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SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2005

or

For the transition period from              to             .

Commission File Number: 0-22419

CARDIMA, INC.

(Exact name of registrant as specified in its charter)

47266 Benicia Street, Fremont, CA 94538-7330

(Address of Principal Executive Offices) (Zip Code)

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).    ¨  Yes    x  No

As of April 30, 2005, there were 101,437,889 shares of Registrant’s Common Stock outstanding.

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CARDIMA, INC.

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PART I. Financial Information

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PART I.

Item 1. Financial Statements

CARDIMA, INC.

BALANCE SHEETS

(In thousands, except per share amounts)

See accompanying notes to financial statements

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CARDIMA, INC.

STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

See accompanying notes to financial statements

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CARDIMA, INC.

STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See accompanying summary of accounting policies and notes to financial statements.

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CARDIMA, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

March 31, 2005

(Unaudited)

1. BASIS OF PRESENTATION

The accompanying unaudited condensed financial statements have been prepared by the Company according to the rules and regulations of the Securities and Exchange Commission for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the financial information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included.

The operating results for the three month period ended March 31, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2005 or for future operating results. The accompanying financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004. The accompanying balance sheet at December 31, 2004 has been derived from those audited financial statements.

Certain reclassifications have been made to prior period amounts to conform to the current period presentation. These reclassifications had no effect on prior reported results of operations or accumulated deficit.

2. MANAGEMENT’S PLANS

As of March 31, 2005 Cardima, Inc. had approximately $1,718,000 in cash and cash equivalents, working capital of $2,200,000 and an accumulated deficit of $115,763,000. Management expects the Company to continue to incur additional losses in the foreseeable future as we work towards regulatory approval and commercialization of the REVELATION^® Tx in the United States, commercialization of the Cardima Surgical Ablation System and the commercialization of the REVELATION^® Helix in Europe. We currently estimate that our cash balances as of March 31, 2005, will be sufficient to fund planned expenditures only for a very limited period of time, likely not extending beyond early June 2005 and possibly earlier, and will not be sufficient to fund planned expenditures into the third quarter of 2005. However the actual amount of our expenditures is inherently uncertain and our cash resources may be exhausted sooner than currently anticipated. Although our management recognizes the need to raise funds in the immediate future, there can be no assurance that we will be successful in consummating any fundraising transaction, or, if we do consummate such a transaction, that its terms and conditions will not be unfavorable to us. Our financing which closed on November 24, 2004 contains terms which substantially restrict our ability to raise the further funding that we will need to continue our operations. For example, if we issue common stock or securities convertible into or exercisable for common stock at a price per share below

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$0.2733 before July 12, 2005, we will be contractually obligated to issue additional common stock to certain investors in our November 2004 financing. We are also contractually prohibited from issuing certain kinds of convertible securities without the consent of some of our investors. We are evaluating various courses of action including selling or licensing some of our proprietary technologies. If we fail to obtain additional funding in the immediate future, our business will fail and our stockholders will likely lose the entire value of their investment. Our independent registered public accountants have stated in their opinion on our December 31, 2004 financial statements that there is substantial doubt as to our ability to continue as a going concern.

On May 6, 2005, we received a Nasdaq Staff Determination indicating that we had not regained compliance with the requirements for continued listing set forth in Marketplace Rule 4310(c)(4), which we refer to as the “Rule” for purposes of this discussion, and that our securities are, therefore, subject to delisting from The Nasdaq SmallCap Market at the opening of business on May 17, 2005. The Rule provides that if the closing bid price of a company’s stock is below $1.00 for more than thirty consecutive trading days, the company faces possible delisting.

We may appeal the Nasdaq Staff’s Determination to a Listing Qualification Panel, pursuant to the procedures set forth in the Nasdaq Marketplace Rule 4800 Series. There can be no assurance that we will appeal the Nasdaq Staff’s Determination or, if we do appeal the Nasdaq Staff’s Determination, that such appeal will be successful.

See “Our stock may be delisted from Nasdaq as soon as the opening of business on May 17, 2005, which would make it more difficult for investors to sell their shares and may lead to costly claims by investors” for more information regarding Nasdaq related matters.

Cardima, Inc., continues to pursue regulatory approvals and distribution relationships in significant market opportunities worldwide. We currently have distribution agreements for various products covering eight countries with an emphasis on Europe and the Pacific Rim, and we are currently seeking a strategic transaction for our Surgical Ablation System, which received United States Food and Drug Administration 510(k) clearance for use in ablating cardiac tissue in 2003. We have arranged for warehousing capacity in Europe to support both distribution and direct customer sales. Securing FDA approval of the REVELATION^® Tx remains one of our primary goals. On May 28, 2004 we received a letter, dated May 21, 2004, from the FDA, stating that our pre-market approval application, or PMA, for the REVELATION Tx linear ablation microcatheter system was not approvable based on the requirements of applicable regulations. At a meeting with the FDA on June 18, 2004, the FDA reiterated its view, as stated in its “not approvable” letter that data from an additional study would be necessary to demonstrate the effectiveness of the REVELATION Tx for atrial fibrillation, and that the nature of the trial’s primary goal would be to require a randomized clinical trial design. We plan to continue to pursue U.S. regulatory approvals for the REVELATION Tx, as well as other therapeutic products already approved in Europe and in other markets which we believe have both the clinical potential and adequate medical support structure to accept a developing technology application. We are continuing to develop broader applications of our Surgical Ablation System as a minimally invasive, stand-alone surgical procedure to treat atrial fibrillation. We cannot assure you that we will be able to obtain or maintain any necessary regulatory approvals or that, if such regulatory approvals are obtained, that we will be able to successfully market our products, or that we will be able to establish a successful distribution channel for our Surgical Ablation System.

3. CRITICAL ACCOUNTING POLICIES

Use of Estimates

We have prepared our financial statements in conformity with generally accepted accounting principles in the United States, which requires management to make estimates and assumptions that effect the amounts reported in financial statement and accompanying notes. Actual results could differ from these estimates. Significant estimates made by us include those related to accounts receivable and inventory reserves.

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Revenue Recognition

We recognize revenue from two types of customers, end users and distributors. Revenue is recognized in accordance with Staff Accounting Bulletin 104, “Revenue Recognition in Financial Statements,” when all of the following criteria are met: a) Persuasive evidence that an arrangement exists (purchase orders from customers); b) Prices are fixed and determinable (purchase orders from customers and our invoices); c) Shipment of the product has occurred and title of products transferred at the point of shipment (shipping documents); and d) Payment of the product is reasonably assured and no substantive obligations to the customer remain (collectability is reasonable assured by the Company, making sure that credit is extended to worthy customers). Revenue is presented net of discounts, allowances, and returns. Customers are not entitled to any rights of product return. Payment terms are either open trade or cash. We have distributors in Asia and Europe and we record as revenue the wholesale price we charge our distributors. Title and risk of loss are assumed by the distributors and end users at shipping point.

Allowance for Doubtful Accounts

We establish estimates of the uncollectability of accounts receivable. Our management analyzes accounts receivable, historical write-offs as bad debts, customer concentrations, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. We maintain an allowance for doubtful accounts at an amount that we estimate to be sufficient to provide adequate protection against losses resulting from collecting less than full payment on receivables. We have not experienced significant bad debt expense and we believe our reserve for doubtful accounts of $35,000 is adequate for any exposure to loss in our March 31, 2005 accounts receivable.

Allowance for Excess and Slow-Moving Inventory

Inventories, which are composed of purchased parts and subassemblies, work in process and finished goods, are valued at the lower of cost or market with cost being determined by the first-in, first-out method. We have analyzed the level of inventory on hand, its cost in relation to market value and estimated customer requirements to determine whether write-downs for excess or slow-moving inventory are required. Actual customer requirements in any future periods are inherently uncertain and thus may differ from estimates. If actual or expected requirements were significantly greater or lower than the established reserves, a reduction or increase to the obsolescence allowance would be recorded in the period in which such a determination was made. We have established reserves for excess and slow-moving inventories and believe the reserve of $655,000 at March 31, 2005 is adequate.

Stock-Based Compensation

The Company has elected to follow Accounting Principles Board Opinion No. (“APB”) 25, “Accounting for Stock Issued to Employees” and related interpretations in accounting for its employee stock options, including Financial Accounting Standard Board Interpretation (“FIN”) 44, “Accounting for Certain Transactions Involving Stock Compensation.” Compensation expense is based on the difference, if any, between the fair value of our common stock and the exercise price of the option or share right on the measurement date, which is typically the grant date.

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This amount is recordable as “deferred stock compensation” in the Balance Sheets and amortized as a charge to operations over the vesting period of the applicable options or share rights. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” we have provided below the pro forma disclosures of the effect on net loss and loss per share as if SFAS 123 had been applied in measuring compensation expense for all periods presented.

The following information regarding pro forma net loss and net loss per share has been determined as if we had accounted for our employee stock options and employee stock plan under the fair value method prescribed by SFAS 123. The resulting effect on net loss and net loss per share pursuant to SFAS 123 is not likely to be representative of the effects on net loss and loss per share pursuant to SFAS 123 in future periods, due to subsequent periods including additional grants and periods of vesting.

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

For purposes of disclosures pursuant to SFAS 123 as amended by FAS 148, the estimated fair value of options is amortized to expense over the options’ vesting period.

The following table illustrates the effect on reported net loss per share if we had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation (in thousands, except per share amounts):

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The fair value of options was estimated at the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions:

Research and Development

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

4. WARRANTS

During the first quarter of 2004, warrants were exercised for a total of 4,144,839 shares of common stock at exercise prices ranging from $0.7282 to $0.8375 per share. Total net proceeds from the exercise of these warrants was $3.1 million.

The Company filed a registration statement with the SEC with respect to the shares underlying the warrants issued in December 2003, which was declared effective in February 2004. Accordingly, the warrant liability was transferred to additional paid in capital during the first quarter of 2004.

5. CONCENTRATIONS OF RISK

During the quarter ended March 31, 2005, our net sales to foreign customers increased to 52% of total net sales, with 39% to Asia (Japan) and 13% to Europe. During the quarter largest ended March 31, 2004, net sales to foreign customers were 50% of total net sales, with 29% to Asia (Japan), 20% to Europe, and 1% to other. Our largest net sales by country in the quarter ending March 31, 2005 was 48% to US and 39% to Japan and for the same quarter in 2004, the largest net sales by country was 50% to US, 29% to Japan and 12% to Germany.

During the quarter ended March 31, 2005 revenues to one customer comprised 39.4% of the company’s total net product sales. During the quarter ending March 31, 2004, two customers comprised 29.1% and 11.9% of the company’s total net product sales. Otherwise, no single customer represented more than 10% of total net product sales in those periods.

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6. INVENTORIES

Inventories consist of the following (in thousands):

Inventory amounts shown above are net of reserves for excess and obsolete inventory of $655,000 at March 31, 2005 and December 31, 2004. The Company provides reserves for inventory amounts by considering the potential excess inventory in relation to sales forecasts and the obsolescence of inventory as a result of technological advancements.

7. IMPAIRMENT OF ASSETS

Because there were indicators of impairment, including continued losses, the Company conducted an analysis during the first quarter of 2005 to determine if there was impairment of any long-lived assets. Pursuant to this analysis, we took an impairment charge of $358,000, which was required to bring fixed assets to their fair value less disposal costs.

8. NET LOSS PER SHARE

Net loss per share has been computed using the weighted average number of shares of common stock outstanding during the period. We have excluded all warrants and stock options from the computation of basic and diluted earnings per share because all such securities are anti-dilutive for all periods presented. Excluded common stock equivalent shares included the following:

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9. RECENT ACCOUNTING PRONOUNCEMENTS

In the fourth quarter of 2004, the Financial Accounting Standards Board (“FASB”) issued and renamed SFAS No. 123R, “Share-Based Payment”, which replaces SFAS No. 123, and supersedes ABP No. 25. SFAS No. 123R establishes accounting standards for equity instruments that an entity exchanges for goods or services. It also addresses transactions where an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. This Statement focuses primarily on accounting for share-based payment transactions as it relates to employee services. SFAS No. 123R requires a public entity to measure an award of equity instruments based on the grant-date fair value of the award, and recognize that cost over the period during which an employee is required to provide services (usually the vesting period). The grant-date fair value of share options and similar instruments is to be estimated using option-pricing models adjusted for the unique characteristics of those instruments.

SFAS No. 123R eliminates the alternative to use ABP No. 25’s intrinsic value method of accounting, under which issuing stock options to employees generally resulted in recognition of no compensation cost. Alternative phase-in methods are allowed under Statement No. 123R, which is effective as of the beginning of the first fiscal year that begins after June 15, 2005. Cardima has not yet determined the phase-in method or potential effects on the Company’s future results of operations.

In November 2004, Statement of Financial Accounting Standards (“SFAS”) No. 151, “Inventory Costs – An Amendment of ARB No. 43, Chapter 4”, was issued which amends the guidance in Accounting Research Bulletin (“ARB”) No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS 151 is effective for fiscal years beginning after June 15, 2005. We are currently evaluating the effect that the adoption of SFAS 151 will have on our consolidated results of operations and financial condition.

10. COMMITMENTS AND CONTINGENCIES

The Company currently is a party to various claims, including claims from private placement agents in conjunction with private placements. While the Company currently believes that the ultimate outcome of these claims will not have a material adverse effect on our results of operations, claims and litigation are subject to inherent uncertainties, and unfavorable rulings could occur. Depending on the amount and timing, an unfavorable outcome of some or all of these matters could have a material adverse effect on the Company’s cash flows, business, results of operations or financial position. An estimate of potential loss from pending claims cannot be made at this time.

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Item 2. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

This quarterly report on Form 10-Q, including management’s discussion and analysis of financial condition and results of operations, contains “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, including, without limitation, statements regarding our goals, plans and efforts to secure regulatory approvals and to raise necessary capital, marketing plans, operating results and capital requirements. Except for historical information, the matters discussed in this Form 10-Q are forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected, estimated or contemplated by the forward-looking statements. These factors include:

We assume no obligation to update the forward-looking statements included in this Form 10-Q. This discussion and analysis should be read in conjunction with the Financial Statements and related Notes thereto included elsewhere in this Form 10-Q and in the Company’s most recent Annual Report on Form 10-K.

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Overview

Since our incorporation in November 1992, we have developed, produced and sold a variety of microcatheters, including those for the diagnosis of ventricular tachycardia. Since 2001, however, our efforts have primarily focused on developing differentiated products that diagnose and treat atrial fibrillation, including our REVELATION^® Tx microcatheter for use in the Electrophysiology (EP) market, and our Surgical Ablation System 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. Arrhythmias are abnormal electrical heart rhythms that adversely affect the mechanical activities of the heart and can significantly affect a person’s quality of life and potentially can be fatal. We have developed microcatheter-based systems designed (1) to locate and provide more extensive and less traumatic access to arrhythmia-causing tissue for diagnosing the arrhythmia, referred to as mapping, and (2) to restore normal heart rhythms by isolating and/or blocking the arrhythmia-causing tissue using radio frequency energy, referred to as ablation. Our microcatheters incorporate multiple electrodes at the distal end to record electrical signals for mapping and, with certain microcatheters, to transfer radio frequency energy for tissue ablation, allowing physicians to both map and ablate arrhythmias using the same microcatheter. Our microcatheters are designed with variable stiffness guidewire technology and a highly flexible distal tip to allow more extensive and less traumatic access to the chambers and vasculature of the heart. In addition, all of our microcatheters are disposable, single-use products that we believe can be adapted to and used with conventional ECG-recording systems and with existing compatible radio frequency generators, eliminating the need for significant new investment in capital equipment by hospitals.

More recently, we have leveraged our proprietary technologies for treating atrial fibrillation, or AF, into the development of products for the surgical market. On January 29, 2003, we received notice from the FDA that it had approved for commercialization the Cardima Surgical Ablation System for use in ablating cardiac tissue during cardiac surgery. This new system connects the Cardima Surgical Ablation Probe, a deflectable multi-electrode linear array microcatheter technology, to a commercially available electrosurgical radio frequency generator through the INTELLITEMP^®, a multi-channel radio frequency, or RF, energy management device. This system allows surgeons to direct RF energy through any combination of up to eight probe electrodes simultaneously into cardiac tissue, a feature which can significantly reduce the time required to perform an ablation-based “maze” procedure. Since September 2003, the Surgical Ablation System has been utilized on a limited basis to treat AF as an adjunct procedure to valve replacement. In the first quarter of 2004, the Surgical Ablation System (SAS) was utilized in two less invasive cases for the treatment of AF, opening the door to the prospect of the SAS technology being broadly used in a stand-alone procedure to treat AF. We do not currently plan to market our Surgical Ablation System ourselves, and are currently seeking to sell or otherwise consummate a strategic transaction for this system.

We have generated revenues of approximately $20.1 million from inception to March 31, 2005. Prior to January 1997, these revenues were generated primarily in Europe and Japan from sales of our PATHFINDER and TRACER microcatheter systems for diagnosing ventricular tachycardia and our REVELATION microcatheter system for diagnosing atrial fibrillation, as well as ancillary products such as the VENAPORT guiding catheters. Since 1997 and the U.S.

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Food and Drug Administration’s clearance of certain of our products, sales in the United States consist primarily of our PATHFINDER and REVELATION lines of microcatheters for diagnosing ventricular tachycardia and atrial fibrillation, respectively. To date, our international sales have been made through our small direct sales force, which currently consists of one salesperson, and distributors who sell our products to physicians and hospitals. European sales consist primarily of the REVELATION Tx, REVELATION T-Flex and REVELATION Helix microcatheters for treatment of atrial fibrillation following receipt of CE Mark for those products in December 1998, December 2001 and November 2002, respectively.

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 operations, otherwise our business will fail and our stockholders will likely lose the entire value of their investment.

Obtaining and maintaining regulatory approvals is critical to our business. We are required to conduct clinical trials, demonstrate safety and effectiveness and obtain either 510(k) or PMA approval from the FDA in order to legally sell any of our products for treating atrial fibrillation or ventricular tachycardia in the United States. While the Surgical Ablation System has received 510(k) approval from the FDA for the ablation of cardiac tissue during cardiac surgery using radio frequency energy, PMA approval will be required prior to the introduction in the United States of the REVELATION Tx, REVELATION T-Flex and REVELATION Helix microcatheter systems for treating atrial fibrillation. Obtaining PMA for any of these products will require additional clinical trials, which will require substantial time and expense. Outside of the United States, our strategy has been to obtain regulatory approvals in those geographies that offer existing infrastructure to support medical technology as well as offer the potential for adequate product demand with the goal of positioning us to expand into these geographies once we have sufficient capital and other resources. To date, we have emphasized obtaining regulatory approvals in Western Europe and select portions of Asia. We cannot assure you that we will be able to obtain or maintain regulatory approvals.

Our primary focus is to obtain FDA approval in the United States of the REVELATION^® Tx microcatheter system for the treatment of atrial fibrillation. On September 30, 2002, we submitted a PMA application for this system to the FDA. On May 29, 2003, we met with the Circulatory System Devices Panel which recommended that the FDA not approve our PMA application. The Circulatory System Devices Panel commented favorably on the safety and need for this type of device. However, the Panel felt that efficacy data was not sufficiently clear and supportive for the approval. The Panel provided several suggestions on how to possibly reexamine the existing data or how to collect more data on existing patients. On June 26, 2003 we received a letter from the FDA, which stated that the FDA concurred with the Panel’s non-approval recommendation. On January 20, 2004 we submitted an amendment to our PMA filing, in which we provided new analysis and an expanded patient base. On May 28, 2004 we received a letter, dated May 21, 2004, from the FDA, stating that our PMA application for the REVELATION Tx linear ablation microcatheter system was not approvable based on the requirements of applicable regulations. The letter stated that, although we had provided information on an additional 32 patients in the clinical trial in our PMA application amendment

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submitted in January 2004, the concerns identified in the FDA’s initial non-approvable letter of June 26, 2003 remain unresolved. Among other things, the FDA’s letter stated that the FDA believes that the least burdensome approach to demonstrate the safety and effectiveness of REVELATION Tx for the intended indication is to collect additional clinical data using a randomized clinical trial design. We have been engaged in continuing dialogue with the FDA since our receipt of the non-approvable letter on May 28, 2004. At a meeting with the FDA’s Center for Devices and Radiological Health on June 18, 2004, the FDA representatives reiterated the view that data from an additional study would be necessary to demonstrate the effectiveness of REVELATION Tx for atrial fibrillation, and that the nature of the trial’s primary goal would require a randomized clinical trial design. The development and implementation of a new clinical trial would require substantial expenditures and management attention, and the timing and success of any such trial cannot be assured.

We had cash and cash equivalents of approximately $1.7 million as of March 31, 2005. Our management believes that our cash balances as of March 31, 2005 will be sufficient to fund planned future expenditures only for a very limited period of time, likely not extending beyond early June 2005 and possibly earlier, and will not be sufficient to fund operations into the third quarter of 2005, although the actual amount of expenditures is inherently uncertain. Although our management recognizes the need to raise funds in the immediate future, we cannot assure you that we will be successful in consummating any fundraising transaction, or, if we do consummate such a transaction, that its terms and conditions will not be unfavorable to us. Our financing which closed on November 24, 2004 contains terms which substantially restrict our ability to raise the further funding that we will need to continue our operations. For example, if we issue common stock or securities convertible into or exercisable for common stock at a price per share below $0.2733 before July 12, 2005, we will be contractually obligated to issue additional common stock to certain investors in our November 2004 financing. We are also contractually prohibited from issuing certain kinds of convertible securities without the consent of some of our investors. We are evaluating various courses of action including selling or licensing some of our proprietary technologies. If we fail to obtain additional funding in the immediate future, our business will fail and our stockholders will likely lose the entire value of their investment. In their opinion accompanying our December 31, 2004 financial statements, our independent registered public accountants concluded that there is substantial doubt as to our ability to continue as a going concern for a reasonable period of time, and have, therefore, modified their report in the form of an explanatory paragraph describing the events that have given rise to this uncertainty.

Results Of Operations – Three Months Ended March 31, 2005 and 2004

Net Sales

Net sales for the quarter ended March 31, 2005 decreased 13% to $555,000 from $636,000 for the same period in 2004. Regionally, net sales in the Europe decreased $61,000 or 47% to $68,000 in the first quarter of 2005, from $129,000 for in the same period of 2004. The decline in European sales is due to the competition our single-use catheter is facing with multi-use catheters. U.S. net sales fell 15.5% or $49,000 to $268,000 in the first quarter of 2005 from $317,000 for the same period in 2004. This was due mainly to lower clinical sales. The company recognizes clinical sales only when studies are complete and cash is received. Net sales in Japan (Asia) increased 18% to $219,000 in the first quarter of 2005 from $185,000 for the same period in 2004. This increase was due to a 22% unit sales improvement over the quarter ending March 31, 2004.

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Accounts receivable decreased 12% to $268,000 as of March 31, 2005 from $303,000 as of December 31, 2004. This decrease is due to lower sales in this quarter compared to the quarter ending December 31, 2004 and to improved collections. The allowance for doubtful accounts was $35,000 as of March 31, 2005 and as of December 31, 2004.

Cost of Goods Sold

Cost of goods sold primarily includes raw materials costs, catheter fabrication costs, system assembly and testing costs, and manufacturing labor and overhead. Cost of goods sold for the quarter ended March 31, 2005 decreased 38%, or $274,000, to $444,000 from $718,000 for the same period in 2004. The decrease in the cost of goods sold was due to increased manufacturing labor utilization, allocations of unused space to general and administration and our continuing cost control efforts as well as an increase in inventory reserves of $87,000 in the quarter ended March 31, 2004, which did not repeat in the quarter ended March 31, 2005.

Research and Development Expenses

Research and development expenses include product development, clinical testing and regulatory expenses. Total research and development expenses for the quarter ended March 31, 2005 decreased 35% to $642,000 from $988,000 for the same period in 2004. This decrease was due to a reduction in regulatory and clinical expenses for the first three months of 2005 of $122,000, or 34%, when compared to the same period in 2004, which was attributable to a reduction in headcount following the submission of the REVELATION^® Tx PMA to the FDA. Also our direct product development costs for the first three months of 2005 decreased $224,000, or 35%, to $410,000 from $634,000 for the same period in 2004. This decrease was due to a decline in the Intellitemp project costs as this project moved from research and development to production.

Clinical trials of our products and regulatory approval efforts have required substantial financial and management resources. We will be required to fund additional clinical trials to obtain U.S. FDA approval of REVELATION Tx and other products for which we plan to seek U.S. regulatory approval. These trials will be expensive and time-consuming. In addition, clinical trials may identify significant technical or other obstacles that we will have to overcome before obtaining the necessary regulatory approvals or market acceptance. Due to the uncertainties associated with our ability to complete clinical trials, demonstrate product safety and effectiveness and obtain regulatory approval for our products, it is difficult for us to accurately predict the time or cost until completion of product development efforts.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the quarter ended March 31, 2005 increased $470,000, or 38%, to $1,697,000 from $1,227,000 for the same period in 2004. Selling expenses for the three months ended March 31, 2005 decreased $19,000, or 8%, to $229,000 from $248,000 for the same period in 2004. General and administrative expenses for the first

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three months of 2005 increased by $497,000, or 58%, to $1,351,000 from $854,000 for the first three months of 2004. This increase was due in part to the costs relating to the implementation of a Sarbanes-Oxley Act compliance program of $255,000 in this quarter and an increase of $71,000 in other public company related expenses. The remainder of the increase is attributable to increase in legal costs of $63,000 and increase in allocation of rent expense to general expenses rather than manufacturing expenses. Marketing expenses for the first three months of 2005 also decreased $8,000, or 6%, to $117,000 from $125,000 for the same period in 2004.

Other Interest and Other Income

The Company recognized a gain of $244,000 in Other income in the first quarter of 2005. This was a payroll tax refund received in 2002 but not recorded until this quarter when we received confirmation of the nature of the refund from our payroll service.

Other Non-Cash Expense

There was no Other Non-cash expense for the first three months ended March 31, 2005 compared to $33,000 for the same period in 2004. The non-cash expense of $33,000 for the three months ended March 31, 2004 was related to the warrants issued in connection with our December 2003 private placement that were carried as liabilities, and represented the difference of the warrants’ valuation between their date of issuance and the date of registration of the shares underlying the warrants.

Liquidity and Capital Resources

We had cash and cash equivalents of approximately $1.7 million as of March 31, 2005. Our management believes that our cash balances will be sufficient to fund planned expenditures only for a very limited period of time, likely not extending beyond early June 2005 and possibly earlier in light of our substantial statutory obligations to pay accrued paid time off to employees in the event of their resignation or termination. However, the actual amount of expenditures is inherently uncertain and our cash resources may be exhausted sooner in the second quarter of 2005 than currently anticipated. Although our management recognizes the need to raise funds in the immediate future, there can be no assurances that we will be successful in doing so, or, if we do consummate a financing transaction, that its terms and conditions will not be unfavorable to us. Our financing which closed on November 24, 2004 contains terms that substantially restrict our ability to raise the further funding that we will need to continue our operations. For example, if we issue common stock or securities convertible into or exercisable for common stock at a price per share below $0.2733 before July 12, 2005, we will be contractually required to issue additional shares of common stock to certain of our investors. We are also contractually prohibited from issuing certain kinds of convertible securities without the consent of some of our investors. If we fail to obtain additional funding in the immediate future, our business will fail and our stockholders will likely lose the entire value of their investment. Our independent registered public accountants have concluded that there is substantial doubt as to our ability to continue as a going concern for a reasonable period of time, and have, therefore, modified their report in the form of an explanatory paragraph describing the events that have given rise to this uncertainty.

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We have financed our operations to date principally through private placements of equity securities, which have resulted in net proceeds of approximately $117,177,000 through December 31, 2004, the initial public offering of our common stock in June 1997, which resulted in net proceeds of approximately $13,600,000, together with interest income on such proceeds, borrowings under a $3,000,000 line of credit, sale of certain of our non-core patents to Medtronic, Inc. for $8,000,000, and equipment leases to finance certain capital equipment which have provided proceeds in the amount of $4,700,000. As of March 31, 2005 we had approximately $1,718,000 in cash and cash equivalents.

Net cash used in operating activities for the first three months of 2005 was approximately $1,991,000, compared to the net cash used of $2,525,000 for the first three months of 2004. The decrease of $534,000, or 21%, in net cash used in operating activities is mainly due to an increase in our payables and inventories. Net cash used in investing activities was $85,000 in the first three months of 2005 related to the capital expenditures of property and equipment, as compared to $15,000 for the same period in 2004. Net cash used by financing activities was approximately $60,000 for the first three months of 2005, compared to net cash provided of $3,029,000 for the same period in 2004. This change was due to the exercise of warrants during the first quarter of 2004, following our redemption call for warrants issued as part of the August 2003 private placement.

Our future liquidity and capital requirements will depend upon numerous factors, including whether we succeed in raising adequate funding in the immediate term, whether we are successful in consummating a strategic sale, distribution or licensing transaction for our surgical business, the scope and cost of new clinical trial activities that may be required by the FDA or other regulatory agencies, the progress of our clinical trials, the progress and cost of our product development efforts, actions relating to regulatory matters, the costs and timing of expansion of product development, the level of sales and marketing activities, manufacturing costs, the extent to which our products gain market acceptance, the outcome of legal proceedings, and competitive developments.

FACTORS AFFECTING FUTURE RESULTS

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

We have very limited cash resources and will need to raise additional capital in the immediate future through a sale or other strategic transaction involving our Surgical Ablation System, public or private financings or other arrangements in order to continue operations. We are evaluating various potential courses of action including selling or licensing some of our proprietary technologies, or selling debt or equity securities, to raise funds. If we are unable to raise funds in the immediate future, our business will fail. Even assuming no increase in our cash utilization rate from recent months, management estimates that our cash balance as of the filing of this report will be sufficient to fund planned expenditures only for a very limited period of time, likely not extending beyond early June 2005 and possibly earlier, particularly given the statutory requirements to satisfy our substantial accrued paid time off obligations in connection with any resignation or termination of our employees. As of the filing of this report, those accrued obligations totalled approximately $400,000. The actual level of our expenditures cannot be predicted with certainty and it is possible that our cash balance may be exhausted sooner in the second quarter of 2005 than currently anticipated. We cannot assure you that additional capital will be available to us in the immediate future, if at all, or, if available, will be obtained on terms that preserve the value of your investment.

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Our financing which closed on November 24, 2004 contains, and, if we succeed in closing future financings, those future financings will likely contain, terms which place substantial restrictions on our ability to raise the further funding that we will need to continue our operations, and include requirements that will impair our ability to operate our business and that will further dilute your investment in us, such as anti-dilution protection in the event of subsequent financings. For example, if we issue common stock or securities convertible into or exercisable for common stock at a price per share below $0.2733 before July 12, 2005, we will be contractually required to issue additional common stock to some of our investors. We are also restricted from issuing certain types of convertible securities without the consent of these investors.

We have financed our operations since inception primarily through the private placement of equity securities, proceeds from our initial public offering in June 1997, loan facilities and the sale of certain of our patents and other intellectual property. We had negative cash flow from operations of $2.1 million for the first three months of 2005, and for the twelve month period ending December 31, 2004 of over $9.3 million, and we expect to continue to incur substantial negative cash flow from operations for the foreseeable future. We may be required to expend greater than anticipated funds if unforeseen difficulties arise in the course of completing the development, approval and marketing of our products, such as the additional clinical trial activities that the U.S. Food and Drug Administration, or FDA, recently stated would be required with respect to our pre-market approval application, or PMA, for REVELATION Tx, or in other aspects of our business. Even if we raise capital in the near term, our future cash needs may, at a minimum, cause us to delay, scale back or eliminate some or all of our product research and development programs, to limit the marketing of our products, or to license or sell to third parties the rights to commercialize our products or technologies that we would otherwise develop and market ourselves. Furthermore, our November 2004 equity financing included, and future debt or equity financing, if available, will likely involve, restrictive covenants and other restrictions that impair our ability to raise additional capital and operate our business. Our failure to raise capital when needed would likely cause us to cease our operations.

Although our management recognizes the need to raise funds in the immediate future, there can be no assurance that we will be successful in consummating any fundraising transaction, or if we do consummate such a transaction, that its terms and conditions will not require us to give investors valuable rights with respect to our products or technology, warrants or other valuable rights to purchase additional interests in our company, or be otherwise unfavorable to us. Among other things, the agreements under which we issued some of our existing securities include, and any securities that we may issue in the future will likely include, terms that could impede our ability to raise additional funding, such as terms requiring the consent of certain security holders before we issue or register additional securities and anti-dilution protection giving those holders the right to receive additional shares of our common stock depending on the terms of our later financings. We may be required to issue preferred stock, debt or other securities with rights and preferences senior to the rights of holders of our common stock. These rights and preferences may reduce or eliminate the value of our common stock upon a liquidation of our company or other events. In addition, the issuance of additional securities will likely dilute the interests of existing common stockholders, and could impose additional restrictions on how we operate and finance our business.

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

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

Our net losses were approximately $2.3 million for the three months ended March 31, 2005 and approximately $9.7 million, $13.2 million, and $12.6 million for the years ended December 31, 2004, 2003 and 2002, respectively. As of March 31, 2005, our accumulated deficit was approximately $115.8 million. Our limited sales history, and the fact that we have very limited cash resources, makes it difficult to assess or predict our future results. We cannot be certain that we will ever generate substantial revenue or achieve profitability. Our failure to generate substantial revenues would harm our business.

Our stock may be delisted from Nasdaq as soon as the opening of business on May 17, 2005, which would make it more difficult for investors to sell their shares and may lead to costly claims by investors.

On May 6, 2005, we received a Nasdaq Staff Determination indicating that we had not regained compliance with the requirements for continued listing set forth in Marketplace Rule 4310(c)(4), which we refer to as the “Rule” for purposes of this discussion, and that our securities are, therefore, subject to delisting from The Nasdaq SmallCap Market at the opening of business on May 17, 2005.

The Rule provides that if the closing bid price of a company’s stock is below $1.00 for more than thirty consecutive trading days, the company faces possible delisting. On May 10, 2004, we received a letter from Nasdaq stating that for the last thirty consecutive business days the closing bid price of our common stock had remained below $1.00 per share. We were provided 180 calendar days to regain compliance with the $1.00 closing bid price requirement for the time period required by Nasdaq, as well as Nasdaq’s other requirements. Although we had not regained compliance by November 8, 2004, Nasdaq granted us an additional 180 calendar days, or until May 5, 2005, to regain compliance with the $1.00 minimum closing bid price requirement for at least 10 consecutive trading days. We did not regain compliance with the Rule by May 5, 2005.

We may appeal the Nasdaq Staff’s Determination to a Listing Qualification Panel, pursuant to the procedures set forth in the Nasdaq Marketplace Rule 4800 Series. There can be no assurance that we will appeal the Nasdaq Staff’s Determination or, if the Company does appeal the Nasdaq Staff’s Determination, that such appeal will be successful.

In addition, Nasdaq Marketplace Rule 4310(c)(2)(B) requires a company to maintain at least $2.5 million in stockholders’ equity or a market capitalization of at least $35 million, or to have specified levels of net income that we do not anticipate meeting for the foreseeable future. As of March 31, 2005, as reported in this quarterly report on Form 10-Q, our stockholders’ equity was below $2.5 million and our market capitalization was below $35 million as of the filing of this report. We also expect to continue to incur net losses, which will cause continued reductions in

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our stockholders’ equity. Accordingly, we are not currently in compliance with Rule 4310(c)(2)(B) and our ability to comply with these additional listing requirements will depend on our ability to raise substantial additional equity capital or on our market capitalization increasing and remaining above $35 million, over which we have limited or no control.

In addition to the notices from Nasdaq described above, we have received other notices of possible delisting from Nasdaq in 2001, 2002, 2003 and 2004.

Investors in our common stock should anticipate that our stock will no longer be listed on the Nasdaq SmallCap Market. Delisting may adversely affect the liquidity and value of your investment and could impair our ability to raise additional equity capital, which we may need to continue to operate our business. Among other things, if our common stock is delisted, it would be considered a “penny stock” under regulation of the Securities and Exchange Commission and would therefore be subject to rules that impose additional sales practice requirements on broker-dealers who sell our securities. These requirements could discourage broker-dealers from effecting transactions in our common stock, which could severely limit the market liquidity of the common stock and your ability to sell our securities in the secondary market. Delisting would also make it more difficult and expensive for us to register our shares for resale, which would impair our ability to raise equity capital and increase our costs.

In addition, we may face contractual claims under purchase agreements from our past private placement financings, and possibly non-contractual claims from other stockholders, if our common stock is delisted. Any such claim would likely be costly and disruptive, even if resolved favorably to us.

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

In order to continue operations, we will need to immediately raise additional capital. Subject to the contractual restrictions described above, we may attempt to raise capital through the public or private sale of our common stock or securities convertible into or exercisable for our common stock. Any such sales will further dilute the percentage of our equity that you own. In addition, our recent private placement financings have involved the issuance of securities at a price per share that represented a discount to the closing price of our common stock and any future private placements will likely involve the issuance of securities at a discount to prevailing market prices. Depending upon the price per share of securities that we sell in the future, if any, your interest in us could be further diluted by any adjustments to the number of shares and the applicable exercise price required pursuant to the terms of the agreements under which we previously issued securities. No assurance can be given that previous or future investors, finders or placement agents will not claim that they are entitled to additional antidilution adjustments or dispute the Company’s calculation of any such adjustments. Any such claim or dispute could require us to incur material costs and expenses regardless of the resolution and, if resolved unfavorably to us, to effect dilutive securities issuances or adjustments to previously issued securities. In addition, certain of our prior securities issuances have included, and future financings may also include, provisions requiring

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us to make additional payments to the investors if we fail to obtain or maintain the effectiveness of SEC registration statements by specified dates or take other specified action. Our ability to meet these requirements may depend on actions by regulators and other third parties, over which we will have no control. These provisions may require us to make payments or issue additional dilutive securities, or could lead to costly and disruptive disputes. In addition, these provisions could require us to record additional non-cash expenses, as we were required to do in the third quarter of 2003 with respect to certain warrants issued in that quarter.

The audit report accompanying our 2004 financial statements indicates there is substantial doubt as to our ability to continue as a going concern.

As a result of our losses to date and accumulated deficit, the audit report on our 2004 financial statements contains an explanatory paragraph indicating that there is substantial doubt as to our ability to continue as a going concern. The audit reports on our 2003 and 2002 financial statements contained similar explanatory paragraphs. Our continuation as a going concern will depend upon our ability to generate or obtain sufficient cash to meet our obligations on a timely basis and ultimately to attain profitable operations. Concern about our ability to continue as a going concern may make it more difficult for us to obtain additional funding to meet our obligations or adversely affect the terms of any additional funding we are able to obtain. We anticipate that we will continue to incur significant losses until successful commercialization of one or more of our products. There can be no assurance that we can or will operate profitably in the future, or that we will continue as a going concern.

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

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

Before we can market any of our products in the United States or other countries, we must demonstrate that our products are safe and effective and obtain approval or clearance from the applicable governmental authorities. In the United States, we must obtain from the FDA 510(k) pre-market notification clearance for devices that are classified as Class II or lower, or a

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

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

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

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

In the United States, we are required to seek a PMA for our ablation products, including the REVELATION Tx microcatheter, since they have been classified as Class III devices. The process of obtaining a PMA is expensive, lengthy and uncertain and requires clinical trials to demonstrate the safety and effectiveness of the product. In December 1997, the FDA approved a 10-patient atrial fibrillation feasibility study for mapping and ablation with the REVELATION Tx. We received FDA approval to conduct a Phase III clinical trial for this system in 2000, and filed portions of the PMA in 2001. On September 20, 2002, we submitted our PMA to the FDA with data on more than 80 patients treated with our REVELATION Tx microcatheter system. We met with the Circulatory Systems Device Panel on May 29, 2003, and on that date, the Panel recommended that the FDA not approve our PMA for the REVELATION Tx linear ablation microcatheter system. The Circulatory System Devices Panel felt that the efficacy data was not

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sufficiently clear and supportive for the approval. The Panel provided the FDA and the Company with several suggestions on how to possibly reexamine the existing data or how to collect more data on existing patients. On June 26, 2003, we received a letter from the FDA, which reiterated the recommendation of the Panel and stated the FDA concurred with the recommendation of the Panel. On January 20, 2004, we submitted an amended PMA that provided new analysis, including data from an expanded patient base, to the FDA.

On May 28, 2004 we received a letter, dated May 21, 2004, from the FDA, stating that our PMA for the REVELATION Tx linear ablation microcatheter system was not approvable based on the requirements of applicable regulations. The letter stated that, although we had provided information on an additional 32 patients in the clinical trial in our PMA amendment submitted in January 2004, the concerns identified in the FDA’s initial non-approvable letter of June 26, 2003 remain unresolved. Among other things, the FDA’s letter stated that the FDA believes that the least burdensome approach to demonstrate the safety and effectiveness of REVELATION Tx for the intended indication is to collect additional clinical data using a randomized clinical trial design. At a meeting with the FDA’s Center for Devices and Radiological Health on June 18, 2004, the FDA representatives reiterated the view that data from an additional study would be necessary to demonstrate the effectiveness of REVELATION Tx for atrial fibrillation, and that the nature of the trial’s primary goal would require a randomized clinical trial design. The development and implementation of a new clinical trial would require substantial expenditures and management attention, and the timing and success of any such trial cannot be assured.

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

Through pre-clinical studies and clinical trials, we must demonstrate that our products are safe and effective for their indicated uses. Results from pre-clinical studies and early clinical trials may not allow us to predict results in later-stage testing. No assurance can be given that, even if we are able to afford to conduct future clinical trials, those trials will demonstrate the safety and effectiveness of any of our products or will result in regulatory approval to market our products. We may never meet our development schedule for any of our products in development. Even if a product is successfully developed and clinically tested, we cannot be certain that it will be approved by the FDA or other regulatory agency on a timely basis or at all. If the FDA does not approve our products for commercial sales, our business will be harmed. As described above, we have devoted considerable resources to developing, testing and seeking regulatory approval for our REVELATION Tx microcatheter systems designed for ablation of atrial fibrillation. On May 28, 2004 we received a letter, dated May 21, 2004, from the FDA, stating that our PMA for the REVELATION Tx linear ablation microcatheter system was not approvable based on the requirements of applicable regulations. Among other things, the FDA’s letter stated that the FDA believes that the least burdensome approach to demonstrate the safety and effectiveness of REVELATION Tx for the intended indication is to collect additional clinical data using a randomized clinical trial design. At a meeting with the FDA’s Center for Devices and Radiological Health on June 18, 2004, the FDA representatives reiterated the view that data from an additional study would be necessary to demonstrate the effectiveness of REVELATION Tx for atrial fibrillation, and that the nature of the trial’s primary goal would require a randomized clinical trial design. The development and implementation of a new clinical trial

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would require substantial expenditures and management attention, and the timing and success of any such trial cannot be assured. We must receive PMA approval before marketing our products for ablation in the United States.

In December 2001, the REVELATION Helix received the CE mark allowing sales in the European Economic Area. We also received in December 1999 approval for an IDE to begin clinical testing of our THERASTREAM microcatheter system for ablation of ventricular tachycardia and during calendar year 2000 approval to expand that trial; however, we have postponed the clinical feasibility trial for the THERASTREAM microcatheter system for ablation of ventricular tachycardia to focus on obtaining regulatory approval of our REVELATION Tx for atrial fibrillation. We have no estimate as to when, or if, we will resume the clinical trial for our THERASTREAM microcatheter system. If we resume that trial, completing it could take several years.

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

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

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

We have entered into engagement letters in connection with our actual and proposed private placements that have in the past and may in future lead to disputes and also may lead to additional payments of cash or issuances of securities in connection with past or future sales of our securities.

We have entered into several agreements with parties to act as our financial advisors, finders or agents in connection with actual and proposed equity financings, including agreements entered into in April 2001 and on July 15, 2002, November 13, 2002, December 9, 2002, December 28, 2002 (with another agreement signed with the same party in January 2003), March 11, 2003, July 15, 2003, July 18, 2003, August 2003 (oral agreement), November 2003, September 2004 and October 2004. These agreements have provided that we will pay cash fees, generally expressed as 6% to 8% of the funds raised, and issue warrants to purchase specified numbers of shares of our common stock, generally not exceeding 10% of the number of shares sold, to these parties in connection with our financings. Additional details concerning the terms of these various agreements, and the fees and warrants previously paid to these parties, can be reviewed in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 31, 2004.

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In connection with our prior financings, some of these advisors, finders and agents have alleged that they are owed additional cash and warrant compensation to which we have felt they were not entitled, and which would be in addition to fees and warrants paid to other advisors with respect to the same investors. Our financial advisors, finders and agents may assert similar claims in the future.

For example, the advisor that assisted us with a 2001 private placement, which we refer to as the 2001 Advisor, communicated to us in 2002 that it believes that it is entitled to cash fees and warrants in connection with the August 2002 private placement. We strongly disagree with the 2001 Advisor’s interpretation of its letter agreement with us. In August 2002, we sent the 2001 Advisor a termination letter relating to its 2001 agreement. If the 2001 Advisor prevails on its claims in connection with the August 2002 private placement, we would be required to pay this advisor $381,570, or 7.5% of the gross proceeds that we received from the sale of common stock, and issue to the advisor warrants to purchase up to 698,287 shares of common stock (and if all of the warrants issued to the investors in that private placement are exercised, an additional $133,549 in cash). We also received letters from this advisor in early 2003 asserting that it is also owed approximately $300,000 plus warrants to purchase approximately 533,332 shares of our common stock at an exercise price of $0.8245 per share, arising in connection with private placements we consummated in December 2002 and January 2003. There can be no guarantee that the 2001 Advisor will not claim additional fees or warrants in connection with our financings closed after January 2003 or in connection with any future financing.

In addition, by letters dated September 19, 2003 and January 29, 2004, an advisor that we had retained in November 2002 (under an agreement that we terminated effective May 18, 2003) has claimed that under its November 13, 2002 agreement with us, we are obligated to pay such advisor cash fees of $82,500 and warrants to purchase “Units” (comprising 207,698 shares of our common stock and warrants to purchase 62,309 shares of common stock at an exercise price per share of $0.7282) at an exercise price per Unit of $0.58256, in connection with three enumerated purchasers’ investments in our August 2003 private placement. This advisor has also stated its belief that we would have additional obligations to the advisor in the event that other investors in the August 2003 private placement were investors as to which the advisor is entitled to compensation under its agreement. In a letter dated January 29, 2004, the advisor submitted information alleged to support a portion of its claim, and stated its belief that we are obligated to register the claimed securities for resale. In our opinion, this advisor has not established the merits of its claim. We cannot predict whether additional claims will be made, or the resolution of any current or future claims, by this former advisor.

In August 2003, one of the advisors that we retained in connection with our August 2003 private placement notified us of its belief that it was entitled to an additional fee of approximately $35,000 and additional warrants to purchase approximately 47,000 shares of common stock, in connection with the August 2003 private placement. We responded that, based on the information in our possession, we believed that such advisor is not entitled to such fees and warrants. To date, we have received no further information from such advisor in support of its claim.

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Due to the existence of these various letter agreements, we may be obligated to pay cash fees and issue warrants to one or more financial advisors in connection with the closing of any of our private placements. In addition, we may in the future enter into further agreements with financial advisors, finders or placement agents, similar to those discussed above, in connection with private or public offerings of our securities. We might agree to pay to these parties a commission on any sales of securities to investors introduced to us by such parties or a commission based upon the exercise price of any warrants or other securities exercised by investors introduced to us by such parties, and that such commissions will be in addition to commissions payable to other financial advisors, finders and placement agents working on our behalf. In addition, we may agree to issue to these additional financial advisors, finders and placement agents securities such as warrants to purchase shares of our common stock, which could dilute your investment in our company. We also may be obligated to pay termination or break-up fees to our current or future financial advisors, finders and placement agents in connection with our financings. These commissions paid or warrants or other securities issued may be in addition to the commissions payable or securities issuable to other financial advisors, finders or placement agents in respect of the same transaction, and could be substantial. Disputes have arisen from time to time concerning our financial advisors’ entitlement to cash and equity compensation associated with our past financings, and additional disputes may arise in the future. Any issuances of equity compensation to advisor could also be restricted by, or give rise to disputes under, the terms or our previously issued securities. Any dispute relating to these advisors will tend to divert management’s time and attention from running our business and may cause us to incur material costs and expenses.

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

We have only limited experience marketing and selling our products in commercial quantities. Currently, we are solely responsible for marketing and distributing our products in the United States. We had previously signed an exclusive three-year distribution agreement with St. Jude Medical Corporation in 2000, but St. Jude did not meet the first year minimum annual sales quota under the distribution agreement and, in June 2001, we mutually agreed with St. Jude to terminate the agreement. If we receive FDA approval of our PMA for REVELATION^® Tx, we may not have an adequate marketing and sales force to adequately sell that product. Expanding our marketing and sales capability to support sales in commercial quantities adequately will require substantial effort and require significant management and financial resources. Our failure to establish an effective sales and marketing force will prevent us from being able to generate significant revenues from the sale of our products.

We have only a single direct salesperson in Europe. Building and managing a larger remote sales force effectively, in Europe or elsewhere, would require additional resources, time and expense, which could have a material adverse effect on our business, financial condition and results of operations. We cannot be certain that we will be able to build a successful European business. Failure to do so would harm our business.

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Currently, international sales and marketing of our PATHFINDER, PATHFINDER mini, REVELATION and TRACER microcatheter systems are conducted through a number of exclusive distributors in certain European countries and Japan and a direct salesperson in Europe. We have sold only a limited number of systems through these distributors. We cannot be certain that these distributors will be able to effectively market and sell our products. For example, we have terminated several distribution arrangements in Europe because of the distributors’ failure to meet minimum sales levels under those agreements. We do not currently plan to market our Surgical Ablation System ourselves, and are currently seeking a strategic transaction for this system. We cannot assure you that we will be able to enter into such an agreement on a timely basis or at all, that any distributor or licensee will devote adequate resources to selling our products, or that distribution relationships will not lead to costly and disruptive disputes. Our failure to establish and maintain successful distribution relationships would harm our business.

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

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

We cannot assure the safety or effectiveness of our products.

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

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

Our microcatheter systems represent novel approaches to diagnosing and treating atrial fibrillation and ventricular tachycardia and our surgical ablation system represents a novel approach to ablating cardiac tissue during surgery. Acceptance of our products and procedures by physicians, patients and health care payors will be necessary in order for us to be successful. If the market does not accept our products and the procedures involved in their use, our business would be harmed and our revenues would decline.

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

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

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

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

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

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

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

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

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

In July 2003, we received a Section 40 Letter (intention to suspend a medical device license) from the Medical Devices Bureau of the Health Products and Food Branch of Health Canada. On December 1, 2003, after meeting with the Medical Devices Bureau and providing additional analysis from our current trial, we received notification from the Bureau that the medical device license would not be suspended. We may receive similar notices in the future from U.S. or foreign agencies relating to approvals previously obtained or pending regulatory submissions.

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

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

Difficulties presented by international factors could negatively affect our business.

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

Any of these factors could damage our business results.

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

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

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

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

We rely on license agreements for some of our product technology from potential competitors. A license from Target Therapeutics, Inc., a subsidiary of Boston Scientific Corporation, is the technological basis for our microcatheter systems for mapping and ablation. Boston Scientific Corporation currently has research efforts in the field of electrophysiology that may compete with our products. Under the Target Therapeutics license agreement we have an exclusive license under specific issued United States patents. The exclusive license from Target Therapeutics covers the diagnosis and treatment of electrophysiological disorders in areas other

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than the central nervous system. In addition, we have obtained a non-exclusive license to use Target Therapeutics’ technology, provided we have made a substantial improvement of such technology, for the diagnosis or treatment of diseases of the heart, other than by balloon angioplasty. The license will terminate upon the expiration or invalidation of all claims under the underlying patents. In addition, Target Therapeutics has the right to terminate the license earlier if we fail to comply with various commercialization, sublicensing, insurance, royalty, product liability, indemnification, non-competition and other obligations. Furthermore, either party can terminate the license if a material breach remains uncured for thirty days or if either party ceases to be actively engaged in its present business for a period of twelve months. We may lose the licensed rights in the event of an assignment for the benefit of creditors or other bankruptcy or insolvency-related event. The loss of our exclusive rights to the Target Therapeutics-based microcatheter technology would significantly harm our business.

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

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

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

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

We have received in the past and expect to continue to receive letters from others threatening to enforce patent or other intellectual rights against us. We cannot be certain that we will not become subject to patent or intellectual property infringement claims or litigation, interference proceedings in the U.S. Patent and Trademark Office to determine the priority of inventions, or oppositions to patent grants in foreign countries. Any such claim, litigation or proceeding, regardless of the outcome, would likely require us to expend substantial defense costs and would disrupt our business. An adverse determination in litigation, interference or

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opposition proceedings could subject us to significant liabilities to third parties, require us to cease using important technology invalidate our intellectual property rights, or require us to license disputed rights from third parties. However, we cannot be certain that any licenses will be available to us on commercially reasonable terms or at all. Our inability to obtain such a license could materially delay the commercialization of our products, require us to expend substantial resources to design and develop alternative to the disputed technology, and otherwise harm our business. Our license with Target Therapeutics does not provide us with indemnification against claims brought by third parties alleging infringement of patent rights. Consequently, we would bear the liability resulting from such claims. We cannot be certain that we will have the financial resources to protect and defend our intellectual property, as such defense is often costly and time-consuming. Our failure to protect our patent rights, trade secrets, know-how or other intellectual property would harm our business.

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

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

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

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

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

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

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

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

Our manufacturing facilities are subject to periodic inspection by regulatory authorities. Our operations must either undergo Quality System Regulations compliance inspections conducted by the FDA or receive an FDA exemption from such compliance inspections in order for the FDA to permit us to produce products for sale in the United States. Our facilities and manufacturing processes are subject to inspections from time to time by the FDA, the State of California and European Notified Bodies. We have demonstrated compliance with ISO 13485 or ISO 9001 quality standards, as well as compliance with 93/42/EEC, the Medical Device Directive. We comply with procedures to produce products for sale in Europe. Any failure by us to comply with the Quality System Regulations requirements or to maintain our compliance with ISO 13485 or ISO 9001 standards and 93/42/EEC, the Medical Device Directive, will require us

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to take corrective actions, such as modification of our policies and procedures. In addition, we may be required to cease all or part of our operations for some period of time until we can demonstrate that appropriate steps have been taken to comply with Quality System Regulations or ISO 13485 or ISO 9001 standards. There can be no assurance that we will be found in compliance with the Quality System Regulations by regulatory authorities, or that we will maintain compliance with ISO 13485 or ISO 9001 standards in future audits. Our failure to comply with state or FDA Quality System Regulations, maintain compliance with ISO 13485 or ISO 9001 standards, or develop our manufacturing capability in compliance with such standards, would have a material adverse effect on our business, financial condition and results of operations.

Our facilities and manufacturing processes have undergone a successful annual surveillance audit by the European Notified Body in December 2004 and a pre-PMA inspection in December 2003. In November 2000 and in January 2003, the FDA conducted an inspection of our quality system, which we successfully passed. There is no assurance that our manufacturing facilities will continue to meet such compliance audits and will maintain such compliance standards.

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

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

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

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

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may not be available in the future on acceptable terms, if at all. Any claims or series of claims against us, regardless of their merit or eventual outcome, could have a material adverse effect on our business, financial condition and results of operations.

We are dependent upon our key personnel.

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

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

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

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

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

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

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

Each of these provisions could discourage potential takeover attempts.

In May 2002, we adopted a stockholder rights plan and declared a dividend distribution of one right for each outstanding share of common stock on May 21, 2002. Each right, when exercisable, entitles the registered holder to purchase from us one one-hundredth of a share of a

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

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We did not have material exposure to market risk from derivatives or other financial instruments as of March 31, 2005, and we do not expect any significant effect on our results of operations from interest rate and foreign currency fluctuations.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures. We maintain “disclosure controls and procedures,” as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Subject to the limitations noted above, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the fiscal year covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective to meet the objective for which they were designed and operate at the reasonable assurance level.

Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting during the quarter ended March 31, 2005, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

The Company has been subject to certain legal proceedings and claims that arose in the ordinary course of business. The Company currently is a party to various claims, including claims from private placements agents in conjunction with private placements. While the Company currently believes that the ultimate outcome of these claims will not have a material adverse event on our results of operations, claims and litigation are subject to inherent uncertainties, and unfavorable outcomes could occur. Depending on the amount and timing, an unfavorable outcome of some or all of these matters could have a material adverse effect on the Company’s cash flows, business, results of operations or financial position. An estimate of potential loss from pending claims cannot be made at this time.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of the Security Holders

None.

Item 5. Other Information

None.

Item 6. Exhibits

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CARDIMA, INC.

SIGNATURES

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

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