<PAGE>

-------------------------------------------------------------------------------
-------------------------------------------------------------------------------

                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549

                                   FORM 10-K

     [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
         SECURITIES EXCHANGE ACT OF 1934. For the fiscal year ended
         December 31, 1997 or

     [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
         SECURITIES EXCHANGE ACT OF 1934. For the transition period
         from ________ to ________ .

                        COMMISSION FILE NUMBER: 0-22419

                                 CARDIMA, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
 <S>                                             <C>
                   DELAWARE                                       94-3177883
 (STATE OR OTHER JURISDICTION OF INCORPORATION        (I.R.S. EMPLOYER IDENTIFICATION NO.)
               OR ORGANIZATION)
       47266 BENICIA STREET, FREMONT, CA                          94538-7330
   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                        (ZIP CODE)
</TABLE>

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

       SECURITIES REGISTERED PURSUANT TO SECTION 12 (B) OF THE ACT: NONE

         SECURITIES REGISTERED PURSUANT TO SECTION 12 (G) OF THE ACT:
                         COMMON STOCK, $.001 PAR VALUE

  Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) had been subject to
such filing requirements for the past 90 days. [X] Yes  No [_]

  Indicate by check mark if disclosure of delinquent filers pursuant to item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

  The aggregate market value of the voting stock held by non-affiliates of the
registrant was $5,759,918, based on the last reported sales price of the
Common Stock on the Nasdaq National Market on March 23, 1998.

  As of March 23, 1998, there were 8,154,527 shares of Registrant's Common
Stock outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

  The Registrant has incorporated by reference into Part III of this Form 10-K
portions of its Proxy Statement for the Annual Meeting of Stockholders to be
held May 19, 1998.

-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
<PAGE>

                                 CARDIMA, INC.

                                   FORM 10-K

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

                                     INDEX

<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           NO.
                                                                           ----
<S>                                                                        <C>
PART I....................................................................   3
   ITEM 1.  BUSINESS......................................................   3
   ITEM 2.  PROPERTIES....................................................  24
   ITEM 3.  LEGAL PROCEEDINGS.............................................  24
   ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...........  24
PART II...................................................................  25
   ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
            MATTERS.......................................................  25
   ITEM 6.  SELECTED FINANCIAL DATA.......................................  26
   ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
            AND RESULTS OF OPERATIONS.....................................  27
   ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................  39
   ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
            AND FINANCIAL DISCLOSURE......................................  39
PART III..................................................................  40
   ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...........  40
   ITEM 11.  EXECUTIVE COMPENSATION.......................................  41
   ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
             MANAGEMENT...................................................  41
   ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...............  41
PART IV...................................................................  41
   ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
             FORM 8-K.....................................................  41
SIGNATURES................................................................  43
</TABLE>

                                       2
<PAGE>

                                    PART I

ITEM 1. BUSINESS

OVERVIEW

  Cardima, Inc. designs, develops, manufactures and markets minimally
invasive, single-use, microcatheter-based systems for the mapping and ablation
of the two most common forms of cardiac arrhythmias: atrial fibrillation
("AF") and ventricular tachycardia ("VT"). Arrhythmias are abnormal electrical
heart rhythms that adversely affect the mechanical activities of the heart and
can potentially be fatal. The Company is developing microcatheter systems
designed to provide enhanced access to arrhythmia causing tissue, to diagnose
the arrhythmia by locating its origin ("mapping") and to restore normal heart
rhythms by isolating and destroying the arrhythmia causing sites ("ablation")
using radiofrequency ("RF") energy. The Company's microcatheters incorporate
multiple electrodes at the distal end of the catheter that are designed to
record electrical signals for mapping with diagnostic products and, with some
products, to emit RF energy for ablation, allowing physicians to both map and
ablate using the same catheter. Cardima's microcatheters are designed with
variable stiffness and a highly flexible distal tip to allow enhanced access
to the vasculature of the heart. In addition, they are designed to be
compatible with existing signal display systems and RF generators, eliminating
the need for significant new investment in capital equipment. The Company's
microcatheter technology was originally conceived at Advanced Cardiovascular
Systems, Inc. ("ACS," now a division of Guidant Corporation), from 1979 to
1982. Target Therapeutics, Inc. ("Target," now a division of Boston Scientific
Corporation ("Boston Scientific")) purchased this technology in 1985 from ACS
for use in neurological applications. In 1993, Target granted Cardima an
exclusive, royalty-free license to use the microcatheter technology in the
treatment of electrophysiological diseases affecting areas other than the
central nervous system.

  In January 1997, the Cardima Pathfinder microcatheter system received 510(k)
clearance from the United States Food and Drug Administration ("FDA") for use
in mapping VT, and in November 1997 the Revelation microcatheter system
received 510(k) clearance from the FDA for use in mapping AF. These products
are currently being marketed for these applications in the United States,
Europe, Japan, Australia and Canada. Also in January 1997, the Company filed
an Investigational Device Exemption ("IDE") for clinical testing of the
Revelation microcatheter systems for the mapping and ablation of AF. The
Company completed the mapping phase of this feasibility study in August 1997
and began treating the first patient in the ablation phase with the Cardima
Pathfinder AFTC (AF Temperature Control) microcatheter system in March 1998.
The Company has initiated a clinical trial in Europe to treat AF at seven
clinical sites. Upon completion of this trial, the Company will submit this
data for CE mark approval, which is necessary for AF therapeutic sales in
Europe. The Company will then need to conduct a pivotal study in the U.S.,
ultimately leading to submission of a PMA. The Company currently expects to
file an IDE to begin clinical testing its Therastream microcatheter system for
VT ablation in the second half of 1998.

DISCUSSION OF THE HEART AND ARRHYTHMIC DISORDERS

  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 called the
atria, and the two lower chambers called the ventricles. The heart consists of
two pumps working side by side, each with its own atrium and ventricle. The
pump on the right side collects venous blood from the body and sends it to the
lungs for oxygenation. The pump on the left side receives the oxygenated blood
from the lungs and pumps it through the body. The process is repeated as
venous blood returns to the right side of the heart.

  The heart, as with any other organ, requires oxygen and nutrients to
function. Because the heart has large oxygen and nutrient demands, it requires
an extensive, well developed vascular network to bring blood to and carry
blood away from its tissue. This coronary vascular network is located
throughout the majority of the heart's walls to nourish the heart tissue
directly. This network is comprised of an arterial system and a venous system,

                                       3
<PAGE>

both of which originate on the epicardium, or outer surface, of the ventricles
and penetrate into the tissues of the ventricular walls. Thus, the anatomy of
the ventricular walls consists of a thick mass of contracting muscle cells
with a framework of coronary blood vessels.

  The heart's pumping action is controlled by an electrical conduction system
comprised of a specialized network of cells within the heart muscle tissue.
This conduction system allows electrical signals to propagate through the
heart in a systematic and organized way. These specialized conduction cells
are placed throughout the walls of the chambers, from just underneath the
inner, or endocardial, surface of the heart to the outer, or epicardial,
surface. This conduction system carries electrical signals, in a properly
timed sequence, to the muscle cells throughout the heart. The electrical
conduction cycle that results in a normal heart beat starts in the right
atrium, which contains a specialized group of cells called the Sino-Atrial
("SA") node.

  The SA node is the heart's "natural pacemaker," regularly discharging an
electrical signal that, under normal circumstances, is responsible for setting
the heart rate, usually 60 to 100 beats per minute. The signal generated in
the SA node is propagated through the atria until it is delayed in the Atrio-
Ventricular ("AV") node. This delay provides enough time for the atria to fill
the ventricles with blood before they contract.

  Once the electrical signal exits the AV node, it is rapidly conducted down
the His Bundle, and is distributed widely throughout both ventricles via the
Purkinje Fibers, delivering the electrical signal to both ventricles at the
same time, causing them to contract in unison. Since the ventricles pump blood
to the lungs and the body (while the atria only pump blood to the ventricles),
the ventricles are composed of a larger amount of muscle tissue 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 against a high vascular resistance.
In the normal heart, the four chambers work in rhythm with each other to
ensure that properly oxygenated blood is delivered throughout the body.

 Arrhythmias

  Arrhythmias are abnormal electrical heart rhythms that adversely affect the
mechanical activities of the heart. Arrhythmias result in insufficient blood
flow, which may cause dizziness, inadequate function of important organs in
the body, stroke or even death. Arrhythmias have numerous causes, including
congenital defects, tissue damage from heart attacks or arteriosclerosis and
other conditions that accelerate, delay or redirect the normal transmission of
electrical activity, thereby disrupting the normal coordinated contractions of
heart muscle cells. There are two general types of arrhythmias: tachycardia, a
fast resting heart rate, typically more than 100 beats per minute, and
bradycardia, a slow resting heart rate, typically less than 60 beats per
minute. Tachycardias fall into one of two major categories: supraventricular
tachycardia ("SVT"), which has its origin above the ventricles (typically in
the atria) with AF being the most common form of SVT, and VT, which has its
origin in the wall of the ventricles. Generally, arrhythmias degenerate and
worsen over time.

 Atrial Fibrillation

  AF is characterized by the irregular and very rapid beating of the heart and
results when the normal electrical conduction system of the atria
malfunctions, leading to irregular and chaotic electrical signals. During AF,
the regular pumping action of the atria is replaced by irregular, disorganized
and quivering spasms of atrial 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 cardiac output can lead to blood
pooling in the atria and the formation of blood clots. Blood clots in the left
atrium can dislodge and travel through the bloodstream to the brain, resulting
in stroke and even death.

  In the United States, AF affects an estimated two million people, with
approximately 160,000 new cases being diagnosed each year. It is estimated
that about 1.5 million outpatient hospital visits per year in the United

                                       4
<PAGE>

States are associated with AF and there are more than 200,000 admissions to
hospitals for AF each year. The American Heart Association estimates that AF
is responsible for over 70,000 strokes each year in the United States. The
Company estimates that the cost of treating these patients is more than $3.6
billion annually. The cost of drug treatment for AF alone is estimated to be
in excess of $400 million worldwide each year.

  AF is routinely diagnosed using an electrocardiogram, in which electrodes
are placed on the skin to record the irregular beating of the heart. However,
electrocardiograms are unable to locate the origin, or focus, of the AF.
Another diagnostic method, called mapping, involves placing catheters with
electrodes inside the chambers of the heart to record the electrical signals
generated by the heart in order to locate the focus of the arrhythmia. Since
AF is an arrhythmia that typically affects both the right and left atria at
the same time, the Company believes that optimal mapping of AF requires the
simultaneous evaluation of electrophysiological information from both atria.
The Company believes electrophysiologists do not routinely map AF because
currently available catheters are inadequate to map either the entire right or
left atrium, or both simultaneously.

  Current AF treatments are directed at trying to reestablish a normal
heartbeat and prevent stroke, and are primarily supportive and palliative,
rather than curative. Antiarrhythmic and anticoagulant drugs, the most common
treatment for AF, are typically used to attempt to control AF by restoring the
heart's natural rhythm and limiting the natural clotting mechanism of the
blood. However, antiarrhythmic drug therapy often becomes less effective over
time, with approximately half of the patients eventually developing
resistance. In addition, antiarrhythmic drugs can have severe side effects,
including pulmonary fibrosis and impaired liver function. Another palliative
procedure for AF is external cardioversion, or the application of strong
electrical current under general anesthesia. This treatment is usually
effective for a limited period of time as well. Implantable atrial
defibrillators are being investigated to detect the onset of AF internally and
then deliver an electrical shock to convert the heart back to normal rhythm.
Although the preliminary results of clinical studies indicate that this
approach may be feasible, AF is not cured with this approach. There are
significant problems including pain tolerance, reversion to AF and creation of
VT as a result of the electrical shock. Purposeful destruction of the AV node
followed by implantation of a pacemaker is typically a treatment of last
resort for AF patients, but does not cure or treat the AF itself. Since atrial
function remains poor following the procedure, chronic anticoagulant therapy
is generally required.

  The Company believes that the only curative therapy for AF used today is an
open heart operation. The most common procedure is the "maze" procedure, in
which a surgeon makes several slices through the wall of the atrium with a
scalpel and then sews the cuts back together creating a scar pattern. The
scars isolate and contain the chaotic electrical impulses to control and
channel the electrical signal emanating from the SA node. This open heart
operation is expensive and associated with long hospital stays and high
morbidity and mortality. Although this approach is not commonly used because
it is highly invasive, containing the movement of the chaotic impulses in the
atrium through scar creation is generally considered effective in controlling
AF.

  Electrophysiologists are also experimenting with less invasive, catheter-
based ablation procedures that attempt to mimic the results of the maze
procedure. Although these procedures offer the benefit of a minimally invasive
approach, they are difficult to perform because of the shortcomings of
existing catheter technology and appear unable to create lesions that
effectively isolate portions of the atria where the arrhythmia causing tissue
is located.

 Ventricular Tachycardia

  VT is a life-threatening condition in which heartbeats are improperly
initiated from within the ventricular wall, rather than from the SA node, thus
bypassing the heart's normal conduction system. The typical VT patient has
experienced a myocardial infarction, or heart disease, which leads to the
formation of a scar or electrical barrier inside the ventricular wall,
resulting in improper electrical conduction in the cells immediately bordering
the scar. During episodes of VT, the ventricles beat at such an abnormally
rapid rate that they are unable to fill completely with blood, thus impairing
the ventricles' ability to pump oxygenated blood throughout the body. The
resulting reduction in the amount of oxygen transported to the tissues and
organs of the body can cause

                                       5
<PAGE>

dizziness and loss of consciousness. VT can often progress into ventricular
fibrillation ("VF"), which is an irregular, chaotic and ineffective spasming
of the ventricles. VF is fatal within a few minutes of its occurrence, unless
orderly contractions of the ventricles are restored.

  It is estimated that more than 300,000 people in the United States suffer
from sudden cardiac death each year. Of these, approximately 50,000 people
survive, primarily through emergency defibrillation. These survivors are at
risk of developing VT or subsequently VF. The Company estimates that each year
over 100,000 people in the United States who have never suffered VF are
diagnosed with symptomatic VT. The American Heart Association estimates that
approximately 1.5 million people in the United States suffer myocardial
infarctions each year, of which approximately one million survive.
Approximately 30% of the survivors of a myocardial infarction suffer an
episode of VT within the following year. The Company believes all of these
individuals are potential candidates for a safe and cost-effective mapping and
ablation procedure.

  VT may be diagnosed using a standard electrocardiogram in a manner similar
to the diagnosis of AF. The cardiac electrophysiologist typically attempts to
map VT to locate the focus of the arrhythmia within the heart's structure.
However, locating the arrhythmia causing tissue, which can occur at any point
in the thickness of the ventricular wall, from the endocardium, or inner
surface of the heart wall, to the intramyocardium, inside of the heart wall
itself, to the epicardium, or outer surface of the heart wall, can be
difficult.

  Similar to AF, current treatments for VT are primarily supportive and
palliative. Antiarrhythmic drugs are the most common treatment, although these
drugs have been shown to have a number of unwanted side effects, and in some
circumstances may actually induce VT. The MADIT trial has demonstrated that
the implantable cardiac defibrillator is a more effective treatment for VT
than antiarrhythmic drugs, but it also is a palliative treatment and is
associated with a number of undesirable characteristics, such as patient
reliance on an implantable device with a limited battery life, the high cost
of the implantation procedure and the risks associated with implanting foreign
objects. In addition, the implantable cardioverter is only palliative and does
not cure the VT or destroy the arrhythmia causing tissue.

  Similar to the treatment of AF, electrophysiologists are also experimenting
with less invasive, catheter-based ablation procedures for the treatment of
VT. However, access limitations and shortcomings of existing endocardial
catheter technology for ablation have limited the use of catheter technology
to treat VT.

 Limitations of Current Catheter-Based Diagnosis and Therapy

  The demonstrated medical benefits and cost efficiency of minimally invasive
surgical procedures have encouraged electrophysiologists to seek a means of
employing new, minimally invasive techniques for the diagnosis and treatment
of arrhythmias. In the case of AF, electrophysiologists are experimenting with
a treatment technique, often referred to as the "drag and burn procedure," in
which conventional RF ablation catheters are dragged along the inside surface
of an atrium while applying RF energy. However, creating continuous, linear,
transmural lesions to isolate portions of the atria using this experimental
procedure with standard catheters has proven time consuming and difficult.
Endocardial catheter technology is also being tested for the treatment of VT.
The Company believes that an endocardial approach is suboptimal because the
muscle tissue of the ventricles is significantly thicker than the muscle
tissue in the atria, requiring the use of large amounts of RF energy. As a
consequence, the endocardial approach generates larger, less focused lesions,
increasing the amount of ventricular tissue destroyed in the procedure.

  The Company believes that the disadvantages of existing catheter based
approaches for AF and VT are attributable not to the minimally invasive
approach of the procedure, but instead to existing catheter technology. The
catheters currently used are relatively large (typically six to eight French
in diameter) and stiff, increasing the risk of trauma to the heart during the
procedure, and restricting access primarily to the chambers of the heart. When
attempting to diagnose and treat VT using standard electrophysiology
catheters, the electrophysiologist is unable to access smaller blood vessels
within the ventricular wall. As a result, generally only signals generated
within one to two millimeters of the inner wall can be recorded. The current
technology is inadequate because

                                       6
<PAGE>

the normal ventricular wall is five to 20 millimeters thick, and arrhythmia
causing tissue, especially tissue causing VT, can reside anywhere within that
thickness. In addition, the information generated by the endocardial
diagnostic procedure is limited, as the electrophysiologist can observe and
evaluate only a limited number of signals in a confined area. In order to
observe more signals, the user must mechanically manipulate the catheter to
change its location. As a result, the standard endocardial electrophysiology
procedure is extremely laborious and time consuming, in some cases requiring
up to 15 or more RF energy deliveries per treatment. Although there are
endocardial basket-type catheters in development that enable the
electrophysiologist to record information from multiple points in the
ventricle at once, the Company believes that these catheters suffer the same
access limitations to arrhythmia causing tissue located in the intramyocardium
and epicardium as standard endocardial catheters and often require additional
investments in capital equipment.

  Based on experience with standard endocardial catheters,
electrophysiologists recognize the need to record and evaluate a greater
amount of electrical information from various areas in the heart
simultaneously during AF or VT procedures. In the case of AF, the Company
believes there is a need for catheters that are able to map both right and
left atria at the same time, if warranted, and then immediately and
appropriately ablate the AF causing tissue. In the case of VT, the Company
believes there is a need for catheters that are able to map safely the entire
thickness of the ventricular wall, not just the endocardial surface, and
appropriately ablate the VT causing tissue with minimal trauma to normal
conducting heart tissue.

THE CARDIMA MICROCATHETER SYSTEM SOLUTION

  The primary clinical goal in the diagnosis and treatment of AF and VT is
precise mapping and effective, less destructive ablation. To achieve this, the
electrophysiologist must be able to access areas of the heart that are
currently inaccessible, using techniques that are easy to perform and that do
not increase the trauma to the patient. The Company is working to achieve this
goal by designing microcatheter systems which provide enhanced access to the
arrhythmia causing tissue, by mapping the location of the arrhythmia and then
ablating the arrhythmia causing tissue using RF energy to cure the patient,
all in one procedure using the same catheter. The Company's microcatheter
systems are designed to offer the following advantages:

  .  MINIMALLY INVASIVE APPROACH. The Cardima microcatheter systems are
     designed to provide a minimally invasive approach to the treatment of
     both AF and VT, resulting in decreased procedure time, shorter hospital
     stays, lower procedure costs and fewer complications than the surgical
     procedures currently in use.

  .  SINGLE CATHETER FOR RAPID MAPPING AND ABLATION. By using microcatheters
     that can map, as well as ablate, the Company believes the
     electrophysiologist need only access the arrhythmia causing tissue once
     in order to map it, verify that it is causing the arrhythmia and then,
     using the same device, ablate the tissue to cure the patient. The
     Company believes this single catheter, dual function characteristic of
     its microcatheter systems will decrease procedure times and improve
     treatment of both AF and VT.

  .  ENHANCED ACCESS TO THE VASCULATURE OF THE HEART. Cardima's
     microcatheters feature a significantly smaller diameter than standard
     electrophysiology catheters, and incorporate Target variable stiffness
     technology and a highly flexible distal tip. As a result, the Company's
     microcatheters are more flexible and torqueable than standard
     electrophysiology catheters and have varying degrees of flexibility at
     the distal end to allow enhanced access to the vasculature of the heart,
     to conform easily to the contours of the heart wall and to maintain
     controlled, regular contact even in a fast beating heart.

  .  ABILITY TO GATHER MORE INFORMATION. The Company's microcatheter system
     designs include a large number (up to 16) of narrow electrodes, while
     maintaining a high degree of flexibility. The Company believes that this
     design permits the electrophysiologist to acquire and evaluate far more
     information in a mapping procedure than is available using standard
     electrophysiology catheters, which typically incorporate fewer
     electrodes. The increased amount of information recorded using the
     microcatheter approach should enable the electrophysiologist to target
     the arrhythmia causing tissue with greater precision, in order to permit
     effective ablation.


                                       7
<PAGE>

  .  CURATIVE TREATMENT FOR AF. The Cardima Pathfinder AF microcatheter
     system is designed to treat AF by creating long, thin, continuous,
     linear, transmural lesions in both the right and left atria to isolate
     and contain the arrhythmia causing tissue, thereby restoring normal
     electrical function by controlling and reorganizing the random, chaotic
     electrical activity that characterizes AF. In animal studies, the
     Company's microcatheter systems have required less RF energy and created
     significantly thinner lesions than standard electrophysiology catheters,
     preserving a greater amount of atrial tissue following the procedure.
     The Company believes this will result in a significant improvement in
     atrial function and a reduction in the risk of blood clotting, reducing
     or eliminating the need for chronic anticoagulant therapy. The Company
     believes this approach has the potential to offer the effectiveness of
     the open heart surgical cure for AF, but with significantly less trauma,
     fewer complications, reduced pain, shorter hospital stays and lower
     procedure costs.

  .  CURATIVE APPROACH FOR VT. The Company's microcatheter systems for the
     mapping and ablation of VT are designed for use inside the vasculature
     of the heart wall, facilitating access to arrhythmia causing tissue
     through the venous system. Cardima believes that at least half of VT
     foci are located in the intramyocardium and the epicardium, areas that
     are ineffectively accessed using standard endocardial catheters or
     basket type catheters in development. The intravascular approach to VT
     ablation should permit the microcatheters to be positioned in close
     proximity to the arrhythmia causing tissue, facilitating the creation of
     smaller, more focused lesions. The Company believes 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. The Company is not aware of any epicardial mapping
     catheters other than the Cardima Pathfinder and Tracer under
     development.

  .  COMPATIBLE WITH EXISTING CAPITAL EQUIPMENT. The Company's microcatheter
     systems are designed to be compatible with leading electrophysiology
     signal display systems and RF generators, in order to eliminate the need
     for significant new investment in additional capital equipment. By
     facilitating the rapid and precise location of the arrhythmia causing
     tissues using a system that is compatible with standard laboratory
     equipment, the Company believes its products will be rapidly adopted by
     electrophysiologists.

  .  REDUCED PROCEDURE AND RADIATION EXPOSURE TIMES. The Company believes
     that its microcatheter systems will reduce procedure times and thereby
     decrease cumulative x-ray exposure to both patients and lab personnel.
     Standard electrophysiology procedures, in many cases, expose both the
     patient and the lab personnel to over one hour of accumulated x-ray time
     during fluoroscopy, which is used to visualize the placement of the
     catheters. The Company believes that the total procedure and fluoroscopy
     time associated with the use of its microcatheter systems are less than
     those using standard electrophysiology catheters, thereby reducing
     procedure costs and the risk of disease resulting from extended exposure
     to x-ray fluoroscopy.

STRATEGY

  Cardima's objective is to establish its microcatheter systems as the
standard of electrophysiological care for mapping and ablating AF and VT. To
achieve its objective, the Company is pursuing the following strategies:

  DEVELOP MICROCATHETER TECHNOLOGY TO ADDRESS UNMET CLINICAL NEEDS FOR BOTH
MAPPING AND ABLATION. Cardima is developing microcatheter systems to address
clinical needs that are not adequately addressed by current technology.
Cardima is focused on both endocardial access for AF and intravascular access
for VT, and provides a microcatheter systems approach to addressing AF and VT.
Cardima has designed systems incorporating variable stiffness technology
originally developed at Target, including guiding catheters, fixed-wire and
over-the-wire systems, in order to optimize the physician's ability to access
the areas of interest in the heart easily and safely. By using microcatheters
that can map as well as ablate, the Company believes the electrophysiologist
need only access the arrhythmia causing tissue once in order to map it, verify
that it is causing the arrhythmia and then ablate the tissue using the same
catheter.

                                       8
<PAGE>

  PROVIDE MICROCATHETER SYSTEMS THAT LOWER THE COST OF TREATING
ELECTROPHYSIOLOGICAL DISORDERS. The Company's microcatheter systems are
designed to reduce the average time required for AF and VT diagnostic and
therapeutic procedures significantly. As a result, time spent in high cost
electrophysiology laboratories should be reduced, lowering the overall cost of
AF or VT treatments. The shorter procedure time that the Company believes will
result from the use of its microcatheter systems should enable physicians to
perform a greater number of AF or VT procedures and reduce the overall cost
per procedure. In addition, the Company intends to use data derived from its
clinical studies to establish reimbursement for AF and VT procedures using the
Company's microcatheter systems. The Company believes that its microcatheter
systems will appeal to patients and third party payors seeking a cost-
effective solution to the diagnosis and treatment of AF and VT.

  ACCELERATE ACCEPTANCE AND ADOPTION OF THE COMPANY'S MICROCATHETER SYSTEMS BY
LEADING ELECTROPHYSIOLOGISTS. The Company has formed relationships with
leading medical centers in the United States, and is developing relationships
with medical centers in Europe and Japan, to perform clinical trials of its
microcatheter systems for the diagnosis and treatment of AF and VT. In the
United States, the Company has formal clinical trial agreements with
Massachusetts General Hospital, Stanford University Medical Center and Johns
Hopkins University Hospital to perform the ablation phase of the Company's
feasibility study of the Pathfinder AFTC microcatheter system for mapping and
ablation of AF. Cardima believes that successful acceptance and adoption of
these systems by widely recognized experts in the field of electrophysiology
is a critical step in the overall market acceptance of its microcatheter
systems. In addition, the Company has established a Scientific Advisory Board
composed of leading electrophysiologists at medical centers in the United
States to consult with the Company concerning the pre-clinical and clinical
development of the Company's microcatheter systems. The Company intends to
continue to work with leading physicians and medical centers and to initiate
clinical trials to demonstrate the safety and effectiveness of its
microcatheter systems and ultimately to establish broad market acceptance. In
addition, Cardima intends to accelerate physician education and adoption
through peer-reviewed publications concerning the clinical trials of the
Company's microcatheter systems.

  BUILD MARKET LEADERSHIP THROUGH STAGED INTRODUCTION OF MICROCATHETER
SYSTEMS. In the United States, the Company intends to first introduce
microcatheter systems for mapping while continuing to develop its
microcatheter systems for ablating AF and VT. The Company received 510(k)
premarket clearances for its Cardima Pathfinder microcatheter system for VT
mapping in January 1997 and its Revelation microcatheter system for AF mapping
in November 1997. The Company expects to establish the benefits of its
microcatheter systems by encouraging their use initially as a diagnostic
complement to standard ablation catheters. As a result, the Company's strategy
is to establish the utility of these diagnostic systems in advance of
regulatory approval for the Company's microcatheter systems for the treatment
of AF and VT.

  INCREASE SALES BY FURTHER PENETRATING INTERNATIONAL MARKETS. The Company
intends to devote significant resources to further penetrate international
markets, given their substantial size and the relatively lower regulatory
barriers. The Company has received ISO 9001 (EN 46001) Quality Systems
certification, as well as the right to affix the CE Mark to a number of its
products. The Company has received regulatory approval in the United States,
Europe, Japan, Australia and Canada for the Cardima Pathfinder microcatheter
system for mapping VT and has received regulatory approval in the United
States, Europe, Japan and Australia for the Cardima Revelation microcatheter
system for mapping AF. The Company is pursuing additional regulatory approvals
in Europe, Canada and Japan necessary to market its microcatheter systems for
ablation. In addition, the Company has trained electrophysiologists in the
United States, Europe, Canada and Japan in the use of its products.

PRODUCTS

  Cardima is developing microcatheter systems for the diagnosis and treatment
of AF and VT. These systems are designed, in the case of AF, to access both
the right and left atria and, in the case of VT, to be positioned within the
coronary vasculature using a guiding catheter in a system similar to that used
in angioplasty procedures. Cardima's microcatheter systems are designed to be
used endocardially in the atria to map and then ablate AF through the creation
of long, thin, continuous, linear, transmural lesions. For VT, these systems
are designed to provide intravascular access to the heart to map and ablate
within the wall of the ventricles. All of

                                       9
<PAGE>

the Company's microcatheters are available in a variety of electrode numbers,
electrode spacing configurations and outer diameters. These microcatheter
systems are smaller in diameter and are designed to be more flexible and
torqueable than standard electrophysiology catheters, providing better
steerability for the electrophysiologist. In addition, these systems have a
series of electrodes at their distal ends that can both receive electrical
signals for mapping and emit RF energy for ablation. The Company's Cardima
Pathfinder and Tracer microcatheters are designed for single use. The Company
is designing its products to be used with existing electrophysiology recording
systems and RF ablation generators. The Company's ancillary products,
including guiding catheters, guidewires and connecting cables, support these
families of microcatheter systems.

  The following table describes the Company's products and their intended
indications and regulatory status:

<TABLE>
<CAPTION>
                                                                                INTERNATIONAL
 AF PRODUCTS        DESCRIPTION         INDICATION U.S. REGULATORY STATUS(1) REGULATORY STATUS(1)
 ----------- ------------------------   ---------- ------------------------- --------------------
 <C>         <S>                        <C>        <C>                       <C>
 Revelation  Fixed-wire multi-          Mapping      510(k) clearance         Approved in
             electrode microcatheter                 obtained.                Europe (CE Mark)
             system designed to map                                           and Japan.
             in both right and left
             atria.
 Pathfinder  Fixed-wire multi-          Ablation     Feasibility IDE          European clinical
 AFTC        electrode microcatheter                 approved; clinical       trial in
             system with temperature                 trial in progress.       progress; data
             sensors designed to map                                          expected to be
             and create long, thin,                                           used for Japanese
             continuous, linear,                                              submission.
             transmural lesions in
             both right and left
             atria.
<CAPTION>
 VT PRODUCTS
 -----------
 <C>         <S>                        <C>        <C>                       <C>
 Cardima     Fixed-wire multi-          Mapping      510(k) clearance         Approved in
 Pathfinder  electrode microcatheter                 obtained.                Europe (CE Mark)
             system designed for                                              and Japan.
             accessing coronary
             vasculature to locate
             the arrhythmia causing
             tissue.
 Cardima     Smallest Cardima           Mapping      510(k) submitted in      Approved in
 Pathfinder  Pathfinder microcatheter                May 1997.                Europe (CE Mark)
 Mini        (1.5 French) designed to                                         and Japan.
             provide more distal
             access to smaller blood
             vessels in the heart
             wall.
 Tracer      Over-the-wire multi-       Mapping      510(k) submitted in      Approved in
             electrode microcatheter                 July 1997.               Europe (CE Mark)
             system designed to be                                            and Japan.
             used in the veins of the
             heart wall over a
             steerable guidewire.
 Therastream Over-the-wire multi-       Ablation     IDE submission           European ablation
             electrode microcatheter                 expected in late         submissions
             system designed for                     1998 for ablation        necessary for
             mapping and ablation                    using Therastream.       clinical trials
             from within the veins of                                         expected in 1998.
             the heart wall.
<CAPTION>
  ANCILLARY
  PRODUCTS
 -----------
 <C>         <S>                        <C>        <C>                       <C>
 Venaport    Coronary sinus guiding     Venous       510(k) clearance         Approved in
             catheters with a family    access       obtained.                Europe (CE Mark)
             of curve shapes and                                              and Japan.
             lengths. Designed to
             deliver Cardima
             microcatheter systems.
</TABLE>
--------
(1) The regulatory status of the Company's microcatheter systems reflects the
    Company's current estimates of the timing of regulatory submission in the
    United States, Europe and Japan. See "--Government Regulation." The actual
    submission times could differ materially from those anticipated in these
    forward-looking statements as a result of certain factors, including
    failure to complete development of microcatheter systems or to demonstrate
    safety or effectiveness in clinical studies, as well as the other factors
    set forth under the Company's "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.

                                      10
<PAGE>

 Products Designed for Mapping and Ablating AF

  The Company believes its microcatheter systems can access the right and left
atria in a minimally invasive procedure and are designed to effectively ablate
AF by creating long, thin, continuous, linear, transmural lesions in the
atria.

  Cardima Revelation for AF Mapping. The Revelation microcatheter system is
designed to facilitate mapping of the atria. The Revelation is a thin,
flexible, multi-electrode microcatheter. The Revelation microcatheter system
utilizes a three French diameter microcatheter that incorporates variable
stiffness technology that both permits access to any area of the atria and
enhances contact to surrounding heart tissue, and also has three millimeter
long platinum coil electrodes for added flexibility. This microcatheter system
is being sold for mapping AF in the United States, Europe and Japan.

  There is considerable clinical debate regarding the need for mapping AF
prior to ablation, because, among other reasons, the electrical
characteristics of the arrhythmia causing tissue cannot be assessed adequately
using current technology. No mapping is performed during the open heart
surgical maze procedure. However, the Company believes that mapping prior to
ablation may be useful to identify different segments of the AF population,
each of which could require slightly different mapping and ablation
procedures. For example, some electrophysiologists believe most AF patients
will need to be mapped and ablated in both the left and right atria, while
others believe only right atrial intervention is warranted. The Company
believes that its products will have clinical utility in either of these
situations.

  Cardima Pathfinder AFTC for AF Ablation. The multiple electrodes of the
Cardima Pathfinder AF microcatheter is closely grouped and can be used to
create a continuous lesion that extends through the thickness of the atrial
wall. The Company believes that the electrophysiologist will be able to use
the Cardima Pathfinder AFTC microcatheter system to create long, thin,
continuous, linear, transmural lesions in both the right and left atria,
thereby restoring normal electrical function in the atria by isolating the
arrhythmia causing tissue in a manner similar to the open heart surgical maze
procedure, without the associated risk and expense. Unlike other catheter-
based ablation techniques, such as the "drag and burn" approach, the Cardima
approach does not involve resetting the catheter position during the linear
ablation procedure. As a result, the Cardima Pathfinder AFTC may have the
ability to more effectively and rapidly ablate the arrhythmia causing tissue.

  The Cardima Pathfinder AFTC microcatheters are designed with narrow
electrodes that are able to deliver ablation level energy to the atrial tissue
at much lower power settings than documented with standard electrophysiology
catheters. The Company's animal studies have demonstrated the ability of the
Cardima Pathfinder AFTC to create the thinnest linear lesions that the Company
believes have ever been documented and presented generally to the
electrophysiology community. The Company has designed its Cardima Pathfinder
AFTC microcatheter system to be used with leading cardiac electrophysiology RF
generators and electrophysiology mapping computer systems.

  The Company filed an IDE with the FDA for the Revelation microcatheter
system for mapping and ablation of AF in January 1997. The protocol for this
feasibility study was divided into two parts, one focusing on mapping and one
focusing on ablation. The Company completed the mapping phase of the study in
August 1997 and treated the first patient in the ablation phase in March 1998.
The Company believes that PMA approval will be required before the Cardima
Pathfinder AFTC for atrial ablation can be marketed in the United States. See
"--Government Regulation."

 Products Designed for Mapping and Ablating VT

  The Company's intravascular approach allows its microcatheters to be
positioned in close proximity to the VT causing tissue and provides stable
positioning within the vascular system. The Company believes this

                                      11
<PAGE>

approach will result in greater accuracy of diagnosis and more effective
treatment. The Company is not aware of any other epicardial mapping catheters
in development.

  Cardima Pathfinder and Tracer for VT Mapping. The Company's microcatheter
systems used for diagnosing and treating VT are designed to be positioned
within the coronary vasculature using a guiding catheter or guidewire in a
system similar to that used in angioplasty procedures and also have a series
of electrodes at their distal ends in order to perform as electrophysiology
catheters. The Cardima Pathfinder and Tracer microcatheter systems can be used
to subselect vessels and access the small veins located at the apex (lower
tip) of the heart. The Cardima Pathfinder microcatheter systems are configured
with either four, eight or 16 electrodes, that enable the physician to perform
a narrow focus evaluation using a smaller number of electrodes, if there is
reason to believe the VT causing tissue is located in a specific area, or a
wider focus evaluation using larger number of electrodes, if there is little
indication regarding the location of the VT causing tissue.

  The Company received 510(k) clearance for the Cardima Pathfinder
microcatheter system for VT mapping in January 1997 and is marketing and
selling the product in the United States. The Company is also currently
selling the Cardima Pathfinder product for VT mapping in Europe, Japan,
Australia and Canada. The Company's animal studies have shown that the Cardima
Pathfinder can safely map via the vessels of the coronary venous system and
have demonstrated the ability to simultaneously position up to five different
Cardima Pathfinders in various vessels of the coronary system. To date,
Cardima microcatheter systems have been used to map VT in 109 documented
patients in the United States, Europe, South America and Japan. See "--
Government Regulation."

  Cardima Pathfinder Mini for VT Mapping. The Cardima Pathfinder Mini, the
Company's smallest microcatheter system, is being developed for VT mapping in
the venous system. The Cardima Pathfinder Mini is 1.5 French in diameter (the
typical catheter is six to eight French) and provides more distal access to
smaller vasculature of the heart. Similar to the Cardima Pathfinder
microcatheter, the Cardima Pathfinder Mini microcatheter is constructed around
a finely ground core-wire to provide the steerability necessary to access
distal vasculature. The Cardima Pathfinder Mini microcatheter has a flexible
platinum tip coil and contains a variable number of electrodes with different
spacing options. The Company submitted a 510(k) premarket notification for
this product in May 1997. The Company has been asked by the FDA to perform
some additional testing on the Pathfinder Mini which has been completed. This
data is expected to be submitted to the FDA in April 1998.

  Therastream for VT Ablation. The Company's epicardial approach to VT
ablation is intended to address the shortcomings of standard endocardial
ablation catheters. Once a VT focus has been identified as being epicardial or
intramyocardial, the electrophysiologist must decide whether or not to attempt
to ablate that focus from the endocardial side of the heart wall. Physicians
using existing ablation systems are faced with a fundamental problem: the
further the VT focus is from the endocardial side of the heart wall, the
larger the lesion size necessary to cure the condition. Traditionally,
electrophysiologists have had to use catheters and generators capable of
making larger lesions since they can only ablate the arrhythmia causing tissue
from the endocardial side. A large number of VT ablation cases required
multiple endocardial RF energy deliveries (up to 30 or more in one
electrophysiology study). Increased endocardial RF energy in ablation may
result in greater risk that the patient will develop blood clots, which may
dislodge and travel to the brain causing stroke and decreased cardiac output.
Cardima's microcatheter systems are intended to offer an alternative approach
to current ablation techniques by facilitating access to the arrhythmia
causing tissue and providing greater ablation accuracy using less RF energy.
The Company is not aware of any epicardial RF ablation catheter other than its
Therastream microcatheter system under development.

  The Therastream microcatheter tracks over a guidewire in the coronary veins
and can access the important distal vasculature regions of the heart and
deliver RF energy to the epicardium. The Therastream is designed to map,
locate and ablate the VT focus using RF energy directly applied through the
veins. The Company is currently conducting animal studies to demonstrate the
ability of the Therastream to access the distal venous

                                      12
<PAGE>

system and safely deliver RF energy with no damage to the adjacent arteries.
In these experiments the Therastream has required significantly less energy to
ablate VT than standard endocardial catheters.

  The Company plans to submit an IDE for the Therastream microcatheter system
in 1998 and to begin clinical trials if the IDE is approved. The Company must
receive PMA approval before the Therastream for VT ablation can be marketed in
the United States. See "--Government Regulation."

  The Company's intravascular electrophysiology catheters are coated with a
hydrophilic coating. This coating has been used on Target's products designed
to access the vessels of the brain. The Company believes the coating
significantly improves mechanical function. The Company has an exclusive
license to use the hydrophilic coating technology in products designed to map
and ablate cardiac arrhythmias while positioned within coronary vasculature.

  Cardima's microcatheter systems for venous mapping of VT and for atrial
mapping of AF have received 510(k) clearances from the FDA for sale in the
United States and includes the Cardima Pathfinder and Revelation microcatheter
systems and the Venaport family of guiding catheters. The Company's other
microcatheter systems for mapping or ablation have not received FDA clearance
or approval for marketing and distribution in the United States. The Company's
microcatheter systems for ablation are at an early stage of testing. There can
be no assurance that the results of the Company's human clinical ablation
studies will validate the results of its animal studies. The Company has not
received approval to begin clinical trials of its microcatheter system for VT
ablation and there can be no assurance that any such approval will be
received. See "Management's Discussion and Analysis of Financial Conditions
and Results of Operations--No Assurance of Safety and Effectiveness; Early
Stage of Product Development" and "-- No Assurance of Obtaining, Required
Regulatory Approvals; Government Regulation."

RESEARCH AND NEW PRODUCT DEVELOPMENT

  The Company believes its future success will depend in large part on its
ability to develop and introduce clinically advanced diagnostic and
therapeutic systems that are effective, easy to use, safe and reliable. The
Company's research and new product development department focuses on the
continued development and refinement of its existing diagnostic devices,
systems and procedures, as well as on the development of new devices, systems
and procedures for treating cardiac arrhythmias. The Company's primary
research and development programs involve completing the development of
microcatheter systems for AF and VT ablation and developing smaller second
generation microcatheter systems for multi-catheter mapping of VT.

  Research and development expenses for the years ended December 31, 1997,
1996 and 1995, were $5.3 million, $3.3 million and $2.6 million, respectively.
The Company intends to continue to make significant investments in research
and new product development for the foreseeable future.

MARKETING AND DISTRIBUTION

  The Company markets and sells its microcatheter systems through a direct
sales force in the United States, France and Germany, and medical device
distributors in other countries. The Company believes there are between 500
and 600 hospitals in the United States and an additional 600 hospitals
internationally that perform electrophysiology procedures on a routine basis.
Further, the Company believes there are over 600 board certified
electrophysiologists in the United States, and an equal number of practicing
electrophysiologists internationally. The Company believes that a small sales
force can serve its target market effectively due to the relatively small
number of physicians performing a significant percentage of electrophysiology
procedures. However, there can be no assurance that the Company will be able
to commercialize its products through these channels in the future.

 United States

  The Company's sales strategy in the United States involves the use of both
direct sales representatives and clinical specialists. The Company intends to
use its clinical specialists to support U.S. clinical trials for the AF

                                      13
<PAGE>

and VT microcatheter systems. The Company currently sells the Cardima
Pathfinder microcatheter for VT mapping and Revelation microcatheter for AF
mapping through a direct sales force in the United States consisting of six
sales personnel and two clinical specialists.

  The Company is currently establishing relationships with regional training
hospitals in the United States in order to provide physicians with both a
clinical perspective on the use of the Company's products as well as the
appropriate technical training for the handling of its products. The Company
intends to continue to develop relationships with key academic institutions
and physicians who are well recognized in the field of electrophysiology for
the quality of their research and their ability to influence medical opinion.
The Company intends to utilize these product champions in the United States,
as it is internationally, to assist it in gaining broad market acceptance and
adoption of its products. Several of these physicians have been involved in
the development of the Company's products, and the Company intends to continue
to build these relationships through its Scientific Advisory Board,
participation in regional training centers and physician-oriented symposia.

 International

  The Company's international distributors are experienced in cardiovascular
products and many have prior experience with electrophysiology. The Company
currently has a salesman in Germany and is establishing a direct sales force
covering France and Germany. The Company currently sells through distributors
in Italy, Spain, Portugal, the United Kingdom, Belgium, The Netherlands and
Japan. International sales accounted for approximately 31% and 99% of the
Company's total sales in 1997 and 1996, respectively. In addition, the
Company's products are distributed in other countries in Europe and the
Pacific Rim. The decrease in international sales as a percentage of the
Company's total sales is due to the commencement in 1997 of sales of the
Company's products in the United States.

  While the Company is in the process of terminating certain of its European
distribution arrangements in favor of continuing to develop its direct sales
force, the Company operates under written distribution agreements in Spain,
Portugal, Belgium, The Netherlands and Japan. These agreements grant the
respective distributor exclusive rights to sell the Company's products within
a defined territory for periods ranging from approximately two to three years.
These agreements generally reserve for the Company the right to terminate the
distribution agreement for cause, which includes failure to meet specified
minimum performance obligations, or the failure of the distributor to obtain
required governmental approvals to distribute the Company's products in the
territory. The Company has retained the right to terminate these distribution
agreements should the distributor begin to market medical devices that compete
directly with those of the Company. In Italy and the United Kingdom, the
Company is currently negotiating distribution agreements on similar terms;
however, there can be no assurance that the Company will be able to complete
these negotiations and enter into agreements with these distributors on
commercially reasonable terms. In other countries where the Company's products
are sold, the Company's distributors operate under other written or oral
arrangements. In the territories where the Company does not have written
agreements with its exclusive distributors, the terms of the arrangements,
such as the duration of the arrangements and minimum purchase obligations are
uncertain. In addition, the laws in certain international jurisdictions may
make it difficult for the Company to terminate such distribution arrangements
absent specific written termination terms. These distributors also sell
medical products manufactured by other companies. Distributors typically
purchase the Company's products at a discount to list price and resell the
products to hospitals and physicians at a price determined by the distributor.
Sales to the international distributors are denominated in U.S. dollars.

  The Company currently has a limited sales organization. The Company's Vice
President of World Wide Sales manages distributor relationships on a worldwide
basis. In addition, the Company currently has a salesman in Germany and is in
the process of hiring sales representatives in France and Germany to support
the Company's sales efforts in those countries.

  Establishing a sales organization with the ability to support sales in
significant volumes will require significant management and financial
resources. To date, the Company has not established all of the international
distribution alliances necessary to fully market these products on a worldwide
basis, nor does the Company have written distribution agreements with all of
its international distributors. There can be no assurance the Company

                                      14
<PAGE>

will be able to enter into agreements with the desired distributors on a
timely basis, or that such distributors will devote adequate resources to
selling the Company's products.

  Since the Company introduces its products initially in foreign markets, the
Company expects to continue to derive a significant portion of its revenues
from international sales. The Company expects that international sales will
continue to account for a significant portion of the Company's total revenues
for the foreseeable future. As a result, a significant portion of the
Company's revenues will be subject to the risks associated with international
sales. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Risks Associated with International Sales."

MANUFACTURING

  The Company fabricates certain proprietary components of the Company's
products and assembles, inspects, tests and packages most components into
finished products. Designing and manufacturing its products from raw materials
allows the Company to maintain greater control of quality and manufacturing
process changes and the ability to limit outside access to its proprietary
technology.

  The Company believes its custom-designed, proprietary process equipment is
an important component of its manufacturing strategy. In some cases, the
Company has developed proprietary enhancements for existing production
machinery to facilitate the manufacture of its products to exacting standards.
The Company has also developed core manufacturing technologies and processes,
including proprietary extrusion techniques and equipment, polymer processing
capabilities, including composite lamination, welding of dissimilar materials,
balloon forming and proprietary precision guidewire grinding techniques
enabling fabrication of a large variety of guidewire core profiles.
Furthermore, the Company's technological expertise includes braiding,
hydrophilic coating, material cleaning and surface preparation.

  The manufacture of catheters is a complex operation involving a number of
separate processes and components. Catheters are assembled and tested by the
Company prior to sterilization. The manufacturing process for the connecting
cable consists primarily of packaging and testing purchased units. The Company
has no experience manufacturing its products in the volumes that will be
necessary for the Company to achieve significant commercial sales, and there
can be no assurance that reliable, high-volume manufacturing capacity can be
established or maintained at commercially reasonable costs. If the Company
receives additional FDA clearance or approval for its products, it will need
to expend significant capital resources and develop additional manufacturing
expertise to establish large-scale manufacturing capabilities.

  Components and raw materials are purchased from various qualified suppliers
and subjected to stringent quality specifications. The Company expects to
conduct supplier quality audits and is establishing a supplier certification
program. A number of the components such as the laminate tubing, core wiring
mandrels, connector components and hydrophilic coating are provided by sole
source suppliers. For certain of these components, there are relatively few
alternative sources of supply, and establishing additional or replacement
suppliers for such components, particularly the laminate tubing, could not be
accomplished quickly. The Company plans to qualify additional suppliers if and
as future production volumes increase. Because of the long lead time for some
components which are currently available from a single source, a supplier's
inability to supply such components in a timely manner could have a material
adverse effect on the Company's ability to manufacture products and therefore
on its business, financial condition and ability to test or market its
products on a timely basis.

  The Company's manufacturing facilities are subject to periodic inspection
from regulatory authorities, and its operations must undergo QSR and ISO 9001
(EN 46001) compliance inspections conducted by the FDA and TUV, a notified
body (a regulatory agency) in the European Union ("EU"), respectively. In
addition, the Company has obtained ISO 9001 (EN 46001) Quality Systems
certification from TUV and has obtained the right to affix the CE Mark to its
electrophysiology mapping catheters and accessories. The Company's facilities
and manufacturing processes have recently successfully undergone a combined
inspection by the FDA and California Department of Health Services in February
1997 and an annual reinspection by TUV in February 1997. See "-- Government
Regulation."

                                      15
<PAGE>

PATENTS AND PROPRIETARY RIGHTS

  The Company's success will depend in part on its ability to obtain patent
and copyright protection for its products and processes, to preserve its trade
secrets and to operate without infringing or violating the proprietary rights
of third parties. The Company's strategy is to actively pursue patent
protection in the United States and foreign jurisdictions for technology it
believes to be proprietary and which offers a potential competitive advantage
for its products. The Company has filed and intends to continue to file patent
applications, both in the United States and selected international markets, to
seek protection for proprietary aspects of the technology. The Company holds
eight issued U.S. patents and has filed 18 pending U.S. patent applications.
The Company has also filed 37 patent applications in major international
markets. No assurance can be given that these patent applications will provide
competitive advantages for the Company's products or that any patent
application filed by the Company will issue as a patent. In addition, there
can be no assurance any of the Company's patents or patent applications will
not be challenged, invalidated, or circumvented in the future. There can also
be no assurance that competitors, many of whom have greater resources than the
Company and have substantial investments in competing technologies, will not
apply for and obtain patents which will prevent, limit or interfere with the
Company's ability to make, use, or sell its products either in the United
States or internationally.

  The Company has also obtained rights to certain technology by entering into
license arrangements. Pursuant to a license agreement with Target (the
"License Agreement"), the Company obtained an exclusive, royalty-free,
worldwide license under certain patents issued in the United States and
corresponding international patents to use Target's 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 applies to any
Target technology developed through May 1996 and will terminate on April 23,
2013, the expiration date of the last-to-issue licensed patents issued prior
to May 21, 1996. In addition to this exclusive license to use Target's
technology to develop products for electrophysiological diseases, the Company
has obtained a non-exclusive license to use Target's technology, provided it
has made a substantial improvement on such technology, for the diagnosis or
treatment of diseases of the heart other than using balloon angioplasty. As
defined in the License Agreement, a substantial improvement is any
modification, improvement or enhancement of Target technology that results in
a material change in the function, purpose or application of a particular
product incorporating Target technology. The Company believes that the
incorporation of electrodes in its microcatheter systems, together with other
modifications, satisfies the substantial improvement requirement, although the
Company has not confirmed this belief in writing with Target. To date, the
Company has not developed products for use in the field covered by such non-
exclusive license.

  Under the License Agreement, Cardima granted back to Target an exclusive,
royalty-free, worldwide license to use technology developed by Cardima through
May 1996 in the fields of neurology, interventional neuroradiology,
interventional radiology, reproductive disorders and vascular prostheses (the
"Target Field"). In addition, the Company agreed not to conduct material
research and development, acquire corporate entities or make or sell products
in the Target Field or to sell products, other than products utilizing
Target's technology, for use in diagnosis or treatment of diseases related to
the production of electrical current in tissue located in areas of the body
other than the heart, without first notifying Target and negotiating a
distribution agreement. Cardima also agreed that it would not sell products
utilizing Target's technology for use in diagnosis or treatment of diseases
related to the production of electrical current in tissue located in areas of
the body other than the heart without, if selling to a distributor, first
notifying Target and offering Target the right of first refusal with respect
to the terms of the distribution, or if selling directly to the consumer,
paying to Target an amount equal to 40% of the gross profit for such product.

  Boston Scientific acquired Target in April 1997. As a result of the
acquisition, Boston Scientific exercises control over approximately 9.5% of
the Company's outstanding Common Stock. Accordingly, Boston Scientific may be
able to exercise influence over the business and financial affairs of the
Company. Boston Scientific develops, markets and sells cardiac
electrophysiology products that compete directly with the microcatheter
products being developed by the Company. There can be no assurance that Boston
Scientific will not take actions

                                      16
<PAGE>

or engage in activities that could have a material adverse effect on the
Company's business, financial condition or results of operations.

  The Company obtained rights to its biocompatible hydrophilic coating
material and process through an exclusive, royalty bearing license to use the
hydrophilic coating technology in products designed to map and ablate cardiac
arrhythmias while positioned within the coronary arteries and coronary veins.
The license will terminate upon the later of 15 years from first commercial
sale of catheters treated with the coating material or the expiration of the
last-to-issue licensed patent, unless terminated earlier for material breach.

  In addition to patents and licenses, the Company also relies upon trade
secrets, technical know-how and continuing technical innovation to develop and
maintain its competitive position. The Company typically requires its
employees, consultants, and advisors to execute confidentiality and assignment
of invention agreements in connection with their employment, consulting or
advisory relationships with the Company. There can be no assurance, however,
that the agreements will not be breached or that the Company will have
adequate remedies for any breach. Furthermore, no assurance can be given that
competitors will not independently develop substantially equivalent
proprietary information and techniques or otherwise gain access to the
Company's proprietary knowledge, or that the Company can meaningfully protect
its rights in unpatented proprietary technology.

  Patent applications in the United States Patent and Trademark Office
("USPTO") are maintained in secrecy until patents issue, and patent
applications in the patent offices of foreign countries are maintained in
secrecy for a period of 18 months from the priority date. Publication of
discoveries in the scientific or patent literature tend to lag behind actual
discoveries and related patent applications, and the large number of patents
and applications and the fluid state of the Company's development activities
make comprehensive patent searches and analysis impractical or not cost-
effective. Although the Company has made patent and publication searches in
the United States and in foreign countries to determine whether materials,
processes or designs used by it or its potential products infringe or will
infringe third-party patents, such searches have not been comprehensive.
Patents issued and patent applications filed relating to medical devices are
voluminous and there can be no assurance that current and potential
competitors and other third parties have not filed or will not file
applications for, or have not received or will not receive, patents and will
not obtain additional proprietary rights relating to products, materials or
processes used or proposed to be used by the Company.

  The medical device industry has been characterized by extensive litigation
regarding patents and other intellectual property rights, and companies in the
medical device industry have employed intellectual property litigation to gain
a competitive advantage.

  Although there are no claims against the Company, any such claims, whether
with or without merit, could be time-consuming and expensive to respond to and
could divert the Company's technical and management personnel. If any third
party patent claims are upheld as valid and enforceable in any litigation or
administrative proceeding, the Company could be prevented from practicing the
subject matter claimed in such patents, or could be required to obtain
licenses from the patent owners of each patent, or redesign its products or
processes to avoid infringement. There can be no assurance such licenses will
be available or, if available, will be available on terms acceptable to the
Company or that the Company will be successful in any attempt to redesign its
products or processes to avoid infringement. Accordingly, an adverse
determination in a judicial or administrative proceeding or failure to obtain
necessary licenses could prevent the Company from manufacturing and selling
its products, which would have a material adverse effect on the Company's
business, financial condition, and results of operations. The Company intends
to vigorously protect and defend its intellectual property. Costly and time-
consuming litigation brought by the Company may be necessary to enforce
patents issued to the Company, to protect trade secrets or know-how owned by
the Company or to determine the enforceability, scope and validity of the
proprietary rights of others.

  The validity and breadth of claims in medical technology patents involve
complex legal and factual questions and, therefore, may be highly uncertain.
There can be no assurance that any issued patent or patents

                                      17
<PAGE>

based on pending patent applications or any future patent application will
exclude competitors or provide competitive advantages to the Company, that any
of the Company's patent or patents in which it has licensed rights will be
held valid if subsequently challenged or that others will not claim rights in
or ownership of the patents and other proprietary rights held or licensed by
the Company. There can be no assurance that others have not developed or will
not develop similar products, duplicate any of the Company's products or
design around any patents issued to or licensed by the Company or that may be
issued in the future to the Company. Since patent applications in the United
States are maintained in secrecy until the patent issues, the Company also
cannot be certain that others did not first file applications for inventions
covered by the Company's pending patent applications, nor can the Company be
certain that it will not infringe any patents that may issue to others on such
applications. The Company periodically reviews the scope of patents of which
it is aware. Although the Company does not believe that it infringes patents
known to it, the question of patent infringement involves complex legal and
factual issues and there can be no assurance that any conclusion reached by
the Company regarding infringement will be consistent with the resolution of
any such issues by a court.

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

COMPETITION

  The Company believes it currently has the only intravascular approach to
diagnosing and testing VT. The Company considers its primary competitors to be
companies engaged in the development and marketing of more established, but
the Company believes, less effective therapies for the treatment of AF and VT,
such as drugs, external electrical cardioversion and defibrillation,
implantable defibrillators and purposeful destruction of the AV node, followed
by implantation of a pacemaker and open heart surgery. 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 spacial 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 open
heart surgical maze procedure in a minimally invasive manner. If any of these
new approaches or new products prove to be safe and effective, the Company's
products could be rendered uncompetitive or obsolete, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.

  Many of the Company's competitors have an established presence in the field
of interventional cardiology and electrophysiology, including Boston
Scientific, C.R. Bard, Inc., Johnson & Johnson, through its Cordis division,
St. Jude Medical, Inc., through its Daig division, and Medtronic, Inc. These
competitors have substantially greater financial and other resources than the
Company, including larger research and development staffs and more experience
and capabilities in conducting research and development activities, testing
products in clinical trials, obtaining regulatory approvals, and
manufacturing, marketing and distributing products. Other companies are
developing proprietary systems for the diagnosis and treatment of cardiac
arrhythmias, including Biosense, Inc., Cardiac Pathways, Inc. and Endocardial
Solutions, Inc. Other companies develop, market and sell alternative
approaches to the treatment of AF and VT, including Guidant, Medtronic, Inc.,
and Ventritex Inc., a subsidiary of St. Jude Medical, the leading
manufacturers of implantable defibrillators. There can be no assurance that
the Company will succeed in developing and marketing technologies and products
that are more clinically effective and cost-effective than the more
established treatments or the new approaches and products being developed and
marketed by its competitors. Furthermore, there can be no assurance that the
Company will succeed in developing new technologies and products that are
available prior to its competitors' products. Failure of the Company to
demonstrate the competitive advantages of its products would have a material
adverse effect on the Company's business, financial condition and results of
operations.

                                      18
<PAGE>

  In the market for cardiac mapping and ablation devices, the Company believes
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, the Company's success will depend in part
on its ability to respond quickly to medical and technological changes through
the development and introduction of new products. Product development involves
a high degree of risk and there can be no assurance that the Company's new
product development efforts will result in any commercially successful
products. The Company believes it competes favorably with respect to these
factors, although there is no assurance that it will be able to continue to do
so. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Rapid Technological Change; Significant Competition."

GOVERNMENT REGULATION

  The preclinical and clinical testing, manufacturing, labeling, distribution
and promotion of the Company's products are subject to extensive and rigorous
government regulation in the United States and other countries. Noncompliance
with applicable 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
premarket clearances or approvals, withdrawal of marketing approvals and
criminal prosecution.

 United States

  A medical device may be marketed in the United States only with the FDA's
prior authorization. Devices classified by the FDA as posing less risk are
placed either in Class I or II and require the manufacturer to seek 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 "preamendment"
Class III device (i.e., one that has been in commercial distribution since
before May 28, 1976) for which the FDA has not called for PMA applications.
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. The Company believes that it usually takes from four to
12 months from the date of submission to obtain 510(k) clearance, but it may
take longer, and there can be no assurance that 510(k) clearance will ever be
obtained. 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, or would constitute a major
change in the intended use of the device, will require a new 510(k)
submission.

  The Company believes that its current mapping products, including the
Cardima Pathfinder, will be Class II devices and will require 510(k) clearance
prior to marketing. To date, the Company has received section 510(k)
clearances from the FDA for its Cardima Pathfinder and Revelation
microcatheter systems for mapping VT and AF, respectively. In addition, 510(k)
clearance has been received for marketing its line of Venaport guiding
catheters used for introducing electrophysiology catheters into the heart.
Section 510(k) notifications have also been submitted for an over-the-wire
product, the Tracer, and for the Pathfinder Mini for mapping VT, as well as
for the Naviport deflectable guiding catheter. These submissions may need to
include clinical trial data, which could lengthen the time necessary to
prepare a 510(k) submission and the time in which the Company could receive
510(k) clearance. There can be no assurance that any of these products will
receive 510(k) clearance in a timely fashion, or at all. Delays in market
introduction resulting from the 510(k) clearance process would have a material
adverse effect on the Company's business, financial condition and results of
operation.

  A device that does not qualify for 510(k) clearance is placed in Class III,
which is reserved for devices classified by the FDA as posing the greatest
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

                                      19
<PAGE>

generally must receive PMA approval, which requires the manufacturer to
establish the safety and effectiveness of the device to the FDA's
satisfaction. A PMA application must provide extensive preclinical and
clinical trial data and also include information about the device and its
components regarding, among other things, manufacturing, labeling and
promotion. As part of the PMA review, the FDA will inspect the manufacturer's
facilities for compliance with the Quality System Regulation ("QSR"), which
includes elaborate testing, control, documentation and other quality assurance
procedures.

  Upon submission, the FDA determines if the PMA 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 the Company believes typically takes one to three years,
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.
During the review, an FDA advisory committee, typically a panel of clinicians,
likely will 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.

  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 a PMA for the approved indications, which can be more limited than
those originally sought by the manufacturer. The PMA can include postapproval
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, which in turn would have a material adverse effect on the
Company. The PMA process can be expensive and lengthy, and no assurance can be
given that any PMA application will ever be approved for marketing. Even after
approval of a PMA, a new PMA or PMA supplement generally is required for any
modification to the device, its labeling or its manufacturing process.

  The Company anticipates that its ablation products, including the Cardima
Pathfinder AFTC and Therastream, will be 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.

  A clinical trial in support of a 510(k) submission or PMA application
generally requires an IDE application approved in advance by the FDA for a
specific number of patients. 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, the Company 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. The Company's failure to adhere to
regulatory requirements generally applicable to clinical trials and to the
conditions of an IDE approval could result in a material adverse effect on the
Company, including termination of the IDE and an inability to obtain marketing
clearance or approval for its products.

  In January 1997, the Company submitted an IDE for the Revelation
microcatheter system for mapping of AF and received conditional approval from
the FDA to begin its feasibility study for mapping AF. The Company completed
the mapping study for its Revelation microcatheter system in 1997, and
received conditional approval to begin feasibility clinical trials with the
Cardima Pathfinder AFTC product for ablation in January 1998. An additional
IDE for its Therastream VT ablation microcatheter system is expected to be
submitted to the FDA in

                                      20
<PAGE>

the first half of 1998. These studies are not expected to supply pivotal
evidence of safety and effectiveness; rather, they are intended to generate
data to help finalize the device's design and determine its potential for
further development, if any. Additional clinical trials will be necessary to
support PMA applications by the Company. There can be no assurance that any
clinical study proposed by the Company will be approved by the FDA, will be
completed or, if completed, will provide data and information that supports
PMA approval or additional clinical investigations of the type necessary to
obtain PMA approval.

  Any devices manufactured or distributed by the Company pursuant to FDA
clearances or approvals will be subject to pervasive and continuing regulation
by the FDA and certain state agencies. The Company will be subject to
inspection by the FDA and the California Department of Health Services and,
once it commences marketing products, will have to comply with various other
regulatory requirements that usually apply to medical devices marketed in the
United States, including labeling regulations, the QSR, the Medical Device
Reporting ("MDR") regulation (which requires 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 ("off-label")
uses. In addition, Class II devices, such as the Company's mapping products,
can be subject to additional special controls (e.g., performance standards,
postmarket surveillance, patient registries, and FDA guidelines) that do not
apply to Class I devices. The Company's failure to comply with applicable
regulatory requirements could result in enforcement action by the FDA, which
could have a material adverse effect on the Company.

  Unanticipated changes in existing regulatory requirements, failure of the
Company to comply with such requirements or adoption of new requirements could
have a material adverse effect on the Company. The Company also is 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 substance disposal. There can be no
assurance the Company will not be required to incur significant costs to
comply with such laws and regulations in the future or that such laws or
regulations will not have a material adverse effect upon the Company's
business, financial condition and results of operations.

 International

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

  The EU has promulgated rules that require medical products to bear the CE
mark by mid-1998. The CE mark is recognized by the EU as a symbol of adherence
to strict quality systems requirements set forth in the ISO 9001 (EN 46001)
quality standards, as well as compliance with 93/42/EEC, the Medical Device
Directive. A CE mark allows the Company to avoid the costly and cumbersome
requirements to obtain approvals in each EU country. In December 1995, the
Company received ISO 9001 (EN 46001) Quality Systems certification for its
manufacturing facilities in Fremont, California. This certification provides
approval for the Company to apply the CE mark to the Tracer and Cardima
Pathfinder mapping products and to the Venaport guiding catheter.

  The Company has initiated clinical trials in Europe to treat AF and plans to
commence clinical trials in Japan for its ablation products. Although the
Company intends to seek international approvals for its ablation products,
including certification to enable CE marking, there can be no assurance the
Company will be successful in obtaining such approvals. Failure to receive
approval to affix the CE mark would prohibit the Company from selling these
products in member countries of the EU, and would require significant delays
in obtaining

                                      21
<PAGE>

individual country approvals. There can be no assurance that such approvals
will ever be obtained. In such event, the Company would be materially and
adversely affected. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- No Assurance of Obtaining Required
Regulatory Approvals; Government Regulation."

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 payors, principally federal Medicare, state
Medicaid and private health insurance plans, to reimburse all or a part of the
costs and fees associated with the procedures performed using these products.
The Company's success will be dependent upon, among other things, the ability
of health care providers to obtain satisfactory reimbursement from third-party
payors for medical procedures in which the Company's products are used. Third-
party payors may deny reimbursement if they determine that a prescribed device
has not received appropriate regulatory clearances or approvals, is not used
in accordance with cost-effective treatment methods as determined by the
payor, or is experimental, unnecessary, inappropriate or used for a
nonapproved indication. If FDA clearance or approval is received, third-party
reimbursement would also depend upon decisions by the U.S. Health Care
Financing Administration ("HCFA") for Medicare, as well as by individual
health maintenance organizations, private insurers and other payors.
Government agencies, private insurers and other payors 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 payors reimburse health care providers for medical
treatment at a fixed rate based on, or adapted from the diagnosis-related
group ("DRG") established by the HCFA. The fixed rate of reimbursement is
typically based on the patient's diagnosis and the procedure performed, and
unrelated to the specific type or number of devices used in a procedure. The
Company intends to seek an appropriate Medicare DRG assignment by HCFA for
procedures performed using its devices. As part of this process, during
clinical trials the Company intends to collect economic data regarding
resources expended in performing procedures with the devices. The Company
expects to use this data to document differences in resource use between
procedures performed with the Company's devices and procedures currently
categorized under existing DRGs. The Company intends to meet with HCFA policy
staff to request and support development of appropriate hospital payment
policies for the procedures performed using the Company's devices. In
addition, the Company may also collect resource use data regarding physician
services to support establishment of appropriate fee schedules by third-party
payors. The Company believes these efforts may also support reimbursement
among private payors. However, there can be no assurance that reimbursement
for the Company's products will be available in sufficient amounts if, at all,
or that future reimbursement policies of payors will not adversely affect the
Company's ability to sell its 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, for
example if the treatment is not medically needed for the specific patient.
There can be no assurance that the Company's systems will be covered when they
are used in clinical trials and, if covered, whether the payment amounts for
their use will be considered to be adequate by hospitals and physicians. If
the devices are not covered or the payments are considered to be inadequate,
the Company may need to bear additional costs to sponsor such trials, and such
costs could have a material adverse effect on the Company's business,
financial condition and results of operations.

  In addition, there is proposed federal legislation that would change the
traditional Medicare payment system by creating a new visit-based payment
system called ambulatory patient groups ("APG") that establishes fixed
payments for specific medical procedures that are performed on an outpatient
basis. If the Company's products

                                      22
<PAGE>

increase the cost per procedure above the fixed rate under the APG system,
market acceptance of such products could be impaired.

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

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

PRODUCT LIABILITY AND INSURANCE

  The development, manufacture and sale of the Company's microcatheter systems
may expose the Company to product liability claims. Although to date no claim
has been asserted against the Company, there can be no assurance that the
Company will not experience losses due to product liability claims in the
future. Although the Company currently has 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
the Company in the future on reasonable terms, if at all. In addition, there
can be no assurance that all of the activities encompassed within the
Company's business are or will be covered under the Company's policies.
Although the Cardima Pathfinder and Tracer products are labeled for single use
only, the Company is aware that some physicians are reusing such products.
Moreover, despite labeling of the Company's microcatheters for diagnostic use
only, the Company believes physicians are using such mapping microcatheters
for ablation. Multiple use or "off-label" use of the Company's microcatheters
could subject the Company to increased exposure to product liability claims,
which could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company may require
additional product liability coverage if the Company significantly expands
commercialization of its 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 the Company,
regardless of their merit or eventual outcome, could have a material adverse
effect on the Company's business, financial condition and results of
operations. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Risk of Product Liability; Adequacy of Insurance
Coverage."

EMPLOYEES

  At December 31, 1997, the Company had 101 employees, 26 of whom were engaged
directly in research and new product development, 13 in regulatory affairs,
quality assurance and clinical activities, 25 in

                                      23
<PAGE>

manufacturing, 22 in sales and marketing and 15 in finance and administration.
The Company maintains compensation, benefits, equity participation, and work
environment policies intended to assist in attracting and retaining qualified
personnel. The Company believes the success of its business will depend, in
significant part, on its ability to attract and retain such personnel. No
employee of the Company is represented by a collective bargaining agreement,
nor has the Company experienced any work stoppage. The Company considers its
relations with its employees to be good. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Dependence on Key
Personnel."

ITEM 2. PROPERTIES

  The Company leases approximately 44,000 square feet in Fremont, California.
The Company's facility includes a 4,000 square foot cleanroom, a machine shop
for prototyping and tooling, extrusion and braiding capability, wire grinding
operations, general assembly / test / inspection areas, and a materials area.
The facility is leased through November 1999, at which time the Company has
the option to extend the lease for an additional five-year term. The Company
believes this facility will be adequate to meet its requirements for the
foreseeable future.

ITEM 3. LEGAL PROCEEDINGS

  The company is not a party to any material legal proceedings.

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

  No matters were submitted to a vote of security holders of the Company,
through solicitation of proxies or otherwise, during the last quarter of the
Company's fiscal year ended December 31, 1997.

                                      24
<PAGE>

                                    PART II

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

  The Common Stock of the Company has been traded on the Nasdaq National
Market under the symbol CRDM since the Company's initial public offering in
June 1997. Prior to that time there was no public market for the Common Stock.
The following table sets forth for the periods indicated the high and low sale
prices of the Common Stock.

<TABLE>
<CAPTION>
                                                                    HIGH   LOW
                                                                    ----- -----
   <S>                                                              <C>   <C>
   YEAR ENDED DECEMBER 31, 1997
   Second Quarter (from June 6, 1997).............................. $7.50 $5.75
   Third Quarter...................................................  7.38  5.00
   Fourth Quarter..................................................  6.38  3.75
</TABLE>

  As of March 23, 1998, there were approximately 1,800 holders of record of
the Common Stock.

  The Company has never declared or paid cash dividends on its capital stock.
The Company currently expects to retain its future earnings for use in the
operation and expansion of its business and does not anticipate paying any
cash dividends in the foreseeable future.

USE OF PROCEEDS

  In connection with its initial public offering in June 1997, the Company
filed a Registration Statement on Form S-1, SEC File No. 333-23209 (the
"Registration Statement"), which was declared effective by the Commission on
June 5, 1997. Pursuant to the Registration Statement, the Company registered
2,275,000 shares of its Common Stock, $0.001 par value per share. The offering
commenced on June 5, 1997 and did not terminate until all of the registered
shares had been sold. The aggregate offering price of the registered shares
was $15,925,000. The managing underwriter of the offering was Bear Stearns &
Company.

  From July 1996 to December 1997, the Company incurred the following expenses
in connection with the offering:

<TABLE>
   <S>                                                               <C>
   Underwriting discounts and commissions........................... $1,114,750
   Other expenses...................................................  1,170,859
                                                                     ----------
   Total expenses................................................... $2,285,609
                                                                     ==========
</TABLE>

  All of such expenses were direct or indirect payments to others.

  The net offering proceeds to the Company after deducting the total expenses
above were $13,639,391. From January 1, 1997 to December 31, 1997, the Company
used such net offering proceeds, in direct or indirect payments to others, as
follows:

<TABLE>
   <S>                                                              <C>
   Research and development........................................ $ 2,313,462
   Repayment of indebtedness.......................................           0
   Acquisitions of other businesses................................           0
   Temporary investments*..........................................   5,616,713
   Working capital.................................................   5,709,216
                                                                    -----------
   Total........................................................... $13,639,391
                                                                    ===========
</TABLE>
--------
*  All temporary investments are available-for-sale securities; see note 1 of
   the financial statements in Part IV, Item 14.

                                      25
<PAGE>

  Each of such amounts is a reasonable estimate of the application of the net
offering proceeds. This use of proceeds does not represent a material change
in the use of proceeds described in the prospectus of the Registration
Statement.

ITEM 6. SELECTED FINANCIAL DATA

  The data set forth below should be read in conjunction with the financial
statements and related notes attached to this report on Form 10-K as pages F-1
through F-17.

<TABLE>
<CAPTION>
                                                                   PERIOD FROM
                                                                     11/12/92
                                 YEAR ENDED DECEMBER 31,          (INCEPTION) TO
                             -----------------------------------   DECEMBER 31,
                               1997     1996     1995     1994       1993(1)
                             --------  -------  -------  -------  --------------
                                 (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<S>                          <C>       <C>      <C>      <C>      <C>
STATEMENTS OF OPERATIONS
 DATA:
Net Sales..................  $  1,261  $   593  $   362  $    86     $    --
Cost of goods sold.........     2,011    1,413      830      211          --
                             --------  -------  -------  -------     -------
  Gross profit.............      (750)    (820)    (468)    (125)         --
Operating expenses:
  Research and development.     5,320    3,319    2,581    2,205       1,083
  Selling, general and
   administrative..........     6,656    3,690    2,046    1,309         491
                             --------  -------  -------  -------     -------
    Total operating
     expenses..............    11,976    7,009    4,627    3,514       1,574
                             --------  -------  -------  -------     -------
Operating loss.............   (12,726)  (7,829)  (5,095)  (3,639)     (1,574)
Interest and other income..       602      132       12       15          33
Interest expense...........      (148)     (57)    (117)     (31)         --
                             --------  -------  -------  -------     -------
Net loss...................  $(12,272) $(7,754) $(5,200) $(3,655)    $(1,541)
                             ========  =======  =======  =======     =======
Basic and diluted net loss
 per share(2)..............  $  (2.64)
                             ========
Shares used in computing
 basic and diluted net loss
 per share(2)..............     4,642
                             ========
Pro forma basic and diluted
 net loss per share(3).....            $ (2.29)
                                       =======
Shares used in computing
 pro forma basic and
 diluted net loss per
 share(3)..................              3,384
                                       =======
<CAPTION>
                                                                   PERIOD FROM
                                                                     11/12/92
                                 YEAR ENDED DECEMBER 31,          (INCEPTION) TO
                             -----------------------------------   DECEMBER 31,
                               1997     1996     1995     1994       1993(1)
                             --------  -------  -------  -------  --------------
                                             (IN THOUSANDS)
<S>                          <C>       <C>      <C>      <C>      <C>
BALANCE SHEETS DATA:
Cash, cash equivalents and
 short-term investments....  $ 12,848  $   907  $ 2,993  $   713     $ 1,472
Working capital (deficit)..    11,609   (2,150)   2,647      571       1,318
Total assets...............    17,674    3,964    4,735    2,284       1,701
Capital lease obligation,
 noncurrent portion........       840      722      317      308          50
Accumulated deficit........   (30,422) (18,150) (10,396)  (5,196)     (1,541)
Total stockholders' equity
 (net capital deficiency)..    14,444  (10,368)  (2,675)   1,316       1,412
</TABLE>
--------
(1) The Company's financial data for 1992 and 1993 is not presented separately
    as the Company's operations from November 12, 1992 (inception) to December
    31, 1992 were immaterial.
(2) The basic and diluted net loss per share amounts prior to 1997 have been
    restated as required to comply with Statement of Financial Standards No.
    128, "Earnings per Share" and Staff Accounting Bulletin No. 98. See Note 1
    of the Notes to Financial Statements.
(3) See Note 1 of Notes to financial statements for information concerning
    calculation of the pro forma basic and diluted net loss per share.


                                      26
<PAGE>

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

  This discussion and analysis contains statements of a forward-looking nature
relating to future events or the future financial performance of the Company.
Such statements are only predictions and the actual events or results may
differ materially from the results discussed in the forward-looking
statements. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in "--Factors Affecting
Future Results" as well as those discussed elsewhere in this Annual Report on
Form 10-K. The historical results set forth in this discussion and analysis
are not necessarily indicative of trends with respect to any actual or
projected future financial performance of the Company. This discussion and
analysis should be read in conjunction with the Financial Statements and the
related Notes thereto included elsewhere in the Annual Report on Form 10-K.

OVERVIEW

  Since its incorporation in November 1992, Cardima has been engaged in the
design, research and development, manufacturing and testing of microcatheter
systems for the mapping (diagnosis) and ablation (treatment) of cardiac
arrhythmias. The Company has a limited history of operations and has
experienced significant operating losses since inception. The Company expects
that its operating losses will continue for the foreseeable future as the
Company continues to invest substantial resources in product development,
preclinical and clinical trials, obtaining regulatory approval, sales and
marketing and manufacturing.

  Cardima has generated limited revenues, which until January 1997 were
primarily in Europe and Japan, from sales of the Cardima Pathfinder and Tracer
microcatheter systems for diagnosing Ventricular Tachycardia (VT) and the
Revelation microcatheter system for diagnosing Atrial Fibrillation (AF), as
well as ancillary products such as Venaport. In January 1997, the Company
received a 510(k) clearance in the United States and began to market and sell
the Cardima Pathfinder system for diagnosing VT. As a result, the Company has
derived a majority of its revenues in 1997 through sales of the Cardima
Pathfinder for diagnosis of VT in the United States. To date, the Company's
international sales have been made primarily through distributors who sell the
Company's products to physicians and hospitals. The Company currently has a
salesman in Germany and is establishing a direct sales force in France and
Germany. The Company has obtained the right to affix the CE mark to its
Cardima Pathfinder, Tracer and Cardima Pathfinder 3mm microcatheter systems,
permitting the Company to market these products in the member countries of the
EU. The Company received 510(k) clearance for the Revelation microcatheter for
mapping of AF in November 1997 and intends to seek 510(k) clearance for its
other diagnostic products, including the Cardima Pathfinder Mini and Tracer
products. The Company will be required to conduct clinical trials, demonstrate
safety and effectiveness, and obtain PMA approval from the FDA in order to
sell any of the Company's products designed for treatment of AF or VT in the
United States. Specifically, PMA approval will be required prior to the
introduction in the United States of the Cardima Pathfinder AFTC microcatheter
system for treatment of AF or Therastream microcatheter system for treatment
of VT.

RESULTS OF OPERATIONS--YEARS ENDED 1997 AND 1996

 Net Sales

  Net sales for 1997 increased 113% to $1,261,000 from $593,000 for 1996. The
increase in net sales is due primarily to U.S. sales of the Cardima Pathfinder
line of microcatheters for diagnosis of ventricular tachycardia following FDA
clearance in January 1997. Net sales in 1997 were lower than the Company
expected in Europe due to the termination of distribution arrangements in
major European markets.

 Cost of Goods Sold

  Cost of goods sold primarily includes raw materials costs, catheter
fabrication costs, system assembly, test costs and manufacturing overhead.
Cost of goods sold for 1997 increased 42% to $2,011,000 from $1,413,000

                                      27
<PAGE>

for 1996. The increase in cost of goods sold is due primarily to the growth of
the Company's sales and vertical integration whereby many components formerly
produced by outside vendors have been brought in-house. Product costs were
initially higher due to the set-up and training of personnel to utilize the
new equipment and related depreciation. The Company expects to have lower
costs than when these components were purchased from outside vendors and
greater flexibility in production of its microcatheter systems.

 Research and Development Expenses

  Research and development expenses for 1997 increased 60% to $5,320,000 from
$3,319,000 in 1996. The increase in research and development expenses is due
primarily to staff additions and associated expenses in research and
development and clinical and regulatory areas (product testing and approvals)
incurred as the Company increased human resources to meet program goals and
clinical objectives.

 Selling, General and Administrative Expenses

  Selling, general and administrative expenses for 1997 increased 80% to
$6,656,000 from $3,690,000 in 1996. The increase in selling, general and
administrative expenses is due primarily to costs associated with the
establishment and expansion of the Company's U.S. sales force, which occurred
in fourth quarter 1996 and third quarter 1997, respectively. The Company has
incurred expenses relating to the termination of several distribution
arrangements, the establishment of a direct sales force in several major
markets in Europe and the commencement of clinical trials, which require some
training from sales and clinical specialists. In addition, the increase in
general and administrative expenses is due primarily to additional staffing
and expenses to meet the growth of the Company and expenses related to the
requirements of a public company. The increase in marketing expenses is due
primarily to additional staffing, marketing materials and programs to meet new
product introductions.

 Interest and Other Income, Interest Expense

  Interest and other income for 1997 increased to $602,000 from $132,000 in
1996. The increase is due primarily to larger cash, cash equivalent and short-
term investment balances as a result of the Company's initial public offering
in June 1997. Interest expense for 1997 increased to $148,000 from $57,000 in
1996. The increase is due primarily to higher borrowing levels for purchases
of capital equipment.

RESULTS OF OPERATIONS--YEARS ENDED 1996 AND 1995

 Net Sales

  Net sales for 1996 increased 64% to $593,000 from $362,000 for 1995. The
increase in net sales was primarily due to increased international sales of
the Cardima Pathfinder and Tracer microcatheter systems and reflects the
growing user base for the Company's microcatheter systems in Europe and Japan.

 Research and Development Expenses

  Research and development expenses for 1996 increased 29% to $3,319,000 from
$2,581,000 in 1995. The increase in research and development expenses was
primarily due to increases in regulatory and quality systems' personnel and,
to a lesser extent, an increase in expenses associated with preclinical
studies.

 Selling, General and Administrative Expenses

  Selling, general and administrative expenses for 1996 increased 80% to
$3,690,000 from $2,046,000 in 1995. The increase in selling expenses was
primarily due to expenses associated with increased sales and marketing
activities, including the hiring of additional personnel to support growth of
the Company's sales and marketing efforts. The increase in general and
administrative expenses was primarily due to additional staffing and expenses
to meet the growth of the Company.

                                      28
<PAGE>

 Interest and Other Income, Interest Expense

  Interest and other income for 1996 increased to $132,000 from $12,000 in
1995. The increase in interest and other income was primarily due to an
increase in the average investment balances as a result of the Series D
preferred Stock financing in December 1995 and February 1996. Interest expense
for 1996 decreased to $57,000 from $117,000 in 1995, primarily as a result of
decreased borrowing in 1996.

LIQUIDITY AND CAPITAL RESOURCES

  The Company has financed its operations to date principally through private
placements of equity securities, which had yielded net proceeds of $30,900,000
as of December 31, 1997, together with interest income on such proceeds, an
initial public offering of Common Stock in June 1997, which resulted in net
proceeds of approximately $13,600,000, and equipment leases, to finance
certain capital equipment which have provided proceeds in the amount of
$2,400,000. As of December 31, 1997, the Company had approximately $12,800,000
in cash, cash equivalents and short-term investments.

  Net cash used in operating activities was approximately $12,500,000 ,
$6,700,000 and $4,500,000 for the years ended December 31, 1997, 1996 and
1995, respectively, resulting primarily from operating losses incurred. Net
cash used in investing activities was $5,150,000, $388,000 and $78,000 for the
years ended December 31, 1997, 1996 and 1995, respectively, attributable
primarily to capital expenditures during such periods. Net cash provided by
financing activities was approximately $25,300,000 , $5,000,000 and $6,900,000
for the years ended December 31, 1997, 1996 and 1995, respectively, resulting
primarily from the Company's initial public offering, the sale of equity
securities in private placement transactions and proceeds from bridge loans
during such periods.

  In February 1998, the Company entered into an equipment lease that permits
the Company up to $1,500,000 of financing for the purchase of office and
manufacturing equipment, software and custom built equipment. In March 1998,
the Company secured a commitment for a $3,000,000 line of credit which may be
used for general working capital purposes. The availability of this line of
credit is subject to the satisfaction of a number of conditions, including the
completion by the proposed lender of its legal due diligence and the
negotiation and execution of definitive agreements. There can be no assurance
that these conditions will be satisfied on a timely basis, if at all. The
Company's future liquidity and capital requirements will depend upon numerous
factors, including the progress of the Company's product development efforts,
the progress of the Company's clinical trials, actions relating to regulatory
matters, the costs and timing of expansion of product development,
manufacturing, sales and marketing activities, the extent to which the
Company's products gain market acceptance, and competitive developments. The
Company believes that available cash, a line of credit and lease lines will be
sufficient to meet the Company's operating expenses and capital requirements
through early 1999. There can be no assurance, however, that the Company will
not require additional financing during that period, or that if required, such
additional financing will be available on terms acceptable to the Company, if
at all. The Company may seek to raise additional funds through public or
private financing, collaborative relationships or other arrangements. There
can be no assurance that such additional funding, if needed, will be available
on terms acceptable to the Company, if at all. Furthermore, any additional
equity financing may be dilutive to stockholders, and debt financing, if
available, may involve restrictive covenants. Collaborative arrangements, if
necessary to raise additional funds, may require the Company to relinquish its
rights to certain of its technologies, products or marketing territories. The
failure of the Company to raise capital when needed would have a material
adverse effect on the Company's business, financial condition and results of
operations.

FACTORS AFFECTING FUTURE RESULTS

 History of Losses and Expectation of Substantial Future Losses

  Since inception, the Company has experienced losses and expects to
experience substantial net losses for the foreseeable future. To date, sales
of the Company's microcatheter systems have been limited. The Company had net
losses of approximately $12.3 million and $7.8 million for the Company's
fiscal years ended 1997 and

                                      29
<PAGE>

1996, respectively. As of December 31, 1997, the Company had an accumulated
deficit of approximately $30.4 million. The Company expects to incur
substantial net operating losses for the foreseeable future as a result of
research and product development, clinical trials, manufacturing, sales,
marketing and other expenses expected to be incurred as the Company further
develops, seeks regulatory approvals, tests and distributes its microcatheter
systems. The Company's limited operating history makes accurate prediction of
future operating results difficult or impossible. There can be no assurance
that the Company will ever generate substantial revenue or achieve
profitability. Failure by the Company to generate substantial revenues would
have a material adverse effect on the Company's business, financial condition
and results of operations.

 Future Additional Capital Requirements; No Assurance Future Capital Will be
Available

  The Company's future liquidity and capital requirements will depend on
numerous factors, including the progress of the Company's clinical research
and product development programs; the receipt of, and the time required to
obtain, regulatory clearances and approvals; the costs and timing of expansion
of product development, manufacturing and sales and marketing activities; the
extent to which the Company's products gain market acceptance; competitive
developments; and other factors. In February 1998, the Company entered into an
equipment lease agreement that permits the Company to finance up to $1,500,000
of office and manufacturing equipment, software and custom built equipment. In
March 1998, the Company secured a commitment letter for a $3,000,000 line of
credit which may be used for general working capital purposes. The
availability of this line of credit is subject to the satisfaction of a number
of conditions, including the completion by the proposed lender of its legal
due diligence and the negotiation and execution of definitive agreements.
There can be no assurance that these conditions will be satisfied on a timely
basis, if at all. The Company currently expects that, without additional
funding, the Company's current cash reserves will be depleted in early 1999.
In addition, if unforeseen difficulties arise in the course of developing its
products, performing clinical trials, obtaining necessary regulatory
clearances and approvals or other aspects of the Company's business, the
Company may be required to invest greater-than-anticipated funds. As a
consequence, the Company will be required to raise additional funds through
public or private debt or equity financings, collaborative relationships, bank
facilities or other arrangements. There can be no assurance that, if
additional financing is needed, it will be available on terms acceptable to
the Company, if at all. Any additional equity financing may be dilutive to
stockholders, and debt financing, if available, may involve restrictive
covenants.

 No Assurance of Safety and Effectiveness; Early Stage of Product Development

  The Company is currently developing versions of its microcatheter systems
for mapping AF and VT. To date, the Company has completed two clinical trials
and has received two 510(k) pre-market clearances from the FDA with respect to
its Cardima Pathfinder microcatheter system for venous mapping of VT and
Revelation microcatheter system for mapping and pacing of the atria. Failure
to obtain clearances for the Company's other diagnostic products under
development on a timely basis would have a material adverse effect on the
Company's business, financial condition and results of operations.

  The Company is in the early stage of developing, testing and obtaining
regulatory approval for its microcatheter systems designed for ablation of AF
and VT. The Company is currently developing the Cardima Pathfinder AFTC
microcatheter system for ablation of AF and the Therastream microcatheter
system for ablation of VT. The Company is required to obtain an IDE from the
FDA prior to conducting human clinical trials of its microcatheter systems for
ablation. The Company filed an IDE for clinical testing of the Revelation
microcatheter system for the mapping and ablation of AF in January 1997. The
Company completed the mapping phase of this feasibility study in August 1997
and began treating the first patient in the ablation phase with the Cardima
Pathfinder AFTC microcatheter system in March 1998. The Company currently
expects to file an IDE to begin clinical testing of its Therastream
microcatheter system for VT ablation in 1998. The Company must complete these
clinical trials and a pivotal trial, if initiated, prior to the filing of a
PMA, and must receive PMA approval prior to marketing such products for
ablation in the United States. Clinical trials of the Company's microcatheter
systems will require substantial financial and management resources of the
Company and the completion of such trials will

                                      30
<PAGE>

take several years. There can be no assurance that necessary IDEs will be
granted by the FDA, that human clinical trials, if initiated, will be
completed or that these clinical studies will validate the results of the
Company's pre-clinical studies or demonstrate that such products are safe and
effective. In addition, the clinical trials may identify significant technical
or other obstacles to be overcome prior to obtaining necessary regulatory
approvals or market acceptance. The failure of the Company to initiate and
complete clinical trials, demonstrate product safety and clinical
effectiveness, or obtain regulatory approval for the use of the Company's
microcatheter systems for the ablation of AF or VT would have a material
adverse effect on the Company's business, financial condition and results of
operations.

 Uncertainty of Product and Procedure Acceptance

  The Company's microcatheter systems represent a novel approach to the
mapping and ablation of AF and VT. Acceptance of the Company's products and
procedures by physicians, patients and health care payors will be necessary in
order for the Company to be successful. The Company's microcatheter systems
for the mapping and ablation of AF and VT are new technologies that must
compete with more established treatments such as drugs, external electrical
cardioversion and defibrillation, implantable defibrillators, purposeful
destruction of the Atrio-Ventricular ("AV") node followed by implantation of a
pacemaker, and open heart surgery. It is likely that physicians will not
recommend the use of the Company's microcatheter systems unless they conclude,
based on clinical data and other factors, that these systems provide a safe,
effective and cost-efficient alternative to established or emerging approaches
to the mapping and ablation of AF and VT. Except for the Cardima Pathfinder
microcatheter system for mapping VT and the Revelation microcatheter system
for mapping AF, none of the products currently being developed by Cardima for
the mapping and ablation of AF and VT has obtained regulatory clearance or
approval in the United States. Even if the Company's products are successfully
developed and the required regulatory clearance or approval is obtained, there
can be no assurance that such products and the associated procedures will
ultimately gain any significant degree of market acceptance. Since the
Company's sole product focus is to design and market microcatheter systems to
map and ablate AF and VT, the failure to successfully commercialize these
systems would have a material and adverse affect on the Company's business,
financial condition and results of operations.

 Risks Regarding Products and Procedures Designed for Mapping and Ablation of
AF

  Cardima is developing its Cardima Pathfinder AFTC microcatheter system for
mapping and ablation of AF. Currently, there is considerable clinical debate
about the need for mapping AF prior to ablation, and no mapping is performed
during the open heart surgical maze procedure. However, the Company believes
that mapping prior to ablation may be useful to identify different segments of
the AF population, each of which could require slightly different mapping and
ablation procedures. For example, some electrophysiologists believe most AF
patients will need to be mapped and ablated in both the left and right atria,
while others believe only the right atrial intervention is warranted. Market
acceptance of this product for mapping will depend largely on a determination
that there is a clinical need for diagnostic mapping prior to ablation of AF.
The Cardima Pathfinder AFTC ablation procedure requires the use of RF energy
in the right and left atria to produce lesions. In general, the use of RF
energy in the left atrium has the potential to create blood clots, which could
travel through the vasculature to the brain and cause a stroke. Consequently,
physicians may not recommend this procedure, in which event the Cardima
Pathfinder AFTC would be unlikely to gain market acceptance. The failure of
the Company to complete development of the Cardima Pathfinder AFTC or to gain
regulatory approval with respect to the Pathfinder AFTC for ablation of AF,
demonstrate safety, clinical effectiveness or cost effectiveness, gain wide
market acceptance or successfully commercialize the Cardima Pathfinder AFTC
for the mapping and ablation of AF would have a material adverse effect on the
Company's business, financial condition and results of operations.

 Risks Regarding Products and Procedures Designed for Mapping and Ablation of
VT

  The Cardima Pathfinder and Tracer microcatheter systems for VT mapping are
designed for use inside the vasculature of the heart wall and to provide
access to the vasculature of the heart through the venous system. To

                                      31
<PAGE>

achieve market acceptance, the Company will need to demonstrate the safety,
clinical effectiveness and cost effectiveness of the Cardima Pathfinder and
Tracer microcatheter systems for VT mapping, of which there can be no
assurance. In addition, electrophysiologists will need to be specially trained
to perform this procedure, which may further impede market acceptance. There
can be no assurance that the Cardima Pathfinder or Tracer microcatheter
systems for VT mapping will ever achieve market acceptance, or in the case of
the Tracer microcatheter system, be cleared for marketing by the FDA, or be
successfully commercialized in the United States or internationally. The
inability of the Company to gain wide market acceptance or successfully
commercialize the Cardima Pathfinder and Tracer microcatheter systems for VT
mapping would have a material adverse effect on the Company's business,
financial condition and results of operations.

  The Company's Therastream microcatheter system is being developed for
ablation of VT using RF energy, which could cause damage to the arteries and
veins of the heart, potentially leading to myocardial infarction and even
death. Consequently, physicians may not recommend this procedure, in which
event the Therastream would be unlikely to gain market acceptance. Failure of
the Company to gain market acceptance or successfully commercialize the
Therastream would have a material adverse effect on the Company's business,
financial condition and results of operations.

 Fluctuations in Operating Results

  The Company's results of operations may fluctuate significantly from quarter
to quarter or year to year depending upon a number of factors, including
actions relating to regulatory matters, progress of pre-clinical and clinical
trials, the extent to which the Company's products gain market acceptance, the
scale-up of manufacturing capabilities, the expansion of sales and marketing
activities, competition, the timing of new product introductions by the
Company or its competitors and the ability of the Company to market its
products successfully in the United States and internationally. Although the
Cardima Pathfinder and Tracer microcatheter systems are labeled for single use
only, the Company is aware that some physicians in international markets are
reusing these products. Reuse of the Company's microcatheter systems would
reduce revenues from product sales and could have a material adverse effect on
future performance and periodic operating results. Due to such fluctuations in
operating results, period to period comparisons of the Company's revenues and
operating results are not necessarily meaningful and should not be relied upon
as indicators of likely future performance or annual operating results.

 No Assurance of Obtaining Required Regulatory Approvals; Government
Regulation

  The pre-clinical and clinical testing, manufacturing, labeling, distribution
and promotion of the Company's products are subject to extensive and rigorous
government regulation in the United States and other countries. Noncompliance
with applicable requirements can result in enforcement actions by the FDA
including, among other things, fines, injunctions, civil penalties, recall or
seizure of products, refusal of the FDA to grant pre-market clearances or
approvals, withdrawal of marketing approvals and criminal prosecution. Any
such action would have a material adverse effect on the Company's business,
financial condition and results of operations.

  The Company is prohibited from marketing its products in the United States
unless it obtains 510(k) clearance or PMA approval from the FDA. The Company
believes that it usually takes up to 12 months from submission to obtain
510(k) clearance, but that it can take longer. The Cardima Pathfinder and
Revelation microcatheter systems for mapping VT and AF, respectively, have
each received 510(k) clearance. The Company believes that its other mapping
products will also be eligible for 510(k) clearance, and has submitted 510(k)
pre-market notifications for the Cardima Pathfinder Mini and Tracer products.
These submissions may need to include clinical trial data. There can be no
assurance, however, that any of these products will receive 510(k) clearance
in a timely fashion, if at all. Delays in market introduction resulting from
the 510(k) clearance process could have a material adverse effect on the
Company's business, financial condition and results of operations.

  The Company will be required to seek PMA approval for its ablation products,
including the Cardima Pathfinder AFTC and the Therastream microcatheters for
ablation. The process of obtaining PMA approval is much

                                      32
<PAGE>

more costly, lengthy and uncertain than the 510(k) clearance process. The
Company believes that the FDA's review of a PMA application after filing can
last from one to three years, or even longer. In order to prepare a PMA
application, the Company will be required to complete clinical trials to
demonstrate the safety and effectiveness of these products. To date, the
Company has not conducted any human clinical studies using its microcatheter
systems for the ablation of AF or VT. The Company submitted an IDE for the
Revelation microcatheter system for mapping and ablation of AF in January
1997, and completed a mapping study at Stanford University Hospital and
Massachusetts General Hospital in September 1997. In addition, the Company
received conditional IDE approval in January 1998 and full approval in March
1998 for a feasibility clinical study for AF ablation using the Cardima
Pathfinder AFTC microcatheter system. The Company expects to file an
additional IDE and begin its clinical trials for the Therastream microcatheter
system in the second half of 1998. There can be no assurance that any clinical
study that the Company proposes will be permitted by the FDA, will be
completed or, if completed, will provide data and information that supports
additional clinical investigations of the type necessary to obtain PMA
approval. The Company expects that a PMA application will not be submitted for
at least one year, if at all. No assurance can be given that the Company will
ever be able to obtain PMA approval for any of its ablation products. Failure
of the Company to obtain timely PMA approval would have a material adverse
effect on the Company's business, financial condition and results of
operations.

  The Company is subject to periodic inspection by the FDA and the California
Department of Health Services, and must comply with various other regulatory
requirements that apply to medical devices marketed in the United States,
including labeling regulations, the Quality System Regulation ("QSR") (which
includes elaborate testing, control, documentation and other quality assurance
procedures), the Medical Device Reporting regulation (which requires 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 ("off-label") uses. The Company's failure to comply with applicable
regulatory requirements could result in enforcement action by the FDA, which
could have a material adverse effect on the Company's business, financial
condition and results of operations.

  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. The Company has obtained
the requisite approvals by means of the CE mark and TGA approval to sell the
Cardima Pathfinder, Cardima Pathfinder Mini , Revelation and Tracer for
mapping in the European Union ("EU") and Australia, respectively, to sell the
Cardima Pathfinder, Cardima Pathfinder Mini, Cardima Pathfinder 3mm and Tracer
in Japan and to sell the Cardima Pathfinder, Tracer and Venaport in Canada.
The Company has initiated clinical trials in the EU for its AF ablation
products, and will use this data to support its application for CE mark. There
can be no assurance the Company will be successful in obtaining such
approvals. Failure to receive approval to affix the CE mark would prohibit the
Company from selling these products in member countries of the EU, and would
require significant delays in obtaining individual country approvals. No
assurance can be given that such approvals will ever be obtained. In such
event, the Company's business, financial condition and results of operations
would be materially and adversely affected.

 Rapid Technological Change; Significant Competition

  The medical device industry is characterized by rapid and significant
technological change. Accordingly, the Company's success will depend in part
on its ability to respond quickly to medical discoveries and technological
changes, including changes in the capital equipment with which the Company's
microcatheter systems are designed to be compatible. Product development
involves a high degree of risk, and there can be no assurance that the
Company's new product development efforts will result in any commercially
successful products. Failure by the Company to respond to and develop new
technologies could have a material adverse effect on the Company's business,
financial condition and results of operations.

  The Company's microcatheter systems for the mapping and ablation of AF and
VT are new technologies that must compete with more established treatments
such as drugs, external electrical cardioversion and

                                      33
<PAGE>

defibrillation, implantable defibrillators, purposeful destruction of the AV
node followed by implantation of a pacemaker, and open heart surgery. In the
market for cardiac mapping and ablation devices, the Company believes that the
primary competitive factors are safety, effectiveness, ease of use and overall
system cost. In addition, the length of time required for products to be
developed and to receive regulatory and, in some cases, reimbursement approval
are important competitive factors. Several of the Company's competitors are
currently marketing and selling catheters in the United States and
internationally that map and ablate a type of arrhythmia known as
supraventricular tachycardia ("SVT"). In addition, 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 RF, ultrasound, microwave, laser and
cryoablation technologies. In addition, companies are developing surgical
procedures that could potentially be used by 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 new products prove to be safe and
effective, the Company's products could be rendered noncompetitive or
obsolete, which could have a material adverse effect on the Company's
business, financial condition and results of operations.

  Many of the Company's competitors have an established presence in the field
of interventional cardiology and electrophysiology, including Boston
Scientific, C.R. Bard, Inc., Johnson & Johnson, through its Cordis division,
St. Jude Medical, Inc., through its Daig division, and Medtronic, Inc. These
competitors have substantially greater financial and other resources than the
Company, including larger research and development staffs and more experience
and capabilities in conducting research and development activities, testing
products in clinical trials, obtaining regulatory approvals, and
manufacturing, marketing and distributing products. In addition, other
companies are developing proprietary systems for the diagnosis and treatment
of cardiac arrhythmias, including Biosense, Inc. a division of Johnson and
Johnson, Cardiac Pathways, Inc. and Endocardial Solutions, Inc. Other
companies develop, market and sell alternative approaches to the treatment of
AF and VT, including Guidant Corporation, Medtronic, Inc., and Ventritex,
Inc., a subsidiary of St. Jude, Inc., the leading manufacturers of implantable
defibrillators. There can be no assurance that the Company will succeed in
developing and marketing technologies and products that are more clinically
effective and cost-effective than the more established treatments or the new
approaches and products being developed and marketed by its competitors.
Furthermore, there can be no assurance the Company will succeed in developing
new technologies and products that are available prior to its competitors'
products. Failure of the Company to demonstrate the competitive advantages of
its products would have a material adverse effect on the Company's business,
financial condition and results of operations.

 Dependence on Patents and Proprietary and Licensed Technology; Risk of Patent
Infringement

  The Company's success will depend in part on its ability to obtain patent
protection for its products and processes, to preserve its trade secrets,
trademarks, copyrights and to operate without infringing or violating the
proprietary rights of others. The Company's strategy is to actively pursue
patent protection in the United States and foreign jurisdictions for
technology that it believes to be proprietary and that offers a potential
competitive advantage for its products. The patent positions of medical device
companies, including the Company, are uncertain and involve complex and
evolving legal and factual questions. The coverage sought in a patent
application either can be denied or significantly reduced before or after the
patent is issued. In addition, the U.S. patent laws were recently amended to
exempt physicians, other health care professionals and affiliated entities
from infringement liability for medical and surgical procedures performed on
patients. The Company cannot predict whether this amendment might have a
material adverse effect on the Company's ability to protect its proprietary
methods and procedures.

  The Company relies on certain license agreements through which it licenses
certain technology from others, including technology of Target Therapeutics,
Inc., a subsidiary of Boston Scientific Corporation, ("Target") that is
integrated into the Company's microcatheter systems for mapping and ablation.
Under a license agreement with Target (the "Target License Agreement"), the
Company has an exclusive license (the "Target License")

                                      34
<PAGE>

under certain issued U.S. patents. The Target License covers the diagnosis and
treatment of electrophysiological disorders in areas other than the central
nervous system. The Target License will terminate upon the expiration or
invalidation of all claims under the underlying patents. In addition, the
Company has obtained a non-exclusive license to use Target's technology,
provided it has made a substantial improvement of such technology, for the
diagnosis or treatment of diseases of the heart, other than using balloon
angioplasty. Under the Target License Agreement, Cardima has granted Target an
exclusive, royalty-free license to use any technology developed by Cardima
prior to May 1996 in the fields of neurology, interventional neuroradiology,
interventional radiology, diagnosis and treatment of male and female
reproductive disorders and vascular prostheses. The Target License Agreement
imposes various commercialization, sublicensing, insurance, royalty, product
liability, indemnification, non-competition and other obligations on the
Company. Failure by the Company to comply with certain of these requirements
could result in a termination of the Target License. The loss of the Company's
exclusive rights to the Target-based microcatheter technology would have a
material adverse effect on the Company's business, financial condition and
results of operations.

  The Company has also licensed a proprietary surface coating material used on
certain of its catheters. There can be no assurance that these licenses will
continue to be available to the Company. The loss of or inability to maintain
any of these licenses could result in delays in commercial shipments by the
Company until equivalent technology could be developed internally or
identified, licensed and integrated, which would have a material adverse
effect on the Company's business, financial condition and results of
operations.

  Although the Company has not received any significant letters from others
threatening to enforce intellectual property rights against the Company, there
can be no assurance that the Company will not become subject to patent
infringement claims or litigation, to interference proceedings in the USPTO to
determine the priority of inventions or to oppositions to patent grants in
foreign jurisdictions. An adverse determination in litigation, interference or
opposition proceedings to which the Company may become a party could subject
the Company to significant liabilities to third parties, require disputed
rights to be licensed from third parties or require the Company to cease using
such technology. Under the Company's license agreement with Target, the
Company is not indemnified against claims brought by third parties alleging
infringement of patent rights. Consequently, the Company could bear the
liability resulting from such claims. There can be no assurance that the
Company will have the financial resources to protect and defend its
intellectual property, as such defense is often costly and time consuming.
Failure of the Company to protect its patent rights, trade secrets, know-how
or other intellectual property could have a material adverse effect on the
Company's business, financial condition and results of operations.

  The validity and breadth of claims in medical technology patents involve
complex legal and factual questions and, therefore, may be highly uncertain.
There can be no assurance that any issued patent or patents based on pending
patent applications or any future patent application will exclude competitors
or provide competitive advantages to the Company, that any of the Company's
patents or patents in which it has licensed rights will be held valid if
subsequently challenged or that others will not claim rights in or ownership
of the patents and other proprietary rights held or licensed by the Company.
There can be no assurance that others have not developed or will not develop
similar products, duplicate any of the Company's products or design around any
patents issued to or licensed by the Company or that may be issued in the
future to the Company. Since patent applications in the United States are
maintained in secrecy until patents issue, the Company cannot be certain that
others were not the first to file applications for inventions covered by the
Company's pending patent applications, nor can the Company be certain that it
will not infringe any patents that may be issued to others on such
applications. The Company periodically reviews the scope of patents of which
it is aware. Although Cardima does not believe that it infringes patents known
to the Company, the question of patent infringement involves complex legal and
factual issues and there can be no assurance that any conclusion reached by
the Company regarding infringement will be consistent with the resolution of
any such issues by a court.

                                      35
<PAGE>

 Risks Associated with International Sales

  International sales have accounted for a significant portion of the
Company's revenues to date and will continue to account for a significant
portion of the Company's revenues for the foreseeable future. A number of
risks are inherent in international transactions. International sales may be
limited or disrupted by the imposition of government controls, export license
requirements, economic or political instability, trade restrictions, changes
in tariffs or difficulties in staffing and management. Additionally, although
the Company's sales are denominated in U.S. dollars, Cardima's business,
financial condition and results of operations may be adversely affected by
fluctuations in currency exchange rates as well as increases in duty rates and
difficulties in obtaining export licenses. The financial condition, expertise
and performance of the Company's international distributors and any future
international distributors could affect sales of the Company's products
internationally and could have a material adverse effect on the Company's
business, financial condition and results of operations. The Company is in the
process of hiring, training and establishing a direct sales force in certain
major European markets. The ability of the Company to effectively operate a
remote sales force will require additional resources, time and expense and
could have a material adverse effect on the Company's business, financial
condition and results of operations. The international nature of the Company's
business also subjects it and its employees, representatives, agents and
distributors to laws and regulations of the international jurisdictions in
which they operate or in which the Company's products may be sold. The
regulation of medical devices in a number of such jurisdictions, particularly
in the EU, continues to develop, and there can be no assurance that new laws
or regulations will not have a material adverse effect on the Company's
business, financial condition and results of operations. Foreign regulatory
agencies often establish product standards different from those in the United
States and any inability to obtain foreign regulatory approvals on a timely
basis could have a material adverse effect on the Company's international
business and its financial condition and results of operations. In addition,
the laws of certain foreign countries do not protect the Company's
intellectual property rights to the same extent as do the laws of the United
States. There can be no assurance that the Company will be able to
successfully commercialize any of its current microcatheter products,
including the Cardima Pathfinder, Cardima Pathfinder Mini, Revelation and
Tracer microcatheter systems, or any future product in any foreign market.

 Uncertainty Related to Third-Party Reimbursement

  U.S. health care providers, including hospitals and physicians, that
purchase medical devices generally rely on third-party payors, principally
federal Medicare, state Medicaid and private health insurance plans, to
reimburse all or a part of the costs and fees associated with the procedures
performed using these devices. The Company's success will depend upon, among
other things, the ability of health care providers to obtain satisfactory
reimbursement from third-party payors for medical procedures in which the
Company's microcatheter systems are used. Third-party payors may deny
reimbursement if they determine that a prescribed device has not received
appropriate regulatory clearances or approvals, is not used in accordance with
cost-effective treatment methods as determined by the payor, or is
experimental, unnecessary or inappropriate. If FDA clearance or approval is
received, third-party reimbursement would also depend upon decisions by 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 the Company's products will be available or, 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, or that physicians will support and advocate
reimbursement for procedures using the Company's products. Failure by
hospitals and other users of the Company's products to obtain reimbursement
from third-party payors or changes in government and private third-party payor
policies toward reimbursement for procedures employing the Company's products
would have a material adverse effect on the Company's business, financial
condition and results of operations. Moreover, the Company is unable to
predict what additional legislation or regulation, if any, relating to the
heath care industry or third-party coverage and reimbursement may be enacted
in the future, or what effect such legislation or regulation would have on the
Company.

                                      36
<PAGE>

 Limited Manufacturing Experience; Scale-Up Risk; Need to Comply with U.S.
 Manufacturing Standards; Dependence on Key Suppliers

  The Company has only limited experience in manufacturing its microcatheter
systems. The Company currently manufactures its microcatheter systems in
limited quantities for U.S. and international sales and for pre-clinical and
clinical trials. The Company has no experience manufacturing its products in
the volumes that will be necessary for the Company to achieve significant
commercial sales, and there can be no assurance that reliable, high-volume
manufacturing capacity can be established or maintained at commercially
reasonable costs. The Company has recently increased the number of
microcatheters manufactured and expects that, if U.S. sales for the Cardima
Pathfinder and Revelation microcatheter systems increase, or if the Company
receives FDA clearance or approvals for other products, it will need to expend
significant capital resources and develop manufacturing expertise to establish
large-scale manufacturing capabilities. Manufacturers often encounter
difficulties in scaling up production of new products, including problems
involving production yields, quality control and assurance, component supply
shortages, shortages of qualified personnel, compliance with FDA regulations,
and the need for further FDA approval of new manufacturing processes. In
addition, the Company believes that substantial cost reductions in its
manufacturing operations will be required for it to commercialize its
microcatheter systems on a profitable basis. Any inability of the Company to
establish and maintain large-scale manufacturing capabilities would have a
material adverse effect on the Company's business, financial condition and
results of operations.

  The Company's manufacturing facilities are subject to periodic inspection by
regulatory authorities, and its operations must either undergo QSR compliance
inspections conducted by the FDA or receive an FDA exemption from such
compliance inspections in order for the Company to be permitted to produce
products for sale in the United States. The Company's facilities and
manufacturing processes have successfully undergone a combined inspection by
the FDA and by the State of California and an annual reinspection by TUV in
February 1997. The Company has demonstrated compliance with ISO 9001 (EN
46001) quality standards, as well as compliance with 93/42/EEC, the Medical
Device Directive and is in compliance with procedures to produce products for
sale in Europe. Any failure by the Company to comply with QSR requirements or
to maintain its compliance with ISO 9001 (EN 46001) standards may result in
the Company being required to take corrective actions, such as modification of
its policies and procedures. In addition, the Company may be required to cease
all or part of its operations for some period of time until it can demonstrate
that appropriate steps have been taken to comply with QSR or ISO 9001 (EN
46001) standards. There can be no assurance that the Company will be found in
compliance with QSR by regulatory authorities, or that it will continue to
comply with ISO 9001 (EN 46001) standards in future audits or that the Company
will not experience difficulties in the course of developing its manufacturing
capability. Any failure of the Company to comply with state or FDA QSR
requirements or to maintain compliance with ISO 9001 (EN 46001) standards, or
to develop its manufacturing capability in compliance with such standards,
would have a material adverse effect on the Company's business, financial
condition and results of operations.

  The Company purchases certain key components of its products, including the
hydrophilic coating for certain of its microcatheters, from sole, single or
limited source suppliers. For certain of these components there are relatively
few alternative sources of supply. Establishing additional or replacement
suppliers for any of the numerous components used in the Company's products,
if required, may not be accomplished quickly and could involve significant
additional costs. Any supply interruption from vendors or failure of the
Company to obtain alternative vendors for any of the numerous components used
to manufacture the Company's products would limit the Company's ability to
manufacture its products and would have a material adverse effect on the
Company's business, financial condition and results of operations.

 Limited Sales, Marketing and Distribution Experience

  The Company has only limited experience marketing and selling its products
in commercial quantities. Expanding the Company's marketing and sales
capability to adequately support sales in commercial quantities will require
substantial effort and require significant management and financial resources.
The Company has

                                      37
<PAGE>

terminated several distribution arrangements in Europe and is in the process
of hiring a direct sales force in France and Germany. The Company currently
has one salesman in Germany, and there can be no assurance that the Company
will be able to build a European direct sales force, that establishing such a
sales force will be cost-effective or that the Company's European sales
efforts will be successful. The Company's Cardima Pathfinder, Cardima
Pathfinder Mini, Revelation and Tracer microcatheter systems for mapping of AF
and VT have obtained regulatory approval in certain international markets, and
sales and marketing of these products is conducted primarily through
distributors. The Company currently has a number of exclusive distributors
that cover certain European countries and Japan and has sold only a limited
number of Cardima Pathfinder, Revelation and Tracer microcatheter systems
through these distributors. The Company does not have written agreements with
certain of its exclusive distributors. Consequently, the terms of such
arrangements, such as length of arrangements and minimum purchase obligations
are uncertain. In addition, the laws in certain international jurisdictions
may make it difficult and costly for the Company to terminate such
distribution arrangements absent specific written termination terms. There can
be no assurance that these distributors will be able to market and sell the
Company's products in these markets. There can be no assurance that the
Company will be able to enter into additional agreements with desired
distributors on a timely basis or at all, or that such distributors will
devote adequate resources to selling the Company's products. Failure to
establish an adequate sales force or to establish and maintain appropriate
distribution relationships would have a material adverse effect upon the
Company's business, financial condition and results of operations.

 Dependence Upon Key Personnel

  The Company's ability to operate successfully depends in significant part
upon the continued service of certain key scientific, technical, clinical,
regulatory and managerial personnel, and its continuing ability to attract and
retain additional highly qualified personnel in these areas. Competition for
such personnel is intense, especially in the San Francisco Bay Area, and there
can be no assurance that the Company can retain such personnel or that it can
attract or retain other highly qualified scientific, technical, clinical,
regulatory and managerial personnel in the future, including key sales and
marketing personnel.

 Risk of Product Liability; Adequacy of Insurance Coverage

  The development, manufacture and sale of the Company's microcatheter systems
may expose the Company to product liability claims. Although the Company has
not experienced any claims to date, there can be no assurance that the Company
will not experience losses due to product liability claims in the future.
Although the Company currently has 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 continue to be available to
the Company on reasonable terms, if at all. In addition, there can be no
assurance that all of the activities encompassed within the Company's business
are or will be covered under the Company's policies. Although the Cardima
Pathfinder, Revelation and Tracer products are labeled for single use only,
the Company is aware that some physicians are reusing such products. Moreover
despite labeling of the Company's microcatheters for diagnostic use only, the
Company believes that physicians are using such mapping microcatheters for
ablation. Multiple use or "off-label" use of the Company's microcatheters
could subject the Company to increased exposure to product liability claims,
which could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company may require
additional product liability coverage if the Company significantly expands
commercialization of its 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 the Company,
regardless of their merit or eventual outcome, could have a material adverse
effect on the Company's business, financial condition and results of
operations.

 Impact of the Year 2000 Issue on the Company's Operations

  Many existing computer programs use only two digits to identify a year in
the date field. These programs were designed and developed without considering
the impact of the up coming change in the century. If not

                                      38
<PAGE>

corrected, many computer applications could fail or create erroneous results
by or at the Year 2000 (the "Year 2000 Issue"). The Company is in the process
of performing an assessment of the potential impact of the Year 2000 Issue on
its operations. Management is in the process of formalizing its assessment
procedures and developing a plan to address identified issues. The Company has
evaluated its financial and accounting and inventory tracking systems and
concluded that they are not materially affected by the Year 2000 Issue. The
extent, if any, of the impact of the Year 2000 Issue on the other systems and
equipment is unknown. A corporate-wide inventory of computer applications is
being performed by the Company and is expected to be completed by the end of
fiscal year 1998, after which time the Company will attempt to remedy any
issues. The Company has also begun communications with its facilities managers
to determine the impact on building security and related equipment. There can
be no assurance that all third parties will address the Year 2000 Issue in a
timely fashion, if at all. Any Year 2000 Issue compliance problems of either
the Company, its business partners or its customers could have a material
adverse effect on the Company's business, operating results and financial
condition.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

  The Company's financial statements and the report of independent auditors
appear on pages F-1 through F-17 of this report.

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

  Not applicable.


                                      39
<PAGE>

                                   PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

  The response to this item is contained in part below and the remainder is
contained in the Company's Proxy Statement for the Annual Meeting of
Stockholders to be held on May 19, 1998 (the "1997 Proxy Statement") under the
caption "Election of Directors" and is incorporated herein by reference.

  The executive officers of the Company are elected annually by the Board of
Directors of the Company (the "Board") and serve at the discretion of the
Board.

  Dr. Phillip Radlick (age 60) has been the President, Chief Executive Officer
and a Director of Cardima since November 1994. Prior to joining the Company,
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 Edwards
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
University of California, Los Angeles.

  Mr. Gabriel Vegh (age 58), the founder of the Company, has been a Director
of Cardima since November 1992. Mr. Vegh has been the Chief Operating Officer
of Cardima since November 1994, and the Executive Vice President since January
1995. From May 1993 until November 1994, Mr. Vegh was the Company's President,
and from May 1993 until July 1996, he served as the Company's Chief Financial
Officer. Prior to joining the Company, from August 1985 until May 1993, Mr.
Vegh was the Vice President, Operations of Target, and from February 1983
until August 1985, Mr. Vegh was General Manager, Pilot Operations of Advanced
Cardiovascular Systems. Mr. Vegh received a B.S. in Mechanical Engineering
from the New Jersey Institute of Technology.

  Dr. Allan Abati (age 53) has been the Vice President, Regulatory Affairs,
Clinical Programs and Quality Assurance of Cardima since February 1996. Prior
to joining the Company, from February 1992 until February 1996, Dr. Abati was
the Vice President, Regulatory Affairs and Quality Assurance of Johnson &
Johnson Professional, Inc., a manufacturer of neurosurgical and orthopedic
medical devices. From August 1989 until February 1992, Dr. Abati was the
Director, Regulatory and Clinical Affairs of Shiley Inc., a Pfizer company and
manufacturer of interventional cardiology products. From June 1986 until
August 1989, Dr. Abati was the Manager, Regulatory Affairs and Clinical
Programs, and from November 1982 until June 1986 he was Senior Regulatory and
Clinical Affairs Specialist, of Edwards Critical-Care Division, a division of
Baxter Healthcare responsible for the development, manufacture and sale of
critical care and interventional cardiology products. Dr. Abati received a
B.S. in Zoology and an M.A. in Biology from California State University, Long
Beach and a Ph.D. in Physiology from Rutgers University.

  Dr. Omar Amirana (age 33) has been the Vice President, Marketing of Cardima
since September 1995. From June 1993 until September 1995, Dr. Amirana was the
Company's Director of Marketing, and from March 1993 until June 1993, he
served as a consultant to the Company. Prior to joining the Company, from May
1992 until November 1992, Dr. Amirana was the Program Manager of the Advanced
Development Group of EP Technologies, Inc. ("EPT"), an electrophysiology
catheter manufacturer that was acquired by Boston Scientific in January 1996.
Dr. Amirana received a B.S. in Mechanical Engineering from Tufts University
and an M.D. from Eastern Virginia Medical School.

  Mr. Ronald Bourquin (age 47) has been the Vice President and Chief Financial
Officer of Cardima since July 1996. Prior to joining the Company, from July
1993 until July 1996, Mr. Bourquin was the Corporate Controller of EPT, and
from April 1993 until July 1993, he served as a consultant to EPT. From
December 1991 until February 1993, Mr. Bourquin was the Controller of the
Endoscopy Division of Stryker Corporation, a medical instrument company. From
January 1979 until December 1991, Mr. Bourquin held various positions of
increasing responsibility at Coherent, Inc., a manufacturer of lasers,
ultimately serving as the Director of Finance of the Medical Group from
November 1985 to December 1991. Mr. Bourquin is a Certified Management
Accountant and received a B.A. in Accounting and a M.B.A. in Finance from
Golden Gate University.

                                      40
<PAGE>

  Mr. Duane Dickens (age 52) has been the Vice President, New Product
Development of Cardima since May 1993. From March 1992 until June 1993, Mr.
Dickens was the President of Rhythmetrix, Inc., a medical device company. From
September 1990 until March 1992, Mr. Dickens was the Director of Science,
Technology and Business Development of Medtronic Inc., a medical device
company. Mr. Dickens received a B.S. in Mechanical Engineering from University
of Nebraska.

  Mr. David Smith (age 44) has been the Vice President, World Wide Sales of
Cardima since March 1996. Prior to joining the Company, from January 1994
until December 1995, Mr. Smith was the Director of Marketing of Baxter
Healthcare, International Cardiology Division, a manufacturer and distributor
of interventional cardiology products. From June 1991 until December 1993, Mr.
Smith was the Business Unit Manager, Germany, and from April 1990 until May
1991, he was the National Sales Manager, Endovascular Products, of Baxter
Healthcare, Less Invasive Surgery Division. Mr. Smith has a B.S. in Business
Administration from Michigan State University.

ITEM 11. EXECUTIVE COMPENSATION

  The response to this item is contained in the Proxy Statement under the
caption "Compensation of Directors" and "Compensation of Executive Officers",
and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

  The response to this item is contained in the 1997 Proxy Statement under the
caption "Common Stock Ownership of Certain Beneficial Owners and Management",
and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

  The response to this item is contained in the 1997 Proxy Statement under the
caption "Transactions with Management", and is incorporated herein by
reference.

                                    PART IV

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

  (a) 1. FINANCIAL STATEMENTS

    The Company's financial statements are indexed on page F-1.

  (a) 2. FINANCIAL STATEMENT SCHEDULES

    All applicable information is readily determinable from the notes to the
  Company's financial statements or the schedule is not applicable,
  therefore, the schedules have been omitted.

  (a) 3. LISTING OF EXHIBITS

<TABLE>
<CAPTION>
   EXHIBIT #                          DESCRIPTION
   ---------                          -----------
   <C>       <S>
    3.1(1)   Certificate of Incorporation, as amended, of the Registrant.
    3.2(1)   Bylaws of Registrant.
    3.3(1)   Form of Amended and Restated Certificate of Incorporation of
             Registrant.
    4.1(1)   Form of Common Stock Certificate.
   10.1(1)   1993 Stock Option Plan.
   10.2(1)   1997 Directors' Stock Option Plan.
   10.3(1)   1997 Employee Stock Purchase Plan.
   10.4(1)   Form of Indemnification Agreement.
</TABLE>

                                      41
<PAGE>

<TABLE>
<CAPTION>
   EXHIBIT #                            DESCRIPTION
   ---------                            -----------
   <C>       <S>
   10.5(1)   Fourth Amended and Restated Stockholders' Rights Agreement dated
             March 7, 1997, between Registrant and certain stockholders of
             Registrant.
   10.6(1)   License Agreement dated May 21, 1993, between Registrant and
             Target Therapeutics, Inc.
   10.7(1)   Lease dated April 25, 1994, between Registrant and State of
             California Public Employees' Retirement System.
   10.8(1)   Sublease dated November 14, 1996, between Registrant and Target
             Therapeutics, Inc.
   10.9(2)   Master Lease Agreement dated January 26, 1996, between
             Registrant and Comdisco, Inc., together with Equipment Schedules
             VL-1, VL-2 and VL-3.
   10.10(1)  Warrant Purchase Agreement dated December 9, 1993, between
             Registrant and Target Therapeutics, Inc., together with the
             Series A Preferred Stock Warrant.
   10.11(1)  Series A Preferred Stock Warrant dated June 10, 1994, issued to
             Silicon Valley Bank.
   10.12(1)  Warrant Purchase Agreement dated July 1, 1994, between
             Registrant and California Public Employees' Retirement System,
             together with the Common Stock Warrant.
   10.13(1)  Series A Preferred Stock Warrant dated October 26, 1994, issued
             to Silicon Valley Bank.
   10.14(1)  Form of Series A Preferred Stock Warrant issued to certain
             investors in December 1994.
   10.15(1)  Series D Preferred Stock Warrant dated October 31, 1995, issued
             to Silicon Valley Bank.
   10.16(1)  Form of Common Stock Warrant issued to certain investors from
             April 1995 to December 1995.
   10.17(1)  Warrant Agreement dated January 23, 1996, between Registrant and
             Comdisco, Inc., together with the Series D Preferred Stock
             Warrant.
   10.18(1)  Electrophysiology Catheter License Agreement dated May 17, 1994,
             between Registrant and BSI Corporation, together with the Credit
             Pool Agreement of same date.
   10.19(1)  Distribution Agreement dated June 15, 1995, between Registrant
             and Paramedic Co., Ltd.
   10.20(1)  Distribution Agreement dated July 14, 1995, between Registrant
             and Werfen Distribution AG, together with the May 15, 1996
             letter amendment.
   10.21(1)  Employment Agreement dated May 21, 1993, between Registrant and
             Gabriel B. Vegh.
   10.22(1)  Employment Letter Agreement dated October 31, 1994, between
             Registrant and Phillip C. Radlick, Ph.D.
   10.23(1)  Warrant Agreement dated April 7, 1997, between Registrant and
             Comdisco, Inc.
   10.24(1)  Distribution Agreement dated April 1, 1997, between Registrant
             and Cardiologic, GmbH.
   10.25     Letter dated March 27, 1996, from Transamerica Business Credit
             Corp.
   23.1      Consent of Ernst & Young LLP, Independent Auditors.
   24.1      Power of Attorney.
   27.1      Financial Data Schedule.
</TABLE>
--------
(1) Incorporated by reference to the same exhibits filed with the Registrant's
    Registration Statement on Form S-1 (File No. 33-23209) declared effective
    on June 5, 1997.
(2) Equipment Schedule VL-3 dated February 3, 1998 to the Master Lease
    Agreement dated January 23, 1996 is filed with this Annual Report on Form
    10-K.


                                      42
<PAGE>

                                   SIGNATURES

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

Date: March 30, 1998                      CARDIMA, INC.
                                          /s/ Phillip C. Radlick, Ph.D.
                                          -------------------------------------
                                          PHILLIP C. RADLICK, Ph.D.
                                          President, Chief Executive Officer
                                           and Director

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

<TABLE>
 <C>                             <S>                              <C>
              NAME                             TITLE                        DATE
</TABLE>

  /s/ Phillip C. Radlick,      President, Chief Executive         3/30/98
           Ph.D.               Officer and Director          ------------------
---------------------------    (Principal Executive Officer)
 Phillip C. Radlick, Ph.D.

  /s/ Ronald E. Bourquin       Vice President and Chief           3/30/98
---------------------------    Financial Officer (Principal  ------------------
    Ronald E. Bourquin         Financial and Accounting
                               Officer)

 /s/ Michael J.F. Du Cros      Director                           3/30/98
---------------------------                                  ------------------
   Michael J.F. Du Cros

    /s/ Joseph S. Lacob        Director                           3/30/98
---------------------------                                  ------------------
      Joseph S. Lacob

    /s/ Neal Moszkowski        Director                           3/30/98
---------------------------                                  ------------------
      Neal Moszkowski

    /s/ Gabriel B. Vegh        Executive Vice President,          3/30/98
---------------------------    Chief Operating Officer and   ------------------
      Gabriel B. Vegh          Director

 /s/ Charles P. Waite, Jr.     Director                           3/30/98
---------------------------                                  ------------------
   Charles P. Waite, Jr.

                                       43
<PAGE>

                                 CARDIMA, INC.

                         INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                         PAGE
                                                                         ----
<S>                                                                      <C>
Report of Ernst & Young LLP, Independent Auditors.......................  F-2
Balance Sheets at December 31, 1997 and 1996............................  F-3
Statements of Operations for the three years ended December 31, 1997....  F-4
Statements of Changes in Redeemable Preferred Stock and Stockholders'
 Equity (Net Capital Deficiency) for the three years ended December 31,
 1997...................................................................  F-5
Statements of Cash Flows for the three years ended December 31, 1997....  F-6
Notes to Financial Statements...........................................  F-7
</TABLE>

                                      F-1
<PAGE>

               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
  Cardima, Inc.

  We have audited the accompanying balance sheets of Cardima, Inc. as of
December 31, 1997 and 1996, and the related statements of operations, changes
in redeemable convertible preferred stock and stockholders' equity (net
capital deficiency), and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

  In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Cardima, Inc. as December
31, 1997 and 1996, and the results of its operations and its cash flows for
each of the three years in the period ended December 31, 1997, in conformity
with generally accepted accounting principles.

                                          /s/ Ernst & Young LLP

Palo Alto, California
February 2, 1998


                                      F-2
<PAGE>

                                 CARDIMA, INC.

                                 BALANCE SHEETS
                    (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                               DECEMBER 31,
                                                             -----------------
                                                               1997     1996
ASSETS                                                       --------  -------
<S>                                                          <C>       <C>
Current assets:
  Cash and cash equivalents................................. $  8,578  $   907
  Short-term investments....................................    4,270       --
  Accounts receivable, net of allowances for doubtful
   accounts of $40 and $30 at December 31, 1997 and 1996,
   respectively.............................................      268       68
  Inventories...............................................      532      377
  Other current assets......................................      261      229
                                                             --------  -------
    Total current assets....................................   13,909    1,581
Property and equipment, net.................................    2,488    1,400
Restricted cash.............................................      192      275
Other assets................................................    1,085      708
                                                             --------  -------
                                                              $17,674  $ 3,964
                                                             ========  =======
Liabilities and stockholders' equity (net capital
 deficiency)
Current liabilities:
  Accounts payable.......................................... $    898  $ 1,155
  Accrued compensation......................................      753      513
  Other current liabilities.................................       55       52
  Notes payable.............................................        7    1,682
  Capital lease obligation--current portion.................      587      329
                                                             --------  -------
                                                                2,300    3,731
Deferred rent...............................................       90      139
Capital lease obligation--noncurrent portion................      840      722
Commitments
Redeemable convertible preferred stock at amount paid in:
  Series D redeemable convertible, none at December 31,
   1997; 1,919,052 shares issued and outstanding as of
   December 31, 1996........................................       --    9,740
  Series E redeemable convertible, none at December 31,
   1997; none as of December 31, 1996.......................       --       --
Stockholders' equity (net capital deficiency):
   Preferred stock, $0.001 par value; 5,000,000 shares
    authorized
    Series A convertible, none at December 31, 1997; 428,567
     shares issued and outstanding as of December 31, 1996
     at amount paid in......................................       --    2,949
    Series B convertible, none at December 31, 1997; 333,333
     shares issued and outstanding as of December 31, 1996
     at amount paid in......................................       --       --
    Series C convertible, none at December 31, 1997; 458,245
     shares issued and outstanding as of December 31, 1996
     at amount paid in......................................       --    4,764
Common stock, $0.001 par value; 25,000,000 shares
 authorized, 8,103,875 shares issued and outstanding at
 December 31, 1997, 74,999 as of December 31, 1996; at
 amount paid in.............................................   45,597      595
Deferred compensation.......................................     (731)    (526)
Accumulated deficit.........................................  (30,422) (18,150)
                                                             --------  -------
  Total stockholders' equity (net capital deficiency).......   14,444  (10,368)
                                                             --------  -------
                                                             $ 17,674  $ 3,964
                                                             ========  =======
</TABLE>


                                      F-3
<PAGE>

                                 CARDIMA, INC.

                            STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                     YEAR ENDED DECEMBER 31,
                                                     --------------------------
                                                       1997     1996     1995
                                                     --------  -------  -------
<S>                                                  <C>       <C>      <C>
Net sales..........................................  $  1,261  $   593  $   362
Cost of goods sold.................................     2,011    1,413      830
                                                     --------  -------  -------
  Gross profit.....................................      (750)    (820)    (468)
Operating expenses:
  Research and development.........................     5,320    3,319    2,581
  Selling, general and administrative..............     6,656    3,690    2,046
                                                     --------  -------  -------
    Total operating expenses.......................    11,976    7,009    4,627
                                                     --------  -------  -------
Operating loss.....................................   (12,726)  (7,829)  (5,095)
Interest and other income..........................       602      132       12
Interest expense...................................      (148)     (57)    (117)
                                                     --------  -------  -------
Net loss...........................................  $(12,272) $(7,754) $(5,200)
                                                     ========  =======  =======
Basic and diluted net loss per share...............  $  (2.64)
                                                     ========
Shares used in computing basic and diluted net loss
 per share.........................................     4,642
                                                     ========
Pro forma basic and diluted net loss per share.....            $ (2.29)
                                                               =======
Shares used in computing pro forma basic and
 diluted net loss per share........................              3,384
                                                               =======
</TABLE>


                 See accompanying notes to financial statements

                                      F-4
<PAGE>

                                 CARDIMA, INC.

      STATEMENT OF CHANGES IN REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
                 STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
              (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                             STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
                                          -----------------------------------------------------------------------------------
                   SERIES D    SERIES E                                                              DEFICIT        TOTAL
                  REDEEMABLE  REDEEMABLE   SERIES A    SERIES B    SERIES C                        ACCUMMULATED STOCKHOLDERS'
                  CONVERTIBLE CONVERTIBLE CONVERTIBLE CONVERTIBLE CONVERTIBLE                       DURING THE   EQUITY (NET
                   PREFERRED   PREFERRED   PREFERRED   PREFERRED   PREFERRED  COMMON    DEFERRED   DEVELOPMENT     CAPITAL
                     STOCK       STOCK       STOCK       STOCK       STOCK     STOCK  COMPENSATION    STAGE      DEFICIENCY)
                  ----------- ----------- ----------- ----------- ----------- ------- ------------ ------------ -------------
<S>               <C>         <C>         <C>         <C>         <C>         <C>     <C>          <C>          <C>
Balances at
December 31,
1994............    $    --    $     --     $ 2,949       $--       $ 3,558   $     5    $  --       $ (5,196)    $  1,316
Issuance of
117,411 shares
of Series C
convertible
preferred stock
to investors for
cash, exercise
of warrants and
conversion of
bridge loans at
$10.50 per share
in March and
July 1995, net
of issuance
costs of $27....         --          --          --        --         1,206        --       --             --        1,206
Issuance of
1,215,924 shares
of Series D
redeemable
convertible
preferred stock
to investors for
cash and
conversion of
bridge loans at
$5.11 per share
in December
1995, net of
issuance costs
of $31..........      6,182          --          --        --            --        --       --             --           --
Issuance of
3,631 common
stock upon
exercise of
employee stock
options for cash
at $0.70-$1.05
per share in
April, October
and December
1995............         --          --          --        --            --         3       --             --            3
Net Loss........                                                                                       (5,200)      (5,200)
                    -------    --------     -------       ---       -------   -------    -----       --------     --------
Balances at
December 31,
1995............      6,182          --       2,949        --         4,764         8       --        (10,396)      (2,675)
Issuance of
703,128 shares
of Series D
redeemable
convertible
preferred stock
to investors for
cash and
cancellation of
notes payable at
$5.11 per share
in February
1996, net of
issuance costs
of $35..........      3,558          --          --        --            --        --       --             --           --
Issuance of
2,206 shares of
common stock for
cash upon
exercise of
employee stock
options at
$0.56-$2.10 per
share in
January-April,
July, September
and November
1996............         --          --          --        --            --         7       --             --            7
Deferred
compensation
related to grant
of stock
options.........         --          --          --        --            --       580     (580)            --           --
Amortization of
deferred
compensation....         --          --          --        --            --        --       54             --           54
Net Loss........                                                                                       (7,754)      (7,754)
                    -------    --------     -------       ---       -------   -------    -----       --------     --------
Balances at
December 31,
1996............      9,740          --       2,949        --         4,764       595     (526)       (18,150)     (10,368)
Issuance of
2,356,741 shares
of Series E
redeemable
convertible
preferred stock
to investors for
cash and
conversion of
bridge loans at
$5.74 per share
in March 1997,
net of issuance
costs of $90....         --      13,442          --        --            --        --       --             --           --
Issuance of
2,275,000 shares
of common stock
at $7.00 per
share in June
1997 through the
initial public
offering, net of
commissions and
issuance costs
of $2,286.......         --          --          --        --            --    13,639       --             --       13,639
Conversion of
redeemable
convertible and
convertible
preferred stock
in connection
with the
Company's
initial public
offering........     (9,740)    (13,442)     (2,949)       --        (4,764)   30,895       --             --       23,182
Issuance of
27,338 shares of
common stock for
cash upon
exercise of
employee stock
options at
$0.56-$1.75 per
share in April-
August and
November 1997...         --          --          --        --            --        36       --             --           36
Deferred
compensation
related to grant
of stock
options.........         --          --          --        --            --       432     (432)            --           --
Amortization of
deferred
compensation....         --          --          --        --            --        --      227             --          227
Net Loss........         --          --          --        --            --        --       --        (12,272)     (12,272)
                    -------    --------     -------       ---       -------   -------    -----       --------     --------
Balances at
December 31,
1997............    $    --    $     --     $    --       $--       $    --   $45,597    $(731)      $(30,422)    $ 14,444
                    =======    ========     =======       ===       =======   =======    =====       ========     ========
</TABLE>

                                      F-5
<PAGE>

                                 CARDIMA, INC.

                            STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                    YEAR ENDED DECEMBER 31,
                                                    --------------------------
                                                      1997     1996     1995
                                                    --------  -------  -------
<S>                                                 <C>       <C>      <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss........................................... $(12,272) $(7,754) $(5,200)
Adjustments to reconcile net loss to net cash
 provided by operations:
  Depreciation and amortization....................      703      403      296
  Amortization of deferred compensation............      227       54       --
  Loss on disposal of assets.......................       --       15       --
  Loss on sale/leaseback of capital equipment......       --       95       --
  Issuance of preferred stock upon conversion of
   various related party payables and interest
   payable.........................................       --       --      339
  Changes in operating assets and liabilities:
    Accounts receivable............................     (200)     (18)      29
    Inventories....................................     (155)    (109)      --
    Other current assets...........................      (32)    (111)      11
    Restricted cash................................       83       70      (15)
    Notes receivable...............................     (301)      --       --
    Other assets...................................     (446)    (526)    (128)
    Accounts payable...............................     (257)     896      (27)
    Accrued employee compensation..................      240      314       52
    Other current liabilities......................        3        1       19
    Deferred rent..................................      (49)      10      107
                                                    --------  -------  -------
      Net cash used in operating activities........  (12,456)  (6,660)  (4,517)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments................   (4,270)      --       --
Capital expenditures...............................     (883)    (388)     (78)
Proceeds from disposal of assets...................        3       --       --
                                                    --------  -------  -------
    Net cash used in investing activities..........   (5,150)    (388)     (78)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of preferred stock......   10,158    2,984    5,189
Proceeds from issuance of bridge loans.............    1,610    1,674    2,263
Payments of bridge loans...........................       --       --     (403)
Principal payments under capital leases............     (469)    (286)    (153)
Payments under notes payable.......................       --       --      (24)
Net proceeds from sale of common stock.............   13,675        7        3
Proceeds from sale/leaseback of capital equipment..      303      583       --
                                                    --------  -------  -------
    Net cash provided by financing activities......   25,277    4,962    6,875
                                                    --------  -------  -------
NET INCREASE/(DECREASE) IN CASH AND CASH
 EQUIVALENTS.......................................    7,671   (2,086)   2,280
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR.......      907    2,993      713
                                                    --------  -------  -------
CASH AND CASH EQUIVALENTS, END OF YEAR............. $  8,578  $   907  $ 2,993
                                                    ========  =======  =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION
Cash paid during the year for interest............. $    122  $    49  $    43
                                                    ========  =======  =======
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
 FINANCING ACTIVITIES
Equipment acquired under capital leases............ $    845  $   746  $   286
                                                    ========  =======  =======
Conversion of various related party payables,
 bridge loans and capital lease obligations and
 related accrued interest to convertible preferred
 stock.............................................       --  $   574  $ 2,199
                                                    ========  =======  =======
</TABLE>


                                      F-6
<PAGE>

                                 CARDIMA, INC.

                         NOTES TO FINANCIAL STATEMENTS

1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NATURE OF BUSINESS

  Cardima, Inc., (the "Company" or "Cardima"), was incorporated in the State
of Delaware on November 12, 1992. The Company designs, develops, manufactures
and markets minimally invasive, single use, microcatheter-based systems for
the mapping and ablation of the two most common forms of cardiac arrhythmias:
atrial fibrillation and ventricular tachycardia. The Company has licensed its
microcatheter technology for use in the treatment of electrophysiological
diseases affecting areas other than the central nervous system from a major
stockholder, Target Therapeutics, Inc. ("Target"), a division of Boston
Scientific Corporation.

  Through 1996, the Company was in the development stage. During fiscal 1997,
the Company recognized increasing revenues associated with its product
approvals in the United States. Consequently, the Company is no longer
considered to be in the development stage. In June 1997, the Company completed
an initial public offering of 2,275,000 shares of Common Stock at an initial
price to the public of $7.00 per share, resulting in net proceeds to the
Company (after deducting underwriting discounts and commissions and offering
expenses) of approximately $13.6 million.

  The Company has sustained continuing operating losses and expects such
losses to continue over the next several years. Management plans to continue
to finance the operations with a combination of stock sales, product revenue
and other financing facilities. In that regard, in February and March 1998,
the Company secured a $1.5 million lease line and a firm commitment letter for
a $3.0 million line of credit, respectively (see Note 8). Management believes
that it will be able to obtain additional funds through either public or
private equity or debt financings, collaborative and other arrangements with
corporate partners or from other sources. If adequate funds are not available,
the Company may be required to reduce its level of spending, including
eliminating one or more of its research and development programs.

USE OF ESTIMATES

  The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

REVENUE RECOGNITION

  Revenues are recognized when products are shipped. To date, product sales
have been direct to customers in the United States and to distributors
primarily in Europe, Japan and South America. No one distributor or direct
customer accounted for more than 10% of the Company's net sales and export
sales represented 31% of net sales for the year ended December 31, 1997. One
distributor accounted for approximately 45% and two distributors each
accounted for 31% of the Company's net sales during the years ended December
31, 1995 and December 31, 1996, respectively. All of the Company's sales from
inception to December 31, 1996 were export sales. Provisions for doubtful
accounts were $119,000 and $11,000 for the years end December 31, 1997 and
1996, respectively.

RESEARCH AND DEVELOPMENT

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

                                      F-7
<PAGE>

                                 CARDIMA, INC.

                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)


NET LOSS PER SHARE

  In 1997, the Financial Accounting Standards Board issued Statements No. 128,
"Earnings Per Share." SFAS 128 replaced the calculation of primary and fully
diluted earnings per share with basic and diluted earnings per share. Unlike
primary earnings per share, basic earnings per share excludes any dilutive
effect of options, warrants and convertible securities. Diluted earnings per
share is very similar to the previously reported fully diluted earnings per
share. All earnings per share amounts for all periods have been restated to
conform to the SFAS 128 requirements. Effective February 3, 1998, Staff
Accounting Bulletin No. 98 ("SAB 98") was issued and amends the existing SEC
staff guidance primarily to give effect to SFAS 128. Topic 4.D of SAB 98
essentially eliminates the cheap stock (convertible preferred stock,
redeemable convertible preferred stock, common stock and common equivalent
shares issued by the Company at prices below the initial public offering price
during the twelve-month period prior to the offering) calculation from an
initial public offering.

  The Company has excluded all convertible debt, convertible preferred stock,
warrants, and employee stock options from the computation of basic and diluted
earnings per share because all such securities are anti-dilutive for all
periods presented.

  The following table sets forth the computation of basic and diluted earnings
per share:

<TABLE>
<CAPTION>
                                                     YEARS ENDED DECEMBER 31,
                                                     (IN THOUSANDS EXCEPT FOR
                                                         PER SHARE DATA)
                                                     --------------------------
                                                      1997      1996     1995
                                                     -------  --------  -------
   <S>                                               <C>      <C>       <C>
   Net loss........................................  $12,272  $  7,754  $ 5,200
                                                     =======  ========  =======
     Weighted average shares outstanding...........    4,642        72       69
     Weighted average unvested common shares issued
      subject to repurchase agreements.............       --        --       (7)
                                                     -------  --------  -------
   Shares used to compute basic and diluted net
    loss per share.................................    4,642        72       62
                                                     =======  ========  =======
   Basic and diluted net loss per share............  $ (2.64) $(107.69) $(83.87)
                                                     =======  ========  =======
</TABLE>

  Pro forma net loss per share for 1997 and 1996 has been computed as
described above and also gives effect, pursuant to SEC staff policy, to the
conversion of convertible preferred shares not included above that were
converted upon completion of the Company's initial public offering (using the
"if converted" method) from the original date of issuance.

  Pro forma basic and diluted net loss per share information is as follows:

<TABLE>
<CAPTION>
                                               YEAR ENDED DECEMBER 31,
                                       (IN THOUSANDS EXCEPT FOR PER SHARE DATA)
                                       ----------------------------------------
                                                         1997
                                                         ----
   <S>                                 <C>
   Shares used in computing basic and
    diluted net loss per share.......                    4,642
                                                        ------
   Adjusted to reflect assumed
    conversion of preferred stock at
    the date of issuance.............                    1,454
                                                        ------
   Shares used in computing pro forma
    basic and diluted loss per share.                    6,096
                                                        ======
   Pro forma basic and diluted net
    loss per share...................                   $(2.01)
                                                        ======
</TABLE>


                                      F-8
<PAGE>

                                 CARDIMA, INC.

                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

  The Company considers investments in highly liquid instruments purchased
with an original maturity of 90 days or less to be cash equivalents. All of
the Company's cash equivalents and short-term investments, consisting
principally of commercial paper and government securities and are classified
as available-for-sale as of the balance sheet date. These securities are
recorded at fair value, which approximates amortized cost. The fair value of
investments is based on quoted market prices at December 31, 1997. All
available-for-sale investments generally mature in one year or less. The fair
value of these securities approximated the amortized cost at December 31,
1997. In 1996, all amounts consisted of cash. There were no short-term
investments.

  Cash, cash equivalents and short-term investments at December 31, 1997 are
as follows:

<TABLE>
<CAPTION>
                                                                  (IN THOUSANDS)
   <S>                                                            <C>
   Cash and cash equivalents:
     Cash........................................................    $   310
     Money market funds..........................................      3,044
                                                                     -------
                                                                       3,354
     Available for sale securities commercial paper..............    5,224
                                                                     -------
       Total cash and cash equivalents...........................    $ 8,578
                                                                     =======
   Short-term investments:
   Commercial paper..............................................    $ 2,233
   Corporate notes...............................................      1,278
                                                                     -------
     Available for sale securities...............................      3,511
   Certificate of deposit........................................        759
                                                                     -------
     Total short-term investments................................    $ 4,270
                                                                     =======
   Restricted investments:
     Restricted certificate of deposit...........................    $   192
                                                                     =======
</TABLE>

  The restricted certificate of deposit is being held as collateral by a
financial institution against a letter of credit for the Company's primary
facilities in Fremont, California.

INVENTORY

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

<TABLE>
<CAPTION>
                                                                        (IN
                                                                     THOUSANDS)
                                                                    DECEMBER 31,
                                                                    -------------
                                                                     1997  1996
                                                                    ------ ------
   <S>                                                              <C>    <C>
   Inventories:
     Raw materials................................................. $  209 $ 145
     Work-in-process...............................................    119   131
     Finished goods................................................    204   101
                                                                    ------ -----
                                                                     $ 532 $ 377
                                                                    ====== =====
</TABLE>

PROPERTY AND EQUIPMENT

  Property and equipment, including equipment under capital leases, are
carried at cost less accumulated depreciation and amortization. Property and
equipment are depreciated using the straight-line method over estimated useful
lives, generally three to five years. Leasehold improvements are amortized
using the straight-line

                                      F-9
<PAGE>

                                 CARDIMA, INC.

                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

method over the shorter of the estimated useful life of the asset or the
remaining term of the lease. Depreciation expense includes amortization of
capital leases and leasehold improvements.

  Property and equipment consist of the following:
<TABLE>
<CAPTION>
                                                                (IN THOUSANDS)
                                                                 DECEMBER 31,
                                                                ---------------
                                                                 1997     1996
                                                                -------  ------
   <S>                                                          <C>      <C>
   Property and equipment:
     Equipment................................................. $ 3,715  $2,008
     Leasehold improvements....................................      99      93
                                                                -------  ------
                                                                  3,814   2,101
     Less accumulated depreciation.............................  (1,326)   (701)
                                                                -------  ------
                                                                $ 2,488  $1,400
                                                                =======  ======
</TABLE>

  Depreciation is provided using the straight-line method over the shorter of
their estimated useful lives or lease term of the respective assets, generally
three to five years. Property and equipment financed under a capital lease
were $2,357,000 and $1,523,000 at December 31, 1997 and 1996, respectively.
Accumulated amortization related to leased assets was $1,072,000 and $564,000
at December 31, 1997 and 1996, respectively. Amortization related to capital
leases are included in depreciation expense.

CONCENTRATIONS OF RISK

  The Company purchases certain key components of its products, including the
hydrophilic coating for certain of its microcatheters, from sole, single or
limited source supplies. For certain of these components, there are relatively
few alternative sources of supply. Establishing additional or replacement
suppliers for any of the numerous components used in the Company's products,
if required, may not be accomplished quickly and could involve significant
additional costs. Any supply interruption from vendors or failure of the
Company's products would limit the Company's ability to manufacture its
products and would have a material adverse effect on the Company's business,
financial condition and results of operations.

PATENTS

  Patent costs deemed to have future benefits are amortized using the
straight-line method over estimated useful lives of seven years, beginning at
their effective dates or over the remainder of such periods from the dates
acquired.

RECLASSIFICATION

  Certain prior period amounts have been reclassified to conform with current
period presentation. Such reclassifications had no effect on the results of
operations or accumulated deficit.

RECENT ACCOUNTING PRONOUNCEMENTS

  In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income
("SFAS 130"), which establishes standards for reporting and display of income
and its components (revenue, expenses, gains, and losses) in a full set of
general-purpose financial statements. SFAS 130 is effective January 1, 1998
and is not expected to have a material impact on the Company's results of
operations, cash flows or financial position.

  In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information ("SFAS 131") which changes the way public
companies report information about operating

                                     F-10
<PAGE>

                                 CARDIMA, INC.

                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

segments. SFAS 131, which is based on the management approach to segment
reporting, established requirements to report selected segment information
quarterly and to report entity wide disclosures about products and services,
major customers and the material countries in which the entity holds assets
and reports revenue. SFAS 131 is effective January 1, 1998 and additional
disclosures will be required as the Company expands its international
operations. The Company does not expect SFAS 131 to have a material impact on
the Company's results of operations, cash flows or financial position.

2. LEASES

  The Company leases facilities under an operating, lease which commenced in
August 1994 and expires November 1999. The Company also leases certain
equipment under a noncancelable capital lease (see Note 6). Following is a
schedule of future minimum lease payments under both operating and capital
leases at December 31, 1997:

<TABLE>
<CAPTION>
                                                         (IN THOUSANDS)
                                                 OPERATING LEASES CAPITAL LEASES
                                                 ---------------- --------------
   <S>                                           <C>              <C>
   Years ending December 31:
     1998.......................................       $360           $  708
     1999.......................................        314              666
     2000.......................................         --              253
     2001.......................................         --               --
                                                       ----           ------
   Total minimum payments required..............       $674           $1,627
                                                       ====
   Less amount representing interest............                        (200)
                                                                      ------
   Present value of future lease payments.......                       1,427
   Less current portion.........................                        (587)
                                                                      ------
   Noncurrent portion...........................                      $  840
                                                                      ======
</TABLE>

  Rent expense, net of rental income was approximately $316,000 in 1997,
$295,000 in 1996 and $312,000 in 1995. In connection with its facilities lease
arrangements, the Company issued letters of credit to lessors which are
collateralized by certificates of deposit totaling approximately $192,000 at
December 31, 1997. Accordingly, this restricted cash amount has been
classified as a noncurrent asset.

  In April 1997, the Company entered into a lease line agreement with a
stockholder for $1,600,000 to finance capital expenditures, approximately
$784,000 of which was outstanding as of December 31, 1997. As partial
consideration for this arrangement, a warrant to purchase 13,937 shares of
common stock was issued to the stockholder. The warrant is exercisable at
$5.74 per share for a period of ten years or five years from the effective
date of the Company's initial public offering, whichever is longer. The
warrant is outstanding as of December 31, 1997.

3. STOCKHOLDERS' EQUITY

 Initial Public Offering

  In June of 1997, upon completion of the Company's initial public offering,
Series A, B, C, D and E preferred stock converted into 5,726,538 shares of
common stock.

  In March and June 1997, the Company amended and restated its certificate of
incorporation to increase the total number of shares authorized to 30,000,000.
Of the shares authorized, 25,000,000 are designated for issuance of common
stock and 5,000,000 are designated for issuance of preferred stock.

                                     F-11
<PAGE>

                                 CARDIMA, INC.

                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)


 Common Stock

  In June 1997, the Company completed its initial public offering and issued
2,275,000 shares of its Common Stock at a price of $7.00 per share. The
Company received approximately $13.6 million in cash, net of underwriting
discounts, commission and other offering costs.

  In May 1993, 66,666 shares of common stock were issued to the Company's
founders at $0.07 per share. Certain of these shares were subject to
repurchase by the Company at the original issue price upon the occurrence of
certain events, including termination of employment. The Company's right of
repurchase expired ratably over three years.

 1993 Stock Option Plan

  During 1993, the board of directors adopted the 1993 Stock Option Plan (the
"Plan") and, as amended, has reserved 1,300,000 shares of common stock for
issuance under the Plan. The Plan provides for both incentive and nonstatutory
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 nonstatutory stock option shall be not less than 85% of the fair
value of the stock subject to the option on the date the option is granted.
All options granted prior to the initial public offering shares are 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 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 48 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.

  Activity under the 1993 Stock Option Plan is as follows:

<TABLE>
<CAPTION>
                                                        OUTSTANDING OPTIONS
                                              ----------------------------------------
                                              NUMBER OF     PRICE     WEIGHTED-AVERAGE
                             SHARES AVAILABLE  SHARES     PER SHARE    EXERCISE PRICE
                             ---------------- ---------  ------------ ----------------
   <S>                       <C>              <C>        <C>          <C>
   Balance at December 31,
    1994...................       133,200       129,906  $0.70--$2.10     $0.9753
   Options granted.........       (41,903)       41,903  $0.56--$2.10      0.9705
   Options exercised.......            --        (3,631) $0.70--$1.05      0.9368
   Options canceled........        19,923       (19,923) $0.70--$1.05      0.9368
                                 --------     ---------
   Balance at December 31,
    1995...................       111,220       148,255  $0.56--$2.10      0.9705
   Additional shares
    reserved...............       640,079            --            --          --
   Options granted.........      (733,778)      733,778  $0.56--$1.75      1.2485
   Options exercised.......            --        (4,708) $0.56--$2.10      1.2534
   Options canceled........        66,635       (66,635) $0.56--$2.10      1.2534
                                 --------     ---------
   Balance at December 31,
    1996...................        84,156       810,690  $0.56--$2.10      1.2534
   Additional shares
    reserved...............       396,825            --            --          --
   Options granted.........      (438,162)      438,162  $1.75--$7.00      4.2533
   Options exercised.......            --       (27,338) $0.56--$7.00      2.3861
   Options canceled........        80,899       (80,899) $0.56--$5.88      2.3681
                                 --------     ---------
   Balance at December 31,
    1997...................       123,718     1,140,615  $0.56--$5.88      2.3681
                                 ========     =========
</TABLE>


                                     F-12
<PAGE>

                                 CARDIMA, INC.

                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

  From April 1996 to April 1997, options to purchase a total of 835,928 shares
were granted at prices ranging from $0.56 to $5.74 per share. Deferred
compensation of approximately $1,012,000 was recorded for these option grants
based on the deemed fair value of common stock (ranging from $1.00 to $8.00
per share).

  At December 31, 1997, 1996 and 1995 approximately 827,920, 810,685 and
145,944 options, respectively, were exercisable under the plan. Of the options
granted in 1997, 69,268 were granted below fair value and 368,894 were granted
at fair value.

 1997 Directors' Stock Option Plan

  In March 1997, the board of directors adopted the 1997 Directors' Stock
Option Plan (the "Directors' Plan"), subject to stockholder approval. A total
of 200,000 shares of common stock has been reserved for issuance under the
Directors' Plan. The Plan provides for the grant of nonstatutory stock options
to nonemployee directors of the Company. At December 31, 1997 no shares had
been issued under this plan.

 1997 Employee Stock Purchase Plan

  In March 1997, the board of directors adopted the 1997 Employee Stock
Purchase Plan (the "Purchase Plan"), subject to stockholder approval. A total
of 250,000 shares of common stock has been reserved for issuance under the
Purchase Plan. As of December 31, 1997, no shares were issued under this
purchase plan.

 Warrants

  At December 31, 1997, the Company had the following warrants outstanding:
warrants to purchase 456,523 shares of common stock at $1.05 per share issued
to certain investors in connection with bridge loans; warrants to purchase
1,428 shares of common stock at $7.00 per share issued in connection with the
facility lease; warrants to purchase 1,905 shares of common stock at $7.00 per
share and 2,142 shares of common stock at $5.11 per share issued in connection
with a letter of credit; warrants to purchase 23,776 shares of common stock at
$5.11 per share issued in connection with a capital lease; and warrants to
purchase 17,543 shares of common stock at $7.00 per share issued to certain
investors in connection with bridge financings. These warrants are exercisable
immediately and expire at the earliest of (i) between 3 to 10 years after the
date of grant or (ii) the closing of the Company's sale of all or
substantially all of its assets or (iii) the acquisition of the Company by
another entity by means of a merger or other transaction.

  In December 1994, the Company also issued warrants to Target to purchase
24,610 shares of the Company's Series C preferred stock at $10.50 per share in
connection with a guarantee of a letter of credit. These warrants were
exercised in March 1995 for cash. Also in connection with a capital lease line
agreement, the Company issued to Target in December 1993 a warrant for $766 to
purchase 10,427 shares of the Company's common stock at $7.00 per share. This
warrant is exercisable immediately and expires at the earlier of December 9,
1998 or the disposition of substantially all of the Company's assets or the
acquisition of the Company by another entity by means of merger or other
transaction.

  In April 1997, the Company entered into a lease agreement with a lessor that
allows for the Company to borrow up to $1.6 million under a lease line
arrangement. In connection with this arrangement, the Company issued to the
lessor a warrant to purchase 13,937 shares of common stock at a price of $5.74
per share. The warrant expires five years from the date of issuance.

  The Company has reserved 527,681 shares of common stock for issuance upon
exercise of the warrants described above.


                                     F-13
<PAGE>

                                 CARDIMA, INC.

                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

 Accounting for Stock-Based Compensation

  The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair-value accounting provided for under FASB
Statement No. 123, ("Statement 123") "Accounting for Stock-Based
Compensation," requires use of option valuation models that were not developed
for use in valuing employee stock options. Under APB 25, because the exercise
price of the Company's employee stock options equals the market price of the
underlying stock on the date of grant as determined by the Company's Board of
Directors, no compensation expense is recognized.

  Pro forma information regarding net loss and loss per share is required by
Statement 123, which also requires that the information be determined as if
the Company had accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method of that Statement. The fair
value for these options was estimated at the date of grant using the minimum
value method for 1996 and 1995 and the Black Scholes option pricing model for
1997 with the following weighted-average assumptions for 1997, 1996 and 1995,
respectively; risk-free interest rates of approximately 6.0%, 7.0% and 7.0%;
dividend yields of 0%, volatility factors of the expected market price of the
Company's Common Stock of 0.6, 0.0 and 0.0 as the Company was not public in
1996 and 1995; and a weighted-average expected life of the options of four
years.

  The option valuation models were developed for use in estimating the fair
value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock options.

  For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information follows:

<TABLE>
<CAPTION>
                                                   YEARS ENDED DECEMBER 31,
                                                   ---------------------------
                                                     1997      1996     1995
                                                   --------  --------  -------
                                                   (IN THOUSANDS, EXCEPT PER
                                                          SHARE DATA)
   <S>                                             <C>       <C>       <C>
   Net loss -- as reported........................ $(12,272) $ (7,754) $(5,200)
                                                   ========  ========  =======
   Net loss -- pro forma.......................... $(12,526) $ (7,776) $(5,201)
                                                   ========  ========  =======
   Net loss -- per share as reported.............. $  (2.64) $(107.69) $(83.87)
                                                   ========  ========  =======
   Net loss -- per share pro forma................ $  (2.70) $(108.00) $(83.89)
                                                   ========  ========  =======
</TABLE>

                                     F-14
<PAGE>

                                 CARDIMA, INC.

                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)


  The following table summarizes information about stock options outstanding
at December 31, 1997:

<TABLE>
<CAPTION>
                              OPTIONS OUTSTANDING              OPTIONS EXERCISABLE
                   ----------------------------------------- ------------------------
                     NUMBER OF                     WEIGHTED-   NUMBER OF    WEIGHTED-
      RANGE OF         SHARES     WEIGHTED-AVERAGE  AVERAGE      SHARES      AVERAGE
      EXERCISE      OUTSTANDING      REMAINING     EXERCISE  EXERCISABLE AS EXERCISE
       PRICES      AS OF 12/31/97 CONTRACTUAL LIFE   PRICE    OF 12/31/97     PRICE
      --------     -------------- ---------------- --------- -------------- ---------
   <S>             <C>            <C>              <C>       <C>            <C>
   $0.56 -- $0.70      139,018          7.51        $0.6010     139,018      $0.6010
    1.05 --  1.40      557,290          8.20         1.3428     557,290       1.3428
    1.75 --  3.75      121,700          9.10         1.9995     109,200       1.7991
    5.00 --  5.50      300,363          8.03         5.0340      20,834       5.0000
    5.88 --  5.88       17,400          9.58         5.8800         986       5.8800
    6.09 --  7.00        4,844          9.54         6.6243         592       7.0000
                     ---------                                  -------
   $0.56 -- $7.00    1,140,615          8.19        $2.3861     827,920      $1.3799
                     =========                                  =======
</TABLE>

  Pro forma information regarding net loss and loss per share is required by
Statement 123, which also requires that the information be determined as if
the Company has accounted for its employee stock options granted subsequent to
December 31, 1994, under the fair-value method of that Statement.

4. NOTES RECEIVABLE

  In December 1997, the Company entered into a $300,000 note receivable
agreement with Phillip C. Radlick, Ph.D., its President and Chief Executive
Officer to facilitate the purchase of a principal residence in the Bay Area.
The note bears interest at the minimum Applicable Federal Rate (6.45% at
December 31, 1997) and is due and payable in a single lump sum forty-eight
months from the note date. As security for the note, Dr. Radlick granted
Cardima a security interest in his vested stock options.

5. INCOME TAXES

  As of December 31, 1997 and December 31, 1996, the Company had federal net
operating loss carryforwards of approximately $29,500,000 and $10,100,000,
respectively. The Company also had federal research and development tax credit
carryforwards of approximately $200,000 as of December 31, 1997 and 1996. The
net operating loss and credit carryforwards will expire at various dates
beginning on December 31, 2008 through December 31, 2012, if not utilized.

  Significant components of the Company's deferred tax assets as of December
31 are as follows (in thousands):

<TABLE>
<CAPTION>
                                                                1997     1996
                                                              --------  -------
   <S>                                                        <C>       <C>
   Net operating loss carryforwards.......................... $ 10,800  $ 6,500
   Research credits carryforwards (federal and state)........      500      300
   Capitalized research and development......................      300      500
   Other, net................................................      300      200
                                                              --------  -------
   Total deferred tax assets.................................   11,900    7,500
   Valuation allowance for deferred tax assets...............  (11,900)  (7,500)
                                                              --------  -------
                                                              $     --  $    --
                                                              --------  -------
</TABLE>

  The valuation allowance increased by $3,050,000 in 1996.

                                     F-15
<PAGE>

                                 CARDIMA, INC.

                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)


  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 and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilization.

6. RELATED PARTY TRANSACTIONS

 License Rights

  In May 1993, Target granted the Company an exclusive royalty-free worldwide
license to use Target's 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 technology developed
through May 1996 and will expire upon the expiration of the last of the
patents relating to the Target technology. Under the License Agreement,
Cardima granted back to Target an exclusive royalty-free license to use
technology developed through May 1996 in the fields of neurology,
interventional neuroradiology, interventional radiology, reproductive
disorders and vascular prostheses (the "Target Field"). Such license will
expire upon the expiration of the last of the patents relating to the Target
technology. Target granted the Company a nonexclusive, royalty-free license to
use Target technology to make, use and sell or otherwise distribute the
Company's products for use within the cardiology field, provided the Company's
products represent a substantial improvement. A substantial improvement is any
modification, improvement or enhancement by the Company of Target technology
in a particular product that results in a material change in the function,
purpose or application of such product. The Company believes that the
incorporation of electrodes in its microcatheter systems, together with other
modifications, satisfies the substantial improvement requirements. As part of
the same agreement, the Company granted to Target an exclusive, royalty-free
license to use the Company's technology to make, have made, use and sell or
otherwise distribute products within the Target Field.

  In addition, the Company agreed not to conduct material research and
development, acquire corporate entities or make or sell products in the Target
Field or to sell products, other than products utilizing Target's technology,
for use in diagnosis or treatment of diseases related to the production of
electrical current in tissue located in areas of the body other than the
heart, without first notifying Target and negotiating a distribution
agreement. Cardima also agreed that it would not sell products utilizing
Target's technology for use in diagnosis or treatment of diseases related to
the production of electrical current in tissue located in areas of the body
other than the heart without, if selling to a distributor, first notifying
Target and offering Target the right of first refusal with respect to the
terms of the distribution or if selling directly to the consumer, paying to
Target an amount equal to 40% of the gross profit for such product. In
exchange for the license, the Company initially issued 333,333 shares of
Series A preferred stock to Target. In June 1993, the Company effected a
recapitalization pursuant to which Target exchanged its existing shares of
Series A preferred stock for shares of newly created Series B preferred stock.

 Stock Transactions

  In December 1994, the Company issued 24,110 shares of common stock to Target
at $10.50 per share for cash and conversion of bridge loans. The Company also
issued to Target warrants to purchase 24,610 shares of the Company's Series C
preferred stock in connection with a guarantee of a letter of credit which
were exercised in March 1995. In January 1995, the Company issued an
additional 10,714 shares of common stock to Target at $10.50 per share for
cash and conversion of bridge loans.

  In December 1995, the Company issued 142,029 shares of common stock to
Target at $5.11 per share for cash and conversion of various payable amounts
and bridge loans. In February 1996, the Company issued an additional 112,374
shares of common stock to Target at $5.11 per share in exchange for the
conversion of outstanding capital lease obligations.

                                     F-16
<PAGE>

                                 CARDIMA, INC.

                  NOTES TO FINANCIAL STATEMENTS--(CONCLUDED)


 Operations and Facilities

  In May 1993, in the Company entered into an agreement with Target whereby
Target agreed to supply and manufacture such products and components necessary
to proceed with research and development activity pursuant to the license
mentioned above. This Agreement expired in May 1996.

  The Company paid $1,000 per month for each employee using Target's
facilities, as well as other miscellaneous administrative expenses incurred by
Target on the Company's behalf.

  As of December 31, 1997, $28,000 has been paid and nothing is owed to Target
under these arrangements (approximately $234,000 and $152,000 was paid and
$38,000 and $31,000 owed at December 31, 1996 and 1995, respectively. Target
owed approximately $17,000 and $21,000 at December 31, 1996 and 1995,
respectively).

  Target had sublet certain facilities from the Company which can be renewed
annually. Net monthly rental income was approximately $4,500. In November
1997, this sublease arrangement was terminated.

 Capital Lease Arrangement

  In December 1993, the Company entered into a $1,000,000 capital lease line
agreement with Target. The lease line remained open until fully utilized or
until March 31, 1995, whichever occurred first. In connection with this lease
line agreement, the Company issued to Target a warrant to purchase 10,427
shares of the Company's common stock. In December 1995 and February 1996, the
outstanding capital lease obligation, plus accrued interest, was converted
into shares of Series D convertible preferred stock, which was converted into
254,403 shares of common stock upon completion of the initial public offering.

8. SUBSEQUENT EVENTS

  In February 1998, the Company entered into a lease agreement with a lessor
that allows for the Company to borrow up to $1.5 million under a lease line
arrangement. The lease line agreement provides for financing of office and
manufacturing equipment, software, custom built equipment and molds for a 48
month term. The lease line agreement will expire December 31, 1998.

  In March 1998, the Company secured a firm commitment letter for a $3.0
million line of credit which may be used for general working capital purposes.
The payment of the lease line is interest only for the first six months,
interest and principal for months seven through thirty-six and a balloon
payment at the end of the lease, if fully utilized.


                                     F-17