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

OVERVIEW

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

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

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

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

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

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

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

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

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

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

                                                            Year ended December 31,
                                                      2008                           2007
                                            Amount        % of Sales       Amount        % of Sales
                                                             (dollar in thousands)
Sales                                      $   1,456            100.0 %   $   1,157            100.0 %
Cost of sales                                  2,481            170.4 %       1,613            139.4 %
Gross deficiency                              (1,025 )          -70.4 %        (456 )           39.4 %

Operating expenses:
Research and development                       4,381            300.9 %       3,091            267.2 %
Selling, general and administrative            8,312            570.9 %       5,203            449.7 %
Total operating expenses                      12,693            871.8 %       8,294            716.9 %

Operating loss                               (13,718 )         -942.2 %      (8,750 )         -756.3 %

Other income (expense)
Interest income and (expense), net               115              7.9 %        (865 )          -74.8 %
Other income (expense)                          (121 )           -8.3 %          17              1.5 %
Loss on debt extinguishment                        -                -       (15,182 )        -1312.2 %
Loss on excess shares over authorized              -                -        (7,737 )         -668.7 %
Loss on debt settlement                            -                -       (10,129 )         -875.4 %
Total other income (expense)                      (6 )           -0.4 %     (33,896 )        -2929.6 %

Total pre-tax loss                           (13,724 )         -942.6 %     (42,646 )        -3685.9 %

Income tax                                         1              0.1 %           -                -

Net loss                                   $ (13,725 )         -942.7 %   $ (42,646 )        -3685.9 %

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

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

Cost of Sales; gross deficiency

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

Research and Development Expenses

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

Selling, Marketing, General and Administrative Expenses

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

Other income (expense)

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

LIQUIDITY AND CAPITAL RESOURCES

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

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

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

Recent Financing Transactions

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

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

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

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

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

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

CRITICAL ACCOUNTING POLICIES

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

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

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

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

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

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

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

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

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

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

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

RECENT ACCOUNTING PRONOUNCEMENTS

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

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

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

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

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

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

In March 2008, the FASB issued FAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities," an amendment of FASB Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities". FAS No. 161 . . .