##### Table of Contents

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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





---



FORM 10-Q



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xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934



For the quarterly period ended March 31, 2003



OR



 ̈TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934



---



Commission
file number 0-21982



Diametrics Medical,
Inc.

Incorporated pursuant to the Laws of Minnesota



---



Internal Revenue Service  Employer Identification No. 41-1663185



2658 Patton Road, Roseville, Minnesota 55113

(651) 639-8035



---



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) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈



Indicate by check mark whether the Registrant is an accelerated filer (as
defined by Rule 12b-2 of the Act).    Yes  x    No ̈



As of April 30, 2003, 27,182,732
shares of Common Stock were outstanding.







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##### Table of Contents

Diametrics Medical, Inc.





|                               |  |                                                                                       |  | Page
|------------------------------ |  | ------------------------------------------------------------------------------------- |  | ----
|Part I  FINANCIAL INFORMATION |  |                                                                                      
|                              
|Item 1.                        |  | Consolidated Financial Statements (unaudited)                                         |  |     
|                              
|                               |  | Consolidated Statements of Operations:Three Months Ended March 31, 2003 and 2002      |  | 3   
|                              
|                               |  | Consolidated Balance Sheets as of March 31, 2003and December 31, 2002                 |  | 4   
|                              
|                               |  | Consolidated Statements of Cash Flows:Three Months Ended March 31, 2003 and 2002      |  | 5   
|                              
|                               |  | Notes to Consolidated Financial Statements                                            |  | 6   
|                              
|Item 2.                        |  | Managements Discussion and Analysis of Results of Operations and Financial Condition |  | 12  
|                              
|Item 3.                        |  | Quantitative and Qualitative Disclosure About Market Risk                             |  | 18  
|                              
|Item 4.                        |  | Controls and Procedures                                                               |  | 19  
|                              
|Part II  OTHER INFORMATION    |  |                                                                                      
|                              
|Item 1.                        |  | Legal Proceedings                                                                     |  | 19  
|                              
|Item 2.                        |  | Changes in Securities                                                                 |  | 19  
|                              
|Item 3.                        |  | Defaults Upon Senior Securities                                                       |  | 19  
|                              
|Item 4.                        |  | Submission of Matters to a Vote of Security Holders                                   |  | 20  
|                              
|Item 5.                        |  | Other Information                                                                     |  | 20  
|                              
|Item 6.                        |  | Exhibits and Reports on Form 8-K                                                      |  | 20  
|                              
|Signatures                     |  | 21                                                                                   
|                              
|Certifications                 |  | 22                                                                                   





2



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##### Table of Contents

PART I  FINANCIAL INFORMATION



Item 1.     Consolidated Financial Statements (unaudited)



DIAMETRICS MEDICAL, INC.

CONSOLIDATED
STATEMENTS OF OPERATIONS



|                                                     |  | Three Months Ended March 31, |           
|---------------------------------------------------- |  | ---------------------------- | ----------
|                                                     |  | 2003                         |           
|Net revenue                                          |  | $                            | 2,176,667 
|                                                    
|Cost of revenue                                      |  |                              | 1,757,746 
|                                                     |  |                              |           
|                                                    
|Gross profit                                         |  |                              | 418,921   
|                                                     |  |                              |           
|                                                    
|Operating expenses:                                  |  |                              |           
|Research and development                             |  |                              | 1,131,506 
|Selling, general and administrative                  |  |                              | 2,048,493 
|                                                     |  |                              |           
|                                                    
|Total operating expenses                             |  |                              | 3,179,999 
|                                                     |  |                              |           
|                                                    
|Operating loss                                       |  |                              | (2,761,078
|                                                    
|Other expense, net                                   |  |                              | (129,543  
|                                                     |  |                              |           
|                                                    
|Net loss                                             |  | $                            | (2,890,621
|                                                     |  |                              |           
|                                                    
|Basic and diluted net loss per common share          |  | $                            | (0.11     
|                                                     |  |                              |           
|                                                    
|Weighted average number of common shares outstanding |  |                              | 26,835,451
|                                                     |  |                              |           



See accompanying notes
to consolidated financial statements.





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##### Table of Contents



DIAMETRICS MEDICAL, INC.

CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                   |  | March 31, 2003 |              |   | December 31, 2002 |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | -------------- | ------------ | - | ----------------- | -
|ASSETS                                                                                                                                                             |  |                |              |   |                   |  
|Current assets:                                                                                                                                                    |  |                |              |   |                   |  
|Cash and cash equivalents                                                                                                                                          |  | $              | 1,452,794    |   |                   | $
|Accounts receivable                                                                                                                                                |  |                | 1,105,979    |   |                   |  
|Inventories                                                                                                                                                        |  |                | 3,491,589    |   |                   |  
|Prepaid expenses and other current assets                                                                                                                          |  |                | 224,501      |   |                   |  
|                                                                                                                                                                   |  |                |              |   |                   |  
|                                                                                                                                                                  
|Total current assets                                                                                                                                               |  |                | 6,274,863    |   |                   |  
|                                                                                                                                                                   |  |                |              |   |                   |  
|Property and equipment                                                                                                                                             |  |                | 23,419,843   |   |                   |  
|Less accumulated depreciation and amortization                                                                                                                     |  |                | (19,157,729  | ) |                   |  
|                                                                                                                                                                   |  |                |              |   |                   |  
|                                                                                                                                                                  
|                                                                                                                                                                   |  |                | 4,262,114    |   |                   |  
|                                                                                                                                                                   |  |                |              |   |                   |  
|                                                                                                                                                                  
|Other assets                                                                                                                                                       |  |                | 6,700        |   |                   |  
|                                                                                                                                                                   |  |                |              |   |                   |  
|                                                                                                                                                                  
|                                                                                                                                                                   |  | $              | 10,543,677   |   |                   | $
|                                                                                                                                                                   |  |                |              |   |                   |  
|                                                                                                                                                                  
|LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)                                                                                                                     |  |                |              |   |                   |  
|Current liabilities:                                                                                                                                               |  |                |              |   |                   |  
|Accounts payable                                                                                                                                                   |  | $              | 1,347,954    |   |                   | $
|Accrued expenses                                                                                                                                                   |  |                | 1,090,598    |   |                   |  
|Convertible senior secured fixed rate notes                                                                                                                        |  |                |             |   |                   |  
|Capital lease obligations and other borrowings                                                                                                                     |  |                | 198,860      |   |                   |  
|                                                                                                                                                                   |  |                |              |   |                   |  
|                                                                                                                                                                  
|Total current liabilities                                                                                                                                          |  |                | 2,637,412    |   |                   |  
|                                                                                                                                                                   |  |                |              |   |                   |  
|Long-term liabilities:                                                                                                                                             |  |                |              |   |                   |  
|Long-term liabilities, excluding current portion                                                                                                                   |  |                | 7,508,512    |   |                   |  
|Accrued retirement plan benefit                                                                                                                                    |  |                | 2,563,201    |   |                   |  
|                                                                                                                                                                   |  |                |              |   |                   |  
|                                                                                                                                                                  
|Total liabilities                                                                                                                                                  |  |                | 12,709,125   |   |                   |  
|                                                                                                                                                                   |  |                |              |   |                   |  
|                                                                                                                                                                  
|Shareholders' equity (deficit):                                                                                                                                    |  |                |              |   |                   |  
|Common stock, $.01 par value: 45,000,000 authorized, 27,182,732 and 27,165,336 shares
issued and outstanding at March 31, 2003 and December 31, 2002, respectively |  |                | 271,827      |   |                   |  
|Additional paid-in capital                                                                                                                                         |  |                | 148,489,706  |   |                   |  
|Accumulated deficit                                                                                                                                                |  |                | (146,309,107 | ) |                   |  
|Deferred compensation                                                                                                                                              |  |                | (549,807     | ) |                   |  
|Accumulated other comprehensive loss                                                                                                                               |  |                | (4,068,067   | ) |                   |  
|                                                                                                                                                                   |  |                |              |   |                   |  
|                                                                                                                                                                  
|Total shareholders' equity (deficit)                                                                                                                               |  |                | (2,165,448   | ) |                   |  
|                                                                                                                                                                   |  |                |              |   |                   |  
|                                                                                                                                                                  
|                                                                                                                                                                   |  | $              | 10,543,677   |   |                   | $
|                                                                                                                                                                   |  |                |              |   |                   |  



See accompanying notes
to consolidated financial statements.





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DIAMETRICS MEDICAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                            |  | Three Months Ended March 31, |           
|--------------------------------------------------------------------------- |  | ---------------------------- | ----------
|                                                                            |  | 2003                         |           
|Cash flows from operating activities:                                       |  |                              |           
|Net loss                                                                    |  | $                            | (2,890,621
|Adjustments to reconcile net loss to net cash used in operating
activities: |  |                              |           
|Depreciation and amortization                                               |  |                              | 396,511   
|Restricted common stock issued in lieu of cash compensation/other           |  |                              | 103,089   
|Changes in operating assets and liabilities:                                |  |                              |           
|Accounts receivable                                                         |  |                              | (15,499   
|Inventories                                                                 |  |                              | 78,926    
|Prepaid expenses and other current assets                                   |  |                              | 135,050   
|Accounts payable                                                            |  |                              | 143,989   
|Accrued expenses                                                            |  |                              | (192,060  
|Deferred credits and revenue                                                |  |                              |          
|                                                                            |  |                              |           
|Net cash used in operating activities                                       |  |                              | (2,240,615
|                                                                            |  |                              |           
|                                                                           
|Cash flows from investing activities:                                       |  |                              |           
|Purchases of property and equipment                                         |  |                              | (188,393  
|Proceeds from maturities of marketable securities                           |  |                              |          
|Other                                                                       |  |                              |          
|                                                                            |  |                              |           
|Net cash provided by (used in) investing activities                         |  |                              | (188,393  
|                                                                            |  |                              |           
|                                                                           
|Cash flows from financing activities:                                       |  |                              |           
|Principal payments on borrowings and capital leases                         |  |                              | (62,056   
|Net proceeds from the issuance of common stock                              |  |                              | 10,203    
|                                                                            |  |                              |           
|Net cash used in financing activities                                       |  |                              | (51,853   
|                                                                            |  |                              |           
|                                                                           
|Effect of exchange rate changes on cash and cash equivalents                |  |                              | (31,136   
|                                                                            |  |                              |           
|Net decrease in cash and cash equivalents                                   |  |                              | (2,511,997
|Cash and cash equivalents at beginning of period                            |  |                              | 3,964,791 
|                                                                            |  |                              |           
|                                                                           
|Cash and cash equivalents at end of period                                  |  | $                            | 1,452,794 
|                                                                            |  |                              |           
|                                                                           
|Supplemental disclosure of cash flow information:                           |  |                              |           
|Cash paid during the period for interest                                    |  | $                            | 12,527    
|                                                                            |  |                              |           



Supplemental
disclosure of noncash investing and financing activities:

The Company entered into capital lease obligations for equipment of $39,371
during the quarter ended March 31, 2003.





See accompanying notes to consolidated financial statements.





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DIAMETRICS MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2003

(Unaudited)



|(1) |  | UNAUDITED FINANCIAL STATEMENTS
|--- |  | ------------------------------



The interim consolidated financial statements of Diametrics Medical, Inc. (the Company) are unaudited and have been prepared by the Company in
accordance with accounting principles generally accepted in the United States of America for interim financial information, pursuant to the rules and regulations of the Securities and Exchange Commission. Pursuant to such rules and regulations,
certain financial information and footnote disclosures normally included in the financial statements have been condensed or omitted. However, in the opinion of management, the financial statements include all adjustments, consisting of normal
recurring accruals, necessary for a fair presentation of the interim periods presented. Operating results for these interim periods are not necessarily indicative of results to be expected for the entire year, due to seasonal, operating and other
factors.



The Company has identified certain of its significant
accounting policies that it considers particularly important to the portrayal of the Companys results of operations and financial position and which may require the application of a higher level of judgment by the Companys management,
and as a result are subject to an inherent level of uncertainty. These are characterized as critical accounting policies and address revenue recognition and accounts receivable, inventories, foreign currency translation and transactions,
impairment of long-lived assets and retirement plan funding, each more fully described under Managements Discussion and Analysis of Results of Operations and Financial Condition in the Companys Annual Report on Form 10-K for
the year ended December 31, 2002. The Companys accounting policy on the recognition of research and development funding, which is also described in the Companys Form 10-K, is no longer considered a critical accounting policy in 2003 as
the Companys recognition of funding from Philips ceased as of November 1, 2002 with the termination of the exclusive agreement with Philips. No other changes to the Companys critical accounting policies have been made during the quarter
ended March 31, 2003.



These statements should be read in
conjunction with the financial statements and related notes which are part of the Companys Annual Report on Form 10-K for the year ended December 31, 2002.



|(2) |  | LIQUIDITY
|--- |  | ---------



The accompanying financial statements have been prepared on a going-concern basis, which contemplates the realization of assets and satisfaction of
liabilities and other commitments in the normal course of business.



At March 31, 2003, the Company had working capital of $3,637,451, an increase of $4,642,667 from the working capital reported at December 31, 2002. The increase is impacted primarily by the reclassification as of March 31, 2003 of
$7.3 million of Convertible Senior Secured Fixed Rate Notes from current to long-term liabilities, as a result of the extension effective April 7, 2003 of the due date of the notes from August 4, 2003 to August 4, 2005.



The Company incurred net losses of $2,890,621 and $1,058,991 for the three
months ended March 31, 2003 and 2002, respectively, and has incurred net losses since inception. Financial results for the year ending December 31, 2003 are expected to show an increase in net loss relative to 2002 due to lower expected revenue and
increased sales and marketing expenses, primarily impacted by the Companys transition to its new distribution and direct sales force channel model. Cash and marketable securities decreased by approximately $2.5 million during the three months
ended March 31, 2003 to



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approximately $1.5 million. The Company is monitoring its cash position carefully and is evaluating its
future operating cash requirements in the context of its strategy, business objectives and expected business performance. As part of this, the Company has elected to delay project spending and capital expenditures, and is implementing other
cost-cutting measures across all areas of the Companys operations, including personnel, facilities and discretionary spending. A significant amount of instrument inventory available to the Company will allow a reduction of inventory purchases
and production requirements during 2003. Further, the Company is positioning its business for future sales and earnings growth with the pursuit of strategic partners for its businesses as well as the expansion of its global distribution channels,
including a direct sales force in the United States, the United Kingdom and Germany, and third-party distributors outside of these countries. In addition to these measures, however, the Company will be required to raise additional capital during
2003 in order to sustain and fund its operations.



On April 7,
2003, the Company completed a renegotiation of the terms of its $7.3 million, 7% Convertible Senior Secured Fixed Rate Notes due August 4, 2003, to extend repayment of the notes to August 4, 2005 (see note 8, Convertible Senior Secured Fixed
Rate Notes). Additionally, on May 12, 2003, the Company completed the sale in a private placement of 15,000 shares of Series E Convertible Preferred Stock, at a price of $100 per share, resulting in aggregate gross proceeds to the Company of
$1,500,000 (see note 12, Subsequent Event). Proceeds from this interim financing are expected to meet the Companys near-term funding requirements for support of its operations, as the Company continues to pursue significant
business alternatives for raising additional capital, including funding from strategic alliances, which may potentially include the sale of segments of the business. The Companys issuance of equity related instruments to raise funding is
currently limited to the level of the Companys remaining unissued and available authorized shares, currently approximating 6.3 million shares. Upon receipt of shareholder approval for an increase in the Companys authorized shares of
common stock at its upcoming annual meeting on May 22, 2003, the Company may pursue the issuance of additional equity or debt securities to the extent funding raised from other business alternatives is not sufficient to meet the Companys
funding requirements. The Company has engaged the Seidler Companies to assist in its efforts to secure partners for strategic alliances and to raise additional capital. Through March 31, 2003, the Company raised approximately $149 million
through the public and private sales of its equity securities and the issuance of convertible promissory notes. If the Company is unable to obtain shareholder approval for an increase in authorized shares of common stock at its annual meeting on
May 22, its future ability to raise equity funding may be negatively affected.



The Company received a Nasdaq Staff Determination on April 25, 2003,
indicating that the Companys common stock was subject to delisting from the Nasdaq SmallCap Market based upon the Companys failure to comply with the minimum common stock market value requirement. The Company has requested a hearing
before a Nasdaq Listing Qualifications Panel to review the delisting decision. The request for a hearing will postpone the delisting of the Companys securities, pending the Panels decision. There can be no assurance the Panel will grant
the Companys request for continued listing. If the Company is unsuccessful in its appeal, trading of its common stock is expected to be conducted in an over-the-counter market established for securities that do not meet Nasdaq listing
requirements. Trading of the Companys common stock in an over-the-counter market may attract a different type of investor in the Companys common stock, which may limit the Companys future equity funding options.



The Companys long-term capital requirements will depend upon numerous
factors, including the impact of changes in distribution relationships and methods on revenue, the rate of market acceptance of the Companys products, the level of resources devoted to expanding the Companys business and manufacturing
capabilities, and the level of research and development activities. While there can be no assurance that adequate funds will be available when needed or on acceptable terms, management believes that the Company will be able to raise adequate funding
to meet its operational requirements. If the Company is unable to raise an adequate level of additional capital or generate sufficient cash flows from operations, the Companys ability to execute its business plan and remain a going concern
will be significantly impaired.





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The financial statements do
not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that may be necessary if the Company is unable to continue as a going concern.



|(3) |  | NET LOSS PER COMMON SHARE
|--- |  | -------------------------



Basic earnings per share (EPS) is calculated by dividing net loss by the weighted average common shares outstanding during the period. Diluted
EPS reflects the potential dilution to basic EPS that could occur upon conversion or exercise of securities, options, or other such items, to common shares using the treasury stock method based upon the weighted average fair value of the
Companys common shares during the period. For each period presented, basic and diluted loss per share amounts are identical, as the effect of potential common shares is antidilutive. The following is a summary of outstanding securities which
have been excluded from the calculation of diluted EPS because the effect on net loss per common share would have been antidilutive:



|                                            |  | March 31,
|------------------------------------------- |  | ---------
|                                            |  | 2003     
|Common stock options                        |  | 3,802,255
|Common stock warrants                       |  | 1,201,667
|Convertible senior secured fixed rate notes |  | 869,047  
|Restricted stock                            |  | 329,885  



|(4) |  | COMPREHENSIVE LOSS
|--- |  | ------------------



|                                            |  | Three Months Ended March 31, |           
|------------------------------------------- |  | ---------------------------- | ----------
|                                            |  | 2003                         |           
|Net loss                                    |  | $                            | (2,890,621
|Change in cumulative translation adjustment |  |                              | (59,015   
|                                            |  |                              |           
|Comprehensive loss                          |  | $                            | (2,949,636
|                                            |  |                              |           



|(5) |  | INVENTORIES
|--- |  | -----------



|                |  | March 31, 2003 |           | December 31, 2002
|--------------- |  | -------------- | --------- | -----------------
|Raw materials   |  | $              | 968,275   |                  
|Work-in-process |  |                | 730,433   |                  
|Finished goods  |  |                | 1,792,881 |                  
|                |  |                |           |                  
|                |  | $              | 3,491,589 |                  
|                |  |                |           |                  



|(6) |  | STOCK BASED COMPENSATION
|--- |  | ------------------------



The Company applies the intrinsic-value method prescribed in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees, to account for the issuance of stock incentives to employees and directors. No compensation expense related to employees and directors stock incentives has been recognized in the financial statements as all
options granted under stock incentive plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Had the Company applied the fair value recognition provisions of Financial Accounting Standards Board
(FASB) Statement No. 123, Accounting for Stock-Based Compensation, to stock-



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based employee compensation,
the Companys net loss per share would have increased to the pro forma amounts indicated below:



|                                                                                                                |  | Three Months Ended March 31, |           
|--------------------------------------------------------------------------------------------------------------- |  | ---------------------------- | ----------
|                                                                                                                |  | 2003                         |           
|Net loss as reported                                                                                            |  | $                            | (2,890,621
|Deduct: Total stock-based employee compensation expense determined under fair value
based method for all awards |  | $                            | (369,431  
|                                                                                                                |  |                              |           
|Net loss pro forma                                                                                              |  | $                            | (3,260,052
|                                                                                                                |  |                              |           
|                                                                                                               
|Basic and diluted net loss per share as reported                                                                |  |                              | (0.11     
|Stock-based compensation expense                                                                                |  |                              | (0.01     
|                                                                                                                |  |                              |           
|Basic and diluted net loss per share pro forma                                                                  |  |                              | (0.12     
|                                                                                                                |  |                              |           



No stock options were
granted under the Companys stock option plans during the three months ended March 31, 2003. The per share weighted-average fair value of options granted under the Companys stock option plans for the three months ended March 31, 2002 was
$3.04, determined using the Black Scholes option-pricing model with the following assumptions: annualized volatility of 91.53%, risk-free interest rate of 3.76%, an expected option life of five years and no dividends.



|(7) |  | PRODUCT WARRANTY
|--- |  | ----------------



The Company, in general, warrants its new hardware and operating system software products to be free from defects in material and workmanship under normal
use and service for a period of eighteen months after date of shipment in the case of distributors, and one year after date of sale in the case of end-user customers. The Company warrants its disposable products to be free from defects in material
and workmanship under normal use until its stated expiration date. Under the terms of these warranties, the Company is obligated to repair or replace the products it deems to be defective due to material or workmanship. Provisions are made for the
estimated cost of maintaining product warranties for the hardware, software and disposable products based on an estimated average per unit repair or replacement cost applied to the estimated number of units under warranty. The estimated average per
unit repair or replacement cost reflects historical warranty incidence over the preceding twelve-month period. These estimates are evaluated on an ongoing basis to ensure the adequacy of the warranty reserve. Warranty provisions and claims for the
three months ended March 31, 2003 and 2002 are summarized as follows:



|     |  | Balance at beginning of period |        | Warranty provisions |       | Warranty claims |        |   | Balance at end of period
|---- |  | ------------------------------ | ------ | ------------------- | ----- | --------------- | ------ | - | ------------------------
|2003 |  | $                              | 30,000 |                     | 1,400 |                 | (1,400 | ) |                         
|2002 |  | $                              | 30,000 |                     | 6,185 |                 | (6,185 | ) |                         



|(8) |  | CONVERTIBLE SENIOR SECURED FIXED RATE NOTES
|--- |  | -------------------------------------------



Effective April 7, 2003, the Company completed the renegotiation of the terms of its $7.3 million Convertible Senior Secured Fixed Rate Notes due August
4, 2003, to extend repayment of the notes to



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##### Table of Contents

August 4, 2005. In exchange for the extension of repayment, the Company reduced the conversion price for
$6.9 million principal value of the notes from $8.40 to $3.51 per share. In addition, the Company issued the note holders five-year warrants for 4,255,837 shares of Common Stock at an exercise price of $.94 per share. The warrants become exercisable
over a one-year period starting April 7, 2004, and fully vest by April 7, 2005. The amended note agreements also provide that 50% of the net proceeds in excess of $10 million obtained from the Companys issuance of any equity securities
prior to August 4, 2005 be used to pay down the principal balance of the notes.



As the extension of the $7.3 million notes was completed prior to the Companys required filing of this quarterly report on Form 10-Q with the Securities and Exchange Commission on May 15, 2003, the Company reclassified the
$7.3 million debt balance as of March 31, 2003 from current to long-term liabilities. The Company will be required in the second quarter ended June 30, 2003 to record a gain or loss, as appropriate, on the modification of the debt.



|(9) |  | DEFERRED COMPENSATION
|--- |  | ---------------------



In July 2002, the Compensation Committee of the Companys Board of Directors approved a retention plan for certain of the Companys key
employees. The plan, which became effective August 1, 2002, provides for a cash bonus and restricted stock grants for certain key employees who remain employed by the Company for at least one year from the plans effective date. The stock
grants consisted of the issuance of an aggregate of 329,885 shares of restricted common stock to 14 key employees. The fair value of the common stock on the date of grant, August 1, 2002, was $824,711, which was recognized as restricted stock with a
corresponding charge to deferred compensation, a contra equity account. The deferred compensation will be recognized as expense ratably over the two-year vesting period. Expense associated with the cash bonus approximates $400,000, and is being
accrued and recognized over a one-year vesting period. Compensation expense of approximately $167,000 was recognized during the three months ended March 31, 2003, in connection with the cash bonus and restricted stock grants.



|(10) |  | RELATED PARTY TRANSACTIONS
|---- |  | --------------------------



In August 1998, the Company issued Convertible Senior Secured Fixed Rate Notes, with proceeds aggregating $7,300,000, which were used to retire other debt
of the Company. The investor group was led by BCC Acquisition II LLC. Effective April 7, 2003, the Company and the note holders completed a modification of the terms of the notes, including a two-year extension of repayment of the notes to August 4,
2005 and a reduction in the conversion price for $6,900,000 of the notes from $8.40 to $3.51 per share. Additionally, the note holders received five-year warrants for 4,255,837 shares of the Companys common stock, at an exercise price of $.94
per share.



Two of the directors of the Company are affiliated
with BCC Acquisition II LLC, and one of these directors participated in the issuance and subsequent modification in terms of the Convertible Senior Secured Fixed Rate Notes, although the conversion price of the note held by the director was not
reduced from $8.40 per share. This director is also a director of DVI, Inc., a health care finance company with which the Company has an outstanding capital lease. As of March 31, 2003, the outstanding balance of the capital lease was approximately
$245,000.



Two of the Companys distributors, Philips and
Codman, are shareholders of the Company. Codman distributes the Companys Neurotrend cerebral tissue monitoring system under an exclusive global distribution agreement entered into effective October 1998. The Companys exclusive global
distribution agreement with Philips for sale of the Companys TrendCare continuous blood gas monitoring systems and intermittent testing blood analysis systems ended effective November 1, 2002, and provided for minimum annual purchase amounts,
market development commitments and research and development funding through October 31, 2002. As provided for under the terms of an amended agreement between the parties, completed on April 10, 2003, and discussed further under



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Managements Discussion and Analysis of Results of Operations and Financial Condition,
Philips maintains a nonexclusive right to sell the Companys disposable cartridges, sensors and related accessories to its existing customer base through October 31, 2004. Philips also has a nonexclusive right through October 31, 2004 to
distribute the Companys Blood Analysis Portal measurement module as a component of Philips Blood Analysis Portal System. Sales to Philips and Codman for the three months ended March 31, 2003 and 2002 were approximately $1.2 million and
$5.2 million, respectively. Outstanding accounts receivable with these parties represented 44% and 71% of total outstanding accounts receivable as of March 31, 2003 and December 31, 2002, respectively.



|(11) |  | NEW ACCOUNTING PRONOUNCEMENTS
|---- |  | -----------------------------



In December 2002, the FASB issued SFAS No. 148, Accounting for Stock Based CompensationTransition and Disclosure, which amends FASB
Statement No. 123. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and requires prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS No. 148 is effective for financial statements for fiscal years ending after December 15, 2002, and
for interim periods beginning after December 15, 2002. The Company has evaluated SFAS No. 148 and has adopted its disclosure provisions. (See note 6, Stock Based Compensation).



In November 2002, the FASB issued FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which addresses certain disclosure requirements to be made by a guarantor about its obligations under guarantees. The Company is required to adopt the provisions of this
interpretation for financial statements of interim and annual periods ending after December 15, 2002. The required disclosures applicable to the Company are included under note 7 Product Warranty.



In January 2003, the FASB issued FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, which addresses accounting for special-purpose and variable interest entities. The Company is required to adopt the provisions of this interpretation for financial statements issued after
December 31, 2002. The Company has evaluated the impact of the adoption of this interpretation on its financial statements and has concluded that it did not have an effect on its financial statements for the three months ended March 31, 2003.



In November 2002, the Emerging Issues Task Force
(EITF) finalized its tentative consensus on EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables, which provides guidance on the measurement and allocation of revenue from sales undertakings to deliver more than
one product or service. The Company is required to adopt the provisions of EITF 00-21 for revenue arrangements entered into after June 15, 2003, and is currently analyzing the expected impact on its financial statements.



|(12) |  | SUBSEQUENT EVENT
|---- |  | ----------------



Effective April 7, 2003, the Company completed the renegotiation of the terms of its $7.3 million, 7% Convertible Senior Secured Fixed Rate Notes due
August 4, 2003, to extend repayment of the notes to August 4, 2005. (See note 8, Convertible Senior Secured Fixed Rate Notes and note 10, Related Party Transactions).



On May 12, 2003, the Company completed the sale in a private placement of
15,000 shares of Series E Preferred Stock at a price of $100 per share, resulting in aggregate gross proceeds to the Company of $1,500,000. Each share of Preferred Stock is convertible at any time into shares of the Companys common stock at a
conversion price equal to 88% of the volume weighted average trading price of the Companys common stock for the five consecutive trading days immediately preceding the conversion date, subject to a maximum and minimum conversion price of $.75
per share and $.35 per share,



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respectively. The purchasers also received five-year warrants to purchase 735,000 shares of common stock
at $.35 per share. The warrants are exercisable at any time after all shares of the Preferred Stock are converted into shares of the Companys common stock. The Company plans to file a Registration Statement on Form S-3 with the Securities and
Exchange Commission to register the underlying shares of common stock that are subject to conversion of the Preferred Stock and exercise of the warrants. Proceeds from this interim financing are expected to meet the Companys near-term funding
requirements for support of its operations, as the Company continues to pursue significant business alternatives for raising additional capital.



Item 2.     Managements Discussion and Analysis of Results of Operations and Financial Condition



The Company has identified certain of its significant accounting policies that it considers particularly important to the portrayal of the Companys
results of operations and financial position and which may require the application of a higher level of judgment by the Companys management, and as a result are subject to an inherent level of uncertainty. These are characterized as
critical accounting policies and address revenue recognition and accounts receivable, inventories, foreign currency translation and transactions, impairment of long-lived assets and retirement plan funding, each more fully described
under Managements Discussion and Analysis of Results of Operations and Financial Condition in the Companys Annual Report on Form 10-K for the year ended December 31, 2002. The Companys accounting policy on the
recognition of research and development funding, which is also described in the Companys Form 10-K, is no longer considered a critical accounting policy in 2003 as the Companys recognition of research and development funding from Philips
ceased as of November 1, 2002 with the termination of the exclusive agreement with Philips. No other changes to the Companys critical accounting policies have been made during the quarter ended March 31, 2003.



The Companys discussion and analysis of results of operations and
financial condition include forward- looking statements, which may include statements regarding the Companys expectations about future financial performance; the continuation of historical trends; the sufficiency of its cash balances and cash
generated from operating activities for future liquidity and capital resource needs; the expected impact of changes in accounting policies on the Companys results of operations, financial condition or cash flows; anticipated problems and its
plans for future operations; and the economy in general or the future of the medical device industry, all of which are subject to various risks and uncertainties. Actual results may differ materially from the Companys expectations depending on
a variety of important factors, including, but not limited to such factors as the Companys ability to raise an adequate level of capital to fund its operations; market demand and pressures on the pricing for its products; changing market
conditions, competition and growth rates within the medical device industry; changes in accounting policies; risks associated with operations outside of the U.S.; changing economic conditions such as general economic slowdown, decreased consumer
confidence and the impact of war on the economy; and other risks and uncertainties, including those described in Exhibit 99.1 to the Companys Form 10-K filed with the U.S. Securities and Exchange Commission, with respect to the Companys
fiscal year ended December 31, 2002. When used in this Form 10-Q, and in future filings by the Company with the Securities and Exchange Commission, in the Companys press releases, presentations to securities analysts or investors, in oral
statements made by or with the approval of an executive officer of the Company, the words or phrases believes, may, will, expects, should, continue, anticipates,
intends, will likely result, estimates, projects, or similar expressions and variations thereof are intended to identify such forward-looking statements.



Summary



Diametrics Medical, Inc., which began operations in 1990, is engaged in the
development, manufacture and commercialization of blood and tissue analysis systems that provide immediate or continuous diagnostic results at the point-of-patient care.





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Since its commencement of
operations in 1990, the Company has transitioned from a development stage company to a full-scale development, manufacturing, sales and marketing organization located in Roseville, Minnesota and High Wycombe, England. As of March 31, 2003, the
primary funding for the operations of the Company has been approximately $149 million raised through public and private sales of its equity securities and issuance of convertible promissory notes.



The Company markets and distributes its products through both direct and
indirect distribution channels. With the termination effective November 1, 2002 of the Companys agreement with Philips Medical Systems for exclusive worldwide distribution of the Companys TrendCare continuous blood gas monitoring systems
and intermittent testing blood analysis systems, the Company began reestablishing a direct sales force in the United States, the United Kingdom and Germany, as well as nonexclusive third-party distributors outside of these countries for sale of
these products. As of March 31, 2003, the Company has expanded its direct sales organization to 11 sales personnel and clinical application specialists based in the United States, the United Kingdom and Germany, with future additions dependent upon
the rate and timing of sales growth. Further, the Company has expanded its global distribution network with the appointment of 20 third-party distributors primarily addressing markets in Europe, the Far East and the Middle East. The Company
continues to sell disposable cartridges, sensors and related accessories to Philips for Philips nonexclusive distribution to its customer base through October 31, 2004 (more fully discussed below). The Company also continues to distribute its
Neurotrend cerebral tissue monitoring system through Codman under an exclusive distribution agreement entered into effective October 1, 1998. Additionally, the Company distributes its products to the veterinary market through direct end-user sales
and regional distributors.



The Codman distribution agreement was
initiated in October 1998, has a term of six years and is renewable for two years. If minimum sales levels are not achieved by Codman, certain payments may be due to the Company. Also, Codman has the right of first refusal to market new continuous
monitoring products developed for the neuro market. In addition, Johnson & Johnson Development Corporation has an equity investment of 773,184 shares of the Companys Common Stock, currently representing an approximate 3% ownership interest
in the Company.



On April 10, 2003, the Company and Philips
signed an amendment to the exclusive distribution agreement between the parties, clarifying certain rights and obligations of the parties subsequent to the termination of the exclusive agreement effective November 1, 2002. Under the terms of the
amendment, Philips will continue to have the nonexclusive right to sell the Companys intermittent testing cartridges, TrendCare sensors and related accessories to Philips existing customer base and support the Companys products in
that base through October 31, 2004. Philips sales and support rights may be transitioned to the Company prior to October 31, 2004 on a territory-by-territory basis under mutual agreement. Under the amendment, the Company will also continue to
manufacture the Portal measurement module for Philips nonexclusive distribution as a component of Philips Portal System through October 31, 2004. The Company also has nonexclusive rights to sell the Portal System. Additionally, the
amendment provides the Company with the option to purchase from Philips unused inventory of the Companys IRMA and TrendCare hardware products previously sold to Philips at quantities determined by the Company. Available instrument inventory
(from completed hardware products in finished goods inventory or otherwise expected to be available to the Company through purchase from Philips) will reduce the Companys inventory purchases and production requirements in 2003.



The Companys revenue from Philips for the three months ended March 31,
2003 and 2002 comprised 48% and 92%, respectively, of total revenue. From the initiation of the exclusive agreement with Philips in mid 1999 through October 31, 2002, revenue from Philips included product purchases by Philips to meet sales demand of
its end-user customers and to fulfill its internal product requirements associated with the sales and service processes and customer financing programs, as well as contractual purchase commitments and royalties under the distribution agreement. As a
result, the level of the Companys sales to Philips during the three-year period ended October 31, 2002 is not indicative of



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Philips sales to its end-user customers during that period, which are estimated to be substantially
less than the Companys sales to Philips during the three year period ended October 31, 2002.



RESULTS OF OPERATIONS



Revenue. The Companys total revenue was $2,176,667 for the three months ended March 31, 2003, compared to $5,462,874 for the same period in the prior year, a decrease of 60%. The decline in revenue
was primarily due to the termination of the exclusive distribution agreement with Philips and the Companys resulting transition to its new distribution and direct sales force channel model. The transition had a negative impact on the volume of
instrument sales during this years first quarter, but positively impacted average selling prices as a higher concentration of sales were made to direct end-user customers rather than distributors. Instrument revenues and related unit sales
declined 83% and 92%, respectively, for the three months ended March 31, 2003, compared to the same period in the prior year. Disposable cartridge and sensor revenue declined 4%, while related unit sales increased 3%. The increase in disposable unit
sales during the quarter relative to the revenue decline occurred due to a higher mix of intermittent testing cartridge sales, which carry a lower average selling price than continuous monitoring sensors. Higher average selling prices for disposable
cartridges and sensors partially offset the impact of the increased mix of cartridge sales. The larger decrease in instrument unit sales relative to the revenue decline primarily reflects a shift in the mix of intermittent testing instrument sales
from the lower priced Portal measurement module to the higher priced IRMA SL analyzer, and also an increase in average instrument selling prices. Intermittent testing products represented 66% of total revenue for the three months ended March 31,
2003, compared to 59% for the comparable period in 2002. Continuous monitoring products comprised the remaining revenue in each period.



The Companys sales to Philips and Codman comprised approximately 53% and 94% of total revenue for the three months ended March 31, 2003 and 2002,
respectively. Due to the significant purchases of the Companys products by Philips, and to a lesser extent, Codman, for their internal use in the sales process and to meet minimum purchase commitments, Philips and Codmans sales to
their end-user customers are estimated to be approximately 50% of the Companys product sales related to those distributors over the approximate three-year period ended October 31, 2002.



For the three months ended March 31, 2003, intermittent testing products
revenue was comprised of 74% disposable cartridge revenue and 26% instrument related revenue. Continuous monitoring products revenue was comprised of 64% disposable sensor revenue and 36% instrument related revenue. The Companys revenues are
affected principally by the number of instruments, consisting of continuous monitoring instruments, IRMA SL analyzers and Portal measurement modules and accessories, sold to distributors and direct customers, the extent to which the distributors
sell the Companys instruments to end-user customers, and the rate at which disposable sensors and cartridges are used in connection with these products. As of March 31, 2003, the Company has sold approximately 13,500 instruments. As the
Company grows, it is expected that the Companys growing end-user customer base will increase the usage and rate of usage of disposable products, with the result that overall disposable product sales will exceed that of instrument sales.



Cost of Revenue. Cost of revenue totaled
$1,757,746, or 81% of revenue for the three months ended March 31, 2003, compared to $4,005,279 or 73% of revenue for the same period last year. The increase in cost of revenue as a percentage of total revenue was primarily impacted by a significant
reduction in the mix of instrument sales to total sales, as instrument sales generally carry higher margins than sales of disposable cartridges and sensors. Partially offsetting the impact of lower instrument revenue was a reduction in overhead
costs of approximately $220,000, stemming from manufacturing work force reductions in the second and third quarters of 2002. These savings, along with improvements in disposable cartridge yields and increased production volumes, helped produce
reductions in cartridge unit manufacturing costs. Also partially offsetting the negative impact of a reduction in instrument sales volumes was an increase in average selling prices for the Companys products, as a result of the Companys
expansion of its distribution channels.





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Operating
Expenses. Research and development expenditures totaled $1,131,506 for the three months ended March 31, 2003, a 7% reduction compared to $1,221,637 for the three months ended March 31, 2002. The decline in expense was primarily
impacted by work force reductions in the second and third quarters of 2002 and other spending reductions stemming from cost containment measures initiated in the last half of 2002. Realized cost savings during the three months ended March 31, 2003
related to research and development work force reductions approximated $220,000, and were in line with managements expectations. The cost savings related to work force reductions and other spending reductions were partially mitigated by the
impact of the recognition in last years first quarter of research and development funding from Philips of $500,000, and no funding recognition in this years first quarter. The Companys recognition of research and development
funding from Philips ceased as of November 1, 2002 with the termination of the exclusive agreement with Philips.



Selling, general and administrative expenses totaled $2,048,493 for the three months ended March 31, 2003, compared to $1,183,946 for the same period in 2002. The 73% increase in expense between
periods was primarily impacted by the establishment during the fourth quarter 2002 of a direct sales force and increased marketing activities stemming from the termination of the exclusive agreement with Philips.



Restructuring charges associated with work force reductions in 2002 and costs
resulting from the resignation effective June 1, 2002 of the Companys Chief Executive Officer and President consisted primarily of severance and related costs amounting to approximately $887,000, accrued during the second and third quarters of
2002. The Company has paid approximately $819,000 of these costs through March 2003 and expects to pay the remaining $68,000 in the second quarter of 2003.



Other Income (Expense). Net other expense totaled $129,543 for the three months ended March 31, 2003, compared to $111,003 for the same
period in 2002. The Company realized interest income of $7,486 for the three months ended March 31, 2003, compared to $32,237 for the same period in 2002. The period-to-period decrease in interest income reflects the impact of lower average cash and
investment balances and lower average interest rates.



Interest
expense totaled $138,527 for the three months ended March 31, 2003, compared to $135,739 for the same period in 2002. The period-to-period increase in interest expense primarily reflects the impact of higher average interest rates on capital lease
debt entered into in late 2002 and early 2003.



Net
Loss. The net loss for the three months ended March 31, 2003 was $2,890,621, compared to $1,058,991 for the same period in 2002, an increase of 173%. The primary contributors to the increase in net loss were a reduction in instrument
revenue and an increase in selling, general and administrative expenses, both stemming from the termination of the exclusive agreement with Philips and the Companys transition to its new distribution and direct sales force channel model.



The Company anticipates that the termination of the exclusive
agreement with Philips and its resulting transition to expanded distribution channels will adversely affect the Companys financial performance in the near term. Annual 2003 revenues are expected to be below 2002 levels. The net loss in 2003 is
expected to be greater than that of 2002, impacted by lower projected revenues and a significant increase in sales and marketing expenses. The Company expects second quarter 2003 revenues and net loss to be similar to or better than that of the
first quarter. Quarterly revenues and net loss performance are expected to improve during the last half of 2003, as the new sales channels begin to show positive results. Projected revenue and earnings levels in 2003 are exclusive of any unusual or
nonrecurring items, and will be primarily impacted by the rate of ramp-up and the effectiveness of the Companys direct sales force and distributors and also by the timing and nature of new strategic alliances intended to be consummated during
the year.



LIQUIDITY AND CAPITAL RESOURCES



The accompanying financial statements have been prepared on
a going-concern basis, which contemplates the realization of assets and satisfaction of liabilities and other commitments in the normal



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course of business. The report of the Companys independent auditors pertaining to the Companys
consolidated financial statements for the year ended December 31, 2002 contained an explanatory paragraph expressing substantial doubt about the Companys ability to continue as a going concern as a result of negative working capital at
December 31, 2002, recurring losses and negative cash flows.



At
March 31, 2003, the Company had working capital of $3,637,451, an increase of $4,642,667 from the working capital reported at December 31, 2002. The increase is impacted primarily by the reclassification as of March 31, 2003 of $7.3 million of
Convertible Senior Secured Fixed Rate Notes from current to long-term liabilities, as a result of the extension effective April 7, 2003 of the due date of the notes from August 4, 2003 to August 4, 2005. A net loss before depreciation and
amortization of approximately $2.4 million and purchases of property and equipment of approximately $188,000 during the three months ended March 31, 2003 partially offset the impact of the increase in working capital.



The Company incurred net losses of $2,890,621 and $1,058,991 for the three
months ended March 31, 2003 and 2002, respectively, and has incurred net losses since inception. Financial results for the year ending December 31, 2003 are expected to show an increase in net loss relative to 2002 due to lower expected revenue and
increased sales and marketing expenses, primarily impacted by the Companys transition to its new distribution and direct sales force channel model. Cash and marketable securities decreased by approximately $2.5 million during the three months
ended March 31, 2003 to approximately $1.5 million. The Company is monitoring its cash position carefully and is evaluating its future operating cash requirements in the context of its strategy, business objectives and expected business performance.
As part of this, the Company has elected to delay project spending and capital expenditures, and is implementing other cost-cutting measures across all areas of the Companys operations, including personnel, facilities and discretionary
spending. A significant amount of instrument inventory available to the Company will allow a reduction of inventory purchases and production requirements during 2003. Further, the Company is positioning its business for future sales and earnings
growth with the pursuit of strategic partners for its businesses as well as the expansion of its global distribution channels, including a direct sales force in the United States, the United Kingdom and Germany, and third-party distributors outside
of these countries. In addition to these measures, however, the Company will be required to raise additional capital during 2003 in order to sustain and fund its operations.



On April 7, 2003, the Company completed a renegotiation of the terms of its $7.3 million, 7% Convertible Senior Secured Fixed
Rate Notes due August 4, 2003, to extend repayment of the notes to August 4, 2005 (see note 8, Convertible Senior Secured Fixed Rate Notes). Additionally, on May 12, 2003, the Company completed the sale in a private placement of 15,000
shares of Series E Convertible Preferred Stock, at a price of $100 per share, resulting in aggregate gross proceeds to the Company of $1,500,000 (see note 12 Subsequent Event). Proceeds from this interim financing are expected to meet
the Companys near-term funding requirements for support of its operations, as the Company continues to pursue significant business alternatives for raising additional capital, including funding from strategic alliances, which may potentially
include sale of segments of the business. The Companys issuance of equity related instruments to raise funding is currently limited to the level of the Companys remaining unissued and available authorized shares, currently approximating
6.3 million shares. Upon receipt of shareholder approval for an increase in the Companys authorized shares of common stock at its upcoming annual meeting on May 22, 2003, the Company may pursue the issuance of additional equity or debt
securities to the extent funding raised from other business alternatives is not sufficient to meet the Companys funding requirements. The Company has engaged the Seidler Companies to assist in its efforts to secure partners for strategic
alliances and to raise additional capital. Through March 31, 2003, the Company raised approximately $149 million through the public and private sales of its equity securities and the issuance of convertible promissory notes. If the Company is unable
to obtain shareholder approval for an increase in authorized shares of common stock at its annual meeting on May 22,
its future ability to raise equity funding may be negatively affected.



The Company received a Nasdaq Staff Determination on April 25, 2003, indicating that the Companys common stock was subject to delisting from the Nasdaq SmallCap Market based upon the Companys



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failure to comply with the minimum common stock market value requirement. The Company has requested a
hearing before a Nasdaq Listing Qualifications Panel to review the delisting decision. The request for a hearing will postpone the delisting of the Companys securities, pending the Panels decision. There can be no assurance the Panel
will grant the Companys request for continued listing. If the Company is unsuccessful in its appeal, trading of its common stock is expected to be conducted in an over-the-counter market established for securities that do not meet Nasdaq
listing requirements. Trading of the Companys common stock in an over-the-counter market may attract a different type of investor in the Companys common stock, which may limit the Companys future equity funding options.



The Companys long-term capital requirements will depend
upon numerous factors, including the impact of changes in distribution relationships and methods on revenue, the rate of market acceptance of the Companys products, the level of resources devoted to expanding the Companys business and
manufacturing capabilities, and the level of research and development activities. While there can be no assurance that adequate funds will be available when needed or on acceptable terms, management believes that the Company will be able to raise
adequate funding to meet its operational requirements. If the Company is unable to raise an adequate level of additional capital or generate sufficient cash flows from operations, the Companys ability to execute its business plan and remain a
going concern will be significantly impaired.



The financial
statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that may be necessary if the Company is unable to continue as a going concern.



Net cash used in operating activities totaled $2,240,615 for the
three months ended March 31, 2003, compared to $2,739,099 for the same period in 2002. This was the result of net losses of $2,890,621 and $1,058,991 for these same periods in 2003 and 2002, respectively, adjusted by changes in operating assets and
liabilities, primarily accounts receivable, inventories, accounts payable, accrued expenses and deferred credits and revenue, discussed below.



Net accounts receivable increased $15,499 for the three months ended March 31, 2003, compared to a $121,255 increase for the same period in 2002. The
increase during the first quarter 2003 was primarily impacted by increased sales in the quarter relative to the fourth quarter 2002. The increase for the same period in 2002 occurred in spite of a reduction in sales from the fourth quarter 2001 due
to the timing of sales and related accounts receivable collections.



Inventories decreased $78,926 for the three months ended March 31, 2003, compared to an increase of $849,890 for the same period in 2002. The decrease in 2003 was primarily due to reduction in required disposable sensor raw material
and instrument purchases, due to inventory availability, partially offset by an increase in cartridge finished goods inventory in preparation for second quarter sales demand. The increase in 2002 was primarily due to a ramp up of intermittent
testing raw material inventories to facilitate second quarter production requirements for Portal measurement modules and IRMA analyzers. This was partially offset by a decline in continuous monitoring instrument inventory resulting from sales of
these products during the quarter.



Accounts payable and accrued
expenses decreased $48,071 and $575,475 on a combined basis for the three months ended March 31, 2003 and 2002, respectively. The reduction in 2003 primarily reflects payments for product purchase commitments and severance costs accrued at
December 31, 2002, partially offset by a net increase in trade payables due to the timing of vendor payments. The reduction in 2002 primarily reflects the payment of employee incentive bonuses earned in the prior year and reduced payroll related
accruals due to the timing of payments. The significantly smaller reduction in 2003 occurred primarily as a result of no accrual or payment of employee incentive bonuses for 2002 performance.



Deferred credits and revenue decreased $583,333 for the three months ended
March 31, 2002, primarily representing the recognition of funding from Philips for research and development costs. No



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related activity occurred during the three months ended March 31, 2003, as the Companys recognition
of funding from Philips ceased as of November 1, 2002, with the termination of the exclusive agreement with Philips.



Net cash used in investing activities totaled $188,393 for the three months ended March 31, 2003, compared to $693,468 provided by investing activities
for the three months ended March 31, 2002. Changes in cash flows from investing activities are typically affected primarily by the amounts and timing of equity or other funding and operating cash flow requirements, which affect the amount of cash
available for the purchase and subsequent maturity of marketable securities. For 2003, the Companys cash and investment balance consisted entirely of cash equivalents, and as a result, no proceeds from maturities of marketable securities
occurred during the quarter. Purchases of property and equipment totaled $188,393 in 2003 and $57,673 in 2002. In 2003, the Company expects capital expenditures and new lease commitments to be below $400,000 for the year, primarily reflecting
investments to support production, internal product requirements for the direct sales process and new product development.



Net cash used by financing activities totaled $51,853 and $24,723 for the three months ended March 31, 2003 and 2002, respectively. The period-to-period
change was primarily impacted by a reduced amount of proceeds from employee stock plans, partially offset by a reduction in principal payments on borrowings.



At March 31, 2003, the Company had U.S. tax net operating loss and research and development tax credit carryforwards for income tax purposes of
approximately $127 million and $1.5 million, respectively. Pursuant to the Tax Reform Act of 1986, use of a portion of the Companys net operating loss carryforwards are limited due to a change in ownership. If not used, these net
operating loss carryforwards begin to expire in 2005 ($500,000) and at increasing amounts between 2006 and 2022 ($31.6 million between 2006 and 2009, and $92.8 million thereafter). The Companys foreign subsidiary also has a net operating loss
carryforward of approximately $51.6 million, which can be carried forward indefinitely, subject to review by the governmental taxing authority.



Item 3.     Quantitative and Qualitative Disclosure About Market Risk



The Company is exposed to market risk from foreign exchange rate fluctuations of the British pound sterling to the U.S. dollar as the financial position
and operating results of the Companys U.K. subsidiary, DML, are translated into U.S. dollars for consolidation. The Companys exposure to foreign exchange rate fluctuations also arises from transferring funds to its U.K. subsidiary in
British pounds sterling. From November 1999 through October 2002, most of the Companys sales were made to the Companys two global distribution partners, Philips and Codman, with sales denominated in U.S. dollars, thereby significantly
mitigating the risk of exchange rate fluctuations on trade receivables. With the termination of the exclusive agreement with Philips, the Company established a direct sales force in the United States, the United Kingdom and Germany, as well as
nonexclusive third-party distributors outside of these countries for sale of the Companys TrendCare Continuous blood gas monitoring systems and IRMA SL intermittent testing blood analysis system. All sales made from the Companys U.S.
operations are denominated in U.S. dollars and, with the exception of sales to end-user customers in Germany (which are denominated in euros), all sales made from DML are denominated in British pounds sterling. The Company is currently reassessing
its risk of exchange rate fluctuations on trade receivables due to changing distribution relationships and methods precipitated by the termination of the Companys exclusive agreement with Philips. The Company plans to minimize exposure to
currency risk due to fluctuations between the exchange rates for the British pound sterling and the euro by offsetting euro denominated payment obligations with euro denominated receipts to the full extent possible. The Company anticipates that any
remaining exposure due to euro denominated sales will not be material, as related sales are not expected to comprise a significant portion of the Companys total sales.



The effect of foreign exchange rate fluctuations on the Companys financial results for the periods presented was not
material. The Company does not currently use derivative financial instruments to



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hedge against exchange rate risk or interest rate risk. Over 99% of the Companys debt balance as of
March 31, 2003 bears interest at fixed rates, and is therefore not subject to exposure from fluctuating interest rates.



The Company is exposed to both market and interest rate risk in the actuarial valuation of its subsidiarys defined benefit retirement plan. The
Retirement Plans projected benefit obligation exceeded the fair value of plan assets by approximately $3 million at the plans valuation date of December 31, 2002, reflecting a $1.6 million increase in the plans underfunded status
relative to the prior year. This occurred due to an environment of weaker investment performance in the global markets over the past two to three years (which negatively affected the value of Retirement Plan assets), and to a lesser extent, lower
prevailing interest rates (which drove the use of a lower discount rate to calculate the projected benefit obligation, thereby increasing the amount of this obligation at December 31, 2002). While the underfunded status of the Companys
Retirement Plan is expected to improve relative to current levels over time as a result of actuarial assumed improvements in future average market (and trust fund) performance, the inability of the trust fund investments to perform at or near these
average projected rates of return over the employees remaining service lives could result in a significant future funding obligation of the Company.



There have been no material changes in market risk faced by the Company from what has been previously reported in the Companys Annual Report on Form
10-K for the year ended December 31, 2002.



Item 4.     Controls and Procedures



|(a) |  | Evaluation of disclosure controls and procedures.
|--- |  | -------------------------------------------------



Under the supervision and with the participation of management, including the Companys Chief Executive Officer and Chief Financial Officer, an
evaluation was carried out of the effectiveness of the design and operation of the Companys disclosure controls and procedures as of a date (the Evaluation Date) within the 90-day period prior to the filing of this report. Based
upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, the Companys disclosure controls and procedures are effective to ensure that information the Company is required to
disclose in its filings with the Securities and Exchange Commission under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commissions rules and forms.



|(b) |  | Changes in internal controls.
|--- |  | -----------------------------



Subsequent to the date of managements evaluation, there were no significant changes made in the Companys internal controls or in other factors
that could significantly affect these controls.





PART II  OTHER INFORMATION



Item 1.     Legal Proceedings



None



Item 2.     Changes in Securities



None



Item 3.
    Defaults Upon Senior Securities



None



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



None



Item 5.     Other Information



None



Item 6.     Exhibits and Reports on Form 8-K



| | a. |  | Exhibits
| | -- |  | --------



|Exhibit No. |  |                                                                                                                                                |  | Method of Filing
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------
|99.1        |  | Certification of the Chief Executive Officer pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 |  | Filed herewith  
|           
|99.2        |  | Certification of the Chief Financial Officer pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 |  | Filed herewith  



| | b. |  | Reports on Form 8-K.
| | -- |  | --------------------



On January 10, 2003, the Company filed a Current Report on Form 8-K under Item 5 relating to the Companys announcement that it received a notice
from the Nasdaq Stock Market, indicating that the Companys stock was subject to delisting from the Nasdaq National Market based upon the Companys failure to comply with the minimum $10,000,000 stockholders equity requirement, as
presented in a press release dated January 10, 2003.



On February
25, 2003, the Company filed a Current Report on Form 8-K under Item 5 relating to the Companys announcement that it received approval from the Nasdaq Stock Market to transfer the listing of its securities from the Nasdaq National Market to the
Nasdaq SmallCap Market, effective as of February 26, 2003, as presented in a press release dated February 25, 2003.



On March 6, 2003, the Company filed a Current Report on Form 8-K under Item 9 relating to the Companys announcement of earnings results for the
quarter and year ended December 31, 2002, as presented in a press release dated March 6, 2003.



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DIAMETRICS MEDICAL, INC.





SIGNATURE



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.





|DIAMETRICS MEDICAL, INC.
|------------------------
|                        
|By:                     
|                        
|                        
|                        
|                        





Dated: May 15, 2003





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##### Table of Contents



Certification of Chief Executive Officer

Pursuant to Section 302 of the

Sarbanes-Oxley Act of 2002



I, David B. Kaysen, certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Diametrics Medical, Inc.;
|-- |  | -------------------------------------------------------------------------------



|2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report.
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which the quarterly report is being prepared;
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report
(the Evaluation Date); and
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c) |  | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation
Date;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee
of registrants board of directors (or persons performing the equivalent function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize
and report financial data and have identified for the registrants auditors any material weakness in internal controls; and
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



/s/     DAVID B. KAYSENDavid B. KaysenChief Executive OfficerMay 15, 2003




22



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Certification
of Chief Financial Officer

Pursuant to Section 302 of the

Sarbanes-Oxley Act of 2002



I, Laurence L. Betterley, certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Diametrics Medical, Inc.;
|-- |  | -------------------------------------------------------------------------------



|2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which the quarterly report is being prepared;
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report
(the Evaluation Date); and
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c) |  | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation
Date;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee
of registrants board of directors (or persons performing the equivalent function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize
and report financial data and have identified for the registrants auditors any material weakness in internal controls; and
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



/s/     LAURENCE L. BETTERLEYLaurence L. BetterleyChief Financial OfficerMay 15, 2003






23