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Form 10QSB for CARDIMA INC

Quarterly Report

ITEM 2. Management's Discussion and Analysis and Results of Operations

Forward Looking Statements

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

or registration statements filed with the United States Securities and Exchange Commission. These factors may cause our actual results to differ materially from any forward-looking statements. We disclaim any obligation to publicly update these statements, or disclose any difference between actual results and those reflected in these statements.

Overview

We are a publicly traded company headquartered in Fremont, California. Our stock is quoted on the Over-The-Counter Bulletin Board under the symbol "CRDM". Since our incorporation in November 1992, we have developed, produced and sold a variety of micro-catheters designed for the diagnosis and treatment of the two most common forms of cardiac arrhythmias: atrial fibrillation (AF) and ventricular tachycardia (VT). Since 2001, however, our efforts have primarily focused on developing differentiated products that diagnose and treat AF, including our REVELATION(R) Tx microcatheter for use in the Electrophysiology (EP) market, and our Surgical Ablation System (SAS) for use in the surgical market.

In January 2003, the US Food and Drug Administration (FDA) approved the commercialization of our SAS for use in ablating cardiac tissue during cardiac surgery. Currently we do not plan to market the SAS ourselves, and are seeking to sell or otherwise consummate a strategic transaction for this system.

In May 2004, we received a letter from the FDA, stating that our amended Pre-Market Approval (PMA) application for the REVELATION(R) Tx linear ablation micro-catheter system was not approvable based on the requirements of applicable regulations.

In June 2005, we met with the FDA's Center for Devices and Radiological Health to continue the process towards seeking approval for the REVELATION(R) Tx ablation catheter for treatment of AF.

On June 16, 2005, our lender, Agility Capital, notified us that in its view an event of default had occurred and that all amounts outstanding were then due and payable. The lender then swept our bank accounts. On June 17, 2005, our cash balances were insufficient to continue operations and all of our employees were placed on indefinite furlough in order to conserve cash. On August 12, 2005, we entered into a Loan Facility Term Sheet with Apix International Limited. On August 15, 2005, we re-hired certain furloughed employees and resumed operations in a reduced capacity.

In May 2006, the FDA granted 510(k) marketing clearance for the new Cardima Ablation System, which ablates cardiac tissue during heart surgery using radio frequency (RF) energy. The system is expected to be used primarily by surgeons performing cardiac surgery using standard hospital laparoscopic as well as thorascopic techniques.

In July 2006, the FDA granted a review of the scientific dispute underlying the FDA's refusal to approve our PMA for the REVELATION(R) Tx micro-catheter System. The review will be conducted by the FDA's Medical Devices Dispute Resolution Panel and is expected to take place in either the fourth quarter of this fiscal year or the first quarter of fiscal year 2007. Obtaining FDA approval in the United States of the REVELATION(R) Tx micro-catheter system for the treatment of AF remains one of our highest priorities.

Results Of Operations - Three and Nine Months Ended September 30, 2006 and 2005

Net Sales

Net sales for the quarter ended September 30, 2006 decreased 27% to $254,000 from $346,000 for the same period in 2005. The decrease in net sales was primarily attributable to: (i) material shortage, and (ii) the limited manufacturing capacity caused by the company-wide furlough instituted from June 2005 until August 15, 2005, when we re-hired certain furloughed employees and resumed operations in a reduced capacity. Regionally, net sales in the United States and Canada decreased slightly by 4% to $111,000 in the third quarter of 2006 from $116,000 for the same period in 2005. Net sales in our Japan/Asia region decreased 17% to $122,000 in the third quarter of 2006 from $147,000 for the same period in 2005 while net sales in our European region decreased 75% to $21,000 in the third quarter of 2006, from $83,000 in the comparable period of 2005. These decreases were due to the material shortage and the limited manufacturing capacity discussed above.

Net sales for the nine months ended September 30, 2006 decreased 31% to $972,000 from $1,411,000 for the same period in 2005. By region, net sales in the United States and Canada decreased 24% to $452,000 for the nine months ended September 30, 2006 from $592,000 for the same period in 2005. European net sales decreased by 28% to $155,000 for the nine months ended September 30, 2006 from $214,000 for the same period in 2005. Net sales in our Japan/Asia region decreased 40% to $365,000 for the nine months ended September 30, 2006 from $605,000 for the same period in 2005. All these decreases were primarily the result of: (i) the termination of our U.S. sales force in 2005 and (ii) the limited manufacturing capacity caused by the June 2005 furlough.

Cost of Goods Sold

Cost of goods sold primarily includes raw materials costs, catheter fabrication costs, system assembly and testing costs, shipping and handling costs, and manufacturing labor and overhead. Cost of goods sold for the quarter ended September 30, 2006 decreased to $447,000 from $483,000 for the same period in 2005. Cost of goods sold for the nine months ended September 30, 2006 decreased to $1,384,000 from $1,671,000 for the same period in 2005.

Cost of goods sold as a percentage of net sales increased from 140% to 176% for the three months ended September 30, 2006 as compared to the same period of the prior year. Cost of goods sold as a percentage of net sales increased from 118% to 142% for the nine months ended September 30, 2006 as compared to the same period of the prior year. The increase in the cost of goods sold as a percentage of net sales for the nine months ended September 30, 2006 was primarily due to: (i) $90,000 increase to the reserve for excess and obsolete inventory and (ii) some products being sold at low and below cost margins.

Net Income (Loss)

Net income for the quarter ended September 30, 2006 was $1,035,000 as compared to a net loss of $1,129,000 for the same period in 2005. The change was primarily attributable to the re-valuation of the Apix warrants and related liability. Net loss for the nine months ended September 30, 2006 increased to $7,621,000 from $6,308,000 as compared to the same period of the prior year. The increase was primarily attributable to the amortization of the loan fees and discounts related to the Apix financing in February 2006.

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 September 30, 2006 increased to $451,000 from $198,000, for the same period in 2005. The increase was primarily related to the temporary shutdown in the third quarter of 2005. Total research and development expenses for the nine months ended September 30, 2006 decreased to $1,242,000 from $1,598,000 for the same period in 2005. The decrease was primarily attributable to declining revenue and headcount reduction in August 2005.

Selling, Marketing, General and Administrative Expenses

Total selling, marketing, general and administrative expenses for the quarter ended September 30, 2006 increased to $746,000 from $613,000 for the same period in 2005. Selling expenses for the three months ended September 30, 2006 increased to $78,000 from $27,000 for the same period in 2005. Marketing expenses for the three months ended September 30, 2006 also increased to $32,000 from $17,000 for the same period in 2005. General and administrative expenses for the quarter ended September 30, 2006 increased to $636,000 from $569,000 for the same period in 2005. These increases were primarily attributable to: (i) the temporary shutdown during the first half of the third quarter in 2005, and (ii) the stock-based compensation expense of $105,000 for the three months ended September 30, 2006 with the adoption of FASB 123(R) in fiscal year 2006.

Total selling, marketing, general and administrative expenses for the nine months ended September 30, 2006 decreased to $2,124,000 from $3,629,000 for the same period in 2005. Selling expenses for the nine months ended September 30, 2006 decreased to $206,000 from $448,000 for the same period in 2005. Marketing expenses for the nine months ended September 30, 2006 also decreased to $119,000 from $237,000 for the same period in 2005. General and administrative expenses

for the nine months ended September 30, 2006 decreased to $1,799,000 to $2,944,000 for the same period in 2005. These decreases were primarily attributable to the company-wide furlough instituted in June 2005 and the subsequent headcount reduction in August 2005 offset partially by the stock-based compensation expense of $320,000 for the nine months ended September 30, 2006 with the adoption of FASB 123(R) in fiscal year 2006. In addition, there was a $255,000 charge relating to the implementation of a Sarbanes-Oxley Act compliance program in the first nine months in 2005. There was no such charge in the same period in 2006.

Interest Expense

Interest expense decreased to $159,000 in the third quarter of 2006 from $785,000 in the third quarter of 2005 primarily as a result of the amortization of the loan fee and warrant-related loan discount associated with the Apix loan financing in August 2005. We had interest expense of $3,721,000 for the nine-month period ended September 30, 2006 compared to interest expense of $1,284,000 for the nine-month period ended September 30, 2005. The increase in interest expense in the nine-month period ended September 30, 2006 was primarily the result of the amortization of the loan fee and warrant-related loan discount associated with the Apix loan financing in August 2005 and February 2006.

Other Income and Expense

We had other income of $2,586,000 for the quarter ended September 30, 2006 compared to other income of $600,000 for the quarter ended September 30, 2005. We had other expense of $120,000 for the nine-month period ended September 30, 2006 compared to other income of $600,000 for the nine-month period ended September 30, 2005. These other incomes and expenses were related to the re-valuation of the Apix warrants and related liability.

Liquidity and Capital Resources

In its opinion accompanying our December 31, 2005 financial statements, our independent registered public accounting firm expressed substantial doubt as to our ability to continue as a going concern for a reasonable period of time, and provided an explanatory paragraph describing the events that have given rise to this uncertainty. We had cash of approximately $760,000 as of September 30, 2006. Our management estimates that our financial resources will be sufficient to sustain our operations until November 30, 2006. 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 may not be favorable to us. 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.

Net cash used in operating activities for the first nine months of 2006 was approximately $3,185,000, compared to the net cash used of $4,698,000 for the first nine months of 2005. The decrease was primarily due to lower operating expenses. Net cash used in investing activities was approximately $76,000 in the first nine months of 2006 related to the capital expenditures of property and equipment, as compared to $124,000 for the same period in 2005. Net cash provided by financing activities was approximately $3,897,000 for the first nine months of 2006, compared to net cash provided of $1,239,000 for the same period in 2005. This change was primarily due to the loan proceeds and advances received from Apix.

During 2005, we entered into a loan facility term sheet with Apix, which provided us a $3,000,000 loan financing. On February 14, 2006, we entered into a new loan facility term sheet with Apix, which provided for the rollover of the original loan agreement and the grant of an additional loan facility in the amount of $660,000 at a stated interest rate of 10% per annum. We received funding under this agreement of $200,000 and $460,000 in February and March 2006, respectively. Even though we were not able to repay the loan at the due date, Apix continues to provide additional advances to the Company in the amount of $2,925,000 through September 30, 2006 and an additional $675,000 through November 10, 2006. Apix has indicated to the Company that it intends to continue to make advances at the current level while working with the Company in finding strategic partners to increase the funding level. Although the terms and conditions of the additional advances have not been finalized, we expect that they will be on similar terms as the previous advances.

Contact:

Cardima, Inc.
Gabriel B. Vegh
510-354-0300
http://www.cardima.com/

Source: Cardima, Inc.