<PAGE>

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q

(Mark One)

[X]           QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934
                FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999

                                       OR

[ ]           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 registrant as specified in its charter)


         DELAWARE                                               94-3184035
(State or other jurisdiction of                              (I.R.S. Employer
incorporation or organization)                               Identification No.)

                          5451 AVENIDA ENCINAS, SUITE A
                               CARLSBAD, CA 92008
                    (Address of principal executive offices)
                                 (760) 603-9120
                (Registrant's phone number, including area code)
                ------------------------------------------------


INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS) AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS:

                       (1)      YES [X]        NO [ ]
                       (2)      YES [X]        NO [ ]

As of November 10, 1999 there were 13,785,062 shares of $.01 par value common
stock outstanding.

<PAGE>

                        VISTA MEDICAL TECHNOLOGIES, INC.
                                    FORM 10-Q
                                TABLE OF CONTENTS



PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

        Consolidated Balance Sheets ..........................................3
        Consolidated Statements of Operations.................................4
        Consolidated Statements of Cash Flows ................................5
        Notes to Consolidated Financial Statements ...........................6

Item 2. Management's Discussion and Analysis
        of Financial Condition and Results of Operations .....................8

Item 3. Quantitative and Qualitative Disclosures About Market Risk ...........12

Risks and Uncertainties.......................................................13

PART II.  OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K......................................27

SIGNATURES....................................................................28


                                       2
<PAGE>

PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements

                        Vista Medical Technologies, Inc.
                           Consolidated Balance Sheets

<TABLE>
<CAPTION>
                                                                                    September 30, 1999     December 31, 1998
                                                                                    ------------------     -----------------
                                                                                        (Unaudited)
<S>                                                                                 <C>                    <C>
ASSETS
Current assets:
    Cash and cash equivalents ......................................................     $  2,060,297          $  7,625,804
    Short-term investments & securities available for sale .........................          293,576             1,176,800
    Accounts receivable ............................................................        1,055,251               752,233
    Inventories ....................................................................        4,251,544             4,354,338
    Other current assets ...........................................................          221,335               157,443
                                                                                         ------------          ------------
Total current assets ...............................................................        7,882,003            14,066,618
Property and equipment, net ........................................................        1,489,758             2,056,535
Patents and other assets ...........................................................          330,786               481,594
                                                                                         ------------          ------------
TOTAL ASSETS .......................................................................     $  9,702,547          $ 16,604,747
                                                                                         ------------          ------------
                                                                                         ------------          ------------

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Accounts payable ...............................................................     $  1,224,558          $    552,441
    Accrued compensation ...........................................................          193,023               300,807
    Accrued liabilities ............................................................        1,497,184             1,085,009
                                                                                         ------------          ------------
Total current liabilities ..........................................................        2,914,765             1,938,257

Commitments
Stockholders' equity:
    Convertible preferred stock, $.01 par value:
        Authorized shares - 5,000,000
        Issued and outstanding shares - no shares outstanding
           on December 31, 1998 or September 30, 1999 ..............................               --                    --
    Common stock, $.01 par value:
        Authorized shares - 35,000,000
        Issued and outstanding shares - 13,572,101 on
            December 31, 1998 and 13,782,362 on September 30, 1999 .................          137,824               135,721
        Additional paid-in capital .................................................       62,942,407            62,856,201
        Notes receivable from stockholders .........................................          (78,375)              (78,375)
        Deferred compensation ......................................................         (661,571)           (1,030,420)
        Unrealized gain/(loss) on investments ......................................                0                 1,211
        Accumulated deficit ........................................................      (55,552,503)          (47,217,848)
                                                                                         ------------          ------------
Total stockholders' equity .........................................................        6,787,782            14,666,490
                                                                                         ------------          ------------
TOTAL LIABILITIES AND STOCKHOLDERS'
    EQUITY .........................................................................     $  9,702,547          $ 16,604,747
                                                                                         ------------          ------------
                                                                                         ------------          ------------
</TABLE>


Note: The balance sheet at December 31, 1998 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
                             See accompanying notes


                                       3
<PAGE>

                        VISTA MEDICAL TECHNOLOGIES, INC.
                      Consolidated Statements of Operations
                                   (Unaudited)

<TABLE>
<CAPTION>

                                               Three Months Ended September 30,        Nine Months Ended September 30,
                                               --------------------------------        -------------------------------
                                                   1999                1998                1999               1998
                                               ------------        ------------        ------------       ------------
<S>                                            <C>                 <C>                 <C>                <C>
Sales .....................................    $  1,649,012        $  1,324,639        $  3,839,676       $  5,638,880
Cost and expenses:
    Cost of sales .........................       1,553,614           1,388,977           4,786,482          4,997,012
    Research and development ..............         748,357           1,173,766           2,745,359          4,361,091
    Sales and marketing ...................         586,633           1,242,488           2,479,365          4,688,272
    General and administrative ............         484,769           1,062,779           1,719,743          3,922,412
    Restructuring expense .................         690,269                  --             690,269            939,919
                                               ------------        ------------        ------------       ------------
Total cost and expenses ...................       4,063,642           4,868,010          12,421,218         18,908,706
                                               ------------        ------------        ------------       ------------

Loss from operations ......................      (2,414,630)         (3,543,371)         (8,581,542)       (13,269,826)

Interest income ...........................          38,445             181,256             196,262            764,302

Other gains/(losses) ......................              --             (24,090)             50,625           (662,090)
                                               ------------        ------------        ------------       ------------

Net loss ..................................    $ (2,376,185)       $ (3,386,205)       $ (8,334,655)      $(13,167,614)
                                               ------------        ------------        ------------       ------------
                                               ------------        ------------        ------------       ------------

Basic and diluted loss per share ..........    $      (0.17)       $      (0.25)       $      (0.61)      $      (0.99)
                                               ------------        ------------        ------------       ------------
                                               ------------        ------------        ------------       ------------

Shares used in computing basic and
    diluted loss per share ................      13,655,734          13,342,758          13,565,711         13,283,583
</TABLE>
                             See accompanying notes


                                       4
<PAGE>

                        VISTA MEDICAL TECHNOLOGIES, INC.
                      Consolidated Statements of Cash Flows
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                                   Nine Months Ended September 30,
                                                                                  ---------------------------------

                                                                                         1999              1998
                                                                                     ------------      ------------
<S>                                                                               <C>                  <C>
OPERATING ACTIVITIES
Net loss .....................................................................       $ (8,334,655)     $(13,167,614)
Adjustments to reconcile net loss to net cash used for
    operating activities:
        Depreciation and amortization ........................................            755,706         1,490,747
        Amortization of premium on short term investments ....................               (301)          124,320
        Amortization of deferred compensation ................................            368,849           675,914
        Loss on disposal of fixed assets .....................................                 --           290,410
        Write down for impairment on available for sale securities ...........                 --           662,090
        Changes in operating assets and liabilities,
            net of effect of acquisitions:
                Accounts receivable ..........................................           (303,018)       (1,093,923)
                Inventories ..................................................            102,795        (1,392,713)
                Other current assets .........................................             57,018           301,363
                Accounts payable .............................................            672,118          (539,503)
                Accrued compensation .........................................           (107,784)         (134,461)
                Accrued liabilities ..........................................            412,174           665,505
                                                                                     ------------      ------------
Net cash flows used for operating activities .................................         (6,377,098)      (12,117,865)

INVESTING ACTIVITIES
Purchases of short-term investments ..........................................           (117,687)       (2,140,526)
Maturities of short-term investments .........................................          1,000,000        13,200,196
Purchase of property and equipment ...........................................           (159,031)         (842,861)
                                                                                     ------------      ------------
Net cash flows provided by (used for) investing activities ...................            723,282        10,216,809

FINANCING ACTIVITIES
Issuance of common stock .....................................................             88,309           263,608
                                                                                     ------------      ------------
Net cash flows provided by (used in) financing activities ....................             88,309           263,608
Net (decrease) increase in cash and cash equivalents .........................         (5,565,507)       (1,637,448)
Cash and cash equivalents at beginning of period .............................          7,625,804         7,328,502
                                                                                     ------------      ------------
Cash and cash equivalents at end of period ...................................       $  2,060,297      $  5,691,054
                                                                                     ------------      ------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest .......................................................       $          0      $        769
                                                                                     ------------      ------------
                                                                                     ------------      ------------
</TABLE>

                             See accompanying notes


                                       5
<PAGE>

                        VISTA MEDICAL TECHNOLOGIES, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)


1.   Basis of Presentation

     The Audited Financial Statements of Vista Medical Technologies, Inc. (the
"Company") and the notes thereto for the year ended December 31, 1998 included
in the Company's Annual Report on Form 10-K filed with the Securities and
Exchange Commission, contain additional information about the Company, its
operations, and its financial statements and accounting practices, and should be
read in conjunction with this quarterly report on Form 10-Q. These unaudited
consolidated financial statements have been prepared in accordance with
generally accepted accounting principles and with the instructions on Form 10-Q
except that certain information and footnote disclosures normally contained in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted.

     The Company believes that its existing cash, cash equivalents and
short-term investments of $2.4 million as of September 30, 1999, together with
anticipated product revenues and interest income, will be sufficient to meet its
anticipated capital requirements through January 2000. Substantial additional
capital resources will be required to fund continuing expenditures related to
the Company's manufacturing, commercialization of new products, and research and
development beyond that point. However, there can be no assurance that the
requisite fundings will be consummated in the necessary time frame or on terms
acceptable to the Company. No provision has been made in the accompanying
financial statements to write down assets to a liquidation value should the
Company be forced to quickly liquidate its assets, and these assets are carried
at a value that presumes the Company will continue as a going concern. The
realizability of the assets at their current book value is heavily dependent
upon obtaining the additional financing to permit the Company to continue
operations.

     The accompanying unaudited consolidated financial statements of the Company
reflect all adjustments of a normal recurring nature which are, in the opinion
of management, necessary for a fair presentation of the financial position,
results of operations and cash flows for all periods presented. The interim
financial information contained herein is not necessarily indicative of results
for any future interim periods or for the full fiscal year ending December 31,
1999.


                                       6
<PAGE>

                        VISTA MEDICAL TECHNOLOGIES, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)


2.   Inventories

<TABLE>
<CAPTION>
                                       September 30, 1999    December 31, 1998
                                       ------------------    -----------------
                                           (Unaudited)
<S>                                    <C>                   <C>
Parts and materials ............           $ 3,185,297          $ 3,913,529
Work in process ................             1,276,371              334,812
Finished goods .................             1,457,182            1,039,997
                                           -----------          -----------
                                             5,918,850            5,288,338

Less: reserves                              (1,667,306)            (934,000)
                                           -----------          -----------
                                           $ 4,251,544          $ 4,354,338
                                           -----------          -----------
                                           -----------          -----------
</TABLE>


                                       7
<PAGE>

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

     THIS QUARTERLY REPORT MAY CONTAIN PREDICTIONS, ESTIMATES AND OTHER
FORWARD-LOOKING STATEMENTS THAT INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES,
INCLUDING THOSE DISCUSSED BELOW AT "RISKS AND UNCERTAINTIES." WHILE THIS OUTLOOK
REPRESENTS OUR CURRENT JUDGMENT ON THE FUTURE DIRECTION OF OUR BUSINESS, SUCH
RISKS AND UNCERTAINTIES COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM ANY
FUTURE PERFORMANCE SUGGESTED BELOW. WE UNDERTAKE NO OBLIGATION TO RELEASE
PUBLICLY THE RESULTS OF ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TO
REFLECT EVENTS OR CIRCUMSTANCES ARISING AFTER THE DATE OF THIS QUARTERLY REPORT.
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED
FINANCIAL STATEMENTS AND THE NOTES THERETO INCLUDED IN ITEM 1 OF THIS QUARTERLY
REPORT ON FORM 10-Q AND OUR 1998 ANNUAL REPORT ON FORM 10-K, FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION.

OVERVIEW OF OUR BUSINESS

     We develop, manufacture and market products that provide information to
doctors performing minimally invasive heart, head, neck and spine, general
surgical and other selected microsurgical procedures. We also market endoscopic
cameras and have generated minimal revenues from the sales of our products since
our formation in July 1993. We expect to continue to incur substantial losses
for at least the next 9-12 months. As of September 30, 1999, our accumulated
deficit was approximately $55,553,000. We are not certain that our development
efforts will result in commercially available products, that we will be
successful in introducing the products under development, or that required
regulatory approval of products will continue to be obtained in a timely manner,
if at all.

     At December 31, 1998 and September 30, 1999, we had 76 and 30 employees,
respectively. On July 14, 1999, we announced that we had taken steps to reduce
staffing levels and operating expenses to reduce cash burn and conserve capital.
We expect staffing levels to stabilize at this level for approximately the next
12 months. Our expectation is based on the fact that significant development
work on our core platform technology is now complete and on strategic decisions
to partner rather than develop an independent distribution capability.

OUR RESULTS OF OPERATIONS

     Sales. We had revenue from product sales of $1,649,000 and $3,840,000 for
the three-and nine- months ended September 30, 1999, respectively, compared to
revenues from product sales and distribution fees of $1,325,000 and $5,639,000
for the same periods in 1998. The increase in revenues for the three-month
period was due to higher sales of OEM products including sales to a second OEM
customer during the 1999 period. The decrease for the nine-month period was due
to a reduction in sales of StereoSite systems and associated distribution fees
paid by Sofamor Danek, our distributor in the head, neck and spine market, and a
reduction


                                       8
<PAGE>

in sales of our Series 8000 Advanced Visualization and Information System
("Series 8000") for minimally invasive cardiac surgery during the 1999 periods
compared to the corresponding periods of 1998. These were partially offset by
higher sales of OEM products, including deliveries to a second OEM customer
during the second and third quarter of 1999, by product deliveries to a second
distributor for the head, neck and spine ("AHNS") market during the second
quarter of 1999, and by product sales to OEC Medical for the medical imaging
market during the 1999 periods.

     Cost of Sales. Our cost of sales were $1,554,000 and $4,786,000 for the
three- and nine-months ended September 30, 1999, respectively, and $1,389,000
and $4,997,000 for the three- and nine-months ended September 30, 1998,
respectively. The increase for the three-month period ended September 30, 1999
was primarily due to higher product sales levels during the 1999 period as
compared to 1998, partially offset by a reduction in manufacturing overhead
expenses during the 1999 period. The decrease for the nine-month period was
primarily due to lower product sales levels during the 1999 period, a reduction
in manufacturing overhead expenses during 1999 and no costs related to the
launch of the StereoSite product in 1999 as compared to 1998, partially offset
by inventory reserves added during the second quarter of 1999.

     Research and Development Expenses. Our research and development expenses
were $748,000 and $2,745,000 for the three- and nine-months ended September 30,
1999, respectively, compared to $1,174,000 and $4,361,000 for the corresponding
periods in 1998. The decrease in research and development expenses for both the
three- and nine- month periods was primarily attributable to decreases in
staffing and related supply and occupancy costs and a decrease in contract
services related to development efforts. We anticipate our spending in research
and development will be at or below current levels the next several quarters as
we near completion of our product for the general surgery market and as a result
of a recently completed restructuring (described below) as we seek to conserve
cash.

     Sales and Marketing Expenses. Our sales and marketing expenses were
$587,000 and $2,479,000 for the three- and nine-months ended September 30, 1999,
respectively, and $1,242,000 and $4,688,000 for the three- and nine-months ended
June 30, 1998, respectively. The decrease in sales and marketing expenses for
both the three- and nine-month periods reflects the transition of all sales,
marketing and distribution efforts associated with our Series 8000 for minimally
invasive cardiac surgery in the United States to Medtronic following an
agreement announced at the end of June 1998 and a reduction in staffing and
related expenses as a result of a recently completed restructuring. We expect
our sales and marketing expenses to decline over the next several quarters as a
result of the restructuring as we seek to conserve cash.

     General and Administrative Expenses. Our general and administrative
expenses were $485,000 and $1,720,000 for the three- and nine-months ended
September 30, 1999, respectively, compared to $1,063,000 and $3,922,000 for the
corresponding periods in 1998. The decrease for both the three- and nine-month
periods was primarily due to a reduction in staffing and related expenses, a
reduction in deferred compensation expense and lower


                                       9
<PAGE>

professional, legal and consulting service fees. We expect our general and
administrative expenses to remain at or near current levels for the next several
quarters as a result of a recently completed restructuring and as we seek to
conserve cash.

     Restructuring Expenses. We had charges associated with restructuring
expenses of $690,000 for both the three- and nine-months ended September 30,
1999, no restructuring expenses during the three-months ended September 30,
1998, and restructuring expenses of $940,000 during the nine-month period ended
September 30, 1998. The restructuring expenses during the 1999 periods relate to
a decision to close part of our facilities in Westborough, MA after a
significant reduction in our workforce during the course of the third quarter of
1999 and represents the value of continuing lease obligations of the facilities.
The restructuring expenses in the 1998 periods related primarily to termination
and severance payments to employees in connection with transfer of sales and
marketing responsibility in the U.S. for our Series 8000 System for minimally
invasive cardiac surgery to Medtronic, Inc., termination and severance payments
to employees in connection with a general Company restructuring and work force
reduction, and write down of assets related to a strategic decision to
discontinue distribution of a line of cardiac instruments and sutures earlier
than previously planned.

     Interest Income. Our net interest income was $38,000 and $196,000 for the
three- and nine-month periods ended September 30, 1999, respectively, compared
to $181,000 and $764,000 for the corresponding periods in 1998. This decrease
for both the three- and nine-month periods was due primarily to decreasing
average investment balances of our excess cash.

     Other Gains and Losses. We had no other gains for the three-month period
ended September 30, 1999, and other gains of $51,000 for the nine-month period
ended September 30, 1999, compared to other losses of $24,000 and $662,000 for
the three- and nine-month periods ended September 30, 1998, respectively. The
gain for the nine-month period ended September 30, 1999 relates to sale of
securities we received in connection with an earlier license agreement signed in
1996 with Imagyn Medical Technologies, Inc. (formerly Urohealth Systems, Inc.),
while the losses in both the three- and nine-month periods ended September 30,
1998 relate to recognition of a permanent reduction in value of those
securities.

LIQUIDITY AND CAPITAL RESOURCES

     We anticipate that our existing cash, cash equivalents and short-term
investments, and product revenues, will be sufficient to fund our operations
through January 2000, as a result of reductions in our workforce and other
operating expenses completed during the third quarter of 1999. Substantial
additional capital resources will be required to fund continuing expenditures
related to manufacturing, commercialization of new products, and research and
development beyond that point. There can be no assurance that the requisite
fundings will be consummated in the necessary time frame or on terms acceptable
to us. Should we be unable to raise sufficient funds, we may be required to
curtail our operating plans and possibly relinquish rights to portions of our
technology or products.


                                       10
<PAGE>

     Net cash used in operating activities for the nine-months ended September
30, 1999 was $6,377,000 compared to net cash used of $12,118,000 for the
corresponding nine-month period in 1998. The decrease in net cash used in
operating activities was primarily attributable to decreasing net losses and
lower accounts receivable balances and inventory purchases during the 1999
period partially offset by lower non-cash expense for depreciation and
amortization and no customer advance payments in 1999 compared to 1998.

     Net cash provided by investing activities was $723,000 for the nine-months
ended September 30, 1999 compared to $10,217,000 of net cash provided in the
same period in 1998. The decrease in net cash provided by investing activities
in 1999 was primarily attributable to declining balances of short term
investments reaching maturity partially offset by decreasing purchases of
property and equipment.

     Net cash provided by financing activities was $88,000 for the nine-months
ended September 30, 1999 compared to $264,000 for the same period in 1998. The
decrease in net cash provided by financing activities during the 1999 period was
primarily attributable to a reduction in purchases of stock by employees through
our employee stock purchase plan and a lower level of stock option exercises.

YEAR 2000

     We recognize the need to ensure our operations will not be adversely
impacted by the inability of our systems to process data having dates on or
after January 1, 2000 (the "Year 2000" issues). Processing errors due to
software failure arising from calculations using the Year 2000 date are a
recognized risk. We are currently addressing the risk, with respect to the
availability and integrity of our financial systems and the reliability of our
operating systems, and are in communication with suppliers, customers, financial
institutions and others with whom we conduct business transactions to
continually assess whether they are Year 2000 compliant.

     We established a Year 2000 Compliance Team in 1998 made up of members of
all of our company's functional organizations and our implementation of a full
Year 2000 Compliance Program is ongoing. Our Chief Financial Officer is the
officer responsible for the Year 2000 Compliance Program and the individual who
leads the Year 2000 Compliance Team reports directly to the Chief Financial
Officer.

     Central to our Year 2000 Compliance Program is a matrix we have developed
of all of our operations and business activities. This matrix which is
constantly updated provides the status of all of our Year 2000 Compliance
efforts in terms of level of assessment, conversion, testing, and completion and
identifies responsibility for each item. In this way, we are able to prioritize
our efforts and provide visibility of the Compliance Program to all Compliance
Team members and management.

     Thus far we have completed the assessment phase of all of our operations
and business activities. We have determined that our products are Year 2000
compliant and during the second


                                       11
<PAGE>

quarter of 1999 completed conversion, testing and implementation of all
remaining non compliant mission critical business systems. During the first
quarter of 1999 we installed a year 2000 compliant version of our business
enterprise software and completed the majority of the testing required of the
system. During the second quarter of 1999 we completed testing of the system and
were fully operational on it by the end of June 1999.

     During the third quarter we began converting the remaining, less critical
systems, which were non-Year 2000 compliant. Examples of these include certain
older desktop computers and applications software. This involved mainly
replacing the older versions withYear 2000 compliant ones which were readily
available, in most cases from internal sources at no additional cost to us. This
activity is now complete. We also have contracted with an information technology
consulting group to perform an independent review of Year 2000 remediation
performed internally and to make any adjustments necessary.

     During the third quarter we also began establishing contingency plans to
deal with unknown problems or events which may occur such as supplier Year 2000
problems, unforseen business system failures, or product failures. We will be
implementing and refining these plans during the fourth quarter. These plans
include such things as identifying alternative sources or buying in excess of
current requirements for critical inventory components, having information
technology professionals on call to deal with potential business system
failures, and having management and engineering staff available to deal with
product or business issues which may arise.

     We currently estimate that the cost of the Year 2000 initiative will not
exceed $150,000, a portion of which, such as the business enterprise software,
was scheduled for upgrade irrespective of the Year 2000 issue and approximately
$45,000 of which was expended in 1998. Additionally, approximately $65,000 was
expended in the first three quarters of 1999 for a total of approximately
$110,000 expended to-date. We do not, therefore, expect the Year 2000 initiative
to be material to our results of operations or financial position.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     At September 30, 1999, our investment portfolio included fixed-income
securities of $2.3 million. These securities are subject to interest rate risk
and will decline in value if interest rates increase. Due to the short duration
of our investment portfolio, an immediate 10 percent increase in interest rates
would have no material impact on our financial condition or results of
operations.

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

                                       12

<PAGE>

RISKS AND UNCERTAINTIES

     You should consider the following factors carefully in evaluating an
investment in our common stock in addition to the other information in this
report. We caution you that the statements in this quarterly report that are not
descriptions of historical facts may be forward-looking statements that are
subject to risks and uncertainties. Our actual results could differ materially
from those currently anticipated due to a number of factors, including those
identified in this section and elsewhere in this prospectus. We undertake no
obligation to release publicly the results of any revisions to these
forward-looking statements to reflect events or circumstances arising after the
date of this quarterly report. The following discussion should be read in
conjunction with our consolidated financial statements and the accompanying
notes.

     WE NEED ADDITIONAL FUNDS TO SUPPORT OUR OPERATIONS. IF WE ARE UNABLE TO
OBTAIN THEM, WE WILL HAVE TO CEASE OR SIGNIFICANTLY SCALE BACK OUR OPERATIONS.

     Our existing working capital will not be sufficient to meet our present
needs past January 2000. If we are unable to raise additional funds, we may be
unable to continue operations. If an offering is not consummated on the required
schedule or on terms acceptable to us, we may be required to curtail or
significantly scale back our operating plans and possibly relinquish rights to
portions of our technology or products and discontinue our operations.

     Our liquidity and capital requirements will depend upon numerous factors,
including the following:

          -    The extent to which our products gain market acceptance;
          -    The progress and scope of product evaluations;
          -    The timing and costs of filing future regulatory submissions;
          -    The timing and costs required to receive both domestic and
               international governmental approvals;
          -    The timing and costs of product introductions;
          -    The extent of our ongoing research and development programs;
          -    The costs of training physicians to become proficient in the use
               of our products and procedures; and
          -    The costs of developing marketing and distribution capabilities.

     WE HAVE A HISTORY OF LOSSES AND MAY NOT BECOME PROFITABLE.

     Since our formation in July 1993, and as of September 30, 1999, we had
incurred cumulative net losses of $55.6 million. We expect to incur substantial
losses for at least the next 9-12 months. We may never achieve or sustain
profitability in the future. Even if we achieve profitability, we may not be
able to sustain it on an ongoing basis.

     WE ARE DEPENDENT ON MEDTRONIC, SOFAMOR DANEK AND OTHER DISTRIBUTION
PARTNERS TO SELL OUR PRODUCTS.

     We do not have a sales force and are currently primarily dependent on our
agreements


                                       13
<PAGE>

with Medtronic and Sofamor Danek for sales of the majority of products derived
from our core three-dimensional technology. The termination or substantial
modification of these relationships would jeopardize our ability to achieve or
sustain profitability. We have not yet concluded agreements for distribution of
our general surgical products and failure to do so would also jeopardize our
ability to achieve or sustain profitability. Our heart surgery product line is
sold by Medtronic's sales force in most of the world's significant markets,
including the United States, under the terms of a sales agreement which we
entered into with Medtronic in June 1998. Our head, neck and spine products are
sold worldwide via Sofamor Danek's sales force, and other distributors in
worldwide markets.

     MEDTRONIC

     Under our sales agreement with Medtronic, we appointed Medtronic as our
exclusive distributor for current and future visualization and information
systems for heart surgery in the United States, Europe, Japan and several other
significant geographical regions. In recent weeks, Medtronic has expressed
concerns about our ability to function as a going concern and that our
performance under our agreements with Medtronic will be disrupted by lack of
capital. We are currently in discussions with Medtronic regarding these issues,
but we may not be successful in addressing their concerns to a degree sufficient
to induce Medtronic to continue committing resources to selling our products. If
Medtronic's concerns cause a disruption in our distribution relationship for any
reason, we will need to support our heart customer base by other means. This
transition may not be achieved without operational disruption and unplanned
cost, or at all.

     SOFAMOR DANEK

     Under an exclusive distribution agreement with Sofamor Danek, we appointed
Sofamor Danek as our exclusive worldwide distributor for our current and future
visualization and information systems for neurosurgery, spinal surgery,
radiation delivery, otolaryngology and maxillofacial surgery, which are known as
our StereoSite systems. This agreement was modified in April 1999 to
non-exclusive status as a partial mitigation of a sales shortfall created when
Sofamor Danek declined to purchase $1.6 million of StereoSite systems within the
required contractual time period. The amended agreement has allowed us to pursue
relationships with other distributors to sell the StereoSite systems worldwide.
Sofamor Danek was acquired by Medtronic in January 1999. As a result, similar
issues to those discussed above under "Medtronic" exist in the Sofamor Danek
relationship. In addition, we are currently, and have been for several months,
in the process of negotiating a monetary settlement with Sofamor Danek, through
Medtronic, to compensate us for lost opportunities as a result of Sofamor Danek
not purchasing our products as contractually committed. No such compensation
amount has been agreed upon to date. We may not be able to be compensated for
such lost opportunities, a result which could have an adverse effect on our
operations and potential profitability.

         We also entered into a cooperative technology agreement with Sofamor
Danek under which we agreed to work exclusively together in performing research
and development specifically designed to enhance StereoSite systems or integrate
StereoSite systems with


                                       14
<PAGE>

Sofamor Danek's image guidance systems and other products, including systems and
instruments for spinal surgery. We may not be successful in our efforts under
this agreement.

     OUR STOCK PRICE COULD CONTINUE TO BE VOLATILE AND OUR COMMON STOCK COULD
SUFFER A DECLINE IN VALUE, ADVERSELY AFFECTING OUR ABILITY TO RAISE ADDITIONAL
CAPITAL.

     The market prices and trading volumes for securities of emerging companies,
like ours, have historically been highly volatile and have experienced
significant fluctuations unrelated to the operating performance. The market
price of our common stock has historically and recently been highly volatile and
may be significantly affected by factors such as:

          -    actual or anticipated fluctuations in our operating results,
          -    changes in financial estimates by securities analysts,
          -    announcements of technological innovations,
          -    new products or new contracts by us or our competitors,
          -    regulatory announcements,
          -    developments with respect to patents or proprietary rights,
          -    conditions and trends in the medical device and other technology
               industries,
          -    adoption of new accounting standards affecting the medical device
               industry, and
          -    general market conditions.

     In addition, the stock market has from time to time experienced significant
price and volume fluctuations that have particularly affected the market prices
for shares of early stage companies. These broad market fluctuations may
adversely affect the market price of our common stock. In the past, following
periods of volatility in the market price of a particular company's securities,
securities class action litigation has often been brought against that company.
Such litigation, if brought against us, could result in substantial costs and a
diversion of management's attention and resources.

     OUR PROFITABILITY IS DEPENDENT UPON THE SUCCESSFUL DEVELOPMENT AND
COMMERCIALIZATION OF OUR PRODUCTS BASED ON OUR CORE THREE-DIMENSIONAL
TECHNOLOGY.

     Products derived from our core technology - the Series 8000 for minimally
invasive heart surgery, StereoSite systems for head, neck and spine microsurgery
and the yet-to-be-introduced visualization product for general surgery, the
ORPC - are expected to account for the majority of our revenues over the next
several years. The demand for these products may not be sufficient to allow
us to achieve profitable operations.

     Development of additional components of the Series 8000 has not yet been
completed, additional versions of our StereoSite products have yet to be
finalized and the ORPC is in pre-production phase. Our development efforts for
these products may not be successful. In addition, other products under
development may not be shown to be safe or effective, capable of being
manufactured in commercial quantities at acceptable costs, acquire appropriate
regulatory


                                       15
<PAGE>

clearances or be successfully marketed.

     OUR SUCCESS IS DEPENDENT UPON ACCEPTANCE OF MINIMALLY INVASIVE
MICROSURGICAL PROCEDURES BY THE MEDICAL COMMUNITY AS A RELIABLE, SAFE AND COST
EFFECTIVE ALTERNATIVE TO EXISTING TREATMENTS.

     To date, minimally invasive microsurgical procedures have only been
performed on a very limited basis by a small number of highly skilled surgeons.
We are unable to predict how quickly, if at all, minimally invasive
microsurgical procedures will be adopted by the medical community or, if they
are adopted, the number of procedures that will be performed.

     Most patients with heart disease first consult with a cardiologist, who
then may treat the patient with drugs or non-surgical interventions, such as
angioplasty, the insertion of a balloon-type device in a heart vessel, and
intravascular stents, or refer the patient to a heart surgeon for open-chest
coronary artery bypass surgery. Cardiologists may not recommend minimally
invasive procedures until such time, if at all, as such procedures can
successfully be demonstrated to be as safe and cost-effective as other accepted
treatments. In addition, heart surgeons may choose not to recommend minimally
invasive procedures until such time, if at all, as such procedures are proven to
be as safe, effective and technically viable as conventional, open-chest surgery
methods, which have become widely adopted by heart surgeons since the initial
use of such surgery in the mid-1950s.

     Even if the clinical safety and effectiveness of minimally invasive
procedures is established in heart and other specialties, surgeons, specialists
and other physicians may choose not to recommend the procedures for any number
of other reasons. Adoption of these procedures by doctors will depend, for
example, upon our ability to facilitate training of surgeons to perform
minimally invasive microsurgery and the willingness of such surgeons to perform
such procedures. Doctors may also elect not to recommend the minimally invasive
procedures based on possible unavailability of acceptable reimbursement from
health care payors. Health care payor acceptance may require evidence of the
cost effectiveness of minimally invasive procedures as compared to other
currently available treatments. We believe that physician endorsements will be
essential for clinical adoption of minimally invasive procedures. To date, these
endorsements have not been obtained and they may not be obtained in the near
future, if at all. Patient acceptance of the procedure will depend upon doctor
recommendations, as well as other factors, including the effectiveness of, and
the rate and severity of complications associated with, the procedure as
compared to other treatments.

     WIDESPREAD USE OF OUR PRODUCTS WILL REQUIRE TRAINING OF A LARGE NUMBER OF
SURGEONS, AND THE TIME REQUIRED TO INSTITUTE A TRAINING PROGRAM AND TO TRAIN
SUCH SURGEONS COULD ADVERSELY AFFECT NEAR TERM MARKET ACCEPTANCE.

     Evaluations of visualization technology such as ours conducted to date have
shown that there is a learning process involved for surgeons and other members
of the surgery team to become proficient with the use of the systems. Based on
the clinical and laboratory procedures performed to date, we cannot assure you
that visualization and information system enhancements


                                       16
<PAGE>

incorporated, or to be incorporated, in our products will prove suitable for use
by a substantial number of surgeons. If they prove unsuitable for a large number
of surgeons to use, the potential markets and applications for our products
would be significantly limited.


     WE LACK COMMERCIAL MANUFACTURING EXPERIENCE AND THERE ARE SIGNIFICANT RISKS
ASSOCIATED WITH OUR SCALE-UP OF MANUFACTURING.

     We lack long term experience in manufacturing our products in the
quantities that are necessary for us to achieve significant commercial sales. We
may not be able to establish or maintain reliable, high-volume manufacturing at
commercially reasonable costs. We may also require additional manufacturing
facilities if production volumes increase; acquisition of new manufacturing
facilities will likely involve relocation. The manufacture of our products
primarily involves the assembly of a number of sub-assemblies and components.
Companies such as ours often encounter difficulties in scaling up manufacturing
of products, which difficulties could include problems involving:

          -    quality control and assurance,
          -    component and service availability,
          -    adequacy of control policies and procedures,
          -    lack of qualified personnel,
          -    compliance with FDA regulations and the need for further FDA
               approval of new manufacturing processes and facilities and
          -    other production constraints.

     We have considered and will continue to consider as appropriate, the
internal manufacture of sub-assemblies currently provided by third-party
subcontractors, as well as the implementation of new production processes. Our
manufacturing yields or costs may increase as a result of the transition to
in-house production or to new production processes when such efforts are
undertaken. In addition, costs in complying with FDA good manufacturing
practices or changes in such practices may exceed our expectations.

     WE MAY FACE COMPONENT SHORTAGES AND ARE DEPENDENT IN SOME INSTANCES ON
SINGLE SOURCES OF SUPPLY.

     Any significant supply interruption, or inventory shortage or overage,
would negatively impact our ability to manufacture our products. We use and rely
on specific components and services used in our systems for which we have only a
single source of supply. The manufacture of our products in larger commercial
quantities will require a substantial increase in component supplies and will
likely necessitate the replacement of current suppliers or the addition of new
suppliers. The qualification of additional or replacement vendors for specified
components or services is a lengthy process. In addition, the substitution of
replacement vendors may entail re-engineering time and cost and could delay the
supply of our products.


                                       17
<PAGE>

     We expect to manufacture our products based on forecasted product orders
and intend to purchase subassemblies and components prior to receipt of purchase
orders from customers. Lead times for ordered materials and components vary
significantly and depend on factors such as the business practices of the
specific supplier, contract terms and general demand for a component at a given
time. Some components used in our products have long lead times. As a result,
there is a risk of excess or inadequate inventory if orders do not match
forecasts.

     WE ARE SUBJECT TO SIGNIFICANT DOMESTIC AND INTERNATIONAL REGULATION AND MAY
NOT BE ABLE TO OBTAIN NECESSARY REGULATORY CLEARANCES TO SELL OUR PRODUCTS.

     The manufacture and sale of medical devices intended for commercial
distribution are subject to extensive governmental regulation. Our failure to
comply with regulatory requirements would jeopardize our ability to market our
products. Noncompliance with applicable requirements can result in failure of
the regulatory agency to grant pre-market clearance or approval for devices,
withdrawal or suspension of approval, total or partial suspension of production,
fines, injunctions, civil penalties, refunds, recall or seizure of products and
criminal prosecution.

     Medical devices are regulated in the United States primarily by the FDA
and, to a lesser extent, by state agencies. Sales of medical device products
outside the United States are subject to foreign regulatory requirements that
vary from country to country. Generally, medical devices require pre-market
clearance or pre-market approval prior to commercial distribution. A
determination that information available on the medical device is not sufficient
to grant the needed clearance or approval will delay market introduction of the
product. In addition, material changes or modifications to, and changes in
intended use of, medical devices also are subject to FDA review and clearance or
approval. The FDA regulates the research, testing, manufacture, safety,
effectiveness, labeling, storage, record keeping, promotion and distribution of
medical devices in the United States and the export of unapproved medical
devices from the United States to other countries.

     In the United States, medical devices are classified into one of three
classes, Class I, II or III, on the basis of the controls deemed by the FDA to
be necessary to reasonably ensure their safety and effectiveness. The Company's
products to date have either been classified as Class I or Class II devices.

     Class I devices are subject to general controls (e.g., establishment
registration and product listing, labeling, adulteration and misbranding
provisions and medical device reporting requirements and, unless exempt, to
pre-market notification and adherence to GMP standards). Class II devices are
subject to general controls and special controls (e.g., performance standards,
post-market surveillance, patient registries and FDA guidelines). Generally,
Class III devices are those that must receive pre-market approval by the FDA to
ensure their safety and effectiveness (e.g., life-sustaining, life-supporting
and implantable or new devices which have not been found to be substantially
equivalent to legally marketed devices). Class III devices ordinarily require


                                       18
<PAGE>

clinical testing to ensure safety and effectiveness and FDA approval prior to
marketing and distribution. The FDA also has the authority to require clinical
testing of Class I and Class II devices. A pre-market approval ("PMA")
application must be filed if a proposed device is not substantially equivalent
to a legally marketed predicate device or if it is a Class III device for which
the FDA has called for such application. A PMA typically takes several years to
be approved by the FDA.

     Generally, before a new device can be introduced into the market in the
United States, the manufacturer or distributor must obtain FDA clearance of a
510(k) notification or submission and approval of a PMA application. If a
medical device manufacturer or distributor can establish that a device is
"substantially equivalent" to a legally marketed Class I or Class II device, or
to a Class III device for which the FDA has not called for a PMA, the
manufacturer or distributor may market the device upon receipt of an FDA order
determining such a device substantially equivalent to a predicate device. The
510(k) notification may need to be supported by appropriate performance,
clinical or testing data establishing the claim of substantial equivalence. The
FDA requires a rigorous demonstration of substantial equivalence.

     Following submission of the 510(k) notification, the manufacturer or
distributor may not place the device into commercial distribution until an FDA
substantial equivalence order permitting the marketing of a device is received
by the person who submitted the 510(k) notification. At this time, the FDA
typically responds to the submission of a 510(k) notification within 90 to 200
days. An FDA letter may declare that the device is substantially equivalent to a
legally marketed device and allow the proposed device to be marketed in the
United States. The FDA, however, may determine that the proposed device is not
substantially equivalent or require further information, including clinical
data, to make a determination regarding substantial equivalence. Such
determination or request for additional information will delay market
introduction of the product that is the subject of the 510(k) notification.

     All clinical investigations involving the use of an unapproved or uncleared
device on humans to determine the safety or effectiveness of the device must be
conducted in accordance with the FDA's investigational device exemption ("IDE")
regulations. If the device presents a "significant risk," the manufacturer or
distributor of the device is required to file an IDE application with the FDA
prior to commencing human clinical trials. The IDE application must be supported
by data, typically the result of animal and bench testing. If the IDE
application is approved by the FDA, human clinical trials may begin at a
specific number of investigational sites with a maximum number of patients, as
approved by the FDA. If the device presents a "non-significant risk," approval
by an Institutional Review Board prior to commencing human clinical trials is
required, as well as compliance with labeling, record keeping, monitoring and
other requirements. However, the FDA can disagree with a non-significant risk
device finding.

     Any products which we manufacture or distribute are subject to continuing
regulation by the FDA, which includes record keeping requirements, reporting of
adverse experience with the use of the device, GMP requirements and post-market
surveillance, and may include post-market registry and other actions deemed
necessary by the FDA. A new 510(k), PMA or PMA


                                       19
<PAGE>

supplement is also required when a medical device manufacturer makes a change or
modification to a legally marketed device that could significantly affect the
safety or effectiveness of the device, or where there is a major change or
modification in the intended use of the device or a new indication for use of
the device. When any change or modification is made to a device or its intended
use, the manufacturer is expected to make the initial determination as to
whether the change or modification is of a kind that would necessitate the
filing of a new 510(k), PMA or PMA supplement.

     Sales of medical device products outside the United States are subject to
foreign regulatory requirements that vary from country to country. The time
required to obtain approvals required by foreign countries may be longer or
shorter than that required for FDA clearance, and requirements for licensing may
differ from FDA requirements. Our failure to comply with regulatory requirements
would jeopardize our ability to market our products. The current regulatory
environment in Europe for medical devices differs significantly from that in the
United States. Since June 1998, all medical devices sold in the European Union
must bear the CE mark. Devices are now classified by manufacturers according to
the risks they represent with a classification system giving Class III as the
highest risk devices and Class I as the lowest. Once the device has been
classified, the manufacturer can follow one of a series of conformity assessment
routes, typically through a registered quality system, and demonstrate
compliance to a European Notified Body. After that, the CE mark may be applied
to the device. Maintenance of the system is ensured through annual on-site
audits by the Notified Body and a post-market surveillance system requiring the
manufacturer to submit serious complaints to the appropriate governmental
authority.

     WE EXPECT TO ENCOUNTER RAPID TECHNOLOGICAL CHANGE AND SIGNIFICANT
COMPETITION.

     The medical device market in which we compete is characterized by intensive
development efforts and rapidly advancing technology. Our future success will
depend, in large part, upon our ability to anticipate and keep pace with
advancing technology and competing innovations. We may not be successful in
identifying, developing and marketing new products or enhancing our existing
products.

     We believe that a number of large companies, with significantly greater
financial, manufacturing, marketing, distribution and technical resources and
experience than ours, are focusing on the development of visualization products
for minimally invasive microsurgery. Several companies are currently developing
and marketing visualization products for minimally invasive microsurgery which
could be applied to heart surgery, to general surgery or to head, neck and spine
microsurgery.

     Technological advances with other therapies such as drugs, interventional
procedures or future innovations in surgical techniques could make such other
therapies more effective or lower in cost than minimally invasive microsurgery
procedures and could render minimally invasive microsurgery obsolete.


                                       20
<PAGE>

     WE EXPECT FLUCTUATIONS IN OUR OPERATING RESULTS.

     Our results of operations may vary significantly from quarter to quarter
depending upon numerous factors, including the following:

          -    timing and results of product evaluations,
          -    delays associated with the FDA and other regulatory approval
               processes,
          -    demand for and utilization of our products,
          -    changes in our pricing policies or those of our competitors,
          -    changes in third-party payment guidelines,
          -    the number, timing and significance of product enhancements and
               new product announcements by us or our competitors,
          -    our ability to develop, introduce and market new and enhanced
               versions of our products on a timely basis,
          -    customer order deferrals in anticipation of enhancements or of
               new product introductions by us or our competitors,
          -    product quality problems,
          -    personnel changes and
          -    the level of international sales.

     OUR PROFITABILITY IS DIRECTLY RELATED TO THE LEVEL OF REIMBURSEMENTS FOR
SURGICAL PROCEDURES USING OUR PRODUCTS.

     Our profitability is directly related to the level of payments for the
surgical procedures in which our products are involved, either by Medicare or
private insurance companies. We could be adversely affected by changes in
payment policies of government or private health care payors, particularly to
the extent any such changes affect payment for the procedure in which our
products are intended to be used. It is a continuing trend in U.S. health care
for such payments to be under continual scrutiny and downward pressure. We
believe that reimbursement in the future will be subject to increased
restrictions, both in the United States and in foreign markets and that the
overall escalating cost of medical products and services has led to and will
continue to lead to increased pressures on the health care industry, both
foreign and domestic, to reduce the cost of products and services, including
products which we offer.

     We expect that our products typically will be used by hospitals and
surgical centers, which bill various third-party payors, such as governmental
programs and private insurance plans, for the health care services provided to
their patients. Third-party payors carefully review and increasingly challenge
the prices charged for medical products and services or negotiate a flat rate
fee in advance. Payment rates from private companies also vary depending on the
procedure performed, the third-party payor, the insurance plan and other
factors. Medicare compensates hospitals at a pre determined fixed amount for the
costs associated with an in-patient hospitalization based on the patient's
discharge diagnosis and compensates physicians at a pre determined fixed amount
based on the procedure performed, regardless of the actual costs incurred by the
hospital or physician in furnishing the care and unrelated to the specific
devices


                                       21
<PAGE>

or systems used in that procedure. Medicare and other third-party payors are
increasingly scrutinizing whether to cover new products and the level of payment
for new procedures. The flat fee reimbursement trend is causing hospitals to
control costs strictly in the context of a managed care system in which health
care providers contract to provide comprehensive health care for a fixed cost
per person. We are unable to predict what changes will be made in the
reimbursement methods utilized by such third-party payors.

     If we obtain the necessary foreign regulatory registrations or approvals,
market acceptance of our products in international markets would be dependent,
in part, upon the acceptance by the prevailing health care financing system in
each country. Health care financing systems in international markets vary
significantly by country and include both government sponsored health care
programs and private insurance. There can be no assurance that these financing
systems will endorse the use of our products.


     WE HAVE LIMITED EXPERIENCE MARKETING OUR PRODUCTS OVERSEAS AND MAY NOT BE
SUCCESSFUL IN EXPANDING INTO INTERNATIONAL MARKETS.

     We have limited experience in marketing our products overseas. Changes in
overseas economic conditions, currency exchange rates, foreign tax laws or
tariffs or other trade regulations could negatively impact our business. The
anticipated international nature of our business is also expected to subject our
representatives, agents and distributors to laws and regulations of the foreign
jurisdictions in which they operate or in which our products are sold, including
laws regulating manufacture and sale of medical devices. In addition, the laws
of some foreign countries do not protect our intellectual property rights to the
same extent as do the laws of the United States.

     WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS AND HAVE LIMITED INSURANCE
COVERAGE.

     We face an inherent and significant business risk of exposure to product
liability claims in the event that the use of our products results in personal
injury or death. Also, in the event that any of our products proves to be
defective, we may be required to recall or redesign such products. Our current
product liability insurance coverage limit is $10.0 million per occurrence and
in the aggregate. Our coverage limits may not be adequate to protect us from any
liabilities we might incur in connection with the development, manufacture and
sale of our products. In addition, increased product liability coverage may be
required if additional products are used in clinical evaluations or successfully
commercialized. Product liability insurance is expensive and in the future may
not be available to us on acceptable terms, if at all. A successful product
liability claim or series of claims brought against us in excess of our
insurance coverage or a product recall would negatively impact our business.


                                       22
<PAGE>

     IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WE MAY BE UNABLE TO
PREVENT OTHER COMPANIES FROM USING OUR TECHNOLOGY IN COMPETITIVE PRODUCTS.

     Our future success will depend, in part, on our ability to continue to
develop patentable products, enforce our patents and obtain patent protection
for our products both in the United States and in other countries. The patent
positions of medical device companies, however, are generally uncertain and
involve complex legal and factual questions. Patents may never issue from any
patent applications owned by or licensed to us. Even if patents do issue, the
claims allowed may not be sufficiently broad to protect our technology. In
addition, issued patents owned by or licensed to us may be challenged,
invalidated or circumvented, or the rights granted thereunder may not provide us
with competitive advantages.

     We rely on a combination of technical leadership, patent, trade secret,
copyright and trademark protection and nondisclosure agreements to protect our
proprietary rights. As of September 30, 1999, we had exclusive ownership rights
to 15 issued United States patents, 12 pending United States patent applications
and 28 pending foreign applications covering various aspects of our devices and
systems. Furthermore, as of the same date, we had exclusive rights in the
medical field to five issued United States patents, one pending United States
patent application, 11 issued foreign patents and 10 pending foreign
applications covering various aspects of our devices and systems. In 1998 we
additionally obtained from Carl Zeiss Inc. non-exclusive rights to three issued
United States patents and four pending foreign applications. We intend to file
additional patent applications in the future. The failure of such patents to
issue could damage our ability to protect our proprietary information.

     The medical device industry has been characterized by extensive litigation
regarding patents and other intellectual property rights. Litigation, which
would result in substantial expense, may be necessary to enforce any patents
issued or licensed to us and/or to determine the scope and 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 interference proceedings declared by the United States Patent and
Trademark Office, which could result in substantial expense, to determine the
priority of inventions covered by our issued United States patents or pending
patent applications. Furthermore, we may have to participate at substantial cost
in International Trade Commission proceedings to enjoin importation of products
which would compete unfairly with our products. Any adverse outcome of any
patent litigation, including interference proceedings, could subject us to
significant liabilities to third parties, require disputed rights to be licensed
from or to third parties or require us to cease using the technology in dispute.
Any such licenses may not be available on acceptable terms, if at all.
Furthermore, parties making such claims may be able to obtain injunctive or
other equitable relief that could effectively block our ability to make, use,
sell or otherwise practice our intellectual property, whether or not patented or
described in pending patent applications, or to further develop or commercialize
our products in the United States and abroad and could result in the award of
substantial damages. Defense of any lawsuit or failure to obtain any such
license could damage our business.


                                       23
<PAGE>

     We rely on unpatented trade secrets to protect our proprietary technology.
Others may independently develop or otherwise acquire the same or substantially
equivalent technologies or otherwise gain access to our proprietary technology
or disclose such technology. It is difficult to protect rights to such
unpatented proprietary technology. Third parties may obtain patent rights to
such unpatented trade secrets, which patent rights could be used to assert
infringement claims against us. We also rely on confidentiality agreements with
our collaborators, employees, advisors, vendors and consultants to protect our
proprietary technology. These agreements may be breached, we may not have
adequate remedies for any breach and our trade secrets may otherwise become
known or be independently developed by competitors. In addition, our agreements
with employees and consultants require disclosure of ideas, developments,
discoveries or inventions conceived during employment or consulting, as the case
may be, and assignment to us of proprietary rights to such matters related to
our business and technology. The extent to which efforts by others will result
in patents and the effect on us of the issuance of such patents is unknown.

     WE HAVE LICENSED SOME ASPECTS OF OUR PRODUCTS FROM THIRD PARTIES AND MAY
LOSE THE RIGHTS TO THESE ESSENTIAL ASPECTS UNDER THE AGREEMENTS WHICH GOVERN
THOSE RELATIONSHIPS.

     We have licensed some aspects of our technology from third parties. In
September 1995, Mr. H. McKinley and McKinley Optics, Inc. (collectively,
"McKinley") granted to us a perpetual, exclusive, worldwide license in the
medical field to make, have made, modify, use, lease, market, sell and otherwise
distribute certain endoscopes and other medical products incorporating a stereo
objective lens and/or a relay lens configuration. Under the terms of this
license agreement, we are obligated to pay McKinley an annual maintenance
royalty, additional royalties upon the sale of certain numbers of systems
incorporating the McKinley technology and royalties on net sales of products
incorporating the McKinley technology. The exclusive license granted under this
agreement becomes a non-exclusive license (or, under certain circumstances, the
license terminates) in the event we fail to pay any royalties. In addition, we
have the right to terminate the agreement with limited notice.

     In June 1996, Fuji Film Co. and Fuji Photo Optical Co., Ltd. (collectively,
"Fuji") granted to us a non-exclusive license to certain optical zoom technology
for use in endoscopes. We are obligated to pay royalties on net sales of
products in the United States which incorporate Fuji's technology. Fuji may
terminate the agreement if we do not cure any violation of the agreement within
a limited period of time. Our failure to retain rights to these technologies
could negatively impact our business.

     IF WE ARE NOT ABLE TO ATTRACT AND RETAIN KEY TECHNICAL AND SENIOR
MANAGEMENT PERSONNEL AND DOCTORS TO PARTICIPATE IN OUR ADVISORY BOARDS, IT MAY
ADVERSELY AFFECT OUR ABILITY TO OBTAIN FINANCING OR DEVELOP OUR PRODUCTS.

     Our future business and operating results depend in significant part upon
the continued contributions of our key technical and senior management
personnel, many of whom would be difficult to replace and some of whom perform
important functions beyond those suggested by


                                       24
<PAGE>

their job titles or descriptions. Our business and future operating results also
depend in significant part upon our ability to attract and retain qualified
management, manufacturing, technical, marketing and sales and support personnel
for our operations. Competition for such personnel is intense, and we may not be
successful in attracting or retaining such personnel.

     Members of our clinical advisory boards consult with us exclusively in the
field of visualization, but are free to consult with other non-competing
instrumentation companies and are employed elsewhere on a full-time basis. As a
result, they only spend a limited amount of time on our business. Although we
have entered into consulting agreements, with terms ranging from 12 months to
two years, including confidentiality provisions with each of the members of our
clinical advisory boards, the consulting and confidentiality agreements between
us and each of the members of our clinical advisory boards may be terminated or
breached. In addition, such agreements may not be renewed upon termination.

     IF WE OR OUR SUPPLIERS FAIL TO BE YEAR 2000 COMPLIANT, IT COULD CAUSE
INTERRUPTIONS IN OUR SUPPLY OF PRODUCTS AND GENERATE SUBSTANTIAL EXPENSES FOR
OUR BUSINESS.

     We recognize the need to ensure our operations will not be adversely
impacted by the inability of our systems to process data having dates on or
after January 1, 2000 (the "Year 2000" issues). Processing errors due to
software failure arising from calculations using the Year 2000 date are a
recognized risk. We are currently addressing the risk, with respect to the
availability and integrity of our financial systems and the reliability of our
operating systems, and are in communication with suppliers, customers, financial
institutions and others with whom we conduct business transactions to
continually assess whether they are Year 2000 compliant.

     Despite the implementation of contingency plans to deal with unknown
problems or events that may occur such as supplier Year 2000 problems, unforseen
business system failures, or product failures, if these plans are unsuccessful
in addressing actual problems, it could cause interruptions in our supply of
products and result in significant expenses or loss of potential revenue.

     OUR USE OF HAZARDOUS MATERIALS MAY RESULT IN UNEXPECTED AND SUBSTANTIAL
CLAIMS AGAINST US FOR WHICH WE DO NOT HAVE SUFFICIENT FINANCIAL RESOURCES.

     Our research and development activities may involve the controlled use of
hazardous materials and chemicals. The risk of accidental contamination or
injury from these materials cannot be completely eliminated. In the event of
such an accident, we could be held liable for any resultant damages, and any
such liability could exceed our resources. We may incur substantial cost to
comply with environmental regulations.

     WE DO NOT ANTICIPATE PAYING ANY DIVIDENDS AND ANY GAINS IN OUR STOCK WILL
HAVE TO COME FROM INCREASES IN THE PRICE OF SUCH STOCK.

     We currently intend to retain any future earnings for use in our business
and do not


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<PAGE>

anticipate paying any cash dividends in the foreseeable future.

     OUR CHARTER DOCUMENTS MAY PREVENT US FROM PARTICIPATING IN TRANSACTIONS
THAT COULD BE BENEFICIAL TO INVESTORS.

     Our charter documents contain provisions that may make it more difficult or
discourage a change in control. This may adversely affect the market price of
our common stock. For a discussion of the provisions in our charter documents
which may have the effect of preventing a change of control, please see
ADescription of Capital Stock B Possible Anti-Takeover Effect of Charter
Provisions."


                                       26
<PAGE>

PART II.  OTHER INFORMATION

Item 1. Not Applicable

Item 2. Not Applicable

Item 3. Not Applicable

Item 4. Not Applicable

Item 5. Not Applicable

Item 6. Exhibits and Reports on Form 8-K

A)      Exhibits

         10.1(1)       Agreement with John Lyon dated July 20, 1999.
         10.2(1)       Agreement with Koichiro Hori dated July 20, 1999.
         10.3(1)       Agreement with Allen Newman dated July 20, 1999.
         10.4(1)       Agreement with Robert De Vaere dated July 20, 1999.
         11.1          Statement Regarding Computation of Per Share Earnings.
         27.1          Financial Data Schedule.

         ------
         (1)    Incorporated by reference to our Registration Statement on
                Form S-1 filed on September 7, 1999.

B)       Reports on Form 8-K

         No reports on Form 8-K were filed by the Company during the three
months ended September 30, 1999.


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<PAGE>

SIGNATURES


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


                                    VISTA MEDICAL TECHNOLOGIES, INC.


Date:    November 12, 1999          /s/ John R. Lyon
         ------------------------   ------------------------
                                    John R. Lyon,
                                    President, Chief Executive Officer
                                    and Director

Date:    November 12, 1999          /s/ Robert J. De Vaere
         ------------------------   ------------------------
                                    Robert J. De Vaere
                                    Vice President of Finance & Administration
                                    & Chief Financial Officer
                                    (Principal financial and accounting officer)


















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