UNITED STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM 10-KSB





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


For the
fiscal year ended December 31, 2007





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


Commission file number:0-22419








CARDIMA, INC.


(Exact
name of registrant as specified in its charter)




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




47266
BENICIA STREET


FREMONT,
CALIFORNIA 94538-7330


(Address,
Including Zip Code of Principal Executive Offices)





(510)
354-0300


(Issuer's
telephone number)








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


NONE





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


COMMON
STOCK, $0.001 PAR VALUE PER SHARE








Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes [ ] No [X]





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes [ ] No [X]





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





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [_]





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





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





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





State
issuer's revenues for its most recent fiscal year. $1,156,746




State the
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
sold, or the average bid and asked price of such common equity, as of a
specified date within the past 60 days. (See definition of affiliate in Rule
12b-2 of the Exchange Act.). Based on the closing sale price on the OTC Bulletin
Board on March 27, 2008, the aggregate market value of the registrant's common
stock held by non-affiliates was approximately $6,189,600. For
purposes of this computation, all directors and executive officers of the
registrant are considered to be affiliates of the registrant. This assumption is
not to be deemed an admission by the persons that they are affiliates of the
registrant.





State the number of shares outstanding
of each of the issuer's classes of common equity, as of the latest practicable
date:116,316,311as of December 31.




1







TABLE
      OF CONTENTS




PART I
            
            6ITEM
      1.
            DESCRIPTION
      OF BUSINESS
            6ITEM
      2.
            DESCRIPTION
      OF PROPERTY
            29ITEM
      3.
            LEGAL
      PROCEEDINGS
            30ITEM
      4.
            SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
            30PART II
            
            30ITEM
      5.
            MARKET
      FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
            30ITEM
      6.
            MANAGEMENT'S
      DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
            30ITEM
      7.
            FINANCIAL
      STATEMENTS
            37ITEM
      8.
            CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE
            38ITEM
      8A.
            CONTROLS
      AND PROCEDURES
            38ITEM
      8B
            OTHER
      INFORMATION
            39PART III
            
            39ITEM
      9.
            DIRECTORS,
      EXECUTIVE OFFICERS, PROMOTERS,CONTROL PERSON AND CORPORATE GOVERNANCE;
      COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
            39ITEM
      10.
            EXECUTIVE
      COMPENSATION
            40ITEM
      11.
            SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS
            42ITEM
      12.
            CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE
            44ITEM
      13.
            EXHIBITS
            44ITEM
      14.
            PRINCIPAL
      ACCOUNTANT FEES AND SERVICES
            46SIGNATURES
            
            47




2




FORWARD-LOOKING
STATEMENTS





This
annual report on Form 10-KSB includes forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, which we refer
to in this annual report as the Securities Act, and Section 21E of the
Securities Exchange Act of 1934, as amended, which we refer to in this annual
report as the Exchange Act. Forward-looking statements are not statements of
historical fact but rather reflect our current expectations, estimates and
predictions about future results and events. These statements may use words such
as "anticipate," "believe," "estimate," "expect," "intend," "predict," "project"
and similar expressions as they relate to us or our management. When we make
forward-looking statements, we are basing them on our management's beliefs and
assumptions, using information currently available to us. These forward-looking
statements are subject to risks, uncertainties and assumptions, including but
not limited to, risks, uncertainties and assumptions discussed in this annual
report. Factors that can cause or contribute to these differences include those
described under the headings "Risk Factors" and "Management Discussion and
Analysis and Plan of Operation."





If one or
more of these or other risks or uncertainties materialize, or if our underlying
assumptions prove to be incorrect, actual results may vary materially from what
we projected. Any forward-looking statement you read in this annual report
reflects our current views with respect to future events and is subject to these
and other risks, uncertainties and assumptions relating to our operations,
results of operations, growth strategy and liquidity. All subsequent written and
oral forward-looking statements attributable to us or individuals acting on our
behalf are expressly qualified in their entirety by this paragraph. You should
specifically consider the factors identified in this annual report, which would
cause actual results to differ before making an investment decision. We are
under no duty to update any of the forward-looking statements after the date of
this annual report or to conform these statements to actual
results.





3




PART
I





ITEM
1. DESCRIPTION OF BUSINESS





Overview




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




The
principal clinical goal in the curative treatment of AF is the creation of thin,
continuous, linear lesions mimicking those scar lesions created by Dr. Jim Cox
in his groundbreaking open surgical maze procedure.  Dr. Cox
demonstrated that anatomically placed scar lesions created surgically using
cut-and-sew techniques in the walls of the atria could interrupt the electrical
activity required to sustain AF, resulting in long-term normal sinus rhythm
maintenance.  Cardima’s technology is designed to recreate the
Cox-Maze scar lesion pattern using our state-of-the-art linear catheter
technology in conjunction with radio frequency (RF) energy.  The
Cardima technology can be used by cardiac electro-physiologists inside the
heart, and by surgeons on the inside or outside surface of the
heart.




Normal
Heart Rhythm




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





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




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




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





Arrhythmias





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




4




Atrial
Fibrillation





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




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





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





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





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





For
almost two decades thought leaders in electrophysiology and cardiac surgery have
worked to develop less invasive catheter approaches to cause scarring in the
heart which would treat AF as successfully as the surgical
Maze.  Various energy sources have been evaluated, and various “lesion
sets” in or on the heart have been tested.  The most successful
results to date are obtained when most or all of the Cox-Maze lesions are
recreated.   If a catheter procedure is to successfully mimic the
maze procedure, it is necessary to make various shaped lines, including
straight, curvilinear and circumferential lesions.  These lesions need
to have adequate depth into atrial tissue, and be continuous, leaving no
gaps.  Cardima’s ablation systems for both inside and on top of the
heart accomplish these goals. If a catheter procedure is to successfully mimic
the maze procedure, it is necessary to make various shaped lines, including
straight, curvilinear and circumferential lesions. Therefore we developed the
REVELATION® Tx, REVELATION® T-Flex and REVELATION® Helix respectively, to mimic
these required shapes.




Ventricular
Tachycardia





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




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




5




Limitations
of Current Catheter-Based Diagnosis and Therapy




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




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




Cardima’s
Micro-catheter System Solution for Electrophysiologists




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




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




·Single
micro-catheter that can both map and ablate.We initially developed
micro-catheters for diagnosing arrhythmias. Our focus today is the refinement of
therapeutic micro-catheters, which we call the REVELATION series of
micro-catheters, capable of both mapping and ablating. Because our
micro-catheter systems can both map and ablate, we believe that it will be able
to decrease procedure times, improve treatment outcomes and enhance the overall
safety of the procedure.  Cardima is launching multicenter EP clinical
studies in Europe (2008) and the US (2009).  There will also be a
focus on market awareness and development through seminars, tradeshows, and site
visits.




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




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




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





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




Over
40,000 numbers of surgical ablations were performed in 2007. In late 1Q - 2008
Cardima commercially launched its surgical ablation system.  Cardima
believes we can offer an ablation solution for surgeons that is safer, more
controlled, less invasive procedure.  The Cardima Surgical Ablation
System is based on the EP technology that has used in over 400 documented
clinical cases.  It can be used in both open and closed-chest
procedures.




6




·Minimally
invasive approach.Our Surgical system is designed to
provide greater access through its size and flexibility. Size constraints can
prevent other systems from performing a true 2 port-hole, endoscopic guided
procedure without the need for additional incisions.  We believe that
this increased access has the potential to decrease procedure time, have shorter
hospital stays, lower procedure costs and provide fewer complications than the
procedures currently in use.




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





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





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





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





·Compatible with
existing capital equipment.Our Surgical Ablation
systems are designed to be compatible with the radio frequency generator
currently in use by operating rooms. .




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





Revelation
Catheters





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





In 2007
Cardima was unsuccessful in obtaining domestic Food and Drug Administration
(FDA) approval through the FDA’s desire for additional clinical
data.  Cardima along with dialog with the FDA is currently designing a
study trial amendable to both parties to seek approval to use its ablation
system to treat AF.  Cardima projects to begin its pivotal study in
2008; however the timing and receiving FDA approval to begin the trial in the
projected timeframe cannot be assured.  Although the study details
have not been finalized, the study can last up to 1 year or longer.




7




Curative
Approach for Ventricular Tachycardia





Our
PATHFINDER®,
PATHFINDER® mini and TRACER® diagnostic
micro-catheter systems for mapping VT are all designed for use inside the
vasculature of the heart wall, facilitating access to arrhythmia-causing tissue
through the venous system. We believe that at least half of the VT foci are
located in the intramyocardium and the epicardium, areas that are ineffectively
accessed using standard endocardial catheters or basket type catheters currently
in development. The intravascular approach to VT ablation should permit our
micro-catheters to be positioned in close proximity to the arrhythmia-causing
tissue, facilitating the creation of smaller, more focused lesions. We believe
that this approach has the potential to be more effective than standard
endocardial ablation procedures, with reduced destruction of surrounding healthy
tissue, thus maximizing and optimizing the normal function of the heart after
the procedure. We also believe that the smaller catheter sizes of our
ventricular systems may be particularly appealing to the pediatric market. We
are aware of at least one other epicardial mapping catheter in addition to the
PATHFINDER®, PATHFINDER® mini, and TRACER®. In January 2001, we decided to focus
our efforts on our AF program and postpone our work on the therapeutic VT
program. These products are currently used to help localize placement of
bi-ventricular pacing leads via CS access.   With a new focus on
VT, Cardima will attend the HRS VT Summit to assess increasing resources to
increase the focus on VT (while maintaining a focus on the treatment of AF and
the ablation of cardiac tissue)






Our
Business Strategy




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




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




Our
strategy incorporates the following key elements:




·Seek funding
necessary to continue operations.Due to our limited cash
resources, we plan to continue to seek additional funding





·Continue
Market Launch and Clinical StudiesWe are launching the
technology on several fronts.  In the US, our partnership with other
companies who have close relationshipswith Cardiothoracic
surgeons will be leveraged to initiate market development of the Surgical
Ablation System.  We will penetrate the market by selecting key sites
and developing them into Centers of Excellence.  Once the Centers of
Excellence are established, we will be able to penetrate the market with
post-approval data, symposia presentations, major meeting/tradeshow strategies,
and a registry database. The EP System is being launched in the UK and
Germany.  Once again we are developing the market by developing key
Centers of Excellence.  Once the Cof E are established, they will act
as peer-to-peer training sites.  We will continue to present at
symposia and major meetings/tradeshows to establish our clinical excellence in
the Electrophysiology Field.  Multi-center clinical studies are
expected to begin in the UK and Germany (2008), followed by the US
(2009).  The additional data gained from these studies will assist in
achieving FDA/PMA approval for the EP Ablation System.  The company
will also be launching its technology in Asia, including China (2008) and Japan
(2009).  Funds will be needed to develop new markets, penetrate
existing markets, and continue clinical studies world-wide.





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





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





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




8




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




Products




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




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




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





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




Therapeutic
      Products
            
            Description
            
            Indication
            
            U.S.
      Regulatory Status(1)
            
            International
              Regulatory
      Status(1)REVELATION®
              Mapping
      Catheter
            
            Eight-electrode
      micro-catheter designed to map in both right and left
      atria.
            
            Mapping
              
              
              
              This
      was only when we did not have the Tx approved.
            
            510(k)
      (2)
      clearance obtained.
            
            Approved
      in the European Economic Area (CE Mark)(3)
      and Canada.REVELATION®
      Tx
            
            Guidewire
      based eight-electrode micro-catheter system with tissue temperature
      sensors designed to map and create long, thin, continuous, linear,
      transmural lesions in the atrium.
            
            Mapping
      and Ablation
            
            Seeking
      FDA approval to treat AF.  Currently in study trial design
      development
            
            Approved
      in the European Economic Area (CE Mark) and
CanadaREVELATION®
      T-Flex
            
            Deflectable
      and steerable eight-and sixteen-electrode micro-catheter system with
      temperature sensors designed to map and create long, thin, continuous,
      linear, transmural lesions in the right atrium.
            
            Mapping
      and Ablation
            
            Seeking
      FDA approval to treat AF.  Currently in study trial design
      development
            
            Approved
      in the European Economic Area (CE Mark) and
CanadaREVELATION®
      Helix
            
            Helical
      shaped guide-wire eight-electrode micro-catheter system with temperature
      sensors designed to map and create circumferential, focal linear lesions
      in the pulmonary vein ostia of the left atrium.
            
            Mapping
      and Ablation
            
            No
      immediate plans
            
            Approved
      in the European Economic Area (CE Mark) and
  Canada




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





9








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




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




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




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




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




10




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




Research and New Product
Development





We
believe that, assuming we obtain the funding necessary to continue operations,
our future success will depend in large part on our ability to develop and
introduce clinically advanced diagnostic and therapeutic systems that are
effective, easy to use, safe and reliable. Our New Product Development
department focuses on the continued development and refinement of our existing
diagnostic devices, systems and procedures, as well as on the development of new
devices, systems and procedures for treating cardiac arrhythmias. While the
primary responsibility of the department is to develop new products and transfer
them to manufacturing, the department also performs applied research to improve
device performance during the earlier stages of product development. In late
2007, as part of gearing up for commercialization, Product Development and Pilot
Production Departments also became actively focused on projects to improve
product quality, increase production yields and decrease manufacturing
times.





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




Research and development expenses for
the years ended December 31, 2007 and 2006, were $3.1million, $1.8 million,
respectively.





Marketing
and Distribution





We have a
direct sales representative responsible for U.S. sales of our products,
including the surgical ablation system for AF and the Pathfinder diagnostic
catheters for mapping along with our series of guides.  We are
focusing our efforts on expanding our domestic customer base working with a
distribution network.  We believe that there are between 500 and 600
hospitals in the United States that perform electrophysiology procedures on a
routine basis. Further, we believe there are over 700 board certified
electro-physiologists practicing domestically.  There are 1100
surgical centers that could be candidates for surgical AF ablation
programs.




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





Paramedic
Co., Ltd., our distributor in Japan, in the first quarter of 2007, notified us
of its failure to maintain the legal documentation standard required to sell our
PATHFINDER® in Japan. As a result, we had no sales in Japan during 2007. We
understand that the reapplication process takes approximately twelve to eighteen
months. We are currently exploring our options with regard to selling the
PATHFINDER® in Japan. During the reapplication process, we may have no sales in
Japan. We anticipate resuming commercial sales in 2009. However, there can be no
assurance that we will be able to resume sales by that time.





Manufacturing





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





We
believe our custom-designed, proprietary processing equipment is an important
component of our manufacturing strategy.  Our technological expertise
includes braiding, precision coil winding, hydrophilic coating application,
material cleaning and surface preparation.





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




11




Our
manufacturing facilities are subject to periodic inspection from regulatory
authorities, and its operations must undergo FDA Quality System Requirements
(QSR) and ISO 13485 compliance inspections conducted by the FDA and the RWTUV
before we can market our products. We have obtained ISO 13485 Quality Systems
certification from RWTUV and have obtained the right to affix the CE Mark to
certain electrophysiology mapping and ablation catheters and accessories as well
as electrosurgical units. We successfully passed a pre PMA inspection by the FDA
in January 2003. In March 2006, the FDA conducted a Quality System Inspection
Technique, (or QSIT) Audit, of our Quality System, which we successfully passed.
However, there can be no assurance that our manufacturing facilities will
continue to meet such compliance audits and will maintain such compliance
standards. See "Government Regulation."





Patents
and Proprietary Rights





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





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





As of
March 31, 2008, Cardima was the assignee to 25 issued United States patents and
5 pending United States patent applications. In December 2000, we sold certain
patents and related intellectual property pertaining to intravascular sensing
and signal detection to Medtronic, Inc., which may have research efforts in the
field of electrophysiology that may compete with our products. We received a
perpetual, worldwide license at no cost from Medtronic to use these 13 issued
United States patents and related intellectual property in our products for
mapping and ablation of arrhythmia-causing tissue. In addition, Medtronic agreed
not to sublicense the patents within our field of use to any non-affiliated
party. We have also licensed a proprietary surface-coating material from another
vendor used on certain of our micro-catheters.





As of
March 31, 2008, we also have 23 patents in major international markets that have
been validated or granted. No assurance can be given that these patent
applications will provide competitive advantages for our products or that any
patent application filed by us will issue as a patent. In addition, there can be
no assurance that any of our 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 us and have
substantial investments in competing technologies, will not apply for and obtain
patents which will prevent, limit or interfere with our ability to make, use, or
sell our products either in the United States or internationally.





We also
obtained rights to certain technology by entering into license arrangements.
Pursuant to a license agreement with Target Therapeutics, we obtained an
exclusive, royalty-free, worldwide license under certain patents issued in the
United States and corresponding international patents to use Target
Therapeutics' technology and to make, use and sell or otherwise distribute
products for the diagnosis and treatment of electrophysiological diseases in the
body, other than in the central nervous system, including the brain. The
exclusive license applies to any of Target Therapeutics’ technology developed
through May 1996 and will terminate on April 23, 2013, the expiration date of
the last-to-issue of the licensed patents covering Target Therapeutics’
technology developed prior to May 31, 1996, unless terminated earlier upon a
breach, specified insolvency and bankruptcy related events or our failure to
continue to be engaged in specified fields of business for 12 months. In
addition to this exclusive license to use Target Therapeutics’ technology to
develop products for electrophysiological diseases, we obtained a non-exclusive
license to use Target Therapeutics' technology, provided we make a substantial
improvement on such technology, for the diagnosis or treatment of diseases of
the heart other than by balloon angioplasty. As defined in the agreement, a
substantial improvement is any modification, improvement or enhancement of
Target Therapeutics’ technology that results in a material change in the
function, purpose or application of a particular product incorporating Target
Therapeutics’ technology.





Under the
Target Therapeutics’ agreement, we granted back to Target Therapeutics an
exclusive, royalty-free, worldwide license to use technology developed by us
through May 1996 in the fields of neurology, interventional neuropathology,
interventional radiology, reproductive disorders and vascular prostheses. In
addition, we agreed not to conduct material research and development, acquire
corporate entities or make or sell products in these areas or to sell products,
other than products utilizing Target Therapeutics' 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 Therapeutics and negotiating a distribution agreement. We
also agreed that we would not sell products utilizing Target Therapeutics'
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 we intend to sell to a distributor, first notifying
Target Therapeutics and offering it the right of first refusal with respect to
the terms of the distribution, or if selling directly to the consumer, paying to
Target Therapeutics an amount equal to 40% of the gross profit for such
product.




12




We
obtained rights to a biocompatible hydrophilic-coating material and process
through a royalty-bearing license to use the hydrophilic coating technology in
products designed to map and ablates 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 or due to our being in insolvency,
dissolution, bankruptcy or receivership proceedings affecting the operation of
our business.





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





U.S.
patent applications filed prior to November 29, 2000 are maintained in secrecy
until patents are issued, however, U.S. patent applications filed after this
date, unless foreign filing is specially disclaimed, are published 18 months
from filing or 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 our development activities make comprehensive patent
searches and analysis impractical or not cost-effective. 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 receive, patents and will obtain additional proprietary rights relating
to products, materials or processes used or proposed to be used by
us.





The
medical device industry has experienced 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. We have from time to time received inquiries and allegations from
parties concerning their intellectual property rights, and we expect to receive
intellectual property inquiries and claims in the future. Any such claims, with
or without merit, could be time-consuming and expensive to respond to and could
divert our technical and management personnel. If any third party patent claims
are upheld as valid and enforceable in any litigation or administrative
proceeding, we could be prevented from practicing the subject matter claimed in
such patents, or could be required to obtain licenses from the patent owners of
each patent, or redesign our 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 us or that we will be successful in any attempt
to redesign our products or processes to avoid infringement. Accordingly, an
adverse determination in a judicial or administrative proceeding or failure to
obtain necessary licenses could prevent us from manufacturing and selling our
products, which would have a material adverse effect on our business, financial
condition, and results of operations. We intend to vigorously protect and defend
our intellectual property. Costly and time-consuming litigation brought by us
may be necessary to enforce patents issued to us to protect trade secrets or
know-how 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 based on pending patent
applications or any future patent application will exclude competitors or
provide competitive advantages to us that any of our patent or patents in which
we have licensed rights will be held valid if subsequently challenged or that
others will not claim rights in or ownership of our patents and other
proprietary rights held or licensed by us. There can be no assurance that others
have not developed or will not develop similar products, duplicate any of our
products or design around any patents issued to or licensed by us or that may be
issued in the future to us. Since patent applications in the United States are
maintained in secrecy for a period of time as stated above, we also cannot be
certain that others did not first file applications for inventions covered by
our pending patent applications, nor can we be certain that we will not infringe
any patents that may issue to others on such applications. We periodically
review the scope of patents of which we are aware. Although we do not believe
that we are infringing on patents known to us, the question of patent
infringement involves complex legal and factual issues and there can be no
assurance that any conclusion reached by us regarding infringement will be
consistent with the resolution of any such issues by a court.





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




13




Competition





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





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





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





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





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




Government
Regulation





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




14




U.S.
Regulation





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





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





A device
that does not qualify for 510(k) clearance is placed in Class III, which is
reserved for devices classified by the FDA as posing greater risk (e.g.,
life-sustaining, life-supporting or implantable devices, or devices that are not
substantially equivalent to a legally marketed Class I or Class II device) or
when there is no similar device already approved. A Class III device generally
must go through the PMA application process to receive FDA approval. This
process requires that the manufacturer establish the safety and effectiveness of
the device to the FDA's satisfaction. This requires the manufacturer to provide
extensive pre-clinical and clinical data, information about the manufacture of
the device and its components and information about the labeling and promotional
material. As part of the PMA application process, the FDA may inspect the
manufacturer's facilities for compliance with the QSR, which includes an
extensive review of design, manufacturing, and process controls, documentation
and other quality assurance procedures.





Upon
submission of the PMA application, the FDA determines if the application is
sufficiently complete to permit a substantive review, and, if so, the
application is accepted for filing. The FDA then commences an in-depth review of
the PMA application, which typically takes six months to two 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. In addition, the FDA may visit an
applicant’s facilities and/or its investigator’s sites to audit the clinical
data and/or the data collection process and procedures. Near the completion of
the PMA application process, an FDA advisory committee, typically a panel of
clinicians, will generally be convened to review the application and recommend
to the FDA whether, or upon what conditions, the device should be approved.
Although the FDA is not bound by the advisory panel decision, the panel's
recommendation is important to the FDA's overall decision-making process and the
panel’s recommendation is generally accepted.





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





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





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




15




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





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





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





Foreign
Regulation





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





The
European Union has promulgated rules that require commercial medical products to
bear the CE Mark. The CE Mark is recognized by the European Union as a symbol of
adherence to strict quality systems requirements set forth in the ISO 13485
quality standards for medical devices, as well as compliance with 93/42/EEC, the
Medical Device Directive. The CE Mark allows us to market our products
throughout the European Economic Area. We received ISO 13485 Quality Systems
certification for our manufacturing facilities in Fremont, California, which
were re-certified in November 2007. These certifications and repeated
inspections are required in order to continue to affix the CE Mark to our
approved products in Europe. In addition, ISO 13485 certification was obtained
in March 2004 to include electrosurgical generators and associated
equipment.





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





In the
first quarter of 2007, our Japanese distributor notified us of its failure to
maintain the legal documentation standard required to sell our PATHFINDER® in
Japan. As a result, we had no sales in Japan during the first quarter of 2007.
We understand that the reapplication process takes approximately six months. We
are currently exploring our options with regard to selling the PATHFINDER® in
Japan. During the reapplication process, we may have limited or no sales in
Japan. We anticipate resuming commercial sales in 2009. However, there can be no
assurance that we will be able to resume sales by that time.




16




Third-Party
Reimbursement





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





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





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





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





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





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




17




Product
Liability and Insurance





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





Employees





At
December 31, 2007, we had 40 employees, of whom 39 were full-time employees and
1 was part-time employee. Moreover, out of the 39 employees, 4 were engaged
directly in research and new product development, 3 in regulatory affairs,
quality assurance and clinical activities, 22 in manufacturing, 5 in sales and
marketing and 5 in finance and administration. We maintain compensation,
benefits, equity participation, and work environment policies intended to assist
in attracting and retaining qualified personnel. We believe the success of our
business will depend, in significant part, on ourability to attract and
retain such personnel. None of our employees is represented by a collective
bargaining agreement, nor have we experienced any work stoppage. We consider our
relations with our employees to be good.





RISK
FACTORS





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





RISKS
RELATED TO OUR FINANCIAL RESULTS:





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




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





Our
financing arrangements contain, and, if we succeed in closing future financings,
those future financings will likely contain, terms which place substantial
restrictions on our ability to raise the further funding, such as anti-dilution
protection in the event of subsequent financings. We had negative cash flow from
operations for the twelve months ended December 31, 2007 of $6.6 million, and we
expect to continue to incur substantial negative cash flow from operations for
the foreseeable future. We may be required to expend greater than anticipated
funds if unforeseen difficulties arise in the course of completing the
development, approval and marketing of our products. Even if we raise capital in
the near term, our future cash needs may, at a minimum, cause us to delay, scale
back or eliminate some or all of our product research and development programs,
to limit the marketing of our products, or to license or sell to third parties
the rights to commercialize our products or technologies that we would otherwise
develop and market ourselves. Our failure to raise capital when needed would
likely cause us to cease our operations.




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




18




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




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




Our net
losses were approximately $42.6 million for the year ended December 31, 2007 and
approximately $12.1 million for the year ended December 31, 2006 restated. As of
December 31, 2007, our accumulated deficit was approximately $176.6 million. Our
limited sales history, and the fact that we have very limited cash resources,
makes it difficult to assess or predict our future results. We cannot be certain
that we will ever generate substantial revenue or achieve profitability. Our
failure to generate substantial revenues would harm our business.





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




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




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




The
audit report accompanying our 2007 financial statements expresses substantial
doubt as to our ability to continue as a going concern




As a
result of our losses to date and accumulated deficit, the audit report on our
2007 financial statements contains an explanatory paragraph indicating that
there is substantial doubt as to our ability to continue as a going concern. Our
continuation as a going concern will depend upon our ability to generate or
obtain sufficient cash to meet our obligations on a timely basis and ultimately
to attain profitable operations. Concern about our ability to continue as a
going concern may make it more difficult for us to obtain additional funding to
meet our obligations or adversely affect the terms of any additional funding we
are able to obtain. We anticipate that we will continue to incur significant
losses until successful commercialization of one or more of our products. There
can be no assurance that we can or will operate profitably in the future, or
that we will continue as a going concern.





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




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





·Product design and
development;


·Product
testing;


·Product
labeling;


·Product
storage;


·Pre-market
clearance and approval;


·Advertising and
promotion; and


·Product sales and
distribution




19




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




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





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





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




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





In 2006
Cardima was unsuccessful in obtaining domestic Food and Drug Administration
(FDA) approval through the FDA’s desire for additional clinical
data.  Cardima along with dialog with the FDA is currently designing a
study trial amendable to both parties to seek approval to use its ablation
system to treat AF.  Cardima projects to begin its pivotal study in
2008; however the timing and receiving FDA approval to begin the trial in the
projected timeframe cannot be assured.  Although the study details
have not been finalized, the study can last up to 1 year or longer.




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




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




In 2007
Cardima was unsuccessful in obtaining domestic Food and Drug Administration
(FDA) approval through the FDA’s desire for additional clinical
data.  Cardima along with dialog with the FDA is currently designing a
study trial amendable to both parties to seek approval to use its ablation
system to treat AF.  Cardima projects to begin its pivotal study in
2008; however the timing and receiving FDA approval to begin the trial in the
projected timeframe cannot be assured.  Although the study details
have not been finalized, the study can last up to 1 year or longer.




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




20




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




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




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





We have a
direct sales representative responsible for U.S. sales of our products,
including the surgical ablation system for AF and the Pathfinder diagnostic
catheters for mapping along with our series of guides.  We are
focusing our efforts on expanding our domestic customer base working with a
distribution network.. If we receive FDA approval of our PMA application for
REVELATION® Tx, we may not have an adequate marketing and sales force to
adequately sell that product. Expanding our marketing and sales capability to
support sales in commercial quantities adequately will require substantial
effort and require significant management and financial resources. Our failure
to establish an effective sales and marketing force will prevent us from being
able to generate significant revenues from the sale of our
products.




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




Currently,
international sales and marketing of our PATHFINDER®, PATHFINDER® mini,
REVELATION® and TRACER® micro-catheter systems are conducted through a number of
exclusive distributors in certain European countries and
Japan   Paramedic Co., Ltd., our distributor in Japan, in the
first quarter of 2007, notified us of its failure to maintain the legal
documentation standard required to sell our PATHFINDER® in Japan. As a result,
we had no sales in Japan during 2007. We understand that the reapplication
process takes approximately six to nine months. We are currently exploring our
options with regard to selling the PATHFINDER® in Japan. During the
reapplication process, we have sold only a limited number of systems through
these distributors. We cannot be certain that these distributors will be able to
effectively market and sell our products. For example, we have terminated
several distribution arrangements in Europe because of the distributors’ failure
to meet minimum sales levels under those agreements. . Our failure to establish
and maintain successful distribution relationships would harm our
business.




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




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





We
cannot assure the safety or effectiveness of our products.




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




21




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




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








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




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





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


·      Anti-arrhythmic and anti-coagulant
drugs;


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


·      Implantable
defibrillators;


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


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




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




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




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





·Fines;


·Injunctions;


·Recall or seizure
of products;


·Withdrawal of
marketing approvals or clearances;


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


·Civil and criminal
penalties




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




22




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




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





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




In the
first quarter of 2007, our Japanese distributor notified us of its failure to
maintain the legal documentation standard required to sell our PATHFINDER® in
Japan. As a result, we had no sales in Japan during 2007. We understand that the
reapplication process takes approximately six to nine months. We are currently
exploring our options with regard to selling the PATHFINDER® in Japan. During
the reapplication process, we may have limited or no sales in Japan. We
anticipate resuming commercial sales in 2009. However, there can be no assurance
that we will be able to resume sales by that time.




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




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




Difficulties
presented by international factors could negatively affect our
business.




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





·Export license requirements for our
products;


·Exchange rate
fluctuations or currency controls;


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


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


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


·Domestic or
international trade restrictions; and


·Changes in
tariffs




Any of
these factors could damage our business results.




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





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




23




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





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




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





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




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




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




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




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




24




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




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




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





·Has not received appropriate regulatory
clearances or approvals;


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


·Is experimental,
unnecessary or inappropriate





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





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


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


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





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




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




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





·Capacity
constraints;


·Production
yields;


·Quality control;
and


·Shortage of
qualified personnel




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




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




25




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




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




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





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




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





We
are dependent upon our key personnel.




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




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




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





We
May Not Be Able to Implement Section 404 of the Sarbanes-Oxley Act of 2002 on a
Timely Basis and we have identified material weakness in our system of internal
controls.





The SEC,
as directed by Section 404 of the Sarbanes-Oxley Act, adopted rules generally
requiring each public company to include a report of management on the company's
internal controls over financial reporting in its annual report on Form 10-KSB
that contains an assessment by management of the effectiveness of the company's
internal controls over financial reporting. Under current rules, commencing with
our annual report for the fiscal year ending December 31, 2008 our independent
registered accounting firm must attest to and report on management's assessment
of the effectiveness of our internal controls over financial
reporting.




26




We have
not yet developed a Section 404 implementation plan. We have in the past
discovered, and may in the future discover, areas of our internal controls that
need improvement. How companies should be implementing these new requirements
including internal control reforms to comply with Section 404's requirements and
how independent auditors will apply these requirements and test companies'
internal controls, is still reasonably uncertain. Our initial assessment has
identified material weeknesses in our controls our financial reports. We may not
be able to remidiate these problem on a timely basis.





We expect
that we will need to hire and/or engage additional personnel and incur
incremental costs in order to complete the work required by Section 404. We may
not be able to complete a Section 404 plan on a timely basis. Additionally, upon
completion of a Section 404 plan, we may not be able to conclude that our
internal controls are effective, or in the event that we conclude that our
internal controls are effective, our independent accountants may disagree with
our assessment and may issue a report that is qualified. Any failure to
implement required new or improved controls, or difficulties encountered in
their implementation, could harm our operating results or cause us to fail to
meet our reporting obligations





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




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




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




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





·              The ability of the Board of Directors
to alter our bylaws without stockholders’ approval;


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


·              The elimination of the rights of
stockholders to act by written consent




Each of
these provisions could discourage potential takeover attempts.




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




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








ITEM
2. DESCRIPTION OF PROPERTY





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








ITEM
3. LEGAL PROCEEDINGS







27




On
October 31, 2007, the Company received a letter from the law firm representing
its former Director of Operations, Mr. Larry Stevens. Mr. Stevens claimed for
damages for wrongful termination in violation of public policy, breach of
contract and related claims.  The Company determined that Mr. Stevens’
termination was “with cause” thus the severance provision of his employment
agreement did not apply. The Company will defend itself vigorously against Mr.
Stevens’ claims.





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





No
matters were submitted to a vote of our security holders in the fourth quarter
of 2007.





PART
II





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





Market
for Common Equity





In
October 2005, our common stock resumed quotation on the Nasdaq Over-the-Counter
Bulletin Board under the symbol CADM.OB. Our common stock was quoted on the Pink
Sheets, Nasdaq SmallCap Market and Nasdaq National Market from May 2005 to
October 2005, June 2001 to May 2005 and June 1997 to June 2001 respectively.
Prior to that time, there was no public market for our common stock. The
following table sets forth for the periods indicated the high and low sale
prices of our common stock.




HIGH
            
            
            LOWYEAR
      ENDED DECEMBER 31, 2007First
      Quarter
            
            $
            0.21
            
            
            $
            0.05Second
      Quarter
            
            
            0.17
            
            
            
            0.04Third
      Quarter
            
            
            0.70
            
            
            
            0.05Fourth
      Quarter
            
            
            0.65
            
            
            
            0.21YEAR
      ENDED DECEMBER 31, 2006First
      Quarter
            
            $
            0.07
            
            
            $
            0.04Second
      Quarter
            
            
            0.25
            
            
            
            0.03Third
      Quarter
            
            
            0.09
            
            
            
            0.05Fourth
      Quarter
            
            
            0.08
            
            
            
            0.04





We have
not declared or paid any cash dividends on our common stock, and we currently
intend to retain future earnings, if any, to finance the expansion of our
business, and we do not expect to pay any cash dividends in the foreseeable
future. The decision whether to pay cash dividends on our common stock will be
made by our board of directors, in their discretion, and will depend on our
financial condition, operating results, capital requirements and other factors
that the board of directors considers significant. As of December 31, 2007,
we had approximately 93 shareholders of record, not including persons who hold
their shares through a nominee.




Recent
Sales of Unregistered Securities





On
December 17, 2007, Cardima, Inc. (the “Company”) consummated a transaction
whereby the Company entered into a series of Subscription Agreements (the
“Subscription Agreement”) with certain accredited investors (collectively, the
“Investors”) providing for the sale by the Company to the Investors of (i) a
total of 18,000,000 shares of the Company’s Common Stock in the aggregate
principal amount of $9,000,000  (the “Shares”) and (ii) warrants (the
“Warrants”) to purchase an aggregate of 2,700,000 shares of the Company’s Common
Stock at an exercise price of $0.55. The Warrants have an exercise price equal
of $0.55.





At the
option of the Company, the Company may force the Holder to exercise the Warrant
at a price per share equal to $0.55, provided that (i) the Company’s Common
Stock is trading at a price equal to or more than $1.00 for a period of fifteen
(15) consecutive trading days ending on the date preceding the date the Company
sends a notice to the Holder in which it announces its intention to force the
exercise of the Warrants and (ii) a registration statement is in effect with
respect to the Warrant Shares.   The Warrants have an expiration
date of 5 years from the date of issuance.





Pursuant
to the Subscription Agreement, the Company has agreed to use its best efforts to
secure effectiveness of, as soon as reasonably practicable after the issuance
and delivery of the Shares and Warrants, a registration statement on
Form





28





ITEM
6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION





The
following discussion of our financial condition and results of operations should
be read in conjunction with our financial statements and related notes, and the
other financial information included in Form 10-KSB. With respect to this
discussion, the terms “Cardima,” “Company,” “we,” “us,” and “our” refer to
Cardima, Inc.




OVERVIEW
AND PLAN OF OPERATION





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





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





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





On July
31, 2007, we announced that our Board of Directors declared a reverse stock
split, at a 1 for 10 ratio, effective at the opening of trading on July 31,
2007.  Following the split, our common stock is traded under a new
ticker symbol, “CADM”.  Our Board declared this reverse stock split
pursuant to the discretionary authority granted by the vote of a majority of our
outstanding shares at the 2007 Annual Shareholders Meeting held June 28,
2007.




On August
31, 2007, our Board of Directors terminated the employment of our Chief
Executive Officer and Acting Chief Financial Officer, Mr. Gabriel
Vegh.  Mr. Vegh remains as a Director and his severance package has
not been finalized.  On the same date, the Board appointed Mr. Robert
Cheney to be our Chief Executive Officer.  Mr. Cheney has been our
Director since February 2006.  Mr. Cheney is also a Director and
shareholder of Apix International Limited, a principal stockholder of the
Company.  In addition, the Board appointed Mr. Tony Shum, one of our
directors, as the Chairman of the Board.  The Board further appointed
Mr. Chris Mak to be our Chief Financial Officer and Corporate
Secretary.





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




On
October 3, 2007, the Company entered into a Debt Settlement Agreement (the
“Settlement Agreement”), with Apix. Under the terms of the Settlement Agreement,
the Company issued 58,870,183 shares of the Company’s common stock to Apix in
settlement of the outstanding balance of $17,661,055 and 29,129,817 shares in
settlement of 20,340,000 warrants. Under the Settlement Agreement, Apix also
released the Company of and from all and all manner or actions, suits, debts,
sums of money, contracts, agreement, claims and demands at law or in equity that
Apix had, or may have arising from the outstanding balance and warrants. The
settlement shares were issued to Apix nominees on October 24, 2007.





On
December 17, 2007, Cardima, Inc. (the “Company”) consummated a transaction
whereby the Company entered into a series of Subscription Agreements (the
“Subscription Agreement”) with certain accredited investors (collectively, the
“Investors”) providing for the sale by the Company to the Investors of (i) a
total of 18,000,000 shares of the Company’s Common Stock in the aggregate
principal amount of $9,000,000  (the “Shares”) and (ii) warrants (the
“Warrants”) to purchase an aggregate of 2,700,000 shares of the Company’s Common
Stock at an exercise price of $0.55. The company granted a total of 5,700,000
warrants to the investors. Apix International Limited (“Apix”) acted as
placement agent for the transaction.  Apix is owned by Robert Cheney
who is the Chief Executive Officer and a Director of the Company. Additional
details can be found in the recent financing section of this
report.





We had
cash and cash equivalents of approximately $4,811,000 as of December 31, 2007
and approximately $942,000 as of December 31, 2006.





29





CRITICAL
ACCOUNTING POLICIES





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





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




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




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





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





Inventories. Inventory
consists of raw materials, work in progress, and finished goods. Inventory is
stated at the lower of cost or market using the first-in, first-out (“FIFO”)
method. Cost includes the acquisition cost of raw materials and components,
direct labor, and manufacturing overhead. We periodically review our inventory
for excess, obsolescence or quality issues. Should we conclude that we have
inventory for which we cannot recover our costs as a result of such review, we
would record a charge to cost of goods sold.





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




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




Stock-Based Compensation.We
adopted Financial Accounting Standards Board (“FASB”) Statement No. 123R,
“Share Based Payment,” on January 1, 2006. Prior to adoption, we disclosed such
expenses on a pro forma basis in the notes to our financial
statements.




30




Recent
Accounting Pronouncements





In June
2006, the FASB issued FASB Interpretation No. (“FIN”) 48, “Accounting
for Uncertainty in Income Taxes, an interpretation of FASB Statement
No. 109.” FIN 48 clarifies the accounting for uncertainty in income taxes.
FIN 48 prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 requires that we recognize in the
financial statements the impact of the tax position if that position will more
likely than not be sustained on audit, based on the technical merits of the
position. FIN 48 also provides guidance related to de-recognition,
classification, interest and penalties, accounting in interim periods and
disclosure. If there are changes in net assets as a result of application of FIN
48, these will be accounted for as an adjustment to retained earnings. We are
adopting FIN 48 at the beginning of our fiscal year 2007.





In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”
which defines fair value, establishes a framework for measuring fair value, and
expands disclosures about fair value measurements. SFAS No. 157 does not
require any new fair value measurements, but rather eliminates inconsistencies
in guidance found in various prior accounting pronouncements. We are currently
evaluating the accounting and disclosure requirements that this guidance will
have on our results of operations or financial condition when we adopt SFAS
No. 157 at the beginning of our fiscal year 2008.





In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements—an amendment of Accounting Research Bulletin
No. 51 (“SFAS No. 160”). SFAS No. 160 establishes accounting and reporting
standards for ownership interests in subsidiaries held by parties other than the
parent, the amount of consolidated net income attributable to the parent and to
the noncontrolling interest, changes in a parent’s ownership interest, and the
valuation of retained noncontrolling equity investments when a subsidiary is
deconsolidated. SFAS No. 160 also establishes disclosure requirements that
clearly identify and distinguish between the interests of the parent and the
interests of the noncontrolling owners. SFAS No. 160 is effective for fiscal
years beginning after December 15, 2008, and will be adopted by us in the first
quarter of fiscal 2009. We are currently evaluating the potential impact, if
any, of the adoption of SFAS No. 160 on our consolidated balance sheet,
statement of income and statement of cash flows.





In June
2007, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 06-11,
"Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards."
EITF 06-11 provides for the recognition and classification of deferred taxes
associated with dividends or dividend equivalents on non-vested equity shares or
non-vested equity share units (including restricted stock units (RSUs)) that are
paid to employees and charged to retained earnings. This issue is effective for
annual periods beginning after September 15, 2007. Also in June 2007, the FASB
ratified EITF Issue No. 07-3, "Accounting for Advance Payments for Goods or
Services to Be Used in Future Research and Development Activities." EITF 07-3
provides that nonrefundable advance payments made for goods or services to be
used in future research and development activities should be deferred and
capitalized until such time as the related goods or services are delivered or
are performed, at which point the amounts would be recognized as an expense.
This issue is effective for fiscal years beginning after December 15,
2007.  The Company has evaluated the potential impact of these issues
and anticipates that they will have no material impact on its financial position
and results of operations.





In
February 2007, the FASB issued SFAS 159 (“SFAS 159”), “The Fair Value Option for
Financial Assets and Financial Liabilities – Including an Amendment of FASB
Statement No. 115”. This Statement provides companies with an option to measure,
at specified election dates, many financial instruments and certain other items
at fair value that are not currently measured at fair value.  A
company that adopts SFAS 159 will report unrealized gains and losses on items
for which the fair value option has been elected in earnings at each subsequent
reporting date. This Statement also establishes presentation and disclosure
requirements designed to facilitate comparisons between entities that choose
different measurement attributes for similar types of assets and
liabilities.  This Statement is effective for fiscal years beginning
after November 15, 2007. The Company is currently assessing the impact of
adopting SFAS 159.





In
December 2006, the FASB issued FSP EITF 00-19-2, Accounting for Registration Payment
Arrangements (“FSP 00-19-2”), which addresses accounting for registration
payment arrangements. FSP 00-19-2 specifies that the contingent obligation to
make future payment or otherwise transfer consideration under a registration
payment arrangement, whether issued as a separate agreement or included as a
provision of a financial instrument or other agreement, should be separately
recognized and measured in accordance with FASB Statement No. 5, Accounting for Contingencies.
FSP 00-19-2 further clarifies that a financial instrument subject to a
registration payment arrangement should be accounted for in accordance with
other applicable generally accepted accounting principles without regard to the
contingent obligation to transfer consideration pursuant to the registration
payment arrangement. For registration payment arrangements and financial
instruments subject to those arrangements that were entered into prior to the
issuance of EITF 00-19-2, this guidance shall be effective for financial
statements issued for fiscal years beginning after December 15, 2006 and interim
periods within those fiscal years. The Company has determined that the adoption
of FSP 00-19-2 will have no impact its financial statements.




31




Results
of Operations - Years Ended December 31, 2007 and 2006





Net
Sales





For the
year ended December 31, 2007, revenues decreased 25% to $1,157,000 from
$1,541,000 in 2006, primarily due to no sales in Japan.  Excluding
Japan, which contributed $650,000 in 2006 to zero in 2007, we had significant
growth in all other regions. We expect to see continued improvements in our
sales effort in 2008.





North
American sales increased significantly by 44% to $914,000 from $636,000 in 2006
while European sales also increased by 26% to $321,000 from $255,000 in 2006.
The increases in Sales in both regions is due to increased sales efforts in
Europe and a new distributor agreement with On-X in the US. We had no sales
in Japan in 2007 vs. $650,000 in 2006. This was caused by the
expiration of certification of our Japanese distributor.





Cost
of Goods Sold





Cost of
goods sold primarily includes raw materials costs, catheter fabrication costs,
system assembly and testing costs, shipping and handling costs, and
manufacturing labor and overhead Cost of goods sold for 2007 decreased by 20% to
$1,613,000 from $2,023,000 for 2006. Cost of goods sold as a percentage of net
sales increased slightly by 8%, from 131% in 2006 to 139% in 2007. The decrease
in the cost of goods sold reduced standard costs due to decreased burden cost
and lower volume. The standard margin was still higher than 2006 due to sales of
higher margin products in the US. This was in addition to the return of
$85K of product returns from our Japanese distributor. Also as the company
prepared for the commercialization of surgical line of products, the production
capacity was used by R&D and clinical department to build clinical products
and R&D test units of T-flex and Probe. The company experts that the cogs
will drop as a % of sales a s volume increases.





Net
Loss





Net loss
increased by $30,495,000, to $42,646,000 in 2007 from $12,151,000 on a restated
basis in 2006. The increase in net loss resulted primarily from the other
expense of $33,048,000 in 2007 compared with other expense of $5,142,000 on a
restated basis in 2006. These losses were associated with $10,129,000n on non
cash conversion of debt in to equity, $15,182,000 of non cash loss on debt
extinguishment, and $7,737,000, non-cash loss from liability created from the
issuance of options, warrants, and other convertible instruments in access od
authorized shares, This problem was corrected during the year with the
reverse stock split approved by the shareholders.




Research
and Development Expenses





Research
and development expenses include product development, clinical testing and
regulatory expenses. Total expenses increased 73% to $3,091,000 in 2006 from
$1,787,000 in 2006. The increase in 2007 was primarily   due to
activities related to the surgical line of products and costs related to the
FDA’s MDDRP meeting held on April 19, 2007. The cost incurred over this period
included increased headcount, testing, and clinical research. The cost
associated with the surgical line increased by $461,000 and the FDA cost
increased by $718,000 over the same period last year.


.




The costs
associated with research and pre-clinical programs and clinical development
programs were approximately (in thousands):





Year
      ended December 31,2007
            
            2006Clinical
      development programs
            
            $
            2,073
            
            
            $
            1,110Research
      and preclinical programs
            
            
            1,017
            
            
            
            679Total
      research and development
            
            $
            3,090
            
            
            $
            1,787




Selling,
General and Administrative Expenses





Selling,
general and administrative expenses for 2007 increased 426% to $5,203,000 from
$2,987,000 in 2006. Selling expenses for 2007 increased by 70% to $477,000 from
$281,000 in 2006 primarily due to hiring of a sales consultant in Europe. Marketing expenses
for 2007 also increased 315% to $507,000 from $161,000 in 2006. The increase in
marketing expenses is due to increased headcount (three persons), and increased
sales and promotional activities to stimulate sales in US. General and
administrative expenses for 2007 increased 166% to $4,219,000 from $2,544,000 in
2006. The increase in general and administrative expenses was primarily due to
$125,000 expense for Section 404 effort and transition from one audit company to
another. As a non-accelerated filer, Section 404 of the Sarbanes-Oxley Act
requires management to report on the effectiveness of the Company's internal
controls and procedures over financial reporting as of December 31, 2007. During
the third quarter of 2007, we initiated the implementation of meeting Section
404 requirements which resulted in increased professional fees. Increased
professional fees are expected to continue into 2008. Since Apix is wholly owned
by the Company's CEO, the non-cash payment to Apix in regards to the services
connected with 2007 private placement was $1,408,000 recorded as compensation
expense.




32




Interest
Expense





Interest
expense for 2007 decreased 49% to $891,000 from $1,754,000 in 2006. The decrease
was primarily due to the conversion of Apix loans into stock
equity.





Other
Income and Expense





Other
expense for 2007 was $33,048,000 from $5,142,000 in 2006. This was due
principally to the loss on conversion of debt in to equity $10,129,000, loss on
debt extinguishment of $15,182,000, an dnon-cash loss of 7,737,000 from the
liabilities created from the issuers of options, warrants, + other convertible
instruments in excess of authorized shares.





As a
result of an accounting error in applying the proper accounting treatment in the
recording of convertible notes and warrants and their related debt derivatives
pursuant to EITF 19 and SFAS 133 which resulted in significant changes in the
financial statements, those financial statements should not be relied upon.
Accordingly cash restates its December 31, 2006 twelve month financial and the
quarter ending March, June + September 2007 in this Form 10-KSB.




LIQUIDITY
AND CAPITAL RESOURCES




We had
cash and cash equivalents of approximately $4,811,000 as of December 31, 2007and
$942,000 as of December 31, 2006. In addition we have $2,008,000 in certificate
of deposit in Bank of America with a maturity date of four months. As of
December 31, 2007, we had positive working capital of $6,018,000, and an
accumulated deficit of approximately $176,559,000.





Net cash
used in operating activities was approximately 6,666,000 and for the years ended
December 31, 2007 and 2006, respectively, resulting primarily from operating
losses incurred. Net cash used in investing activities was $112,000 in 2006 and
related to the capital expenditures of property and equipment, as compared to
$2,185,000 used in 2007 for purchases of short term investments and fixed
assets. Net cash provided by financing activities was approximately $12,720,000
and $5,468,000 for the years ended December 31, 2006 and 2006, respectively,
resulting primarily from the Apix loan financing and advances in 2007 and
2006.





Net
non-cash items affecting operating activities for the period ending December 31,
2007 amounted to $34,456,000, which mainly consisted of the following: 1) loss
on debt extinguishment of $15,182,000; 2) loss on excess shares over authorized
of $7,737,000; 3) compensation expense related to warrants granted to officer of
$1,408,000; 4) loss on conversion of debt and warrants in to equity of
$10,129,000.





On
December 31, 2007 the Company had total assets of $8,004,000 compared to
$2,379,000 on December 31, 2006, a increase of  $5,625,000 (260% The
Company had a total stockholder's equity of $6,381,000 on December 31, 2007,
compared to a stockholders’ deficit of $(12,719,000) on December 31,
2006.





Contractual
Commitments:





Following
is a schedule of future contractual commitments at December 31, 2007(in
thousands):





Fiscal
      Year
              
              Operating
      Leases
              
              
              Capital
      Leases2008
              
              $
              265
              
              
              $
              242009
              
              
              272
              
              
              
              72010
              
              
              115Total
      minimum lease payments
              
              
              652
              
              
              
              33Less
      amounts representing interest
              
              
              
              
              
              
              2Present
      value of net minimum lease payments
              
              
              
              
              
              $
              31




The total
capital leases of $33,000 include interest payments $2,000 interest payments,
respectively. Our purchase obligations are guaranteed payments consisting of
contracts relating to material purchasing.




33




Recent
Financings




Apix
International





On August
12, 2005, we entered into a Loan Facility Term Sheet with Apix, which provided
us with up to $2 million in new financing. We received the first $500,000, a
portion of which was used to retire our outstanding secured loan agreement with
Agility Capital. On August 15, 2005, we re-hired certain furloughed employees
and resumed operations.





On August
28, 2005, we signed a loan agreement with Apix, which increased the total
amounts to be financed from $2 million to $3 million. The principal amount of
the promissory note dated August 12, 2005 for $500,000 was rolled over into the
new loan agreement. We received an additional $500,000 on this closing date. Per
the funding schedule, we received $500,000 on September 8, 2005 and $500,000 on
October 11, 2005. The remainder of the loan was received as follows: $350,000 on
November 16, 2005, $350,000 on December 14, 2005 and $300,000 on January 18,
2006. The loan agreement was secured by a first lien on all our assets and
intellectual property. All funds had interest at a rate of 10% per
annum.





According
to the loan agreement, we were required to pay a facility fee of $60,000, a due
diligence fee of $25,000, a document review and preparation fee of $50,000 and
an exit fee of $900,000 at the end of the loan agreement. All these fees were
being amortized as non-cash interest expense over the life of the
loan.





Also the
loan agreement has an optional conversion clause that at its sole option, Apix
may elect to receive payment for all or any portion of the facility fee, the
exit fee and the accrued interest due under the loan, in full or partial
satisfaction of such amounts, that respective number of our common stock at a
rate of $0.10 per share. Any additional gains or losses on the difference
between the conversion price and the fair value of the stock at the time of
conversion will be included in our earnings during that period.





Additionally,
we provided Apix warrants with registration rights to purchase 30,000,000 shares
of capital stock with a strike price of $0.10 per share. The warrants were free
standing instruments. As of September 30, 2005, we have failed to file a
registration statement with the SEC, as required by the loan agreement, to
register all of the shares of Common Stock issued or issuable with respect to
these warrants. Apix and we have entered into an amendment to the Loan Agreement
to extend the date by which we are required to file a registration statement in
accordance with Section 10(b)(i) of the Loan Agreement. The amendment agreement
extends the date by which we are required to file a registration statement from
September 30, 2005 to January 1, 2006.




On
February 14, 2006, we entered into a new loan facility with Apix, which provided
for the rollover of the original loan agreement and the grant of an additional
loan facility in the amount of $660,000 at an interest rate of 10% per annum. In
addition, we and the lender have agreed to the following terms: (i) the maturity
date of the original loan facility is extended from February 28, 2006 to May 18,
2006; (ii) the exercise price of the original warrant has been adjusted to $0.06
per share. In addition, we have granted the Lender a new warrant to purchase
23,800,000 shares of our common stock at an exercise price of $0.06 per share
for a term of ten years. In addition, upon completion of the full funding under
the new loan facility, we will grant the lender warrants to purchase an
additional 8,000,000 shares of our common stock at an exercise price of $0.06
per share for a term of ten years; (iii) we have granted the lender the right to
convert the loan principal, interest, facility fees and exit fees into shares of
our common stock at a conversion price of $0.06 per share; (iv) the facility fee
has been increased from $60,000 to $80,000. In addition, the exit fee has been
increased from $900,000 to $1,300,000; (v) upon completion of the full funding
under the new loan facility, the exit fee would be increased by $260,000; (vi)
we agree to register the shares underlying the loan principal, facility fees,
and warrants on a registration statement on Form S-1 as soon as practicable
after the date of issuing the warrant, but in any event no later than May 31,
2006. We received funding under this agreement of $200,000 and $460,000 in
February and March 2006, respectively.





On
January 15, 2007, the Company entered into a new term sheet with Apix, which
provides for the rollover of prior loan facilities and subsequent advances
(Prior Facilities) and an additional loan facility between the parties (the "New
Facility"). The New Facility provides for the following terms and
conditions:





(i)
            Additional
      loan facility - Apix has granted the Company an additional loan facility
      in the amount of $5,625,000. Advances pursuant to the additional facility
      shall be made on a bi-weekly basis the Company’s discretion in
      denominations of $225,000 per
advance;


(ii)
            New
      maturity date - the maturity date of the New Facility and Prior Facilities
      is the earlier of (a) December 31, 2007 or (b) the date that Apix makes a
      demand for payment;


(iii)
            Facility
      fee adjustment - the aggregate facility fee for the Prior Facilities and
      the New Facility shall be $500,000 (the “Facility Fee”) which is payable
      through the issuance of five million shares of our preferred stock with
      the following minimum preferences: (a) 28 votes per share at any general
      or extraordinary meeting of the common shares of the company convened by
      the Company or its shareholders for a total of 140 million votes at any
      such meeting; and (b) convertible into common shares of the Company at any
      time at the sole and absolute discretion of the holder on the basis of two
      (2) common shares for each preferred share tendered for conversion for a
      total of ten (10) million common shares in the event all preferred shares
      are tendered for conversion;


(iv)
            Exit
      fees - the aggregate exit fees for the Prior Facilities and the New
      Facility shall be $2,800,000 plus $80,000 for each advance made which
      shall be due and payable on the earliest to occur of: (1) the maturity
      date, (2) generally the sale of the company or substantially all of its
      assets, a reorganization or a new loan facility in excess of $1,000,000,
      or (3) an event of default;


(v)
            Price
      adjustment to existing warrant and new warrants - pursuant to the Prior
      Facilities, the Company agreed to issue to Apix warrants to purchase
      118,800,000 shares of the Company's common stock at an exercise price of
      $0.06 per share (the “Existing Warrants”). Pursuant to the New Facility,
      the exercise price of the Existing Warrants has been adjusted to $0.04 per
      share. In addition, the Company has agreed to issue to Apix additional
      warrants to purchase 20,000,000 shares of the Company’s common stock at an
      exercise price of $0.03 per share (the “New Warrants”). All warrants have
      a term of ten years;


(vi)
            Conversion
      price adjustment - the loan principal and exit fees are convertible into
      shares of the Company’s common stock at a conversion price of $0.04 per
      share; and


(vii)
            Registration
      rights - the Company agrees to register a percentage of the shares
      underlying the loan principal, facility fees, and warrants on a
      registration statement at its best
effort.





34





The final
financing agreements were executed on June 7, 2007. With the loan agreement’s
optional conversion clause on all or any portion of the principal, the facility
fee, the exit fee and the accrued interest due under the loan, any gains or
losses on the difference between the conversion price and the fair value of the
stock at the time of conversion will be included in the Company's earnings
during that period.  In addition, as the lender gave up all of its
rights that might be net settled in cash, the Company reversed it’s previously
accrued warrant liability as required under EITF 00-19.





On June
4, 2007, Cardima, Inc. (the "Company") filed with the Secretary of State of
Delaware a Certificate of Elimination to remove from its certificate of
incorporation the Series A Participating Preferred Stock. On June 6, the Company
filed with the Secretary of State of Delaware a Certificate of Designation for a
new Series A Preferred Stock.








On
October 3, 2007, Cardima, Inc. (the “Company”) entered into a Debt Settlement
Agreement (the “Settlement Agreement”), with Apix International Limited
(“Apix”). The Settlement Agreement arose from an initial loan made by Apix to
the Company in August 2005 for $3,000,000 as well as two loan facility term
sheets which provided financial accommodation to the Company entered into on
February 14, 2006 and January 16, 2007.  The terms of the Settlement
Agreement require the Company to issue an aggregate of 88,000,000 million shares
of the Company’s common stock to Apix in settlement of an outstanding balance
(“Outstanding Balance”) of $17,661,055 and 20,340,000 warrants (“Warrants”) owed
to Apix by the Company.  Specifically, 58,870,183 shares of the
Company’s common stock were issued to Apix in settlement of the Outstanding
Balance and 29,129,817 shares of the Company’s common stock were issued to Apix
in settlement of the Warrants. As a result of the execution of the Settlement
Agreement, Apix releases and forever discharges the Company of and from all and
all manner or actions, suits, debts, sums of money, contracts, agreement, claims
and demands at law or in equity that Apix had, or may have arising from the
Outstanding Balance and Warrants.





On
December 17, 2007, Cardima, Inc. (the “Company”) consummated a transaction
whereby the Company entered into a series of Subscription Agreements (the
“Subscription Agreement”) with certain accredited investors (collectively, the
“Investors”) providing for the sale by the Company to the Investors of (i) a
total of 18,000,000 shares of the Company’s Common Stock in the aggregate
principal amount of $9,000,000  (the “Shares”) and (ii) warrants (the
“Warrants”) to purchase an aggregate of 2,700,000 shares of the Company’s Common
Stock at an exercise price of $0.55. The Warrants have an exercise price equal
of $0.55.





At
the option of the Company, the Company may force the Holder to exercise the
Warrant at a price per share equal to $0.55, provided that (i) the Company’s
Common Stock is trading at a price equal to or more than $1.00 for a period of
fifteen (15) consecutive trading days ending on the date preceding the date the
Company sends a notice to the Holder in which it announces its intention to
force the exercise of the Warrants and (ii) a registration statement is in
effect with respect to the Warrant Shares.   The Warrants have an
expiration date of 5 years from the date of issuance.





Pursuant
to the Subscription Agreement, the Company has agreed to use its best efforts to
secure effectiveness of, as soon as reasonably practicable after the issuance
and delivery of the Shares and Warrants, a registration statement on Form
SB-2.




35




Apix
International Limited (“Apix”) acted as placement agent for the
transaction.  Apix is owned by Robert Cheney who is the Chief
Executive Officer and a Director of the Company. In consideration for the
services provided, the Company has entered into a Funding Agreement with Apix
whereby the Company agreed to: (i) pay a placement fee of 5% of gross proceeds,
payable in the Company’s common shares issued at $0.50 per share; (ii) grant two
million warrants to purchase shares of the Company’s Common Stock for a period
of five years at an exercise price of $0.55; and (iii) reimburse Apix’s expenses
totaling $75,000.  Subsequently the Funding Agreement was amended by
the Company and Apix in which Apix waived its five-percent common share
placement fee and  accepted for its services rendered; (i) an
additional one million warrants (total three million warrants) to purchase
shares of the Company’s common stock at an exercise price of $0.55; and (ii) all
rights, title and interest in a loan totaling $360,000, including accrued
interest, owed to the Company by Phil Radlick, with a guarantee by the Company
that the minimum recoverable value of the loan is not less than
$100,000.  In the event the actual amount recovered is less than
$100,000, the Company agrees to pay to Apix the amount of shortfall on or before
December 18, 2008.  The other terms of the Funding Agreement remain
the same.





In summary, the company had obtained an
initial funding of $3m in August 2005; issued 30 million warrants at exercise
price of $0.10 and was charged various additional fees totaling
$1,035,000.   At the February 16, 2006 round of financing the
company secured additional funding of $660,000, charged additional fees of
$860,000 and granted an additional 31.8 million warrants at an exercise price of
$0.10. The term of this loan was through May 16, 2006. The company continued to
receive additional funding of $4.5 million and had accrued additional interest
of $375K. As of December 31, 2006 the company had received cash of $8.16
million, had accrued $592K in interest and accrued various fees amounting to
$1,715,000.





On January17, 2007 the old loan was
rolled over in to a new loan with additional loan funding up to $5.625 million
to be drawn in installments of $220K each. The company also granted additional
warrants totaling 118, 800,000(rolled the previous 30M and 31,8M in previous
agreement), 3.8M warrants for each draw of funds and additional 20M warrants.
The total of all warrants was 203,400,000, at the exercise price of $0.03 for
the 118.8M warrants and $0.03 for the remaining 84.6M. In addition the company
agreed to pay the cumulative facility fee of 500,000 in the form of 5,000,000
preferred shares with additional voting rights. The exit fee was increased from
$1.56 million to $4.16 million and the other expenses rose to $425,000. The
total outstanding amount at September 30, 2007 comprised of principal amount of
$11.88 million, accrued interest of $1.44 million, the exit fee of $1.16 million
and other expenses of $425K, totaling to $17.661 million.





On
October 3, 2007, the entire loan was converted in to equity giving Apix 88
million shares for the total loan outstanding of $17.661 million. The details of
the transactions are listed above.




ITEM
7. FINANCIAL STATEMENTS





Reference
is made to the Index of Financial statements following Part III of this Report
for a listing of the Company’s financial statements and notes
thereto.





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





On October 19, 2007, Marc Lumer &
Company (the "Former Accountant") resigned asourauditors.The Company engaged
PMB+Helin Donovan LLP (the "New Accountant"), as its independent certified
public accountant. The Company's decision to engage the New Accountant was
approved by its Board of Directors on October 19, 2007.





The
reports of the Former Accountant on the financial statements of the Company for
each of the two most recent fiscal years, did not contain an adverse opinion or
disclaimer of opinion and was not qualified or modified as to uncertainty, audit
scope or accounting principles for the two most recent fiscal years, except that
the Former Accountant's opinion in its report on the Company's financial
statements expressed substantial doubt with respect to the Company's ability to
continue as a going concern for the last two fiscal years.





During
the Company's two most recent fiscal years and the subsequent interim period
through the date of resignation, there were no reportable events as the term is
described in Item 304(a)(1)(iv) of Regulation S-B.





During
the Company's two most recent fiscal years and the subsequent interim period
through the date of resignation, there were no disagreement with the Former
Accountant on any matters of accounting principles or practices, financial
statement disclosure or auditing scope or procedure, which, if not resolved to
the satisfaction of the Former Accountant would have caused it to make reference
to the subject matter of the disagreements in connection with its reports on
these financial statements for those periods.




36




The
Company did not consult with the New Accountant regarding the application of
accounting principles to a specific transaction, either completed or proposed,
or the type of audit opinion that might be rendered on the Company's financial
statements, and no written or oral advice was provided by the New Accountant
that was a factor considered by the Company in reaching a decision as to the
accounting, auditing or financial reporting issues.





The
Company has requested that the Former Accountant furnish it with a letter
addressed to the Securities and Exchange Commission stating whether it agrees
with the above statements. The requested letter is attached as Exhibit 16.1 to
this Form 8-K.





ITEM
8A. CONTROLS AND PROCEDURES




Evaluation
and Disclosure Controls and Procedures





Management's Report on Internal
Control Over Financial Reporting





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





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





Our
management, including the chief executive officer and chief financial officer,
has assessed the effectiveness of our internal control over financial reporting
as of December 31, 2007, following the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission in Internal Control -
Integrated Framework.





Based on
our assessment under the framework in Internal Control - Integrated Framework,
the Company's management, including the chief executive officer and chief
financial officer, has concluded that our internal control over financial
reporting was not effective as of December 31, 2007.




Specifically,
we identified ineffective controls over certain processes involving insufficient
knowledge of generally accepted accounting principles which resulted in a
restatement of our 10KSB at December 31, 2006 and our 10QSB filings for each of
the quarters ended March 31, June 30, and September 30 2007; . There were
inadequate processes and procedures for assuring that the documentation of
certain warrant awards properly reflected the non-economic terms of the grants
and that such awards, as documented, were properly recorded under applicable
equity compensation accounting rules. In addition, the information technology department
did not maintain adequate procedures and documentation when implementing system
changes.


Management
recognizes the need to remediate these weaknesses, and has embarked on a plan to
strengthen both the finance and the IT departments





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





Changes
in Internal Controls





There
were no changes to the internal controls, except as described in the previous
paragraph, during the fourth quarter ended December 31, 2007, that have
materially affected or that are reasonably likely to affect the internal
controls.




37




Limitations
on the Effectiveness of Controls





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





ITEM
8B. OTHER INFORMATION





None.








PART
III





ITEM
9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE
GOVERNANCE; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT





The
following sets forth certain information regarding our directors and executive officersas of March 31, 2008:




Name
      of Director
              Age
              Title
              Director
      SinceTony
      K. Shum
              38
              Chairman
      of our Board of Directors
              2006John
      R. Cheney
              49
              Chief
      Executive Officer and Director
              2006Dr.
      Eric Chan
              50
              Chief Technolgy Officer
              2007Phillip
      Radlick, Ph.D.
              69
              Independent
      Consultant Director
              1994Gabriel
      B.Vegh
              67
              Director
              1992Dr.
      Richard (aston
              64
              Director
              2007




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





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





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




38




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





Mr.
Gabriel B. Vegh, our founder was has our Chief Executive Officer from June 2000
through July 2007.  In addition, he was our Acting Chief Financial
Officer from June 2005 through July 2007 and Chairman of our Board of Directors
from May 2001 through that date.  Mr. Vegh has been one of our
directors since November 1992, and served as our President from June 2000 to May
2001. He was our Executive Vice President from January 1995 until June 2000, and
our Chief Operating Officer from November 1994 through January 1995. Mr. Vegh
was our President from May 1993 through November 1994. From August 1985 until
May 1993, Mr. Vegh was the Vice President, Operations of Target Therapeutics,
Inc., which is now a division of Boston Scientific Corporation. From February
1983 until August 1985, Mr. Vegh was General Manager, Pilot Operations of
Advanced Cardiovascular Systems, Inc., which is now a division of Boston
Scientific Corporation. Mr. Vegh received a B.S. in Mechanical Engineering from
the New Jersey Institute of Technology.





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





ITEM
10. EXECUTIVE COMPENSATION





SUMMARY
      COMPENSATION TABLEName
      and principal position
              Year
              
              Salary
      ($)
              
              
              Bonus
      ($)
              
              
              Stock
      Awards ($)
              
              
              Option
      Awards ($)
              
              
              Non-Equity
      Incentive Plan Compensation ($)
              
              
              Nonqualified
      Deferred Compensation Earnings ($)
              
              
              All
      Other Compensation ($)
              
              
              Total
      ($)(a)
              (b)
              
              (c)
              
              
              (d)
              
              
              (e)
              
              
              (f)
              
              
              (g)
              
              
              (h)
              
              
              (i)
              
              
              (j)Robert
      Cheney
              2007
              
              
              0
              
              
              
              -
              
              
              
              -
              
              
              
              70,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              70,0002006
              
              
              0
              
              
              
              -
              
              
              
              -
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              -Eric
      Chan
              2007
              
              
              200,000
              
              
              
              42,000
              
              
              
              -
              
              
              
              70,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              312,0002006
              
              
              200,000
              
              
              
              18,000
              
              
              
              -
              
              
              
              0
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              218,000




(1)  The
fee of $1,408,000 paid in warrants and other assets to Mr. Cheney in connection
with the sale of securities of the Company as described in Note 1 to the
Financial Statements was charged to general and administrative
expenses.  The amount has been excluded from the table above because
the promotion of the sale of securities of the Company is not within the normal
purview of the person’s activities on behalf of the Company.




39




On September 26, 2007, Mr. Cheney was
issued 10 year option to purchase 1,000,000 shares of the Company’s common stock
at an optionprice of$0.44 per share.




Mr. Chan
got a bonus of $42k and
$18K in 2007 and 2006 respectively. On September 26, 2007, Mr. Chan was issued
10 year option to purchase 1,000,000 shares of the Company’s common stock at an
option price of $0.44 per share.




OUTSTANDING
EQUITY AWARDS AT FISCAL YEAR-END


OPTION
      AWARDS
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              STOCK
      AWARDSName
              
              Number
      of Securities Underlying Unexercised Options
              
              
              Number
      of Securities Underlying Unexercised Options
              
              
              Equity
      Incentive Plan Awards: Number of Securities Underlying Unexercised
      Unearned Options
              
              
              Option
      Exercise Price
              
              Option
      Expiration Date
              
              Number
      of Shares or Units of Stock That Have Not Vested
              
              
              Market
      Value of Shares or Units of Stock That Have Not Vested
              
              
              Equity
      Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights
      That Have Not Vested
              
              
              Equity
      Incentive Plan Awards: Market or Payout Value Unearned Shares, Units or
      Other Rights That Have Not Vested(a)
              
              
              (#
              )
              
              
              (#
              )
              
              
              (#
              )
              
              ($)
              
              (f)
              
              
              (#
              )
              
              ($)
              
              
              
              (#
              )
              
              ($)Exercisable
              
              
              Unexercisable
              
              
              (d)
              
              
              (e)
              
              
              
              (g)
              
              
              (h)
              
              
              (i)
              
              
              (j)(b)
              
              
              (c)Richard
      Cheney
              
              
              
              
              
              
              1,000,000
              
              
              
              -
              
              
              $
              0.44
              
              September
      2, 2017
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              -500
              
              
              
              1,500
              
              
              
              -
              
              
              $
              0.50
              
              February
      13, 2016
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              -5,200
              
              
              
              
              
              
              
              -
              
              
              $
              0.70
              
              July
      27, 2016
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              -Eric
      Chan
              
              
              300
              
              
              
              
              
              
              
              -
              
              
              $
              19.10
              
              July
      6, 2009
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              -500
              
              
              
              
              
              
              
              -
              
              
              $
              19.10
              
              July
      6, 2009
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              -7,000
              
              
              
              
              
              
              
              -
              
              
              $
              11.60
              
              July
      21, 2008
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              -2,500
              
              
              
              
              
              
              
              -
              
              
              $
              12.20
              
              October
      4, 2010
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              -2,500
              
              
              
              
              
              
              
              -
              
              
              $
              3.40
              
              April
      6, 2011
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              -16,224
              
              
              
              
              
              
              
              -
              
              
              $
              15.00
              
              February
      6, 2012
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              -13,921
              
              
              
              
              
              
              
              -
              
              
              $
              10.30
              
              March
      5, 2013
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              -1,080
              
              
              
              
              
              
              
              -
              
              
              $
              10.30
              
              March
      5, 2013
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              -7,500
              
              
              
              625
              
              
              
              -
              
              
              $
              10.40
              
              February
      12, 2014
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              -6,875
              
              
              
              
              
              
              
              -
              
              
              $
              10.40
              
              February
      12, 2014
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              -13,021
              
              
              
              11,979
              
              
              
              -
              
              
              $
              0.60
              
              November
      10, 2015
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              --
              
              
              
              1,000,000
              
              
              
              -
              
              
              $
              0.11
              
              September
      26, 2017
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              -




Compensation of
Directors:





DIRECTOR
      COMPENSATIONName
              
              Fees
      Earned or Paid in Cash
              
              
              Stock
      Awards ($)
              
              
              Option
      Awards ($)
              
              
              Non-Equity
      Incentive Plan
              
              
              Non-Qualified
      Deferred Compensation Earnings
              
              
              All
      other Compensation($)
              
              
              Total($)
              
              
              
              
              
              
              
              
              Compensation
      ($)
              
              
              ($)
              
              
              ($)
              
              
              ($)(a)
              
              (b)
              
              
              
              
              
              (d)
              
              
              (e)
              
              
              (f)
              
              
              (g)
              
              
              (j)Richard
      Gaston
              
              
              -
              
              
              
              -
              
              
              $
              109,075
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              109,075Andrew
      K. Lee
              
              
              -
              
              
              
              -
              
              
              $
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Phil
      Radlick
              
              
              -
              
              
              
              -
              
              
              $
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Tony
      Shum
              
              
              -
              
              
              
              -
              
              
              $
              436,300
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              436,300Tina
      Sim
              
              
              -
              
              
              
              -
              
              
              $
              21,815
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              21,815Gabriel
      Vegh
              
              
              -
              
              
              
              -
              
              
              $
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Ms.
      Tina Sim and Mr. Andrew K. Lee resigned from the Board on October 5,
      2007





Directors
receive nocash
remuneration for their services as directors at this time.




40




The
following is the list of Directors who were on the Board of Directors in
2007.




Phil
Radlick director since 1994, has been granted non-qualified option for Directors
to purchase 5000 shares of the Company’s common stock at an option price of
$8.70 per share on May 20, 2004, 800 shares of the Company’s common stock at an
varying prices between $8.40 to $14.50 per share between May 5, 2001 through
June 6, 2005, and 5,200 shares of the Company’s common stock at an option price
of $0.70 per share on July 27, 2007





Dick
Gaston, since Oct5, 2007, was issued 10 year option to purchase 250,000 shares
of the Company’s common stock at an option price of $0.44 per
share.





Tina Sim,
director since 2006, was issued 10-year option to purchase 50,000 shares of the
Company’s common stock at an option price of $0.44 per share. On December 5,
2007, the Board approved immediate vesting of these options. She was also was
granted non-qualified option for Directors to purchase  500 shares of
the Company’s common stock at an option price of $0.30 per share on April 24,
2006 and 5,200  shares of the Company’s common stock at an option
price of $0.70 per share on July, 27, 2006





Andrew K.
Lee, director from 2006 thru October 5, 2007 was granted non-qualified option to
purchase 500 shares of the Company’s common stock at an option price of $0.30
per share on April 24, 2006 and 5,200 shares of the Company’s common stock at an
option price of $0.70 per share on July, 27, 2006.





Mr. Gabriel Vegh has no options
outstanding.


.


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





The
following table sets forth certain information known to the Company with respect
to the beneficial ownership of the Company’s common stock as of December 31,
2007 by (i) each person who is known by the Company to own beneficially more
than 5% of the Company's common stock and (ii) all officers and directors of
Cardima as a group.




41





Shares
      beneficially ownedStockholder
              
              Number
      of shares
              
              
              Percentage
      of class (2)Peter
      L Yuan (4)
              
              
              39,182,200
              
              
              
              31.02
              %24F
      Block 48 Bagulo Villa550
      Victoria RoadPokfulam,
      ChinaVictor
      Shui Kwai Lee & Agnes (3)
              
              
              45,766,126
              
              
              
              36.23
              %Wing
      Chi Li Jtten54
      LaSalle Road, 2nd
      FloorKowloon
      TongKowloon,
      Hong KongJohn
      R. Cheney (2)
              
              
              27,807,200
              
              
              
              22.01
              %Nelson
      Capital Corporation24F
      Block 48Bagulo
      Villa550
      Victoria RoadPokfulam,
      ChinaTony
      K. Shum
              
              
              1,007,200
              
              
              
              0.87
              %Dr.
      Eric Chan
              
              
              1,132,597
              
              
              
              0.90
              %Philip
      Radlick, PhD
              
              
              11,000
              
              
              
              0.01
              %Gabriel
      B. Vegh
              
              
              226,989
              
              
              
              0.18
              %Dr.
      Richard Gaston
              
              
              265,431
              
              
              
              0.21
              %Ms.
      Tina Sim
              
              
              55,700
              
              
              
              0.04
              %Andrew
      K. Lee
              
              
              5,700
              
              
              
              0.00
              %Total
              
              
              115,460,143
              
              
              
              91.47
              %




(1)
Beneficial Ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or investment
power with respect to securities. Shares of common stock subject to options or
warrants currently exercisable or convertible, or exercisable or convertible
within 90 days of December 31, 2005 are deemed outstanding for computing the
percentage of the person holding such option or warrant but are not deemed
outstanding for computing the percentage of any other person. Except as pursuant
to applicable community property laws, the persons named in the table have sole
voting and investment power with respect to all shares of common stock
beneficially owned.





(2) Includes
16,800,000  shares held by Nelson Capital Corporation of which Mr.
Cheney is a director.  Also includes 10,000,000 shares issuable upon
conversion of 5,000,000 shares of Series A Preferred Stock (the "Series A")
held by Apix International Limited of which Mr. Cheney is a director and
principal shareholder.  The Series A vote on an as converted
basis.  Although the certificate of designation for the Series A that
is currently on file with the State of Delaware states that each share of Series
A votes on a 28 for 1 basis, the Company and Apix have agreed to amend the terms
of the Series A to reduce the voting rights to two for
one




(3)
22,244,800 shares were issued to Victor Shui Kwai Lee pursuant to a Debt
Settlement Agreement entered in to between the Company and Apix International
Limited. 317,711 shares were purchased by Mr. Lee prior to the agreement. In
addition 20,000,000 shares were issued to Asia Peak holdings Ltd. pursuant to a
Debt Settlement Agreement entered in to between the Company and Apix
International Limited. Mr. Lee is a majority owner in the company. The number of
shares does not include 652,500 shares issuable upon exercise of warrants that
may not be exercised before 6/17.




42




(4) The
29,182,200 shares were issued to Peter L. Yuan pursuant to a Debt Settlement
Agreement entered in to between the Company and Apix International Limited.
Cardima, Inc. (the Company) issued 10,000,000 shares of common shares to Mr.
Yuan in connection with the December 2007 financing by the
company.  The number of shares does not include 1,500,000 shares
issuable upon exercise of warrants that may not be exercised before
6/17.


.


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





As
previously disclosed, the Company’s former President and Chief Operating
Officer, Mr. William K. Wheeler, has threatened to sue the Company for the
recovery of $375,000 plus interest, which he has claimed that he was owed under
the terms of his amended executive agreement. He made a settlement proposal,
which would extinguish his repayment obligation on the loan that he had received
from the Company in June 2000 and May 2001, in the total principal amount of
$192,500.





In
December 2006, a settlement agreement was reached in principle, which the
Company would pay $295,000 to Mr. Wheeler ($5,000 per month for 59 months). In
accordance with the Accounting Principle Board (“APB”) No. 21, “Interest on
Receivables and Payables”, the $295,000 note payable is discounted at 10% (same
as the interest rate on the current loan financing) and the $192,500 note
receivable is discounted at 6% (the original note’s interest rate). The
discounted value of the note payable and note receivable is $232,287 and
$162,022, respectively. The net of these two values of $70,265 is the note
payable balance as of December 31, 2006.





As part
of the December 17, 2007 agreement with Apix waived its five-percent common
share placement fee and accepted for its services rendered, all rights, title
and interest in a loan totaling $360,000, including accrued interest, owed to
the Company by Phil Radlick, a Director, with a guarantee by
the Company that the minimum recoverable value of the loan is not less than
$100,000.  In the event the actual amount recovered is less than
$100,000, the Company agrees to pay to Apix the amount of shortfall on or before
December 18, 2008.





In
December 2007, Apix International Limited (“Apix”) acted as placement agent in a
financing transaction in which the Company raised an aggregate of
$9,000,000.  Apix is owned by Robert Cheney, our Chief Executive
Officer and a Director.  In consideration for the services provided,
the Company agreed to compensate Apix as follows: (i) three million warrants to
purchase shares of the Company’s common stock at an exercise price of $0.55; and
(ii) all rights, title and interest in a loan totaling $360,000, including
accrued interest, owed to the Company by Phil Radlick, with a guarantee by the
Company that the minimum recoverable value of the loan is not less than
$100,000.  In the event the actual amount recovered is less than
$100,000, the Company agrees to pay to Apix the amount of shortfall on or before
December 18, 2008.




43




ITEM
13. EXHIBITS





3.1
              Amended
      and Restated Certificate of Incorporation of Cardima, Inc. (as
      incorporated by reference to the Company’s Annual Report on Form 10-K for
      the year ended December 31, 2003 filed with the Securities and Exchange
      Commission on March 31,
2004).





3.1a
              Certificate
      of Elimination of Series A Participating Preferred Stock (as incorporated
      by reference to the Company's Form 8-K filed with the Securities and
      Exchange Commission on June 8,
2008).





3.1b
              Certificate
      of Designation Series A Preferred Stock (as incorporated by reference to
      the Company's Form 8-K filed with the Securities and Exchange Commission
      on June 8, 2008).





3.2
              Bylaws
      of Cardima, Inc. (as incorporated by reference to the Company’s
      Registration Statement on Form S-1 (File No. 33-23209) declared effective
      on June 5, 1997).





4.1
              Form
      of Grid Note dated June 7, 2007 (included
  herein).





4.2
              Form
      of Warrant dated June 7, 2007 (included
herein).





4.3
              Form
      of Warrant dated December 17, 2007 ((incorporated by reference to the
      Company’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on December 26, 2007).





10.1
              1993
      Stock Option Plan, as amended (Incorporated by reference to Exhibit 10.1
      filed with the Company’s Annual Report on Form 10-K (File No. 000-22419)
      filed on March 31, 2003)





10.2
              1997
      Directors’ Stock Option Plan (Incorporated by reference to the exhibit of
      the same number filed with the Company’s Registration Statement on Form
      S-1 (File No. 33-23209) declared effective on June 5,
    1997).





10.3
              1997
      Employee Stock Purchase Plan (Incorporated by reference to the exhibit of
      the same number filed with the Company’s Registration Statement on Form
      S-1 (File No. 33-23209) declared effective on June 5,
    1997).





10.4
              2003
      Stock Option Plan (Incorporated by reference to Exhibit 99.1 filed with
      the Company’s Registration Statement on Form S-8 (File No. 333-106922)
      filed on July 10, 2003).





10.5
              Loan
      Agreement dated August 28, 2005 by and between Apix International Limited
      and Cardima, Inc. (as incorporated by reference to the Company's Form 8-K
      filed with the Securities and Exchange Commission on September 1,
      2005).





10.6
              10%
      Promissory Note of Cardima, Inc. dated August 26, 2005 (as incorporated by
      reference to the Company's Form 8-K filed with the Securities and Exchange
      Commission on September 1,
2005).





10.7
              Warrant
      Agreement to purchase shares of the common stock of Cardima, Inc. dated as
      of August 28, 2005 (as incorporated by reference to the Company's Form 8-K
      filed with the Securities and Exchange Commission on September 1,
      2005).





10.8
              Security
      Agreement dated August 12, 2005, by and between Cardima, Inc. and Apix
      International Limited (as incorporated by reference to the Company's Form
      8-K filed with the Securities and Exchange Commission on August 16,
      2005).





10.9
              Trademark
      Security Agreement dated August 12, 2005, by and between Cardima, Inc. and
      Apix International Limited (as incorporated by reference to the Company's
      Form 8-K filed with the Securities and Exchange Commission on August 16,
      2005).





10.10
              Patent
      Security Agreement dated August 12, 2005, by and between Cardima, Inc. and
      Apix International Limited (as incorporated by reference to the Company's
      Form 8-K filed with the Securities and Exchange Commission on August 16,
      2005).





10.11
              Patent,
      Trademark and Copyright Security Agreement dated August 12, 2005, by and
      between Cardima, Inc. and Apix International Limited (as incorporated by
      reference to the Company's Form 8-K filed with the Securities and Exchange
      Commission on August 16,
2005).





10.12
              Loan
      Facility Term Sheet (as incorporated by reference to the Company’s Current
      Report on Form 8-K filed with the Securities and Exchange Commission on
      February 21, 2006).





10.13
              Loan
      Agreement dated June 7, 2007 (included
herein).





10.14
              Patent
      Security Agreement dated June 7, 2007 (included
  herein).





10.15
              Trademark
      Security Agreement dated June 7, 2007 (included
  herein).





10.16
              Patent,
      Trademark and Copyright Security Agreement dated June 7, 2007 (included
      herein).





10.17
              Debt
      Settlement Agreement dated October 3, 2007 (incorporated by reference to
      the Company’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on October 9,
2007).





10.18
              Form
      of Subscription Agreement dated December 17, 2007 (incorporated by
      reference to the Company’s Current Report on Form 8-K filed with the
      Securities and Exchange Commission on December 26,
  2007).





10.19
              Funding
      Agreement dated October 5, 2007 (incorporated by reference to the
      Company’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on December 26,
2007).





10.20
              Amendment
      to Funding Agreement dated December 14, 2007 (incorporated by reference to
      the Company’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on December 26,
2007).





16.1
              Letter
      from Former Accountant dated as of September 22, 2005 (as incorporated by
      reference to the Company’s Current Report on Form 8-K filed with the
      Securities and Exchange Commission on October 21,
  2005).





31.1
              Certification
      of the Chief Executive Officer and Chief Financial Officer pursuant to
      Item 601(b)(31) of Regulation S-B, as adopted pursuant to Section 302 of
      the Sarbanes-Oxley Act of
2002.





32.1
              Certification
      of the Chief Executive Officer and Chief Financial Officer pursuant to 18
      U.S.C. Section 1350 as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.




44





ITEM
14. Principal
Accountant Fees and Services





On October 19, 2007, Marc Lumer &
Company (the "Former Accountant") resigned asourauditors.The Company engaged PMB+Helin Donovan
LLP (the "New Accountant"), as its independent certified public
accountant.




NEW
      ACCOUNTANT
              
              For
      the Year Ended December 31,
                2007Audit
      Fees
              
              $
              65,000Audit-Related
      Fees
              
              $
              63,164Tax
      Fees
              
              $
              0All
      Other Fees
              
              $
              0Total
      Fees
              
              $
              128,164




"Audit
Fees" consisted of fees billed for services rendered for the audit of the
Company’s annual financial
statements and audit related fees are for review of the financial statements
included in the Company’s
quarterly reports on Form 10-QSB. The
Company paid or accrued the following fees in 2007 its independent certified
public accountants,
  PRIOR ACCOUNTANT
              
              For
      the Year Ended December 31,
                2006
      and 2007Audit
      Fees
              
              $
              159,024Audit-Related
      Fees
              
              $
              12,485Tax
      Fees
              
              $
              0All
      Other Fees
              
              $
              35,674Total
      Fees
              
              $
              207,399




"Audit
Fees" consisted of fees billed for services rendered for the audit of the
Company’s annual financial
statements and audit related fees are for review of the financial
statementsincluded in the Company’s
quarterly reports on Form 10-QSB. Other
Fees” consisted of fees associated with the Sarbanes 404
work.




45





SIGNATURES





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





CARDIMA,
      INC.April
      17, 2007
              By:
              /s/ John.
      R. CheneyChief
      Executive Officer


POWER
OF ATTORNEY





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





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





NAME
            
            TITLE
            
            DATE/s/
      Tony R. Shum
            
            Chairman
      of the Board
            
            April
      15,
    2008Tony
      R. Shum/s/
      Phillip Radlick, Ph.D.
            
            Director
            
            April
      15,
    2008Phillip
      Radlick, Ph.D./s/
      John R. Cheney
            
            Chief
      Executive Officer
            
            April
      15,
    2008John
      R. Cheney/s/
      Richard Gaston
            
            Director
            
            April
      15,
    2008Richard
      GastonDirector
            
            April
      ___, 2008Gabriel
      B. Vegh/s/ Eric Chan
            
            Director
            
            April
      15, 2008Eric
      Chan










46




CARDIMA, INC.





INDEX TO
FINANCIAL STATEMENTS











PAGEReport
      of  Independent Registered Public Accounting
Firm
            F-2Balance
      Sheet at December 31, 2007
            F-3Statements
      of Operations for the years ended December 31, 2007 and 2006
      restated
            F-4Statements
      of Stockholders’ Equity (Deficit)for
      the years ended December 31, 2007, and 2006 restated
            F-5Statements
      of Cash Flows for the years ended December 31, 2007 and 2006
      restated
            F-6Notes
      to Financial Statements
            F-7
      - F-38





F-1




REPORT OF
PMB HELIN DONOVAN, LLP


INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM














The Board
of Directors and Stockholders


Cardima,
Inc.







We have
audited the accompanying balance sheet of Cardima, Inc. as of December 31, 2007
and the related statements of operations, stockholders’ equity (deficit), and
cash flows for the year ended December 31, 2007. These financial statements are
the responsibility of the Company’s management. Our responsibility is to express
an opinion on these financial statements based on our audit.




We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company has determined that it
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.




In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Cardima, Inc. at December 31, 2007
and the results of its operations and its cash flows for the year ended December
31, 2007 in conformity with accounting principles generally accepted in the
United States of America.




The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in Note 1 to the financial
statements, the Company has suffered recurring losses from operations that raise
substantial doubt about its ability to continue as a going concern. Management’s
plans in regard to these matters are also described in Note 1. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.




/s/ PMB
Helin Donovan


San
Francisco, California




April 14,
2008





F-2







REPORT OF
MARC LUMER & COMPANY,




INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM









The Board
of Directors and Stockholders




Cardima,
Inc.




We
have audited the accompanying  the related statements of operations,
stockholders’ equity (deficit), and cash flows of Cardima, Inc.for year ended
December 31, 2006 . 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 audit.




We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company has determined that it
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.




In our
opinion, the financial statements referred to above present fairly, in all
material respects,   the results of  operations
and  cash flows of Cardima, Inc. for the years ended December 31,
2006  in conformity with accounting principles generally accepted in
the United States of America.




The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in Note 1 to the financial
statements, the Company has suffered recurring losses from operations that raise
substantial doubt about its ability to continue as a going concern. Management’s
plans in regard to these matters are also described in Note 1. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.




As
discussed in Note 2 to the financial
statements, the Company has restated its financial statements for the year ended
December 31, 2006 to properly reflect the accounting for, extinguishment of debt
and accrual of derivative excess authorized share liability, related to
convertible debt.






Marc
Lumer & Company


San
Francisco, California


April 17,
2007 except for the effects of
the restatement  as




Disclosed in Note2




April 14,
2008







F-3




CARDIMA,
INC.


BALANCE
SHEET


(In
thousands, except per share amounts)


ASSETS
                
                December
      31, 2007Current
      assets:Cash
                
                $
                4,811Accounts
      receivable, net of allowances for doubtful accounts of $77
                
                
                183Short
      term investment
                
                
                2,008Inventories
                
                
                402Prepaid
      expenses
                
                
                46Other
      current assets
                
                
                131Total
      current assets
                
                
                7,581Property
      and equipment, net
                
                
                362Other
      assets
                
                
                61TOTAL
      ASSETS
                
                $
                8,004LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable
                
                $
                443Accrued
      liabilities
                
                
                911Notes
      payable to related parties - current portion
                
                
                10Capital
      leases - current portion
                
                
                24Payable
      related party
                
                
                175Total
      current liabilities
                
                
                1,563Capital
      leases - noncurrent portion
                
                
                7Notes
      payable to related parties - noncurrent portion
                
                
                53TOTAL
      LIABILITIES
                
                
                1,623Stockholders'
      Equity:Preferred
      stock, $0.001 par value, liquidation preference of $0.10, 5,000,000 shares
      authorized, 5,000,000 issued and outstanding.
                
                
                500Common
      stock, $0.001 par value, 300,000,000 shares authorized, 116,316,311 shares
      issued and outstanding
                
                
                116Additional
      paid-in-capital
                
                
                182,324Accumulated
      deficit
                
                
                (176,559
                )Total
      Stockholders' Equity
                
                
                6,381TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                
                $
                8,004




The
accompanying notes are an integral part of these financial
statements




F-4




CARDIMA,
INC.


STATEMENTS
OF OPERATIONS
 (In
thousands, except per share amounts)


Year
      Ended December 31, 2007
                
                
                Year
      Ended December 31, 2006 (Restated)Net
      sales
                
                $
                1,157
                
                
                $
                1,541Cost
      of goods sold
                
                
                1,613
                
                
                
                2,023Gross
      deficiencies
                
                
                (456
                )
                
                
                (482
                )Operating
      expenses:Research
      and development
                
                
                3,091
                
                
                
                1,787Selling,
      general and administrative
                
                
                5,203
                
                
                
                2,987Total
      operating expenses
                
                
                8,294
                
                
                
                4,774Operating
      loss
                
                
                (8,750
                )
                
                
                (5,256
                )Other
      income (expenses):Interest
      income
                
                
                26
                
                
                
                1Interest
      expense
                
                
                (891
                )
                
                
                (1,754
                )Other
      income
                
                
                17
                
                
                
                -Loss
      on debt extinguishment
                
                
                (15,182
                )
                
                
                (2,256
                )Loss
      on excess shares over authorized
                
                
                (7,737
                )
                
                
                (2,886
                )Loss
      on debt settlement
                
                
                (10,129
                )
                
                
                -Total
      other income (expenses)
                
                
                (33,896
                )
                
                
                (6,895
                )Net
      loss
                
                $
                (42,646
                )
                
                $
                (12,151
                )Basic
      and diluted net loss per share
                
                $
                (1.31
                )
                
                $
                (1.19
                )Shares
      used in computing basic and diluted net loss per share
                
                
                32,442
                
                
                
                10,170




The
accompanying notes are an integral part of these financial
statements




F-5





CARDIMA,
Inc.
 Statements
of Stockholders’ Equity (Deficit)
 (In
thousands)


No.
      of Shares
                Common
      Stock
                
                Paid-In-Capital
                
                
                Preferred
      Stock
                
                
                Accumulated
      Deficit
                
                
                Total
      Stockholders’ EquityBalance
      at December 31, 2005
                
                
                10,162
                
                
                $
                9
                
                
                $
                117,991
                
                
                $
                -
                
                
                $
                (121,762
                )
                
                $
                (3,762
                )Common
      stock issued under employee stock plans
                
                
                70
                
                
                
                
                
                
                
                28
                
                
                
                
                
                
                
                -
                
                
                
                28Common
      stock issued to non-employees
                
                
                3
                
                
                
                -
                
                
                
                
                
                
                
                
                
                
                
                -
                
                
                
                -Expense
      for vesting of stock options granted to employees
                
                
                -
                
                
                
                -
                
                
                
                390
                
                
                
                
                
                
                
                -
                
                
                
                390Relative
      fair value of warrants issued and beneficial conversion
      feature
                
                
                2,776
                
                
                
                
                
                
                
                -
                
                
                
                2,776Net
      Loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                
                
                
                
                (12,151
                )
                
                
                (12,151
                )Balance
      at December 31, 2006 (restated)
                
                
                10,235
                
                
                $
                9
                
                
                $
                121,185
                
                
                $
                -
                
                
                $
                (133,913
                )
                
                $
                (12,719
                )Common
      stock issued under employee stock plans
                
                
                75
                
                
                
                1
                
                
                
                34
                
                
                
                -
                
                
                
                -
                
                
                
                35Common
      stock issued for services
                
                
                6
                
                
                
                
                
                
                
                3
                
                
                
                -
                
                
                
                -
                
                
                
                3Expense
      for vesting of stock options granted to employees
                
                
                488
                
                
                
                -
                
                
                
                -
                
                
                
                488Relative
      fair value of warrants issued and beneficial conversion
      feature
                
                
                12,073
                
                
                
                -
                
                
                
                -
                
                
                
                12,073Warrants
      issued as compensation expense
                
                
                
                
                
                
                
                1,234
                
                
                
                -
                
                
                
                -
                
                
                
                1,234Conversion
      of Debt to Common stock and repurchase of warrants
                
                
                88,000
                
                
                
                88
                
                
                
                27,702
                
                
                
                -
                
                
                
                -
                
                
                
                27,790Sale
      of common stock
                
                
                18,000
                
                
                
                18
                
                
                
                8,982
                
                
                
                -
                
                
                
                -
                
                
                
                9,000Preferred
      Stock issued for fees (5,000,000 shares)
                
                
                
                
                
                
                -
                
                
                
                500
                
                
                
                -
                
                
                
                500Reclassification
      of derivative liability for excess shares to paid-in
    capital
                
                
                -
                
                
                
                10,623
                
                
                
                -
                
                
                
                -
                
                
                
                10,623Net
      Loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                -
                
                
                $
                (42,646
                )
                
                $
                (42,646
                )Balance
      at December 31, 2007
                
                
                116,316
                
                
                $
                116
                
                
                $
                182,324
                
                
                $
                500
                
                
                $
                (176,559
                )
                
                $
                6,381




The
accompanying notes are an integral part of these financial
statements




F-6




CARDIMA,
INC.


STATEMENTS
OF CASH FLOWS


(In
thousands)





Years Ended December
      31,2007
                
                
                2006
      (Restated)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
                
                $
                (42,646
                )
                
                $
                (12,151
                )Adjustments
      to reconcile net loss to net cash used in operating activities provided by
      operations:Depreciation
      and amortization
                
                
                97
                
                
                
                123Non-cash
      stock-based compensation
                
                
                491
                
                
                
                391Non-cash
      interest expense
                
                
                649
                
                
                
                -Loss
      on excess shares over authorized
                
                
                7,737
                
                
                
                2,886Loss
      on debt extinguishment
                
                
                15,182
                
                
                
                2,256Loss
      on debt settlement
                
                
                10,129
                
                
                
                -Preferred
      Shares issued for fees
                
                
                500Non-cash
      compensation
                
                
                1,234Non-cash
      expense relating to net change in cash settlement terms
                
                
                
                
                
                
                520Change
      in warrant liability
                
                
                -
                
                
                
                (1,200
                )Excess
      and obsolete inventory
                
                
                37
                
                
                
                (18
                )Write-off
      of interest income
                
                
                -
                
                
                
                (26
                )Allowance
      for doubtful accounts
                
                
                63
                
                
                
                (12
                )Changes
      in operating assets and liabilities:
                
                
                -
                
                
                
                -Accounts
      receivable
                
                
                168
                
                
                
                (138
                )Inventories
                
                
                (116
                )
                
                
                81Prepaid
      and other assets
                
                
                18
                
                
                
                396Accounts
      payable, accrued compensation and other liabilities
                
                
                (112
                )
                
                
                120Notes
      payable
                
                
                (7
                )
                
                
                70Accrued
      fees
                
                
                (111
                )
                
                
                2,164Net
      cash used in operating activities
                
                
                (6,686
                )
                
                
                (4,538
                )CASH
      FLOWS FROM INVESTING ACTIVITIESShort-term
      investment
                
                
                (2,008
                )
                
                
                -Purchase
      of property and equipment
                
                
                (177
                )
                
                
                (112
                )Net
      cash used in investing activities
                
                
                (2,185
                )
                
                
                (112
                )CASH
      FLOWS FROM FINANCING ACTIVITIESPrincipal
      payments under capital leases and credit facility
                
                
                (15
                )
                
                
                (20
                )Net
      proceeds from loan financing
                
                
                3,720
                
                
                
                5,460Net
      proceeds from sale of common stock
                
                
                9,035
                
                
                
                28Net
      cash provided by financing activities
                
                
                12,740
                
                
                
                5,468Change
      in cash and cash equivalents
                
                
                3,870
                
                
                
                818Beginning
      cash and cash equivalents
                
                
                942
                
                
                
                124Ending
      cash and equivalents
                
                $
                4,811
                
                
                $
                942SUPPLEMENTAL
      DISCLOSURE OF CASH FLOWS INFORMATIONCash
      paid for income taxes
                
                $
                -
                
                
                $
                -Cash
      paid for interest
                
                $
                10
                
                
                $
                6SUPPLEMENTAL
      SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIESConversion
      of debt to equity
                
                $
                10,129Preferred
      Shares issued for fees
                
                $
                500Debt
      Extinguishment
                
                $
                15,182
                
                
                
                2,256Equipment
      acquired under capital lease arrangements
                
                $
                -
                
                
                $
                37Warrants
      issued for loan financing
                
                $
                -
                
                
                $
                1,422




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




F-7





CARDIMA,
INC.


Notes
to Financial Statements


December
31, 2007







1. Nature of Business and Summary of
Significant Accounting Policies




Nature
of Business




Cardima,
Inc., (“The Company”) was incorporated in the State of Delaware on November 12,
1992. The Company designs, develops, manufactures and markets minimally
invasive, single-use, micro-catheter 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 micro-catheter technology
for use in the treatment of electrophysiological diseases affecting areas other
than the central nervous system from Target Therapeutics. The Company sells its
products worldwide through both direct sales and distribution channels, with a
substantial portion of its sales to international customers.




Going
Concern




The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the settlement of liabilities
and commitments in the normal course of business. As reflected in the
accompanying financial statements, as of December 31, 2007, the Company had cash
on hand of $4,811,000, positive working capital of $6,018,000, and an
accumulated deficit of approximately $176,559,000. Cardima had a net loss of
$42,646,000 and $12,151,000 for the years ending December 31, 2007 and 2006
respectively.  In October 2007, Cardima and its major creditor Apix
International, Ltd., (“Apix”) reached an agreement to convert all of its
outstanding debt, $17,661,000 into equity, which resulted in Apix becoming the
majority stockholder of the company.




These
matters, among others, raise substantial doubt about the Company’s ability to
continue as a going concern.  In view of the matters described above,
recoverability of a major portion of the recorded asset amounts shown in the
accompanying consolidated balance sheet is dependent upon the Company’s
ability to generate sufficient sales volume to cover its operating expenses and
to raise sufficient capital to meet its payment
obligations.  Management is taking action to address these matters,
which include:




·
            Retaining
      and hiring experienced management personnel with particular skills in the
      development and sale of its products and
  services.


·
            Developing
      new markets and expanding its sales
efforts.


·
            Evaluating
      funding strategies in the public and private
  markets.





Historically,
management has been able to raise additional capital. During the December 2007,
the Company obtained equity capital of $9 million through the sale of common
stock and warrants. The consolidated financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts, or amounts and classification of liabilities that might be necessary
should the Company be unable to continue in existence. The successful outcome of
future activities cannot be determined at this time and there is no assurance
that if achieved, the Company will have sufficient funds to execute its intended
business plan or generate positive operating results.





Reverse
Stock split





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








Reverse
            Percentage
            Post-splitStock
      Split
            Reduction
            Shares1 for
      10
            90%
            10,235,486







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




F-8




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




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




Restatement




The
Company has restated it’s previously issued 2006 financial statements for
matters related to the following previously reported items: accounting for debt
modification; loss on debt extinguishment; accounting for warrant liabilities;
convertible debentures; and a liability for excess shares over the authorized
share amount; and the related income tax effects. The accompanying financial
statements for 2006 have been restated to reflect the
corrections.  (see Note 12)





On
November 16, 2007, in connection with the preparation of the quarterly report on
Form 10-QSB for the quarterly period ended September 30, 2007 of Cardima, Inc.
(the “Company”), the Company’s Board of Directors determined that its previously
issued financial statements as of and for the three-month period ended June 30,
2007 included in its Quarterly Report on Form 10-QSB as filed with the
Securities and Exchange Commission on August 30 , 2007 (the “Q2 2007 Form
10-QSB”), should no longer be relied upon as a result of incorrect accounting
for certain non-cash debt extinguishment. This had the effect of understating
the Company's Net Loss Attributable to Common Stockholders by approximately
$21.7 million or $2.21 per share. As originally stated for the three and six
months ended June 30, 2007, Net Income (loss) and Net Income (loss) per share
were $4,367,000, $0.42  and $(2,657,000), $(0.26) respectively.  As
restated for the three and six months ended June 30, 2007, Net (loss) and Net
(loss) per share were $(17.4) million, $(1.69) and $(27.2) million, $(2.65)
respectively.





Additionally,
the Company determined that its previously issued financial statements as of and
for the three-month periods ended March 31, 2006; June 30, 2006; September 30,
2006; March 31, 2007; September 30, 2007, and the year ended December 31, 2006
should no longer be relied upon as a result of the Company's determination that
it had incorrectly accounted for the non-cash extinguishment of debt and
commitment of unauthorized shares.




Use
of Estimates




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





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





Revenue
Recognition




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





Comprehensive
Income




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





F-9





Inventories




Inventories
are stated at the lower of cost or market value.  Cost is determined
by the first-in, first-out method and market represents the estimated net
realizable value. We base our provisions for excess, obsolete or expired
inventory primarily on a percentage based on our aged category and on our
production levels. A significant change in the timing or level of demand for our
products as compared to forecasted amounts may result in recording additional
provisions for excess, obsolete or expired inventory in the future. The industry
in which we participate is characterized by rapid product development and
frequent new product introductions. Uncertain timing of next-generation product
approvals, variability in product launch strategies, product recalls and
variation in product utilization all affect the estimates related to excess and
obsolete inventory.




Assets
Held as Leasehold Improvements




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


Cost
of Goods Sold





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





Research
and Development




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




Impairment
of Long-Lived Assets




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




The
Company reviews the carrying value of property and equipment for impairment
whenever events and circumstances indicate that the carrying value of an asset
may not be recoverable from the estimated future cash flows expected to result
from its use and eventual disposition. In cases where undiscounted expected
future cash flows are less than the carrying value, an impairment loss is
recognized equal to an amount by which the carrying value exceeds the fair value
of assets. The factors considered by management in performing this assessment
include current operating results, trends, and prospects, as well as the effects
of obsolescence, demand, competition, and other economic factors. During the
year ended December 31, 2007, the Company believes that there has been no
indicator of impairment.





Reclassification





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




Income
Taxes




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





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





F-10




Stock
Based Compensation





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


Stock
compensation expense recognized during the period is based on the value of
share-based awards that are expected to vest during the period. Stock
compensation expense recognized in the Company’s statements of operations for
2007 and 2006 include compensation expense related to share-based awards granted
prior to January 1, 2006 that vested during 2007 and 2006 based on the
grant date fair value estimated in accordance with the pro forma provisions of
SFAS 123. Stock compensation expense in 2007 and 2006 also includes
compensation expense for the share-based awards granted subsequent to
January 1, 2006 based on the grant date fair value estimated in accordance
with the provisions of SFAS 123(R).




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




Net
Loss per Share




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





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





2007
            
            2006Options
      to purchase common stock
            
            
            5,988,496
            
            5,108,628Warrants
      to purchase common stock
            
            
            5,700,000
            
            75,793,526Total
            
            
            11,688,496
            
            80,902,154





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




2007
            
            
            2006
      (Restated)Net
      loss available to common shareholders
            
            $
            (42,646
            )
            
            $
            (12,151
            )Weighted
      average common shares outstanding
            
            
            32,442
            
            
            
            10,170Basic
      and diluted net loss per share available to common
      shareholders
            
            $
            (1.31
            )
            
            $
            (1.19
            )




F-11




Cash
and Cash Equivalents




Cash and
cash equivalents include all cash balances and highly liquid investments with an
initial maturity of three months or less. The Company places its temporary cash
investments with high credit quality financial institutions. At times such
investments may be in excess of the Federal Deposit Insurance Corporation (FDIC)
insurance limit. As of December 31, 2007, the Company maintains its cash and
cash equivalents with a major bank.


.


Accounts
Receivables and Allowance for Doubtful Accounts




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





Short-Term
Investments





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





Property
and Equipment





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




Deferred
Financing Costs





Costs
relating to obtaining debt financing are capitalized and amortized over the term
of the related debt using the effective interest method. When a loan is paid in
full, any unamortized financing costs are removed from the related accounts and
charged to interest expense.





Comprehensive
Loss





Comprehensive
loss consists of net loss and other gains and losses affecting stockholders’
equity that, under generally accepted accounting principles are excluded from
net loss in accordance with Statement of Financial Accounting Standards No. 130,
Reporting Comprehensive
Income.  The Company, however, does not have any components of
other comprehensive loss as defined by SFAS No. 130 and therefore, for the years
ended December 31, 2007 and 2006, comprehensive loss is equivalent to the
Company’s reported net loss.  Accordingly, a statement of
comprehensive loss is not presented.





CLASSIFICATION
OF FINANCIAL INSTRUMENTS





In
accordance to FASB Statement of Financial Accounting Standards ("SFAS") 150,
"Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity", financial instruments with a mandatory redemption
rights are to be recorded as liabilities unless the redemption is to occur upon
the liquidation or termination of the issuer. SFAS 150 also specifies that a
financial instrument that embodies a conditional obligation is based solely or
predominantly on variations inversely related to changes in the fair value of
the issuer's equity shares. Based on these characteristics, the Company has
recorded the value of warrants issued and the outstanding shares of Preferred
Stock Series X as a component of equity on the balance sheet. See Note 9,
Preferred Series Shares.




F-12




Accounting for Convertible
Debt Securities





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





Extinguishment of
Debt





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





From  the  debtor's  perspective,  an  exchange
of debt instruments between or a modification  of  a debt
instrument by a debtor and a creditor in a non-troubled
debt  situation  is  deemed to have been
accomplished with debt instruments that are substantially different if the net
present value of the cash flows under the
terms  of  the  new  debt  instrument  is
at least 10 percent different from the
present  value  of  the  remaining  cash  flows  under
the terms of the original instrument.  The Company had Amendments in
February 2006 and June 2007  to the Convertible Note and the related
warrants,  the  Company  feels  that  a  substantial  modification
in terms of the
Convertible  Note  has  occurred.  Upon  further  analysis,  the  Company  has
determined  that  a  greater than 10% difference
in the net present value of the
remaining  cash  flows  of  both  the  original  Convertible  Note  and  the
New
Convertible  Note  has  occurred.  Therefore,
the Company has extinguished the original Convertible Note, along with the
related unamortized discounts and deferred loan costs, and recorded the New
Convertible Note at its fair
value.  The  extinguishments  required  the  Company  to  record
an
extinguishment  debt  expense  of  $15,182,000
and $2,526,000 in 2007 and 2006, respectively.





Stock Warrants Issued to
Third Parties





The
Company accounts for stock warrants issued to third parties, including
customers, in accordance with the provisions of the EITF Issue No. 96-18, Accounting for Equity Instruments
That Are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling Goods or Services, and EITF 01-9, Accounting for Consideration Given
by a Vendor to a Customer (Including a Reseller of the Vendor’s
Products). Under the provisions of EITF 96-18, because none of the
Company’s agreements have a disincentive for nonperformance, the Company records
a charge for the fair value of the portion of the warrants earned from the point
in time when vesting of the warrants becomes probable. Final determination of
fair value of the warrants occurs upon actual vesting. EITF 01-9 requires that
the fair value of certain types of warrants issued to customers be recorded as a
reduction of revenue to the extent of cumulative revenue recorded from that
customer.  The Company has not issued any warrants to customers in
2007 or 2006.




Segment
Reporting




The
Company identifies its operating segments based on how management internally
evaluates separate financial information (if available), business activities and
management responsibilities. The Company operates in a single business segment,
the manufacturing and sale of device-based medical therapies. All of the
Company’s revenues have been derived from this business segment.




F-13




Fair
Value of Financial Instruments




The
Company’s financial instruments at December 31, 2007 consist of cash, a short
term investment, accounts receivable, accounts payable, warrant liabilities,
other current liabilities, loan payable and capital lease obligation. The
carrying values of these financial instruments approximate their fair
values.




Off-Balance-Sheet
Arrangements





As of
December 31, 2007, the Company did not have any off-balance sheet
arrangements.





Commitments
and Contingencies




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





Concentration
of Credit Risk




Financial
instruments which potentially subject the Company to concentrations of credit
risk consist of cash and cash equivalents and accounts receivable. The Company
places its cash and cash equivalents with high credit, quality financial
institutions. The Company has not experienced any losses in such accounts and
believes it is not exposed to any significant credit risk on cash and cash
equivalents. With respect to accounts receivable, the Company routinely assesses
the financial strength of its customers and, as a consequence, believes that the
receivable credit risk exposure is limited.




Recent
Accounting Pronouncements




In March
2008 the Financial Accounting Standards Board (“FASB”) issued SFAS No. 161,
which amends FASB Statement No. 133, Accounting for Derivative Instruments
and Hedging Activities, requires companies with derivative instruments to
disclose information about how and why a company uses derivative instruments,
how derivative instruments and related hedged items are accounted for under
Statement 133, and how derivative instruments and related hedged items
affect a company’s financial position, financial performance, and cash flows.
The required disclosures include the fair value of derivative instruments and
their gains or losses in tabular format, information about credit-risk-related
contingent features in derivative agreements, counterparty credit risk, and the
company’s strategies and objectives for using derivative instruments. The
Statement expands the current disclosure framework in Statement 133.
Statement 161 is effective prospectively for periods beginning on or after
November 15, 2008. The Company is currently evaluating this
pronouncement.





In December 2007, the Financial
Accounting Standards Board Statement issued SFAS No. 141(R), "Business
Combinations". This Statement replaces SFAS No. 141, Business Combinations, and
requires an acquirer to recognize the assets acquired, the liabilities assumed,
including those arising from contractual contingencies, any contingent
consideration, and any noncontrolling interest in the acquiree at the
acquisition date, measured at their fair values as of that date, with limited
exceptions specified in the statement. SFAS No. 141(R) also requires the
acquirer in a business combination achieved in stages (sometimes referred to as
a step acquisition) to recognize the identifiable assets and liabilities, as
well as the noncontrolling interest in the acquiree, at the full amounts of
their fair values (or other amounts determined in accordance with SFAS No.
141(R)). In addition, SFAS No. 141(R)'s requirement to measure the
noncontrolling interest in the acquiree at fair value will result in recognizing
the goodwill attributable to the noncontrolling interest in addition to that
attributable to the acquirer. SFAS No. 141(R) amends SFAS No. 109, Accounting
for Income Taxes, to require the acquirer to recognize changes in the amount of
its deferred tax benefits that are recognizable because of a business
combination either in income from continuing operations in the period of the
combination or directly in contributed capital, depending on the circumstances.
It also amends SFAS No. 142, Goodwill and Other Intangible Assets, to, among
other things; provide guidance on the impairment testing of acquired research
and development intangible assets and assets that the acquirer intends not to
use. SFAS No. 141(R) applies prospectively to business combinations for which
the acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. The Company is currently
evaluating the potential impact that the adoption of SFAS No. 141(R) could have
on its financial statements.




F-14




In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements—an amendment of Accounting Research Bulletin
No. 51 (“SFAS No. 160”). SFAS No. 160 establishes accounting and reporting
standards for ownership interests in subsidiaries held by parties other than the
parent, the amount of consolidated net income attributable to the parent and to
the noncontrolling interest, changes in a parent’s ownership interest, and the
valuation of retained noncontrolling equity investments when a subsidiary is
deconsolidated. SFAS No. 160 also establishes disclosure requirements that
clearly identify and distinguish between the interests of the parent and the
interests of the noncontrolling owners. SFAS No. 160 is effective for fiscal
years beginning after December 15, 2008, and will be adopted by us in the first
quarter of fiscal 2009. The
Company does not expect it to have a significant impact on its financial
position, results of operations or cash flows.




In June
2007, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 06-11,
"Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards."
EITF Issue No 06-11 requires that tax benefits generated by dividends paid
during the vesting period on certain equity-classified share-based compensation
awards be treated as additional paid-in capital and included in a pool of excess
tax benefits available to absorb tax deficiencies from share-based payment
awards. EITF Issue No. 06-11 is effective beginning with the 2009 fiscal
year. The Company does not expect it to have a significant impact on its
financial position, results of operations or cash flows.


Also in
June 2007, the FASB ratified EITF Issue No. 07-3, "Accounting for Advance
Payments for Goods or Services to Be Used in Future Research and Development
Activities." EITF 07-3 provides that nonrefundable advance payments made for
goods or services to be used in future research and development activities
should be deferred and capitalized until such time as the related goods or
services are delivered or are performed, at which point the amounts would be
recognized as an expense. This issue is effective for fiscal years beginning
after December 15, 2007.  The Company has evaluated the potential
impact of these issues and anticipates that they will have no material impact on
its financial position and results of operations.





In
February 2007, the FASB issued SFAS 159 (“SFAS 159”), “The Fair Value Option for
Financial Assets and Financial Liabilities – Including an Amendment of FASB
Statement No. 115”. This Statement provides companies with an option to measure,
at specified election dates, many financial instruments and certain other items
at fair value that are not currently measured at fair value.  A
company that adopts SFAS 159 will report unrealized gains and losses on items
for which the fair value option has been elected in earnings at each subsequent
reporting date. This Statement also establishes presentation and disclosure
requirements designed to facilitate comparisons between entities that choose
different measurement attributes for similar types of assets and
liabilities.  This Statement is effective for fiscal years beginning
after November 15, 2007. The Company is currently assessing the impact of
adopting SFAS 159.





In
December 2006, the FASB issued FSP EITF 00-19-2, Accounting for Registration Payment
Arrangements (“FSP 00-19-2”), which addresses accounting for registration
payment arrangements. FSP 00-19-2 specifies that the contingent obligation to
make future payment or otherwise transfer consideration under a registration
payment arrangement, whether issued as a separate agreement or included as a
provision of a financial instrument or other agreement, should be separately
recognized and measured in accordance with FASB Statement No. 5, Accounting for Contingencies.
FSP 00-19-2 further clarifies that a financial instrument subject to a
registration payment arrangement should be accounted for in accordance with
other applicable generally accepted accounting principles without regard to the
contingent obligation to transfer consideration pursuant to the registration
payment arrangement. For registration payment arrangements and financial
instruments subject to those arrangements that were entered into prior to the
issuance of EITF 00-19-2, this guidance shall be effective for financial
statements issued for fiscal years beginning after December 15, 2006 and interim
periods within those fiscal years. The Company has determined that the adoption
of FSP 00-19-2 will have no impact its financial statements.





In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”
which defines fair value, establishes a framework for measuring fair value, and
expands disclosures about fair value measurements. SFAS No. 157 does not
require any new fair value measurements, but rather eliminates inconsistencies
in guidance found in various prior accounting pronouncements. We are currently
evaluating the accounting and disclosure requirements that this guidance will
have on our results of operations or financial condition when we adopt SFAS
No. 157 at the beginning of our fiscal year 2008.




In
September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108,
“Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements.” SAB No. 108 addresses how
the effects of prior year uncorrected misstatements should be considered when
quantifying misstatements in current year financial statements. SAB No. 108
requires companies to quantify misstatements using a balance sheet and income
statement approach and to evaluate whether either approach results in
quantifying an error that is material in light of relevant quantitative and
qualitative factors. SAB No. 108 is effective for periods ending after November
15, 2006. The adoption of SAB No. 108 did not have a material effect on the
Company’s financial statements. The Company's restatement is discussed in Note
12.




In June
2006, the FASB issued FASB Interpretation No. (“FIN”) 48, “Accounting
for Uncertainty in Income Taxes, an interpretation of FASB Statement
No. 109.” FIN 48 clarifies the accounting for uncertainty in income taxes.
FIN 48 prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 requires that we recognize in the
financial statements the impact of the tax position if that position will more
likely than not be sustained on audit, based on the technical merits of the
position. FIN 48 also provides guidance related to de-recognition,
classification, interest and penalties, accounting in interim periods and
disclosure. If there are changes in net assets as a result of application of FIN
48, these will be accounted for as an adjustment to retained earnings. We are
adopting FIN 48 at the beginning of our fiscal year 2007.




F-15





In
February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 155, “Accounting for Certain Hybrid Financial Instruments,” which
amends SFAS No. 133, “Accounting for Derivatives Instruments and Hedging
Activities” and SFAS No. 140, “Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities.” SFAS No. 155 amends
SFAS No. 133 to narrow the scope exception for interest-only and
principal-only strips on debt instruments to include only such strips
representing rights to receive a specified portion of the contractual interest
or principle cash flows. SFAS No. 155 also amends SFAS No. 140 to
allow qualifying special-purpose entities to hold a passive derivative financial
instrument pertaining to beneficial interests that are themselves derivative
instruments. Management does not expect adoption of SFAS No. 155 to have a
material impact on the Company’s financial statements.





Apix
International Limited.





Apix
International, Ltd., (“APIX”) is an entity that is solely owned by Mr. Robert
Cheney, CEO and a Director of the Company. Mr. Cheney was appointed as the CEO
in June 2007.





Transactional
History





In August
2005, the Company issued secured promissory notes in the aggregate principal
amount of $3,000,000 (the Notes) and warrants to purchase the Company's common
stock (the Warrants) to APIX. The Notes bear interest at a rate of 10%,
originally maturing on February 28, 2006. Additionally, the Company was required
to pay various loan related fees totaling $1,035,000 to APIX on the maturity
date. The associated Warrants are exercisable for 3,000,000 post split shares of
common stock at an exercise price of $1.00 per share. The Warrants, which
expired ten years after issuance, were assigned a value of $3 million, estimated
using the Black-Scholes valuation model.  In accordance with EITF No.
00-19, Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock, the values assigned to both the Notes and the
Warrant were allocated based on their fair values. The discounts on the Notes
for the Warrants and fees were being amortized to interest expense, using the
effective interest method, over the term of the Notes.




The
holder of the Warrants had registration rights that required the Company to file
a registration statement with the Securities and Exchange Commission to register
the resale of the common stock issuable upon the exercise of the Warrants. In
2005 the Company determined that under EITF No. 00-19, the ability to register
stock was deemed to be outside of the Company's control. Accordingly, the
initial fair value of the Warrants of $3 million was recorded as an accrued
warrant liability in the consolidated balance sheet, and was marked to market at
the end of each reporting period.




In
February 2006 the Company modified the terms of its 10% note payable to APIX
with an outstanding principal; balance of $3,000,000 and related loan fees
payable of $1,035,000, due on February 28, 2006. APIX  agreed to (1)
provide an additional $660,000 in funding, (2) the original Notes being modified
to include a conversion feature (convertible into 9,150,000 shares of the
Company's common stock at a conversion price of $.40 per share., (3) extend the
due date to May 16, 2006; (4) receive an additional warrant exercisable into
3,100,000 post split shares of common stock at and exercise price of $1.00 per
share with a ten year life; (6) the registration rights agreement language was
clarified to mean the Company that the Company would use its “best efforts” and
there were no liquidated damages provisions for non-registration; and (7) to
receive additional fees of $860,000 due on the revised maturity date. The
Company evaluated the modification of the Note pursuant to SFAS 140, EITF Issue
Nos. 96-19, 02-04, and 06-06 and management determined that the debt instruments
that are substantially different since the net present value of the cash flows
under the terms
of  the  new  debt  instrument  was
at least 10 percent different from the
present  value  of  the  remaining  cash  flows  under
the terms of the original instrument.  Accordingly, the excess of the
consideration provided to APIX, the note holder, over the principal and interest
due, and loan related fees due, of $2,256,000, was recorded as Loss on
Extinguishment of Debt on the Company’s Statement of Operations for
2006.




The
Company has evaluated the terms of the modified 10% secured convertible
debenture in accordance with EITF Issue Nos. 00-19 and  05-02 and the
debenture was deemed "conventional convertible debt instruments". The Company
evaluated the registration rights agreement and determined that there were no
amount of liquated damages payable or other provisions that would cause net cash
settlement related to the warrants or conversion feature. Accordingly, the
Warrants (a free-standing instrument) were classified as equity (a component of
Additional-Paid-in-Capital). Additionally, the application of the provisions of
EITF 98-5, “Accounting for Convertible Securities with Beneficial Conversion
Features or Contingently Adjustable Conversion Ratios,” and EITF 00-27,
“Application of Issue 98-5 to Certain Convertible Instruments” resulted in the
calculation of an embedded beneficial conversion feature. The value of the
beneficial conversion feature was limited to the relative fair value of the
debentures.




F-16




The new
10% secured convertible promissory notes issued to APIX in February 2006, in
essence consisted of a $3,660,000 Secured Convertilbe Note Unit (Note
Unit).  The Note Unit consisted of $3,660,000 principal amount of 10%
secured Note ,( the Convertible Note) due May 16, 2006, and  Common
Stock Purchase Warrants (collectively the Warrants) to purchase 6,100,000 post
split shares of the Company’s common stock, par value $0.01 per share (the
Common Stock), at an exercise price of $1.00 per share. The relative fair value
of the Warrants of $1,093,000 which was determined using the Black-Scholes
option-pricing model, and the intrinsic value of the Beneficial Conversion
Feature of $483,000 at the time of modification, were both recorded as
additional paid-in capital The fair value of the Warrants at the time of
modification was determined using the Black-Scholes option-pricing
model.




From May
2006 through December 2006,  APIX provided the Company with additional
debt financing of $4,500,000 to meet the Company’s working capital needs. These
unsecured borrowings under bear interest at 10% per annum and were due on
demand.  As of December 31, 2006, the Company had total obligations
due to APIX of the following: (1) a $3,660,000 10% secured convertible note
payable due on demand with accrued interest of $592,000; (2) $4,500,000 in
unsecured borrowings due on demand with accrued interest of $375,000; and (3)
various loan related fees aggregating to $1,715,000.




In 2007
the Company modified the terms of its 10% secured convertible note payable to
APIX with an outstanding principal balance of $3,660,000 and its 10% unsecured
loan obligation of $4,500,000 and related loan fees payable of $1,715,000, which
were due on demand. APIX  agreed to (1) provide an additional
$5,625,000 in funding (which can be drawn in traunches of $220,000 each, (2) the
convertible secured note and unsecured borrowing being modified to include a
reduction to the conversion price for the secured convertible note and adding a
conversion feature to the unsecured borrowings  (convertible into
44,153,000 shares of the Company's common stock at a conversion price of $0.40
per share., (3) extend the due date to December 31, 2007; (4) receive an
additional warrants exercisable into an aggregate of 11,880,000 shares of common
stock at and exercise price of $0.30 per share with a ten year life; (5) receive
$500,000 in exit fees convertible into 5 million shares of Preferred Stock
Series A (see Note 9);  (7) the registration rights agreement language
included that the Company would use its “best efforts” and there were no
liquidated damages provisions for non-registration; and (8) to receive
additional fees and expenses of $2,870,000 due on the revised maturity date. The
Company evaluated the modification of the Note pursuant to SFAS 140, EITF Issue
Nos. 96-19, 02-04, and 06-06 and management determined that the debt instruments
that are substantially different since the net present value of the cash flows
under the terms
of  the  new  debt  instrument  was
at least 10 percent different from the
present  value  of  the  remaining  cash  flows  under
the terms of the original instrument.  Accordingly, the excess of the
consideration provided to APIX, the note holder, over the principal and interest
due, and loan related fees due, of $6,329,000, was recorded as Loss on
Extinguishment of Debt on the Company’s Statement of Operations for
2007.In  2007, APIX and the Company concluded a set
of  restructuring transactions whereby the outstanding debt (secured
and unsecured)





On
October 3, 2007, the Company reached an agreement with APIX whereby the Company
granted 58,870,183 shares of the Company’s $.01 par value common stock to APIX
in full settlement of the $17,661,000 outstanding balance related to the 10%
secured convertible note payable to the APIX due on December 31, 2007 and
related interest due, plus any all related loan fees.  At the grant
date, the quoted fair market value of the common stock transferred was
$23,989,600 which exceeded outstanding carrying value of debt by $6,329,000;
accordingly, a loss of $6,328,546, net of income taxes, has been included in the
Statement of Operations in 2007. The Company also agreed to repurchase from APIX
warrants, which were convertible into 20,340,000 shares of common stock at an
exercise price of $0.40 per share in exchange for 29,129,817shares of the
Company’s common stock having a quoted market price of
$12,525,800.  The fair value of the repurchased APIX warrant
was $8,725,600 based on the Black-Scholes Option Pricing Model. As a result
of this transaction, the Company recorded a loss of $3,800,000 on the Statement
of Operations for 2007. The Company subsequently cancelled these warrants
returned by APIX.




SERIES
A PREFERRED SHARES




In 2007,
the Company entered into an agreement with APIX in which the Company issued
convertible preferred stock in exchange for $500,000 of a loan facility fee due
to APIX. On June 7, 2007, the Company issued 5 million shares of Series A
Convertible Preferred Stock ("Series A shares"), with a stated value of $0.001
per share and a liquidation value of $500,000, to APIX in full settlement of the
$500,000 facility fee due to APIX. The Series A Preferred Stock is voting with a
voting preference of 2.8 to 1 to an individual common share, and the Series A
shareholders vote as a single class with the common shares. The Series A
shareholders are entitled to receive  dividends only if declared. The
preferred stock is convertible from the date of issuance into shares of the
Company's common stock ("Common Stock") at a fixed exchange rate of 0.2 shares
of common stock for each Series A share. The Company can redeem Series A shares
at any time at a price of $0.10 per Series A share. The number of shares of
common stock to be issued upon conversion is determined by dividing the
aggregate stated value of the preferred stock by the ("Conversion
Price").




F-17




In
accordance with SFAS 150, "Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity", Series A shares do not have
mandatory redemption rights are to be recorded as equity. Series A shares
redemption is at the sole option of the Company and redemption would only occur
upon the liquidation or termination of the issuer. Based on characteristics of
the agreement as described above, the Company has recorded the Preferred Series
A shares as a equity on the balance sheet.




The
market price of the Company's common stock on the date of commitment was
$0.50per share. In accordance with EITF 98-5, as amended by EITF 00-27, because
the effective conversion price associated with the preferred shares equal to the
quoted market value, no beneficial conversion should be recognized.




2007
Private Placement




On
December 14, 2007, the Company entered into an agreement with APIX to act as its
placement agent to conduct the offer of its securities in a private placement
(“Offering”). The CEO of the Company is the owner of the placement agent. The
contract provides for the Placement Agent to be paid a fee if the gross proceeds
received from the sale of units comprising the Company’s shares and warrants
(“Units”) sold in the Offering is at least $9 million. Pursuant to this
agreement, the APIX will provide the following services: (1) APIX to act on
behalf of the Company to raise a minimum of $9 million of additional equity
financing; (2) APIX to receive  a warrant convertible into 3 million
shares of common stock at an exercise price of $0.55 per share and having a 5
year term with a fair value of approximately $1,234,000 using the Black Scholes
method assuming interest free rate of 4.05% and volatility rate of 96.19%; (3)
APIX to receive all rights, title and interest in a personal loan owing by Mr.
Phil Radlick, a Director of the Company, with the Company guaranteeing a minimum
recoverable amount of $100,000 within 12 months; and (4) APIX to receive
reimbursement for expenses of $75,000.






As of
December 31, 2007, the Company completed its private placement whereby it sold
18 million shares of our Common Stock (the “Shares”) and issued warrants to
purchase another 2,700,000 shares of our Common Stock (the “ December 2007
Private Placement Warrant Shares”) to accredited investors (as defined by Rule
501 under the Securities Act of 1933, as amended), resulting in proceeds, net of
issuance costs, of approximately $9 million (the transaction is referred to
herein as the “2007 Private Placement”). Included in the issuance costs are
direct costs related to the 2007 Private Placement which were
$1,408,000.




Since,
APIX is wholly owned and controlled the Company’s CEO, the payments made to APIX
in regards to the services connected with the 2007 Private Placement were
recorded as an expense in the Statement Operations for 2007.




Pursuant
to the Subscription Agreement. the Company has agreed to use its best efforts to
secure effectiveness of, as soon as reasonably only practicable after the
insurance and delivery of the Shares and Warrants , the filling of a
registration statement on Form SB-2  (the "Filling Date").








As of
December 31, 2007 the Company had $175,000 in loans payable due to
APIX.




2. Extinguishment of
debt





On
February 14, 2006 the company received an extension of its credit facility of
$660,000 and an extension of the maturity date from February 28, 2006 to May 31,
2006, and was granted control of the exercise of warrants. At that date the
company was deemed no longer to be required to net cash settle the warrants or
the convertible features of the debt. In exchange the company granted the lender
an additional 3,180,000 (post split) warrants, reduced the exercise price from
$0.10 to $0.06 per share. The company also agreed to pay additional fees of
$680,000 and give the lender convertibility of the principal portion of the
debt. The company determined that the transaction should be treated as an
extinguishment of debt. In conjunction with the transaction the company
recognized a loss of $2,256,072, The Value of the beneficial conversion feature
was recorded at their intrinsic value. The additional Warrants were computed
using the Black Scholes method assuming a 5.08% risk free interest rate, a life
of 9.16 years, and a volatility rate of 160.39%.  At the same time the
company eliminated its derivative Warrant Liability as described in EITF 00-19.
As the maturity date was short and within the company’s fiscal year, the company
deemed that the additional fees were part of the extinguishment and included
them as part of the loss as noted above.




F-18




On June
27, 2007 the company received an additional extension of its credit facility and
an extension of the maturity date from February to December 31, 2007 in
conjunction with a plan to convert all of the existing debt to equity, as
discussed in Note 1. In exchange the company granted the lender an additional
14,160,000 warrants, reduced the exercise price from $0.06 to $0.04 per share.
The company also agreed to pay additional fees of $3,370,000 The Company
determined that the transaction should be treated as an extinguishment of debt.
In conjunction with the transaction the company recognized a loss of $
15,182,000. The Value of the beneficial conversion feature was recorded at their
intrinsic value. The additional Warrants were computed using the Black Scholes
method assuming a 4.8% risk free interest rate interest rate a life of .32 years
and a volatility rate of 92.29,




2.
Extinguishment of debt (continued)





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




The table
below details the specific components of both the February 14, 2006 and the
January 27, 2007 extinguishments and shows the computation of the loss on
extinguishment of debt:




F-19




3.
Inventories





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




December
      31, 2007Raw
      Materials
            
            $
            202Work-In-Process
            
            
            23Finished
      Goods
            
            
            177$
            402





Inventories
shown above are valued using FIFO and are adjusted to the lower of cost or
market. The Company had allowances for excess and obsolete inventory of
approximately $615,000 at December 31, 2007. Moreover, as of December 31, 2007,
the Company has approximately $50,000--in inventories located in foreign
countries, which were held by the local distributors.







4.
Property and Equipment




Property
and equipment, including equipment under capital leases, are carried at cost
less accumulated depreciation and amortization. Property and equipment are
depreciated using the straight-line method over the estimated useful lives,
generally three to five years. Leasehold improvements are amortized using the
straight-line method over the shorter of the estimated useful life of the asset
or the remaining term of the lease. Depreciation expense includes amortization
of capital leases and leasehold improvements. Depreciation expense was
approximately $97,000 and $123,000 for fiscal years 2007 and 2006,
respectively.




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




December
      31, 2007Equipment
            
            $
            2230Leasehold
      improvements
            
            
            270$
            2500Less
      accumulated depreciation and amortization
            
            
            (2138
            )$
            362Idle
      Equipment
            
            $
            1290Less
      accumulated depreciation and amortization
            
            
            (1290
            )$
            0-





Equipment
includes property and equipment financed under capital leases, which amounts to
approximately $78,000 at December 31, 2007. Accumulated amortization related to
the leased assets was $53,000. The Company had fully depreciated its idle
equipment as of December 31, 2007.




F-20




5.
Payable - Related Party





On
December 17, 2007, Cardima, Inc. (the “Company”) consummated a transaction
whereby the Company entered into a series of Subscription Agreements (the
“Subscription Agreement”) with certain accredited investors (collectively, the
“Investors”) providing for the sale by the Company to the Investors of (i) a
total of 18,000,000 shares of the Company’s Common Stock in the aggregate
principal amount of $9,000,000  (the “Shares”) and (ii) warrants (the
“Warrants”) to purchase an aggregate of 2,700,000 shares of the Company’s Common
Stock at an exercise price of $0.55.





Apix
International Limited (“Apix”) acted as placement agent for the
transaction.  Apix is owned by Robert Cheney who is the Chief
Executive Officer and a Director of the Company. In consideration for the
services provided, the Company has entered into a Funding Agreement with Apix
whereby the Company agreed to: (i) pay a placement fee of 5% of gross proceeds,
payable in the Company’s common shares issued at $0.50 per share; (ii) grant two
million warrants to purchase shares of the Company’s Common Stock for a period
of five years at an exercise price of $0.55; and (iii) reimburse Apix’s expenses
totaling $75,000.  Subsequently the Funding Agreement was amended by
the Company and Apix in which Apix waived its five-percent common share
placement fee and  accepted for its services rendered; (i) an
additional one million warrants (total three million warrants) to purchase
shares of the Company’s common stock at an exercise price of $0.55; and (ii) all
rights, title and interest in a loan totaling $360,000, including accrued
interest, owed to the Company by Phil Radlick, with a guarantee by the Company
that the minimum recoverable value of the loan is not less than
$100,000.  In the event the actual amount recovered is less than
$100,000, the Company agrees to pay to Apix the amount of shortfall on or before
December 18, 2008.  The other terms of the Funding Agreement remain
the same.  As a result, the Company had $175,000 in loan payable at
December 31, 2007.




6.
Short term investment





The
company had a certificate of deposit with Bank of America with a four-month
maturity in the amount of $2,008,000 at December 31, 2007.







7.
Commitments and Contingencies




Commitments




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




Fiscal
      Year
              
              Operating
      Leases
              
              
              Capital
      Leases2008
              
              
              265
              
              
              
              252009
              
              
              272
              
              
              
              82010
              
              
              115Total
      Minimum Lease Payments
              
              
              652
              
              
              
              33less:
      amounts representing interest
              
              
              
              
              
              
              2Present
      Value of net minimum lease payments
              
              
              
              
              
              
              31




Rent
expense was approximately $265,000 in 2007 and $260,000 in 2006.




Contingencies





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


.


On
October 31, 2007, the Company received a letter from the law firm representing
its former Director of Operations, Mr. Larry Stevens. Mr. Stevens claimed for
damages for wrongful termination in violation of public policy, breach of
contract and related claims.  The Company determined that Mr. Stevens’
termination was “with cause” thus the severance provision of his employment
agreement did not apply. The Company will defend itself vigorously against Mr.
Stevens’ claims.





In
addition, the Company is subject to numerous risks and uncertainties because of
the nature and status of its operations and could be subject to claims and legal
actions arising in the ordinary course of business. The Company maintains
insurance coverage for events in amounts that it deems appropriate. Management
believes that uninsured losses, if any, will not be materially adverse to the
Company’s financial position or results of operations




F-21




8.
Concentrations of Risk




To date,
product sales have been direct to customers in the United States and to
distributors primarily in Europe and Japan. During the year ended December 31,
2006, revenues to the Company’s largest customer, Paramedics Co. Ltd. in Japan,
comprised 42% of the Company’s total net product sales respectively. In the
first quarter of 2007, our Japanese distributor notified us of its failure to
maintain the legal documentation standard required to sell our PATHFINDER® in
Japan.  Paramedics returned $85,000 of inventory on hand in 2007. DOT
Medical LTD, our distributor in Germany, had $127, 000 or 12% of net product
sales in 2007. No other single customer represented greater than 10% of net
product sales in the years 2007 and 2006. Accounts receivable from this customer
was $9,700 at the end of 2007. The total export sales represented 25% of net
sales for the year ended December 31, 2007. Allowances for doubtful accounts
were $63,000 and $14,000 as of December 31, 2007 and 2006, respectively. When
necessary, estimated provisions for product returns are recorded. The geographic
distribution of net sales was as follows (in thousands):




Year
      Ended December 31,2007
            
            2006United
      States
            
            $
            857
            
            74%
            
            $
            624
            
            41
            %Germany
            
            
            86
            
            8%
            
            
            146
            
            9
            %Europe
      - Other
            
            
            277
            
            24%
            
            
            109
            
            7
            %Japan
            
            
            (78)
            
            (7)%
            
            
            650
            
            42
            %Others
            
            
            15
            
            1%
            
            
            12
            
            1
            %Total
      Net Sales
            
            $
            1,157
            
            
            
            $
            1,541





During
the first quarter of 2007, the Company’s Japanese distributor notified the
Company of its failure to maintain the legal documentation standard required to
sell its PATHFINDER® in Japan.  As a result, the Company had no sales
in Japan during the first three quarters of 2007.  In addition, in
compliance with the local import rules, the Japanese distributor returned a
total of $85,000 of products during the second quarter of 2007. The Company
understands that the reapplication process takes approximately twelve to
eighteen months.  The Company is currently exploring its options with
regard to selling the PATHFINDER® in Japan. Furthermore, the Company
entered into a distribution agreement with Robert Reid Inc. in Japan to be its
exclusive distributor in the country effective August 1, 2007 with an initial
term of five (5) years. Robert Reid Inc. will not be able to start importing and
selling our products until the reapplication process is
complete.   During the reapplication process, the Company may
have limited or no sales in Japan.  The Company anticipates resuming
commercial sales in 2009.  However, there can be no assurance that it
will be able to resume sales by that time.





The
Company’s diagnostic product group, namely the Pathfinder® family of
micro-catheter systems, accounted for 62% and 74% of net sales for the years
ended December 31, 2007 and 2006, respectively.





The
Company purchases certain key components of its products for which there are
relatively few alternative sources of supply including the hydrophilic coating
for certain of its micro-catheters, from sole or limited source supplies.
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.





The
Company receives payments from its customers and deposits them in federally
insured financial institutions during its normal course of business. From time
to time, the balances with these deposit accounts may exceed the federally
insured maximum limit, $100,000. . As at the end of December 31, 2007, the
Company had uninsured cash and a short term investment totaling $6,648,000 in
two major banks – primarily in one large financial institution.




F-22




9.
Stockholders’ Equity





The
Company is authorized to have two classes of capital stock: Preferred Stock
(Series A) and Common Stock. Holders of Common Stock are entitled to one vote
for each share held. Holders of Series A Preferred Stock are required to vote as
a single class with holders of Common Stock but are entitled to 2.8 votes for
each share held and a liquidation preference of $0.10 per share.




Preferred
stock




The
Company is authorized to issue 5,000,000 shares of Preferred Stock. The
Board of Directors can authorize the issuance of Preferred stock in one or more
series without obtaining further stockholder approval. On June 7, 2007, the
Company issued to Apix International Limited (“Apix”) 5,000,000 shares of its
Series A Preferred Stock (the “Series A Preferred”) in payment of a facility fee
of $500,000 in connection with the execution of a Loan Agreement between the
Company and Apix on June 7, 2007.  Each share of Series A Preferred is
convertible into 0.2 shares of common stock at the option of the holder
thereof.  The Series A Preferred may be called by the Company at any
time at $0.10 per share.  Each share of Series A Preferred may be
voted as a single class with the common stock on 2.8 votes per shares
basis.There were 5,000,000 issued and outstanding at December 31, 2007. Series A
Preferred stock has a liquidation preference of $0.10 per share, but there are
no other dividend requirements.





The
Series A Preferred was issued without registration in reliance on the exemption
provided by Section 4(2) of the Securities Act of 1933, as amended, and Rule 506
promulgated there under.




Common
Stock




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




As
described in Note 1, Effective June 30, 2007, the Board of Directors authorized
a one-for-ten reverse stock split to be effective in June 30, 2007 to
shareholders of record. Stockholders’ equity reflects the stock split by
reclassifying from “Additional paid-in capital” to “Common stock” an amount
equal to the change in par value of the shares arising from the reverse split.
In addition, as a result of a restatement of previously issued financial
statements, approximately $2,776,000 was the effect on additional paid-in
capital at the beginning of the current period.




In August
2005 the Company obtained $3,000,000 in debt financing through the issuance of a
secured note payable with detachable warrants. The Company issued warrants to
purchase 300,000 shares of common stock at $1.00 per share, which were valued at
the issuance date at $3 million. As the warrants originally included a
requirement for net cash settlement if the Company was unable to register the
shares to be issued upon exercise of the warrants, these warrants were required
to be recorded as a liability until such time as the registration requirements
expired. The Company subsequently signed an amendment with the warrant holder,
which resulted in the warrants not requiring any cash settlement in the event of
a Nonregistration Event, as defined, and the elimination of the net cash
settlement provision. In addition, certain penalty provisions were clarified to
provide that the warrant holder would receive no liquidated damages in the event
of a Nonregistration Event. Upon the elimination of the net cash settlement
provision in February 2006, the fair value of the warrants was reclassified from
other current liabilities to additional paid-in capital. As of December 31,
2007, there are no remaining warrants which have a net cash settlement
provisions, accordingly all warrants are classified as a component of
additional-paid-in capital in the accompanying consolidated balance
sheet.




In April,
2006, the Company approved a stock issuance in the amount of 3,000 (post-split)
shares of the common stock to a third party for its services. A non-cash stock
compensation expense of $1,200 based on the fair value of the common stock
issued was recorded in 2006.





In June,
2007, the Company approved a stock issuance in the amount of 29,000 (post-split)
shares of the common stock to a third party for its services. A non-cash stock
compensation expense of $2,900 based on the fair value of the common stock
issued  was recorded in 2007.







2007
Private Placement




On
December 17, 2007, the Company completed a private placement whereby it sold
18,000,000 shares of  Common Stock (the “Shares”) and issued 2007
Private Placement warrants to purchase another 2,700,000 shares of Common Stock
(the “ 2007 Private Placement Warrant Shares”) to accredited investors (as
defined by Rule 501 under the Securities Act of 1933, as amended), resulting in
proceeds, net of issuance costs, of approximately $9,000,000(the transaction is
referred to herein as the “2007 Private Placement”). APIX, an entity wholly
owned and controlled by the Company’s CEO acted as the placement and received a
payment of $450,000. The 2007 Private Placement warrants have an exercise price
of $0.55 per share and expire 5 years from the date of issuance. The Company
will evaluated the appropriate classification of the warrants issued in
accordance with EITF Issue No. 00-19 and FSP-019-02 and determined that the
warrants did not have any net cash settlement provisions.




F-23




Pursuant to
the Subscription Agreement. the Company has agreed to use its best efforts to
secure effectiveness of, as soon as reasonably only practicable after the
insurance and delivery of the Shares and Warrants , the filling of a
registration statement on Form SB-2  (the "Filling Date").






Repurchase
of Warrants




In
October 2007, the board of directors authorized the purchase of warrants
convertible into 20,340,000 shares of the Company’s common stock at an exercise
price of $0.40. These warrants were repurchased and subsequently cancelled. The
Company issued 29,129,817 shares of its common stock having a quoted fair value
of $12,525,800 for the purchase of these warrants.





As of
December 31, 2007, the Company had 116,316,311 outstanding shares of common
stock, and there were options outstanding to purchase 5,988,496 shares of common
stock.




10.
Stock Based Compensation




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




The
Black-Scholes model requires the use of highly subjective and complex
assumptions which determine the fair value of share-based awards, including the
option’s expected term and the price volatility of the underlying stock.
Stock-based compensation expense is calculated based on the fair market value of
our stock on the date of grant. For the years ended December 31, 2007 and 2006,
the weighted average grant date fair value per option share was $0.44 and $0.64,
respectively.




The total
stock-based compensation expense under FAS 123R was approximately $491,000 and
$390,000, for the years ended December 31, 2007 and 2006, respectively.
This expense reduced our basic and diluted earnings per share by less than a
penny and by $0.04 for the years ended December 31, 2007 and 2006,
respectively.  Our unamortized stock compensation expense as of
December 31, 2007 is $2,243,000.




2007
Stock Option Plan




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




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





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




Outstanding
      OptionsShares
      Available
            
            Number
      of Shares
            Exercise
      Price Per Share
            Weighted-Average
      Exercise PriceBalance
      as of 12/31/2006
            
            
            ---
            
            ---
            
            ---
            
            ---Shares
      Reserved in 2007
            
            
            30,000,000
            
            ---
            
            ---
            
            ---Options
      Granted in 2007
            
            
            (5,815,000
            )
            5,815,000
            $
            0.44
      - $0.55
            $
            0.44Balance
      as of 12/31/2007
            
            
            24,185,000
            
            5,815,000
            $
            0.44
      - $0.55
            $
            0.44




At
December 31, 2007, 5,815,000 options were outstanding and exercisable under the
2007 Stock Plan. All options granted in 2007 were granted at exercise price
equal to the common stock’s fair value. The weighted average fair value of
options granted in 2007 under the 2007 Stock Plan was $0.44 per
share.




F-24




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




Options
      Outstanding
            
            
            Options
      ExercisableRange
      of Exercise Prices
            
            
            Number
      of shares Outstanding
            
            
            Weighted-Average
      Remaining Contractual Life
            
            
            Weighted-Average
      Exercise Price
            
            
            Number
      of shares Exercisable
            
            
            Weighted-Average
      Exercise Price$
      0.44 - $0.45
            
            
            
            5,495,000
            
            
            
            9.7
            
            
            
            $
      0.44
            
            
            
            $
      303,750
            
            
            
            $
      0.44$
      0.50 - $0.55
            
            
            
            320,000
            
            
            
            9.9
            
            
            
            $
      0.52
            
            
            
            $
      8,333
            
            
            
            $
      0.505,815,000
            
            
            
            9.7
            
            
            
            $
      0.44
            
            
            
            312,083
            
            
            
            $
      0.44




As of
December 31, 2007, vested options of 312,083 and non-vested options of 5,207,917
had an aggregate intrinsic value of approximately $21,000 and $363,000,
respectively.





2003
Stock Option Plan




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




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




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




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




Outstanding
      OptionsShares
      Available
            
            Number
      of Shares
            
            Exercise
      Price Per Share
            Weighted-Average
      Exercise PriceBalance
      as of 12/31/2005
            
            
            536,853
            
            283,147
            
            $
            0.60
      - $12.40
            $
            5.30Options
      Granted in 2006
            
            
            (20,050
            )
            20,050
            
            $
            0.50
      - $2.50
            $
            0.70Options
      Cancelled in 2006
            
            
            95,019
            
            (95,019
            )
            $
            0.50
      - $10.40
            $
            4.80Balance
      as of 12/31/2006
            
            
            611,822
            
            208,178
            
            $
            0.50
      - $12.40
            $
            4.50Options
      Granted in 2007
            
            
            (4,700
            )
            4,700
            
            $
            0.55
      - $0.60
            $
            0.55Options
      Cancelled in 2007
            
            
            131,453
            
            (131,453
            )
            $
            0.50
      - $10.40
            $
            5.18Balance
      as of 12/31/2007
            
            
            738,575
            
            81,425
            
            $
            0.55
      - $12.40
            $
            3.17




At
December 31, 2007 and 2006, 81,425 and 208,178 options were outstanding and
exercisable under the 2003 Stock Plan. All options granted in 2007 and 2006 were
granted at exercise price equal to the common stock’s fair value. The weighted
average fair value of options granted under the Stock Plan was $0.55 and $0.70
per share for 2007 and 2006, respectively.




F-25




The
following table summarizes information about stock options outstanding under the
2003 Stock Plan at December 31, 2007:




Options
      Outstanding
            
            
            Options
      ExercisableRange
      of Exercise Prices
            
            
            Number
      of shares Outstanding
            
            
            Weighted-Average
      Remaining Contractual Life
            
            
            Weighted-Average
      Exercise Price
            
            
            Number
      of shares Exercisable
            
            
            Weighted-Average
      Exercise Price$
      0.55 - $2.50
            
            
            
            57,450
            
            
            
            8.0
            
            
            
            $
      0.62
            
            
            
            28,900
            
            
            
            $
      0.64$
      3.50 - $12.40
            
            
            
            23,975
            
            
            
            6.3
            
            
            
            $
      9.29
            
            
            
            22,624
            
            
            
            $
      9.4481,425
            
            
            
            7.5
            
            
            
            $
      3.17
            
            
            
            51,524
            
            
            
            $
      4.50





As of
December 31, 2007, outstanding stock options under the 2003 Stock Plan did not
have any intrinsic value.




1993
Stock Option Plan




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





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




Outstanding
      OptionsShares
      Available
            
            Number
      of Shares
            
            Exercise
      Price Per Share
            Weighted-Average
      Exercise PriceBalance
      as of 12/31/2005
            
            
            ---
            
            399,550
            
            $
            3.40
      - $70.00
            
            $
      12.00Options
      Granted in 2006
            
            
            ---
            
            ---
            
            
            ---
            
            ---Options
      Cancelled in 2006
            
            
            ---
            
            (131,064
            )
            $
            3.40
      - $70.00
            
            $
      12.10Balance
      as of 12/31/2006
            
            
            ---
            
            268,486
            
            $
            3.40
      - $52.50
            
            $
      11.80Options
      Expired in 2007
            
            
            (208,215
            )
            ---
            
            
            ---
            
            ---Options
      Cancelled in 2007
            
            
            208,215
            
            (208,215
            )
            $
            3.40
      - $52.50
            
            $
      12.01Balance
      as of 12/31/2007
            
            
            ---
            
            60,271
            
            $
            3.40
      - $46.30
            
            $
      11.24




At
December 31, 2007 and 2006, 60,271 and 268,486 options were outstanding and
exercisable under the 1993 Stock Plan. There were no options granted in 2007 and
in 2006.




F-26




The
following table summarizes information about stock options outstanding under the
1993 Stock Option Plan at December 31, 2007:




Options
      Outstanding
            
            Options
      ExercisableRange
      of Exercise Prices
            
            
            Number
      of shares Outstanding
            
            Weighted-Average
      Remaining Contractual Life
            
            Weighted-Average
      Exercise Price
            
            Number
      of shares Exercisable
            
            Weighted-Average
      Exercise Price$
            3.40
      - $15.00
            
            
            
            57,393
            
            3.7
            
            $
            10.36
            
            57,393
            
            $
            10.36$
            19.10
      - $46.30
            
            
            
            2,878
            
            0.9
            
            $
            28.74
            
            2,878
            
            $
            28.7460,271
            
            3.6
            
            $
            11.24
            
            60,271
            
            $
            11.24





As of
December 31, 2007, outstanding stock options under the 1993 Stock Plan did not
have any intrinsic value.





1997
Directors' Stock Option Plan




In March
1997, the Board of Directors adopted the 1997 Directors’ Stock Option Plan and
reserved 90,000 (post-split) shares of common stock for issuance. The plan
provides for the grant of non-statutory stock options to non-employee directors
of the Company.




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




Outstanding
      OptionsShares
      Available
            
            Number
      of Shares
            
            Exercise
      Price Per Share
            Weighted-Average
      Exercise PriceBalance
      as of 12/31/2005
            
            
            59,800
            
            29,800
            
            $
            1.00
      - $19.40
            
            $
      5.10Options
      Granted in 2006
            
            
            (34,000
            )
            34,000
            
            $
            0.30
      - $0.70
            
            $
      0.60Options
      Cancelled  in 2006
            
            
            29,000
            
            (29,000
            )
            $
            1.0
      - $19.40
            
            $
      5.00Balance
      as of 12/31/2006
            
            
            54,800
            
            34,800
            
            $
            0.30
      - $14.50
            
            $
      0.90Options
      Granted in 2007
            
            
            ---
            
            ---
            
            
            ---
            
            ---Options
      Cancelled in 2007
            
            
            3,000
            
            (3,000
            )
            $
            0.30
      - $0.50
            
            $
      0.40Balance
      as of 12/31/2007
            
            
            57,800
            
            31,800
            
            $
            0.30
      - $14.50
            
            $
      0.90




At
December 31, 2007 and 2006, 31,800 and 34,800 options were outstanding and
exercisable under the 1997 Directors’ Stock Plan. No stock options were granted
in 2007. Option shares granted in 2006 were granted at exercise price equal to
the common stock’s fair value. The weighted average fair value of options
granted in 2006 under the Stock Plan was $0.60 per share.




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




Options
      Outstanding
            
            
            Options
      ExercisableRange
      of Exercise Prices
            
            
            Number
      of shares Outstanding
            
            
            Weighted-Average
      Remaining Contractual Life
            
            
            Weighted-Average
      Exercise Price
            
            
            Number
      of shares Exercisable
            
            
            Weighted-Average
      Exercise Price$
            0.30
      - $0.70
            
            
            
            31,000
            
            
            
            8.5
            
            
            $
            0.66
            
            
            
            28,800
            
            
            $
            0.68$
            8.40
      - $14.50
            
            
            
            800
            
            
            
            4.9
            
            
            $
            10.10
            
            
            
            800
            
            
            $
            10.1031,800
            
            
            
            8.4
            
            
            $
            0.90
            
            
            
            28,800
            
            
            $
            0.94





As of
December 31, 2007, vested options of 5,000 had an aggregate intrinsic value of
approximately $2,500 and the non-vested options had no intrinsic
value.





F-27




1997
Employee Stock Purchase Plan




In March
1997, the Board of Directors adopted the 1997 Employee Stock Purchase Plan, as
amended, and reserved 250,000 (post-split) shares of common stock for issuance.
The purchase plan is intended to provide an opportunity for eligible employees
of the Company and its designated subsidiaries to acquire common stock on a
favorable basis. The purchase plan is implemented by a series of offering
periods of twelve months duration, with two consecutive purchase periods of six
months in duration. New offering periods commence on or about February 1 and
August 1 of each year (or at such other time or times as may be determined by
the Board of Directors). Through periodic payroll deductions, which may not
exceed $25,000 per offering period or 10% of any employee’s compensation,
eligible employees may purchase common stock at a price equal to the lower of:
(i) 85% of the fair market value of the common stock on the offering date; or
(ii) 85% of the fair market value of the common stock on the purchase date. As
of December 31, 2007, 235,368 shares of common stock have been issued under the
purchase plan. In 2007 and 2006, a total of 31,335 and 53,713 shares were issued
under the plan.




Share-Based Compensation to
Non-Employees





From time
to time the Company grants options to Non-Employees to purchase common stock at
a specific price with various vesting dates. The options are typically granted
for services rendered and/or specific milestone met.





In April, 2006, the Company approved a
stock issuance in the amount of 3,000 (post-split) shares of the common stock to
a third party for its services. A non-cash stock compensation expense of $1,200
was recorded in 2006.





In June,
2007, the Company approved a stock issuance in the amount of 29,000 (post-split)
shares of the common stock to a third party for its services. A non-cash stock
compensation expense of $2,900 was recorded in 2007.





11. Related-Party
Transactions




The
Company has entered into employment agreements with several of its key
employees. The agreements specify various employment-related matters, including
confidentiality requirements, competitive restrictions, assignment of
inventions, annual compensation, and severance benefits ranging from six months’
to thirty-six months’ salary in the event of termination without
cause.




In
December 1997, the Company entered into a $300,000 note receivable agreement
with Phillip Radlick, Ph.D., a Director of the Company and then President and
Chief Executive Officer, to facilitate the purchase of a principal residence in
the San Francisco Bay Area. The note bears interest at the minimum Applicable
Federal Rate, and was due and payable in a single lump sum forty-eight months
from the note date. In August, 2001, the Board of Directors amended Dr.
Radlick’s agreement to extend this loan until the first of (i) the date that Dr.
Radlick no longer serves as a member of the Board of Directors, (ii) the date
when Dr. Radlick sells his house and (iii) December 16, 2005. As a security for
the note, Dr. Radlick granted the Company a security interest in his vested
stock options. At December 16, 2005, Dr. Radlick informed the Company that he
was unable to repay the loan. At December 31, 2005, the balance of the loan is
approximately $357,085, including approximately $78,585 of accrued interest. No
interest accrual was made after December 31, 2004. The loan balance is fully
reserved as of the end of December 31, 2007. In the recently concluded round of
financing on December 17, 2008,  Apix accepted for its services
rendered all rights, title and interest in a loan totaling $360,000, including
accrued interest, owed to the Company by Phil Radlick, with a guarantee by the
Company that the minimum recoverable value of the loan is not less than
$100,000.  In the event the actual amount recovered is less than
$100,000, the Company agrees to pay to Apix the amount of shortfall on or before
December 18, 2008.




As
previously disclosed, the Company’s former President and Chief Operating
Officer, Mr. William K. Wheeler, has threatened to sue the Company for the
recovery of $375,000 plus interest, which he has claimed that he was owed under
the terms of his amended executive agreement. He made a settlement proposal,
which would extinguish his repayment obligation on the loan that he had received
from the Company in June 2000 and May 2001, in the total principal amount of
$192,500.





In December 2006, a settlement
agreement was reached in principle, which the Company would pay $295,000 to Mr.
Wheeler ($5,000 per month for 59 months). The liability is accounted for in
accordance with APB 21 as discussed in the footnote to the filing. The liability
was recorded at the final date of the settlement. Until that date the exact
terms had not been agreed to by both parties. The Company advises netted the
notes receivable and payable in accordance with the underlying agreement that
gave both parties the right of offset in accordance with FASB Technical Bulletin
88-2 which provides the specific requirements for liabilities and receivables to
be offset. The technical bulletin has been superseded, but paragraph 4 of FIN 39
says that the guidance in the Technical Bulletin has been incorporated largely
without change. In accordance with the Accounting Principle Board (“APB”) No.
21, “Interest on Receivables and Payables”, the $295,000 note payable is
discounted at 10% (same as the interest rate on the current loan financing) and
the $192,500 note receivable is discounted at 6% (the original note’s interest
rate). The discounted value of the note payable and note receivable is $232,287
and $162,022, respectively. The net of these two values of $63,667 is the note
payable balance as of December 31, 2007.





As part
of the December 17, 2007 agreement with Apix waived its five-percent common
share placement fee and accepted for its services rendered, all rights, title
and interest in a loan totaling $360,000, including accrued interest, owed to
the Company by Phil Radlick, a Director, with a guarantee by the Company that
the minimum recoverable value of the loan is not less than
$100,000.  In the event the actual amount recovered is less than
$100,000, the Company agrees to pay to Apix the amount of shortfall on or before
December 18, 2008. The Company has accrued this amount as part of the loan
payable.




F-28




In
December 2007, Apix International Limited (“Apix”) acted as placement agent in a
financing transaction in which the Company raised an aggregate of
$9,000,000.  Apix is owned by Robert Cheney, our Chief Executive
Officer and a Director.  In consideration for the services provided,
the Company agreed to compensate Apix as follows: (i) three million warrants to
purchase shares of the Company’s common stock at an exercise price of $0.55; and
(ii) all rights, title and interest in a loan totaling $360,000, including
accrued interest, owed to the Company by Phil Radlick, with a guarantee by the
Company that the minimum recoverable value of the loan is not less than
$100,000.  In the event the actual amount recovered is less than
$100,000, the Company agrees to pay to Apix the amount of shortfall on or before
December 18, 2008.  The Company has recognized this amount as
liability.




12. Restatement
of Financial Statements




The Company has restated it’s previously issued 2006 consolidated financial
statements for matters related to the following previously reported
items:


·
            To
      properly reflect the accounting for convertible notes, the related debt
      derivative and warrants pursuant to EITF Nos. 00-19, 05-02, 05-04 and SFAS
      No. 133.


·
            Recognize
      a debt extinguishment and the resulting loss as a result of debt
      modification


·
            Recognize
      common shares in excess of shares authorized that potentially subject to
      net cash settlement.


·
            Related
      income tax effects




12. Restatement
of Financial Statements (continued)





The accompanying financial statements for 2006 have been restated to reflect the
corrections. The  net loss for 2006  increased by $2,618,000
as a result of these adjustments to the carrying value of convertible
debentures, warrant liability and share liability which were not properly
recorded in 2006.






Year ended December 31,
2006(in
      thousands except per share data)The
      following is a summary of the restatements for the year ended December 31,
      2006:Accrual
      of Excess Share liability
            
            $
            2,886Net
      changes in fair value of warrant liability
            
            
            (3,044
            )Loss
      on extinguishment of debt
            
            
            2,256Net
      changes resulting from change in net cash settlement
            
            
            520$
            2,618





The following is a summary of the restatements for the year ended December 31,
2006:








Income tax effect of
      restatement
            
            $
            0.0Total
      increase in net loss
            
            $
            2,618






The effect on the Company’s previously issued December 31, 2006 financial
statements are summarized as follows:





As
      previously reported
              
              
              Change
              
              
              RestatedBalance
      SheetExcess
      Share Liability
              
              $
              -
              
              
              $
              2,886
              
              
              $
              2,886Warrant
      Liabilities
              
              
              3,044
              
              
              
              (3,044
              )
              
              
              0Total
      current liabilites
              
              
              15,010
              
              
              
              (158
              )
              
              
              14,852Total
      Long term Liability
              
              
              84
              
              
              
              -
              
              
              
              84Total
      Liability
              
              
              15,094
              
              
              
              (158
              )
              
              
              14,936Common
      Stock and Paid-in-capital
              
              
              118,418
              
              
              
              2,776
              
              
              
              121,194Accumulated
      Deficit
              
              
              (131,295
              )
              
              
              (2,618
              )
              
              
              (133,913
              )TOTAL
      STOCKHOLDER'S EQUITY
              
              
              (12,877
              )
              
              
              158
              
              
              
              (12,719
              )TOTAL
      LIABILITIES & EQUITY
              
              
              2,217
              
              
              
              -
              
              
              
              2,217


Statement
      of Operations year ended December 31, 2006Operating
      Loss
              
              
              (5,256
              )
              
              
              -
              
              
              
              (5,256
              )Interest
      Expense
              
              
              (3,897
              )
              
              
              2,143
              
              
              
              (1,754
              )Other
      Expense
              
              
              (381
              )
              
              
              (4,761
              )
              
              
              (5,142
              )Net
      Loss
              
              $
              (9,533
              )
              
              $
              (2,618
              )
              
              $
              (12,151
              )Basic
      and diluted net loss per share
              
              $
              (0.94
              )
              
              $
              (0.26
              )
              
              $
              (1.19
              )Shares
      used in computing basic and diluted net loss per share
              
              
              10,170
              
              
              
              10,170
              
              
              
              10,170





F-29




12. Restatement
of Financial Statements (continued)




The net loss
for 2006 was originally $9,533,000, while the 2006 restated net loss is reported
as $12,151,000, an increase in loss of $2,618,000.  This increase in
loss is related to the convertible debt, warrants, and common shares in excess
of corporate authority through December 31, 2006.  The details of
which are as follows




·
            a
      charge arising from shares to settle convertible debt in excess of
      corporate authority of $2,885,744


·
            The
      elimination of derivative share liability of $3,043,740 relating to the
      fair value of warrant liability


·
            Loss
      on extinguishment of debt of
$2,256,072


·
            expenses  due
      to change in fair value of to the debt derivatives of
    $520,000





On the 2006
balance sheet, the restatement resulted in a decrease in liabilities and equity
of $157,996 consisting of the following:


·
            an
      decrease to the warrant liability from $3,043,740 to
  0;


·
            an
      increase to the net cash settlement of excess share  liability
      from $0 to $2,885,744;




·
            a
      net increase in retained deficit of
$2,618,000.


·
            an
      increase in additional paid in capital of
  $2,776,000





The basic and
diluted loss per share increased $0.25 from $(0.94) to $(1.19).





Restatement of Financial
Statements (continued)





Three months ending March
31, 2007





The following
is the summary of the restatements as of March 31, 2007(unaudited) (in
thousands):





Net
change in fair value of warrant
liability                                                                            $4,910,000.





The following
is the summary of the restatements for the three month ending March 31, 2007:
(unaudited) (in thousands):





Income
tax effect of
restatement                                                                                               $0.0


Total
increase in net
loss                                                                                                           $
2,826,000





F-30




12. Restatement
of Financial Statements (continued)








The effect on
the Company’s previously issued March 31, 2007 financial statements are
summarized as follows (in thousands):





Three months ending March 31,
2007:






The
      effect on the Company’s previously issued March 31, 2007 financial
      statements are summarized as follows:(000's)As
      previously reported
              
              
              Change
              
              
              RestatedBalance
      SheetExcess
      Share Liability
              
              $
              -
              
              
              $
              10,623
              
              
              $
              (10,623
              )Warrant
      Liabilities
              
              
              7,954
              
              
              
              (7,954
              )
              
              
              -Total
      current liabilites
              
              
              21,527
              
              
              
              2,669
              
              
              
              24,196Total
      Long term Liability
              
              
              79
              
              
              
              -
              
              
              
              79Total
      Liability
              
              
              21,606
              
              
              
              2,669
              
              
              
              24,275Common
      Stock
              
              
              118,503
              
              
              
              2,776
              
              
              
              121,279Accumulated
      Deficit
              
              
              (138,318
              )
              
              
              (5,444
              )
              
              
              (143,762
              )Total
      Stock Holders' Equity
              
              
              (19,815
              )
              
              
              (2,669
              )
              
              
              (22,483
              )Total
      Liabilities and equity
              
              $
              1,791
              
              
              $
              (0
              )
              
              $
              1,792Statement
      of Operations three months ending March 31, 2006Operating
      Loss
              
              $
              (1,892
              )
              
              $
              -
              
              
              $
              (1,892
              )Interest
      Expense
              
              $
              (220
              )
              
              $
              -
              
              
              $
              (220
              )Other
      Expense
              
              $
              (4,911
              )
              
              $
              4,911
              
              
              $
              -Excess
      Shares Liability
              
              $
              -
              
              
              $
              (7,737
              )
              
              $
              (7,737
              )




The net
loss for the three months ending March 31, 2007 was originally $7,023,000. While
the three months ending March 31, 2007 restated net loss is reported as
$9,849,000, an increase in loss of $2,826,000. This increase in loss is due to
elimination of derivative share liability of $4,911,000 relating to the fair
value of warrant liability offset by a charge arising from shares to settle
convertible debt in excess of corporate authority of $7,737,000




On
March 31, 2007 balance sheet, the restatement resulted in a increase in
liabilities of $2,827,000 due to a) elimination of derivative liability relating
to warrants of $4,911,000 offset by a charge arising from shares to settle
convertible debt in excess of corporate authority of $7,737,084, offset in
stockholder's equity increase in accumulated deficit of $2,826,000 due to an
increase in operating loss of $2,826,000.




The basic
and diluted loss per share increased by $0.28 from $(0.68) to
$(0.96).





Three and six months ended
June 30, 2007




The
following is the summary of the restatements for the three months ended June 31,
2007:




(000's)Net change in fair
      value of conversion liability
            
            $
            (400,000
            )Net adjustment to
      Loss and paid in capital for debt
      extinguishment
            
            $
            (1,346,000
            )Reduction of
      Deferred expenses
            
            $
            1,746,000Total
            
            $
            0.0




The
following is a summary of the restatements for the three and six months ended
June 30, 2007 (000's)






Income tax effect of
      restatement
            
            $
            0.0Total increase in
      net loss
            
            $
            23,938,000




F-31




12. Restatement
of Financial Statements (continued)




The
effect on the Company’s previously issued June 30, 2007 financial statements are
summarized as follows:




Three and six months ended
June 30, 2007




(000's)As
      previously reported
              
              
              Change
              
              
              RestatedBalance
      SheetAssetsDeferred
      expense
              
              $
              1,746
              
              
              $
              (1,746
              )
              
              $
              -Total
      current assets
              
              
              2,681
              
              
              
              (1,746
              )
              
              
              935Total
      Assets
              
              $
              3,010
              
              
              $
              (1,746
              )
              
              $
              1,264-
              
              
              
              
              
              
              
              -Liabilities
      & EquityConversion
      features liability
              
              $
              400
              
              
              $
              (400
              )
              
              $
              -Total
      current liabilites
              
              
              18,240
              
              
              
              (400
              )
              
              
              17,840Total
      Long term Liability
              
              
              74
              
              
              
              -
              
              
              
              74Total
      Liability
              
              
              18,314
              
              
              
              (400
              )
              
              
              17,914Common
      Stock
              
              
              103
              
              
              
              -
              
              
              
              103Preferred
      Stock
              
              
              5
              
              
              
              -
              
              
              
              5Additional
      Paid-In-Capital
              
              
              118,939
              
              
              
              25,211
              
              
              
              144,150Accumulated
      Deficit
              
              
              (134,351
              )
              
              
              (26,557
              )
              
              
              (160,908
              )Total
      Stock Holders' Equity
              
              
              (15,304
              )
              
              
              (1,346
              )
              
              
              (16,650
              )Total
      Liabilities and equity
              
              $
              3,010
              
              
              $
              (1,746
              )
              
              $
              1,264Statement
      of Operations three months ending June 30, 2007Operating
      Loss
              
              $
              (1,927
              )
              
              $
              -
              
              
              $
              (3,819
              )Interest
      Expense
              
              
              (1,665
              )
              
              
              1,399
              
              
              
              (266
              )Deferred
      expense
              
              
              
              
              
              
              624Loss
      on debt restructuring
              
              
              -
              
              
              
              (15,182
              )
              
              
              (15,182
              )Other
      Expense
              
              
              7,959
              
              
              
              (7,954
              )
              
              
              5Net
      Loss
              
              $
              4,367
              
              
              $
              (21,113
              )
              
              $
              (16,746
              )Basic
      and diluted net loss per share
              
              $
              0.42
              
              
              $
              (2.05
              )
              
              $
              (1.63
              )Shares
      used in computing basic and diluted net loss per share
              
              
              10,286
              
              
              
              10,286
              
              
              
              10,286Statement
      of Operations six months ending June 30, 2007Operating
      Loss
              
              $
              (3,819
              )
              
              $
              -
              
              
              $
              (3,819
              )Interest
      Expense
              
              
              (1,886
              )
              
              
              1,400
              
              
              
              (486
              )Other
      Expense
              
              
              3,048
              
              
              
              (3,043
              )
              
              
              5Loss
      on debt restructuring
              
              
              -
              
              
              
              (15,182
              )
              
              
              (15,182
              )Deferred
      expense
              
              
              
              
              
              
              624Excess
      shares Liability
              
              
              
              
              
              
              (7,737
              )
              
              
              (7,737
              )Net
      Loss
              
              $
              (2,657
              )
              
              $
              (23,938
              )
              
              $
              (27,219
              )Basic
      and diluted net loss per share
              
              $
              (0.26
              )
              
              $
              (2.33
              )
              
              $
              (2.59
              )Shares
      used in computing basic and diluted net loss per share
              
              
              10,285
              
              
              
              10,285
              
              
              
              10,285




The net
income for the three months ending June 30, 2007 was originally $4,367,000. The
three months ending June 30, 2007 restated net loss is reported as $16,746,000,
a decrease in net income of $21,113,000. This increase in loss is due to
elimination of derivative share liability of $1,400,000 relating to the fair
value of warrant liability offset by charges arising from the recognition of the
extinguishment of debt treatment which included a decrease in interest of
$1,179,000, recognition of a debt restructuring of $15,182,000 and a reduction
of other expense of $7,954, 000 primarily from elimination of the warrant
liability. The effect of the above adjustment and prior restatement adjustments
resulted in an increase in the net loss at June 30, 2007 to increase $24,562,000
from $2,657,000 to $27,219.000.




F-32




The basic
and diluted loss per share increased by $2.11and $1.95 from $0.42 and (0.26) to
$(1.69) and $(2.20) for the three and six months ended June 30, 2007
respectively




On June
30, 2007 balance sheet, the restatement resulted in a decrease in liabilities of
$400,000  a reduction of the deferred charges of
$1,746,000  and adjustment to paid in capital of 28,453,000, all
resulting from the recognition of the extinguishment of debt




Three and nine months ended
September 30, 2007




The
following is the summary of the restatements for the three months ended
September 31, 2007(unaudited):




Net change in fair
      value of conversion liability
            
            $
            (400,000
            )Net adjustment to
      Loss and paid in capital for debt
      extinguishment
            
            $
            400,000Total
            
            $
            0.0




The
following is a summary of the restatements for the three and nine months ended
September 30, 2007:




Income tax effect of
      restatement
              
              $                       
       0.0Total increase in
      net loss
              
              $
              15,580,000


F-33





12. Restatement
of Financial Statements (continued)





The
effects on the Company's previously issued September 30, 2007 financial
statements are summarized as follows:




Three months and nine months
ended September 30, 2007:




As
      previously reported
              
              
              Change
              
              
              RestatedBalance
      SheetConversion
      feature laibility
              
              $
              400
              
              
              $
              (400
              )
              
              $Total
      current liabilites
              
              
              20,422
              
              
              
              (400
              )
              
              
              20,022Total
      Long term Liability
              
              
              68
              
              
              
              -
              
              
              
              68Total
      Liability
              
              
              20,490
              
              
              
              (400
              )
              
              
              20,090Common
      Stock
              
              
              10
              
              
              
              -
              
              
              
              10Preferred
      Stock
              
              
              5
              
              
              
              -
              
              
              
              5Additional
      Paid-In-Capital
              
              
              125,557
              
              
              
              18,599
              
              
              
              144,156Accumulated
      Deficit
              
              
              (144,326
              )
              
              
              (18,199
              )
              
              
              (162,525
              )Total
      Stock Holders' Equity
              
              $
              (18,754
              )
              
              $
              400
              
              
              
              (18,354
              )Total
      Liabilities and Equity
              
              
              1,736
              
              
              
              0
              
              
              $
              1,736Statement
      of Operations three months ending September 30, 2007Operating
      Loss
              
              $
              (1,459
              )
              
              $
              -
              
              
              $
              (1,459
              )Interest
      Expense
              
              
              (2,314
              )
              
              
              1,189
              
              
              
              (1,125
              )Other
      Expense
              
              
              9
              
              
              
              -
              
              
              
              9Net
      Loss
              
              $
              (3,764
              )
              
              $
              1,189
              
              
              $
              (2,575
              )Basic
      and diluted net loss per share
              
              $
              (0.37
              )
              
              $
              0.12
              
              
              $
              (0.25
              )Shares
      used in computing basic and diluted net loss per share
              
              
              10,300
              
              
              
              10,300
              
              
              
              10,300Statement
      of Operations nine months ending September 30, 2007Operating
      Loss
              
              $
              (5,278
              )
              
              $
              -
              
              
              $
              (5,278
              )Interest
      Expense
              
              
              (9,651
              )
              
              
              8,040
              
              
              
              (1,611
              )Deferred
      expense
              
              
              
              
              
              
              1,583
              
              
              
              1,583Other
      Expense
              
              
              3,058
              
              
              
              (3,044
              )
              
              
              14Loss
      on debt restructuring
              
              
              (760
              )
              
              
              (14,422
              )
              
              
              (15,182
              )Excess
      Shares Liability
              
              
              
              
              
              
              (7,737
              )
              
              
              (7,737
              )Net
      Loss
              
              $
              (12,631
              )
              
              $
              (15,580
              )
              
              $
              (28,211
              )Basic
      and diluted net loss per share
              
              $
              (1.23
              )
              
              $
              (1.52
              )
              
              $
              (2.75
              )Shares
      used in computing basic and diluted net loss per share
              
              
              10,267
              
              
              
              10,267
              
              
              
              10,267




The net
loss for the three months ending September 30, 2007 was originally $3,764,000.
The three months ending September, 2007 restated net loss is reported as
$2,575,000, a decrease in loss of $1,189,000.  This decrease in loss
is due to the inclusion of additional fee expenses included in the debt
extinguishment loss previously amortized.




The
effect of the above adjustment and prior restatement adjustments resulted in an
increase in the net loss for the nine months ending September 30, 2007 to
increase $15,580,000 from $12,631,000 to $28,211,000




$5,807,000
included in interest expense for the nine months ended September 30, 2007 was
included in the loss on extinguishment at June 30, 2007, and was not included as
interest at June 30, 2007





F-34




12. Restatement
of Financial Statements (continued)





On
September 30, 2007 balance sheet, the restatement resulted in a decrease in
liabilities of $400, resulting from elimination of the conversion liability
originally recognized.





The basic
and diluted loss per share increased for the three and nine months ended
September 30, 2007 respectively




13. Income Taxes




The
Company adopted the provisions of FIN 48 on January 1, 2007. The implementation
of FIN 48 did not result in a cumulative effect adjustment to retained
earnings.




The
      components of the provision for income taxes are as follows (in
      thousands):DECEMBER
      31,2007
              
              
              2006Current:Federal
              
              
              -
              
              
              
              -State
              
              
              -
              
              
              
              --
              
              
              
              -Deferred:Federal
              
              
              -
              
              
              
              -State
              
              
              -
              
              
              
              --
              
              
              
              -Total
      provision for (benefit from) income taxes
              
              
              -
              
              
              
              -A
      reconciliation of income taxes at the statutory federal income tax rate to
      net income taxes included in the accompanying statement of operations is
      as follows:DECEMBER
      31,2007
              
              
              2006Tax
      Benefit at expected federal rate
              
              
              -34.0
              %
              
              
              -34.0
              %State,
      Net of Federal Benefit
              
              
              -5.8
              %
              
              
              -5.8
              %Research
      and development credits
              
              
              2.6
              %
              
              
              -0.8
              %Non-deductible
      derivative and other expense
              
              
              24.0
              %
              
              
              19.6
              %Net
      operating loss net benefited
              
              
              13.2
              %
              
              
              21.1
              %Other,
      net
              
              
              0.0
              %
              
              
              -0.1
              %0.0
              %
              
              
              0.0
              %
  At
December 31, 2007, the Company had federal and state net operating loss carry
forwards of approximately $61,084,000
and $41,722,000,
respectively.  The federal and state net operating loss
carry forwards expire at various dates beginning in 2008 through 2027, if not
utilized.
 The
Company also had federal and state research and development tax credit carry
forwards of approximately $11,000
and $1,123,000,
respectively. The
federal research and development tax
credits begin to expire in 2027. The state research and development tax credits
carry forward
indefinitely.
  Utilization
of the net operating losses and credits may be subject to a substantial annual
limitation due to
the "change in ownership" provisions of the Internal Revenue Code of 1986, as
amended, and similar
state provisions.  The annual limitation may result in the expiration
of net operating losses and credits
before utilization.
  Significant
components of the Company's deferred tax assets for federal and state income
taxes as follows
(in thousands):
  DECEMBER
      31,2007
              
              
              2006Net
      operating loss carry forwards
              
              $
              23,203
              
              
              $
              42,523Research
      credits carry forwards (federal and state)
              
              
              752
              
              
              
              1,836Manufacturing
      investment credit carry forwards
              
              
              78
              
              
              
              78Capitalized
      research and development
              
              
              1,555
              
              
              
              1,375Other,
      net
              
              
              1,203
              
              
              
              532Total
      deferred tax assets
              
              
              26,791
              
              
              
              46,344Valuation
      Allowance for deferred tax assets
              
              
              (26,791
              )
              
              
              (46,344
              )$
              -
              
              
              $
              -
  F-35
  As of
December 31, 2007 and 2006, the Company had deferred tax assets of
approximately$
26,791,000 and $46,344,000,
respectively.  Realization of the deferred tax assets is dependent
upon future
taxable income, if any, the amount and timing of which are
uncertain.  Accordingly, the net deferred tax
assets have been fully offset by a valuation allowance.  The net
valuation allowance decreased by approximately
$19,553,000
and
increased $641,000
during
the years ended December 31, 2007 and 2006,
respectively.  Deferred tax assts primarily relate to net operating
loss and tax credit carry
forwards.
  The
Company realizes tax benefits as a result of the exercise of non-qualified stock
options and the exercise
and subsequent sale of certain incentive stock options (disqualified
dispositions).  For financial reporting
purposes, any reduction in income tax obligations as a result of these tax
benefits will be credited
to additional paid-in capital upon utilization of the NOLs including these
benefits.
  On
January 1, 2007, the Company adopted FASB Interpretation No. 48 (FIN 48),Accounting for Uncertainty in
Income Taxes. FIN 48 clarifies the accounting for uncertainty in income
taxes and prescribes a recognition threshold, measurement attribute for the
 The
implementation of FIN 48 did not have a material impact on the Company's
financial statements.  At January 1, 2007, the Company has not accrued
an amount for tax liability from unrecognized tax
benefits.
 A
reconciliation of the beginning and ending unrecognized tax benefit amounts for
2007 are as follows:
 Balance
      at January 1, 2007
              $
              -Increases
      related to current year tax positions
              -Expiration
      of the statute of limitations
              -Balance
      at December 31, 2007
              $
              -
  The
      Company does not believe the total amount of unrecognized benefit as of
      December 31, 2007 will increase or decrease significantly in the next
      twelve months.  The Company’s Federal, California, Illinois and
      Wisconsin tax returns are subject to
examinat





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




F-36





14.
License Rights




In May
1993, in exchange for an equity interest in the Company, Target Therapeutics,
Inc. granted the Company an exclusive royalty-free worldwide license to use
Target Therapeutics' technology and to make, use and sell or otherwise
distribute products for the diagnosis and treatment of electrophysiological
diseases in the body, other than in the central nervous system, including the
brain. The exclusive license grant applied to any Target Therapeutics’
technology developed through May 1996 and will expire upon the expiration of the
last of the patents relating to Target Therapeutics’ technology. Under the
License Agreement, the Company granted back to Target Therapeutics an exclusive
royalty-free license to use technology developed through May 1996 in the fields
of neurology, interventional neuro-radiology, 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
Target Therapeutics’ technology. Target Therapeutics granted the Company a
non-exclusive, royalty-free license to use Target Therapeutics’ 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 Therapeutics’ 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 micro-catheter systems, together with other modifications,
satisfies the substantial improvement requirements. As part of the same
agreement, the Company granted to Target Therapeutics 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 Therapeutics' 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 Therapeutics and negotiating a distribution
agreement. The Company also agreed that it would not sell products utilizing
Target Therapeutics' 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 Therapeutics and offering it the right of first refusal with
respect to the terms of the distribution, or if selling directly to the
consumer, paying to Target Therapeutics an amount equal to 40% of the gross
profit for such product.




15.
Retirement Benefit Plan





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





16. Warrant Activity





During
the year ended December 31, 2007, the board of directors approved the issuance
of warrants to purchase an aggregate of 5,700,000 shares of the Company’s common
stock at an exercise price of $0.55 per share. These shares are all vested upon
issuance and expire in year 2012.





Included
in the issuance of warrants to purchase 5,700,000 aggregate shares of the
Company’s common stock is a warrant to purchase 3,000,000 shares that was issued
to APIX, an entity wholly owned and controlled by the Company’s CEO and director
under the terms of service agreements during fiscal 2007. Such issuance was
accounted for under Financial Accounting Standards Board Statement No. 123R
using the Black-Scholes option-pricing model (with the same assumptions as those
used for the option), which resulted in the recording of $1,234,000 in
compensation cost during the year ended December 31, 2007.





The
following table summarizes warrant activities for years 2007 and
2006:







Outstanding
      WarrantsWarrant
      Shares Available
            
            Number
      of Warrant Shares
            
            Exercise
      Price Per Warrant Share
            Weighted-Average
      Exercise PriceBalance
      as of 12/31/2005
            
            
            5,072,611
            
            5,072,611
            
            $
            1.00
      - $15.20
            $
            3.70Warrant
      Shares Granted in 2006
            
            
            3,180,000
            
            3,180,000
            
            $
            0.60
      - $0.60
            $
            0.60Warrant
      Shares Cancelled  in 2006
            
            
            (498,239
            )
            (498,239)
            
            $
            0.64
      - $15.20
            $
            8.70Warrant
      Shares Exercised in 2006
            
            
            ---
            
            ---
            
            
            ---
            
            ---Balance
      as of 12/31/2006
            
            
            7,754,372
            
            7,754,372
            
            $
            0.60
      - $14.00
            $
            3.20Warrant
      Shares Granted in 2007
            
            
            5,700,000
            
            5,700,000
            
            $
            0.55
      - $0.55
            $
            0.55Warrant
      Shares Cancelled  in 2007
            
            
            (528,613
            )
            (528,613
            
            $
            0.78
      - $13.40
            $
            10.60Warrant
      Shares Exercised in 2007
            
            
            (6,180,000
            )
            (6,180,000
            )
            $
            0.60
      - $0.60
            $
            0.60Balance
      as of 12/31/2007
            
            
            6,745,759
            
            6,745,759
            
            $
            0.55
      - $14.00
            $
            1.30




F-37




The
following table summarizes information about warrants outstanding at December
31, 2007:





Outstanding
      Warrants
            
            
            Warrants
      ExercisableRange
      of Exercise Prices
            
            
            Number
      of Warrant Shares Outstanding
            
            
            Weighted-Average
      Remaining Contractual Life
            
            
            Weighted-Average
      Exercise Price
            
            
            Number
      of Warrant Shares Exercisable
            
            
            Weighted-Average
      Exercise Price$
            0.55
      - $4.30
            
            
            
            6,457,409
            
            
            
            4.5
            
            
            $
            1.00
            
            
            
            6,457,409
            
            
            $
            1.00$
            8.30
      - $14.00
            
            
            
            288,350
            
            
            
            1.6
            
            
            $
            9.30
            
            
            
            288,350
            
            
            $
            9.306,745,759
            
            
            
            4.4
            
            
            $
            1.30
            
            
            
            6,745,759
            
            
            $
            1.30




17. Subsequent Event





On March 23, 2008, the Board of
Directorsapproved
a resolution appointing Apix International Limited (the “Agent”) to be its
exclusive agent to arrange a best efforts private placement funding with
qualified investors (the “Placees”) for a period of 90 days. The minimum
placement is for 8,000,000 shares ($4,800,000) to a maximum of 16,000,000 shares
( $9,600,000) at a price of $0.60 per share. The placement fee is waived but a
warrant entitling the Agent to purchase 1.5 Million shares of the Company for a
period of 5 years at an exercise price of $0.65 for placement of the initial 10
Million shares or less. For shares placed over and above this level the Agent
shall receive an additional warrant on the same terms equal to 15% of the total
additional shares placed.  The current plan is to obtain
between $6 to $7 million. There are signed agreements from investors
committing around US$5 million.




On March
23, 2008, the Board approved a resolution to change the provisions of the
Preferred Shares to reflect the following:  Apix, at its sole
discretion, can convert the five million Preferred Share into 10 million Common
Shares (i.e., new common shares post common share consolidation) .Apix will be
able to vote the Preferred Shares based on their economic interest in the
Company (i.e. each Preferred Share carries the vote of two Common Shares). All
other provisions, rights and responsibilities for either party per the term
sheet, if any, are null and void. The Company will evaluate the appropriate
classification of the changes to the Series A Preferred Stock issued in
accordance with SFAS No. 150,  EITF Issue Nos.98-05, 00-19 and 00-27,
during the first quarter of 2008.