs that do not increase the useful life of the assets are
expensed as incurred.  (see Note 4)




Comprehensive
Loss





Comprehensive
loss consists of net loss and other gains and losses affecting stockholders’
equity that, under generally accepted accounting principles are excluded from
net loss in accordance with Statement of Financial Accounting Standards No. 130,
Reporting Comprehensive
Income.  We, however, do not have any components of other
comprehensive loss as defined by SFAS No. 130 and therefore, for the years ended
December 31, 2008 and 2007, comprehensive loss is equivalent to our reported net
loss.  Accordingly, a statement of comprehensive loss is not
presented.





Classification
of Financial Instruments





In
accordance to FASB Statement of Financial Accounting Standards ("SFAS") 150,
"Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity", financial instruments with mandatory redemption rights are to be
recorded as liabilities unless the redemption is to occur upon the liquidation
or termination of the issuer. SFAS 150 also specifies that a financial
instrument that embodies a conditional obligation is based solely or
predominantly on variations inversely related to changes in the fair value of
the issuer's equity shares. Based on these characteristics, we have recorded the
value of warrants issued and the outstanding shares of Preferred Stock Series A
as a component of equity on the balance sheet.





Accounting
for Convertible Debt Securities





We
account for the notes and related provisions in accordance with provisions of
EITF 98-5, “Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios”, EITF 00-27, “Application of Issue No. 98-5
to Certain Convertible Instruments”, FASB Staff Position (“FSP”) No. EITF
00-19-2 “Accounting for
Registration Payment Arrangements”, EITF 00-19 Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company's Own
Stock, and EITF 01-6, The Meaning of “Indexed to a
Company’s Own Stock”.The Company also evaluates the instruments in
accordance with Statement of Financial Accounting Standards (“FAS”)
No. 133, “Accounting for
Derivative Instruments and Hedging Activities” requires bifurcation of
embedded derivative instruments and measurement of fair value for accounting
purposes. In addition, FAS 155, “Accounting for Certain Hybrid
Financial Instruments” allows measurement of fair values of hybrid
financial instruments for accounting purposes. In determining the appropriate
fair value, we use the Black Scholes model and the net present value of certain
penalty amounts.






43




Extinguishment
of Debt





We follow
the provisions of SFAS No. 140 "Accounting for Transfers and
Servicing ofFinancialAssets and Extinguishments of
Liabilities" ("SFAS No. 140") along with related interpretations from
Emerging Issues Task Force No. 96-19 ("EITF No. 96-19"). The Task Force
reached a consensus that an exchange of debt instruments with substantially
different terms is a debt extinguishment and should be accounted for in
accordance with paragraph 16 of SFAS No. 140. The Task Force also observed that
a debtor could achieve the same economic effect by making a substantial
modification of terms of an existing debt instrument. Accordingly, the Task
Force reached a consensus that a substantial modification of terms should be
accounted for like, and reported in the same manner as, an extinguishment of
debt.





From the
debtor's perspective, an exchange of debt instruments between or a modification
of a debt instrument by a debtor and a creditor in a non-troubled debt situation
is deemed to have been accomplished with debt instruments that are substantially
different if the net present value of the cash flows under the terms of the new
debt instrument is at least 10 percent different from the present value of the
remaining cash flows under the terms of the original instrument. We had
Amendments in February 2006 and June 2007 to the convertible promissory note and
the related warrants issued to APIX, and substantial modification in terms of
the convertible note occurred. Upon further analysis, we determined that a
greater than 10% difference in the net present value of the remaining cash flows
of both the original convertible note and the new convertible note had occurred.
Therefore, we extinguished the original convertible note, along with the related
unamortized discounts and deferred loan costs, and recorded the new convertible
note at its fair value. The extinguishments required us to record an
extinguishment debt expense of $15.2 million in 2007.





Stock
Warrants Issued to Third Parties





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




Segment
Reporting




We
identify our operating segments based on how we evaluate separate financial
information (if available), business activities and management responsibilities.
We have determined that we operate in a single business segment, the
manufacturing and sale of device-based medical therapies. All of our revenues
have been derived from this business segment.




Fair
Value of Financial Instruments




Our
financial instruments at December 31, 2008 consist of cash, a short term
investment, accounts receivable, inventory, accounts payable, other current
liabilities, loan payable and capital lease obligation. The carrying values of
these financial instruments approximate their fair values.




Off-Balance-Sheet
Arrangements





As of
December 31, 2008 and 2007, we did not have any off-balance sheet
arrangements.





Commitments
and Contingencies




Certain
conditions may exist as of the date the financial statements are issued, which
may result in a loss to us but which will only be resolved when one or more
future events occur or fail to occur. Our management and our legal counsel
assess such contingent liabilities, and such assessment inherently involves an
exercise of judgment. In assessing loss contingencies related to legal
proceedings that are pending against us or unasserted claims that may result in
such proceedings, our legal counsel evaluates the perceived merits of any legal
proceedings or unasserted claims as well as the perceived merits of the amount
of relief sought or expected to be sought therein. If the assessment of a
contingency indicates that it is probable that a material loss has been incurred
and the amount of the liability can be estimated, then the estimated liability
would be accrued in our financial statements. If the assessment indicates that a
potentially material loss contingency is not probable, but is reasonably
possible, or is probable but cannot be estimated, then the nature of the
contingent liability, together with an estimate of the range of possible loss if
determinable and material, would be disclosed. Loss contingencies considered
remote are generally not disclosed unless they involve guarantees, in which case
the nature of the guarantee would be disclosed.






44







Concentration
of Credit Risk




Financial
instruments which potentially subject us to concentrations of credit risk
consist of cash and cash equivalents and accounts receivable. We place our cash
and cash equivalents with high credit, quality financial institutions. We have
not experienced any losses in such accounts and believe we are not exposed to
any significant credit risk on cash and cash equivalents. With respect to
accounts receivable, we routinely assesses the financial strength of our
customers and, as a consequence, believe that the receivable credit risk
exposure is limited.




Recent
Accounting Pronouncements





In
June 2007, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 06-11,
"Accounting for Income Tax
Benefits of Dividends on Share-Based Payment Awards." EITF Issue No 06-11
requires that tax benefits generated by dividends paid during the vesting period
on certain equity-classified share-based compensation awards be treated as
additional paid-in capital and included in a pool of excess tax benefits
available to absorb tax deficiencies from share-based payment awards. EITF Issue
No. 06-11 is effective beginning with the 2008 fiscal year. The adoption of
EITF Issue No. 06-11 did not have a significant impact on our financial
position, results of operations or cash flows.





Also in
June 2007, the FASB ratified EITF Issue No. 07-3, "Accounting for Advance Payments for
Goods or Services to Be Used in Future Research and Development
Activities." EITF 07-3 provides that nonrefundable advance payments made
for goods or services to be used in future research and development activities
should be deferred and capitalized until such time as the related goods or
services are delivered or are performed, at which point the amounts would be
recognized as an expense. This issue is effective for fiscal years beginning
after December 15, 2007.  The adoption of EITF 07-3 did not have a
material impact on our financial position and results of
operations.





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




In
September 2006, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements (SFAS
No. 157)”. SFAS No. 157 establishes a framework for measuring fair
value, clarifies the definition of fair value and requires additional
disclosures about fair-value measurements. In general, SFAS No. 157 applies
to fair value measurements that are already required or permitted by other
accounting standards and is expected to increase the consistency of those
measurements. SFAS No. 157, as issued, is effective for fiscal years
beginning after November 15, 2007. In February 2008, the FASB issued FASB
Staff Position (FSP) SFAS No. 157-2, Effective Date of FASB Statement No.
157 (FSP SFAS No. 157-2) which deferred the effective date of SFAS No.
157 for one year for certain nonfinancial assets and nonfinancial liabilities.
Accordingly, we adopted the required provisions of SFAS No. 157 at the beginning
of fiscal year 2008 and the remaining provisions will be adopted by us at the
beginning of fiscal year 2009. The 2008 fiscal year adoption did not result in a
material impact to our financial statements. In October 2008, the FASB issued
FSP 157-3, Determining the
Fair Value of a Financial Asset when the Market of that Asset is not
Active, or FSP 157-3. FSP 157-3 clarifies the application of SFAS 157 in
a market that is not active and provides an example to illustrate key
considerations in determining the fair value of a financial asset when the
market for that financial asset is not active. We are currently evaluating the
impact of adopting the remaining parts of SFAS No. 157 and FSP 157-3 in fiscal
year 2009.




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




In
December 2007, the FASB issued FAS No. 160, “Accounting for Noncontrolling
Interests.” FAS No. 160 clarifies the classification of noncontrolling
interests in consolidated statements of financial position and the accounting
for and reporting of transactions between the reporting entity and holders of
such noncontrolling interests. Under the standard, noncontrolling interests are
considered equity and should be reported as an element of consolidated equity,
and net income will encompass the total income of all consolidated subsidiaries
and there will be separate disclosure on the face of the income statement of the
attribution of that income between the controlling and noncontrolling interests.
FAS No. 160 is effective prospectively for fiscal years beginning after December
15, 2008. The adoption of FAS No. 160 did not have a significant impact on our
results of operations, financial condition or liquidity.








45





In March
2008, the FASB issued FAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities,” an amendment of FASB Statement No.
133 “Accounting for Derivative
Instruments and Hedging Activities”. FAS No. 161 requires entities to
provide greater transparency about how and why an entity uses derivative
instruments, how derivative instruments and related hedged items are accounted
for under FAS No. 133, and how derivative instruments and related hedged items
affect an entity’s financial position, results of operations, and cash flows.
The statement is effective for financial statements issues for fiscal years and
interim periods beginning after November 15, 2008, and is not expected to have a
significant impact on our results of operations, financial condition or
liquidity.





In May
2008, the FASB issued Financial Accounting Standard (“FAS”) No. 162, “The Hierarchy of Generally Accepted
Accounting Principles.” The statement is intended to improve financial
reporting by identifying a consistent hierarchy for selecting accounting
principles to be used in preparing financial statements that are prepared in
conformance with generally accepted accounting principles. Unlike Statement on
Auditing Standards (“SAS”) No. 69, “The Meaning of Present in Conformity
With GAAP,” FAS No. 162 is directed to the entity rather than the
auditor. The statement is effective 60 days following the SEC’s approval of the
Public Company Accounting Oversight Board (“PCAOB”) amendments to AU Section
411, “The Meaning of Present
Fairly in Conformity with GAAP,” and is not expected to have any impact
on our results of operations, financial condition or liquidity.





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





In June
2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff
Position (“FSP”) Emerging Issues Task Force (EITF) No. 03-6-1, “Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating
Securities.” Under the FSP, unvested share-based payment awards that
contain rights to receive nonforfeitable dividends (whether paid or unpaid) are
participating securities, and should be included in the two-class method of
computing earnings per share. The FSP is effective for fiscal years beginning
after December 15, 2008, and interim periods within those years, and is not
expected to have a significant impact on our results of operations, financial
condition or liquidity.





Private
Placement




Apix
International Limited (“APIX”) is an entity that is solely owned by Robert
Cheney who is also the CEO, CFO and a Director of our Company. Mr. Cheney was
appointed as the CEO in June 2007. APIX acted as agent for all of our recent
financing activities.





In
December 2007, we entered into a series of Subscription Agreements (the
“Subscription Agreement”) with certain accredited investors (collectively, the
“Investors”) providing for the sale of (i) a total of 18 million shares of our
Common Stock in the aggregate principal amount of $9 million (the “Shares”)
and (ii) warrants (the “Warrants”) to purchase an aggregate of 2.7 million
shares of our Common Stock at an exercise price of $0.55 per share. At our
option, we may force the Investors to exercise the Warrant at a price per share
equal to $0.55, provided that (i) our Common Stock is trading at a price equal
to or greater than $1.00 for a period of fifteen (15) consecutive trading days
ending on the date preceding the date we send a notice to the Holder in which we
announce our intention to force the exercise of the Warrants and (ii) a
registration statement is in effect with respect to the Warrant
Shares.  The Warrants have an expiration date of 5 years from the date
of issuance. Pursuant to the Subscription Agreement, we have agreed to use our
best efforts to secure effectiveness of, as soon as reasonably practicable after
the issuance and delivery of the Shares and Warrants, a registration statement
on Form SB-2, now S-1. We issued warrants to APIX to purchase an aggregate of 3
million shares of our Common Stock at an exercise price of $0.55 per
share.  We provided for $75,000 in expense
reimbursements.




In May
2008, we entered into a series of Subscription Agreements (the “Subscription
Agreement”) with certain accredited investors (collectively, the “Investors”)
providing for the sale of (i) a total of 8,474,992 shares of our Common Stock in
the aggregate principal amount of $5.1 million (the “Shares”) and (ii)
warrants (the “Warrants”) to purchase an aggregate of 1,271,247 shares of our
Common Stock at an exercise price of $0.65 per share. At our option, we may
force the Investors to exercise the Warrant at a price per share equal to $0.65,
provided that (i) our Common Stock is trading at a price equal to or greater
than $1.00 per share for a period of fifteen (15) consecutive trading days
ending on the date preceding the date we send a notice to the Holder in which we
announce our intention to force the exercise of the Warrants and (ii) a
registration statement is in effect with respect to the Warrant Shares. We
also issued 1,500,000 warrants to purchase shares of our common stock to APIX at
an exercise price of $0.60 per share. The Warrants have an expiration date of 5
years from the date of issuance. Pursuant to the Subscription Agreement, we have
agreed to use our best efforts to secure effectiveness of, as soon as reasonably
practicable after the issuance and delivery of the Shares and Warrants, a
registration statement on Form SB-2, now S-1. We provided for $80,000 in expense
reimbursements.






46






On
February 28, 2009, we entered into a subscription agreement with an accredited
investor providing for the sale of (i) a total of 18,518,518 shares of our
Common Stock at a price equal to $1.08 per share, in the aggregate principal
amount of $20 million and (ii) warrants to purchase an aggregate of 5,555,555
shares of our Common Stock at an exercise price of $1.25 per share. At our
option, we may force the Holder to exercise the Warrant at a price per share
equal to $1.08, provided that (i) our Common Stock is trading at a price equal
to or greater than $1.58 per share for a period of fifteen (15) consecutive
trading days ending on the date preceding the date we send a notice to the
Holder in which we announce our intention to force the exercise of the Warrants
and (ii) a registration statement is in effect with respect to the Warrant
Shares. The Warrants have an expiration date of 5 years from the date of
issuance. Pursuant to the Subscription Agreement, we have agreed to use our best
efforts to secure effectiveness of, as soon as reasonably practicable after the
issuance and delivery of the Shares and Warrants, a registration statement on
Form SB-2, now S-1.  We provided for up to $80,000 in expense
reimbursements.





All of
the above offerings and sales were deemed to be exempt under rule 506 of
Regulation D and Section 4(2) and/or Regulation S of the Securities Act of 1933,
as amended. No advertising or general solicitation was employed in offering the
securities. The offerings and sales were made to a limited number of persons,
all of whom were accredited investors, business associates of the Company or
executive officers of the Company, and transfer was restricted by the Company in
accordance with the requirements of the Securities Act of 1933. In addition to
representations by the above-referenced persons, we have made independent
determinations that all of the above-referenced persons were accredited or
sophisticated investors, and that they were capable of analyzing the merits and
risks of their investment, and that they understood the speculative nature of
their investment. Furthermore, all of the above-referenced persons were provided
with access to our Securities and Exchange Commission filings.





Extinguishment
of debt





On
February 14, 2006 we received an extension of our credit facility of $660,000
and an extension of the maturity date from February 28, 2006 to May 31, 2006,
and were granted control of the exercise of warrants. At that date we were
deemed no longer to be required to net cash settle the warrants or the
convertible features of the debt. In exchange, we granted the lender an
additional 3,180,000 (post split) warrants and reduced the exercise price from
$0.10 to $0.06 per share. We also agreed to pay additional fees of $680,000 and
give the lender convertibility of the principal portion of the debt. We
determined that the transaction should be treated as an extinguishment of debt.
In conjunction with the transaction we recognized a loss of $2.3 million. The
value of the beneficial conversion feature was recorded at its intrinsic value.
The additional warrants were computed using the Black Scholes method assuming a
4.8% risk free interest rate, a life of 0.32 years, and a volatility rate of
92.29%.




On June
27, 2007 we received an additional extension of our credit facility and an
extension of the maturity date from February to December 31, 2007 in conjunction
with a plan to convert all of the existing debt to equity, as discussed in Note
1. In exchange we granted the lender an additional 14,160,000 warrants, reduced
the exercise price from $0.06 to $0.04 per share. We also agreed to pay
additional fees of $3.4 million. We determined that the transaction should be
treated as an extinguishment of debt. In conjunction with the transaction, we
recognized a loss of $15.2 million. The additional warrants were computed using
the Black Scholes method assuming a 4.8% risk free interest rate, a life of 9.16
years, and a volatility rate of 160.39%.  At the same time we eliminated
our derivative warrant liability as described in EITF 00-19. As the maturity
date was short and within our fiscal year, we deemed that the additional fees
were part of the extinguishment and included them as part of the loss as noted
above.




As the
conversion of debt to equity was pending, October 3, 2007, and within our fiscal
year, we deemed that the additional fees were part of the extinguishment and
included them as part of the loss. The facility fee of $500,000 was immediately
converted to 5,000,000 shares of preferred stock series A.





2.  Short
term investment





As of
December 31, 2008, and 2007, we had $50,000 and $2 million, respectively, in a
certificate of deposit with maturity periods of less than twelve-months. The
$50,000 certificate-of-deposit is used as a collateral for our corporate credit
card.






47





3.  Inventories





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




December
      31,2008
                
                
                2007Raw
      Materials
                
                $
                736
                
                
                $
                611Work-In-Process
                
                
                34
                
                
                
                23Finished
      Goods
                
                
                1,024
                
                
                
                384Reserve
      for obsolescence
                
                
                (228
                )
                
                
                (616
                )Inventories
                
                $
                1,566
                
                
                $
                402





Inventories shown above are valued
using FIFO and are adjusted to the lower of cost or market.  The
Company had allowances for excess and obsolete inventory of approximately
$228,000 and $616,000 at December 31, 2008 and 2007,
respectively.  The Company had inventories located in foreign
countries, and held by our local distributors, of approximately $83,000 and
$50,000 as of December 31, 2008 and 2007, respectively.





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





Pursuant
to SAFA No. 151, “Inventory
Costs – an amendment of ARB No. 43, Chapter 4” (“SFAS No. 151”), which
amends the guidance in Accounting Research Bulletin No. 43, Chapter 4, "Inventory Pricing," to
clarify the accounting for abnormal amounts of idle facility expense, freight,
handling costs and wasted material, or spoilage. Under some circumstances, SFAS
No. 151 mandates that items such as idle facility expense, excessive spoilage,
double freight and re-handling costs be recognized as current-period charges. In
addition, SFAS No. 151 requires that allocation of fixed production overheads to
the costs of conversion be based on the normal capacity of the production
facilities. SFAS No. 151 is effective for inventory costs incurred during fiscal
years beginning after June 15, 2005. In the fourth quarter of 2008, we had
identified $261,000 of idle facility costs as certain plant operating costs as a
result of an extended period of production down-time for maintenance of
manufacturing equipment as well as down-time due to FDA audits. These are
included in our research and development and general and administrative expenses
on our statement of operations for 2008.





4.  Property
and Equipment




Property
and equipment, including equipment under capital leases, are carried at cost
less accumulated depreciation and amortization. Property and equipment are
depreciated using the straight-line method over the estimated useful lives,
generally three to five years. Leasehold improvements are amortized using the
straight-line method over the shorter of the estimated useful life of the asset
or the remaining term of the lease. Depreciation expense includes amortization
of capital leases and leasehold improvements. Depreciation expense was
approximately $190,000 and $97,000 for fiscal years 2008 and 2007,
respectively.




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




December
      31, 2008
                    
                    
                    December
      31, 2007Equipment
                    
                    $
                    3,554
                    
                    
                    $
                    3,520Leasehold
      improvements
                    
                    
                    358
                    
                    
                    
                    2703,912
                    
                    
                    
                    3,790Less
      accumulated depreciation and amortization
                    
                    
                    (2,988
                    )
                    
                    
                    (3,428
                    )Property
      and equipment, net
                    
                    $
                    924
                    
                    
                    $
                    362





Equipment
includes property and equipment financed under capital leases, which amounts to
approximately $79,000 at December 31, 2008. Accumulated amortization related to
the leased assets is $16,000.  Equipment also includes $1,290,000 of fully
depreciated idle equipment during 2008 and 2007.




5.  Loans
Payable





On
November 11, 2008, we executed a Loan Term Sheet and Loan Commitment letter with
an accredited investor and shareholder of our company pursuant to which we
issued a secured promissory note (the "Note") in the principal amount of $6
million.  The Note bears interest at a rate of 10% per year and
matures on November 10, 2009.  The Note includes a general security
interest in all of our assets. APIX acted as placement agent for the
transaction. We provided for $80,000 in expense reimbursements.






48







As
previously disclosed, in December 2006, a settlement agreement was reached with
our former President and Chief Operating Officer, William K. Wheeler, in which
we agreed to pay Mr. Wheeler $295,000 and he agreed to reimburse the Company
$192,500 for a loan he received from Cardima in June 2000 and May
2001.  In accordance with the Accounting Principle Board (“APB”) No.
21, “Interest on Receivables and Payables”, we recorded the discounted value of
the note payable and note receivable of $232,287 and $162,022, respectively at
December 31, 2006.  The net of these two values, or $53,000, is
reported as $12,000 and $41,000 under current and non-current loans payable, as
of December 31, 2008, respectively.





6. Related
Party Note Payable





In
December 2007, we entered into a series of Subscription Agreements with certain
accredited investors providing for the sale of 18 million shares of our Common
Stock in the aggregate principal amount of $9 million. Per the Amended Funding
Agreement, APIX waived its five-percent common share placement fee and accepted
for its services rendered; (i) an additional one million warrants (total three
million warrants) to purchase shares of our common stock at an exercise price of
$0.55 per share; and (ii) all rights, title and interest in a loan totaling
$360,000, including accrued interest, owed to us by Phil Radlick, a Director of
our Company, with a guaranteed minimum recoverable value of not less than
$100,000. We have extinguished all of our obligations under this Amended Funding
Agreement in the first quarter of 2009.





On
November 11, 2008, we executed a Loan Term Sheet and Loan Commitment letter (the
"Financing Documents") with an accredited investor and our largest individual
shareholder of our company (the “Note Holder”) pursuant to which we issued
a secured promissory note (the "Note") in the principal amount of $6 million
(the “Advance”).  The Note provided for interest at a rate of 10% per
year and a maturity date of November 10, 2009.  We agreed to grant the
Holder a general charge on all of our assets.





On
February 28, 2009, we entered into a subscription agreement with the Note Holder
providing for the sale of 18,518,518 shares of our Common Stock in the aggregate
principal amount of $20 million. Under the terms of the agreement, the Note
Holder agreed to convert the $6 million in aggregate principal amount of the
Note into shares of common stock, in accordance with the same terms of the
subscription agreement. The exchange relieves us from the need to retire the
Note at its maturity.





7.  Commitments
and Contingencies




Commitments




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




Fiscal Year
                    
                    Operating
      Leases
                    
                    
                    Capital
      Leases2009
                    
                    $
                    272
                    
                    
                    $
                    312010
                    
                    $
                    115
                    
                    
                    $
                    312011
                    
                    $
                    -
                    
                    
                    $
                    18$
                    387
                    
                    
                    $
                    80Less
      amounts representing interest
                    
                    $
                    -
                    
                    
                    $
                    (10
                    )Present
      Value of net minimum lease payments
                    
                    $
                    387
                    
                    
                    $
                    70Less
      short-term capital lease
                    
                    $
                    
                    
                    
                    $
                    (25
                    )Long-term
      capital lease
                    
                    $
                    387
                    
                    
                    $
                    45





For
the years ended December 31, 2008, and 2007, building rent
expense under operating leases totaled $268,000 and $265,000,
respectively.




Contingencies





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






49







On
October 31, 2007, we received a letter from the law firm representing our former
Director of Operations, Mr. Larry Stevens. Mr. Stevens claimed for damages for
wrongful termination in violation of public policy, breach of contract and
related claims.  We determined that Mr. Stevens’ termination was “with
cause” thus the severance provision of his employment agreement did not apply.
In February 2009, we reached an agreement with Mr. Stevens to settle all
disputes and release all claims against each other.





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




8.  Concentrations
of Risk




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




Years
      Ended December 31,2008
                
                2007United
      States
                
                $
                1,101
                
                
                
                76
                %
                
                $
                857
                
                
                
                74
                %Europe
                
                
                354
                
                
                
                24
                %
                
                
                363
                
                
                
                31
                %Asia/Pacific
                
                
                1
                
                
                
                0
                %
                
                
                (78
                )
                
                
                (6
                )
      %Others
                
                
                -
                
                
                
                -
                
                
                
                15
                
                
                
                1
                %Total
      Net Sales
                
                $
                1,456
                
                
                
                100
                %
                
                $
                1,157
                
                
                
                100
                %





During
the first quarter of 2007, our Japanese distributor notified us of their failure
to maintain the legal documentation standard required to sell our PATHFINDER in
Japan.  As a result, we had no sales in Japan in 2007 and
2008. We have filed a “Shonin Application” to obtain the necessary
regulatory approval to re-start PATHFINDER sales in the Japanese market. We
anticipate resuming commercial sales in Japan the second quarter of 2009.
However, there can be no assurance that we will be able to resume sales by that
time.





Our
diagnostic product group, namely the Pathfinder family of micro-catheter
systems, accounted for 50% and 62% of net sales for the years ended December 31,
2008 and 2007, respectively.





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




9.  Stockholders’
Equity





We are
authorized to have two classes of capital stock: Preferred Stock Series A and
Common Stock. Holders of Common Stock are entitled to one vote for each share
held. Holders of Series A Preferred Stock are required to vote as a single class
with holders of Common Stock.




Preferred
stock




We are
authorized to issue 10,000,000 shares of Series A Preferred Stock. Our Board of
Directors can authorize the issuance of Preferred stock in one or more series
without obtaining further stockholder approval. In 2007, we entered into an
agreement with APIX in which we issued convertible preferred stock in exchange
for $500,000 of a loan facility fee due to APIX. On June 7, 2007, we issued 5
million shares of Series A Convertible Preferred Stock ("Series A shares"), with
a stated value of $0.001 per share and a liquidation value of $500,000 ($0.10
per share), to APIX in full settlement of the $500,000 facility fee due to APIX.
The Series A Preferred Stock is voting with a voting preference of 28 to 1 to an
individual common share, and the Series A shareholders vote as a single class
with the common shares. The Series A shareholders are entitled to receive
dividends only if declared. As a result of the ten for one reverse stock that
was effectuated on July 31, 2007, the Series A Preferred Stock is currently
convertible into 1,000,000 shares of our common stock. We can redeem Series A
shares at any time at a price of $0.10 per Series A share.






50






Common
Stock




We are
authorized to issue 300,000,000 shares of common stock. Holders of common stock
are entitled to one vote per share on all matters to be voted upon by our
stockholders. No dividends have been declared to date.




On June
30, 2007, our Board of Directors authorized a one-for-ten reverse stock split
which became effective on July 31, 2007 to shareholders of record. Stockholders’
equity reflects the stock split by reclassifying from “Additional paid-in
capital” to “Common stock” an amount equal to the change in par value of the
shares arising from the reverse split.




In
June, 2007, we approved a stock issuance for 5,800 (post-split) shares of the
common stock to a third party for its services. A non-cash stock compensation
expense of $2,900 based on the fair value of the common stock issued was
recorded in 2007.





In
October 2007, we granted 58,870,183 shares of our Common Stock to APIX in full
settlement of the $17.7 million outstanding related to the 10% convertible notes
payable to APIX. We also repurchased from APIX warrants, which were convertible
into 20,340,000 share of our Common Stock in exchange for 29,129,817 shares of
our Common Stock.





In
December 2007, we entered into a series of Subscription Agreements with certain
accredited investors providing for the sale of (i) a total of 18 million shares
of our Common Stock in the aggregate principal amount of $9 million and (ii)
warrants to purchase an aggregate of 2.7 million shares of our Common Stock at
an exercise price of $0.55 per share. We have issued warrants to the placement
agent to purchase an aggregate of 3 million shares of our Common Stock at an
exercise price of $0.55 per share.




In May
2008, we entered into a series of Subscription Agreements with certain
accredited investors in a private placement and issued a total of 8,474,992
shares of our Common Stock at a price equal to $0.60 per share, for an aggregate
principal amount of $5.1 million.  In connection with the Subscription
Agreements, we issued warrants to purchase an aggregate of 1,271,247 shares of
our Common Stock at an exercise price of $0.65 per share to the accredited
investors and 1,500,000 warrants to purchase shares of our common stock to the
placement agent at an exercise price of $0.60 per share..




During 2008, we issued 343,418 of
common stock and received an aggregate principal amount of approximately
$161,000 upon exercises of stock option grants issued under our Stock Option
Plans by employees and consultants of the Company and through our Employee Stock
Purchase Plan.





On
February 28, 2009, we entered into a subscription agreement with an
accredited investor providing for the sale by us of (i) a total of 18,518,518
shares of our Common Stock at a price equal to $1.08 per share, in the aggregate
principal amount of $20 million and (ii) warrants to purchase an aggregate of
5,555,555 shares of our Common Stock at an exercise price of $1.25 per
share.






Repurchase
of Warrants




In
October 2007, our board of directors authorized the purchase of warrants
convertible into 20,340,000 shares of the Company’s common stock at an exercise
price of $0.40. These warrants were repurchased and subsequently cancelled. We
issued 29,129,817 shares of our common stock having a quoted fair value of $12.5
million for the purchase of these warrants.





As of
December 31, 2008, we had 125,134,721 outstanding shares of common stock, and
there were 9,301,636 options outstanding and 9,228,656 warrants outstanding to
purchase shares of common stock.




10.  Stock
Based Compensation




We
adopted Financial Accounting Standards Board (“FASB”) Statement No. 123R,
“Share Based Payment,”
on January 1, 2006.  SFAS 123(R) requires companies to estimate the
fair value of share-based awards on the date of grant using an option pricing
model. The value of the portion of the award that is ultimately expected to vest
is recognized as expense over the requisite service periods in our statements of
operations. We adopted SFAS 123(R) using the modified prospective transition
method which requires the measurement and recognition of compensation expense
for all share-based awards made to employees, consultants, directors, including
employee non-qualified and incentive stock options, and employee purchase rights
under our Employee Stock Purchase Plan based on estimated fair values. We use
the Black-Scholes method to determine fair value of stock options
granted.




The
Black-Scholes model requires the use of highly subjective and complex
assumptions which determine the fair value of share-based awards, including the
option’s expected term and the price volatility of the underlying stock.
Stock-based compensation expense is calculated based on the fair market value of
our stock on the date of grant. For the years ended December 31, 2008 and 2007,
the weighted average grant date fair value per option share was $1.24, and
$0.44, respectively.








51






The total
stock-based compensation expense under FAS 123R was approximately $1,369,000 and
$491,000, for the years ended December 31, 2008 and 2007, respectively.
This expense reduced our basic and diluted earnings per share by $0.01 and
by $0.04 for the years ended December 31, 2008 and 2007,
respectively.  Our unamortized stock compensation expense as of
December 31, 2008 is approximately $6,120,000.




2007
Stock Option Plan




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




Under the
plan in no event shall the option price per share be less than 85% of the fair
market value of a share of Common Stock on the date of the grant. In case of
incentive stock option, except options to 10% stockholders, the exercise price
of the option will not be less than 100% of the fair value of the Common Stock
at the grant date. Each option agreement specifies the term as to when the
option is to become exercisable. Standard options vest at a rate of at least 20%
of the underlying shares per year over 5 years and have a maximum term of 10
years. However, in no event shall an incentive stock option granted to a 10%
stockholder under the plan shall have a maximum term in excess of more than 5
years from the date of the grant. Any optionee (as determined under Section 424
(d) of the Internal Revenue Code) who owns more than 10% of the combined voting
power of all classes of outstanding stock of the Company, its Parent or
Subsidiary is not eligible for the grant unless the exercise price of the option
is at least 110% of the fair market value of the Common Stock on the date of the
grant.





Assumptions
used for 2008 and 2007 and the resulting estimates of weighted-average fair
value per share of options granted and shares purchased during these periods
were as follows:





2008
                  
                  
                  2007Stock
      options:Dividend
      yield
                  
                  
                  0.0%
                  
                  
                  
                  0.0%Volatility
      factor
                  
                  
                  159.6%
                  
                  
                  
                  188.0%Risk-free
      interest rate
                  
                  
                  3.6%
                  
                  
                  
                  4.3%Expected
      term (years)
                  
                  
                  7
                  
                  
                  
                  7Weighted-average
      fair value
                    of
      options granted during the
                    periods
                  
                  $
                  1.36
                  
                  
                  $
                  0.44





The
following table summarizes activities under the 2007 Stock Option
Plan:




Outstanding
      OptionsShares
      Available
                  
                  Number
      of Shares
                  
                  Exercise
      Price Per Share
                  
                  Weighted-Average
      Exercise PriceBalance
      as of 12/31/2006
                  
                  ---
                  
                  ---
                  
                  
                  ---
                  
                  
                  ---Shares
      Reserved in 2007
                  
                  30,000,000
                  
                  ---
                  
                  
                  ---
                  
                  
                  ---Options
      Granted in 2007
                  
                  (5,815,000)
                  
                  5,815,000
                  
                  $
                  0.44
      - $0.55
                  
                  $
                  0.44Balance
      as of 12/31/2007
                  
                  24,185,000
                  
                  5,815,000
                  
                  $
                  0.44
      - $0.55
                  
                  $
                  0.44Options
      Granted in 2008
                  
                  (4,960,000)
                  
                  4,960,000
                  
                  $
                  0.42
      - $1.85
                  
                  $
                  1.24Options
      Cancelled in 2008
                  
                  1,393,333
                  
                  (1,393,333)
                  
                  $
                  0.41
      - $1.65
                  
                  $
                  0.52Options
      Exercised in 2008
                  
                  ---
                  
                  (214,445)
                  
                  $
                  0.44
      - $0.62
                  
                  $
                  0.48Balance
      as of 12/31/2008
                  
                  20,618,333
                  
                  9,167,222
                  
                  $
                  0.41
      - $1.85
                  
                  $
                  0.86




Total
options outstanding and exercisable at December 31, 2008, and 2007, were
9,167,222 and 5,815,000, respectively, under the 2007 Stock Plan. All options
granted in 2008 and 2007 were granted at exercise price equal to or greater than
the common stock’s fair value on the date of grant. The weighted average fair
value of options granted in 2008 under the 2007 Stock Plan was $1.24 per
share.






52






The
following table summarizes information about stock options outstanding under the
2007 Stock Plan at December 31, 2008:




Options
      Outstanding
                
                
                Options
      ExercisableOption
      Plan
                
                Range
      of exercise prices
                
                
                As
      of December 31, 2008
                
                
                Weighted
      avg. remaining contractual life
                
                
                Weighted
      avg. exercise price
                
                
                As
      of December 31, 2008
                
                
                Weighted
      avg. remaining contractual life
                
                
                Weighted
      avg. exercise price2007
                
                $
                0.41-$0.62
                
                
                
                6,117,222
                
                
                
                8.83
                
                
                $
                0.46
                
                
                
                2,040,575
                
                
                
                8.91
                
                
                $
                0.48$
                1.25-$1.62
                
                
                
                515,000
                
                
                
                9.80
                
                
                $
                1.43
                
                
                
                -
                
                
                
                -
                
                
                
                -$
                1.65-$1.85
                
                
                
                2,535,000
                
                
                
                9.63
                
                
                $
                1.70
                
                
                
                -
                
                
                
                -
                
                
                
                -Total
                
                
                
                9,167,222
                
                
                
                9.11
                
                
                $
                0.86
                
                
                
                2,040,575
                
                
                
                8.91
                
                
                $
                0.48





As of
December 31, 2008, vested options of 2,040,575 and non-vested options of
7,126,647 had an aggregate intrinsic value of approximately $2.3 million and
$7.0 million, respectively.





2003
Stock Option Plan




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




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




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




The
following table summarizes activities under the 2003 Stock Option
Plan:




Outstanding
      OptionsShares
      Available
                                                                            
                                                                            
                                                                            
                                                                            Number
      of Shares
                                                                            
                                                                            
                                                                            
                                                                            Exercise
      Price Per Share
                                                                            
                                                                            
                                                                            
                                                                            Weighted-Average
      Exercise PriceBalance
      as of 12/31/2006
                                                                            
                                                                            
                                                                            611,822
                                                                            
                                                                            
                                                                            
                                                                            208,178
                                                                            
                                                                            
                                                                            $
                                                                            0.50
      - $12.40
                                                                            
                                                                            
                                                                            $
                                                                            4.50Options
      Granted in 2007
                                                                            
                                                                            
                                                                            (4,700
                                                                            )
                                                                            
                                                                            
                                                                            4,700
                                                                            
                                                                            
                                                                            $
                                                                            0.55
      - $0.60
                                                                            
                                                                            
                                                                            $
                                                                            0.55Options
      Cancelled in 2007
                                                                            
                                                                            
                                                                            131,453
                                                                            
                                                                            
                                                                            
                                                                            (131,453
                                                                            )
                                                                            
                                                                            $
                                                                            0.50
      - $10.40
                                                                            
                                                                            
                                                                            $
                                                                            5.18Balance
      as of 12/31/2007
                                                                            
                                                                            
                                                                            738,575
                                                                            
                                                                            
                                                                            
                                                                            81,425
                                                                            
                                                                            
                                                                            $
                                                                            0.55
      - $12.40
                                                                            
                                                                            
                                                                            $
                                                                            3.17Options
      Granted in 2008
                                                                            
                                                                            
                                                                            -
                                                                            
                                                                            
                                                                            
                                                                            -
                                                                            
                                                                            
                                                                            
                                                                            -
                                                                            
                                                                            
                                                                            
                                                                            -Options
      Cancelled in 2008
                                                                            
                                                                            
                                                                            9,063
                                                                            
                                                                            
                                                                            
                                                                            (9,063
                                                                            )
                                                                            
                                                                            $
                                                                            0.55
      - $ 2.50
                                                                            
                                                                            
                                                                            $
                                                                            0.65Options
      Exercised in 2008
                                                                            
                                                                            
                                                                            -
                                                                            
                                                                            
                                                                            
                                                                            (4,791
                                                                            )
                                                                            
                                                                            $
                                                                            0.55
      - $0.60
                                                                            
                                                                            
                                                                            $
                                                                            0.60Balance
      as of 12/31/2008
                                                                            
                                                                            
                                                                            747,638
                                                                            
                                                                            
                                                                            
                                                                            67,571
                                                                            
                                                                            
                                                                            $
                                                                            0.55
      - $12.40
                                                                            
                                                                            
                                                                            $
                                                                            3.69







At
December 31, 2008 and 2007, 67,571 and 81,425 options were outstanding and
exercisable under the 2003 Stock Plan, respectively.  There were no
options granted in 2008 under the 2003 Plan.  All options granted in
2007 were granted at exercise price equal to the common stock’s fair value. The
weighted average fair value of options granted under the Stock Plan was zero and
$0.55 per share for 2008 and 2007, respectively.






53






The
following table summarizes information about stock options outstanding under the
2003 Stock Plan at December 31, 2008:




Options
      Outstanding
                    
                    
                    Options
      ExercisableOption
      Plan
                    
                    Range
      of exercise prices
                    
                    
                    As
      of December 31, 2008
                    
                    
                    Weighted
      avg. remaining contractual life
                    
                    
                    Weighted
      avg. exercise price
                    
                    
                    As
      of December 31, 2008
                    
                    
                    Weighted
      avg. remaining contractual life
                    
                    
                    Weighted
      avg. exercise price2003
                    
                    $
                    0.55-$2.50
                    
                    
                    
                    43,596
                    
                    
                    
                    6.90
                    
                    
                    $
                    0.62
                    
                    
                    
                    33,263
                    
                    
                    
                    6.88
                    
                    
                    $
                    0.62$
                    3.50-$12.40
                    
                    
                    
                    23,975
                    
                    
                    
                    5.27
                    
                    
                    $
                    9.29
                    
                    
                    
                    23,908
                    
                    
                    
                    5.26
                    
                    
                    $
                    9.31Total
                    
                    
                    
                    67,571
                    
                    
                    
                    6.32
                    
                    
                    $
                    3.69
                    
                    
                    
                    57,171
                    
                    
                    
                    6.21
                    
                    
                    $
                    4.25





As of
December 31, 2008, vested options of 57,171 and non-vested options of 10,400 had
an aggregate intrinsic value of approximately $33,000 and $10,000,
respectively.





1993
Stock Option Plan




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





The
following table summarizes activities under the 1993 Stock Option
Plan:




Outstanding
      OptionsShares
      Available
                                                  
                                                  
                                                  Number
      of Shares
                                                  
                                                  Exercise
      Price Per Share
                                                  
                                                  
                                                  Weighted-Average
      Exercise PriceBalance
      as of 12/31/2006
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  268,486
                                                  
                                                  
                                                  $
                                                  3.40
      - $52.50
                                                  
                                                  
                                                  $
                                                  11.80Options
      Expired in 2007
                                                  
                                                  
                                                  (208,215
                                                  )
                                                  
                                                  
                                                  -Options
      Cancelled in 2007
                                                  
                                                  
                                                  208,215
                                                  
                                                  
                                                  
                                                  (208,215
                                                  )
                                                  
                                                  $
                                                  3.40
      - $52.50
                                                  
                                                  
                                                  $
                                                  12.01Balance
      as of 12/31/2007
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  60,271
                                                  
                                                  
                                                  $
                                                  3.40
      - $46.30
                                                  
                                                  
                                                  $
                                                  11.24Options
      Expired in 2008
                                                  
                                                  
                                                  (19,028
                                                  )
                                                  
                                                  
                                                  -Options
      Cancelled in 2008
                                                  
                                                  
                                                  19,028
                                                  
                                                  
                                                  
                                                  (19,028
                                                  )
                                                  
                                                  $
                                                  3.40
      - $46.30
                                                  
                                                  
                                                  $
                                                  9.54Balance
      as of 12/31/2008
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  41,243
                                                  
                                                  
                                                  $
                                                  3.40
      - $25.60
                                                  
                                                  
                                                  $
                                                  12.03





At
December 31, 2008 and 2007, 60,271 and 41,243 options were outstanding and
exercisable under the 1993 Stock Plan, respectively. There were no options
granted in 2008 and in 2007 under the 1993 Stock Option Plan.






54






The
following table summarizes information about stock options outstanding under the
1993 Stock Option Plan at December 31, 2008:





Options
      Outstanding
                
                
                Options
      ExercisableOption
      Plan
                
                Range
      of exercise prices
                
                
                As
      of December 31, 2008
                
                
                Weighted
      avg. remaining contractual life
                
                
                Weighted
      avg. exercise price
                
                
                As
      of December 31, 2008
                
                
                Weighted
      avg. remaining contractual life
                
                
                Weighted
      avg. exercise price1993
                
                $
                3.40-$10.30
                
                
                
                19,651
                
                
                
                3.81
                
                
                $
                8.95
                
                
                
                19,651
                
                
                
                3.81
                
                
                $
                8.95$
                11.60-$25.60
                
                
                
                21,592
                
                
                
                2.81
                
                
                $
                14.83
                
                
                
                21,592
                
                
                
                2.81
                
                
                $
                14.83Total
                
                
                
                41,243
                
                
                
                3.29
                
                
                $
                12.03
                
                
                
                41,243
                
                
                
                3.29
                
                
                $
                12.03





As of
December 31, 2008, outstanding stock options under the 1993 Stock Plan did not
have any intrinsic value.





1997
Directors' Stock Option Plan




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




The
following table summarizes activity under the 1997 Director’s Stock Option
Plan:


Outstanding
      OptionsShares
      Available
                                                        
                                                        
                                                        Number
      of Shares
                                                        
                                                        
                                                        Exercise
      Price Per Share
                                                        
                                                        
                                                        Weighted-Average
      Exercise PriceBalance
      as of 12/31/2006
                                                        
                                                        
                                                        54,800
                                                        
                                                        
                                                        
                                                        34,800
                                                        
                                                        
                                                        
                                                        $
                                                        0.30
      - $14.50
                                                        
                                                        
                                                        $
                                                        0.90Options
      Granted in 2007
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -Options
      Cancelled in 2007
                                                        
                                                        
                                                        3,000
                                                        
                                                        
                                                        
                                                        (3,000
                                                        )
                                                        
                                                        
                                                        $
                                                        0.30
      - $0.50
                                                        
                                                        
                                                        $
                                                        0.40Balance
      as of 12/31/2007
                                                        
                                                        
                                                        57,800
                                                        
                                                        
                                                        
                                                        31,800
                                                        
                                                        
                                                        
                                                        $
                                                        0.30
      - $14.50
                                                        
                                                        
                                                        $
                                                        0.90Options
      Expired in 2008
                                                        
                                                        
                                                        (64,000
                                                        )
                                                        
                                                        
                                                        -Options
      Cancelled in 2008
                                                        
                                                        
                                                        6,200
                                                        
                                                        
                                                        
                                                        (6,200
                                                        )
                                                        
                                                        
                                                        $
                                                        0.30
      - $0.70
                                                        
                                                        
                                                        $
                                                        0.67Balance
      as of 12/31/2008
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        25,600
                                                        
                                                        
                                                        
                                                        $
                                                        0.50
      - $14.50
                                                        
                                                        
                                                        $
                                                        1.02







At
December 31, 2008 and 2007, 25,600 and 31,800 options were outstanding and
exercisable under the 1997 Directors’ Stock Plan, respectively.  No stock
options were granted in 2008 and 2007.




The
following table summarizes information about stock options outstanding under the
1997 Directors’ Stock Option Plan at December 31, 2007:




Options
      Outstanding
                
                
                Options
      ExercisableOption
      Plan
                
                Range
      of exercise prices
                
                
                As
      of December 31, 2008
                
                
                Weighted
      avg. remaining contractual life
                
                
                Weighted
      avg. exercise price
                
                
                As
      of December 31, 2008
                
                
                Weighted
      avg. remaining contractual life
                
                
                Weighted
      avg. exercise price1997
      Plan
                
                $
                0.50-$0.70
                
                
                
                19,600
                
                
                
                7.48
                
                
                $
                0.66
                
                
                
                17,600
                
                
                
                7.52
                
                
                $
                0.68$
                1.00-$14.50
                
                
                
                6,000
                
                
                
                6.12
                
                
                
                2.21
                
                
                
                6,000
                
                
                
                6.12
                
                
                
                2.21Total
                
                
                
                25,600
                
                
                
                7.16
                
                
                $
                1.02
                
                
                
                23,600
                
                
                
                7.16
                
                
                $
                1.07





As of
December 31, 2008, vested options of 23,600 and non-vested options of 2,000 had
an aggregate intrinsic value of approximately $19,000 and $2,000,
respectively.








55





1997
Employee Stock Purchase Plan




In March
1997, the Board of Directors adopted the 1997 Employee Stock Purchase Plan (the
“Plan”), as amended, and reserved 2.5 million shares of common stock for
issuance. On June 28, 2007, the shareholders authorized to increase the number
of authorized shares of common stock issuable under the Plan to 3.5 million. The
purchase plan is intended to provide an opportunity for eligible employees and
our designated subsidiaries to acquire common stock on a favorable basis. The
purchase plan is implemented by a series of offering periods of twelve months
duration, with two consecutive purchase periods of six months in duration. New
offering periods commence on or about February 1 and August 1 of each year (or
at such other time or times as may be determined by the Board of Directors).
Through periodic payroll deductions, which may not exceed $25,000 per offering
period or 10% of any employee’s compensation, eligible employees may purchase
common stock at a price equal to the lower of: (i) 85% of the fair market value
of the common stock on the offering date; or (ii) 85% of the fair market value
of the common stock on the purchase date. During the January and July 2008
offerings, 124,182 shares of common stock were issued under the purchase plan.
In August 2008, our Board of Directors reviewed our stock-based compensation
plans and decided to terminate the 1997 Employee Stock Purchase Plan. As of
December 31, 2008, there were 420,958 shares issued under the Plan.





Share-Based Compensation to
Non-Employees





We
account for options issued to non-employees under SFAS 123 and EITF 96-18,
“Accounting for Equity
Instruments that are Issued to Other than Employees for Acquiring, or in
Conjunction with Selling Goods or Services”, using the Black-Scholes
option pricing model. The value of such non-employee options is periodically
re-measured over their vesting terms. The fair value of options was re-measured
at period-end using the Black-Scholes option pricing model with the following
assumptions: a risk-free interest rate of 1.87% to 4.1%, using applicable
United States Treasury rates; a dividend yield of 0.0%; an annual
volatility factor of 159.1% to 163.7%; and an average expected life based on the
terms of the option grant or contractual term of the warrant of 5 to
10 years.  We granted 1,060,000 and 5,800 (post-split) shares to
non-employees during years ended December 31, 2008 and 2007, respectively.
Expense recognized related to options issued to non-employees was approximately
$422,000 and $3,000 during the years ended December 31, 2008, and
2007, respectively.





11.  Related-Party
Transactions




We have
entered into employment agreements with several of our key employees. The
agreements specify various employment-related matters, including confidentiality
requirements, competitive restrictions, assignment of inventions, annual
compensation, and severance benefits in the event of termination without
cause.




In
December 2007, we entered into a series of Subscription Agreements (the
“Subscription Agreement”) with certain accredited investors (collectively, the
“Investors”) providing for the sale of (i) a total of 18 million shares of our
Common Stock in the aggregate principal amount of $9 million (the “Shares”)
and (ii) warrants (the “Warrants”) to purchase an aggregate of 2.7 million
shares of our Common Stock at an exercise price of $0.55 per share. We provided
for $75,000 in expense reimbursements. Per an Amended Funding Agreement,
APIX waived its five-percent common share placement fee and  accepted
for its services rendered; (i) an additional one million warrants (total three
million warrants) to purchase shares of our common stock at an exercise price of
$0.55 per share; and (ii) all rights, title and interest in a loan totaling
$360,000, including accrued interest, owed to us by Phil Radlick, a Director of
our Company, with a guaranteed minimum recoverable value of not less than
$100,000. We have extinguished all of our obligations under this Amended Funding
Agreement in the first quarter of 2009.




In May
2008, we entered into a series of Subscription Agreements with certain
accredited investors providing for the sale of (i) a total of 8,474,992 shares
of our Common Stock in the aggregate principal amount of $5.1 million and (ii)
warrants to purchase an aggregate of 1,271,247 shares of our Common Stock at an
exercise price of $0.65 per share. We also issued 1,500,000 warrants to purchase
shares of our common stock to APIX at an exercise price of $0.60 per share. We
provided for $80,000 in expense reimbursements.




On
November 11, 2008, we executed a Loan Term Sheet and Loan Commitment letter (the
"Financing Documents") with an accredited investor and our largest individual
shareholder of our company (the “Note Holder”) pursuant to which we issued
a secured promissory note (the "Note") in the principal amount of $6 million
(the “Advance”).  The Note provided for interest at a rate of 10% per
year and a maturity date of November 10, 2009.  We agreed to grant the
Holder a general charge on all of our assets. APIX acted as placement agent for
the transaction. We provided for $80,000 in expense reimbursements.





On
February 28, 2009, we entered into a subscription agreement with the Note Holder
providing for the sale of (i) 18,518,518 shares of our Common Stock in the
aggregate principal amount of $20 million, and (ii) warrants to purchase an
aggregate of 5,555,555 shares of our Common Stock at an exercise price of $1.25
per share. APIX acted as placement agent. We provided for up to $80,000 in
expense reimbursements. The Advance was converted into subscription of the
shares. The Note Holder agreed to waive all interests accrued on the Advance.
The Financing Documents were also terminated. As of February 28, 2009, the Note
Holder owns 46.7% of our Company’s Common Stock.






56







12.  Income
Taxes




The
components of the provision for income taxes are as follows (in
thousands):




December
      31,2008
                                
                                
                                2007Current:Federal
                                
                                $
                                -
                                
                                
                                $
                                -State
                                
                                
                                1
                                
                                
                                
                                -1
                                
                                
                                
                                -Deferred:Federal
                                
                                
                                -
                                
                                
                                
                                -State
                                
                                
                                -
                                
                                
                                
                                --
                                
                                
                                
                                -Total
      provision for income taxes
                                
                                $
                                1
                                
                                
                                $
                                -
  A
      reconciliation of income taxes at the statutory federal income tax rate to
      net income taxes included in the accompanying statement of operations is
      as follows:
  December
      31,2008
                  
                  
                  2007Tax
      Benefit at expected federal rate
                  
                  
                  -34.0
                  %
                  
                  
                  -34.0
                  %State,
      Net of Federal Benefit
                  
                  
                  -5.1
                  %
                  
                  
                  -5.8
                  %Research
      and development credits
                  
                  
                  -1.5
                  %
                  
                  
                  2.6
                  %Non-deductible
      expenses
                  
                  
                  2.4
                  %
                  
                  
                  24.0
                  %Net
      operating benefit
                  
                  
                  38.0
                  %
                  
                  
                  13.2
                  %Other,
      net
                  
                  
                  0.2
                  %
                  
                  
                  0.0
                  %0.0
                  %
                  
                  
                  0.0
                  %




At
December 31, 2008, we had federal and state net operating loss carry forwards of
approximately $68.3 million and $49.5 million,
respectively.  The federal and state net operating loss carry forwards
expire at various dates beginning in 2009 through 2028, if not
utilized.




We also
had federal and state research and development tax credit carry forwards of
approximately $146,000 and $1.2 million, respectively. The federal
research and development tax credits begin to expire in 2009. The state research
and development tax credits carry forward indefinitely.




Utilization
of the net operating losses and credits may be subject to a substantial annual
limitation due to the "change in ownership" provisions of the Internal
Revenue Code of 1986, as amended, and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilization.




Significant
components of our deferred tax assets for federal and state income taxes as
follows (in thousands):




December
      31,2008
                
                
                2007Net
      operating loss carry forwards
                
                $
                26,127
                
                
                $
                23,203Research
      credits carry forwards (federal and state)
                
                $
                954
                
                
                $
                752Manufacturing
      investment credit carry forwards
                
                $
                78
                
                
                $
                78Capitalized
      research and development
                
                $
                2,048
                
                
                $
                1,555Other,
      net
                
                $
                1,927
                
                
                $
                1,203Total
      deferred tax assets
                
                $
                31,134
                
                
                $
                26,791Valuation
      Allowance for deferred tax assets
                
                $
                (31,134
                )
                
                $
                (26,791
                )$
                -
                
                
                $
                -




As of
December 31, 2008 and 2007, we had deferred tax assets of approximately $
31.1 million and $26.8 million, respectively.  Realization of the
deferred tax assets is dependent upon future taxable income, if any, the
amount and timing of which are uncertain.  Accordingly, the net
deferred tax assets have been fully offset by a valuation
allowance.  The net valuation allowance increased by approximately
$4.3 million and decreased $19.6 million during the years ended December 31,
2008 and 2007, respectively.  Deferred tax assets primarily relate to
net operating loss and tax credit carry forwards.






57




We
realize tax benefits as a result of the exercise of non-qualified stock options
and the exercise and subsequent sale of certain incentive stock options
(disqualified dispositions).  For financial reporting purposes,
any reduction in income tax obligations as a result of these tax benefits will
be credited to additional paid-in capital upon utilization of the NOLs including
these benefits.




On
January 1, 2007, we adopted FASB Interpretation No. 48 (FIN 48),“Accounting for Uncertainty in Income
Taxes”. FIN 48
clarifies the accounting for uncertainty in income taxes and prescribes a
recognition threshold, measurement attribute for the financial statement
recognition and measurement of a tax position taken, or expected to be taken, in
a tax return. Under FIN 48, we are required to recognize in the financial
statements the impact of a tax position, if that position is more likely than
not of being sustained on audit, based on the technical merits of the position.
FIN 48 also provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods and disclosure. Our policy is to record
interest and penalties related to unrecognized tax benefits in income tax
expense.




The
implementation of FIN 48 did not have a material impact on the Company's
financial statements.  At January 1, 2008, we have not accrued an
amount for tax liability from unrecognized tax benefits.  There were
no unrecognized tax benefits recorded as of December 31, 2008 and
2007.




We do not
believe the total amount of unrecognized benefit as of December 31, 2008 will
increase or decrease significantly in the next twelve months.  Our
Federal, California, Illinois and Wisconsin tax returns are subject to
examination by the tax authorities.





13.  License
Rights




We have
an exclusive royalty-free worldwide license to use Target Therapeutics’
technology and to make, use and sell or otherwise distribute products for the
diagnosis and treatment of electrophysiological diseases in the body, other than
in the central nervous system, including the brain. The exclusive license grant
applied to any Target Therapeutics’ technology developed through May 1996 and
will expire upon the expiration of the last of the patents relating to Target
Therapeutics’ technology. We also have a royalty agreement with SurModics, Inc.
for the non-exclusive use of licensed products and patents for products treated
with photoreactive polyvinylpyrrolidone copolymer and non-photoreactive
polyvinylpyrrolidone.




14.  Retirement
Benefit Plan





We have a
401(k) plan (“the 401(k) Plan”) whereby eligible employees may contribute a
percentage of eligible compensation but not greater than 60% of their earnings
up to the maximum as required by law. Company contributions are discretionary.
No Company contributions have been made since inception of the 401(k)
Plan.





15.  Warrant
Activity





The
following table summarizes warrant activities for years 2008 and
2007:


Outstanding
      WarrantsWarrant
      Shares Available
                                            
                                            
                                            Number
      of Warrant Shares
                                            
                                            
                                            Exercise
      Price Per Warrant Share
                                            
                                            
                                            Weighted-Average
      Exercise PriceBalance
      as of 12/31/2006
                                            
                                            
                                            7,579,353
                                            
                                            
                                            
                                            7,579,353
                                            
                                            
                                            $
                                            0.60
      - $14.00
                                            
                                            
                                            $
                                            3.20Warrant
      Shares Granted in 2007
                                            
                                            
                                            19,860,000
                                            
                                            
                                            
                                            19,860,000
                                            
                                            
                                            $
                                            0.30
      - $0.55
                                            
                                            
                                            $
                                            0.55Warrant
      Shares Cancelled  in 2007
                                            
                                            
                                            (537,359
                                            )
                                            
                                            
                                            (537,359
                                            )
                                            
                                            $
                                            0.78
      - $13.40
                                            
                                            
                                            $
                                            10.60Warrant
      Shares Exercised in 2007
                                            
                                            
                                            (20,340,000
                                            )
                                            
                                            
                                            (20,340,000
                                            )
                                            
                                            $
                                            0.40
                                            
                                            
                                            $
                                            0.40Balance
      as of 12/31/2007
                                            
                                            
                                            6,561,994
                                            
                                            
                                            
                                            6,561,994
                                            
                                            
                                            $
                                            0.55
      - $14.00
                                            
                                            
                                            $
                                            1.30Warrant
      Shares Granted in 2008
                                            
                                            
                                            2,771,247
                                            
                                            
                                            
                                            2,771,247
                                            
                                            
                                            $
                                            0.60
      - $0.65
                                            
                                            
                                            $
                                            0.62Warrant
      Shares Cancelled  in 2008
                                            
                                            
                                            (104,585
                                            )
                                            
                                            
                                            (104,585
                                            )
                                            
                                            $
                                            7.79
      - $12.38
                                            
                                            
                                            $
                                            0.88Warrant
      Shares Exercised in 2008
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -Balance
      as of 12/31/2008
                                            
                                            
                                            9,228,656
                                            
                                            
                                            
                                            9,228,656
                                            
                                            
                                            $
                                            0.55
      - $4.30
                                            
                                            
                                            $
                                            0.88








58






The
following table summarizes information about warrants outstanding at December
31, 2008:





Warrants
      Outstanding
                          
                          
                          Warrants
      ExercisableRange
      of Exercise Prices
                          
                          Number
      of Warrant Shares Outstanding
                          
                          Weighted-Average
      Remaining Contractual Life
                          
                          
                          Weighted-Average
      Exercise Price
                          
                          
                          Number
      of Warrant Shares Exercisable
                          
                          
                          Weighted-Average
      Exercise Price$
                          0.55
      - $0.65
                          
                          
                          8,471,247
                          
                          
                          4.1
                          
                          
                          $
                          0.57
                          
                          
                          
                          8,471,247
                          
                          
                          $
                          0.57$
                          4.30
                          
                          
                          757,409
                          
                          
                          0.8
                          
                          
                          $
                          4.30
                          
                          
                          
                          757,409
                          
                          
                          $
                          4.309,228,656
                          
                          
                          3.8
                          
                          
                          $
                          0.88
                          
                          
                          
                          9,228,656
                          
                          
                          $
                          0.88





Contractual
Commitments:





Following
is a schedule of future contractual commitments that are non-cancelable at
December 31, 2008 (in thousands):





Fiscal Year
                    
                    Operating
      Leases
                    
                    
                    Capital
      Leases2009
                    
                    $
                    272
                    
                    
                    $
                    312010
                    
                    $
                    115
                    
                    
                    $
                    312011
                    
                    $
                    -
                    
                    
                    $
                    18$
                    387
                    
                    
                    $
                    80Less
      amounts representing interest
                    
                    $
                    -
                    
                    
                    $
                    (10
                    )Present
      Value of net minimum lease payments
                    
                    $
                    387
                    
                    
                    $
                    70Less
      short-term capital lease
                    
                    $
                    -
                    
                    
                    $
                    (25
                    )Long-term
      capital lease
                    
                    $
                    387
                    
                    
                    $
                    45





16.  Subsequent
Events




On
February 26, 2009, the Board of Directors of Cardima Inc. (the “Company”)
approved and ratified an Executive Agreement with Paul Cheng dated as of
November 24, 2008 (the “Agreement”). The Agreement provides for compensation to
Mr. Cheng as Chief Accounting Officer of the Company of $180,000. In addition,
the Agreement provides for the payment of salary for a period of 6 months in the
event Mr. Cheng is terminated without cause (as defined in the Agreement). In
the event of a termination for any other reason, including but not to, with
cause (as defined in the Agreement), death, or disability or voluntary
resignation, Mr. Cheng will be entitled to receive any earned but unpaid salary
and vacation through the termination date. The Agreement also provides that in
the vent of a change in control (as defined in the Agreement), all options
issued to Mr. Cheng will immediately become vested.


On
February 28, 2009, we entered into a subscription agreement with an accredited
investor and largest individual shareholder (the “Investor”) providing for
the sale of (i) a total of 18,518,518 shares of our Common Stock at a price
equal to $1.08 per share, in the aggregate principal amount of $20.0 million and
(ii) warrants to purchase an aggregate of 5,555,555 shares of our Common Stock
at an exercise price of $1.25 per share. The Investor agreed to convert the
advance of $6.0 million received in November 2008 into shares of our Common
Stock and waive all accrued interest.





On March
15, 2009, we executed consulting agreements with Tony Shum, Chairman of our
Board of Directors and Robert Cheney, Chief Executive Officer, Chief Financial
Officer and Director, whereby Mr. Shum and Mr. Cheney will continue to provide
their services to us which are customarily associated with the positions of
Chairman, Chief Executive Officer and Chief Financial Officer. To compensate for
the services provided, we have agreed to pay at the net rate of $288,000 and
$238,000 per year to Mr. Shum and Mr. Cheney, respectively. The term of each of
the agreements is for thirty six months and can be extended for another thirty
six months.





ITEM 9.
            CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE





There are
no disagreements with our auditors.





On
October 19, 2007, Marc Lumer & Company resigned as our auditors. At the same
time, our Board of Directors approved the engagement of PMB+Helin Donovan LLP as
our independent certified public accountant.





ITEM
9A.           CONTROLS
AND PROCEDURES




Evaluation
and Disclosure Controls and Procedures





Management's
Report on Internal Control Over Financial Reporting





Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as such term is defined in Rule 13a-15(f) under
the Securities Exchange Act of 1934.





All
internal control systems, no matter how well designed, have inherent limitations
including the possibility of human error and the circumvention or overriding of
controls. Further, because of changes in conditions, the effectiveness of
internal controls may vary over time. Projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate. Accordingly, even those systems
determined to be effective can provide us only with reasonable assurance with
respect to financial statement preparation and presentation.





Our
management, including the chief executive officer and chief financial officer,
has assessed the effectiveness of our internal control over financial reporting
as of December 31, 2008, following the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control
- Integrated Framework, and with further guidance for internal controls for
small business provided by the SEC’s new Interpretive Guidance in Release No.
34-55929.






59







Based on
our assessment under the COSO Internal Control framework in -, the Company's
management, including the chief executive officer and chief financial officer,
has concluded that our internal control over financial reporting was effective
as of December 31, 2008.




This
Annual Report on Form 10-K does not include an attestation report of the
Company's independent registered public accounting firm regarding internal
control over financial reporting. Management's report was not subject to
attestation by the Company's independent registered public accounting firm
pursuant to temporary rules of the SEC that permit the Company to provide only
management's report in this Annual Report on Form 10-K.





Changes
in Internal Controls





There
were no changes to the internal controls that have materially affected or that
are reasonably likely to affect the internal controls.





Limitations
on the Effectiveness of Controls





A control
system, no matter how well conceived and operated, can provide only reasonable,
not absolute, assurance that the objectives of the control system are met.
Because of the inherent limitations in all control systems, no evaluation of
controls can provide absolute assurance that all control issues and instances of
fraud, if any, within a company have been detected. Our disclosure controls and
procedures are designed to provide reasonable assurance of achieving its
objectives. Our Principal Executive Officer and Principal Financial Officer
concluded that the Company's disclosure controls and procedures are effective at
that reasonable assurance level.





ITEM
9B.           OTHER
INFORMATION





None.








60










PART
III





ITEM
10.                      DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE





The
following sets forth certain information regarding our directors and executive
officers as of December 31, 2008:





Name of Director
                          
                          Age
                          
                          Title
                          
                          Director SinceTony
      Shum
                          
                          39
                          
                          Chairman
      of the Board of Directors
                          
                          2006Robert
      Cheney
                          
                          50
                          
                          Chief
      Executive Officer, Chief Financial Officer and Director
                          
                          2006Eric
      Chan, Ph.D.
                          
                          50
                          
                          Chief
      Technology Officer and Director
                          
                          2007Richard
      Gaston, M.D.
                          
                          65
                          
                          Director
                          
                          2007Phillip
      Radlick, Ph.D.
                          
                          70
                          
                          Director
                          
                          1994Sung
      Chun, M.D.
                          
                          46
                          
                          Director
                          
                          2008





TonyShum has been our
Chairman since September 2007 and our directors since February 2006. Mr. Shum is
a Business Development Executive for the global banking group HSBC since
February 2006. From February 2001 to January 2006, Mr. Shum worked as a
consultant providing business strategy and analysis services in Asia Pacific and
Europe for businesses ranging from start-up ventures to multi-national
corporations. Also Mr. Shum worked for Walt Disney Television International
where he helped to establish its broadcast television business in the
Asia-Pacific region. Mr. Shum is a Chartered Accountant and worked for Deloitte
& Touche in Canada and Price Waterhouse in Hong Kong.





Robert Cheney has been
our Chief Executive Officer and Interim Chief Financial Officer since August
2007 and has been one of our directors since February 2006. Mr. Cheney is a
corporate consultant based in Hong Kong since January 2001. Mr. Cheney is also a
director and shareholder of Apix International Limited. Mr. Cheney was
previously the Chairman and CEO of a Hong Kong based telecommunications and
Internet Services Company. Prior to his business career, Mr. Cheney was a
corporate lawyer in private practice qualified in Hong Kong, Canada and
Britain.





Eric Chan, co-inventor of
Cardima’s INTELLITEMP Energy Management System, the Surgical Ablation Probe with
Stabilization Sheath, and the REVELATION Helix catheter, has been our Senior
Vice President of Product Development since February 2007.  Dr. Chan
was promoted to Chief Technical Officer in September 2007. Dr. Chan received a
B.S.E.E. from Purdue University, and both the M.S.E. and Ph.D. degrees in
Biomedical Engineering from the University of Texas at Austin.  He
also completed the Global Bio-Executive Program at the University of California,
Berkeley, Haas School of Business.  He is a Senior Member of the
Institute of Electrical and Electronic Engineers, and an elected Fellow of the
European Society of Cardiology.




Richard Gaston has been a
director since October 5, 2007.He retired
in 2006 from clinical practice as a Board certified
cardiologist.   From 1981 to 2006, Dr. Gaston practiced as a
cardiologist in Petaluma, California and played a major role in establishing
state of the art intensive care unit at Petaluma Valley Hospital in 1980’s. From
1997 to 2003, Dr. Gaston also was the biotechnology and pharmaceutical analyst
of AmeriCal Securities in San Francisco, California with a prominent role in
selling Imatron Inc. to GE Healthcare.  Dr. Gaston received an A.B. in
Psychology from Stanford University, M.D. from University of Michigan,
Internship and Medical Residency from University of Utah and Cardiology
Fellowship from Michigan State University.





Phillip Radlickhas been one
of our directors since November 1994. Dr. Radlick is currently an independent
consultant in the healthcare industry. Dr. Radlick served as President and Chief
Executive Officer of Lipid Sciences, Inc., a publicly held biotechnology
company, from June 2000 until October 2002. Dr. Radlick was our President and
Chief Executive Officer from November 1994 to June 2000. Prior to joining us,
from November 1992 until October 1994, Dr. Radlick was the President and Chief
Executive Officer of Hepatix, Inc., a start-up medical device company. From
November 1986 until November 1992, Dr. Radlick was the President of Edward's
Cardiovascular Surgery Division, a division of Baxter Healthcare responsible for
the development, manufacture and sale of cardiovascular products. Dr. Radlick
received a B.S. in Chemistry and a Ph.D. in Organic Chemistry from the
University of California, Los Angeles.





Sung Chun has been our Chief
Medical Officer since November 2007. Since May 2004, Dr. Chun has been the
Director of Cardiac Arrhythmia Service in the Palo Alto Medical Foundation. From
May 2004 to December 2005, Dr. Chun was the Clinical Assistant Professor
(Cardiovascular) in the Stanford University School of Medicine. From September
2001 to April 2004, Dr. Chun was the Program Director of Cardiac
Electrophysiology Fellowship of the Stanford University of Medicine. Dr. Chun
received a B.S. in Medical Microbiology from Stanford University and M.D. from
George Washington University School of Medicine. Dr. Chun is currently a Board
of Director of the Beautiful Mind Ensemble Charity Organization, a member of the
Editorial & Advisory Committee, the Japanese Journal of
Arrhythmia, and the editorial reviewer for Kluwer Academic
Publishers.






61







Code
of Ethics





We
adopted a Code of Business Conduct and Ethics Policy that applies to all
directors and employees, including our principal executive officer, principal
financial officer, principal accounting officer, and persons performing similar
functions. A copy of the Code of Ethics and Business Conduct is available on our
Web site, http://www.cardima.com/about/compliance/principles-and-ethics, or may
be obtained upon request from us.





ITEM
11.                      EXECUTIVE
COMPENSATION





The following table sets forth the cash
compensation (including cash bonuses) paid or accrued and equity awards granted
by us for years ended December 31, 2008, 2007 and 2006 to our Chief Executive
Officer and our most highly compensated officers other than the Chief Executive
Officer at December 31, 2008 whose total compensation exceeded
$100,000.





SUMMARY
COMPENSATION TABLE




Name
      and principal position
                        Year
                        
                        Salary
      ($)
                        
                        
                        Bonus
      ($)
                        
                        
                        Stock
      Awards ($)
                        
                        
                        Option
      Awards ($)
                        
                        
                        Non-Equity
      Incentive Plan Compensation ($)
                        
                        
                        Non-Qualifed
      Deferred Compensation Earnings ($)
                        
                        
                        All
      Other Compensation ($)
                        
                        
                        Total
      ($)(a)
                        (b)
                        
                        (
      c)
                        
                        
                        (d)
                        
                        
                        (e)
                        
                        
                        (f)
                        
                        
                        (g)
                        
                        
                        (h)
                        
                        
                        (i)
                        
                        
                        (j)Robert
      Cheney (1)
                        2008
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        241,226
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        79,333
                        
                        
                        
                        320,5592007
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        40,422
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        40,4222006
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,746
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,746Eric
      Chan (2)
                        2008
                        
                        
                        200,000
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        151,865
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        351,8652007
                        
                        
                        200,000
                        
                        
                        
                        42,000
                        
                        
                        
                        -
                        
                        
                        
                        75,316
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        317,3162006
                        
                        
                        200,000
                        
                        
                        
                        18,000
                        
                        
                        
                        -
                        
                        
                        
                        65,548
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        283,548Paul
      Cheng
                        2008
                        
                        
                        12,584
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        161,840
                        (3)
                        
                        
                        174,424





(1) On September 26, 2007, Mr.
Cheney was issued a 10 year option to purchase 1,000,000 shares of the Company’s
common stock at an option price of $0.44 per share.  On August 28,
2008, Mr. Cheney was issued a 10-year option to purchase 500,000 shares of the
Company’s common stock at an option price of $1.69.  Other
Compensation includes fees earned under a consulting agreement executed on March
15, 2009..




(2) On
September 26, 2007, Mr. Chan was issued a 10-year option to purchase 1,000,000
shares of the Company’s common stock at an option price of $0.44 per
share.





(3) The
amount represents payments to Mr. Cheng who provided service to the Company from
June to November 2008 as a consultant.





None
of our named executive officers had shares of performance-based stock awards or
have account balances in qualified or non-qualified defined benefit plans
sponsored by us.





Employment
Agreements





Effective
as of November 24, 2008, our Board of Directors approved and ratified an
Executive Agreement with Paul Cheng dated as of November 24, 2008. The Agreement
provides for compensation to Mr. Cheng as Chief Accounting Officer of the
Company of $180,000. In addition, the Agreement provides for the payment of
salary for a period of 6 months in the event Mr. Cheng is terminated without
cause (as defined in the Agreement). In the event of a termination for any other
reason, including but not limited to, with cause (as defined in the Agreement),
death, or disability or voluntary resignation, Mr. Cheng will be entitled to
receive any earned but unpaid salary and vacation through the termination date.
The Agreement also provides that in the event of a change in control (as defined
in the Agreement), all options issued to Mr. Cheng will immediately becomevested.





On March
15, 2009, we executed consulting agreements with Tony Shum, Chairman of our
Board of Directors and Robert Cheney, Chief Executive Officer, Chief Financial
Officer and Director, whereby Mr. Shum and Mr. Cheney will continue to provide
their services to us which are customarily associated with the positions of
Chairman, Chief Executive Officer and Chief Financial Officer. To compensate for
the services provided, we have agreed to pay at the net rate of $288,000 and
$238,000 per year to Mr. Shum and Mr. Cheney, respectively. The term of each of
the agreements is for thirty six months and can be extended for another thirty
six months.






62









OUTSTANDING
EQUITY AWARDS AT FISCAL YEAR-END





Option
      Awards
                
                Stock
      AwardsName
                
                
                Number
      of Securities Underlying Unexercised Options Exercisable
    (#)
                
                
                Number
      of Securities Underlying Unexercised Options Unexercisable
    (#)
                
                Equity
      Incentive Plan Awards: Number of Securities Underlying Unexcercised
      Unearned Options (#)
                
                Option
      Exercise Price ($)
                
                Option
      Expiration Date
                
                Number
      of Shares or Units of Stock That Have Not Vested (#)
                
                
                Market
      Value of Shares or Units of Stock That Have Not Vested ($)
                
                
                Equity
      Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights
      That Have Not Vested (#)
                
                
                Equity
      Incentive Plan Awards: Market Payout Value Unearned Shares, Units or Other
      Rights That Have Not Vested ($)(a)
                
                
                (b)
                
                
                (
      c)
                
                (d)
                
                (e)
                
                (f)
                
                (g)
                
                
                (h)
                
                
                (i)
                
                
                (j)Robert
      Cheney (1)
                
                
                
                0
                
                
                
                500,000
                
                
                
                
                1.69
                
                8/28/2018
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -(1
                )
                
                
                333,334
                
                
                
                666,666
                
                
                
                
                0.44
                
                9/26/2017
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -5,200
                
                
                
                0
                
                
                
                
                0.70
                
                7/27/2016
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -1,000
                
                
                
                1,000
                
                
                
                
                0.50
                
                2/13/2016
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Eric
      Chan (1)
                
                
                
                222,223
                
                
                
                666,666
                
                
                
                
                0.44
                
                9/26/2017
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -(2
                )
                
                
                19,271
                
                
                
                5,729
                
                
                
                
                0.60
                
                11/10/2015
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -6,875
                
                
                
                0
                
                
                
                
                10.40
                
                2/12/2014
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -8,125
                
                
                
                0
                
                
                
                
                10.40
                
                2/12/2014
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -1,080
                
                
                
                0
                
                
                
                
                10.30
                
                3/5/2013
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -13,921
                
                
                
                0
                
                
                
                
                10.30
                
                3/5/2013
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -16,224
                
                
                
                0
                
                
                
                
                15.00
                
                2/6/2012
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -2,500
                
                
                
                0
                
                
                
                
                3.40
                
                4/6/2011
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -2,500
                
                
                
                0
                
                
                
                
                12.20
                
                10/4/2010
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -0
                
                
                
                0
                
                
                
                
                11.60
                
                6/2/2010
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -300
                
                
                
                0
                
                
                
                
                19.10
                
                7/6/2009
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -500
                
                
                
                0
                
                
                
                
                19.10
                
                7/6/2009
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -0
                
                
                
                0
                
                
                
                
                25.60
                
                4/28/2009
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -0
                
                
                
                0
                
                
                
                
                25.60
                
                4/28/2009
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -





(1)
            The
      option vests over three years in equal increments on each anniversary date
      from the date of grant.


(2)
            The
      option vests over four years with one-eight (1/8th)
      of the shares of underlying common stock vesting on the sixth month
      anniversary of the grant date and one-forty-eight (1/48th)
      monthly thereafter.








OPTION
EXERCISES AND STOCK VESTED TABLE





Option
      Awards
                
                
                Stock
      AwardsName
                
                Number
      of Shares Acquired on Exercise (#)
                
                
                Value
      Realized ($)
                
                
                Number
      of Shares Acquired on Vesting (#)
                
                
                Value
      Realized on Vesting ($)(a)
                
                (b)
                
                
                (
      c)
                
                
                (d)
                
                
                (e)Robert
      Cheney
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Eric
      Chan
                
                
                111,111
                
                
                
                128,889
                
                
                
                -
                
                
                
                -








63






Compensation of
Directors:





Directors
receive no cash remuneration for their services as directors at this
time.  The following table sets forth a summary of the compensation we
paid to our non-employee directors in 2008:





NON-EMPLOYEE
DIRECTOR COMPENSATION




Name
                
                Fees
      Earned or Paid in Cash ($)
                
                
                Stock
      Awards ($)
                
                
                Option
      Awards (1) ($)
                
                
                Non-Equity
      Incentive Plan Compensation ($)
                
                
                Change
      in Pension Value and Non-Qualifed Deferred Compensation Earnings
      ($)
                
                
                All
      other Compensation ($)
                
                
                Total
      ($)(a)
                
                (b)
                
                
                (c
      )
                
                
                (d)
                
                
                (e)
                
                
                (f)
                
                
                (g)
                
                
                (j)Tony
      Shum (2)
                
                
                -
                
                
                
                -
                
                
                
                241,226
                
                
                
                -
                
                
                
                -
                
                
                
                96,000
                
                
                
                337,226Phil
      Radlick (3)
                
                
                -
                
                
                
                -
                
                
                
                38,185
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                38,185Richard
      Gaston (4)
                
                
                -
                
                
                
                -
                
                
                
                93,662
                
                
                
                -
                
                
                
                -
                
                
                
                98,000
                
                
                
                191,662Sung
      Chun (5)
                
                
                -
                
                
                
                -
                
                
                
                159,083
                
                
                
                -
                
                
                
                -
                
                
                
                104,000
                
                
                
                263,083Gabriel
      Vegh (6)
                
                
                -
                
                
                
                -
                
                
                
                15,295
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                15,295





(1)
            The
      method of and assumptions used to calculate the value of the options
      granted to our directors is discussed in Note 1 of our notes to our
      financial statements included in our Annual Report on Form
      10-K.


(2)
            Tony
      Shum, director since 2006, was granted a 10-year option to purchase
      500,000 shares of the Company’s common stock at an exercise price of $1.69
      on August 28, 2008.  Mr. Shum owns options to purchase up to
      1,507,200 of our common stock of which 339,534 are exercisable as of
      December 31, 2008. Other Compensation includes fees earned under a
      consulting agreement executed on March 15,
2009.


(3)
            Phil
      Radlick, director since 1994, was granted a 10-year option to purchase
      200,000 shares of the Company’s common stock at an exercise price of $1.69
      on August 28, 2008.  Mr. Radlick owns options to purchase up to
      216,200 of our common stock of which 16,200 are exercisable as of December
      31, 2008.


(4)
            Richard
      Gaston, director since 2007, was granted a 10-year option to purchase
      300,000 shares of the Company’s common stock at an exercise price of $1.69
      on August 28, 2008.  Mr. Gaston owns options to purchase up to
      550,000 of our common stock of which 83,334 are exercisable as of December
      31, 2008. Other compensation includes consulting fees paid under Mr.
      Gaston’s consulting agreement.


(5)
            Sung
      Chun, director since 2008, was granted 10-year options to purchase 600,000
      shares of the Company’s common stock at an exercise price of $1.69 on
      August 28, 2008.  Mr. Chun owns options to purchase up to
      750,000 of our common stock of which 50,000 are exercisable as of December
      31, 2008. Other compensation includes consulting fees paid under Mr.
      Chun’s consulting agreement.


(6)
            Gabriel
      Vegh, director from 2001 through August 2008, had no options granted in
      2008.  As of December 31, 2008 Mr. Vegh had no options
      outstanding with the Company.






64









ITEM 12.
            SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS





The
following table sets forth certain information known to us with respect to the
beneficial ownership of our common stock as of February 28, 2009 by (i) each
person who is known by us to own beneficially more than 5% of our common stock
and (ii) all officers and directors as a group.





Shares
      beneficially ownedStockholder
                  
                  Number
      of shares
                  
                  
                  Percentage
      of class (1)Peter
      Yuan (2)
                  
                  
                  67,075,383
                  
                  
                  
                  46.7
                  %NN
      65 Tomson VillaNo.
      1, Long Dong Ave.Pudong,
      Shanghai, ChinaVictor
      Shui Kwai Lee & Agnes (3)
                  
                  
                  48,755,120
                  
                  
                  
                  33.9
                  %54
      LaSalle Road, 2nd
      FloorKowloon
      TongKowloon,
      Hong KongRobert
      Cheney (4)
                  
                  
                  22,640,034
                  
                  
                  
                  15.7
                  %Nelson
      Capital Corporation24F
      Block 48Baguio
      Villa550
      Victoria RoadPokfulam,
      Hong Kong, ChinaTony
      Shum
                  
                  
                  340,034
                  
                  
                  
                  *
                  %Eric
      Chan
                  
                  
                  405,913
                  
                  
                  
                  *
                  %Philip
      Radlick
                  
                  
                  16,200
                  
                  
                  
                  *
                  %Richard
      Gaston
                  
                  
                  83,334
                  
                  
                  
                  *
                  %Sung
      Chun
                  
                  
                  50,000
                  
                  
                  
                  *
                  %All
      executive officers and directors as a group (6
    persons)
                  
                  
                  23,535,515
                  
                  
                  
                  16.4
                  %




(*) Less
than one percent.





(1)
Beneficial Ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or investment
power with respect to securities. Shares of common stock subject to options or
warrants currently exercisable or convertible, or exercisable or convertible
within 60 days of February 28, 2009 are deemed outstanding for computing the
percentage of the person holding such option or warrant but are not deemed
outstanding for computing the percentage of any other person. Except as pursuant
to applicable community property laws, the persons named in the table have sole
voting and investment power with respect to all shares of common stock
beneficially owned.




(2)
Includes 29,955,200 shares issued to Peter Yuan pursuant to a Debt Settlement
Agreement entered in to between the Company and Apix International Limited, and
10,000,000 shares of common shares issued to Mr. Yuan in connection with the
December 2007 financing.  Also includes 6,666,666 shares of common
stock issued to Mr. Yuan in connection with the May 2008 financing and
18,518,518 shares of common stock issued in connection with the February 28,
2009 financing.  The number of shares also includes warrants to
purchase 2,499,999 common shares exercisable within 60 days of February 28,
2009.




(3)
Includes ownership contained on Form 4 filed with the SEC on March 9,
2009.  The number of shares also includes a warrant to purchase
602,499 common shares exercisable within 60 days of February 28,
2009.





(4)
Includes 16,800,000 shares held by Nelson Capital Corporation of which Mr.
Cheney is a director.  Also includes 1,000,000 shares issuable upon
conversion of 5,000,000 shares of Series A Preferred Stock (the "Series A")
held by Apix International Limited of which Mr. Cheney is a director and
principal shareholder.  Also includes 4,500,000 warrants and 340,034
options exercisable within 60 days of February 28, 2009.








65





Section
16(a) Beneficial Ownership Reporting Compliance





Section 16(a)
of the Securities Exchange Act of 1934, as amended, requires our directors,
executive officers and holders of more than 10% of our Common stock to file with
the SEC reports regarding their ownership and changes in ownership of our
securities. We believe that, during 2008, our directors, executive officers and
10% stockholders complied with all Section 16(a) filing requirements, other
than the filings by (1) Eric Chan on (a) a Form 4 on November 25, 2008 to report
the exercise and sale common stock, effective November 18, 2008, (b) a Form 4 on
December 29, 2008 to report the sale of common stock, over the period of
December 19 through 23, 2008, (2) Tony Shum on a Form 4 on December 22, 2008 to
report the acquisition of derivative securities on September 26, 2007 and August
28, 2008 pursuant to stock options granted under the Company’s 2007 Stock Option
Plan, (3) by Robert Cheney on (a) a Form 4 on January 22, 2008 to report the
acquisition of a warrants to purchase common stock on December 31, 2007, (b) a
Form 4 on March 16, 2009 to report the acquisition of three derivative
securities on July 27, 2006, September 26, 2007 and August 28, 2008, (4) Philip
Radlick on a Form 4 on December 22, 2008 to report the acquisition of three
derivative securities on June 16, 2005, on July 27, 2006, and shares on August
28, 2008, (5) Paul Cheng on a Form 3 on January 9, 2009 to report the
appointment of Mr. Cheng to Chief Accounting Officer on November 24, 2008, (6)
Sung Chun on a Form 3 for his appointment to the Board of Directors and the
acquisition of derivative securities on August 28, 2008 has not been filed, (7)
Richard Gaston on a Form 3 on February 19, 2009 to report his appointment to the
Board of Directors on October 5, 2007 and the acquisition of derivative
securities on August 28, 2008, (8) Peter Yuan on (a) a Form 3 on March 7, 2008
as a result of becoming a holder of more than 10% of our common stock, (b)
eleven Form 4 which were filed late between March 7, 2008 and December 31, 2008
which included 36 late transactions involving the purchase and acquisition of
common stock and warrants, (9) Victor Lee on (a) a Form 3 filed on January 18,
2008 as a result of becoming a holder of more than 10% of our common stock, (b)
twenty-five Form 4 were filed late between January 22, 2008 and January 5, 2009
which included 91 late transactions involving the purchase and acquisition of
common stock and warrants.





In making
these statements, we have relied upon examination of the copies of Forms 3, 4
and 5, and amendments to these Forms, provided to us and the written
representations of our directors, executive officers and 10%
stockholders.





ITEM
13.                      CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE





As
previously disclosed, our former President and Chief Operating Officer, William
K. Wheeler, threatened to sue us for the recovery of $375,000 plus interest,
which he claimed that was owed under the terms of his amended executive
agreement. He made a settlement proposal, which would extinguish his repayment
obligation on the loan that he had received from us in June 2000 and May 2001,
in the total principal amount of $192,500. In December 2006, a settlement
agreement was reached in principle, which we would pay $295,000 to Mr. Wheeler
($5,000 per month for 59 months). In accordance with the Accounting Principle
Board (“APB”) No. 21, “Interest on Receivables and Payables”, the $295,000 note
payable is discounted at 10% (same as the interest rate on the current loan
financing) and the $192,500 note receivable is discounted at 6% (the original
note’s interest rate). As of December 31, 2006, the discounted value of the note
payable and note receivable was $232,287 and $162,022, respectively. As of
December 31, 2008, the net of these two values payable to Mr. Wheeler is
$53,379.





In
December 2007, we entered into a series of Subscription Agreements (the
“Subscription Agreement”) with certain accredited investors (collectively, the
“Investors”) providing for the sale of (i) a total of 18 million shares of our
Common Stock in the aggregate principal amount of $9 million (the “Shares”)
and (ii) warrants (the “Warrants”) to purchase an aggregate of 2.7 million
shares of our Common Stock at an exercise price of $0.55 per share. We provided
for $75,000 in expense reimbursements. Per an Amended Funding Agreement,
APIX waived its five-percent common share placement fee and  accepted
for its services rendered; (i) an additional one million warrants (total three
million warrants) to purchase shares of our common stock at an exercise price of
$0.55 per share; and (ii) all rights, title and interest in a loan totaling
$360,000, including accrued interest, owed to us by Phil Radlick, a Director of
our Company, with a guaranteed minimum recoverable value of not less than
$100,000. We have extinguished all of our obligations under this Amended Funding
Agreement in the first quarter of 2009.




In May
2008, we entered into a series of Subscription Agreements with certain
accredited investors, certain of whom were existing shareholders of our Company,
providing for the sale of (i) a total of 8,474,992 shares of our Common Stock in
the aggregate principal amount of $5.1 million and (ii) warrants to purchase an
aggregate of 1,271,247 shares of our Common Stock at an exercise price of $0.65
per share. We also issued 1,500,000 warrants to purchase shares of our common
stock to APIX at an exercise price of $0.60 per share. We provided for $80,000
in expense reimbursements.




On
November 11, 2008, we executed a Loan Term Sheet and Loan Commitment letter with
an accredited investor and shareholder of our company pursuant to which we
issued a secured promissory note in the principal amount of $6 million. APIX
acted as placement agent for the transaction.  We provided for $80,000
in expense reimbursements.





On
February 28, 2009, we entered into a subscription agreement with an accredited
investor and our largest individual shareholder, providing for the sale of (i) a
total of 18,518,518 shares of our Common Stock at a price equal to $1.08 per
share, in the aggregate principal amount of $20.0 million and (ii) warrants to
purchase an aggregate of 5,555,555 shares of our Common Stock at an exercise
price of $1.25 per share. APIX acted as placement agent. We provided for up to
$80,000 in expense reimbursements. The Investor agreed to convert the advance of
$6.0 million received in November 2008 into shares of our Common Stock and waive
all accrued interest. As of February 28, 2009, the shareholder owns 46.7 % of
our Company’s Common Stock.








66





ITEM
14.                      PRINCIPAL
ACCOUNTANT FEES AND SERVICES





The following table represents
aggregate fees billed to us for fiscal years ended December 31, 2008 and 2007 by
PMB Helin Donovan LLP and Mark Lumer & Company, our former
accountant.





Fiscal
      Years Ended December 31,2008
                
                
                2007Audit
      fees
                
                $
                143,000
                
                
                $
                137,000Audit
      related fees
                
                
                -
                
                
                
                -Tax
      fees
                
                
                -
                
                
                
                -All
      other fees
                
                
                -
                
                
                
                -Total
      fees
                
                $
                143,000
                
                
                $
                137,000








(1)
            Audit
      fees consist of fees billed for professional services rendered for the
      audit of the Company’s consolidated annual financial statements and review
      of the interim consolidated financial statements included in quarterly
      reports, as well as services normally provided by our principal accounting
      firm in connection with statutory and regulatory filings or engagements,
      including registration statements


(2)
            Audit-related
      fees consist of fees billed for assurance and related services that are
      reasonably related to the performance of the audit or review of the
      Company’s consolidated financial statements and are not reported under
      “Audit Fees.” None were provided by our principal accounting
      firm.


(3)
            Tax
      fees consist of fees billed for professional services rendered for tax
      compliance, tax advice and tax planning (domestic and
      international).  These services include assistance regarding
      federal, state and international tax compliance, acquisitions and
      international tax planning.  None is provided by our principal
      accounting firm.








67




PART
IV




ITEM
15.                      EXHIBITS




3.1
                            
                            Amended
      and Restated Certificate of Incorporation of Cardima, Inc. (as
      incorporated by reference to the Company’s Annual Report on Form 10-K for
      the year ended December 31, 2003 filed with the Securities and Exchange
      Commission on March 31, 2004).3.1a
                            
                            Certificate
      of Elimination of Series A Participating Preferred Stock (as incorporated
      by reference to the Company's Form 8-K filed with the Securities and
      Exchange Commission on June 8, 2008).3.1b
                            
                            Certificate
      of Designation Series A Preferred Stock (as incorporated by reference to
      the Company's Form 8-K filed with the Securities and Exchange Commission
      on June 8, 2008).3.1c
                            
                            Amended
      and Restated Certificate to set forth Designations, Voting powers,
      Preferences, Limitations, Restrictions, and Relative rights of Series A
      Convertible Preferred Stock (as incorporated by reference to the Company’s
      Form 8-K filed with the Securities and Exchange Commission on December 2,
      2008)3.2
                            
                            Bylaws
      of Cardima, Inc. (as incorporated by reference to the Company’s
      Registration Statement on Form S-1 (File No. 33-23209) declared effective
      on June 5, 1997).4.3
                            
                            Form
      of Warrant dated December 17, 2007 ((incorporated by reference to the
      Company’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on December 26, 2007).10.1
                            
                            1993
      Stock Option Plan, as amended (Incorporated by reference to Exhibit 10.1
      filed with the Company’s Annual Report on Form 10-K (File No. 000-22419)
      filed on March 31, 2003)10.2
                            
                            1997
      Directors’ Stock Option Plan (Incorporated by reference to the exhibit of
      the same number filed with the Company’s Registration Statement on Form
      S-1 (File No. 33-23209) declared effective on June 5,
    1997).10.3
                            
                            1997
      Employee Stock Purchase Plan (Incorporated by reference to the exhibit of
      the same number filed with the Company’s Registration Statement on Form
      S-1 (File No. 33-23209) declared effective on June 5,
    1997).10.4
                            
                            2003
      Stock Option Plan (Incorporated by reference to Exhibit 99.1 filed with
      the Company’s Registration Statement on Form S-8 (File No. 333-106922)
      filed on July 10, 2003).10.5
                            
                            Loan
      Agreement dated August 28, 2005 by and between Apix International Limited
      and Cardima, Inc. (as incorporated by reference to the Company's Form 8-K
      filed with the Securities and Exchange Commission on September 1,
      2005).10.6
                            
                            10%
      Promissory Note of Cardima, Inc. dated August 26, 2005 (as incorporated by
      reference to the Company's Form 8-K filed with the Securities and Exchange
      Commission on September 1, 2005).10.7
                            
                            Warrant
      Agreement to purchase shares of the common stock of Cardima, Inc. dated as
      of August 28, 2005 (as incorporated by reference to the Company's Form 8-K
      filed with the Securities and Exchange Commission on September 1,
      2005).10.8
                            
                            Security
      Agreement dated August 12, 2005, by and between Cardima, Inc. and Apix
      International Limited (as incorporated by reference to the Company's Form
      8-K filed with the Securities and Exchange Commission on August 16,
      2005).10.9
                            
                            Trademark
      Security Agreement dated August 12, 2005, by and between Cardima, Inc. and
      Apix International Limited (as incorporated by reference to the Company's
      Form 8-K filed with the Securities and Exchange Commission on August 16,
      2005).10.10
                            
                            Patent
      Security Agreement dated August 12, 2005, by and between Cardima, Inc. and
      Apix International Limited (as incorporated by reference to the Company's
      Form 8-K filed with the Securities and Exchange Commission on August 16,
      2005).10.11
                            
                            Patent,
      Trademark and Copyright Security Agreement dated August 12, 2005, by and
      between Cardima, Inc. and Apix International Limited (as incorporated by
      reference to the Company's Form 8-K filed with the Securities and Exchange
      Commission on August 16, 2005).10.11
                            
                            Patent,
      Trademark and Copyright Security Agreement dated August 12, 2005, by and
      between Cardima, Inc. and Apix International Limited (as incorporated by
      reference to the Company's Form 8-K filed with the Securities and Exchange
      Commission on August 16, 2005).10.12
                            
                            Loan
      Facility Term Sheet (as incorporated by reference to the Company’s Current
      Report on Form 8-K filed with the Securities and Exchange Commission on
      February 21,
2006).
 
  68
  10.13
                            
                            Debt
      Settlement Agreement dated October 3, 2007 (incorporated by reference to
      the Company’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on October 9, 2007).10.14
                            
                            Form
      of Subscription Agreement dated December 17, 2007 (incorporated by
      reference to the Company’s Current Report on Form 8-K filed with the
      Securities and Exchange Commission on December 26,
  2007).10.15
                            
                            Funding
      Agreement dated October 5, 2007 (incorporated by reference to the
      Company’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on December 26, 2007).10.16
                            
                            Amendment
      to Funding Agreement dated December 14, 2007 (incorporated by reference to
      the Company’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on December 26, 2007).10.17
                            
                            Executive Agreement effective as of November 24, 2008 by
      and between Cardima, Inc. and Paul Cheng*10.18
                            
                            Consultant Agreement dated as of September 1, 2008 by
      and between Cardima, Inc. and Robert Cheney.*10.19
                            
                            Consultant Agreement dated as of September 1, 2008 by
      and between Cardima, Inc. and Tony Shum.*10.20
                            
                            Form
      of Subscription Agreement executed on February 28, 2009 (as incorporated
      by reference to the Company’s
      current      report on Form 8-K filed with
      the Securities and Exchange Commission on March 4,
2009)16.1
                            
                            Letter
      from Former Accountant dated as of September 22, 2005 (as incorporated by
      reference to the Company’s Current Report on Form 8-K filed with the
      Securities and Exchange Commission on October 21,
2005).16.1
                            
                            Letter
      from Former Accountant dated as of October 19, 2007 (as incorporated by
      reference to the Company’s Current Report on Form 8-K filed with the
      Securities and Exchange Commission on October 23,
2007).31.1
                            
                            Certification of the Chief Executive Officer and Chief
      Financial Officer pursuant to Item 601(b)(31) of Regulation S-B, as
      adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      2002.*32.1
                            
                            Certification of the Chief Executive Officer and Chief
      Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant
      to Section 906 of the Sarbanes-Oxley Act of 2002.*
 *  Filed
herewith.
   69







SIGNATURES





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







CARDIMA,
      INC.March
      19, 2009
            By:
            /s/ Robert
      CheneyRobert
      CheneyChief
      Executive Officer and Chief Financial Officer





POWER
OF ATTORNEY





KNOW ALL
PERSONS BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Robert Cheney, his attorney-in-fact, each with the
power of substitution, for him in any and all capacities, to sign any amendments
in this Annual Report on Form 10-K, and to file the same, with exhibits thereto
and other documents in connections therewith, with the Securities and Exchange
Commission, hereby ratifying and conforming all that each of said
attorneys-in-fact, or his or her substitutes, may do or cause to be done by
virtue of hereof.





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.





NAME
                              
                              TITLE
                              
                              DATE/s/
      Tony Shum
                              
                              Chairman
      of the Board
                              
                              March
      19, 2009Tony
      Shum/s/
      Robert Cheney
                              
                              Chief
      Executive Officer
                              
                              March
      19, 2009Robert
      Cheney/s/
      Eric Chan
                              
                              Director
                              
                              March
      19, 2009Eric
      Chan/s/
      Sung Chun
                              
                              Director
                              
                              March
      19, 2009Sung
      Chun/s/
      Richard Gaston
                              
                              Director
                              
                              March
      19, 2009Richard
      Gaston/s/
      Phillip Radlick
                              
                              Director
                              
                              March
      19, 2009Phillip
      Radlick