UNITED STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-KSB/A





[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 June 30, 2008, the aggregate market value of the registrant's common
stock held by non-affiliates was approximately $21,819,000. 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: 116,316,311 as of December 31, 2007.











EXPLANATORY
NOTE




This
amendment to the Annual Report on Form 10KSB/A for the year ended December 31,
2007 (the “Annual Report”) is being filed to revise certain disclosures in the
sections included in this amendment in response to comments raised by the
Securities and Exchange Commission.










1






















TABLE
      OF CONTENTS




ITEM
      1.
            MANAGEMENT'S
      DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
            3ITEM
      2.
            FINANCIAL
      STATEMENTS
            11ITEM
      3A.
            CONTROLS
      AND PROCEDURES
            11ITEM
      4.
            EXHIBITS
            14SIGNATURES
            15










2













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





Cautionary
Statement Regarding Forward-Looking Statements




The
information in this discussion may contain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. These forward-looking statements involve risks and uncertainties,
including statements regarding our capital needs, business strategy and
expectations. Any statements that are not of historical fact may be deemed
to be forward-looking statements. These forward-looking statements involve
substantial risks and uncertainties. In some cases you can identify
forward-looking statements by terminology such as “may,” “will,” “should,”
“expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,”
“potential,” or “continue”, the negative of the terms or other comparable
terminology. Forward-looking statements in this Report may also include
references to anticipated sales volume and product margins, efforts aimed at
establishing new or improving existing relationships with customers, other
business development activities, anticipated financial performance, business
prospects and similar matters. Actual events or results may differ
materially from the anticipated results or other expectations expressed in the
forward-looking statements. In evaluating these statements, you should consider
various factors, including the risks included from time to time in other reports
or registration statements filed with the United States Securities and Exchange
Commission. These factors may cause our actual results to differ materially
from any forward-looking statements. We disclaim any obligation to publicly
update these statements, or disclose any difference between actual results and
those reflected in these statements.





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 atrial fibrillation (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. Our products include the PATHFINDER®,
TRACER® AND
VUEPORT® series
of the diagnostic catheters, the NAVIPORT® series
of guiding catheters, the REVELATION® series
of ablation catheters, the Surgical Ablation System with its series of ablation
probes, and the INTELLITEMP® Energy
Management Device series for radiofrequency energy management. These devices are
CE marked and/or received U.S. FDS 510(k) clearance. The RAVELATION series of
ablation catheters with INTELLITEMP EP Energy Management Device was developed
for marketed for the treatment of AF with CE mark approval in Europe; it is not
yet commercially available in the United States.





Our
primary focus is to generate revenue from our surgical devices, which have Food
and Drug Administration (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 may need to raise additional capital to implement our marketing
strategy relating to the sale of surgical devices.





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, 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 premarket
approval (PMA).  In consultation with the FDA, we are currently
designing a study trial amenable to both parties to seek approval to use our
ablation system to treat AF.  We project to begin our 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. 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.





We
have had a considerable financing arrangement with APIX International Ltd.
(APIX) since 2005, an entity owned by Robert Cheney, who is our Chief Executive
Officer and a Director.  We had obtained an initial funding of $3,000,000
in August 2005; issued 3,000,000 warrants at exercise price of $1.00 and agreed
to pay various additional fees totaling $1,035,000.   At the
February 16, 2006 round of financing the company secured additional funding of
$660,000, agreed to pay additional fees of $860,000, and granted an additional
3,180,000 warrants at an exercise price of $1.00. The term of this loan was
through May 16, 2006. We continued to receive additional funding of $4,500,000
and had accrued additional interest of $375K. As of December 31, 2006 we had
received cash funding of $8,160,000, had accrued $592,000 in interest and
accrued various fees amounting to $1,715,000.





On
January 17, 2007, the old loan with APIX was rolled over in to a new loan with
additional loan funding up to $5,625,000 to be drawn in installments of $220,000
each. We also granted additional warrants with the new and old warrants totaling
118,800,000(rolled the previous 3,000,000 and 3,180,000 in previous agreements),
3,800,000 warrants for each draw of funds and additional 20,000,000 warrants.
The total of all warrants added up to 20,340,000, at the exercise price of $0.40
for the 11,880,000 warrants and $0.30 for the remaining 8,460,000 warrants. In
addition, we agreed to pay the cumulative facility fee of 500,000 in the
form of 5,000,000 preferred shares with a stated value $0.001 with additional
voting rights. The exit fee was increased from $1,560,000 to $3,920,000 and the
other expenses rose to $425,000. The total outstanding amount at September 30,
2007 comprised of principal amount of $11,880,000, accrued interest of
$1,436,000, exit fee of $3,920,000 and other expenses of $425,000 totaling to
$17,661,000.The details of the transactions are listed in the section titled
“Recent Financings”.








3





On
July 31, 2007, we implemented a ten for one reverse stock
split.  Following the split, our common stock is traded under a new
ticker symbol, “CADM”.




On
October 3, 2007, we entered into a Debt Settlement Agreement (the “Settlement
Agreement”), with APIX. Under the terms of the Settlement Agreement, we 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 us 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, we consummated a private placement transaction whereby we
entered into a series of Subscription Agreements (the “Subscription Agreement”)
with certain accredited investors (collectively, the “Investors”) providing for
the sale by us 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. We granted a total of 5,700,000 warrants to the
investors. APIX  acted as placement agent for the transaction.
Additional details can be found in the recent financing section of this
report.





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,” when all of the following criteria are met: persuasive evidence of
an arrangement exists, shipment of the product has occurred and title of
products transferred at the point of shipment, payment of the product is
reasonably assured and no substantive obligations to the customer remain.
Revenue is presented net of discounts, allowances, and returns. Payment terms
are either open trade credit or cash. We generally allow the customers to return
defective, damaged and in certain cases expired products for credit. We have
distributors in Asia and Europe and we record as revenue the wholesale price we
charge our distributors. The distributors assume the title and the risk of loss
at the shipping point. The distributors do not have any price protection or
return rights. We 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.




Research
and Development





Research
and development costs, which includeclinical 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. Net losses are charged off against the
reserve, while recoveries of amounts previously charged off are credited to the
reserve. Evaluations of the reserve balance are conducted
quarterly.





Allowance
for Doubtful Accounts





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








4





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.





Income
Taxes





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





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. We
determined that there was no impact as a result of the adoption of FIN No.
48.





Stock-Based
Compensation





On
January 1, 2006, we adopted SFAS 123 (revised 2004), Share-Based
Payment (“SFAS 123(R)”), which requires the measurement and recognition of
compensation expense for all share-based awards made to employees and directors,
including employee stock options and shares issued through its employee stock
purchase plan, based on estimated fair values. In March 2005, the Securities and
Exchange Commission issued Staff Accounting Bulletin 107 (“SAB 107”)
relating to SFAS 123(R). We have applied the provisions of SAB 107 in
its adoption of SFAS 123(R). We adopted SFAS 123(R) using the modified
prospective transition method, which requires the measurement and recognition of
compensation expense for all share-based awards made to employees, consultants,
directors, including employee non-qualified and incentive stock options, and
employee purchase rights under our Employee Stock Purchase Plan based on
estimated fair values beginning in 2006.  In January 2008 the
Securities and Exchange Commission issued Staff Accounting Bulletin 110
(“SAB 110”) relating to SFAS 123(R). We have reviewed the provisions
of SAB 110 and will be implementing the “simplified” method in
2008.





Stock
Warrants Issued to Third Parties





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





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. We are currently evaluating this
pronouncement.






5







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. We are currently
evaluating the potential impact that the adoption of SFAS No. 141(R) could have
on its financial statements.





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 do not expect it to have a significant impact on our
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 for fiscal years beginning after
December 15, 2007. We do not expect this EITF to have a significant impact on
our financial position, results of operations or cash flows.




Also
in June 2007, the FASB ratified EITF Issue No. 07-3, "Accounting for Advance
Payments for Goods or Services to Be Used in Future Research and Development
Activities." EITF 07-3 provides that nonrefundable advance payments made for
goods or services to be used in future research and development activities
should be deferred and capitalized until such time as the related goods or
services are delivered or are performed, at which point the amounts would be
recognized as an expense. This issue is effective for fiscal years beginning
after December 15, 2007.  We have evaluated the potential impact of
this issue and do not expect that it will have a material impact on our
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. We are currently assessing the impact of adopting SFAS
159.





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. This statement is
effective for fisal years beginning after November 15, 2007. 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 had a material effect on our financial
statements. Our restatement is discussed in Note 13.








6





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





Net
Sales





For
the year ended December 31, 2007, sales decreased 25% to $1,157,000 from
$1,541,000 for the same period in 2006.  The decrease in net sales was
primarily due to our discontinued Japanese distributor’s failure to maintain the
legal documentation standard required to sell our PATHFINDER products in Japan,
resulting in no sales to this region in 2007. As the distributor no longer had
the right to sell our product, the goods were taken back and returned to
inventory. We also note that the credit to receivables resulted in a charge to
sales net of return. Excluding Japan, which contributed $650,000 in sales in
2006, we had significant growth in all other regions. We expect to see continued
sales growth in 2008 as we continue to explore ways to market our products in
Japan and other countries.





Net
sales in the United States increased significantly by 33% to $857,000 from
$624,000 in 2006 as we continue to focus our efforts on expanding our domestic
customer base. European sales also increased by 15% to $363,000 from $255,000 in
2006. The increases in sales in both regions are due to increased sales efforts
and the signing of new distributors in key target markets.  We expect
to see continued sales growth in 2008 as we continue to explore ways to market
our products in Japan and other countries.





Cost
of Goods Sold





Cost
of goods sold primarily includes raw materials, catheter fabrication, quality
control, and packaging costs. Cost of goods sold as a percentage of net sales
increased slightly by 8%, from 131% in 2006 to 139% in 2007 mostly due to higher
headcount and other spending in the manufacturing area in 2007 in anticipation
of the commercialization of the surgical line of products. We expect the cost of
goods sold as a percentage of sales to improve as sales 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 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 $10,129,000 loss 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 excess of
authorized shares. This liability of excess shares over authorized shares was
corrected during the year by the reverse stock split approved by the
shareholders in July 2007. The accounting explanation of these non-cash
losses is provided in Note 13 of the “Notes to Financial
Statements”.




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 2007 from
$1,787,000 in 2006. The increase in 2007 was primarily due to activities related
to the surgical product line 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 trial 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 as follows (in thousands):





Year
      ended December 31,2007
            
            2006Clinical
      development programs
            
            $
            2,073
            
            
            $
            1,110Research
      and preclinical programs
            
            
            1,018
            
            
            
            677Total
      research and development
            
            $
            3,091
            
            
            $
            1,787






7






Selling,
General and Administrative Expenses




Selling, general and
administrative expenses for 2007 increased 74% to $5,203,000 from $2,987,000 in
2006. Selling expenses for 2007 increased by 69% to $477,000 from $282,000 in
2006 primarily due to hiring of a sales consultant in Europe. Marketing expenses
for 2007 also increased 215% 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 66% to $4,219,000 from $2,544,000 in
2006. The increase in general and administrative expenses was primarily due to
the recording of $1,408,000 non-cash payment to APIX for services connected with
the 2007 private placement and $125,000 expenses for the initial implementation
of meeting Section 404 internal control requirements and transition from one
audit company to another company. Section 404 implementation expenses are
expected to increase in 2008.




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, up from $5,142,000 in 2006. This was
principally due to the non-cash loss on conversion of debt in to equity of
$10,129,000, non-cash loss on debt extinguishment of $15,182,000 and non-cash
loss of 7,737,000 from the liabilities created from the issuance of options,
warrants and 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 00-19 and SFAS 133 which resulted in significant changes in the
financial statements, those financial statements should not be relied upon.
Accordingly, we have restated our twelve-month financials for December 31, 2006
and the quarters ended March, June and September 2007 financials in footnote 13
to the “Notes to Financial Statements” in this Form 10-KSB/A.





LIQUIDITY
AND CAPITAL RESOURCES




We had
cash and cash equivalents of approximately $4,811,000 as of December 31,
2007 and $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. We have improved our
working capital situation by raising additional financing in December 2007. In
addition, we also have raised additional funding in May 2008 through a series of
identical agreements with a number of accredited investors for the private sale
of 8,474,992 shares of common stock at US$0.60 per share.  The total
gross proceeds from the sale are expected to be $5,085,000.  We
believe that with new financing, increased sales and focus on managing costs, we
will have enough cash to fund the operations of the company through
2008.





Net
cash used in operating activities was approximately $6,680,000 and $4,608,000
for the years ended December 31, 2007 and 2006, respectively, resulting
primarily from working capital needs and current year operations. Net cash used
in investing activities in 2007 was $2,185,000 for purchases of short term
investment of $2,008,000 and fixed assets of $177,000, as compared to $112,000
in 2006 and related to the capital expenditures of property and equipment. Net
cash provided by financing activities was approximately $12,734,000 and
$5,538,000 for the years ended December 31, 2007 and 2006, respectively,
resulting primarily from the APIX loan financing and sale of common
stock.





Net
non-cash items affecting operating activities for the period ending December 31,
2007 amounted to $36,019,000, which mainly consisted of the following: (i) loss
on debt extinguishment of $15,182,000; (ii) loss on excess shares over
authorized of $7,737,000; (iii) compensation expense related to warrants granted
to officer of $1,408,000; (iv) loss on conversion of debt and warrants into
equity of $10,129,000.





On
December 31, 2007 we had total assets of $8,004,000 compared to $2,217,000 on
December 31, 2006, an increase of $5,787,000 (261%). We had a total
stockholder's equity of $6,381,000 on December 31, 2007, compared to a
stockholder’s equity of $12,719,000 on December 31, 2006.








8





Contractual
Commitments:





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




12/31/2007Fiscal
      Year
              
              Operating
      Leases
              
              
              Capital
      Leases2008
              
              $
              265
              
              
              $
              262009
              
              
              272
              
              
              
              72010
              
              
              115
              
              
              
              -Total
      minimum lease payments
              
              $
              652
              
              
              $
              33Less
      amounts representing interest
              
              
              N/A
              
              
              $
              (2
              )Present
      value of net minimum lease payments
              
              $
              652
              
              
              $
              31


Recent
Financings




APIX
International Ltd.





On
August 12, 2005, we entered into a Loan Facility Term Sheet with APIX, which
provided us with up to $2 million in debt 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 June 17, 2005, all
our employees had been furloughed indefinitely and our operations were
temporarily halted to conserve cash.





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 had an optional conversion clause, allowing APIX to receive
payment for all or any portion of the facility fee, the exit fee and the accrued
interest due under the loan, in shares 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 was
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
extended 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 was adjusted to $0.06 per
share. In addition, we 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 agreed to 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 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 was increased
from $60,000 to $80,000. In addition, the exit fee was 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) 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, we 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:








9







(i)  Additional
loan facility - APIX granted us an additional loan facility in the amount of
$5,625,000 with advances to be made on a bi-weekly basis at our discretion in
denominations of $225,000 per advance;





(ii)  New
maturity date - the maturity date of the New Facility and Prior Facilities was
changed to 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 was adjusted to $500,000 (the “Facility Fee”) payable through the
issuance of five million shares of our preferred stock with the following
minimum preferences: (a) 28 votes per share; and (b) convertible into our common
shares at any time at the option of the holder on the basis of two (2) common
shares for each preferred share tendered for conversion;





(iv)
Exit fees – exit fees for the Prior Facilities and the New Facility of
$2,800,000 plus $80,000 for each advance made due and payable on the earliest to
occur of: (1) the maturity date, (2) generally the sale of the company or
substantially all of our 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, we agreed to issue to APIX warrants to purchase 118,800,000 shares
of our 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 was adjusted to $0.04 per share. In addition, we issued to APIX
additional warrants to purchase 20,000,000 shares of our 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 our common stock at a conversion price of $0.04 per share;
and





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





The
final financing agreements were executed on June 7, 2007. 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 were included in our earnings during that
period.  A loss of approximately $10,129,000 was recognized in the
fourth quarter of 2007 when the debt was converted to equity. We had previously
determined that there were no derivative liabilities that needed to be accrued
under SFAS 133 or EITF 00-19.




On
June 4, 2007, we filed with the Secretary of State of Delaware a Certificate of
Elimination to remove from our certificate of incorporation the Series A
Participating Preferred Stock. On June 6, we filed with the Secretary of State
of Delaware a Certificate of Designation for a new Series A Preferred
Stock.





On
October 3, 2007, we 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 us in August 2005 for $3,000,000 as
well as two loan facility term sheets which provided financial accommodation to
us entered into on February 14, 2006 and January 16, 2007.  The terms
of the Settlement Agreement require us to issue an aggregate of 88,000,000
million shares of our common stock to APIX in settlement of an outstanding
balance (“Outstanding Balance”) of $17,661,055 owed to APIX by us and the
repurchase of warrants exercisable into 20,340,000 shares of common stock
(“Warrants”) held by APIX. Specifically, 58,870,183 shares of our common
stock were issued to APIX in settlement of the Outstanding Balance and
29,129,817 shares of our common stock were issued to APIX in the repurchase of
the Warrants. As a result of the execution of the Settlement Agreement, APIX
releases and forever discharges us 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, we consummated a transaction whereby we entered into a series
of Subscription Agreements (the “Subscription Agreement”) with certain
accredited investors (collectively, the “Investors”) providing for the sale by
us to the Investors of (i) a total of 18,000,000 shares of our 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 our
Common Stock at an exercise price of $0.55. The Warrants have an exercise price
equal of $0.55.





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








10





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




APIX
acted as placement agent for the transaction.  In consideration for
the services provided, we have entered into a Funding Agreement with APIX
whereby we agreed to: (i) pay a placement fee of 5% of gross proceeds, payable
in our common shares issued at $0.50 per share; (ii) grant two million warrants
to purchase shares of our 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 us and
APIX in which APIX waived its 5% common share placement fee
and  accepted for its services rendered; (i) an additional one million
warrants (total three million warrants) to purchase shares of our common stock
at an exercise price of $0.55; and (ii) all rights, title and interest in a loan
totaling $360,000, including accrued interest, owed to us by Phil Radlick, with
a guarantee by us 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, we agree to pay to APIX the amount of shortfall on or before December
18, 2008.  The other terms of the Funding Agreement remain the
same.





ITEM
2. 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
3A. 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 defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act. Our internal control over financial reporting is
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. Our internal control
over financial reporting includes those policies and procedures
that:




1.
            Pertain
      to the maintenance of records that in reasonable detail accurately and
      fairly reflect the transactions and dispositions of our
      assets;




2.
            Provide
      reasonable assurance that transactions are recorded as necessary to
      permit  preparation of financial  statements in
      accordance with U.S. GAAP, and that our receipts and expenditures are
      being made only in accordance with the authorization of our management and
      directors; and




3.
            Provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of our assets that could have
      a material effect on the financial
  statements.




Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Also, 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.




Management
assessed the effectiveness of our internal control over financial reporting as
of December 31,
2007.  In  making  this  assessment,
management  used  the  framework  set  forth  in
the  report  entitled  Internal
Control--Integrated   Framework   issued   by
the   Committee   of   Sponsoring
Organizations of the Treadway Commission, or (“COSO”).  The COSO
framework summarizes each of the components of a company's internal control
system, including (i) the control  environment,  (ii)
risk  assessment,  (iii)  control  activities,  (iv)
information and communication,  and (v) monitoring.




This
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial
reporting.  Management's report was not subject to attestation by our
registered public accounting firm pursuant to temporary rules of the Securities
and Exchange Commission that permits us to provide only management's report in
this annual report.




A
Material weakness, as defined in standards established by the Public Company
Accounting Oversight Board (United States), has been identified. A material
weakness is a deficiency in internal control over financial reporting that
results in more than a remote likelihood that a material misstatement of the
annual or interim financial statements will not be prevented or
detected.






11




The
material weakness consisted of inadequate levels of review of complex and
judgmental accounting issues. Various audit adjustments were needed to correct
errors resulting from this internal control deficiency, which manifested itself
in the determination of loss on extinguishment of debt due to a debt
modification as well as recording of convertible debentures. We did not have
sufficient internal personnel and technical expertise to properly apply
accounting principles to certain non-routine matters. As a result, we
inappropriately applied the provisions of EITF Issue No. 96-19, “Debtor's
Accounting for a Modification or Exchange of Debt Instruments”, EITF Issue No.
00-19, “Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company’s Own Stock”, SFAS No. 150, “Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity” and, SFAS No. 133, “Accounting for Derivative Instruments and Hedging
Activities.” while conducting our annual analysis for debt modification and
accounting of convertible debentures that led to an error that was identified
and subsequently corrected. In addition, during 2007, we became aware of the
need to restate our financial statements due to the failure to consider the
effects of loss on debt extinguishment and the recording of freestanding and
embedded derivatives related to the issuance of convertible debt. These errors
also represent an effect of the material weakness in review of complex and
judgmental accounting issue. These adjustments are reflected in our audited
financial statements for the year ended December 31, 2006 and
2007.





To
address this material weakness, we continue to implement remediation plans,
including the following:





·
              We
      implemented increased levels of review of complex and judgmental
      accounting issues.


·
              We
      initiated plan to add personnel with technical accounting expertise and
      began a search for qualified candidates in order to help us maintain
      effective disclosure controls and procedures as well as internal control
      over financial reporting.


·
              We
      will be implementing a new policy and guidelines for increased,
      individualized professional development for finance and accounting
      personnel.





Because
of the material weakness described above, our Chief Executive Officer and Chief
Financial Officer concluded that, as of December 31, 2007, our disclosure
controls and procedures were not effective.  In addition, they
concluded that as of that same date our internal control over financial
reporting were not effective.  PMB Helin Donovan, LLP, the registered
public accounting firm that audited our financial statements included in the
Form 10-KSB has not issued an attestation report on management’s assessment
of the effectiveness of internal control over financial reporting as of
December 31, 2007.








Although
we are not required to disclose significant deficiencies, we have chosen to
disclose those significant deficiencies, which if not corrected in the next year
may become material weaknesses.




·
            Segregation
      of duties




Certain
Duties within our Financial Group were not properly segregated.  Our
then Controller/Interim Chief Financial Officer had the ability to direct other
personnel within the finance group to initiate and enter manual journal entries
in our books and records without authorization or review by other members of the
financial organization.




No
audit adjustments to our audited financial statements for the year ended
December 31, 2007 resulted from this significant
deficiency.




·
            Certain
      Controls Associated with the Financial Reporting and close process were
      not effective:




Management’s
review of certain quarterly and year-end accruals was not effective in 2007.
Specifically, the review failed to identify that an accrual was not adequately
supported by reasonable assumptions and sufficient documentation. We will be
implementing new procedures during 2008 that require our financial group to
collect, analyze and monitor all necessary and relevant supporting documentation
for accrual balances and any adjustments. We also will be introducing additional
procedures to ensure a more thorough review of financial data in the financial
reporting and close process.




Management
effected all audit adjustments identified by our independent registered public
accounting firm, or otherwise identified, through the processes described above
prior to the publication of our 2007 and 2006 audited financial
statements.




MANAGEMENT'S
REMEDIATION INITIATIVES





We are
in the process of evaluating our material weakness and significant deficiencies.
We have already begun to remediate the deficiencies as described
above.  However, certain deficiencies will require additional people
and might take longer to remediate.





In an
effort to remediate the identified material weaknesses and the significant
deficiencies and enhance our internal controls, we have initiated the following
series of measures:




·
            We
      have begun to search for a new Corporate Controller/Secretary, added
      additional staff to our financial department and have assigned to our CEO
      some of the duties of our previous interim CFO as of March
      2008.




·
            We
      have added two additional accounting staff in 2008 to allow for sufficient
      segregation of duties.






12




·
            Management
      and the Finance group performed additional analyses, including but not
      limited to a detailed balance sheet and statement of operations analytical
      review that compared changes from the prior period's financial statements
      and analyzed all significant differences.  These procedures were
      completed so management could gain assurance that the financial statements
      and schedules included in this Form 10-KSB/A fairly present in all
      material respects our financial position, results of operations, and cash
      flows for the periods
presented.




·
            We
      implemented new procedures during the first quarter of 2008 that required
      an additional individual within our finance department to perform a
      detailed review of all non-recurring manual journal entries above a
      certain dollar threshold and also to review all other journal
      entries.




·
            We
      have retained a consultant to analyze and update our written internal
      controls over financial reporting as
  necessary.




CHANGES
IN INTERNAL CONTROL OVER FINANCIAL REPORTING





No
change in internal control over financial reporting was made in the fourth
quarter of 2007 that materially affected, or is likely to materially affect, our
internal control over financial reporting. However, changes noted above, are the
only changes during our first fiscal quarter of 2008 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act.





As
noted above we began to initiate certain changes to our internal control over
financial reporting in the first quarter of 2008 to address the material
weaknesses/significant deficiencies described in our report.  We
continue to implement those changes, and introduce additional controls, to
remediate the material weaknesses and significant deficiencies that we
identified as of December 31, 2007.




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.






13







ITEM
4. EXHIBITS






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.







14







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.July
      15, 2008
            By:
            /s/ Robert
      CheneyChief
      Executive Officer











POWER
OF ATTORNEY





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





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





NAME
            
            TITLE
            
            DATE/s/
      Tony Shum
            
            Chairman
      of the Board
            
            July
      15, 2008Tony
      Shum/s/
      Robert Cheney
            
            Chief
      Executive Officer
            
            July
      15, 2008Robert
      Cheney/s/
      Phillip Radlick
            
            Director
            
            July
      15, 2008Phillip
      Radlick/s/
      Richard Gaston
            
            Director
            
            July
      15, 2008Richard
      Gaston/s/
      Gabriel Vegh
            
            Director
            
            July
      15, 2008Gabriel
      Vegh/s/
      Eric Chan
            
            Director
            
            July
      15, 2008Eric
      Chan








15













CARDIMA,
INC.





INDEX
TO FINANCIAL STATEMENTS











PAGEReports
      of  Independent Registered Public Accounting
      Firm
            F-2-F-3Balance
      Sheet at December 31, 2007
            F-4Statements
      of Operations for the years ended December 31, 2007 and 2006
      (restated)
            F-5Statements
      of Stockholders’ Equity (Deficit) for the years ended December 31, 2007,
      and 2006 (restated)
            F-6Statements
      of Cash Flows for the years ended December 31, 2007 and 2006
      (restated)
            F-7Notes
      to Financial Statements
            F-8









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 (except for Footnote Nos. 2, 3, and 13, as to which the date is July 9,
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 1 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 a derivative liability
due to potential dilutive instruments exceeding the authorized
shares.






Marc
Lumer & Company


San
Francisco, California


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


Disclosed inNote 1 and 13 is April 14,
2008)







F-3




CARDIMA,
INC.


BALANCE
SHEET


(In
thousands, except shares and per share amounts)




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





Years
      Ended December 31,2007
              
              
              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
              )
              
              
              -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
              
              
              2006CASH
      FLOWS FROM OPERATING ACTIVITIES:
              
              
              
              
              (Restated)Net
      loss
              
              $
              (42,646
              )
              
              $
              (12,151
              )Adjustments
      to reconcile net loss to net cash used in operating
      activities: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
              
              
              500
              
              
              
              -Non-cash
      compensation
              
              
              1,234
              
              
              
              -Non-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
              )
              
              
              120Accrued
      fees
              
              
              (111
              )
              
              
              2,164Net
      cash used in operating activities
              
              
              (6,680
              )
              
              
              (4,608
              )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
              )Proceeds
      (payments) from related party
              
              
              (6
              )
              
              
              70Net
      proceeds from loan financing
              
              
              3,720
              
              
              
              5,460Net
      proceeds from sale of common stock
              
              
              9,035
              
              
              
              28Net
      cash provided by financing activities
              
              
              12,734
              
              
              
              5,538Change
      in cash and cash equivalents
              
              
              3,869
              
              
              
              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
              
              $
              10,129
              
              
              
              -Preferred
      shares issued for fees
              
              $
              500
              
              
              $
              -Debt
      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. We design, develop, manufacture and market 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. We have
licensed our micro-catheter technology from Target Therapeutics for use in the
treatment of electrophysiological diseases affecting areas other than the
central nervous system. We sell our products worldwide through both direct sales
and distribution channels, with a substantial portion of our 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, we had cash on hand
of $4,811,000, short term investments of $2,008,000, positive working capital of
$6,018,000, and an accumulated deficit of approximately $176,559,000. We had a
net loss of $42,646,000 and $12,151,000 for the years ended December 31, 2007
and 2006, respectively.  In October 2007, we reached an agreement with
our major creditor, APIX International, Ltd., (“APIX”), to convert all of our
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 our 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 balance sheet is dependent upon our ability to generate
sufficient sales volume to cover its operating expenses and to raise sufficient
capital to meet its payment obligations.  Our 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 our products and
  services.


·
            Developing
      new markets and expanding our sales
efforts.


·
            Evaluating
      funding strategies in the public and private
  markets.





Historically,
our management has been able to raise additional capital. During the December
2007, we obtained equity capital of $9 million through the sale of common stock
and warrants. The 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 we 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, we will have
sufficient funds to execute its intended business plan or generate positive
operating results.





Reverse
Stock split





Effective
June 30, 2007, our 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%
            10,235,468





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




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 our common stock have been restated to
reflect the effect of the stock split for all periods
presented.




Restatement




We
have restated our 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 and 2007 have been restated to reflect the
corrections.  (See Note 13)





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. ,
our Board of Directors determined that our 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 our Net Loss Attributable to
Common Stockholders by approximately $20.68 million or $2.01 per share for the
three months ended June 30, 2007. 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, $0.43 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 $(16,312,000) million, $(1.59) and $(26,162,000) million,
$(2.55), respectively.





Additionally,
we determined that our 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 our determination that we 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 us to make estimates and
assumptions that affect the amounts of assets and liabilities, disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reported period. Actual
results could differ from those estimates and such differences could affect the
results of operations reported in future periods.





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





Revenue
Recognition




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




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








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




We
assessed 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”.




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





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. Net losses are charged off against the
reserve, while recoveries of amounts previously charged off are credited to the
reserve. Evaluations of the reserve balance are conducted
quarterly.





Reclassification





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




Income
Taxes




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








F-10





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
determined that there was no impact as a result of the adoption of FIN No.
48.




Stock
Based Compensation





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





Stock
compensation expense recognized during the period is based on the value of
share-based awards that are expected to vest during the period. Stock
compensation expense recognized in our statements of operations 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).




We use
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.  The fair value
of employee stock options granted was determined using the Black-Scholes method
with the following assumptions:




2007
              
              
              2006Expected
      life (years)
              
              
              7
              
              
              
              4Interest
      Rate
              
              
              4.3
              %
              
              
              4.6
              %Volatility
              
              
              188
              %
              
              
              160
              %Dividend
      Yield
              
              
              0
              %
              
              
              0
              %






Net
Loss per Share




We
utilize SFAS No. 128, “Earnings per Share.” Basic loss per share is
computed by dividing loss available to common stockholders by the
weighted-average number of common shares outstanding. Diluted loss per share is
computed similar to basic loss per share except that the denominator is
increased to include the number of additional common shares that would have been
outstanding if the potential common shares had been issued and if the additional
common shares were dilutive. Common equivalent shares are excluded from the
computation if their effect is anti-dilutive. Our common share equivalents
consist of stock options 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
              
              
              
              510,863Warrants
      to purchase common stock
              
              
              5,700,000
              
              
              
              7,579,353Preferred
      Shares
              
              
              1,000,000
              
              
              
              -Total
              
              
              12,688,496
              
              
              
              8,090,216











F-11










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
            )






Cash
and Cash Equivalents




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





Accounts
Receivables and Allowance for Doubtful Accounts




Trade
accounts receivable are stated at the amount we expect to collect. We recognize
allowances for doubtful accounts for estimated losses resulting from the
inability of our customers to make required payments. We use the allowance
method to account for uncollectible accounts receivable. Our estimate is based
on historical collection experience and a review of the current status of
accounts receivable. We review our accounts receivable balances by customer for
accounts greater than 90 days old and make a determination regarding the
collectability of the accounts based on specific circumstances and the payment
history that exists with such customers. We also take into account our prior
experience, the customer’s ability to pay and an assessment of the current
economic conditions in determining the net realizable value of our receivables.
We also review our allowance for doubtful accounts in aggregate for adequacy
following this assessment. Accordingly, we believe that our allowance for
doubtful accounts fairly represent the underlying collectability risks
associated with our accounts receivable. For the period ended December 31,
2007, we 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 5)




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.  We, however, do not have any components of other
comprehensive loss as defined by SFAS No. 130 and therefore, for the years ended
December 31, 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, we have recorded the
value of warrants issued and the outstanding shares of Series A Preferred Stock
as a component of equity on the balance sheet. See Note 10, Stockholders’
equity.






F-12






Accounting
for Convertible Debt Securities





We
account for the notes and related provisions in accordance with provisions of
EITF 98-5, “Accounting for Convertible Securities with Beneficial Conversion
Features or Contingently Adjustable Conversion Ratios”, EITF 00-27, “Application
of Issue No. 98-5 to Certain Convertible Instruments”, FASB Staff Position
(“FSP”) No. EITF 00-19-2 “Accounting for Registration Payment
Arrangements”, EITF 00-19 Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Company's Own Stock, and EITF 01-6,
The Meaning of “Indexed to a
Company’s Own Stock”.We also evaluate 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 model, Binomial
Option Pricing models, Standard Put Option Binomial models and the net present
value of certain penalty amounts.





Extinguishment
of Debt





We
follow 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 % different
from the present value of the remaining cash flows under the
terms of the original instrument. We had amendments in February 2006 and
June 2007 to the Convertible Note and the related warrants. We feel that a
substantial modification in terms of the Convertible Note
has occurred. Upon further analysis, we have
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, we have
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 extinguishment required us to record an extinguishment debt
expense of $15,182,000 and $2,256,000 in 2007 and 2006
respectively.





Stock
Warrants Issued to Third Parties





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




Segment
Reporting




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




Fair
Value of Financial Instruments




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




Off-Balance-Sheet
Arrangements





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








F-13







Commitments
and Contingencies




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





Concentration
of Credit Risk




Financial
instruments which potentially subject us to concentrations of credit risk
consist of cash and cash equivalents and accounts receivable. We place our cash
and cash equivalents with high credit, quality financial institutions. We have
not experienced any losses in such accounts and believe it is not exposed to any
significant credit risk on cash and cash equivalents. With respect to accounts
receivable, we 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. We are 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. We are currently evaluating the
potential impact that the adoption of SFAS No. 141(R) could have on its
financial statements.





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 do not expect it to have a significant impact on our
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 for fiscal years beginning after
December 15, 2007. We do not expect this EITF to have a significant impact on
our financial position, results of operations or cash flows.




F-14






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.  We have evaluated the potential impact of
this issue and do not expect that it will have a material impact on our
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. We are currently assessing the impact of adopting SFAS
159.





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. This statement is
effective for fisal years beginning after November 15, 2007. 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 had a material effect on our financial
statements. Our restatement is discussed in Note 13.




2.
APIX International Limited.





APIX
International, Ltd., (“APIX”) is an entity that is solely owned by Robert
Cheney, CEO who is also one of our Directors. Mr. Cheney was appointed as the
CEO in August 2007.





Transactional
History





In
August 2005, we issued secured promissory notes in the aggregate principal
amount of $3,000,000 (the Notes) and warrants to purchase our common stock (the
Warrants) to APIX. The Notes bear interest at a rate of 10%, originally maturing
on February 28, 2006. Additionally, we were 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 us 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 we determined that under EITF No. 00-19, the ability to register stock was
deemed to be outside of our 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 we 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 our common stock at a
conversion price of $.40 per share post-split, (3) extend the due date to May
16, 2006; (4) receive an additional warrant exercisable into 3,180,000 post
split shares of common stock at an exercise price of $0.60 per share with a ten
year life; (6) the registration rights agreement language was clarified to mean
that we would use our “best efforts” and there were no liquidated damages
provisions for non-registration; and (7) to receive additional fees of $680,000
due on the revised maturity date. We 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 are substantially different since the net
present value of the cash flows under the terms of the new debt instrument was
at least 10% 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 our Statement of Operations for 2006.










F-15




We
have 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". We evaluated the
registration rights agreement and determined that there was no amount of
liquidated 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.





The
new 10% secured convertible promissory notes issued to APIX in February 2006, in
essence consisted of a $3,660,000 Secured Convertible 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 6,180,000 post
split shares of our common stock, par value $0.001 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 us with additional debt
financing of $4,500,000 to meet our working capital needs. These unsecured
borrowings bear interest at 10% per annum and were due on demand.  As
of December 31, 2006, we 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 $421,000; (2) $4,500,000 in unsecured borrowings due on demand with
accrued interest of $171,000; and (3) various loan related fees aggregating to
$1,715,000.




In 2007 we modified the terms
of our 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 for the unsecured borrowings
(convertible into 44,153,000 shares of our 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 with a ten year life exercisable into an aggregate of
11,880,000 shares of common stock at an exercise price of $0.30 per share; (5)
receive $500,000 in facility fees convertible into 5 million shares of Preferred
Stock Series A (see Note 10); (7) the registration rights agreement language
included that we would use our “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. We 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 % 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 $15,182,000, was
recorded as Loss on Extinguishment of Debt on our Statement of Operations for
2007. In 2007, APIX and we concluded a set of restructuring transactions whereby
the outstanding debt (secured and unsecured) was converted into
equity.
  On
October 3, 2007, we reached an agreement with APIX whereby we granted 58,870,183
shares of our $.001 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 approximately
$6,329,000 of income taxes, has been included in the Statement of Operations in
2007. We 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 our 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, we recorded a loss of $3,800,000 on the Statement of
Operations for 2007. We subsequently cancelled these warrants returned by
APIX.






F-16







The
following table provides a summary of the loss on conversion of debt into equity
and the repurchase of warrants:




I.
      DEBT:Shares
      to be issued for debt per agreement on 10/03/2007
              
              
              
              
              
              
              
              
              58,870,183Outstanding
      principal, accrued interest, and fees outstanding as of
      10/03/2007
              
              
              $
              17,661,055Conversion
      price
              
              
              
              
              
              
              
              $
              0.40Shares
      issued per conversion feature
              
              
              
              
              
              
              
              
              44,152,638Share
      premium issued for conversion of debt into equity
              
              
              
              
              
              
              
              
              14,717,546Market
      price on 10/03/2007
              
              
              
              
              
              
              
              $
              0.43Loss
      on conversion of debt into equity on 10/03/2007
              
              
              
              
              
              
              
              $
              6,328,545II.
      WARRANTS:
              
              
              
              
              Black
      ScholesNumber
      of Existing Warrants:
              
              
              
              
              Fair
      Value11,880,000
              
              
              $
              0.4289
              
              
              $
              5,095,3328,460,000
              
              
              $
              0.4291
              
              
              $
              3,630,186Total
      Value of warrants on 10/03/2007
              
              
              20,340,000
              
              
              
              
              
              
              $
              8,725,518Shares to
      be issued for warrants per agreement on 10/03/2007
              
              
              
              
              
              
              
              29,129,817Market
      price on 10/03/2007
              
              
              
              
              
              
              
              
              
              $
              0.43Market
      Value of shares issued for warrants on 10/03/2007
              
              
              
              
              
              
              
              
              
              $
              12,525,821Loss
      on repurchase of warrants on 10/03/2007
              
              
              
              
              
              
              
              
              
              $
              3,800,303Total
      loss on conversion of debt and warrants
              
              
              
              
              
              
              
              
              
              $
              10,128,848







Series
A Preferred Shares




In
2007, we entered into an agreement with APIX in which we issued convertible
preferred stock in exchange for $500,000 of a loan facility fee due to APIX. On
June 7, 2007, we issued 5 million shares of Series A Convertible Preferred Stock
("Series A shares"), with a stated value of $0.001 per share and a liquidation
value of $500,000, 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 our common stock ("Common Stock") at a fixed
exchange rate of 0.2 shares of common stock for each Series A share. We 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”).





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 and are recorded as equity. Series A share
redemption is at our sole option and redemption would only occur upon the
liquidation or termination of the issuer. Based on characteristics of the
agreement as described above, we have recorded the Preferred Series A shares as
equity on the balance sheet.




The
market price of our common stock on the date of commitment was $0.50 per 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.








F-17


2007
Private Placement
  On
December 14, 2007, we entered into an agreement with APIX to act as our
placement agent to conduct the offer of our securities in a private placement
(the “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 of our shares and warrants
(the “Units”) sold in the Offering is at least $9 million. Pursuant to this
agreement, APIX will provide the following services: (1) APIX to act on our
behalf 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 owed by Phil Radlick, a Director
of the Company, with we 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, we completed our private placement whereby we 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 by 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 of operations for 2007.
  Pursuant
to the Subscription Agreement, we have agreed to use our 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"). On January 29, 2008, all
parties to the above mentioned private placement
 waived
any registration rights and other rights under the Registration Rights Agreement
and any and all penalties that may be due as a result of the Registration
Statement's not having been filed by the Filing Date.
  As of
December 31, 2007 we had $175,000 in loans payable due to APIX.
 3. Extinguishment of
debt
 
 On
February 14, 2006 we received an extension of our credit facility of $660,000
and an extension of the maturity date from February 28, 2006 to May 31, 2006,
and were granted control of the exercise of warrants. At that date we were
deemed no longer to be required to net cash settle the warrants or the
convertible features of the debt. In exchange we granted the lender an
additional 3,180,000 (post split) warrants, reduced the exercise price from
$0.10 to $0.06 per share. We also agreed to pay additional fees of $680,000 and
give the lender convertibility of the principal portion of the debt. We
determined that the transaction should be treated as an extinguishment of debt.
In conjunction with the transaction we recognized a loss of $2,256,072. The
value of the beneficial conversion feature was recorded at its intrinsic value.
The additional warrants were computed using the Black Scholes method assuming a
4.8% risk free interest rate, a life of 0.32 years, and a volatility rate of
92.29%.




On
June 27, 2007 we received an additional extension of our credit facility and an
extension of the maturity date from February to December 31, 2007 in conjunction
with a plan to convert all of the existing debt to equity, as discussed in Note
1. In exchange we granted the lender an additional 14,160,000 warrants, reduced
the exercise price from $0.06 to $0.04 per share. We also agreed to pay
additional fees of $3,370,000. We determined that the transaction should be
treated as an extinguishment of debt. In conjunction with the transaction, we
recognized a loss of $ 15,182,000. The additional warrants were computed using
the Black Scholes method assuming a 4.8% risk free interest rate, a life of 9.16
years, and a volatility rate of 160.39%.  At the same time we eliminated
our derivative warrant liability as described in EITF 00-19. As the maturity
date was short and within our fiscal year, we deemed that the additional fees
were part of the extinguishment and included them as part of the loss as noted
above.




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










F-18








The
table below details the specific components of both the February 14, 2006 and
the June 7, 2007 extinguishments and shows the computation of the loss on
extinguishment of debt:




Loss
      on extinguishment of Debt due to modification of DebtAt
      February 14, 2006
              
              Pre-Modification
              
              
              Post
      Modification
              
              
              DifferenceNote
      Payable
              
              $
              3,000,000
              
              
              $
              3,000,000
              
              
              $
              -Exit
      Fee Payable
              
              
              900,000
              
              
              
              1,560,000
              
              
              
              660,000Facility
      Fee Payable
              
              
              60,000
              
              
              
              80,000
              
              
              
              20,000Other
      Loan Fees Payable
              
              
              75,000
              
              
              
              75,000
              
              
              
              -New
      Warrants
              
              
              -
              
              
              
              1,093,036
              
              
              
              1,093,036Beneficial
      Conversion feature
              
              
              -
              
              
              
              483,036
              
              
              
              483,036Total
              
              $
              4,035,000
              
              
              $
              6,291,072
              
              
              $
              2,256,072At
      June 7, 2007
              
              Pre-Modification
              
              
              Post
      Modification
              
              
              DifferenceNote
      Payable
              
              $
              10,635,000
              
              
              $
              10,635,000
              
              
              $
              -Exit
      Fee Payable
              
              
              1,560,000
              
              
              
              4,160,000
              
              
              
              2,600,000Facility
      Fee Payable
              
              
              80,000
              
              
              
              500,000
              
              
              
              420,000Other
      Loan Fees Payable
              
              
              75,000
              
              
              
              425,000
              
              
              
              350,000New
      Warrants
              
              
              -
              
              
              
              4,421,217
              
              
              
              4,421,217Beneficial
      Conversion feature
              
              
              -
              
              
              
              7,391,217
              
              
              
              7,391,217Total
              
              $
              12,350,000
              
              
              $
              27,532,434
              
              
              $
              15,182,434




4.
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
            
            $
            356Work-In-Process
            
            
            23Finished
      Goods
            
            
            23$
            402





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







5.
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.






F-19






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


December 31, 2007Equipment
            
            $
            2,230Leasehold
      improvements
            
            
            270$
            2,500Less
      accumulated depreciation and amortization
            
            
            (2,138
            )$
            362Idle
      Equipment
            
            $
            1,290Less
      accumulated depreciation and amortization
            
            
            (1,290
            )$
            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. We had fully depreciated its idle equipment as of
December 31, 2007.




6.
Payable - Related Party





On
December 17, 2007, We consummated a transaction whereby we entered into a series
of Subscription Agreements (the “Subscription Agreement”) with certain
accredited investors (collectively, the “Investors”) providing for the sale by
us to the Investors of (i) a total of 18,000,000 shares of our 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 our
Common Stock at an exercise price of $0.55.





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, we have entered into a Funding
Agreement with APIX whereby we agreed to: (i) pay a placement fee of 5% of gross
proceeds, payable in our common shares issued at $0.50 per share; (ii) grant two
million warrants to purchase shares of our 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
us and APIX in which APIX waived its 5% common share placement fee
and  accepted for its services rendered; (i) an additional one million
warrants (total three million warrants) to purchase shares of our common stock
at an exercise price of $0.55; and (ii) all rights, title and interest in a loan
totaling $360,000, including accrued interest, owed to us by Phil Radlick, with
a guarantee by us 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, we had $175,000 in loan payable at December
31, 2007.




7.
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.









F-20






8.
Commitments and Contingencies




Commitments




We
lease facilities under an operating lease, which has been extended through May
2010. We also lease 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
            
            
            $
            262009
            
            
            272
            
            
            
            72010
            
            
            115
            
            
            
            -Total
      Minimum Lease Payments
            
            $
            652
            
            
            $
            33less:
      amounts representing interest
            
            
            N/A
            
            
            
            (2)Present
      Value of  net minimum lease payments
            
            $
            652
            
            
            $
            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, 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, we may face potential lawsuit arising from Mr. Vegh’s
termination. On March 3, 2008, we received a letter from the law firm
representing our former Chief Executive Officer and Acting Chief Financial
Officer Mr. Vegh. Mr. Vegh claimed for damages for wrongful termination in
violation of statutes, breach of contract and related claims.  We
determined that Mr. Vegh’s termination was “with cause” thus the severance
provision of his employment agreement did not apply. We will defend ourselves
vigorously against Mr. Vegh’s claims.





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





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




9.
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 our largest customer in Japan, comprised of 42% of our total
net product sales.  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
26% of net sales for the year ended December 31, 2007. Allowances for doubtful
accounts were $77,000 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%Europe
              
              
              363
              31%
              
              255
              16%Asia/Pacific
              
              
              (78)
              (6)%
              
              650
              42%Others
              
              
              15
              1%
              
              12
              1%Total
      Net Sales
              
              
              $    1,157
              100%
              
              $    1,541
              100%








F-21






During
the first quarter of 2007, our Japanese distributor notified us of its failure
to maintain the legal documentation standard required to sell our PATHFINDER
products in Japan.  As a result, we 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. We understand that the reapplication
process takes approximately twelve to eighteen months.  We are
currently exploring our options with regard to selling the PATHFINDER product in
Japan. Furthermore, we entered into a distribution agreement with a new
Japanese distributor, to be our exclusive distributor in the country effective
August 1, 2007 with an initial term of five (5) years. The distributor, however,
will not be able to start importing and selling our products until the
reapplication process is complete.   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 it will be able to resume sales by that time.





Our
diagnostic product group, namely the Pathfinder family of micro-catheter
systems, accounted for 62% and 77% of net sales for the years ended December 31,
2007 and 2006, respectively.





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





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




10.
Stockholders’ Equity





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




Preferred
stock




We are
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, we 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 us and APIX on June 7,
2007.  Each share of Series A Preferred is convertible into 0.2 shares
post-split of common stock at the option of the holder thereof.  The
Series A Preferred may be called by us 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




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




As
described in Note 1, Effective June 30, 2007, our 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 we obtained $3,000,000 in debt financing through the issuance of a
secured note payable with detachable warrants. We issued warrants to purchase
3,000,000 shares of common stock at $1.00 per share post-split, which were
valued at the issuance date at $3 million. As the warrants originally included a
requirement for net cash settlement if we were 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. We 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 balance sheet.






F-22






In
April, 2006, we 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, we 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, we 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
$1,408,000. The 2007 Private Placement warrants have an exercise price of $0.55
per share and expire 5 years from the date of issuance. We had 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.




Pursuant
to the Subscription Agreement, we have agreed to use our best efforts to secure
effectiveness of, as soon as reasonably practicable after the insurance and
delivery of the shares and warrants, the filling of a registration statement on
Form SB-2 (the "Filling Date"). On January 29, 2008, all parties to the above
mentioned private placement waived any registration rights and other rights
under the Registration Rights Agreement, and any and all penalties that may be
due as a result of the Registration Statement's not having been filed by the
Filing Date.




Repurchase
of Warrants




In
October 2007, our board of directors authorized the purchase of warrants
convertible into 20,340,000 shares of our common stock at an exercise price of
$0.40. These warrants were repurchased and subsequently cancelled. We 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, we had 116,316,311 outstanding shares of common stock, and
there were options outstanding to purchase 5,988,496 shares of common
stock.




11.
Stock Based Compensation




We
adopted Financial Accounting Standards Board (“FASB”) Statement No. 123R,
“Share Based Payment,” on January 1, 2006.  SFAS 123(R) requires
companies to estimate the fair value of share-based awards on the date of grant
using an option pricing model. The value of the portion of the award that is
ultimately expected to vest is recognized as expense over the requisite service
periods in our statements of 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. We use the Black-Scholes method to determine fair value
of stock options granted.




The
Black-Scholes model requires the use of highly subjective and complex
assumptions which determine the fair value of share-based awards, including the
option’s expected term and the price volatility of the underlying stock. We used
the weighted average remaining contractual life and the treasury notes with 9.75
years remaining life. The volatility was computed based on a look back period of
two years and 10 years for 2007 and 2006 respectively. Stock-based compensation
expense is calculated based on the fair market value of our stock on the date of
grant.




2007
              
              
              2006Expected
      life (years)
              
              
              7
              
              
              
              4Interest
      Rate
              
              
              4.3%
              
              
              
              4.6%Volatility
              
              
              188%
              
              
              
              160%Dividend
      Yield
              
              
              0%
              
              
              
              0%





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.






F-23






The
total stock-based compensation expense under FAS 123R was approximately $488,000
and $390,000, for the years ended December 31, 2007 and 2006, respectively.
This expense reduced our basic and diluted earnings per share by $0.02 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 $2,283,000.  The weighted average period over
which we expect to recognize the unamortized stock compensation expense is 2.66
years.  We intend to amortize the costs ratably over three
years.




2007
Stock Option Plan




On
September 14, 2007, Our Board of Directors adopted the 2007 Stock Option Plan
(the “2007 Stock Plan”). The 2007 Stock Plan authorizes the Board of Directors
or one or more of its members to grant options to purchase our shares to
eligible individuals.  Eligible individuals may be employees,
non-employee members of the Board or the board of directors of any Parent or
Subsidiary, and consultants who provide valuable service to us or our Parent or
Subsidiary. Options to purchase our Common Stock 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 33%
of the underlying shares per year over 3 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
              
              
              30,000,000Options
      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 issued and outstanding 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.




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
      Avg. Remaining Contractual Life
              Weighted
      Avg. Exercise Price
              Number
      of Shares Exercisable
              Weighted
      Avg. 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 5,502,917
had an aggregate intrinsic value of approximately $22,000 and $385,000,
respectively.





F-24


2003
Stock Option Plan
  On
April 17, 2003 our Board of Directors adopted the 2003 Stock Option Plan (the
“Stock Plan”). The Stock Plan authorizes the Board of Directors or one or more
of its members to grant to employees, consultants and non-employee directors
options to purchase our Common Stock. 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:


Options
      OutstandingShares
      Available
              
              
              Number
      of Shares
              
              
              Exercise
      Price per Share
              
              
              Weighted-Avg.
      Exercise PriceBalance
      as of 12/31/2005
              
              
              536,853
              
              
              
              283,147
              
              
              $
              0.60
              
              
              
              -
              
              
              $
              12.40
              
              
              $
              0.53Options
      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 respectively 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.




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-AverageRemaining
      Contractual Life
              
              Weighted-AverageExercise
      Price
              
              
              Number
      of Shares Exercisable
              
              
              Weighted-AverageExercise
      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, our 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 us. Subsequent to our 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.








F-25







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


Outstanding
      OptionsShares
      Available
              
              
              Number
      of Shares
              
              
              Exercise
      Price/Share
              
              
              Weighted
      Avg. 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 respectively under the 1993 Stock Plan. There were no options
granted in 2007 and in 2006.




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




Options
      Outstanding
              
              Options
      ExercisableWeighted-AverageRange
      of Exercise Prices
              Number
      of shares Outstanding
              Remaining
      Contractual Life
              Weighted
      Avg. Exercise Price
              Number
      of Shares Exercisable
              Weighted
      Avg. 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, our 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)
              
              $          1.00
              -
              $        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 respectively 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.






F-26






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
              
              
              
              28,000
              
              
              $
              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, of the 28,800 vested options, 5,000 options had an aggregate
intrinsic value of approximately $2,500 and the remaining vested and non-vested
options had no intrinsic value.





1997
Employee Stock Purchase Plan




In
March 1997, our 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
respectively under the plan.





We
believe that under paragraph 12 of SFAS 123R a plan is not compensatory if among
other things “any purchase discount from the market price does not exceed the
per-share amount of share issuance costs that would have been incurred to raise
a significant amount of capital by a public offering. A purchase discount of 5 %
or less from the market price shall be considered to comply with this condition
without further justification. A purchase discount greater than 5% that cannot
be justified under this condition results in compensation cost for the entire
amount of the discount.”





We do
not believe that we are in a position to raise significant amount of capital
through a public offering. Therefore, we looked at our recent cost of raising a
‘significant amount of capital’ as follows:





·
            In
      October 2007 we raised approximately $27,702,000, through conversion of
      debt to equity. The cost as reported in form 10-KSB was $10,129,000,
      approximately 37%; and


·
            In
      December 2007 we raised an additional $8,982,000, through a private
      placement. The cost of the placement was $1,408,000, or approximately
      16%.





In
both cases the cost exceeded the 15% discount given under the plan. The plan was
therefore considered non-compensatory.  We understand that in
accordance with footnote 115 to SFAS 123R, if an entity justifies a purchase
discount in excess of 5%, we would be required to reassess that discount at
least annually and no later than the first share purchase offer during the
fiscal year.  If upon reassessment that discount is not deemed
justifiable, subsequent grants using that discount would be
compensatory.




Share-Based Compensation to
Non-Employees





From
time to time we grant 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, we 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, we 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.








F-27







12. Related-Party
Transactions




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




In
December 1997, we entered into a $300,000 note receivable agreement with Phillip
Radlick, 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, our Board of Directors amended Mr. Radlick’s
agreement to extend this loan until the first of (i) the date that Mr. Radlick
no longer serves as a member of the Board of Directors, (ii) the date when Mr.
Radlick sells his house and (iii) December 16, 2005. As a security for the note,
Mr. Radlick granted us a security interest in his vested stock options. At
December 16, 2005, Mr. Radlick informed us 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 us
by Mr. Radlick, with a guarantee by us 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, we agree to pay to APIX the amount of shortfall
on or before December 18, 2008.


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





In
December 2006, a settlement agreement was reached in principle, which we would
pay $295,000 to Mr. Wheeler ($5,000 per month for 59 months). 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. We 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.





In
December 2007, APIX International Limited (“APIX”) acted as placement agent in a
financing transaction in which we raised an aggregate of
$9,000,000.  As part of the December 17, 2007 agreement, APIX waived
its 5% common share placement fee. In consideration for the services provided,
we agreed to compensate APIX as follows: (i) three million warrants to purchase
shares of our 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 us by Phil Radlick, with a guarantee by us 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, we agree to pay to APIX the amount of shortfall
on or before December 18, 2008.  We have recognized this amount as
liability.




13. Restatement
of Financial Statements




We
have restated our previously issued 2006 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.
      Specifically webelieve that our
      accounting treatment for excess shares and warrant liability are
      appropriate for the following
reasons:


·
            At
      the inception of the loan for which the warrants were granted in 2005
      included a mandatory registration rights provision, SFAS 133 (paragraphs
      11 and 12), EITF Issue Nos. 00-19, 05-02, and 05-04 (view A), our
      management determined that under EITF Issue No. 00-19, the ability to
      register stock was deemed to be outside of our control and there was a
      possibility of cash penalties. Thus, in accordance with EITF 00-19, when
      the potential cash penalties could exist in registration rights
      arrangements, the estimated fair value of the warrants should be recorded
      as a liability.


·
            As
      described in Note 2, we had an extinguishment of debt on February 14,
      2006. Under the terms of the new debt we granted additional warrants to
      the lender, agreed to pay additional fees, and gave the lender
      convertibility of the principal as well as the accrued interest and fees
      which had been convertible since inception. In return, we did not require
      a penalty if the registration rights provision was violated, thereby
      giving the company “best efforts” and ‘control’ with respect to the
      warrants.


·
            Given
      the terms of the modified notes which were now convertible secured notes
      Management determined that a Beneficial Conversion Feature (BCF) was
      present. A BCF was recorded by the Company as pursuant to EITF Issue No.
      98-5 ("EITF 98-05"), Accounting for Convertible Securitieswith Beneficial
      Conversion Features or Contingency Adjustable Conversion Ratio, and EITF
      Issue No. 00-27.


·
            We
      also evaluated the embedded derivative, conversion feature, and the
      freestanding derivative, the Warrants, in regards to whether they should
      be recorded as a liability or equity. Our management reviewed the guidance
      provided by EITF Issue Nos.98-5, 00-19, 05-02, 05-04 and 00-27 and FSP,
      EITF 00-19-2, "Accounting for Registration Payment
      Arrangements."  FSP EITF No. 00-19-2 specified that companies
      that enter into agreements to register securities will be required to
      recognize a liability only if a payment to investors for failing to
      fulfill the agreement is probable and can be reasonably
      estimated.








F-28






Furthermore,
it clarified that financial instruments, such as warrants, subject to a
registration payment arrangement should be accounted for in accordance with
applicable generally accepted accounting principles without regard to the
contingent obligation.  Thus, a warrant classified as a liability
under EITF 00-19 is determined under applicable generally accepted accounting
principles to be equity without regard to the registration payment arrangement,
and that it should be reclassified.  This is differed from EITF 00-19,
which required a liability to be recognized and measured at fair value,
regardless of probability.




At
February 14, 2006 we compared our authorized shares to the sum of the
outstanding shares and all other share commitments. There were sufficient shares
to meet all obligations including the warrant obligation.




After
review and consultation with its independent registered public accountants and
its audit committee, our management determined to restate our historical
financial statements for the year ended December 31, 2006 as result of the debt
modification (accounted for as a debt extinguishment). Accordingly, we did not
classify the warrants as a liability after the debt modification in February
2006, since they met the criteria for equity classification.





At
February 14, 2006, there was no amount of liquidated damages payable or other
provisions that would cause net cash settlement related to the warrants or
conversion feature. Accordingly, the free-standing Warrants and the BCF, and
embedded instrument, were classified as equity within
“Additional-Paid-in-Capital”.





·
            Recognize a debt extinguishment
      and the resulting loss as a result of debt modification.  See
      detailed explanation is provided in Note
3.





·
            Recognize common shares in
      excess of shares authorized thatarepotentially subject to net cash
      settlement.  Specifically asnoted
      above, we had previously treated the warrants as a liability, and revalued
      them quarterly.  On February 14, 2006, based on new debt terms
      and the provisions and clarifications of FSP –00-19-02, we
      reclassified the warrants as equity when it recorded the new
      debt.





Beginning
in April 2006 and continuing through December 2006 and October 2007, APIX
provided us with additional convertible debt financing.   These
unsecured borrowings bear interest at 10% per annum and were due on
demand.  In October 2007 we reached an agreement with APIX, pursuant
to which all the outstanding convertible notes, related interest due, and all
loan fees were converted into shares of common stock.





We
previously evaluated the convertible notes issued during the period starting
April 2006 through June 2007 in accordance with EITF Issue Nos. 00-19 and 05-02
and determined that they were conventional convertible debt instruments in which
the APIX, the holder, could only realize the value of the conversion option by
exercising the conversion right and receiving the entire proceeds in a fixed
number of shares.  We could settle these 2006 convertible debentures
in unregistered shares.  Alternatively, we could pay the equivalent
amount of cash.





Since
these 2006 convertible notes were due on demand, we determined that the best
measure of “fair value” would be the market price of our common shares on each
of the balance sheet dates. According, to EITF 00-19, the estimated fair value
of the liability due to the lack of authorized shares was re-measured at each
reporting date and on the date when the shareholders approved the reverse stock
split, with the increase or decrease in fair value recorded as other expense or
income in the statement of operations.





In
October 2007, when we repurchased all of the warrants exercisable, we repaid the
debt with unregistered common stock.





As
noted above, when the financing was agreed to in February 2006, we had
sufficient authorized shares to meet the existing requirements of convertibility
as well as new warrants issued at that time and discussed
above.





With
the post March 31, 2006 additional convertible cash advances and accrued
interest, the number of common shares issuable upon the conversion of these new
financings, when combined with existing outstanding common shares, options,
warrants and shares issuable upon the conversion of previously existing
convertible notes payable and related interest and fees ("diluted shares"),
exceeded the then-authorized common shares in April 2006. From June 30, 2006
through March 31, 2007 we recorded a quarterly liability for “excess shares”
over authorized. By June 2007, as result of the shareholders approving a reverse
stock split without a decrease in authorized shares, we had sufficient
authorized shares to again meet its option and conversion commitments. At that
date, we eliminated the excess share liability.








F-29







Therefore,
as required by EITF 00-19, asset or liability classification of the conversion
feature was required for these excess shares.





From
April 2006 to June 2007, only a portion of our common shares issuable upon the
conversion of these new 2006 convertible notes became subject to liability
classification and their values were marked-to-market quarterly in accordance
with EITF 00-19.





Effective
June 30, 2007, our shareholders approved a reverse split of 1 share for every 10
previously held. As a result, there were sufficient shares to meet the
outstanding warrant option and conversion commitments. At June 30, 2007, we
reversed the excess share liability. The credit was applied to Additional Paid
in Capital.





In the
aggregate, there was no affect on total shareholder equity as a result of the
above transactions.





The
following table provides a detailed schedule in regards to the calculation of
“excess” shares:




Excess
      Share Liability Computation(shares,
      warrants, options and $ data is in thousands)Period
      ending
              
              Outstanding
      Shares
              
              
              No.
      of Shares on debt conversion
              
              Total
      Warrants Outstanding
              
              Total
      Options Outstanding
              
              Total Shares Needed
              
              Authorized
      Shares
              
              
              Excess
      Shares
              
              
              FMV
              
              
              Excess Share
                Value
      as ofMarch
      31, 2006
              
              
              101,665
              
              
              
              92,040
              
              
              
              81,169
              
              
              
              6,374
              
              
              
              281,248
              
              
              
              300,000
              
              
              
              (18,752
              )
              
              $
              0.05
              
              
              
              -June
      30, 2006
              
              
              101,695
              
              
              
              120,133
              
              
              
              80,944
              
              
              
              6,151
              
              
              
              308,923
              
              
              
              300,000
              
              
              
              8,923
              
              
              $
              0.09
              
              
              $
              776September
      30, 2006
              
              
              102,355
              
              
              
              145,111
              
              
              
              78,162
              
              
              
              5,705
              
              
              
              331,332
              
              
              
              300,000
              
              
              
              31,332
              
              
              $
              0.05
              
              
              $
              1,410December
      31, 2006
              
              
              102,355
              
              
              
              174,458
              
              
              
              75,794
              
              
              
              5,109
              
              
              
              357,715
              
              
              
              300,000
              
              
              
              57,715
              
              
              $
              0.05
              
              
              $
              2,886March
      31, 2007
              
              
              102,841
              
              
              
              200,588
              
              
              
              73,818
              
              
              
              4,468
              
              
              
              381,714
              
              
              
              300,000
              
              
              
              81,714
              
              
              $
              0.13
              
              
              $
              10,623
  Loan
financing History
 ($ and
no. of shares in thousands)
 Period
      ending
              
              Principal
              
              
              Accrued
      Interest
              
              Loan Fees
              
              Total Debt
      Outstanding
              
              No.
      of Shares on debt conversionMarch
      31, 2006
              
              $
              3,660
              
              
              $
              147
              
              
              $
              1,715
              
              
              $
              5,522
              
              
              
              92,040June
      30, 2006
              
              $
              5,235
              
              
              $
              258
              
              
              $
              1,715
              
              
              $
              7,208
              
              
              
              120,133September
      30, 2006
              
              $
              6,585
              
              
              $
              407
              
              
              $
              1,715
              
              
              $
              8,707
              
              
              
              145,111December
      31, 2006
              
              $
              8,160
              
              
              $
              592
              
              
              $
              1,715
              
              
              $
              10,467
              
              
              
              174,458March
      31, 2007
              
              $
              9,510
              
              
              $
              810
              
              
              $
              1,715
              
              
              $
              12,035
              
              
              
              200,588




Year
      ended December 31, 2006





The
accompanying financial statements for year ended December 31, 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.





The
following is a summary of the restatements for the year ended December 31, 2006
(in thousands, except per share data):





Income
      tax effect of restatement
            
            $
            0Total
      increase in net loss
            
            $
            2,618






F-30




The
      effect on the Company’s previously issued December 31, 2006 financial
      statements are summarized as follows (in thousands, except per share
      data):Balance
      Sheet
              
              As
      Reported
              
              Change
              
              
              RestatedExcess
      share liability
              
              $
              -
              
              
              $
              2,886
              
              
              $
              2,886Warrant
      liabilities
              
              $
              3,044
              
              
              $
              (3,044
              )
              
              $
              -Total
      current liabilities
              
              $
              15,010
              
              
              $
              (158
              )
              
              $
              14,852Total
      long-term liability
              
              $
              84
              
              
              $
              -
              
              
              $
              84Total
      liabilities
              
              $
              15,094
              
              
              $
              (158
              )
              
              $
              14,936Common
      stock
              
              $
              118,418
              
              
              $
              (118,316
              )
              
              $
              102Additional
      paid-in-capital
              
              
              -
              
              
              
              121,092
              
              
              
              121,092Accumulated
      deficit
              
              
              (131,295
              )
              
              
              (2,618
              )
              
              
              (133,913
              )Total
      stockholder's equity
              
              $
              (12,877
              )
              
              $
              158
              
              
              $
              (12,719
              )Total
      liabilities and stockholder's equity
              
              $
              2,217
              
              
              $
              -
              
              
              $
              2,217Statement
      of Operations year ended December 31, 2006
              
              As
      Reported
              
              Change
              
              
              RestatedOperating
      loss
              
              $
              (5,256
              )
              
              $
              -
              
              
              $
              (5,256
              )Interest
      income (expense)
              
              
              (3,896
              )
              
              
              2,102
              
              
              
              (1,794
              )Other
      expense
              
              
              (381
              )
              
              
              (4,720
              )
              
              
              (5,101
              )Net
      loss
              
              $
              (9,533
              )
              
              $
              (2,618
              )
              
              $
              (12,151
              )Basic
      and diluted net loss per share
              
              $
              (0.94
              )
              
              $
              (0.25
              )
              
              $
              (1.19
              )Shares
      used in computing basic and diluted net loss per share
              
              
              10,170
              
              
              
              
              
              
              
              10,170
    F-31
  The
restated Stockholder’s Equity for the year ended December 31, 2006 is as
follows:
  Statement
of Stockholder's Equity Restated


(In
thousands)


As
      of December 31, 2006
              
              As
      Reported
              
              
              Changes
              
              
              As
      RestatedNo.
      of SharesBalance
      at December 31, 2005
              
              
              10,162
              
              
              
              
              
              
              10,162Common
      stock issued under employee stock plans
              
              
              70
              
              
              
              -
              
              
              
              70Common
      stock issued to non employees
              
              
              3
              
              
              
              -
              
              
              
              3Balance
      at December 31, 2006
              
              
              10,235
              
              
              
              -
              
              
              
              10,235Common
      stock
              
              $
              118,418
              
              
              $
              (118,316
              )
              
              $
              102Paid-In-CapitalBalance
      at December 31, 2005
              
              
              -
              
              
              
              117,898
              
              
              
              117,898Common
      stock issued under employee stock plans
              
              
              -
              
              
              
              28
              
              
              
              28Expense
      for vesting of stock options granted to employees
              
              
              -
              
              
              
              390
              
              
              
              390Relative
      fair value of warrants and beneficial conversion
    features
              
              
              -
              
              
              
              2,776
              
              
              
              2,776Balance
      at December 31, 2006
              
              $
              -
              
              
              $
              121,092
              
              
              $
              121,092Total
      Common stock and paid-in-capital
              
              $
              118,418
              
              
              $
              2,776
              
              
              $
              121,194Accumulated
      DeficitBalance
      at December 31, 2005
              
              $
              (121,762
              )
              
              $
              -
              
              
              $
              (121,762
              )Net
      Loss
              
              
              (9,533
              )
              
              
              (2,618
              )
              
              
              (12,151
              )Balance
      at December 31, 2006
              
              $
              (131,295
              )
              
              $
              (2,618
              )
              
              $
              (133,913
              )Total
      Stockholders' Equity
              
              $
              (12,877
              )
              
              $
              158
              
              
              $
              (12,719
              )









F-32






13. Restatement
of Financial Statements (continued)




Statement
      of Cash Flows for year ended December 31, 2006CASH
      FLOWS FROM OPERATING ACTIVITIES
              
              As
      Reported
              
              
              Changes
              
              
              As RestatedNet
      loss
              
              $
              (9,533
              )
              
              $
              (2,618
              )
              
              $
              (12,151
              )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
              
              
              123
              
              
              
              -
              
              
              
              123Non-cash
      stock-based compensation
              
              
              391
              
              
              
              -
              
              
              
              391Loss
      on excess shares over authorized
              
              
              -
              
              
              
              2,886
              
              
              
              2,886Loss
      on debt extinguishment
              
              
              -
              
              
              
              2,256
              
              
              
              2,256Non-cash
      expense relating to net change in cash settlement
terms
              
              
              -
              
              
              
              520
              
              
              
              520Change
      in warrant liability
              
              
              2,806
              
              
              
              (4,006
              )
              
              
              (1,200
              )Gain
      on settlement
              
              
              (35
              )
              
              
              35
              
              
              
              -Excess
      and obsolete inventory
              
              
              (18
              )
              
              
              -
              
              
              
              (18
              )Write-off
      of interest income
              
              
              26
              
              
              
              (52
              )
              
              
              (26
              )Allowance
      for doubtful accounts
              
              
              (12
              )
              
              
              -
              
              
              
              (12
              )Accounts
      receivable
              
              
              (138
              )
              
              
              -
              
              
              
              (138
              )Inventories
              
              
              81
              
              
              
              -
              
              
              
              81Prepaid
      and other assets
              
              
              396
              
              
              
              -
              
              
              
              396Accounts
      payable, accrued compensation and other liabilities
              
              
              102
              
              
              
              17
              
              
              
              119Notes
      payable
              
              
              70
              
              
              
              (70
              )
              
              
              -Accrued
      fees
              
              
              1,203
              
              
              
              962
              
              
              
              2,165Net
      cash used in operating activities
              
              $
              (4,538
              )
              
              $
              (70
              )
              
              $
              (4,608
              )CASH
      FLOWS FROM INVESTING ACTIVITIES
              
              $
              (112
              )
              
              $
              -
              
              
              $
              (112
              )CASH
      FLOWS FROM FINANCING ACTIVITIESPrincipal
      payment under capital leases and credit facilities
              
              $
              (20
              )
              
              $
              -
              
              
              $
              (20
              )Proceeds
      (payments) from related party
              
              
              -
              
              
              
              70
              
              
              
              70Net
      proceeds from loan financing
              
              
              5,460
              
              
              
              -
              
              
              
              5,460Net
      proceeds from sale of common stock
              
              
              28
              
              
              
              -
              
              
              
              28Net
      cash provided by financing activities
              
              $
              5,468
              
              
              $
              70
              
              
              $
              5,538Change
      in cash and cash equivalents
              
              $
              818
              
              
              $
              -
              
              
              $
              818Beginning
      cash and cash equivalents
              
              
              124
              
              
              
              -
              
              
              
              124Ending
      cash and cash equivalents
              
              $
              942
              
              
              $
              -
              
              
              $
              942


The
net loss for year ended December 31, 2006 as originally reported was $9,533,000,
as compared to the restated net loss of $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
$2,886,000


·
            The
      elimination of derivative share liability of $3,044,000 relating to the
      fair value of warrant liability


·
            Loss
      on extinguishment of debt of
$2,256,000


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








F-33







On
the 2006 balance sheet, the restatement resulted in a decrease in liabilities
and equity of $158,000 consisting of the following:





·
            an
      decrease to the warrant liability from $3,044,000 to
  0;


·
            an
      increase to the net cash settlement of excess share  liability
      from $0 to $2,886,000


·
            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).




The
      following is the summary of the restatements as of March 31, 2007
      (unaudited)(in
      thousands, except per share data):Net
      change in fair value of warrant liability
              
              
              
              
              $
              4,910Accrual
      of excess shares liability
              
              
              
              
              
              (7,737
              )Total
      increase in net loss
              
              
              
              
              $
              2,827The
      following is the summary of ther restatements for the three month ending
      March 31, 2007 (unaudited) (in thousands):Income
      tax effect of restatement
              
              
              
              
              $
              -Total
      increase in net loss
              
              
              
              
              $
              2,827The
      effect on the Company’s previously issued March 31, 2007 financial
      statements are summarized as follows:Three months ended March 31, 2007 (unaudited)
      (in thousands):Balance
      Sheet
              
              As
      Reported
              
              
              Change
              
              
              RestatedExcess
      share liability
              
              $
              -
              
              
              $
              10,623
              
              
              $
              10,623Warrant
      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
              
              
              $
              (118,401
              )
              
              $
              102Additional
      paid-in-capital
              
              
              -
              
              
              
              121,177
              
              
              
              121,177Accumulated
      deficit
              
              
              (138,318
              )
              
              
              (5,445
              )
              
              
              (143,763
              )Total
      stock holders' equity
              
              $
              (19,815
              )
              
              $
              (2,669
              )
              
              $
              (22,484
              )Total
      liabilities and shareholders' equity
              
              $
              1,791
              
              
              $
              -
              
              
              $
              1,791Statement
      of Operations three months ending March 31, 2007
              
              As
      Reported
              
              
              Change
              
              
              RestatedOperating
      loss
              
              $
              (1,892
              )
              
              $
              -
              
              
              $
              (1,892
              )Interest
      expense
              
              
              (220
              )
              
              
              -
              
              
              
              (220
              )Other
      expense
              
              
              (4,911
              )
              
              
              4,910
              
              
              
              (1
              )Excess
      shares liability
              
              
              -
              
              
              
              (7,737
              )
              
              
              (7,737
              )Net
      loss
              
              $
              (7,023
              )
              
              $
              (2,827
              )
              
              $
              (9,850
              )Basic
      and diluted net loss per share
              
              $
              (0.68
              )
              
              $
              (0.28
              )
              
              $
              (0.96
              )Shares
      used in computing basic and diluted net loss per share
              
              
              10,267
              
              
              
              
              
              
              
              10,267






F-34




Statement
of Cash Flows for three months ended March 31, 2007 (in
thousands):
  CASH
      FLOWS FROM OPERATING ACTIVITIES
              
              As
      Reported
              
              
              Change
              
              
              RestatedNet
      loss
              
              $
              (7,023
              )
              
              $
              (2,827
              )
              
              $
              (9,850
              )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
              
              
              21
              
              
              
              -
              
              
              
              21Non-cash
      stock-based compensation
              
              
              66
              
              
              
              -
              
              
              
              66Loss
      on excess shares over authorized
              
              
              -
              
              
              
              7,737
              
              
              
              7,737Derivative valuation
              
              
              4,910
              
              
              
              (4,910
              )
              
              
              -Excess
      and obsolete inventory
              
              
              51
              
              
              
              -
              
              
              
              51Accounts
      receivable
              
              
              273
              
              
              
              -
              
              
              
              273Inventories
              
              
              (240
              )
              
              
              -
              
              
              
              (240
              )Prepaid
      and other assets
              
              
              74
              
              
              
              -
              
              
              
              74Accounts
      payable and other liabilities
              
              
              40
              
              
              
              -
              
              
              
              40Loss
      on excess shares over authorized Accrued
      interest and fees
              
              
              217
              
              
              
              -
              
              
              
              217Net
      cash used in operating activities
              
              $
              (1,611
              )
              
              $
              -
              
              
              $
              (1,611
              )CASH
      FLOWS FROM INVESTING ACTIVITIES
              
              $
              (24
              )
              
              $
              -
              
              
              $
              (24
              )CASH
      FLOWS FROM FINANCING ACTIVITIESPrincipal
      payments under capital leases and credit facility
              
              $
              (5
              )
              
              
              -
              
              
              $
              (5
              )Net
      proceeds from loan financing
              
              
              1,350
              
              
              
              -
              
              
              
              1,350Net
      proceeds from sale of common stock
              
              
              19
              
              
              
              -
              
              
              
              19Net
      cash provided by financing activities
              
              $
              1,364
              
              
              $
              -
              
              
              $
              1,364Change
      in cash and cash equivalents
              
              $
              (271
              )
              
              $
              -
              
              
              $
              (271
              )Beginning
      cash and cash equivalents
              
              
              942
              
              
              
              -
              
              
              
              942Ending
      cash and cash equivalents
              
              $
              671
              
              
              $
              -
              
              
              $
              671






The
net loss for the three months ended March 31, 2007 was originally $7,023,000 as
compared to the restated  net loss of $9,850,000, an increase in loss
of $2,827,000. This increase in loss is due to elimination of derivative share
liability of $4,910,000 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.




The
restated balance sheet as of March 31, 2007 resulted in a increase in
liabilities of $2,669,000 due to the elimination of derivative liability
relating to warrants of $7,954,000 offset by a charge arising from shares to
settle convertible debt in excess of corporate authority of $10,623,000, offset
by net increase in stockholders’deficit of $2,669,000.  The
stockholder’s equity was previously adjusted in December 31, 2006 by
an increase in additional paid-in-capital of $2,776,000 and by an increase
in accumulated deficit of $2,618,000.





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





F-35





Three and six months ended
June 30, 2007




Restatement of
      Financial StatementsThe
      following is the summary of the restatements for the three months ended
      June 30, 2007(unaudited) (in thousands):Net
      change in interest expense
              
              
              
              
              $
              1,957Loss
      on debt extinguishment
              
              
              
              
              
              (15,182
              )Other
      expenses
              
              
              
              
              
              (7,454
              )Total
      increase in net loss
              
              
              
              
              $
              20,679The
      following is a summary of the restatements for the three and six months
      ended June 30, 2007Income
      tax effect of restatement
              
              
              -Total
      increase in net loss for 3 months ended June 30, 2007
              
              $
              20,679Total
      increase in  net loss for 6 months ended June 30,
      2007
              
              $
              23,505The
      effect on the Company’s previously issued June 30, 2007 financial
      statements are summarized as follows (in thousands):Three months and six
      months ended June 30, 2007:Balance
      Sheet as of June 30, 2007
              
              As
      Reported
              
              
              Change
              
              
              RestatedAssetsDeferred
      expense
              
              $
              1,746
              
              
              $
              (1,746
              )
              
              $
              -Other
      current assets
              
              $
              45
              
              
              $
              71
              
              
              $
              116Total
      current assets
              
              $
              2,681
              
              
              $
              (1,675
              )
              
              $
              1,006Total
      assets
              
              $
              3,010
              
              
              $
              (1,675
              )
              
              $
              1,335Liabilities
      & Stockholders' 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
              
              $
              119,042
              
              
              $
              (118,939
              )
              
              $
              103Preferred
      stock
              
              
              5
              
              
              
              -
              
              
              
              5Additional
      paid-in-capital
              
              
              -
              
              
              
              143,389
              
              
              
              143,389Accumulated
      deficit
              
              
              (134,351
              )
              
              
              (25,725
              )
              
              
              (160,076
              )Total
      stockholders' equity
              
              
              (15,304
              )
              
              
              (1,275
              )
              
              
              (16,579
              )Total
      liabilities and stockholders' equity
              
              $
              3,010
              
              
              $
              (1,675
              )
              
              $
              1,335











F-36






Statement
      of Operations three months ended June 30, 2007 (in thousands, except per
      share data):
              
              As
      Reported
              
              
              Changes
              
              
              As
      RestatedOperating
      loss
              
              $
              (1,927
              )
              
              $
              -
              
              
              $
              (1,927
              )Interest
      expense
              
              
              (1,665
              )
              
              
              1,957
              
              
              
              292Loss
      on debt extinguishment
              
              
              -
              
              
              
              (15,182
              )
              
              
              (15,182
              )Other
      expense
              
              
              7,959
              
              
              
              (7,454
              )
              
              
              505Net
      income (loss)
              
              $
              4,367
              
              
              $
              (20,679
              )
              
              $
              (16,312
              )Basic
      and diluted net loss per share
              
              $
              0.42
              
              
              $
              (2.01
              )
              
              $
              (1.59
              )Shares
      used in computing basic and diluted net loss per share
              
              
              10,286
              
              
              
              
              
              
              
              10,286Statement
      of Operations six months ended June 30, 2007 (in thousands, except per
      share data):
              
              As
      Reported
              
              
              Changes
              
              
              As
      RestatedOperating
      loss
              
              $
              (3,819
              )
              
              $
              -
              
              
              $
              (3,819
              )Interest
      expense
              
              
              (1,886
              )
              
              
              1,958
              
              
              
              72Loss
      on debt extinguishment
              
              
              -
              
              
              
              (15,182
              )
              
              
              (15,182
              )Other
      expense
              
              
              3,048
              
              
              
              (2,544
              )
              
              
              504Excess
      shares liability
              
              
              -
              
              
              
              (7,737
              )
              
              
              (7,737
              )Net
      loss
              
              $
              (2,657
              )
              
              $
              (23,505
              )
              
              $
              (26,162
              )Basic
      and diluted net loss per share
              
              $
              (0.26
              )
              
              $
              (2.29
              )
              
              $
              (2.55
              )Shares
      used in computing basic and diluted net loss per share
              
              
              10,286
              
              
              
              
              
              
              
              10,277Statement
      of Cash Flows for six months ended June 30, 2007 (in
      thousands)CASH
      FLOWS FROM OPERATING ACTIVITIES
              
              As
      Reported
              
              
              Changes
              
              
              As
      RestatedNet
      loss
              
              $
              (2,657
              )
              
              $
              (23,505
              )
              
              $
              (26,162
              )Adjustements
      to reconcile net loss to net cash used inoperating
      activities:Depreciation
      and amortization
              
              
              49
              
              
              
              -
              
              
              
              49Non-cash
      stock-based compensation
              
              
              110
              
              
              
              (3
              )
              
              
              107Non-cash
      interest expense (income)
              
              
              280
              
              
              
              (1,023
              )
              
              
              (743
              )Loss
      on excess shares over authorized
              
              
              -
              
              
              
              7,737
              
              
              
              7,737Loss
      on debt extinguishment
              
              
              -
              
              
              
              15,182
              
              
              
              15,182Non-cash
      change to warrant liability
              
              
              (3,044
              )
              
              
              3,044
              
              
              
              -Preferred
      shares issued for fees
              
              
              -
              
              
              
              500
              
              
              
              500Excess
      and obsolete inventory
              
              
              142
              
              
              
              -
              
              
              
              142Allowance
      for doubtful accounts
              
              
              19
              
              
              
              -
              
              
              
              19Accounts
      receivable
              
              
              252
              
              
              
              (38
              )
              
              
              214Inventories
              
              
              (298
              )
              
              
              -
              
              
              
              (298
              )Prepaid
      and other assets
              
              
              113
              
              
              
              (55
              )
              
              
              58Accounts
      payable, accrued compensation and other liabilitiies
              
              
              (312
              )
              
              
              39
              
              
              
              (273
              )Accrued
      interest and fees
              
              
              1,594
              
              
              
              1,010
              
              
              
              2,604Excess
      share liability
              
              
              -
              
              
              
              (2,886
              )
              
              
              (2,886
              )Net
      cash used in operating activities
              
              $
              (3,752
              )
              
              $
              2
              
              
              $
              (3,750
              )CASH
      FLOWS FROM INVESTING ACTIVITIES
              
              $
              (27
              )
              
              $
              -
              
              
              $
              (27
              )CASH
      FLOWS FROM FINANCING ACTIVITIESPrincipal
      payments under capital leases and credit facilities
              
              $
              (10
              )
              
              $
              -
              
              
              $
              (10
              )Proceeds
      (payments) from related party
              
              
              -
              
              
              
              (2
              )
              
              
              (2
              )Net
      proceeds from loan financing
              
              
              3,045
              
              
              
              -
              
              
              
              3,045Net
      proceeds from sale of common stock
              
              
              19
              
              
              
              -
              
              
              
              19CASH
      FLOWS FROM FINANCING ACTIVITIES
              
              $
              3,054
              
              
              $
              (2
              )
              
              $
              3,052Change
      in cash and cash equivalents
              
              $
              (725
              )
              
              $
              -
              
              
              $
              (725
              )Beginning
      cash and cash equivalents
              
              
              942
              
              
              
              -
              
              
              
              942Ending
      cash and cash equivalents
              
              $
              217
              
              
              $
              -
              
              
              $
              217




F-37




The
net income for the three months ended June 30, 2007 was originally $4,367,000.
The three months ended June 30, 2007 restated net loss is reported as
$16,312,000, a decrease in net income of $20,679,000. This increase in loss is
due to elimination of interest expense of $1,957,000 associated with the loan,
offset by charges arising from the recognition of the extinguishment of debt
treatment of $15,182,000 and elimination of derivative liability relating to
warrants of $7,454,000.  The effect of the above adjustments and prior
period adjustments of March 31, 2007 resulted in an  increase in net
loss of  $23,505,000 from a loss of $2,567,000 to $26,162,000 for six
months ending June 30, 2007.




The
originally reported diluted net income per share for the three months ended June
30, 2007 of $0.42 is reduced by $2.01 to a net loss per share of $1.59. The
basic and diluted net loss per share for the six months ended June 30, 2007 of
$0.26 is increased by $2.29 to a net loss per share of $2.55.




The
restated June 30, 2007 balance sheet resulted in a decrease in liabilities of
$400,000, a reduction of the deferred charges of $1,746,000, (due to
recognition of extinguishment of debt and elimination of derivative liability
and increase in accumulated deficit of $25,725,000 due to income statement
adjustments for periods ended June 30, 2007 and December 31,
2006.





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)(in thousands):




Net
      change in fair value of conversion
      liability
              
              $
              (400
              )Net
      adjustment to loss and paid in capital for debt
      extinguishment
              
              
              400Total
              
              $
              -


Net
      change in interest expense
              
              $
              (761)Other
      expenses
              
              $
              1,675Total
      decrease in net loss for 3 months ended September 30,
    2007
              
              $
              914




The
following is a summary of the restatements for the three and nine months ended
September 30, 2007 (unaudited) (in thousands):


Income
      tax effect of restatement
              
              $
              -Total
      increase in net loss for the nine months ended September 30,
      2007
              
              $
              16,381





F-38





Restatement of
      Financial StatementsThree
      months and nine months ended September 30,
      2007:The
      effects on the Company's previously issued September 30, 2007 financial
      statements are summarized as follows (in
thousands):Balance
      Sheet
              
              As
      Reported
              
              Change
              
              
              RestatedConversion
      feature laibility
              
              $
              400
              
              
              $
              (400
              )
              
              $
              -Total
      current liabilites
              
              $
              20,422
              
              
              $
              (400
              )
              
              $
              20,022Total
      long-term liability
              
              $
              68
              
              
              $
              -
              
              
              $
              68Total
      liability
              
              $
              20,490
              
              
              $
              (400
              )
              
              $
              20,090Common
      stock
              
              $
              125,567
              
              
              $
              (125,557
              )
              
              $
              10Preferred
      stock
              
              $
              5
              
              
              $
              -
              
              
              $
              5Additional
      paid-in-capital
              
              $
              -
              
              
              $
              144,556
              
              
              $
              144,556Accumulated
      deficit
              
              
              (144,326
              )
              
              
              (18,599
              )
              
              
              (162,925
              )Total
      stockholders' equity
              
              $
              (18,754
              )
              
              $
              400
              
              
              $
              (18,354
              )Total
      liabilities and equity
              
              $
              1,736
              
              
              $
              -
              
              
              $
              1,736
   F-39




Statement
      of Operations three months ended September 30, 2007 (in thousands, except
      per share data):
              
              As
      Reported
              
              Change
              
              RestatedOperating
      loss
              
              $
              (1,459
              )
              
              $
              -
              
              
              $
              (1,459
              )Interest
      expense
              
              
              (2,314
              )
              
              
              (761
              )
              
              
              (3,075
              )Other
      expense
              
              
              9
              
              
              
              1,675
              
              
              
              1,684Net
      loss
              
              $
              (3,764
              )
              
              $
              914
              
              
              $
              (2,850
              )Basic
      and diluted net loss per share
              
              $
              (0.37
              )
              
              $
              0.09
              
              
              $
              (0.28
              )Shares
      used in computing basic and diluted net loss per share
              
              
              10,300
              
              
              
              
              
              
              
              10,307Statement
      of Operations nine months ended September 30, 2007 (in thousands, except
      per share data):
              
              As
      Reported
              
              Change
              
              RestatedOperating
      loss
              
              $
              (5,278
              )
              
              $
              -
              
              
              $
              (5,278
              )Loss
      on debt restructuring
              
              
              (760
              )
              
              
              (14,422
              )
              
              
              (15,182
              )Excess
      shares liability
              
              
              -
              
              
              
              (7,737
              )
              
              
              (7,737
              )Interest
      expense
              
              
              (9,651
              )
              
              
              6,648
              
              
              
              (3,003
              )Other
      expense
              
              
              3,058
              
              
              
              (870
              )
              
              
              2,188Net
      loss
              
              $
              (12,631
              )
              
              $
              (16,381
              )
              
              $
              (29,012
              )Basic
      and diluted net loss per share
              
              $
              (1.23
              )
              
              $
              (1.59
              )
              
              $
              (2.82
              )Shares
      used in computing basic and diluted net loss per share
              
              
              10,267
              
              
              
              
              
              
              
              10,288Statement
      of Cash Flows for nine months ended September 30, 2007 (in
      thousands)CASH
      FLOWS FROM OPERATING ACTIVITIES
              
              As
      Reported
              
              Change
              
              RestatedNet
      loss
              
              $
              (12,631
              )
              
              $
              (16,381
              )
              
              $
              (29,012
              )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
              
              
              69
              
              
              
              -
              
              
              
              69Non-cash
      stock-based compensation
              
              
              145
              
              
              
              -
              
              
              
              145Non-cash
      interest expense
              
              
              6,213
              
              
              
              (5,915
              )
              
              
              298Loss
      on debt extinguishment
              
              
              -
              
              
              
              15,182
              
              
              
              15,182Loss
      on excess shares over authorized
              
              
              -
              
              
              
              7,737
              
              
              
              7,737Loss
      on debt restructuring
              
              
              760
              
              
              
              (760
              )
              
              
              -Warrant
      liability valuation
              
              
              (3,044
              )
              
              
              3,044
              
              
              
              -Preferred
      shares issued for fees
              
              
              -
              
              
              
              500
              
              
              
              500Excess
      and obsolete inventory
              
              
              129
              
              
              
              -
              
              
              
              129Allowance
      for doubtful accounts
              
              
              26
              
              
              
              -
              
              
              
              26Accounts
      receivable
              
              
              223
              
              
              
              -
              
              
              
              223Inventories
              
              
              (284
              )
              
              
              -
              
              
              
              (284
              )Prepaid
      and other assets
              
              
              (54
              )
              
              
              -
              
              
              
              (54
              )Accounts
      payable, accrued compenssation and other liabilities
              
              
              (128
              )
              
              
              (17
              )
              
              
              (145
              )Excess
      share liability
              
              
              -
              
              
              
              (2,886
              )
              
              
              (2,886
              )Accrued
      interest and fees
              
              
              3,473
              
              
              
              (500
              )
              
              
              2,973Net
      cash used in operating activities
              
              $
              (5,103
              )
              
              $
              4
              
              
              $
              (5,099
              )CASH
      FLOWS FROM INVESTING ACTIVITIES
              
              $
              (83
              )
              
              $
              -
              
              
              $
              (83
              )CASH
      FLOWS FROM FINANCING ACTIVITIESPrincipal
      payments under capital leases and credit facility
              
              $
              (25
              )
              
              $
              -
              
              
              $
              (25
              )Proceeds
      (payments) from related party
              
              
              -
              
              
              
              (4
              )
              
              
              (4
              )Net
      proceeds from loan financing
              
              
              4,720
              
              
              
              -
              
              
              
              4,720Net
      proceeds from sale of common stock
              
              
              36
              
              
              
              -
              
              
              
              36Net
      cash provided by financing activities
              
              $
              4,731
              
              
              $
              (4
              )
              
              $
              4,727Change
      in cash and cash equivalents
              
              $
              (455
              )
              
              $
              -
              
              
              $
              (455
              )Beginning
      cash and cash equivalents
              
              
              942
              
              
              $
              -
              
              
              
              942Ending
      cash and cash equivalents
              
              $
              487
              
              
              $
              -
              
              
              $
              487








F-40






The
net loss for the three months ended September 30, 2007 was originally
$3,764,000. The three months ended September, 2007 restated net loss is reported
as $2,850,000, a decrease in loss of $914,000.  This decrease in loss
is due to the elimination of amortization of debt related fees.




The
effect of the above adjustment and prior period restatement adjustments resulted
in an increase in the net loss for the nine months ending September 30, 2007 by
$16,381,000 from $12,631,000 to $29,012,000.




The
restated balance sheet as of September 30, 2007 resulted in a decrease in
liabilities of $400,000, resulting from elimination of the conversion liability
originally recognized. The adjustment in Additional paid-in-capital and
accumulated deficit are due to all prior period adjustments.





For
the three months ended September 30, 2007, the basic and diluted loss per share
increased by $0.09 from the originally reported loss per share of $0.37 to a
restated loss per share of $0.28. For the nine months ended September 30, 2007,
the basic and diluted loss per share increased by $1.59 from the originally
reported loss per share of $1.23 to a restated loss per share of
$2.82.





14. 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 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
                %







F-41







At
December 31, 2007, we 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.




We
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 our 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
              )-
              
              
              
              -






As of
December 31, 2007 and 2006, we 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 assets primarily relate to net
operating loss and tax credit carry forwards.




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




On
January 1, 2007, we adopted FASB Interpretation No. (“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 is
more likely than not be sustained on audit, based on the technical merits of the
position. FIN 48 also provides guidance related to de-recognition,
classification, interest and penalties, accounting in interim periods and
disclosure. If there are changes in net assets as a result of application of FIN
48, these will be accounted for as an adjustment to retained earnings. We
determined that there was no impact as a result of the adoption of FIN No.
48.




The
implementation of FIN 48 did not have a material impact on our financial
statements.  At January 1, 2007, we have not accrued an amount for tax
liability from unrecognized tax benefits.






F-42




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
            
            $
            -




We
      do not believe the total amount of unrecognized benefit as of December 31,
      2007 will increase or decrease significantly in the next twelve months.
       Our Federal, California, Illinois and Wisconsin tax returns are
      subject to examination by the tax
  authorities.





15.
License Rights




In May
1993, in exchange for an equity interest in us, Target Therapeutics, Inc.
granted us 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, we
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 us a non-exclusive, royalty-free license to use Target
Therapeutics’ technology to make, use and sell or otherwise distribute our
products for use within the cardiology field, provided our products represent a
substantial improvement. A substantial improvement is any modification,
improvement or enhancement by us of Target Therapeutics’ technology in a
particular product that results in a material change in the function, purpose or
application of such product. We believe that the incorporation of electrodes in
our micro-catheter systems, together with other modifications, satisfies the
substantial improvement requirements. As part of the same agreement, we granted
to Target Therapeutics an exclusive, royalty-free license to use our technology
to make, use and sell or otherwise distribute products within the Target
Field.




In
addition, we agreed not to conduct material research and development, acquire
corporate entities or make or sell products in the Target Field, 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 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.




16.
Retirement Benefit Plan





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





17. Warrant
Activity





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








F-43







Included
in the issuance of warrants to purchase 5,700,000 aggregate shares of our common
stock is a warrant to purchase 3,000,000 shares that was issued to APIX, an
entity wholly owned and controlled by our 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
              
              
              $
              0.60Warrant
      Shares Cancelled  in 2006
              
              
              (673,258
              )
              
              
              (673,258
              )
              
              $
              0.64
              
              
              
              -
              
              
              $
              15.20
              
              
              $
              8.70Warrant
      Shares Exercised in 2006
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              
              
              
              
              -
              
              
              
              -Balance
      as of 12/31/2006
              
              
              7,579,353
              
              
              
              7,579,353
              
              
              $
              0.60
              
              
              
              -
              
              
              $
              14.00
              
              
              $
              3.20Warrant
      Shares Granted in 2007
              
              
              19,860,000
              
              
              
              19,860,000
              
              
              $
              0.30
              
              
              
              
              
              
              $
              0.55
              
              
              $
              0.55Warrant
      Shares Cancelled  in 2007
              
              
              (537,359
              )
              
              
              (537,359
              )
              
              $
              0.78
              
              
              
              -
              
              
              $
              13.40
              
              
              $
              10.60Warrant
      Shares Exercised in 2007
              
              
              (20,340,000
              )
              
              
              (20,340,000
              )
              
              
              
              
              
              
              
              
              
              $
              0.40
              
              
              $
              0.40Balance
      as of 12/31/2007
              
              
              6,561,994
              
              
              
              6,561,994
              
              
              $
              0.55
              
              
              
              -
              
              
              $
              14.00
              
              
              $
              1.30





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






Warrants
      Outstanding
              
              
              Warrants
      ExercisableRange
      of Exercise Prices
              
              Number
      of Warrants Outstanding
              
              Weighted-Average Remaining
      Contractual Life
              
              Weighted-Average
      Exercise Price
              
              Number
      of Warrants 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
              
              
              
              104,585
              
              
              
              1.6
              
              
              $
              9.30
              
              
              $
              104,585
              
              
              $
              9.306,561,994
              
              
              
              4.4
              
              
              $
              1.30
              
              
              $
              6,561,994
              
              
              $
              1.30
  18. Subsequent
Event





On
March 23, 2008, our Board of Directorsapproved a resolution
appointing APIX International Limited (the “Agent”) to be our 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 is issued entitling
the Agent to purchase 1.5 Million our shares 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. On May 8, 2008, we entered into a series of identical
agreements with a number of accredited investors for the private sale
of 8,474,992 shares of common stock at US$0.60 per share.  The total
gross proceeds from the sale are expected to be $5,085,000.  In
addition, we will issue to these investors warrants to purchase 1,271,247
shares of common stock at an exercise price of US$0.65 per
share.





On
March 23, 2008, our 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 us (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. We 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.