** **

**UNITEDSTATES**SECURITIES AND EXCHANGE COMMISSION

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 
| **ý**                                                                                                                                                                                                                                                                                                                                                                                                                                 |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**   |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                 |   |
| **FOR THE QUARTERLY PERIOD ENDED  MARCH 31, 2004**                                                                                                                                                                                                                                                                                                                                                                                    |
|                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                       |   | **OR**                                                                                               |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                 |   |
| **o**                                                                                                                                                                                                                                                                                                                                                                                                                                      |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT  OF 1934** |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                 |   |
| **For the transition period from                                    to                                 .** |

 

**COMMISSION FILE NUMBER 0-22743**

 

**VISTA MEDICAL TECHNOLOGIES, INC.**

(Exact name of registrantas specified in its charter)

 
| **DELAWARE**                                                     |   | **94-3184035**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |
| **2101 FARADAY AVENUE  CARLSBAD, CA  92008**                |
| (Address of principal  executive offices)                        |
|                                                             |
| **(760) 603-9120**                                               |
| (Registrant’s telephone  number, including area code)       |

 

**Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports) and (2) has been subject to such filingrequirements for the past 90 days:**

 

**(1)      Yes****ý       No****o**

**(2)      Yes****ý       No****o**

 

**Indicateby check mark whether the registrant is an accelerated filer (as defined inrule 12b-2 of the Exchange Act)                      Yes****o        No****ý**

 

As of May 10, 2004 there were 5,451,273 shares of $.01 par value commonstock outstanding.

 

 

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**VISTA MEDICAL TECHNOLOGIES, INC.FORM 10-QTABLE OF CONTENTS**

 
| PART 1. FINANCIAL  INFORMATION |                                                                                            |
|--------------------------------|-------------------------------------------------------------------------------------------------|
|                           |                                                                                            |   |
| Item 1.                        | Financial  Statements (unaudited)                                                               |   |
|                           |                                                                                            |   |
|                           | Consolidated Balance Sheets  as of March 31, 2004 and December 31, 2003               |   |
|                           | Consolidated  Statements of Operations for the three months ended March 31, 2004 and  2003 |   |
|                           | Consolidated  Statements of Cash Flows for the three months ended March 31, 2004 and  2003 |   |
|                           | Notes to  Consolidated Financial Statements                                                     |   |
|                           |                                                                                            |   |
| Item  2.                       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations     |   |
|                           |                                                                                            |   |
| Item  3.                       | Quantitative  and Qualitative Disclosures About Market Risk                                     |   |
|                           |                                                                                            |   |
| Risks and Uncertainties        |                                                                                            |
|                           |                                                                                            |   |
| Item 4.                        | Controls and  Procedures                                                                        |   |
|                           |                                                                                            |   |
|                           |                                                                                            |   |
| PART II. OTHER INFORMATION     |                                                                                            |
|                           |                                                                                            |   |
| Item 1.                        | Legal Proceedings                                                                               |   |
|                           |                                                                                            |   |
| Item  2.                       | Changes  in Securities and Use of Proceeds                                                      |   |
|                           |                                                                                            |   |
| Item 3.                        | Defaults Upon  Senior Securities                                                                |   |
|                           |                                                                                            |   |
| Item  4.                       | Submission  of Matters to a Vote of Security Holders                                            |   |
|                           |                                                                                            |   |
| Item  5.                       | Other Information                                                                               |   |
|                           |                                                                                            |   |
| Item 6.                        | Exhibits and  Reports on Form 8-K                                                               |   |
|                           |                                                                                            |   |
| SIGNATURES                     |                                                                                            |

 

2

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PART 1. FINANCIAL INFORMATION

 

Item 1. Financial Statements (Unaudited)

 

VistaMedical Technologies, Inc.Consolidated Balance Sheets

 
|                                                                                                                                        |   | **March 31, 2004** |      | **December 31, 2003** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|-----------|----------------------------|--------|
|                                                                                                                                        |   | **(Unaudited)**         |      |                       |   |
| ASSETS                                                                                                                                      |   |                    |      |                       |   |
| Current assets:                                                                                                                             |   |                    |      |                       |   |
| Cash and cash equivalents                                                                                                                   |   | $                       | 692,784   |                       | $      | 448,943 |   |
| Short-tern investments                                                                                                                      |   | 187,675                 |      | 187,209                    |   |
| Accounts receivable, net                                                                                                                    |   | 371,660                 |      | 979,877                    |   |
| Inventories, net                                                                                                                            |   | 917,824                 |      | 1,159,207                  |   |
| Other current assets                                                                                                                        |   | 147,262                 |      | 174,466                    |   |
| Total current assets                                                                                                                        |   | 2,317,205               |      | 2,949,702                  |   |
| Property and equipment, net                                                                                                                 |   | 30,966                  |      | 41,459                     |   |
| TOTAL ASSETS                                                                                                                                |   | $                       | 2,348,171 |                       | $      | 2,991,161 |   |
|                                                                                                                                        |   |                    |      |                       |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                   |   |                    |      |                       |   |
| Current liabilities:                                                                                                                        |   |                    |      |                       |   |
| Accounts payable                                                                                                                            |   | $                       | 422,583   |                       | $      | 702,838 |   |
| Current portion of capital leases                                                                                                           |   | 21,064                  |      | 23,984                     |   |
| Short-term bank borrowings                                                                                                                  |   | —                  |      | 200,000                    |   |
| Accrued compensation                                                                                                                        |   | 326,355                 |      | 235,993                    |   |
| Deferred revenue                                                                                                                            |   | 411,750                 |      | 480,000                    |   |
| Accrued liabilities                                                                                                                         |   | 354,234                 |      | 221,558                    |   |
| Total current liabilities                                                                                                                   |   | 1,535,986               |      | 1,864,373                  |   |
|                                                                                                                                        |   |                    |      |                       |   |
| Long term portion of capital leases                                                                                                         |   | 15,236                  |      | 18,624                     |   |
|                                                                                                                                        |   |                    |      |                       |   |
| TOTAL LIABILITIES                                                                                                                           |   | 1,551,222               |      | 1,882,997                  |   |
|                                                                                                                                        |   |                    |      |                       |   |
| Stockholders’ equity:                                                                                                                  |   |                    |      |                       |   |
| Preferred stock, $.01 par value:                                                                                                            |   |                    |      |                       |   |
| Authorized shares - 5,000,000                                                                                                               |   |                    |      |                       |   |
| Issued and outstanding shares - 1,000,000 at March 31, 2004 and  1,000,000 at December 31, 2003 (Liquidation Value of $3,800,000) |   | 1,104,212               |      | 1,068,686                  |   |
| Common stock, $.01 par value:                                                                                                               |   |                    |      |                       |   |
| Authorized shares - 35,000,000                                                                                                              |   |                    |      |                       |   |
| Issued and outstanding shares - 5,451,273 at March 31, 2004 and  5,007,918 at December 31, 2003                                   |   | 54,512                  |      | 50,079                     |   |
| Additional paid-in capital                                                                                                                  |   | 68,699,428              |      | 68,111,244                 |   |
| Deferred compensation                                                                                                                       |   | (31,503                 | )         | (29,856                    | )      |
| Accumulated deficit                                                                                                                         |   | (69,029,700             | )         | (68,091,989                | )      |
| Total stockholders’ equity                                                                                                             |   | 796,949                 |      | 1,108,164                  |   |
|                                                                                                                                        |   |                    |      |                       |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                             |   | $                       | 2,348,171 |                       | $      | 2,991,161 |   |

 

Note:  Thebalance sheet at December 31, 2003 has been derived from the auditedfinancial statements at that date but does not include all of the informationand footnotes required by generally accepted accounting principles for completefinancial statements.

 

See accompanying notes.

 

3

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VistaMedical Technologies, Inc.Consolidated Statements ofOperations(Unaudited)

 
|                                                      |   | **Three Months Ended March 31,** |      |
|-----------------------------------------------------------|--------|---------------------------------------|-----------|
|                                                      |   | **2004**                              |      | **2003** |   |
|                                                      |   |                                  |      |   |   |
| Sales                                                     |   | $                                     | 1,711,431 |   | $ | 2,849,585 |   |
|                                                      |   |                                  |      |   |   |
| Costs and expenses:                                       |   |                                  |      |   |   |
|                                                      |   |                                  |      |   |   |
| Cost of sales                                             |   | 1,132,539                             |      | 1,575,178 |   |
| Research and development                                  |   | 204,312                               |      | 257,160 |   |
| Sales and marketing                                       |   | 634,234                               |      | 548,757 |   |
| General and administrative                                |   | 641,726                               |      | 516,314 |   |
| Total cost and expenses                                   |   | 2,612,811                             |      | 2,897,409 |   |
|                                                      |   |                                  |      |   |   |
| Loss from operations                                      |   | (901,380                              | )         | (47,824 | ) |
|                                                      |   |                                  |      |   |   |
| Interest income                                           |   | 861                                   |      | 2,083 |   |
| Interest expense                                          |   | (1,666                                | )         | — |   |
|                                                      |   |                                  |      |   |   |
| Net loss                                                  |   | (902,185                              | )         | (45,741 | ) |
|                                                      |   |                                  |      |   |   |
| Less: Accretion of dividends on preferred stock           |   | 35,527                                |      | 11,322 |   |
|                                                      |   |                                  |      |   |   |
| Net loss applicable to common stockholders                |   | $                                     | (937,712  | ) | $ | (57,063 | ) |
|                                                      |   |                                  |      |   |   |
| Basic and diluted loss per share                          |   | $                                     | (0.18     | ) | $ | (0.01 | ) |
|                                                      |   |                                  |      |   |   |
| Shares used in computing basic and diluted loss per share |   | 5,259,462                             |      | 5,001,749 |   |

 

See accompanying notes.

 

4

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VistaMedical Technologies, Inc.Consolidated Statements of Cash Flows(Unaudited)

 
|                                                                         |   | **Three Months Ended March 31,** |     |
|------------------------------------------------------------------------------|--------|---------------------------------------|----------|
|                                                                         |   | **2004**                              |     | **2003** |   |
| OPERATING ACTIVITIES                                                         |   |                                  |     |   |   |
| Net loss                                                                     |   | $                                     | (902,185 | ) | $ | (45,741 | ) |
| Adjustments to reconcile net loss to net cash used in operating  activities: |   |                                  |     |   |   |
| Depreciation and amortization                                                |   | 24,312                                |     | 57,482 |   |
| Amortization of deferred compensation                                        |   | (3,512                                | )        | 10,029 |   |
| Changes in operating assets and liabilities:                                 |   |                                  |     |   |   |
| Accounts receivable, net                                                     |   | 607,238                               |     | 558,414 |   |
| Inventories, net                                                             |   | 467,223                               |     | (98,836 | ) |
| Other current assets                                                         |   | 4,089                                 |     | (30,624 | ) |
| Accounts payable                                                             |   | (269,560                              | )        | (198,213 | ) |
| Accrued compensation                                                         |   | 90,362                                |     | 37,344 |   |
| Deferred revenue                                                             |   | (55,750                               | )        | (221,500 | ) |
| Accrued liabilities                                                          |   | (110,458                              | )        | (69,479 | ) |
| Net cash flows used in operating activities                                  |   | (148,241                              | )        | (1,124 | ) |
|                                                                         |   |                                  |     |   |   |
| INVESTING ACTIVITIES                                                         |   |                                  |     |   |   |
| Maturities of short-term investments                                         |   | (466                                  | )        | 168,553 |   |
| Purchases of property and equipment                                          |   | (13,819                               | )        | (51,386 | ) |
| Payments on capital leases                                                   |   | (3,388                                | )        | — |   |
| Net cash flows (used in) provided by investing activities                    |   | (17,673                               | )        | 117,167 |   |
|                                                                         |   |                                  |     |   |   |
| FINANCING ACTIVITIES                                                         |   |                                  |     |   |   |
| Issuance of preferred stock                                                  |   | —                                |     | 950,000 |   |
| Issuance of common stock                                                     |   | 609,755                               |     | 2,210 |   |
| Repayment of short term bank borrowings                                      |   | (200,000                              | )        |   |   |
| Net cash flows provided by financing activities                              |   | 409,755                               |     | 952,210 |   |
|                                                                         |   |                                  |     |   |   |
| Net increase in cash and cash equivalents                                    |   | 243,841                               |     | 1,068,253 |   |
| Cash and cash equivalents at beginning of period                             |   | 448,943                               |     | 457,052 |   |
| Cash and cash equivalents at end of period                                   |   | $                                     | 692,784  |   | $ | 1,525,305 |   |
|                                                                         |   |                                  |     |   |   |
| NONCASH INVESTING AND FINANCING ACTIVITIES:                                  |   |                                  |     |   |   |
| Accretion of dividends on preferred stock                                    |   | $                                     | 35,527   |   | $ | 11,322 |   |

 

5

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VISTAMEDICAL TECHNOLOGIES, INC.NOTES TO CONSOLIDATED FINANCIALSTATEMENTSMARCH 31, 2004

 

(UNAUDITED)

 

1.   Basis of Presentation

 

The audited financial statements of Vista MedicalTechnologies, Inc. (the “Company”) and the notes thereto for the year endedDecember 31, 2003 included in the Company’s Annual Report on Form 10-Kfiled with the Securities and Exchange Commission, contain additionalinformation about the Company, its operations, and its financial statements andaccounting practices, and should be read in conjunction with this quarterlyreport on Form 10-Q.  These unauditedconsolidated financial statements have been prepared in accordance withgenerally accepted accounting principles and with the instructions on Form 10-Qexcept that certain information and footnote disclosures normally contained infinancial statements prepared in accordance with generally accepted accountingprinciples have been condensed or omitted.

 

The accompanying unaudited consolidated financialstatements of the Company reflect all adjustments of a normal recurring naturewhich are, in the opinion of management, necessary for a fair presentation ofthe financial position, results of operations and cash flows for all periodspresented.  The interim financialinformation contained herein is not necessarily indicative of results for anyfuture interim periods or for the full fiscal year ending December 31,2004.

 

AtMarch 31, 2004, the Company had an accumulated deficit of $69.0 million.  The accompanying consolidated financialstatements have been prepared assuming that the Company will continue as agoing concern.  This basis of accountingcontemplates the recovery of the Company’s assets and the satisfaction of itsliabilities in the normal course of conducting business.  Management does not believe that theCompany’s existing capital resources will enable the Company to fund operationsfor the next twelve months. Our existing capital resources are insufficient toenable us to continue operations as currently conducted.  The cash requirement is very serious.  We need additional funding to meet currentcommitments and continue development of our business. We currently have thecash resources to continue our business at its current levels only for ourimmediate needs.  If we do not receiveadditional funding, our ability to continue as a going concern cannot beassured. Please see “Liquidity and Capital Resources” for additional disclosureregarding our cash requirements.

 

Management’splans are to manage costs in all operational areas until sufficient capital israised to support growth and more substantial revenues materialize. The Companyhas implemented various cost savings plans and continues to manage costs.  However, even with the focus on managingcosts, the Company needs to raise additional funding to continue operations.

 

6

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OnApril 15, 2004 we sold substantially all the assets of our VisualizationTechnology business to Viking Systems, Inc. The impact of this sale will result in the presentation of ourfinancials as discontinued operations for the Visualization Technology businesseffective with the filing of our 10-Q for the period ending June 30,2004.  For additional details of thistransaction, please refer to our proxy filed March 25, 2004 for ourSpecial Meeting of Stockholders held on April 15, 2004.  Additionally, please refer to our segmentnote number 6 for details of the Visualization Technology business.

 

2.   Inventories

 
|                |   | **March 31, 2004** |      | **December 31, 2003** |   |
|---------------------|--------|-------------------------|-----------|----------------------------|--------|
|                |   | **(Unaudited)**         |      |                       |   |
|                |   |                    |      |                       |   |
| Parts and materials |   | $                       | 1,287,564 |                       | $      | 1,279,958 |   |
| Work in process     |   | 210,463                 |      | 340,502                    |   |
| Finished goods      |   | 763,863                 |      | 841,317                    |   |
|                |   | 2,261,890               |      | 2,461,777                  |   |
| Less: reserves      |   | (1,344,066              | )         | (1,302,570                 | )      |
| Inventories, net    |   | $                       | 917,824   |                       | $      | 1,159,207 |   |

 

Of the $917, 824 of net inventory on the balance sheet atMarch 31, 2004, $878,578 relates to the Visualization Technology business 

 

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3.   Loss Per Share

 

Basic net loss per share is calculated based on the weighted averagenumber of common shares outstanding during the period. Diluted net loss pershare incorporates the dilutive effect of common stock equivalents, includingstock options, warrants and other convertible securities.  Common stock equivalents have been excludedfrom the calculation of weighted average number of diluted common shares, astheir effect would be antidilutive for all periods presented.  The number of common stock equivalents excludedfrom the calculation of weighted average number of diluted common shares forthe periods ended March 31, 2004 and March 31, 2003 are 846,092 and685,628, respectively.

 

4.  Other Comprehensive Income

 

Other comprehensive income/(loss) includes certain changes in equitythat are excluded from net loss. The Company had no items of comprehensiveincome (loss) other than its net loss.

 

5.  Stock-Based Compensation

 

The Company applies the principles of Accounting Principles BoardOpinion No. 25, “*Accounting for Stock Issuedto Employees*,” and related interpretations in accounting for itsemployee stock option compensation plans. Under APB No. 25, compensationexpense is measured as the difference, if any, between the option exerciseprice and the fair value of the Company’s common stock at the date ofgrant.  The Company has historicallygranted options to employees and directors at exercise prices equal to the fairvalue of the Company’s common stock. Accordingly, no compensation expense hasbeen recognized for its employee stock-based compensation plans.

 

SFAS No. 123, “*Accounting forStock-Based Compensation*,” establishes a fair value based approachfor valuing stock options.  The Companyfollows the disclosure-only alternative afforded by SFAS No. 123.  Had compensation costs for stock optionsissued to employees and directors been determined based on the estimated fairvalue at the grant dates as calculated in accordance with SFAS No. 123, theCompany’s reported net loss and basic and diluted net loss per common share forthe periods ended March 31, 2004 and 2003 would have been adjusted to thepro forma amounts indicated below:

 

8

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|                                   |   | **For the  period ended  March 31,** |     |
|----------------------------------------|--------|-------------------------------------------|----------|
|                                   |   | **2004**                                  |     | **2003** |   |
|                                   |   |                                      |     |   |   |
| Net Loss:                              |   |                                      |     |   |   |
| As reported                            |   | $                                         | (902,185 | ) | $ | (45,741 | ) |
| Pro forma  compensation expense        |   | (60,258                                   | )        | (58,065 | ) |
| Pro forma SFAS  No. 123 net loss       |   | $                                         | (962,443 | ) | $ | (103,806 | ) |
|                                   |   |                                      |     |   |   |
| Basic and  diluted net loss per share: |   |                                      |     |   |   |
| As reported                            |   | $                                         | (0.18    | ) | $ | (0.01 | ) |
| Pro forma                              |   | $                                         | (0.18    | ) | $ | (0.02 | ) |

 

6.  Segment and GeographicInformation

 

*SegmentInformation:*The Company operates 2 segments which consist ofour Obesity Management Services business and our Visualization Technologybusiness.  We sold our VisualizationTechnology business in April 2004. The Company’s chief operating decisionmaker evaluates the performance of the two segments based on segment revenuesand certain segment costs and expenses, including cost of revenues and researchand development expenses.  Other operatingexpenses, including sales and marketing expenses and general and administrativeexpenses, are not allocated or evaluated on an individual segment basis, butrather on an enterprise-wide basis.  Asummary of the Company’s profitability by segment for the periods endedMarch 31, 2004 and  2003 is asfollows:

 
|                                                       |   | **Obesity  Surgery  Management** |    | **Visualization  Technology** |   | **Total** |     |
|------------------------------------------------------------|--------|----------------------------------|---------|-------------------------------|--------|-----------|----------|
| **Period  ended March 31, 2004:**                     |   |                             |    |                          |   |      |     |
| Revenues                                                   |   | $                                | 599,804 |                          | $      | 1,111,627 |     | $ | 1,711,431 |   |
| Cost of revenues                                           |   | 218,075                          |    | 914,464                       |   | 1,132,539 |     |
| Research and  development                                  |   | —                           |    | 204,312                       |   | 204,312   |     |
| Segment  contribution                                      |   | $                                | 381,729 |                          | $      | (7,149    | )        | $ | 374,580 |   |
|                                                       |   |                             |    |                          |   |      |     |
| Reconciliation  of segment contribution to total net loss: |   |                             |    |                          |   |      |     |
| Sales and marketing                                        |   |                             |    |                          |   | 634,234   |     |
| General and  administrative                                |   |                             |    |                          |   | 641,726   |     |
| Interest income                                            |   |                             |    |                          |   | 861       |     |
| Interest expense                                           |   |                             |    |                          |   | 1,666     |     |
| Net loss                                                   |   |                             |    |                          |   | $         | (902,185 | ) |

 

9

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|                                                       |   | **Obesity  Surgery  Management** |    | **Visualization  Technology** |   | **Total** |    |
|------------------------------------------------------------|--------|----------------------------------|---------|-------------------------------|--------|-----------|---------|
| **Period  ended March 31, 2003:**                     |   |                             |    |                          |   |      |    |
| Revenues                                                   |   | $                                | 668,274 |                          | $      | 2,181,311 |    | $ | 2,849,585 |   |
| Cost of revenues                                           |   | 167,346                          |    | 1,407,832                     |   | 1,575,178 |    |
| Research and  development                                  |   | —                           |    | 257,160                       |   | 257,160   |    |
| Segment  contribution                                      |   | $                                | 500,928 |                          | $      | 516,319   |    | $ | 1,017,247 |   |
|                                                       |   |                             |    |                          |   |      |    |
| Reconciliation  of segment contribution to total net loss: |   |                             |    |                          |   |      |    |
| Sales and  marketing                                       |   |                             |    |                          |   | 548,757   |    |
| General and  administrative                                |   |                             |    |                          |   | 516,314   |    |
| Interest income                                            |   |                             |    |                          |   | 2,083     |    |
| Net loss                                                   |   |                             |    |                          |   | $         | (45,741 | ) |

 

The Company reports assets on a consolidated basis to the chiefoperating decision maker, and all the assets are located within the UnitedStates.

 

*Geographicinformation:* Net sales by major geographical area, determinedon the basis of destination of the goods, are as follows:

 
|          |   | **Period  ended March 31,** | ** ** |
|---------------|--------|----------------------------------|------------|
|          |   | **2004**                         |       | **2003** | ** ** |
| United States |   | $                                | 1,240,634  |   | $ | 1,873,567 |   |
| Europe        |   | 470,797                          |       | 976,018 |   |
| Total         |   | $                                | 1,711,431  |   | $ | 2,849,585 |   |

 

7.  Stockholders Equity

 

In February, 2004, the Company sold 439,000 shares ofcommon stock in a private

 

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placement for gross proceeds of $588,000.  Additionally, 219,500 warrants to purchase common stock wereissued to the investors at an exercise price of $2.97 per share.

 

8.  New Accounting Standards

 

In January 2003 FASB Interpretation No.46, “Consolidation of Variable Interest Entities” was issued. Thisinterpretation requires a company to consolidate variable interest entities(“VIE”) if the enterprise is a primary beneficiary (holds a majority of thevariable interest) of the VIE and the VIE passes specific characteristics. Italso requires additional disclosures for parties involved with VIEs.  In December, 2003, the FASB issued arevision of Interpretation No. 46 (the Revised Interpretation 46). RevisedInterpretation 46 codifies both the proposed modifications and other decisionspreviously issued through certain FASB Staff Positions (FSPs) and supersedesthe original Interpretation No. 46 to include: (1) deferring the effective dateof the Interpretation’s provisions for certain variable interests, (2)providing additional scope exceptions for certain other variable interests, (3)clarifying the impact of troubled debt restructurings on the requirement toreconsider (a) whether an entity is a VIE or (b) which party is the primary beneficiaryof a VIE, and (4) revising Appendix B of the Interpretation to provideadditional guidance on what constitutes a variable interest. Accordingly, theCompany adopted Revised Interpretation No. 46 effective the first quarter 2004and the adoption of this interpretation did not have an impact on itsconsolidated financial position or results of operations.

 

9. Warranty Accrual

 

The Company provides for an estimated amountof product warranty at the time revenue is recognized. This estimated amount isprovided by product and based on historical warranty experience.  A rollforward of the product warrantyaccrual is as follows:

 
| Balance at  December 31, 2003 |   | $      | 13,261 |   |
|------------------------------------|--------|--------|--------|--------|
|                               |   |   |   |
| Warranty expense                   |   | 2,500  |   |
|                               |   |   |   |
| Deductions and  other              |   | (8,826 | )      |
|                               |   |   |   |
| Balance at  March 31, 2004    |   | $      | 6,935  |   |

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Resultsof Operations

 

THIS QUARTERLY REPORT MAY CONTAIN PREDICTIONS,ESTIMATES AND OTHER FORWARD-LOOKING STATEMENTS THAT INVOLVE A NUMBER OF RISKS ANDUNCERTAINTIES, INCLUDING THOSE DISCUSSED BELOW AT “RISKS AND

 

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UNCERTAINTIES.”  WHILE THISOUTLOOK REPRESENTS OUR CURRENT JUDGMENT ON THE FUTURE DIRECTION OF OURBUSINESS, SUCH RISKS AND UNCERTAINTIES COULD CAUSE ACTUAL RESULTS TO DIFFERMATERIALLY FROM ANY FUTURE PERFORMANCE SUGGESTED BELOW.  WE UNDERTAKE NO OBLIGATION TO RELEASEPUBLICLY THE RESULTS OF ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TOREFLECT EVENTS OR CIRCUMSTANCES ARISING AFTER THE DATE OF THIS QUARTERLYREPORT.  THE FOLLOWING DISCUSSION SHOULDBE READ IN CONJUNCTION WITH OUR CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTESTHERETO INCLUDED IN ITEM 1 OF THIS QUARTERLY REPORT ON FORM 10-Q AND OUR 2003ANNUAL REPORT ON FORM 10-K, FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.

 

# **Overview of our business**

# ** **

Over the course of the past two years, we have definedour business into two separate units, the Obesity Surgery Management Servicesbusiness and the Visualization Technology business.  The Obesity Surgery Management Services business, based inCarlsbad, CA, provides services to physicians and hospitals involved in thesurgical treatment of morbid obesity. Our services include management of the Laparoscopic Bariatric SurgeryPreceptorship, a comprehensive introduction to starting a minimally invasivegastric bypass surgical program. Additionally, we offer systems and consulting services which enable theefficient operation of obesity surgery programs.  With the sale of our Visualization Technology business inApril 2004, we now focus exclusively on the disease state management ofmorbid obesity.

 

  TheVisualization Technology business, based in Westborough, MA, develops,manufactures and markets products that provide information to physiciansperforming minimally invasive general surgical, cardiac surgical and otherselected endoscopic and interventional procedures.  Our technology products combine a head mounted display with videocameras to provide surgeons with critical visual information during complexminimally invasive procedures, and also incorporate the benefit of viewingcomplementary information in a voice-controlled, picture-in-picture format, tofacilitate real-time decision making during surgery.  The Visualization Technology business also manufactures compact,high resolution endoscopic cameras for original equipment manufacturercustomers and strategic partners.   Ingeneral terms, endoscopic surgery involves a telescopic viewing device which isinserted into a small incision in the body and which allows the surgeon anadequate view of the internal part of the body being repaired. TheVisualization Technology business was sold to Viking systems, Inc. onApril 15, 2004.  The sale of theVisualization Technology business required shareholder approval, which wasobtained on April 15, 2004.  TheVisualization Technology business will be treated as a discontinued operationbeginning in the quarter ending June 30, 2004.

 

**CriticalAccounting Policies**

 

The preparation of financialstatements and related disclosures in conformity with accounting principlesgenerally accepted in the United States of America requires management to

 

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make judgments, assumptions and estimatesthat affect the amounts reported in our consolidated financial statements andthe accompanying notes.  The amounts ofassets and liabilities reported in our balance sheets and the amounts ofrevenues and expenses reported for each of our fiscal periods are affected byestimates and assumptions which are used for, but not limited to, accountingfor product returns**,**allowance for doubtful accounts, warrantyand****technicalservice costs, inventory and income taxes. Actual results could differ from these estimates.  The following critical accounting policiesare significantly affected by judgments, assumptions and estimates used in thepreparation of the consolidated financial statements.

 

Revenue Recognition

 

The Company recognizes revenue pursuant to Staff Accounting Bulletin(“SAB”) No. 104 “Revenue Recognition”.   Accordingly, revenue is recognized when all four of the followingcriteria are met: (i) persuasive evidence of an arrangement exists; (ii)delivery of the product and/or services has occurred; (iii) the selling priceis fixed or determinable and; (iv) collectibility is reasonably assured.  Sales returns are estimated based on thehistorical experience and management’s expectations and are recorded at thetime product revenue is recognized. Shipping and handling costs are included in cost of sales.

 

Within the Obesity Surgery Management Services business, the Company’srevenues are derived from consulting and training services.  Consulting and training services revenue isrecognized upon delivery of related marketing materials and completion of therelated training component, provided all of the criteria of SAB 104 are met.

 

Within the Visualization Technology business, the Company’s revenuesare derived from the sale of technology products to end users, distributors andoriginal equipment manufactures. Product revenue is recognized upon shipment, provided all the criteriaof SAB 104 are met.

 

During the quarter ended March 31, 2004 the Company receivedpayments of $500,000 as a result of completing milestones relative to a newMemorandum of Understanding with Ethicon Endo-Surgery, Inc. (EES).  These payments are recognized as revenue ona straight-line basis over the related contract term.

 

Inventory

 

Inventory is accounted for on a first-in first-out basis and is valuedat the lower of cost or market. The Company regularly evaluates inventory forobsolescence and reserves for 100% of inventory considered to be obsolete.  At March 31, 2004, such inventoryreserves approximated $1,344,000. The Company believes it is adequatelyreserved for obsolescence of current inventory.  As part of the Visualization Technology business sale, themajority of the inventory was effectively sold to Viking and Viking isobligated to remit to Vista the cost of any inventory consumed over the 12month period beginning April 16, 2004 and ending April 15, 2005.  Any inventory remaining unsold atApril 15, 2005, Viking will remit $1 to Vista for.

**Ourresults of operations for three-months ended March 31, 2004 versusthree-months ended March 31, 2003**

 

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Revenues.  Wehad revenues from product sales and contract revenue of $1,711,000 for thethree-months ended March 31, 2004, compared to revenues from product salesand contract revenue of $2,850,000 for the same period in 2003.  The decrease in revenue during the firstquarter of 2004 compared to the corresponding period in 2003 was due primarilyto decreased unit sales from our Visualization Technology Business for ourLaparoscopic Bariatric Surgery program along with decreased unit sales to ourOriginal Equipment Manufacturer customers. The overall decrease in sales relative to the Visualization Technologybusiness was a direct effect of focusing on selling this business unit.

 

**Costsand expenses**

 
|                        |   | **Period  ending March  31, 2004** |      | **Period  ending March  31, 2003** |   |
|-----------------------------|--------|------------------------------------|-----------|------------------------------------|--------|
| Cost of revenues            |   | $                                  | 1,132,539 |                               | $      | 1,575,178 |   |
|                        |   |                               |      |                               |   |
| Research and  development   |   | 204,312                            |      | 257,160                            |   |
|                        |   |                               |      |                               |   |
| Sales and  marketing        |   | 634,234                            |      | 548,757                            |   |
|                        |   |                               |      |                               |   |
| General and  administrative |   | 641,726                            |      | 516,314                            |   |
|                        |   |                               |      |                               |   |
| Total costs and  expenses   |   | $                                  | 2,612,811 |                               | $      | 2,897,409 |   |

 

Cost of Revenues. Our cost of revenues were $1,133,000 and $1,575,000 for the three-months ended March 31, 2004 and 2003, respectively, with gross margins of34% and 45%, respectively. The decrease in gross margin was primarily due tolower unit sales from our Visualization Technology business.

 

Research and Development Expenses.  Our research and development expenses were$204,000 and $257,000 for the three-months ended March 31, 2004 and 2003,respectively.  The decrease in researchand development expenses was primarily attributable to a reduction in nextgeneration product development, mainly consisting of reduced product expensesand consultants. We expect our research and development expenses to beeliminated subsequent to the sale of our Visualization Technologybusiness.  There are no research anddevelopment expenses currently incurred or to be incurred for the Obesitymanagement Services business.

 

Sales and Marketing Expenses.  Our sales and marketing expenses were$634,000 and $549,000 for the three-months ended March 31, 2004 and 2003,respectively. The increase in sales and marketing expense during the 2004period reflects increased expenses related to the development of our ObesityManagement Services business, mainly with increased headcount as well asadditional public relations and advertising. We expect a steady increase in sales and marketing expenses during 2004as we ramp up our field activities for the obesity surgery market, however,there will be a decrease of approximately $65,000 relative to sales andmarketing expenses due to the sale of Visualization Technology business.

 

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General and Administrative Expenses.  Our general and administrative expenses were$642,000 and $516,000 for the three-months ended March 31, 2004 and 2003,respectively.  The increase in generaland administrative expenses during the 2004 period reflect one time bonuses andexpenses relative to the sale of the Visualization Technology business.  We expect our general and administrativeexpenses to decrease in the next quarter and then remain at or near thoselevels for the next several quarters.

 

Interest Income. Our net interest income was $900 and $2,000 for the three-months endedMarch 31, 2004 and 2003, respectively. The decrease in net interest income during the 2004 period was dueprimarily to decreasing cash balances.

 

**Liquidityand capital resources**

 

Net cash used for operating activities for thethree-months ended March 31, 2004 was $148,000 compared to net cash usedof $1,000 for the corresponding three-month period in 2003. The increase in netcash used by operating activities during the 2004 period was primarilyattributable to increased net loss partially offset by the decline in inventorybalances and increased cash collections.

 

Net cash used for investing activities was $18,000 forthe three-months ended March 31, 2004 compared to net cash providedof  $117,000  in the same period in 2003. The decrease in net cash provided by investing activities in the 2004period was primarily attributable to a decrease in maturities of short terminvestments.

 

Net cash flows from financing activities were $410,000for the three-months ended March 31, 2004 compared to $952,000 for thesame period in 2003.  Sale of commonstock and preferred stock generated $610,000 and $950,000 during the three month periods endedMarch 31, 2004 and 2003, respectively. We also had payments of short term bank borrowings of $200,000 duringthe 2004 period.

 

We incurredoperating losses in 2001, 2002 and 2003, and at March 31, 2004, had anaccumulated deficit of $69 million.  AtMarch 31, 2004, we had cash and short-term investments of $880,000.  In February 2004, we sold $588,000 ofcommon stock in a private placement.  In addition, we have amounts available under a $2.0 million bank line ofcredit facility, which expires in October 2004 and is subject to annualrenewals.  We believe that these sourcesof liquidity, together with anticipated 2004 product revenues and interestincome, will not be sufficient to operate our business beyondJune 2004.  These factors raisesubstantial doubt about our ability to continue as a going concern.  We are pursuing several alternatives toaddress this situation, including raising additional funding and the completedsale of the Visualization Technology business on April 15, 2004.  However, there can be no assurance that therequisite fundings will be consummated in the necessary time frame or on termsacceptable to us.  Should we be unableto raise sufficient funds, we may be required to curtail our operating plansand possibly relinquish rights to portions of our technology or products.  In addition, increases in expenses or delaysin product development may adversely impact our cash position and require

 

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further cost reductions.  No assurance can be given that we will beable to operate profitably on a consistent basis, or at all, in the future.

 

Item 3.             Quantitativeand Qualitative Disclosures About Market Risk

 

At March 31, 2004, our investment portfolioincluded fixed-income securities of $0.5 million.  These securities are subject to interest rate risk and willdecline in value if interest rates increase. Due to the short duration of our investment portfolio, an immediate 10percent increase in interest rates would have no material impact on ourfinancial condition or results of operations.

 

We generally conduct business, including sales toforeign customers, in U.S. dollars and as a result have limited foreigncurrency exchange rate risk.  The effectof an immediate 10 percent change in foreign exchange rates would not have amaterial impact on our financial condition or results of operations.

 

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RISKS ANDUNCERTAINTIES

 

You should consider the following factors carefully inevaluating an investment in Vista Medical in addition to the other informationin this report.  You are cautioned thatthe statements in this annual report that are not descriptions of historicalfacts may be forward-looking statements that are subject to risks anduncertainties.  Our actual results coulddiffer materially from those currently anticipated due to a number of factors,including those identified in this section and elsewhere in this annualreport.  We undertake no obligation torelease publicly the results of any revisions to these forward-lookingstatements to reflect events or circumstances arising after the date of thisannual report.  The following discussionshould be read in conjunction with our consolidated financial statements andnotes thereto.

 

**We willrequire additional funding to meet current commitments, continue thedevelopment of our business and maintain our ability to continue as a goingconcern.  This includes the divestitureof the Visualization Technology business.**

 

At March 31, 2004, we had cash, cash equivalents and short-terminvestments of $880,000.  We believethat these cash resources, together with cash from operations and theadditional equity raised in February 2004, will not be sufficientresources to operate our business beyond June 2004.  This cash requirement is very serious.  We need additional funding to meet currentcommitments and continue development of our business.  Our current cash resources will only allow us to continue ourbusiness at its current levels for our immediate needs.  If we do not receive additional funding, ourability to continue as a going concern cannot be assured.  We are also dependent on the divestiture ofthe Visualization Technology business to reduce operating costs and providecash.  This divestiture closed onApril 15, 2004.

 

**We are not in compliance with the requirements to maintain the listingof our common stock on The Nasdaq SmallCap Market and have receivednotification of de-listing, which could negatively affect the liquidity of ourstock and our ability to raise capital.**

 

The quantitative standards for continued listing on the Nasdaq SmallCapMarket requires a company to have stockholders’ equity of at least $2,500,000(or satisfy alternative requirements). Failure to comply with these requirements subjects a company tode-listing proceedings.  We receivednotification on March 1, 2004 of a Nasdaq Staff Determination indicatingthat we fail to comply with the Stockholders’ Equity requirement for continuedlisting set forth in Marketplace Rule 4310(c)(2)(B), and that our common stockis, therefore, subject to delisting from the Nasdaq SmallCap Market.  We requested a hearing before a NasdaqListing Qualifications Panel to review the Staff Determination, which stayedthe delisting of our common stock pending the Panel’s decision.  On May 7, 2004 we received a decision fromthe Nasdaq Listing Qualifications Panel to continue the listing of our commonstock on the Nasdaq SmallCap Market pursuant to the following exceptions:  On or about June 1, 2004 we must make apublic filing with the SEC and Nasdaq that included a disclosure that we raised$3,600,000 in additional equity, net of expenses, as well as a description ofthe completed event of transaction(s) that enabled us to satisfy the $2,500,00shareholders’ equity requirements; an affirmative statement that, as of thedate of the report, we believe we have regained compliance with the $2,500,000shareholders; equity requirement based upon the event of transaction(s)referenced therein; and a

 

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disclosure thatthe Panel will continue to monitor our ongoing compliance with the minimumshareholders’ equity threshold until we have evidenced compliance with thatrequirement via a publicly filed balance sheet and demonstrated an ability tosustain compliance with the minimum shareholders’ equity requirement over thelong term.  Therefore, on or beforeAugust 16, and November 15, 2004 we must file Forms 10-Q for thequarters ending June 30, and September 30, 2004, respectively, withthe SEC and Nasdaq, evidencing our continued compliance with the $2,500,000shareholders’ equity requirement. In order to fully comply with the terms ofthis exception, we must be able to demonstrate compliance with all requirementsfor continued listing on the Nasdaq SmallCap Market.  If we are unable to do so, our securities will be delisted fromthe Nasdaq SmallCap Market.  Finally,all companies operating under exceptions are required to issue a press releaseannouncing the conditional listing on The Nasdaq SmallCap Market and are identifiedby a fifth character “C” appended to our trading symbol.  Accordingly, effective with open of businesson May 11, 2004, the trading symbol for our securities was changed from VMTI toVMTIC.  The “C” will be removed from thesymbol upon confirmation of our compliance with the terms of the exception andall other criteria for continued listing.

 

**As acompany, we do not have direct experience in the ownership and management ofhealth care service businesses**.

 

As a company we do not have direct experience in the management ofbariatric surgical programs.  We havebeen involved in the development of bariatric surgical programs since 2000, buthave never directly managed these programs. As such, we have only a limited and indirect operating history uponwhich an evaluation of our prospects can be based.  Our prospects therefore, must be considered in light of therisks, expenses and difficulties frequently encountered by companies in theirearly stages of development, particularly when involved in new and rapidlyevolving markets.  To address theserisks, we must, among other things, respond to competitive developments andattract, retain and motivate qualified staff. There can be no assurance that we will be successful in addressing suchrisks or in implementing our business strategy.  There can be no assurance that we will be able to achieve orsustain revenue growth or profitability.

 

**Roll-outof our VOW Centers depends on our entering into agreements with hospitals andsurgeons; the time to conclude these agreements may be extended and therebydelay or prevent the implementation of our strategy.**

 

We plan to set up our VOW Centers in conjunction with hospitals andsurgeons.  There can be no assurancethat negotiations for the establishment of these Centers will not be protractedor impossible to negotiate satisfactorily. Because of our limited experience in negotiating and concluding theseagreements, we cannot accurately predict the time and expense involved, and anyunexpected delays could prevent the execution of our strategic plan.

 

**We mayneed additional funding for our future operating plans beyond that currentlycontemplated.  These funds may not beavailable on acceptable terms, if at all.**

 

Any deviation in the timing or projected cash flow of our VOW Centersmay cause us to require

 

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additional investment capital. There can be no assurance that such capital will be available to theextent required, or at all.  The amountof additional capital which we may need to raise will depend on many factors,including:

 

•                  the extent towhich the VOW Centers and other services gain market acceptance,

•                  the speed withwhich we can execute our plan;

•                  the levels ofreimbursement for procedures performed; and

•                  the extent ofcompetition.

 

**We havea history of losses and may not become profitable.**

 

Since our formation in July 1993, and as ofMarch 31, 2004, we have incurred cumulative net losses of $69million.  We expect to incur losses forthe foreseeable future.  We may neverachieve or sustain profitability in the future.  Even if we achieve profitability, we may not be able to sustainit on an ongoing basis.

 

**The terms of our March, 2003, preferred stock financing confer seniorrights on the holders of Series A Convertible Preferred Stock, and these rightsmay impair the interests of our common stockholders or impact our results ofoperations.**

 

We issued 1,000,000 sharesof our Series A Convertible Preferred Stock (the “Series A Shares”) in March,2003, which were created pursuant to the terms of a Certificate ofDesignations, for an aggregate of $950,000 in cash.  In connection with this financing, the purchasers of Series AShares were granted several significant rights senior to the rights of holdersof our common stock.  Among otherrights, in the event of a liquidation, dissolution or winding up of our company(including consolidations, mergers or other sales), holders of Series A Shareswill be entitled to receive up to $3.80 per share held by them, in preferenceto any distribution to the holders of common stock.  Also, pursuant to the Certificate of Designations, we must obtainthe consent of the holders of at least two-thirds of the outstanding Series AShares in order to undertake certain actions, including capital expendituresand the issuance of securities. Additionally, for so long as any Series A Shares remain outstandingafter three hundred ninety (390) days following the initial issuance of anySeries A Shares, the holders of Series A Shares will be entitled to elect thegreater of (i) two members of our Board of Directors or (ii) twenty-fivepercent (25%) of the total members of our Board of Directors.  As a result, in the event we do not achievethe criteria necessary for us to redeem some or all of the Series A Shares(e.g., a sale of all or a portion of our Visualization Technology business),the holders of Series A Shares will have the right to control at leastone-fourth of the seats on our Board of Directors.

 

The Series A Shares aresubject to redemption by us upon certain events.  If we choose to redeem some or all of the Series A Sharespursuant to the terms of our Certificate of Designations, we will use cash thatwould otherwise fund our business operations. Although we may believe that such a redemption is the best availablebusiness option, valuable cash would nonetheless be consumed, which wouldimpact our ability to fund operations or grow our business.

 

The holders of Series A Shares are also entitled to require us toregister their shares.  We may be

 

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required to register their shares on Form S-3 within 30 days afterrequest, and in any event prior to four hundred (400) days following theinitial issuance of Series A Shares. This registration will consume management time and effort as well assome cash resources.  We have not yetregistered these shares and may be subject to monetary penalties.

 

**We needto increase market awareness and acceptance of our products and services.**

 

To our company’s knowledge, the comprehensive services offered by ourVOW Solutions business Centers have not been available to date on a nationallevel.  In order to accomplish ourstrategic and business plans, we will have to quickly and effectively increasemarket awareness of our services and convince doctors, hospitals and patientsof the benefits of our services.  Amongother things, this will require that we:

 

•                  increaseawareness of the availability of our services;

•                  strengthen ourbrand name to combat competition;

•                  continue toupgrade and expand our services; and

•                  increaseawareness of the availability of surgery as a means of treating obesity.

 

We intend to make our services available to doctors and hospitalsnationally, which will compound the difficulty of meeting our objectives.  We cannot assure you that we will be able toaccomplish these objectives.

 

**Afterestablishing VOW Centers, we must continue to prove our value proposition.**

 

In order to successfully negotiate and complete agreements with doctorsand hospitals to establish VOW Centers, we will present them with our projectedrevenues and operational metrics.  Wecannot assure you that our projections will prove accurate or that we will beable to provide the anticipated metrics. Our projections are based on limited input and operational history andfailure to meet such projections will negatively impact our business.

 

**Theprovision of health care services is subject to considerable regulation bystate and federal agencies.**

 

The Centers will need to comply with many laws and regulations, bothstate and federal, which govern the provision of health care services.  If they fail to comply with any such lawsand regulations, then the penalties involved could be serious, time-consumingfor management and expensive.    Inexperience in health care services could contribute to an inadvertentbreach of laws or regulations.

 

**Weoperate in a competitive market; new technologies, procedures, orpharmaceuticals could radically change the modality of treatment of morbidobesity and negatively impact the economics of our obesity surgery business**.

 

The market for products and services that address obesity iscompetitive and new offerings and technologies are becoming availableregularly.  We are aware of severaldevelopments, primarily involving nerve stimulation or balloon technology,which may come to the market in the next few

 

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years.  These devices would beimplanted or placed in a relatively simple endoscopic procedure.  If they prove to be more effective thangastric bypass surgery in curing morbid obesity, then the economic structure ofthe industry and the Centers could be negatively impacted.  Also, many pharmaceutical companies areresearching drug therapies for combating obesity.  If they prove successful in finding a more effective solution formorbid obesity than gastric bypass surgery, then demand for surgery is likelyto decline substantially.  We cannotguarantee that we will compete successfully against our current or potentialcompetitors, especially those with significantly greater financial resources orbrand name recognition.

 

**If wefail to retain our key personnel and hire, train and retain additionalqualified and experienced employees, we may not be able to compete effectively,or expand our consulting business and the number of Centers as planned, both ofwhich could result in reduced revenues.**

 

Our future success will depend to a large extent on retaining our coreoperating management team and recruiting sufficient qualified employees tomanage and staff our Centers.  There islikely to be a competitive labor market for such staff and there is noassurance that we will be able to attract and retain an adequate number ofsuitable employees.  If we are unable todo this, then we may not be able to operate and expand our Centers as planned,which may reduce our revenues.

 

To be successful, we must strengthen awareness of our services throughour marketing efforts and through establishment of additional VOW Centers.  We have a limited marketing and businessdevelopment force through which the efforts will be conducted, and we will relyheavily on each of these individuals. We cannot assure you that we will be able to attract and retain sufficientqualified personnel.

 

**Ourfuture financial results will fluctuate significantly.**

 

As a result of our limited operating history, we cannot predict ourfuture revenues or operating results. We do, however, expect our future revenues and operating results tofluctuate due to a combination of factors, including the potential costs ofestablishing VOW Centers.

 

Our future operating expenses are expected to increase in futureperiods as we intend to establish VOW Centers, expand our sales and marketingoperations, expand our service capabilities and improve our internal operatingand financial systems.  In addition, ouroperating expenses are based on our expectations of future revenues, and arerelatively fixed in the short term.  Wemay be unable to adjust spending quickly enough to offset any unexpectedrevenue shortfall.  If we have ashortfall in revenues in relation to our expenses, or if our expenses increasebefore our revenues do, then our business for a particular period would bematerially adversely affected.

 

Because of all of these factors and the other risks discussed in thissection, we believe that our quarterly and annual revenues, expenses andoperating results likely will vary significantly in the future.

 

**Ourliquidity and capital requirements will be difficult to predict.**

 

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In addition to the needs occasioned by our current cash crisis, ourliquidity and capital requirements will depend upon other numerous factors,including the following:

 

•                  The extent towhich our products and services gain market acceptance;

 

•                  Costs associatedwith establishing marketing, and operating our Obesity Surgery and MedicalManagement Services Business and other related programs;

 

•                  The progress andscope of product evaluations;

 

•                  The timing andcosts of filing future regulatory submissions;

 

•                  The timing andcosts required to receive both domestic and international governmentalapprovals;

 

•                  The timing andcosts of product and services introductions;

 

•                  The extent ofour ongoing research and development programs;

 

•                  The costs ofsponsorship training of the physicians to become proficient in the use of ourproducts and procedures; and

 

•                  The costs ofdeveloping marketing and distribution capabilities.

 

Even if we are successful in raising additional funds, circumstances,including slow rate of market acceptance of our products or our inability toscale up manufacturing, would accelerate our use of proceeds from any offeringwe might do and require us to seek additional funds to support our operatingrequirements.

 

**Ourfailure to effectively manage our growth could have a material adverse effecton our business.**

 

Growth in our business will place a significant strain on ourmanagement systems and resources.  We willneed to continue to improve our operational and financial systems andmanagerial controls and procedures, and we will need to continue to expand,train and manage our workforce.  Weexpect that the number of our employees will continue to increase for theforeseeable future.  We will have tomaintain close coordination among our technical, accounting, finance, marketingand sales departments.

 

**Wedepend on our intellectual property for the establishment and operation of ourVOW Centers.**

 

We rely on a combination of trade secrets, know-how and confidentialityrestrictions for the establishment and operation of our VOW Centers.  We have expended significant effortsdevising the types of products and services we will offer and the manner inwhich these will be delivered.  Ourability to maintain the secrecy and confidentiality of our trade secrets andinternal knowledge are crucial to the success of our business.  Any failure to do so may negatively impactour prospects.

 

**When we dispose of our Visualization Technology business, our futuresuccess will depend solely on our ability to establish and grow our obesitysurgery management business.**

 

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The sale of ourVisualization Technology business closed on April 15, 2004 and our futuresuccess as a company will depend on our ability to execute on the establishmentand growth of our Obesity Surgery Management Services business.  As a company, we have limited experience inthe provision of surgical services.  Wewill also be required to build this business from a relatively small base,finding partners and surgeons willing to participate.  We cannot assure you that we will be able to build a successfulservices business in the long term.

 

**We havelimited experience directly marketing our services overseas and may not besuccessful in expanding into international markets without experienced partners**

 

We have limited experience in directly marketing our servicesoverseas.  Changes in overseas economicconditions, currency exchange rates, foreign tax laws or tariffs or other traderegulations could negatively impact our business.  The anticipated international nature of our business is alsoexpected to subject our representatives, agents and distributors to laws andregulations of the foreign jurisdictions in which they operate or in which ourservices are sold, including laws regulating manufacture and sale of medicaldevices.  In addition, the laws of someforeign countries do not protect our intellectual property rights to the sameextent as do the laws of the United States.

 

**We maybe subject to product liability claims and have limited insurance coverage.**

 

We face an inherent and significant business risk of exposure toproduct liability claims in the event that the use of our products results inpersonal injury or death.  Also, in theevent that any of our products proves to be defective, we may be required torecall or redesign such products.  Ourcurrent product liability insurance coverage limit is $10.0 million peroccurrence and in the aggregate.  Ourcoverage limits may not be adequate to protect us from any liabilities we mightincur in connection with the development, manufacture and sale of our products.  In addition, increased product liabilitycoverage may be required if additional products are used in clinicalevaluations or successfully commercialized. Product liability insurance is expensive and in the future may not beavailable to us on acceptable terms, if at all.  A successful product liability claim or series of claims broughtagainst us in excess of our insurance coverage or a product recall wouldnegatively impact our business.

 

**If weare unable to protect our intellectual property, we may be unable to preventother companies from using our technology in competitive products.**

 

Our future success will depend, in part, on our ability to continuedeveloping patentable products, enforcing our patents and obtaining patentprotection for our products both in the United States and in othercountries.  The patent positions ofmedical device companies, however, are generally uncertain and involve complexlegal and factual questions.  Patentsmay never issue from any patent applications owned by or licensed to us.  Even if patents do issue, the claims allowedmay not be sufficiently broad to protect our technology.  In addition, issued patents owned by orlicensed to us may be challenged, invalidated or circumvented, or the rightsgranted thereunder may not provide us with competitive advantages.

 

The medical device industry has been characterized by extensivelitigation regarding patents and

 

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other intellectual property rights. Litigation, which would result in substantial expense, may be necessaryto enforce any patents issued or licensed to us and/or to determine the scopeand validity of proprietary rights of third parties or whether our products,processes or procedures infringe any such third-party proprietary rights.  We may also have to participate in interferenceproceedings declared by the United States Patent and Trademark Office, whichcould result in substantial expense, to determine the priority of inventionscovered by our issued United States patents or pending patent applications.  Furthermore, we may have to participate atsubstantial cost in International Trade Commission proceedings to enjoinimportation of products which would compete unfairly with our products.  Any adverse outcome of any patent litigation,including interference proceedings, could subject us to significant liabilitiesto third parties, require disputed rights to be licensed from or to thirdparties or require us to cease using the technology in dispute.  Any such licenses may not be available onacceptable terms, if at all. Furthermore, parties making such claims may be able to obtain injunctiveor other equitable relief that could effectively block our ability to make,use, sell or otherwise practice our intellectual property, whether or notpatented or described in pending patent applications, or to further develop orcommercialize our products in the United States and abroad and could result inthe award of substantial damages. Defense of any lawsuit or failure to obtain any such license coulddamage our business.

 

In addition to patents, we rely on unpatented trade secrets to protectour proprietary technology.  Others mayindependently develop or otherwise acquire the same or substantially equivalenttechnologies or otherwise gain access to our proprietary technology or disclosethis technology.  It is difficult toprotect rights to unpatented proprietary technology.  Third parties may obtain patent rights to these unpatented tradesecrets, which patent rights could be used to assert infringement claimsagainst us.  We also rely onconfidentiality agreements with our collaborators, employees, advisors, vendorsand consultants to protect our proprietary technology.  These agreements may be breached, we may nothave adequate remedies for any breach and our trade secrets may otherwisebecome known or be independently developed by competitors.  In addition, our agreements with employeesand consultants require disclosure of ideas, developments, discoveries orinventions conceived during employment or consulting, as the case may be, andassignment to us of proprietary rights to such matters related to our businessand technology.  The extent to whichefforts by others will result in patents and the effect on us of the issuanceof such patents is unknown.

 

**We havelicensed some aspects of our products from third parties and may lose therights to these essential aspects under the agreements which govern thoserelationships.**

 

We have licensed some aspects of our technology from thirdparties.  The rights under the governingagreements may be terminated if we breach our obligations or in othercircumstances. Our failure to retain rights to these licensed rights couldnegatively impact our business.  Foradditional information concerning the agreements which govern theserelationships, please see “Business—Strategic Alliances” and “Business –Licenses.”

 

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**If weare not able to attract and retain key management and technical personnel anddoctors to participate in our advisory boards, it may adversely affect ourability to obtain financing or develop our products.**

 

Our future business and operating results depend in significant partupon the continued contributions of our key management and technical personnel,many of whom would be difficult to replace and some of whom perform importantfunctions beyond those suggested by their job titles or descriptions.  Our business and future operating resultsalso depend in significant part upon our ability to attract and retainqualified management, manufacturing, technical, marketing and sales and supportpersonnel for our operations. Competition for such personnel is intense, and we may not be successfulin attracting or retaining such personnel.

 

Members of our clinical advisory boards consult with us exclusively butare free to consult with other non-competing companies and are employedelsewhere on a full-time basis.  As aresult, they only spend a limited amount of time on our business.  Although we have entered into consultingagreements, including confidentiality provisions with each of the members ofour clinical advisory boards, the consulting and confidentiality agreementsbetween us and each of the members of our clinical advisory boards may beterminated or breached.

 

**Ourstock price could continue to be volatile and your investment in our commonstock could suffer a decline in value, adversely affecting our ability to raiseadditional capital.**

 

The market prices and trading volumes for securities of emergingcompanies, like ours, have historically been highly volatile and haveexperienced significant fluctuations unrelated to the operatingperformance.  The market price of ourcommon stock has historically been highly volatile and may be significantlyaffected by factors such as:

 

•                                          actualor anticipated fluctuations in our operating results,

 

•                                          ourability to remain listed on Nasdaq,

 

•                                          changesin financial estimates by securities analysts,

 

•                                          announcementsof technological innovations,

 

•                                          newproducts or new contracts by us or our competitors,

 

•                                          regulatoryannouncements,

 

•                                          developmentswith respect to patents or proprietary rights,

 

•                                          conditionsand trends in the medical device and other technology industries,

 

•                                          adoptionof new accounting standards affecting the medical device industry, and

 

•                                          generalmarket conditions.

 

In addition, the stock market has from time to timeexperienced significant price and volume fluctuations that have particularlyaffected the market prices for shares of early stage companies.  These broad market fluctuations mayadversely affect the market price of our common stock.  In the past, following periods of volatilityin the market price of a particular company’s securities, securities classaction litigation has often been brought against that company.  Such litigation, if brought against us,could result in substantial costs and a diversion

 

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of management’s attention and resources.

 

**There is a limited marketfor our common stock and therefore investors may not be able to liquidate theirinvestment in the foreseeable future, if at all.**

** **

There is a limited market for our common stock even though it ispublicly quoted, and the market is not expected to increase significantly inthe foreseeable future.  The units andthe common stock into which those units are convertible will constituterestricted securities under U.S. federal and applicable state securitieslaws.  As such, they may not betransferred, sold or otherwise disposed of in the United States, except aspermitted under U.S. federal and state securities laws pursuant to aregistration or an exemption from registration.  Investors should be prepared to hold our common stock for anindefinite period.  An investment in ourcompany is highly speculative, and an investor should be able to withstand atotal loss of the investment.

 

**Our charter documents may prevent us from participating intransactions that could be beneficial to you.**

 

Our charter documents contain provisions thatmay make it more difficult or discourage a change in control.  This may adversely affect the market priceof our common stock.

 

Item 4. Controls and Procedures

 

(a)            Evaluation ofdisclosure controls and procedures

 

Underthe supervision and with the participation of our management, including ourchief executive officer and chief financial officer, we evaluated theeffectiveness of our disclosure controls and procedures (as such term isdefined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended(the “Exchange Act”)) as of the end of the period covered by this report. Basedon such evaluation, our chief executive officer and chief financial officerhave concluded that, as of the end of such period, our disclosure controls andprocedures are effective in recording, processing, summarizing and reporting,on a timely basis, information required to be disclosed by us in the reportsthat we file or submit under the Exchange Act.

 

(b)           Changes in internalcontrols of our financial reporting

 

There have not been any changes in our internalcontrols over financial reporting (as such term is defined in Rule 13a-15(f)under the Exchange Act) during our first fiscal quarter that have materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

 

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PART II.  OTHER INFORMATION

 

Item 1.             LegalProceedings

 

From time to time, we may be involved in litigationrelating to claims arising out of our operations in the normal course of business.  We are currently not a party to anylitigation that could have a material adverse effect on our results ofoperations or the financial position of our business.

 

Item 2.             Changesin Securities and Use of Proceeds

 

a.                    Not applicable

 

b.                   Not applicable

 

c.                    In February, 2004, we sold 439,000 shares ofcommon stock in a private placement to a group of accredited investors forgross proceeds of $588,000.  Inconnection with this, we issued to the purchasers warrants to purchase up to219,500 shares of common stock at an exercise price of $2.97 per share.  These securities were issued and sold inreliance on Section 4(2) of the Securities Act of 1933, as amended, andRule 506 of Regulation D promulgated thereunder, as a sale by the Company notinvolving a public offering. No underwriters were involved with the issuanceand sale of these securities

 

d.                   Not applicable

 

Item 3.             Defaults upon Senior Securities

 

None.

 

Item 4.             Submissionof Matters to a Vote of Security Holders

 

Onor about March 25, 2004, we circulated a proxy statement to stockholdersin connection with a special meeting of stockholders held on April 15,2004.  That meeting was held for thepurpose of approving the sale of our Visualization Technology business toViking Systems, Inc.  This sale wasapproved by our stockholders.

 

Item 5.             OtherInformation

 

None.

 

Item 6.             Exhibitsand Reports on Form 8-K

 

A)      Exhibits

 

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|   | 3.1 (1) |                                                                     | Second Restated Certificate of Incorporation                              |
|--------|---------|--------------------------------------------------------------------------|---------------------------------------------------------------------------|
|   | 3.2 (2) |                                                                     | Certificate of Amendment of Second Restated  Certificate of Incorporation |
|   | 3.3 (3) |                                                                     | Certificate of Designations of Series A Convertible  Preferred Stock      |
|   | 3.4 (1) |                                                                     | Restated Bylaws                                                           |
|   | 4.1 (4) |                                                                     | Form of Certificate for Common Stock                                      |
| 31*    |    | Certifications under Section 302 of the  Sarbanes-Oxley Act of 2002 |
| 32*    |    | Certification under Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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* Filed herewith

 
| (1)    |   | Incorporated by reference to our Registration  Statement on Form S-1, as amended, filed March 7, 1997.   |
|--------|--------|---------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                          |
| (2)    |   | Incorporated by reference to our Form 10-Q filed on  November 14, 2001.                                  |
|   |   |                                                                                                          |
| (3)    |   | Incorporated by reference to our Form 10-K, filed  March 31, 2003                                        |
|   |   |                                                                                                          |
| (4)    |   | Incorporated by reference to our Registration  Statement on Form S-1, as amended, Filed on July 2, 1997. |

 

B)      Reports on Form 8-K

 

1. On March 8, 2004, we filed a form 8-K relatingto the completion of a private placement of shares of our common stock.

 

2. On March 9, 2004, we finished a Form 8-K,which attached a press release relating to our financial information for thethree month’s ended and year ended December 31, 2003.

 

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SIGNATURES

 

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

 

 
|   | VISTA MEDICAL TECHNOLOGIES,INC.              |
|--------|----------------------------------------------|
|   |                                         |
|   |                                         |
| Date:  | May 13, 2004                                 |   | /s/ John R. Lyon |   |
|   | John R. Lyon                                 |
|   | President, Chief Executive Officer and       |
|   | Director                                     |
|   |                                         |
| Date:  | May 13, 2004                                 |   | /s/ Stephen A. Gorgol |   |
|   | Stephen A. Gorgol                            |
|   | Vice President of Finance ,Chief Financial   |
|   | Officer and Secretary                        |
|   | (Principal financial and accounting officer) |
|        |                                              |  |  |  |  |

 

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