** **

**UNITED STATES**

**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, 2003** |   |
|                                     |   |   |   |
| **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  registrant as 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)       |

** **

**Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor 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****ý** |   | **No****o** |   |
|---------|--------|-------------------|--------|-------------|--------|
| **(2)** |   | **Yes****ý** |   | **No****o** |   |

 

**Indicate by check mark whether theregistrant is an accelerated filer (as defined in rule 12b-2 of the ExchangeAct)    Yes****o    No****ý**

 

As of May 9, 2003there were 5,003,471 shares of $.01 par value common stock outstanding.

** **

** **

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**VISTA MEDICAL TECHNOLOGIES, INC.**

**FORM 10-Q**

**TABLE OF CONTENTS**

 
| PART 1.   FINANCIAL INFORMATION |
|-------------------------------------------|
|                                      |   |
| Item 1.                                   | Financial Statements  (unaudited) |
|                                      |   |
|                                      | Consolidated Balance Sheets as of March  31, 2003 and December 31, 2002 |
|                                      |   |
|                                      | Consolidated Statements of  Operations for the three months ended March 31, 2003 and 2002 |
|                                      |   |
|                                      | Consolidated  Statements of Cash Flows for the three months ended March 31, 2003 and 2002 |
|                                      |   |
|                                      | 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                                |
|                                      |   |
| CERTIFICATIONS                            |
|                                           |  |  |

 

2

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PART 1. FINANCIAL INFORMATION

 

Item 1. Financial Statements(Unaudited)

 

Vista MedicalTechnologies, Inc.

Consolidated Balance Sheets

 
|                                                                                                                                                     |   | **March 31,  2003** |       | **December  31, 2002** |       |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|------------|------------------------|------------|
|                                                                                                                                                     |   | **(Unaudited)**     | ** ** |                   | ** ** |
| ASSETS                                                                                                                                                   |   |                |       |                   |       |
| Current assets:                                                                                                                                          |   |                |       |                   |       |
| Cash and cash equivalents                                                                                                                                |   | $                   | 1,525,305  |                   | $          | 457,052 |   |
| Marketable securities                                                                                                                                    |   | 203,767             |       | 372,320                |       |
| Accounts receivable, net                                                                                                                                 |   | 1,112,066           |       | 1,670,480              |       |
| Inventories, net                                                                                                                                         |   | 1,592,114           |       | 1,493,278              |       |
| Other current assets                                                                                                                                     |   | 139,160             |       | 108,536                |       |
| Total current assets                                                                                                                                     |   | 4,572,412           |       | 4,101,666              |       |
| Property and equipment, net                                                                                                                         |   | 72,042              |       | 77,431                 |       |
| Patents and other assets, net                                                                                                                       |   | 2,354               |       | 3,061                  |       |
| TOTAL ASSETS                                                                                                                                             |   | $                   | 4,646,808  |                   | $          | 4,182,158 |   |
|                                                                                                                                                     |   |                |       |                   |       |
| LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                                     |   |                |       |                   |       |
| Current liabilities:                                                                                                                                     |   |                |       |                   |       |
| Accounts payable                                                                                                                                         |   | $                   | 757,748    |                   | $          | 955,961 |   |
| Accrued compensation                                                                                                                                     |   | 299,569             |       | 262,225                |       |
| Deferred revenue                                                                                                                                    |   | 277,667             |       | 499,167                |       |
| Accrued liabilities                                                                                                                                      |   | 314,369             |       | 383,848                |       |
| Total current liabilities                                                                                                                                |   | 1,649,353           |       | 2,101,201              |       |
|                                                                                                                                                     |   |                |       |                   |       |
| Commitments and Contingencies                                                                                                                            |   |                |       |                   |       |
| Stockholders' equity:                                                                                                                                    |   |                |       |                   |       |
| Preferred stock, $.01 par value:                                                                                                                         |   |                |       |                   |       |
| Authorized shares - 5,000,000 Issued and outstanding shares - none at  December 31, 2002 and 1,000,000 at March 31, 2003 (Liquidation Value  $3,800,000) |   | 961,322             |       |                   |       |
| Common stock, $.01 par value:                                                                                                                            |   |                |       |                   |       |
| Authorized shares - 35,000,000 Issued and outstanding shares -  5,001,749 at December 31, 2002 and 5,003,471 at March 31, 2003                           |   | 50,035              |       | 50,017                 |       |
| Additional  paid-in capital                                                                                                                              |   | 68,082,055          |       | 68,079,862             |       |
| Notes receivable  from stockholders                                                                                                                      |   | (78,375             | )          | (78,375                | )          |
| Deferred  compensation                                                                                                                                   |   | (35,918             | )          | (45,947                | )          |
| Accumulated  deficit                                                                                                                                     |   | (65,981,664         | )          | (65,924,600            | )          |
| Total stockholders' equity                                                                                                                               |   | 2,997,455           |       | 2,080,957              |       |
|                                                                                                                                                     |   |                |       |                   |       |
| TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                               |   | $                   | 4,646,808  |                   | $          | 4,182,158 |   |

 

Note: The balance sheetat December 31, 2002 has been derived from the audited financial statements atthat date but does not include all of the information and footnotes required bygenerally accepted accounting principles for complete financial statements.

 

See accompanying notes. 

 

3

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Vista MedicalTechnologies, Inc.

Consolidated Statementsof Operations

(Unaudited)

 
|                                                       |   | **Three  Months Ended March 31,** |      |
|------------------------------------------------------------|--------|-----------------------------------|-----------|
|                                                       |   | **2003**                          |      | **2002** |   |
| Sales                                                      |   | $                                 | 2,849,585 |   | $ | 2,672,910 |   |
|                                                       |   |                              |      |   |   |
| Costs  and expenses:                                       |   |                              |      |   |   |
|                                                       |   |                              |      |   |   |
| Cost of sales                                              |   | 1,575,178                         |      | 1,363,141 |   |
| Research and development                                   |   | 257,160                           |      | 424,225 |   |
| Sales and marketing                                        |   | 548,757                           |      | 723,433 |   |
| General and administrative                                 |   | 516,314                           |      | 543,436 |   |
| Total  cost and expenses                                   |   | 2,897,409                         |      | 3,054,235 |   |
|                                                       |   |                              |      |   |   |
| Loss  from operations                                      |   | (47,824                           | )         | (381,325 | ) |
|                                                       |   |                              |      |   |   |
| Interest  income                                           |   | 2,083                             |      | 5,250 |   |
|                                                       |   |                              |      |   |   |
| Net  loss                                                  |   |                              | (45,741   | ) |   | (376,075 | ) |
|                                                       |   |                              |      |   |   |
| Less:  Accretion of dividends on preferred stock           |   | 11,322                            |      | — |   |
|                                                       |   |                              |      |   |   |
| Net  loss applicable to common stockholders                |   | $                                 | (57,063   | ) | $ | (376,075 | ) |
|                                                       |   |                              |      |   |   |
| Basic  and diluted loss per share                          |   | $                                 | (0.01     | ) | $ | (0.08 | ) |
|                                                       |   |                              |      |   |   |
| Shares  used in computing basic and diluted loss per share |   | 5,001,749                         |      | 4,915,540 |   |

 

See accompanyingnotes.  

 

4

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

 
|                                                         |   | **Three  Months Ended March 31,** |      |
|--------------------------------------------------------------|--------|-----------------------------------|-----------|
|                                                         |   | **2003**                          |      | **2002** |   |
| OPERATING ACTIVITIES                                         |   |                              |      |   |   |
| Net loss                                                     |   | $                                 | (45,741   | ) | $ | (376,075 | ) |
| Adjustments to reconcile net loss to net cash used for       |   |                              |      |   |   |
| operating activities:                                        |   |                              |      |   |   |
| Depreciation and amortization                                |   | 57,482                            |      | 116,641 |   |
| Amortization of deferred compensation                        |   | 10,029                            |      | 24,963 |   |
| Changes in operating assets and liabilities:                 |   |                              |      |   |   |
| Accounts receivable                                          |   | 558,414                           |      | 463,598 |   |
| Inventories                                                  |   | (98,836                           | )         | (269,914 | ) |
| Other current assets                                         |   | (30,624                           | )         | 30,812 |   |
| Accounts payable                                             |   | (198,213                          | )         | (6,361 | ) |
| Accrued compensation                                         |   | 37,344                            |      | 59,167 |   |
| Deferred revenue                                             |   | (221,500                          | )         | (250,000 | ) |
| Accrued liabilities                                          |   | (69,479                           | )         | 283,457 |   |
| Net cash flows (used in) provided byfor operating activities |   | (1,124                            | )         | 76,288 |   |
|                                                         |   |                              |      |   |   |
| INVESTING ACTIVITIES                                         |   |                              |      |   |   |
| Maturities of short-term investments                         |   | 168,553                           |      | 60,822 |   |
| Purchases of property and equipment                          |   | (51,386                           | )         | (19,772 | ) |
| Net cash flows provided by investing activities              |   | 117,167                           |      | 41,050 |   |
|                                                         |   |                              |      |   |   |
| FINANCING ACTIVITIES                                         |   |                              |      |   |   |
| Issuance of preferred stock                                  |   | 950,000                           |      | — |   |
| Issuance of common stock                                     |   | 2,210                             |      | 43,897 |   |
| Net cash flows provided by financing activities              |   | 952,210                           |      | 43,897 |   |
| Net increase (decrease) in cash and cash equivalents         |   | 1,068,253                         |      | 161,235 |   |
| Cash and cash equivalents at beginning of period             |   | 457,052                           |      | 800,547 |   |
| Cash and cash equivalents at end of period                   |   | $                                 | 1,525,305 |   | $ | 961,782 |   |
|                                                         |   |                              |      |   |   |
| NONCASH INVESTING AND FINANCING ACTIVITIES:                  |   |                              |      |   |   |
| Accretion of dividends on preferred stock                    |   | $                                 | 11,322    |   | $ | — |   |

 

See accompanying notes

 

5

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VISTA MEDICALTECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS

MARCH 31, 2003

(UNAUDITED)

 

1.     Basis ofPresentation

 

The auditedfinancial statements of Vista Medical Technologies, Inc. (the “Company”) andthe notes thereto for the year ended December 31, 2002 included in theCompany’s Annual Report on Form 10-K filed with the Securities and ExchangeCommission, contain additional information about the Company, its operations,and its financial statements and accounting practices, and should be read in conjunction with this quarterly reporton 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 accompanyingunaudited consolidated financial statements of the Company reflect alladjustments of a normal recurring nature which are, in the opinion ofmanagement, necessary for a fair presentation of the financial position,results of operations and cash flows for all periods presented.  The interim financial information containedherein is not necessarily indicative of results for any future interim periodsor for the full fiscal year ending December 31, 2003.

 

2.     Inventories

 
|                 |   | **March 31,  2003** |      | **December  31, 2002** |   |
|----------------------|--------|---------------------|-----------|------------------------|--------|
|                 |   | **(Unaudited)**     |      |                   |   |
| Parts and  materials |   | $                   | 1,375,406 |                   | $      | 1,243,304 |   |
| Work in process      |   | 178,209             |      | 375,414                |   |
| Finished goods       |   | 1,011,167           |      | 919,344                |   |
|                 |   | 2,564,782           |      | 2,538,062              |   |
| Less: reserves       |   | (972,668            | )         | (1,044,784             | )      |
| Inventories, net     |   | $                   | 1,592,114 |                   | $      | 1,493,278 |   |

 

6

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3.     Loss PerShare

 

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. 

 

4.     OtherComprehensive 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-BasedCompensation

 

The Company applies the principles of AccountingPrinciples Board Opinion No. 25, “*Accountingfor Stock Issued to Employees*,” and related interpretations inaccounting for its employee stock option compensation plans. Under APB No. 25,compensation expense is measured as the difference, if any, between the optionexercise price 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, 2003 and 2002 would have been adjusted to the proforma amounts indicated below:

 

7

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|                                  |   | **For the period ended  March 31,****** |     |
|---------------------------------------|--------|-----------------------------------------|----------|
|                                  |   | **2003******                            |     | **2002****** |   |
| Net Loss                              |   |                                    |     |   |   |
| As reported                           |   | $                                       | (45,741  | ) | $ | (376,075 | ) |
| Pro forma  compensation expense       |   | (58,065                                 | )        | (72,464 | ) |
| Pro forma SFAS  No. 123 net loss      |   | $                                       | (103,806 | ) | $ | (448,539 | ) |
|                                  |   |                                    |     |   |   |
| Basic and  diluted net loss per share |   |                                    |     |   |   |
| As reported                           |   | $                                       | (0.01    | ) | $ | (0.08 | ) |
| Pro forma                             |   | $                                       | (0.02    | ) | $ | (0.09 | ) |

 

6.     Segmentand Geographic Information

 

*SegmentInformation:* Prior to 2002, the Company operated in onebusiness segment, the Visualization Technology business.  Beginning in 2002, the Company reportsrevenue and certain operating expense information to the chief operatingdecision maker for its two operating segments, which are determined on the typeof customer or product. These segments consist of (1) the Obesity SurgeryManagement Services business and (2) Visualization Technology business.

 

The Company’s chief operating decision maker evaluates the performanceof the two segments based on segment revenues and certain segment costs andexpenses, including cost of revenues and research and development expenses.  Other operating expenses, including salesand marketing expenses and general and administrative expenses, are notallocated or evaluated on an individual segment basis, but rather on anenterprise-wide basis.  A summary of theCompany’s profitability by segment for the period ending March 31, 2003and  2002 is as follows: 

 
| **Period ended March 31, 2003:**                           |   | **Obesity  Surgery  Management** |    | **Visualization  Technology** |   | **Total** |    |
|------------------------------------------------------------|--------|----------------------------------|---------|-------------------------------|--------|-----------|---------|
| 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 | ) |

 

8

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| **Period ended March 31, 2002:**                           |   | **Obesity  Surgery  Management** |    | **Visualization  Technology** |   | **Total** |     |
|------------------------------------------------------------|--------|----------------------------------|---------|-------------------------------|--------|-----------|----------|
| Revenues                                                   |   | $                                | 923,609 |                          | $      | 1,749,301 |     | $ | 2,672,910 |   |
| Cost of revenues                                           |   | 261,740                          |    | 1,101,401                     |   | 1,363,141 |     |
| Research and  development                                  |   | —                           |    | 424,225                       |   | 424,225   |     |
| Segment  contribution                                      |   | $                                | 661,869 |                          | $      | 223,675   |     | $ | 885,544 |   |
|                                                       |   |                             |    |                          |   |      |     |
| Reconciliation  of segment contribution to total net loss: |   |                             |    |                          |   |      |     |
| Sales and marketing                                        |   |                             |    |                          |   | 723,433   |     |
| General and  administrative                                |   |                             |    |                          |   | 543,436   |     |
| Interest income                                            |   |                             |    |                          |   | 5,250     |     |
| Net loss                                                   |   |                             |    |                          |   | $         | (376,075 | ) |

 

The Companyreports assets on a consolidated basis to the chief operating decision maker,and all the assets are located within the United States.

 

*Geographic information:*Net sales by major geographical area, determined on the basis of destination ofthe goods, are as follows: 

 
|          |   | **Period  ended March 31,** |      |
|---------------|--------|-----------------------------|-----------|
|          |   | **2003**                    |      | **2002** | ** ** |
| United States |   | $                           | 1,873,567 |   | $ | 1,993,623 |   |
| Europe        |   | 976,018                     |      | 679,287 |   |
| Total         |   | $                           | 2,849,585 |   | $ | 2,672,910 |   |

 

7.     StockholdersEquity

 

In March, 2003,the Company authorized and issued 1,000,000 shares of Series A ConvertiblePreferred Stock (the “Series A Shares”), which were created pursuant to theterms of a Certificate of Designations, for an aggregate of $950,000 incash.  In connection with thisfinancing, the purchasers of Series A Shares were granted several significantrights senior to the rights of holders of our common stock.  Among other rights, in the event of aliquidation, dissolution or winding up of our Company (includingconsolidations, mergers or other sales), holders of Series A Shares will beentitled to receive $3.80 per share in preference to any distribution to theholders of common stock.  Also, pursuantto the Certificate of Designations, the Company must obtain the consent of theholders of at least two-thirds of the outstanding Series A Shares in order toundertake certain actions, including capital expenditures and the issuance ofequity securities.  Additionally, for solong as Series A Shares remain outstanding more than three hundred ninety (390)days following the initial issuance of the Series A Shares, the

 

9

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holders of SeriesA Shares will be entitled to elect the greater of (i) two members of theCompany’s Board of Directors or (ii) twenty-five percent (25%) of the totalmembers of the Company’s Board of Directors.

 

The Series AShares may be redeemed by the Company upon certain events, including a MajorTransaction which is defined as a sale, transfer or other disposition ofsubstantially all of the Company’s assets related to both its OEM endoscopicbusiness and its 3D business in a single transaction or a series of related transactions.The per share redemption price could be between $2.67 and $2.93.

 

The holders of theoutstanding Series A Preferred Shares have the right to one vote for each shareof Common Stock into which such series of Preferred Stock could then beconverted, and with respect to such vote, such holder shall have full votingrights and powers equal to the voting rights and powers of the holders ofCommon Stock.

 

The holders ofshares of Series A Preferred Shares shall be entitled to receive dividends, outof any assets legally available therefore, prior and in preference to anydeclaration or payment of any cash dividend on the Common Stock, at the rate of$0.1425 per share per annum.

 

8.     NewAccounting Standards

 

InDecember 2002, the FASB issued Statement of Financial Accounting StandardsNo. 148, “*Accounting for Stock-Based Compensation—Transition and Disclosure*,”(“FAS 148”). FAS 148 amends FAS 123 and Accounting PrinciplesBoard Opinion No. 28, “*Interim Financial Reporting*” to presentalternative methods of transition for an entity that voluntarily adopts thefair value based method of accounting for stock-based employee compensation,and provides modifications to the disclosure provisions to require prominentdisclosure about the effects on reported net income of an entity’s accountingpolicy decisions with respect to stock-based employee compensation in quarterlyand annual financial statements. At this time, the Company has not voluntarilyadopted the fair value method of accounting under FAS 123. However,appropriate disclosures about the effects on reported net loss of the Company’saccounting policy with respect to stock-based employee compensation areprovided above.

 

In January, 2003,the FASB issued Interpretation No. 46, Consolidation of Variable InterestEntities, (FIN 46) to clarify the conditions under which assets, liabilitiesand activities of another entity should be consolidated into the financialstatements of a company.  FIN 46requires the consolidation of a variable interest entity by a company thatbears the majority of the risk of loss from the variable-interest entity’sactivities, is entitled to receive a majority of the variable-interest entity’sresidual returns or both.  Theprovisions of FIN 46 are required to be adopted by the Company in fiscal2003.  The Company does not believe theadoption of FIN 46 will have a material impact on its overall financialposition or results of operations.

 

The Companyprovides for an estimated amount of product warranty at the time revenue isrecognized. This estimated amount is provided by product and based onhistorical warranty experience. A rollforward of the customer warranty is asfollows:

 

| Balance at  December 31, 2002 |   | $       | 45,261 |   |
|-------------------------------|--------|---------|--------|--------|
| Warranty expense              |   | 5,000   |   |
| Deductions and  other         |   | (17,059 | )      |
| Balance at March  31, 2003    |   | $       | 33,202 |   |

 

Item2.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations

 

10

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THIS QUARTERLYREPORT MAY CONTAIN PREDICTIONS, ESTIMATES AND OTHER FORWARD-LOOKING STATEMENTSTHAT INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES, INCLUDING THOSE DISCUSSEDBELOW AT “RISKS AND UNCERTAINTIES.” WHILE THIS OUTLOOK REPRESENTS OUR CURRENT JUDGMENT ON THE FUTUREDIRECTION OF OUR BUSINESS, SUCH RISKS AND UNCERTAINTIES COULD CAUSE ACTUALRESULTS TO DIFFER MATERIALLY 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 2002ANNUAL REPORT ON FORM 10-K, FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.

 

**Overviewof our business**

 

Over the course ofthe past year, we have defined our business into two separate units.  The Obesity Surgery Management Servicesbusiness, based in Carlsbad, CA, provides services to physicians and hospitalsinvolved in the surgical treatment of morbid obesity.  Our services include management of the Laparoscopic BariatricSurgery Preceptorship, a comprehensive introduction to starting a minimallyinvasive gastric bypass surgical program. Additionally, we offer systems and consulting services which enable theefficient operation of obesity surgery programs.

 

The VisualizationTechnology business, based in Westborough, MA, develops, manufactures andmarkets products that provide information to physicians performing minimallyinvasive general surgical, cardiac surgical and other selected endoscopic andinterventional procedures.  Ourtechnology products combine a head mounted display with video cameras toprovide surgeons with critical visual information during complex minimallyinvasive procedures, and also incorporate the benefit of viewing complementaryinformation in a voice-controlled, picture-in-picture format, to facilitatereal-time decision making during surgery. The Visualization Technology business also manufactures compact, highresolution endoscopic cameras for original equipment manufacturer customers andstrategic partners.In general terms, endoscopic surgery involves a telescopicviewing device which is inserted into a small incision in the body and whichallows the surgeon an adequate view of the internal part of the body beingrepaired.

 

**Critical Accounting Policies**

** **

The preparation of financial statements and related disclosures inconformity with accounting principles generally accepted in the United Statesof America requires management to 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,

 

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accounting for 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.

 

RevenueRecognition

 

Revenue generated from Laparoscopic Bariatric Surgical (LBS)Preceptorship program sales is recognized (i) with regard to equipment sales,upon shipment of equipment and marketing materials and (ii) with regard totraining services, upon completion of the related training component, providedthat a purchase order has been received, there are no uncertainties regardingcustomer acceptance, the sales price is fixed or determinable andcollectibility is deemed probable. Sales of all other products are similarly recognized upon shipmentprovided that a purchase order has been received, there are no uncertaintiesregarding customer acceptance, the sales price is fixed or determinable andcollectibility is deemed probable.

 

The Company receives semiannual payments as a result of fulfillingcertain obligations related to its strategic alliance agreement with EthiconEndo-Surgery, Inc. (EES).  Thesepayments are recognized as revenue on a straight-line basis over the relatedcontract term, provided that the Company has complied with all contractualobligations.

 

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, 2003 such inventory reservesapproximated $973,000.  The Companybelieves it is adequately reserved for obsolescence of current inventory.  However, future product introductions andrelated inventories may require additional reserves based upon changes inmarket demand or introduction of competing technologies

 

**Ourresults of operations for three-months ended March 31, 2003 versus three-monthsended March 31, 2002**

** **

Revenues.  We had revenues from product sales andcontract revenue of $2,850,000 for the three-months ended March 31, 2003,compared to revenues from product sales and contract revenue of $2,673,000 forthe same period in 2002.  The increasein revenue during the first quarter of 2003 compared to the correspondingperiod in 2002 was due primarily to increased unit sales from our VisualizationTechnology Business partially offset by lower sales from our Obesity SurgeryManagement Services Business.

 

Cost ofRevenues.  Our cost of revenues were$1,575,000 and $1,363,000 for the three- months ended March 31, 2003 and 2002,respectively, with gross margins of 45% and 49%, respectively. The decrease ingross margin was primarily due to lower sales of our higher margin ObesitySurgery Management Services Business.

 

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Research andDevelopment Expenses.  Our research anddevelopment expenses were $257,000 and $424,000 for the three-months endedMarch 31, 2003 and 2002, respectively. The decrease in research and development expenses was primarilyattributable to a reduction in next generation product development.  We expect our research and developmentexpenses to remain at or near current levels in the next several quarters as wefinalize our next generation of products for the general surgery market.

 

Sales andMarketing Expenses.  Our sales andmarketing expenses were $549,000 and $723,000 for the three-months ended March31, 2003 and 2002, respectively. The decrease in sales and marketing expenseduring the 2003 period reflects a reduction in consulting and promotionalactivities for the obesity surgery market. We expect our sales and marketing expenses to remain at or near currentlevels during the next several quarters.

 

General andAdministrative Expenses.  Our generaland administrative expenses were $516,000 and $543,000 for the three-monthsended March 31, 2003 and 2002, respectively. We expect our general and administrative expenses to remain at or nearcurrent levels for the next several quarters.

 

InterestIncome.  Our net interest income was$2,000 and $5,000 for the three-months ended March 31, 2003 and 2002,respectively.  The decrease in netinterest income during the 2003 period was due primarily to decreasing cashbalances.

 

**Liquidity and capital resources**  

 

Net cash used foroperating activities for the three-months ended March 31, 2003 was $1,000compared to net cash provided of $76,000 for the corresponding three-monthperiod in 2002.  The decrease in netcash provided by operating activities during the 2003 period was primarilyattributable to increased accounts payable payments partially offset by adecreased net loss.

 

Net cash providedby investing activities was $117,000 for the three-months ended March 31, 2003compared to $41,000 of net cash provided in the same period in 2002.  The increase in net cash provided byinvesting activities in 2003 was primarily attributable to maturities of shortterm investments partially offset by increased purchases of property andequipment.

 

Net cash providedby financing activities was $952,000 for the three-months ended March 31, 2003compared to $44,000 for the same period in 2002.  The increase in net cash provided by financing activities duringthe 2003 period was primarily attributable to the closing of a privateplacement of shares of our Series A Convertible Preferred Stock for totalproceeds of $950,000.

 

We incurredoperating losses in 2000, 2001 and 2002, and at March 31, 2003, had anaccumulated deficit of $66 million.  AtMarch 31, 2003, we had cash and short-term investments of $1,729,000.  In March 2003, we sold $950,000 of preferredstock in a private placement to two accredited investors.  In addition, we have amounts available undera $2.0 million bank line

 

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of credit facility, which expires in October 2003 and is subject toannual renewals.  We believe that thesesources of liquidity, together with anticipated 2003 product revenues andinterest income, will be sufficient to meet our anticipated capitalrequirements through January 2004. However, certain circumstances, including slow rate of market acceptanceof our products or inability to scale up manufacturing, would accelerate use ofthese funds and require us to seek additional funds to support operatingrequirements.There can be no assurance that the requisite fundings will beconsummated in the necessary time frame or on terms acceptable to us.  Should we be unable to raise sufficientfunds, we may be required to curtail our operating plans and possiblyrelinquish rights to portions of our technology or products.  In addition, increases in expenses or delaysin product development may adversely impact our cash position and requirefurther cost reductions.  No assurancecan be given that we will be able to operate profitably on a consistent basis,or at all, in the future.

 

We have a$2,000,000 credit facility with a financial institution.  Interest on this facility was prime plus 2%at March 31, 2003.  At March 31, 2003,we had no advances outstanding under this credit facility.  If we were to draw under this facility,changes in interest rates would affect the interest expense we would pay andcould impact our cash flows and results of operations. 

 

Item 3.    Quantitative and Qualitative DisclosuresAbout Market Risk

 

At March 31, 2003,our investment portfolio included fixed-income securities of $1.0 million.  These securities are subject to interestrate risk and will decline in value if interest rates increase.  Due to the short duration of our investmentportfolio, an immediate 10 percent increase in interest rates would have no materialimpact on our financial condition or results of operations.

 

We generallyconduct business, including sales to foreign customers, in U.S. dollars and asa result have limited foreign currency exchange rate risk.  The effect of an immediate 10 percent changein foreign exchange rates would not have a material impact on our financialcondition or results of operations.

 

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RISKS ANDUNCERTAINTIES

 

You shouldconsider the following factors carefully in evaluating an investment in VistaMedical in addition to the other information in this report.  You are cautioned that the statements inthis annual report that are not descriptions of historical facts may beforward-looking statements that are subject to risks and uncertainties.  Our actual results could differ materiallyfrom those currently anticipated due to a number of factors, including thoseidentified in this section and elsewhere in this annual report.  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 annualreport.  The following discussion shouldbe read in conjunction with our consolidated financial statements and notes thereto.

 

**We may need additional funds to supportour currently proposed operations.  Ifwe are unable to obtain them, we may have to significantly scale back ouroperations or forgo opportunities in new market segments.**

 

At March 31, 2003,we had cash, cash equivalents and short-term investments of $1,729,000.  We believe that these cash resources,together with cash from operations will be sufficient resources for the nextnine months.

 

We are working oninitiatives to extend our business, most immediately in the surgical obesitymarket, by adding new products and services. For our business to be successful,we believe we must establish and grow our Obesity Surgery Management Servicesbusiness, including establishing programs which we will manage directly, inpartnership with surgeons and hospitals (Vista Obesity and WellnessInstitute.).  As a result, we may berequired to raise additional funds to support our planned operations.  In addition, if we are unable to sustain ourcash flow under our current business plan, we will be required to raise additionalfunds.  If we are unable to raisesufficient funds from an offering of securities or otherwise, we may be unableto continue operations at their current level and may be unable to pursue ournew objectives.  Moreover, our liquidityand capital requirements will depend upon other numerous factors, including thefollowing:

 

•                                          Theextent to which our products and services gain market acceptance;

 

•                                          Costsassociated with establishing marketing, and operating our Obesity SurgeryManagement Services Business and other related programs;

 

•                                          Theprogress and scope of product evaluations;

 

•                                          Thetiming and costs of filing future regulatory submissions;

 

•                                          Thetiming and costs required to receive both domestic and internationalgovernmental approvals;

 

•                                          Thetiming and costs of product and services introductions;

 

•                                          Theextent of our ongoing research and development programs;

 

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•                                          Thecosts of sponsorship training of the physicians to become proficient in the useof our products and procedures;

 

•                                          Thecosts of developing marketing and distribution capabilities.

 

Even if we aresuccessful in raising additional funds, circumstances, including slow rate ofmarket acceptance of our products or our inability to scale up manufacturing,would accelerate our use of proceeds from any offering we might do and requireus to seek additional funds to support our operating requirements.

 

**Our failure to maintain compliancewith the continued listing requirements of the Nasdaq SmallCap Market mayresult in the de-listing of our common stock.**

 

We have recently satisfied the requirements for continued listing ofour common stock on the Nasdaq SmallCap Market outlined for us by the NasdaqListing Qualifications Panel on February 21, 2003.  We accomplished this by raising additional equity capital suchthat we achieved a shareholders’ equity balance of at least $2,800,000.  The Nasdaq SmallCap Market has notified usthat our exception to the continued listing requirements shall be extendeduntil March 31, 2003, when our shareholders’ equity balance was$2,997,000.  Although we expect tomaintain the minimum required shareholder’s’ equity balance, we have verylittle cushion to protect against an unexpected decline.  Also, recently our stock has been tradingbelow the $1 minimum bid level required by The Nasdaq SmallCap Market.  Failure to maintain the minimum requiredshareholders’ equity balance or if our stock remains below the $1 bid level, couldcause our common stock to be de-listed from the Nasdaq SmallCap Market.  We cannot assure you that we will be able toremain in compliance.

 

**If we divest some or all of our visualizationtechnology business, our future success will depend on our ability to establishand grow our obesity surgery management business.**

 

Together with ourinvestment advisors, we are currently considering strategic options withrespect to our visualization technology business.  In the event we determine to divest all or a portion of thatbusiness, our future success as a company will increasingly depend on ourability to execute on the establishment and growth of our obesity surgerymanagement services business.  As acompany, we have limited experience in the provision of such services.  We will also be required to build thisbusiness from the ground up, finding hospital partners and surgeons willing toparticipate.  We cannot assure you thatwe will be able to build a successful services business.

 

**We have a history of losses and maynot become profitable.**

 

Since ourformation in July 1993, and as of March 31, 2003, we have incurred cumulativenet losses of $66 million.  We expect toincur losses for at least the next 9 months. We may never achieve or sustain profitability in the future.  Even if we achieve profitability, we may notbe able to sustain it on an ongoing basis.

 

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**As a company, we do not haveexperience in the ownership and management of health care service businesses.**

 

As a company we donot have extensive experience in providing management services and have nodirect experience in the management of bariatric surgical programs.  We have been involved in the development ofbariatric surgical programs since 2000, but have never directly managed theseprograms.  As such, we have only alimited and indirect operating history upon which an evaluation of ourprospects in this business sector 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.

 

**The terms of our recent preferredstock financing confer senior rights to the holders of Series A ConvertiblePreferred Stock, and these rights may impair the interests of our commonstockholders or impact our results of operations.**

 

We recently issued1,000,000 shares of our Series A Convertible Preferred Stock (the “Series AShares”), 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 AShares are subject to redemption by us upon certain events.  If we choose to redeem some or all of theSeries A Shares pursuant to the terms of our Certificate of Designations, wewill use cash that would otherwise fund our business operations.  Although we may believe that such aredemption is the best available business option, valuable cash wouldnonetheless be consumed.  This couldimpact our ability to fund operations or grow our business.

 

The holders ofSeries A Shares are also entitled to require us to register their shares.  We may be required to register their shareson Form S-3 within 30 days after request, and in any

 

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event prior to four hundred (400) days following the initial issuanceof Series A Shares.  This registrationwill consume management time and effort as well as some cash resources.

 

**Success of the Vista Obesity andWellness (VOW) Institutes depends on our entering into agreements withhospitals and surgeons; the time to conclude these agreements may be extendedand thereby delay or prevent the implementation of our strategy. **

 

We plan to set upour VOW Institutes in conjunction with hospitals and surgeons.  There can be no assurance that negotiationsfor the establishment of these Institutes will not be protracted or impossibleto negotiate satisfactorily.  Because ofour limited experience in negotiating and concluding these agreements, we cannotaccurately predict the time and expense involved, and any unexpected delayscould prevent the execution of our strategic plan.

 

**We expect to need additional fundingif we are to fully develop the VOW Institute concept.**

 

Any deviation inthe timing or projected cash flow of our Obesity Surgery Strategy may cause usto require additional investment capital. There can be no assurance that such capital will be available to theextent required, or at all.  The amount ofadditional capital which we may need to raise will depend on many factors, including:  ·the extent to which the Institutes andother services gain market acceptance, 

 

•               the extent towhich the Institutes and other services gain market acceptance; 

•               the speed withwhich we can execute our plan; 

•               the levels ofreimbursement for procedures performed; 

•               the extent ofcompetition.

 

**We willincur significant expenses as we attempt to establish and grow our obesitysurgery management services business.**

 

Establishing ournew services business will be expensive and time-consuming.  Significant management time and energy willbe diverted from our existing visualization technology business as we attemptto establish relationships and partnerships with surgeons and entities willingto participate in the establishment of our obesity surgery centers.  These centers will also be financiallycostly to establish and operate.  If wedo not generate sufficient surgical procedures through these centers, the feeswe receive for the services we provide may be insufficient to sustain thebusiness.

 

**After establishing a VOW Institute,we must continue to prove our value proposition.**

 

In order tosuccessfully negotiate and complete agreements with doctors and hospitals toestablish a VOW Institute, we will present them with our projected revenues andoperational metrics.  We cannot assureyou that our projections will prove accurate or that we will be able to providethe anticipated metrics.  Ourprojections are based on limited input and operational history and failure tomeet such projections will negatively impact our business.

 

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**We operate in a competitive market;new technologies, procedures, or pharmaceuticals could radically change themodality of treatment of morbid obesity and negatively impact our managementservices business and the projected VOW Institutes.**

 

The market forproducts and services that address obesity is competitive and new offerings andtechnologies are becoming available regularly. We are aware of several developments, primarily involving nervestimulation or balloon technology, which may come to the market in the next fewyears.  These devices would be implantedor 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 business could be negatively impacted. Also, many pharmaceutical companiesare researching 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 we fail to retain our keypersonnel and hire, train and retain additional qualified and experiencedemployees, we may not be able to compete effectively.**

 

Our future successwill depend to a large extent on retaining our core operating management teamand recruiting sufficient qualified employees to manage and staff our servicesbusinesses.  There is likely to be acompetitive labor market for such staff and there is no assurance that we willbe able to attract and retain an adequate number of suitable employees.

 

**We are, to a significant extent,dependent on distribution partners to sell our visualization technologyproducts.**

 

We only have asmall direct sales force and, in the past, we were primarily dependent onagreements with third parties for sales of the majority of products derivedfrom our core three-dimensional technology. Two of our primary distribution agreements were terminated in 2000.  We entered into an arrangement with JomedN.V. in May, 2000 to transition distribution in cardiac surgery and to continuesupporting our cardiac customer base. However, the success of this transition depends upon the concurrentdevelopment of new technology by Jomed N.V. and may not be achieved in areasonable timeframe, or at all.  If weare unable to make this transition, we may be unsuccessful in distributing ourcardiac surgery products and may lose revenues. Jomed applied for bankruptcyprotection in the Netherlands in January, 2003.  We have not yet elected to terminate our agreement pendingclarification of Jomed’s ongoing status. 

 

In addition,during 2000, we changed our strategic emphasis for our core three-dimensionaltechnology for applications in general surgery, gynecology and urology.  We cannot assure you that we will besuccessful in these areas of sales. Even if we are successful, we cannot assure you that the revenueachieved in these areas of emphasis will be sufficient to compensate for anyloss of sales revenue from the termination of our previous distributionagreements for cardiac products.  Eitherof these results could have an adverse affect on our financial condition andresults of operations.

 

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**Our profitability is dependent uponthe successful commercialization of our visualization technology products andthe establishment and growth of our obesity surgery management servicesbusiness.**

 

Products derivedfrom our core visualization technology – the Endosite for general surgery andthe Series 8000 for minimally invasive cardiac surgery – are expected toaccount for the majority of our visualization technology revenues over the nextseveral years.  The demand for theseproducts may not be sufficient to allow us to achieve profitable operations.  Our development efforts for improvements tothese products may not be successful. In addition, other products under development may not be shown to besafe or effective, capable of being manufactured in commercial quantities atacceptable costs, acquire appropriate regulatory clearances or be successfullymarketed.  Our obesity surgerymanagement services business is of relatively recent origin and it is difficultto predict its longer term success.

 

**Our success is dependent uponacceptance of a minimally invasive approach to complex procedures as areliable, safe and cost effective alternative to existing treatments.**

 

Complex minimallyinvasive procedures are only performed on a very limited basis by a relativelysmall number of highly skilled surgeons. We are unable to predict how quickly, if at all, complex minimallyinvasive procedures will be adopted by the medical community or, if they areadopted, the number of procedures that will be performed.

 

Even if theclinical safety and effectiveness of complex minimally invasive procedures isestablished in general surgery, cardiac and other specialties, surgeons andother physicians may choose not to recommend the procedures for any number ofother reasons.  Adoption of theseprocedures by doctors will depend, for example, upon our ability to facilitateand sponsor training of surgeons to perform complex minimally invasiveprocedures and the willingness of these surgeons to perform suchprocedures.  Doctors may also elect notto recommend the minimally invasive procedures based on possible unavailabilityof acceptable reimbursement from health care payors.  Health care payor acceptance may require evidence of the costeffectiveness of minimally invasive procedures as compared to other currentlyavailable treatments.  We believe thatphysician endorsements will be essential for clinical adoption of minimallyinvasive procedures and these endorsements may not be obtained.  Patient acceptance of new procedures willdepend upon doctor recommendations, as well as other factors, including theeffectiveness of, and the rate and severity of complications associated with,the procedure as compared to other treatments.

 

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**Widespread use of our products willrequire sponsoring the training of a large number of surgeons, and the timerequired to institute a training program and to train such surgeons couldadversely affect near term market acceptance.**

 

Evaluations ofvisualization technology, such as ours, which have been conducted to date, haveshown that there is a learning process involved for surgeons and other membersof the surgery team to become proficient with the use of the systems.  Based on the clinical and laboratory proceduresperformed to date, we cannot assure you that visualization and informationsystem enhancements incorporated, or to be incorporated, in our products willprove suitable for use by a substantial number of surgeons.  If they prove unsuitable for a large numberof surgeons to use, the potential markets and applications for our productswould be significantly limited.

 

**There are significant risksassociated with any scale-up of manufacturing which may be required to meetmarket demand and become profitable.**

 

We have neverestablished high-volume manufacturing operations and if we are required to doso to meet market demand or to become profitable, we may not be able toestablish or maintain reliable operations at commercially reasonablecosts.  We may also require additionalmanufacturing facilities if production volumes increase.  Acquisition of new manufacturing facilitieswould also likely involve relocation. Difficulties in scaling up manufacturing of products could result fromproblems involving:

 

•                                          qualitycontrol and assurance,

 

•                                          componentand service availability,

 

•                                          adequacyof control policies and procedures,

 

•                                          lackof qualified personnel,

 

•                                          compliancewith FDA regulations and the need for further FDA approval of new manufacturingprocesses and facilities and

 

•                                          otherproduction constraints.

 

We have consideredand will continue to consider as appropriate, the internal manufacture ofsub-assemblies currently provided by third-party subcontractors, as well as theimplementation of new production processes. Our manufacturing yields or costs may increase as a result of thetransition to in-house production or to new production processes when suchefforts are undertaken.  In addition,costs to comply with FDA good manufacturing practices or changes in suchpractices may exceed our expectations.

 

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**We may facecomponent shortages and are dependent in some instances on single sources ofsupply.**

** **

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 andservices used in our systems for which we have only a single source ofsupply.  The manufacture of our productsin larger commercial quantities will require a substantial increase incomponent supplies and will likely necessitate the replacement of currentsuppliers or the addition of new suppliers. The qualification of additional or replacement vendors for specifiedcomponents or services is a lengthy process. In addition, the substitution of replacement vendors may entailre-engineering time and cost and could delay the supply of our products.

 

We expect to manufacture our products based on forecasted productorders and intend to purchase subassemblies and components prior to receipt ofpurchase orders from customers.  Leadtimes for ordered materials and components vary significantly and depend onfactors such as the business practices of the specific supplier, contract termsand 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 orinadequate inventory if orders do not match forecasts.

 

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

** **

The Institutes 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 couldcontribute to an inadvertent breach of laws or regulations.  (See Governmental Regulation.)

 

**We aresubject to significant domestic and international regulation and may not beable to obtain necessary regulatory clearances to sell our products.**

** **

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

 

Medical devices are regulated in the United States primarily by the FDAand, to a lesser extent, by state agencies. Sales of medical device products outside the United States are subjectto foreign regulatory requirements that vary from country to country.  Generally, medical devices requirepre-market clearance or pre-market approval prior to commercialdistribution.  A determination thatinformation available on the medical device is not sufficient to grant theneeded clearance or approval will delay market introduction of theproduct.  In addition, material changesor modifications to, and changes in intended use of, medical devices also aresubject to

 

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FDA review and clearance or approval. The FDA regulates the research, testing, manufacture, safety,effectiveness, labeling, storage, record keeping, promotion and distribution ofmedical devices in the United States and the export of unapproved medicaldevices from the United States to other countries.  The time required to obtain approvals required by foreigncountries may be longer or shorter than that required for FDA clearance, andrequirements for licensing may differ from FDA requirements.  The current regulatory environment in Europefor medical devices differs significantly from that in the United States.

 

**We expectto encounter rapid technological change and significant competition.**

** **

The medical device market in which we compete is characterized byintensive development efforts and rapidly advancing technology.  Our future success will depend, in largepart, upon our ability to anticipate and keep pace with advancing technologyand competing innovations.  We may notbe successful in identifying, developing and marketing new products orenhancing our existing products.

 

We believe that a number of large companies, with significantly greaterfinancial, manufacturing, marketing, distribution and technical resources andexperience than ours, are focusing on the development of visualization productsfor minimally invasive microsurgery. Several companies are currently developing and marketing visualizationproducts for minimally invasive microsurgery which could be applied to generalsurgery or heart surgery.

 

Technological advances with other therapies such as drugs,interventional procedures or future innovations in surgical techniques couldmake such other therapies more effective or lower in cost than minimallyinvasive microsurgery procedures and could diminish growth prospects forminimally invasive microsurgery.

 

**We expectfluctuations in our operating results.**

** **

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

 

•                                          timing and results of product evaluations,

 

•                                          delays associated with the FDA and otherregulatory approval processes,

 

•                                          demand for and utilization of our products,

 

•                                          changes in our pricing policies or those ofour competitors,

 

•                                          changes in third-party payment guidelines,

 

•                                          the number, timing and significance ofproduct enhancements and new product announcements by us or our competitors,

 

•                                          our ability to develop, introduce and marketnew and enhanced versions of our products on a timely basis,

 

•           customer order deferrals in anticipation of enhancements or of newproduct

 

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introductions by us or our competitors,

 

•              productquality problems,

 

•              personnelchanges and  

 

•              the level of international sales.

 

**Ourprofitability in our visualization technology business is directly related tothe level of reimbursements for surgical procedures using our products.**

** **

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

 

We expect that our products typically will be used by hospitals andsurgical centers, which bill various third-party payors, such as governmentalprograms and private insurance plans, for the health care services provided totheir patients.  Third-party payorscarefully review and increasingly challenge the prices charged for medicalproducts and services or negotiate a flat rate fee in advance.  Payment rates from private companies alsovary depending on the procedure performed, the third-party payor, the insuranceplan and other factors.  Medicarecompensates hospitals at a predetermined fixed amount for the costs associatedwith an in-patient hospitalization based on the patient’s discharge diagnosisand compensates physicians at a pre-determined fixed amount based on theprocedure performed, regardless of the actual costs incurred by the hospital orphysician in furnishing the care and unrelated to the specific devices orsystems used in that procedure. Medicare and other third-party payors are increasingly scrutinizingwhether to cover new products and the level of payment for new procedures.  The flat fee reimbursement trend is causinghospitals to control costs strictly in the context of a managed care system inwhich health care providers contract to provide comprehensive health care for afixed cost per person.  We are unable topredict what changes will be made in the reimbursement methods utilized by suchthird-party payors.

 

If we obtain the necessary foreign regulatory registrations orapprovals, market acceptance of our products in international markets would bedependent, in part, upon the acceptance by the prevailing health care financingsystem in each country.  Health carefinancing systems in international markets vary significantly by country andinclude both government sponsored health care programs and privateinsurance.  We cannot assure you thatthese financing systems will endorse the use of our products.

 

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**We havelimited experience directly marketing our products overseas and may not besuccessful in expanding into international markets without experiencedpartners.**

** **

We have limited experience in directly marketing our productsoverseas.  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 ourproducts  are sold, including laws regulatingmanufacture and sale of medical devices. In addition, the laws of some foreign countries do not protect ourintellectual property rights to the same extent as do the laws of the UnitedStates.

 

**We may besubject 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 ourproducts.  In addition, increasedproduct liability coverage may be required if additional products are used inclinical evaluations or successfully commercialized.  Product liability insurance is expensive and in the future maynot be available to us on acceptable terms, if at all.  A successful product liability claim orseries of claims brought against us in excess of our insurance coverage or aproduct recall would negatively impact our business.

 

**If we areunable to protect our intellectual property, we may be unable to prevent othercompanies 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 allowed may not be sufficiently broad toprotect our technology.  In addition,issued patents owned by or licensed to us may be challenged, invalidated orcircumvented, or the rights granted thereunder may not provide us withcompetitive advantages.

 

The medical device industry has been characterized by extensivelitigation regarding patents and other intellectual property rights.  Litigation, which would result insubstantial expense, may be necessary to enforce any patents issued or licensedto us and/or to determine the scope and validity of proprietary rights of thirdparties or whether our products, processes or procedures infringe any suchthird-party proprietary rights.  We mayalso have to participate in interference proceedings declared by the UnitedStates Patent and Trademark Office, which could result in substantial expense,to determine the priority of inventions covered by our issued United Statespatents or pending patent applications. Furthermore, we may have to participate at

 

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substantial cost in International Trade Commission proceedings toenjoin importation of products which would compete unfairly with ourproducts.  Any adverse outcome of anypatent litigation, including interference proceedings, could subject us tosignificant liabilities to third parties, require disputed rights to belicensed from or to third parties or require us to cease using the technologyin dispute.  Any such licenses may notbe available on acceptable 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 we arenot able to attract and retain key technical and senior management personneland doctors 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 technical and senior managementpersonnel, many of whom would be difficult to replace and some of whom performimportant functions beyond those suggested by their job titles ordescriptions.  Our business and futureoperating results also depend in significant part upon our ability to attractand retain qualified management, manufacturing, technical, marketing and salesand support personnel 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 inthe field of visualization, but are free to consult with other non-competinginstrumentation companies and are employed elsewhere on a full-time basis.  As a result, they only spend a limitedamount of time on our business. Although we have entered into consulting agreements, includingconfidentiality provisions with each of the members of our clinical advisoryboards, the consulting and confidentiality agreements between us and each ofthe members of our clinical advisory boards may be terminated or breached.

 

**Our stockprice could continue to be volatile and your investment in our common stockcould 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 have experiencedsignificant fluctuations unrelated to the operating performance.  The market price of our common stock hashistorically been highly volatile and may be significantly affected by factorssuch as:

 

•                                          actual or anticipated fluctuations in ouroperating results,

 

•                                          changes in financial estimates by securitiesanalysts,

 

•                                          announcements of technological innovations,

 

•                                          new products or new contracts by us or ourcompetitors,

 

•                                          regulatory announcements,

 

•                                          developments with respect to patents orproprietary rights,

 

•                                          conditions and trends in the medical deviceand other technology industries,

 

•                                          adoption of new accounting standardsaffecting the medical device industry, and

 

•                                          general market conditions.

 

In addition, the stock market has from time to time experiencedsignificant price and volume fluctuations that have particularly affected themarket prices for shares of early stage companies.  These broad market fluctuations may adversely affect the marketprice of our common stock.  In the past,following periods of volatility in the market price of a particular company’ssecurities, securities class action litigation has often been brought againstthat

 

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company.  Such litigation, ifbrought against us, could result in substantial costs and a diversion ofmanagement’s attention and resources.

 

**Our use ofhazardous materials may result in unexpected and substantial claims against usfor which we do not have sufficient financial resources.**

 

Our research and development activities may involve the controlled useof hazardous materials and chemicals. The risk of accidental contamination or injury from these materialscannot be completely eliminated.  In theevent 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 environmentalregulations.

 

**We do notanticipate paying any dividends and any gains from your investment in our stockwill have to come from increases in the price of such stock.**

** **

We currently intend to retain any future earnings for use in ourbusiness and do not anticipate paying any cash dividends in the foreseeablefuture.

 

**Our charterdocuments may prevent us from participating in transactions that could bebeneficial to you.**

** **

Our charter documents contain provisions that may make it moredifficult or discourage a change in control. This may adversely affect the market price of our common stock.

 

Item 4.    Controlsand Procedures

 

(a)  Evaluation of disclosure controls andprocedures

 

Based on theirevaluation as of a date ninety (90) days of the filing of this Form 10-Q, ChiefExecutive officer and Chief Financial Officer have concluded that ourdisclosure controls and procedures (as defined in  Rules 13a-14 and 15d—14 under the Securities Exchange Act of1934) are effective.

 

(b)  Changes in internal control

 

There have been nosignificant changes in internal controls or in other factors that couldsignificantly affect these controls subsequent to the date of their evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

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PART II.  OTHERINFORMATION

 

Item 1.    LegalProceedings

 

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

 

Item 2.    Changesin Securities and Use of Proceeds

 

a.             Not applicable

 

b.             Not applicable

 

c.             Not applicable

 

d.             Not applicable

 

Item 3.    Defaultsupon Senior Securities

 

None.

 

Item 4.    Submissionof Matters to a Vote of Security Holders

 

None.

 

Item 5.    OtherInformation

 

None.

 

Item 6.    Exhibitsand Reports on Form 8-K

 
| A)     | Exhibits |
|--------|----------|
|   |
| 3.1    | (1)      | Second Restated Certificate of Incorporation |   |
| 3.2    | (2)      | Certificate of Amendment of Second Restated  Certificate of Incorporation |   |
| 3.3    | (3)      | Restated Bylaws |   |
| 4.1    | (3)      | Form of Certificate for Common Stock |   |
| 99.1   |     | Certification of the Chief Executive Officer  pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes – Oxley Act of 2002 |
| 99.2   |     | Certification of the Chief Financial Officer  pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes – Oxley Act of 2002 |
|        |          |  |  |  |

 

 

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(1)           Incorporated by reference to our Form10-K/A filed on September 10, 1998.

 

(2)           Incorporated by reference to our Form10-Q filed on November 14, 2001.

 

(3)           Incorporated by reference to ourRegistration Statement on Form S-1, as amended, Filed on July 2, 1997.

 

B)            Reports on Form 8-K

 

A Form 8-K wasfiled by the Company on March 3, 2003, which attached a press release settingforth certain unaudited financial information with respect to our quarter endedMarch 31, 2003.

 

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**SIGNATURES**

** **

**Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.**

 
|            | **VISTA MEDICAL TECHNOLOGIES,INC.**               |
|-----------------|---------------------------------------------------|
|            |                                              |
| **Date: ** | **May 13, 2003**                                  |   | **/s/  John R. Lyon** |   |
|            | **John R. Lyon**                                  |
|            | **President, Chief Executive  Officer and**       |
|            | **Director**                                      |
|            |                                              |
| **Date: ** | **May 13, 2003**                                  |   | **/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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**Certifications**

** **

**I, John R. Lyon,President, Chief Executive Officer and Director of Vista Medical Technologies,Inc., certify that:**

** **

**1.**                                       Ihave reviewed this quarterly report on Form 10-Q of Vista Medical Technologies,Inc.;

 

**2.**                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

** **

**3.**                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

** **

**4.**                                       Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

** **

**a)**                                      designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

** **

**b)**                                     evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

** **

**c)**                                      presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

** **

**5.**                                       Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunctions):

** **

**a)**                                      allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

** **

**b)**                                     anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

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**6.**                                       Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions with regardto significant deficiencies and material weaknesses.

 
| **Date:  May 13, 2003** | **By:** | **/s/  JOHN R. LYON**                                |
|------------------------------|---------|------------------------------------------------------|
|                         |    | **John R. Lyon**                                     |
|                         |    | **President,  Chief Executive Officer and Director** |

 

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**Certifications**

 

I, Stephen A. Gorgol, Vice President of Finance and Chief FinancialOfficer of Vista Medical Technologies, Inc., certify that:

 

1.                                       Ihave reviewed this quarterly report on Form 10-Q of Vista Medical Technologies,Inc.;

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.                                       Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)                                      presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.                                       Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunctions):

 

a)                                      allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                                     anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officers and I have indicated in this quarterlyreport

 

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whether or not there were significant changes ininternal controls or in other factors that could significantly affect internalcontrols subsequent to the date of our most recent evaluation, including anycorrective actions with regard to significant deficiencies and materialweaknesses.

 
| **Date:  May 13, 2003** | **By:** | **/s/  STEPHEN A. GORGOL**                                 |
|------------------------------|---------|------------------------------------------------------------|
|                         |    | **Stephen A. Gorgol**                                      |
|                         |    | **Vice  President of Finance and Chief Financial Officer** |

 

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