**UNITED STATESSECURITIES 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 June 30,2004**

 

**OR**

 
| **o** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT  OF 1934** |   |
|-------|------------------------------------------------------------------------------------------------------|--------|

 

**For the transition period from                        to                             .**

 

**COMMISSION FILE NUMBER 000-22743**

 

**VISTA MEDICAL TECHNOLOGIES, INC.**

(Exact name of Registrant as Specified in ItsCharter)

 
| **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,including zip code)

 

**(760) 603-9120**

(Registrant’s telephone number, includingarea code)

 

**Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter 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 the registrantis an accelerated filer (as defined in rule 12b-2 of the Exchange Act)Yes ****o    No ****ý**

 

As of July 30, 2004, there were 10,905,817 shares of $.01 parvalue 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 June 30, 2004 and  December 31, 2003                      |   |
|                                |                                                                                                  |   |
|                                | Consolidated Statements of Operations for  the three and six months ended June 30, 2004 and 2003 |   |
|                                |                                                                                                  |   |
|                                | Consolidated Statements of Cash Flows for  the six months ended June 30, 2004 and 2003           |   |
|                                |                                                                                                  |   |
|                                | Notes to Consolidated Financial Statements                                                            |   |
|                                |                                                                                                  |   |
| Item 2.                             | Management’s  Discussion and Analysis of Financial Condition and Results of Operations           |   |
|                                |                                                                                                  |   |
| Item 3.                             | Quantitative and Qualitative Disclosures  About Market Risk                                           |   |
|                                |                                                                                                  |   |
| Risks and Uncertainties             |                                                                                                  |
|                                |                                                                                                  |   |
| Item 4.                             | Controls and Procedures                                                                               |   |
|                                |                                                                                                  |   |
| PART II.  OTHER INFORMATION    |                                                                                                  |
|                                |                                                                                                  |   |
| Item 1.                             | Legal Proceedings                                                                                     |   |
|                                |                                                                                                  |   |
| Item 2.                             | Changes in Securities, Use of Proceeds and  Issuer Purchases of Equity Securities.                    |   |
|                                |                                                                                                  |   |
| Item 3.                             | Defaults Upon Senior Securities                                                                       |   |
|                                |                                                                                                  |   |
| Item 4.                             | Submission of Matters to a Vote of Security  Holders                                                  |   |
|                                |                                                                                                  |   |
| Item 5.                             | Other Information                                                                                     |   |
|                                |                                                                                                  |   |
| Item 6.                             | Exhibits and Reports on Form 8-K                                                                      |   |
|                                |                                                                                                  |   |
| SIGNATURES                          |                                                                                                  |

 

2

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# ***PART I.*****   ****FINANCIAL INFORMATION**

 

## Item1.             Financial Statements

 

Vista Medical Technologies, Inc.

Consolidated Balance Sheets

 
| ** **                                                                                                                                                                                            | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                                                                            | ** ** | **(Unaudited)**        | ** ** | **(Restated)**             | ** ** |
| ASSETS                                                                                                                                                                                                |       |                   |       |                       |       |
| Current assets:                                                                                                                                                                                       |       |                   |       |                       |       |
| Cash and cash equivalents                                                                                                                                                                             |       | $                      | 3,813,897  |                       | $          | 448,943 |   |
| Short-term investments                                                                                                                                                                                |       | 3,501                  |       | 187,209                    |       |
| Accounts receivable, net                                                                                                                                                                              |       | 25,558                 |       | 286,152                    |       |
| Due from Viking Systems, Inc.                                                                                                                                                                         |       | 466,615                |       | —                     |       |
| Inventories, net                                                                                                                                                                                      |       | 11,093                 |       | 45,275                     |       |
| Assets related to discontinued operations                                                                                                                                                             |       | —                 |       | 1,881,237                  |       |
| Other current assets                                                                                                                                                                                  |       | 94,057                 |       | 108,322                    |       |
| Total current assets                                                                                                                                                                                  |       | 4,414,721              |       | 2,957,138                  |       |
| Property and equipment, net                                                                                                                                                                           |       | 41,745                 |       | 34,023                     |       |
| Investment in equity securities of Viking  Systems, Inc.                                                                                                                                              |       | 33,080                 |       | —                     |       |
| TOTAL ASSETS                                                                                                                                                                                          |       | $                      | 4,489,546  |                       | $          | 2,991,161 |   |
|                                                                                                                                                                                                  |       |                   |       |                       |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                             |       |                   |       |                       |       |
| Current liabilities:                                                                                                                                                                                  |       |                   |       |                       |       |
| Accounts payable                                                                                                                                                                                      |       | $                      | 124,777    |                       | $          | 141,631 |   |
| Current portion of capital leases                                                                                                                                                                     |       | 23,984                 |       | 16,517                     |       |
| Short term bank borrowings                                                                                                                                                                            |       | —                 |       | 200,000                    |       |
| Accrued compensation                                                                                                                                                                                  |       | 134,230                |       | 134,156                    |       |
| Deferred revenue payments                                                                                                                                                                             |       | 260,000                |       | 442,500                    |       |
| Liabilities related to discontinued  operations                                                                                                                                                       |       | —                 |       | 755,550                    |       |
| Accrued liabilities                                                                                                                                                                                   |       | 88,175                 |       | 174,019                    |       |
| Total current liabilities                                                                                                                                                                             |       | 631,166                |       | 1,864,373                  |       |
|                                                                                                                                                                                                  |       |                   |       |                       |       |
| Total long term lease obligations                                                                                                                                                                     |       | 11,206                 |       | 18,624                     |       |
|                                                                                                                                                                                                  |       |                   |       |                       |       |
| TOTAL LIABILITIES                                                                                                                                                                                     |       | 642,372                |       | 1,882,997                  |       |
|                                                                                                                                                                                                  |       |                   |       |                       |       |
| Stockholders’ equity:                                                                                                                                                                            |       |                   |       |                       |       |
| Preferred stock, $.01 par value:  Authorized shares - 5,000,000  Issued and outstanding shares - 1,000,000 at December 31, 2003 and  915,000 at June 30,2004 (Liquidation Value $3,477,000) |       | 1,042,863              |       | 1,068,686                  |       |
| Common stock, $.01 par value:  Authorized shares - 35,000,000  Issued and outstanding shares - 5,007,918 at December 31, 2003 and  10,905,817 at June 30, 2004                              |       | 109,058                |       | 50,079                     |       |
| Additional paid-in capital                                                                                                                                                                            |       | 72,712,374             |       | 68,111,244                 |       |
| Deferred compensation                                                                                                                                                                                 |       | (24,320                | )          | (29,856                    | )          |
| Accumulated deficit                                                                                                                                                                                   |       | (69,992,801            | )          | (68,091,989                | )          |
| Total stockholders’ equity                                                                                                                                                                       |       | 3,847,174              |       | 1,108,164                  |       |
|                                                                                                                                                                                                  |       |                   |       |                       |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                       |       | $                      | 4,489,546  |                       | $          | 2,991,161 |   |

 

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

 

Seeaccompanying notes.

 

3

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Vista Medical Technologies, Inc.

Consolidated Statements of Operations

(Unaudited)

 
| ** **                                                          | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                          | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                          | ** ** | ** **                           | ** ** | **(Restated)**                     | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
|                                                                |       |                                 |       |                               |       |   |   |   |   |
| Revenues                                                            |       | $                                    | 302,911    |                               | $          | 637,279 |   | $ | 902,715 |   | $ | 1,305,553 |   |
|                                                                |       |                                 |       |                               |       |   |   |   |   |
| Cost of revenues                                                    |       | 61,706                               |       | 130,571                            |       | 279,781 |   | 297,917 |   |
| Sales and marketing                                                 |       | 626,288                              |       | 429,505                            |       | 1,109,227 |   | 802,493 |   |
| General and administrative                                          |       | 281,732                              |       | 348,118                            |       | 582,598 |   | 642,850 |   |
|                                                                |       |                                 |       |                               |       |   |   |   |   |
| Total cost and expenses                                             |       | 969,726                              |       | 908,194                            |       | 1,971,606 |   | 1,743,260 |   |
|                                                                |       |                                 |       |                               |       |   |   |   |   |
| Loss from operations                                                |       | (666,815                             | )          | (270,915                           | )          | (1,068,891 | ) | (437,707 | ) |
|                                                                |       |                                 |       |                               |       |   |   |   |   |
| Interest income                                                     |       | 4,578                                |       | 34,510                             |       | 5,440 |   | 36,593 |   |
| Interest expense                                                    |       | (1,002                               | )          | (1,054                             | )          | (2,668 | ) | (1,054 | ) |
|                                                                |       |                                 |       |                               |       |   |   |   |   |
| Net loss from continuing operations                                 |       | (663,239                             | )          | (237,459                           | )          | (1,066,119 | ) | (402,168 | ) |
|                                                                |       |                                 |       |                               |       |   |   |   |   |
| Loss from discontinued operations                                   |       | (133,212                             | )          | (220,845                           | )          | (632,516 | ) | (101,877 | ) |
|                                                                |       |                                 |       |                               |       |   |   |   |   |
| Net loss                                                            |       | (796,451                             | )          | (458,304                           | )          | (1,698,635 | ) | (504,045 | ) |
|                                                                |       |                                 |       |                               |       |   |   |   |   |
| Accretion of preferred stock dividends                              |       | (34,665                              | )          | (35,527                            | )          | (70,192 | ) | (46,849 | ) |
| Deemed dividend on redemption of preferred  stock                   |       | (131,985                             | )          | —                             |       | (131,985 | ) | — |   |
|                                                                |       |                                 |       |                               |       |   |   |   |   |
| Net loss applicable to common stockholders                          |       | $                                    | (963,101   | )                                  | $          | (493,831 | ) | $ | (1,900,812 | ) | $ | (550,894 | ) |
|                                                                |       |                                 |       |                               |       |   |   |   |   |
| Net loss per share basic and diluted:                               |       |                                 |       |                               |       |   |   |   |   |
| Continuing operations                                               |       | $                                    | (0.08      | )                                  | $          | (0.05 | ) | $ | (0.16 | ) | $ | (0.08 | ) |
| Discontinued operations                                             |       | (0.02                                | )          | (0.04                              | )          | (0.10 | ) | (0.02 | ) |
|                                                                |       | $                                    | (0.10      | )                                  | $          | (0.09 | ) | $ | (0.26 | ) | $ | (0.10 | ) |
| Basic and diluted loss per share applicable  to common stockholders |       | $                                    | (0.12      | )                                  | $          | (0.10 | ) | $ | (0.29 | ) | $ | (0.11 | ) |
|                                                                |       |                                 |       |                               |       |   |   |   |   |
| Shares used in computing basic and diluted  loss per share          |       | 7,728,995                            |       | 5,003,471                          |       | 6,495,282 |   | 5,002,620 |   |

 

See accompanying notes

 

4

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Vista Medical Technologies, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

 
| ** **                                                                                          | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                          | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| ** **                                                                                          | ** ** | ** **                         | ** ** | **(Restated)** | ** ** |
| OPERATING ACTIVITIES                                                                                |       |                               |       |   |   |
| Net loss from continuing operations                                                                 |       | $                                  | (1,698,635 | ) | $ | (504,045 | ) |
| Adjustments to reconcile net loss to net  cash used for operating activities:                       |       |                               |       |   |   |
| Noncash compensation expense                                                                        |       | —                             |       | 72,750 |   |
| Depreciation and amortization                                                                       |       | 17,853                             |       | 17,625 |   |
| Amortization of deferred compensation                                                               |       | 5,536                              |       | 19,941 |   |
| Changes in operating assets and  liabilities:                                                       |       |                               |       |   |   |
| Accounts receivable                                                                                 |       | 260,594                            |       | (45,222 | ) |
| Inventories, net                                                                                    |       | 34,182                             |       | 12,146 |   |
| Other current assets                                                                                |       | 14,265                             |       | 25,637 |   |
| Accounts payable                                                                                    |       | (16,854                            | )          | (81,995 | ) |
| Accrued compensation                                                                                |       | 74                                 |       | (3,168 | ) |
| Deferred revenue                                                                                    |       | (182,500                           | )          | 64,330 |   |
| Accrued liabilities                                                                                 |       | (85,844                            | )          | (233,825 | ) |
| Changes in assets and liabilities related  to discontinued operations                               |       | 379,073                            |       | (146,927 | ) |
| Net cash flows used for operating  activities                                                       |       | (1,272,256                         | )          | (802,753 | ) |
|                                                                                                |       |                               |       |   |   |
| INVESTING ACTIVITIES                                                                                |       |                               |       |   |   |
| Maturities of short-term investments                                                                |       | 183,708                            |       | 168,783 |   |
| Purchases of property and equipment                                                                 |       | (25,575                            | )          | (65,530 | ) |
| Proceeds from sale of business                                                                      |       | 218,919                            |       | — |   |
| Net cash flows provided by investing  activities                                                    |       | 377,052                            |       | 103,253 |   |
|                                                                                                |       |                               |       |   |   |
| FINANCING ACTIVITIES                                                                                |       |                               |       |   |   |
| Issuance of common stock, net                                                                       |       | 4,660,109                          |       | 2,210 |   |
| Issuance of Series A preferred stock                                                                |       | —                             |       | 950,000 |   |
| Redemption of Series A preferred stock                                                              |       | (200,000                           | )          |   |   |
| Payment on capital leases                                                                           |       | 49                                 |       | 40,877 |   |
| Repayment of short term bank borrowings                                                             |       | (200,000                           | )          | — |   |
| Net cash flows provided by financing  activities                                                    |       | 4,260,158                          |       | 993,087 |   |
| Net increase in cash and cash equivalents                                                           |       | 3,364,954                          |       | 293,587 |   |
| Cash and cash equivalents at beginning of  period                                                   |       | 448,943                            |       | 457,052 |   |
| Cash and cash equivalents at end of period                                                          |       | $                                  | 3,813,897  |   | $ | 750,639 |   |
|                                                                                                |       |                               |       |   |   |
| Non Cash-transactions:                                                                              |       |                               |       |   |   |
| Accretion of dividends on preferred stock                                                           |       | $                                  | 70,192     |   | $ | 46,849 |   |
| Common shares of Viking Systems, Inc.  received for the sale of Visualization Technologies business |       | 61,080                             |       | — |   |
| Common shares of Viking Systems, Inc. distributed  to preferred stockholders                        |       | 28,000                             |       | — |   |

 

See accompanying notes

 

5

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VISTA MEDICAL TECHNOLOGIES, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2004

(UNAUDITED)

 

### 1.                                       Basis of Presentation

###  

The audited financial statements of Vista Medical Technologies, Inc andthe notes thereto for the year ended December 31, 2003 included in the ourAnnual Report on Form 10-K/A filed with the Securities and Exchange Commission,contain additional information about us, our operations, and our financialstatements and accounting practices, and should be read in conjunction withthis quarterly report on Form 10-Q. These unaudited consolidated financial statements have been prepared inaccordance with generally accepted accounting principles and with theinstructions on Form 10-Q except that certain information and footnotedisclosures normally contained in financial statements prepared in accordancewith generally accepted accounting principles have been condensed or omitted.

 

Our accompanying unaudited consolidated financial statements reflectall adjustments 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, 2004.

 

### 2.                                       Discontinued Operations

###  

On April 15, 2004 we sold our Visualization Technology businessunit to Viking Systems, Inc. (“Viking”) under an Asset Purchase Agreement (the“Asset Purchase Agreement”) signed on December 22, 2003.  In accordance with SFAS No. 144 “Accountingfor the Impairment or Disposal of Long-Lived Assets”, the financial results ofthis business have been reported separately as discontinued operations and thefinancial statements for all prior periods have been restated accordingly.  Prior to the sale we conducted our operationsthrough two separate business units.  TheObesity Surgical and Medical Management Services business unit (operated viaour wholly-owned subsidiary, VOW Solutions, Inc.), based in Carlsbad, CA,provides services to physicians and hospitals involved in the surgicaltreatment of morbid obesity.  Inaddition, our former Visualization Technology business unit, based inWestborough, Massachusetts, developed, manufactured and marketed products thatprovide information to physicians performing minimally invasive generalsurgical, cardiac surgical and other selected endoscopic and interventionalprocedures.

 

Under the Asset Purchase Agreement, we sold all the operating assetsand related liabilities of the Visualization Technology business toViking.  In return, Viking agreed to (a)pay us $159,000 at closing, (b) issue to us 3,054,000 shares of Viking commonstock, representing approximately ten percent (10%) of its common sharesoutstanding on a fully diluted basis, and (c) remit to us the value

 

6

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of any former Visualization Technology inventory sold by Viking beforeApril 15, 2005.  We also enteredinto a license agreement with Viking that will pay us royalties over the nextfive (5) years based on sales of the acquired products of the VisualizationTechnology business with minimum royalties during the five (5) year period asfollows: first year $150,000, years two through four $300,000 and year five$375,000 with a maximum aggregate royalties of $4,500,000 over the five (5)year period.  We will maintain ownershiprights of all intellectual property and product rights under the license agreementwith Viking until at least the minimum royalty obligations have been satisfied,at which time we will transfer such ownership rights to Viking.

 

The net operating assets sold to Viking and the total considerationpaid or contractually due from Viking, exclusive of any proceeds from thesubsequent sale of Visualization Technology inventory by Viking, are asfollows:

 

| Net assets sold      |   |      |      |
|----------------------|--------|-----------|-----------|
| Accounts receivable  |   | $         | 372,027   |   |
| Inventories          |   | 787,657   |      |
| Accounts payable     |   | (351,934  | )         |
| Other liabilities    |   | (61,136   | )         |
|                 |   | $         | 746,614   |   |
| Viking consideration |   |      |      |
| Cash                 |   | $         | 158,718   |   |
| Viking Common shares |   | 61,080    |      |
| Minimum royalties    |   | 1,425,000 |      |
|                 |   | $         | 1,644,798 |   |

 

Under generally accepted accounting principles, the transaction isprincipally the exchange of non-monetary assets between Viking and us.  As a result, the value of the net assets sold($746,614) is considered to be equal to the value of the net assets receivedand we are not allowed to recognize a gain at the time of the transaction.  The Viking consideration, exclusive of cash,is considered non-monetary because Viking is a relatively new company that hasnot raised substantial funds and may be unable to raise sufficient funds tosustain its operations or fund its growth plan. Additionally, there can be no assurance that Viking’s business willsucceed.  As a result, all contractualamounts due us are at risk.  All proceedsreceived from Viking will be first credited against the Due from Vikingaccount.  All proceeds in excess of thatbalance will be recorded as a gain from discontinued operations when received.

 

Our financial results for the three months and six months endedJune 30, 2004 and 2003 have been reclassified to show the results ofoperations for the Visualization Technology business as a discontinued operation.  The operating results of the discontinuedoperations were as follows:

 

7

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| ** **                        | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                        | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Sales                             |       | $                                    | 116,045    |                               | $          | 1,641,211 |   | $ | 1,227,672 |   | $ | 3,822,522 |   |
| Costs and Expenses                |       |                                 |       |                               |       |   |   |   |   |
| Cost of sales                     |       | 110,636                              |       | 1,164,756                          |       | 1,035,667 |   | 2,572,590 |   |
| Research and development          |       | 70,556                               |       | 295,021                            |       | 330,014 |   | 552,181 |   |
| Sales and marketing               |       | 14,860                               |       | 61,548                             |       | 78,678 |   | 115,462 |   |
| General and administrative        |       | 52,905                               |       | 339,729                            |       | 415,529 |   | 683,166 |   |
| Total cost and expenses           |       | 248,957                              |       | 1,861,056                          |       | 1,859,888 |   | 3,923,399 |   |
| Interest expense                  |       | 300                                  |       | 1,000                              |       | 300 |   | 1,000 |   |
| Loss from discontinued operations |       | $                                    | (133,212   | )                                  | $          | (220,845 | ) | $ | (632,516 | ) | $ | (101,877 | ) |

 

The equipment financing costs associated with the equipment sold toViking has been included in discontinued operations.

 

The Company had a severance agreement with a former employee who becamean employee of Viking upon the sale of the Visualization Technologybusiness.  Under the agreement, theCompany may be required to pay the employee one year’s compensation(approximately $200,000) if the employee is terminated under certaincircumstances within 18 months following the sale of the business or October2005.  No provision for such payment hasbeen included in the results of discontinued operations and will not beprovided for until such payment is probable.

 

### 3.                                       Segments

###  

Subsequent to the sale of our Visualization Technology business, weoperate only one business segment, focused on the disease state management ofmorbid obesity. This business provides program management, operationalconsulting and clinical training services to physicians and hospitals involvedin the medical and surgical treatment of morbidly obese patients.  We also provide vitamins to patients who haveundergone obesity surgery.

 

### 4.                                       Inventories

###  

Inventories are stated at lower of cost (determined on a first-in,first-out basis) or market and include only finished goods related to ourdisease state management of morbid obesity business.

 

8

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### 5.                                       Loss Per Share

###  

Basic net loss per share is calculated based on the weighted averagenumber of common shares outstanding during the period. Diluted net loss pershare incorporates the dilutive effect of common stock equivalents, includingstock options, warrants and other convertible securities.  Common stock equivalents have been excludedfrom the calculation of weighted average number of diluted common shares, astheir effect would be antidilutive for all periods presented.  For the purpose of determining basic anddiluted net loss per share, dividends accreted on preferred stock and thedeemed dividend with respect to the preferred stock redemption (see Note 8)have been deducted from the net loss to arrive at net loss applicable to commonstockholders. Common stock equivalents that have been excluded from thecalculation of weighted average number of diluted common shares include optionsto purchase up to 692,811 shares of common stock, 915,000 shares of preferredstock and warrants to purchase 3,764,953 shares of common stock.

 

### 6.                                       Other Comprehensive Income

###  

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

 

### 7.                                       Stock-Based Compensation

###  

The Company applies the principles of Accounting Principles BoardOpinion No. 25, “*Accounting for Stock Issuedto Employees*,” and related interpretations in accounting for itsemployee stock option compensation plans. Under APB No. 25, compensation expense is measured as the difference, ifany, between the option exercise price and the fair value of the Company’scommon stock at the date of grant.  TheCompany has historically granted options to employees and directors at exerciseprices equal to the fair value of the Company’s common stock.  Accordingly, minimal 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 three and six month periods ended June 30, 2004 and 2003 would havebeen adjusted to the pro forma amounts indicated below: 

 

9

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| ** **                           | ** ** | **For three months ended June 30,** | ** ** |
|--------------------------------------|------------|------------------------------------------|------------|
| ** **                           | ** ** | **2004**                                 | ** ** | **2003** | ** ** |
| Net Loss                             |       |                                     |       |   |   |
| As reported                          |       | $                                        | (796,451   | ) | $ | (458,304 | ) |
| Pro forma compensation expense       |       | (66,427                                  | )          | (56,664 | ) |
| Pro forma SFAS No. 123 net loss      |       | $                                        | (862,878   | ) | $ | (514,968 | ) |
|                                 |       |                                     |       |   |   |
| Basic and diluted net loss per share |       |                                     |       |   |   |
| As reported                          |       | $                                        | (0.10      | ) | $ | (0.09 | ) |
| Pro forma                            |       | $                                        | (0.11      | ) | $ | (0.10 | ) |

 
| ** **                           | ** ** | **For six months ended June 30,** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|
| ** **                           | ** ** | **2004**                               | ** ** | **2003** | ** ** |
| Net Loss                             |       |                                   |       |   |   |
| As reported                          |       | $                                      | (1,698,635 | ) | $ | (504,045 | ) |
| Pro forma compensation expense       |       | (126,685                               | )          | (114,729 | ) |
| Pro forma SFAS No. 123 net loss      |       | $                                      | (1,825,320 | ) | $ | (618,774 | ) |
|                                 |       |                                   |       |   |   |
| Basic and diluted net loss per share |       |                                   |       |   |   |
| As reported                          |       | $                                      | (0.26      | ) | $ | (0.10 | ) |
| Pro forma                            |       | $                                      | (0.28      | ) | $ | (0.12 | ) |

 

### 8.                                       Stockholders’ Equity

###  

### Preferred Stock

###  

In March 2003 the Company authorized and issued 1,000,000 sharesof Series A Convertible Preferred Stock (the “Series A Shares”), which werecreated pursuant to the terms of a Certificate of Designations, for anaggregate of $950,000 in cash.  Inconnection with this financing, the purchasers of Series A Shares were grantedseveral significant rights senior to the rights of holders of our common stock.Among other rights, in the event of a liquidation, dissolution or winding up ofour Company (including consolidations, mergers or other sales), holders ofSeries A Shares will be entitled to receive $3.80 per share, in preference toany distribution to the holders of common stock.  Also, pursuant to the Certificate ofDesignations, the Company must obtain the consent of the holders of at leasttwo-thirds of the outstanding Series A Shares in order to undertake certainactions, including capital expenditures and the issuance of equitysecurities.  Additionally, for so long asSeries A Shares remain outstanding beyond April 2004, the holders ofSeries A 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.

 

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In June 2004 we amended the Series A Certificate of Designationsto allow us the right to issue equity securities for less than $2.00 pershare.  For that right, the Series Aholders received 1,400,000 shares of Viking common stock valued at$28,000.  In addition, we agreed toredeem 85,000 Series A Shares for $200,000. In addition, we have obtained the right to redeem an additional 300,000Series A Shares at any time on or before January 15, 2006 in exchange for$500,000. The distribution of the Viking shares and the excess of the $200,000over the prior contractual redemption value of the Series A shares ($131,985)have been accounted for as a deemed dividend.

 

The holders of the outstanding Series A Shares have the right to onevote for each share of common stock into which such Series A Shares could thenbe converted, 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 of Series A Shares are 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.

 

Common Stock

 

## InFebruary 2004 we sold to a group of accredited investors 439,000 shares ofcommon stock and warrants to purchase up to 219,500 shares of common stock, fora total of $588,260 as part of a unit offering. The warrants are exercisable ata price of $1.97 per share and expire in February 2009.

##  

## InFebruary 2004 our subsidiary VOW Solutions, Inc. (“VOW”), adopted the VOWSolutions, Inc. 2004 Stock Option/Stock Issuance Plan (the “VOW Plan”) for thebenefit of VOW’s eligible employees, consultants, and directors. The VOW Planinitially reserved 150,000 shares of common stock for issuance upon theexercise of stock options.  Under the terms of the VOW Plan, nonqualifiedand incentive stock options may be granted at prices not less than 85% and 100%of the fair value on the date of grant, respectively. Options are typicallyimmediately exercisable and generally vest over a four year period from thedate of grant. Unvested common shares obtained upon early exercise of optionsare subject to repurchase by VOW at the original issue price. As ofJune 30, 2004, options to purchase up to an aggregate of 112,500 shares ofcommon stock had been issued under the VOW Plan, none of which had beenexercised.

##  

## In May 2004 wesold to a group of accredited investors 5,454,544 units of our securities for$0.85 per unit, each unit consisting of one share of common stock and onewarrant to purchase one-half share of common stock, for aggregate grossproceeds of approximately $4.6 million, or $4.1 million net of expenses.  The warrants are exercisable at a price of$0.95 per share and expire in May

 

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2009.  As part of the May 2004unit sale, we issued warrants to the placement agent to purchase up to 818,181shares of our common stock.  545,454 ofthese warrants are exercisable at a price of $1.02 per share and the remaining272,727 warrants are exercisable at a price of $0.95 per share.  The warrants expire in May 2009.

 

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## Item2

##  

## Management’sDiscussion and Analysis of Financial Condition and Results of Operations

##  

THIS QUARTERLY REPORT MAY CONTAIN PREDICTIONS, ESTIMATES AND OTHERFORWARD-LOOKING STATEMENTS THAT INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES,INCLUDING THOSE DISCUSSED UNDER THE “RISKS AND UNCERTAINTIES”SECTION BELOW.  WHILE THIS OUTLOOK REPRESENTSOUR CURRENT JUDGMENT ON THE FUTURE DIRECTION OF OUR BUSINESS, SUCH RISKS ANDUNCERTAINTIES COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM ANY FUTUREPERFORMANCE SUGGESTED BELOW.  WEUNDERTAKE NO OBLIGATION TO RELEASE PUBLICLY THE RESULTS OF ANY REVISIONS TOTHESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES ARISINGAFTER THE DATE OF THIS QUARTERLY REPORT. THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OURCONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES THERETO INCLUDED IN ITEM 1 OFTHIS QUARTERLY REPORT ON FORM 10-Q, OUR 2003 ANNUAL REPORT ON FORM 10-K AND OUROTHER DISCLOSURE DOCUMENTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.

 

### 9.                                       Overview of our business

###  

Vista Medical Technologies, Inc., through its wholly owned subsidiaryVOW Solutions, Inc. is exclusively focused on the disease state management ofmorbid obesity.

 

We previously conducted our operations through two separate businessunits.  The Obesity Surgical and MedicalManagement Services business unit (now our disease state management of morbidobesity business operated via our wholly-owned subsidiary, VOW Solutions,Inc.), based in Carlsbad, CA, provides services to physicians and hospitalsinvolved in the surgical treatment of morbid obesity.  Our services include management of our originalproduct offering, the Laparoscopic Bariatric Surgery Preceptorship, acomprehensive introduction to starting a minimally invasive gastric bypasssurgical program. We also offer systems, consulting and program managementservices, which enable the efficient operation of obesity surgeryprograms.  In addition, our formerVisualization Technology business unit, based in Westborough, Massachusetts,developed, manufactured and marketed products that provide information tophysicians performing minimally invasive general surgical, cardiac surgical andother selected endoscopic and interventional procedures.  On December 22, 2003 we signed anagreement to sell the Visualization Technology business unit to Viking Systems,Inc. (“Viking”).  This sale was completedon April 15, 2004.  Refer to ourProxy Satement filed with the SEC on March 25, 2004 for further details of thetransaction.

 

As a result of the sale of our Visualization Technology business unit,all of our operations are conducted through our subsidiary VOW Solutions, Inc.,which we refer to as VOW, and are concentrated in the field of bariatricsurgery and bariatric medicine.  Thevision of our VOW business is to enable healthcare providers and organizationsin the ongoing evolution of the highest standards of treatment and services tooptimize the quality of life for morbidly obese patients.  Our

 

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mission is to deliver the leading management portfolio of services andproducts for the clinical and business development of continually successfulobesity surgery programs.

 

In February 2004 we sold to a group of accredited investors439,000 shares of common stock and warrants to purchase up to 219,500 shares ofcommon stock, for a total of $588,260 as part of a unit offering.  We sold 219,500 units; each unit consisted oftwo (2) shares of common stock priced at $1.34 per share and a warrant topurchase one share of common stock. The warrants are exercisable at a price of$1.97 per share and expire in February 2009.  The proceeds were used to fund our obesitydisease state management business unit and our Visualization Technologybusiness unit until it was sold in April 2004.

 

In May 2004 we sold to a group of accredited investors 5,454,544 unitsof our securities for $0.85 per unit, each unit consisting of one share ofcommon stock and one warrant to purchase one-half share of common stock, foraggregate gross proceeds of approximately $4.6 million or $4.1 million net ofexpenses.  The warrants are exercisableat a price of $0.95 per share and expire in May 2009.  The proceeds are to be used to fund ourobesity disease state management business unit. As part of the May 2004 unit sale, we issued warrants to the placementagent to purchase up to 818,181 shares of our common stock.  545,454 of these warrants are exercisable ata price of $1.02 per share and the remaining 272,727 warrants are exercisableat a price of $0.95 per share.  Thewarrants expire in May 2009.

 

In June 2004 we amended our Series A Certificate of Designationsto allow us the right to issue equity securities for a price under $2.00.  For that right, the Series A holders received1,400,000 shares of Viking common stock that we held valued at $28,000.  As part of the amendment, we were required toredeemed 85,000 Series A Shares for $200,000. In addition, we have the right to redeem an additional 300,000 at anytime on or before January 15, 2006 in exchange for $500,000. If we chooseto redeem the additional 300,000 Series A Shares, we will use cash that wouldotherwise fund our business operations. Although we may believe that suchredemption is the best available business option, valuable cash wouldnonetheless be consumed, which would impact our ability to fund operations orgrow our business.

 

Our discussion of our results of operations will be focused on ourremaining business, which is now exclusively focused on the disease statemanagement of morbid obesity.

 

**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, accountingfor product returns, allowance for doubtful accounts, warranty and technicalservice costs, inventory and income taxes.

 

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Actual results could differ from these estimates.  The following critical accounting policiesare significantly affected by judgments, assumptions and estimates used in thepreparation of the consolidated financial statements.

 

*Revenue Recognition*

 

Revenue generated from our disease state management of morbid obesitybusiness are recognized (i) with regard to management services, upon completionof the service period and (ii) with regard to training services or otherconsulting services, upon completion of the related training or consultingcomponent, provided that a contract exists, there are no uncertaintiesregarding customer acceptance, the sales price is fixed or determinable andcollectibility is deemed probable.  Salesof vitamins are similarly recognized upon shipment provided that a purchaseorder has been received, there are no uncertainties regarding customeracceptance, the sales price is fixed or determinable and collectibility isdeemed probable.

 

The Company has received semiannual payments as a result of fulfillingcertain obligations related to its strategic alliance agreement with EthiconEndo-Surgery, Inc. (EES).  These paymentsare recognized as revenue on a straight-line basis over the related contractterm, provided that the Company has complied with all contractual obligations.  No further payments from EES are requiredunder the current agreement.

 

*Due from Viking*

 

This account represents the consideration due from Viking as a resultof the sale of our Visualization Technology business.  Although we may receive amounts in excess ofthe account balance, realization of the balance is not assured.

 

Viking is a relatively new company that has not raised substantialfunds and may be unable to raise sufficient funds to sustain its operations orfund its growth plan.  Additionally,there can be no assurance that Viking’s business will succeed.  As a result, all contractual amounts due usare at risk.

 

**Our results of operations for three- monthsand six- months ended June 30, 2004 versus three- months and six- monthsended June 30, 2003**

 

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Revenues.  Management andconsulting services, product sales and contract revenue for the three- and sixmonths ended June 30, 2004 were $303,000 and $637,000, respectively,compared to $903,000 and $1,306,000 for the same periods ended June 30,2003.  This decrease in revenue for boththe three- and six-month periods was associated with lower training andconsulting services revenues as a result of management focus being directedtowards the completion of the Visualization Technology transaction andconservation of financial resources while the obesity disease state managementmodel was being developed and new capital raised.  With the completion of these transactions andour focus now exclusively directed towards implementation of the obesitydisease state management business model, we anticipate that revenues in futurequarters will increase over current levels.

 

Cost of revenues.  Our cost ofrevenue include direct costs associated with generating management andconsulting services revenues along with the fully burdened cost of our vitaminsales.  Costs of revenue for the three-and six months ended June 30, 2004 were $62,000 and $280,000,respectively, compared to $131,000 and $298,000 for the three- and six- monthsended June 30, 2003. The decrease in the three months ended June 30,2004 was primarily due to a decrease of $330,000 in revenues in the areas oftraining and consulting services. Increased revenues in future quarters will bring an increase in cost ofsales.  The level of increase isdifficult to project due to varying costs associated with each revenue type.

 

Sales and marketing expenses. Sales and marketing expenses were $626,000 and $1,109,000 for the three-and six-months ended June 30, 2004, respectively, and $430,000 and $802,000for the three- and six- months ended June 30, 2003, respectively.  The increase in expenses for both periods wasprimarily due to an increase of $150,000 in staffing related expenses of ourobesity disease state management business in 2004.  We expect to see an increase in our sales andmarketing expenses during the remaining quarters of 2004 as we ramp up ouractivities and expand our staff in an effort to implement our business model.

 

General and administrative expenses. General and administrative expenses were $282,000 and $583,000 for thethree and six months ended June 30, 2004, respectively, and $348,000 and$643,000 for the three and six months ended June 30, 2003,respectively.  The decrease in expensesfor both periods is a result of higher consulting expense of $84,000 during thequarter ended  June 30, 2003 and $67,000for the 6 months ended June 30, 2003. ** **We expect our general andadministrative expenses to increase during the next quarter as we complete thetransition of our information systems and control from Westborough,Massachusetts and increase support staff.

 

Interest income.  Our interestincome was $5,000 and $5,000 for the three- and six- months ended June 30,2004, respectively, and $35,000 and $37,000 for the three- and six- monthsended June 30, 2003, respectively. It is expected that our net interest income will increase in the nextquarter due to higher average cash balance created by the fundraising that wascompleted in the second quarter of 2004.

 

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Discontinued operations.  Theloss from discontinued operations was $133,000 and $633,000 for the threemonths and six months ended June 30, 2004, respectively, and $221,000 and$102,000 for the same periods ended June 30, 2003.  The decrease in loss for the three- monthsended June 30, 2004 was due to having only 15 days of discontinuedoperations in 2004 compared to a full quarter in 2003.  The increase in loss in 2004 over 2003 forthe six- months ended was a result of a significant decrease in sales of$2,595,000 from a shorter operating period and lower than expected marketpenetration.  Also contributing to thisincrease in loss were reduced profit margins due to the fixed manufacturingcosts being spread over lower manufacturing volume along with fixed costs inother operating expenses.

 

**Liquidity and capital resources**

 

Net cash used for operating activities for the six- months endedJune 30, 2004 was $1,272,000 compared to net cash used of $803,000 for thecorresponding six-month period in 2003. The increase in net cash used in operating activities during the 2004period is primarily attributable to reduced revenues of $403,000 and higheroperating expenses of $228,000 that were offset by cash collections on accountsreceivable of $261,000.

 

Net cash provided by investing activities was $377,000 for the six-months ended June 30, 2004 compared to $103,000 in the same period in2003.  The increase in net cash providedby investing activities during the 2004 period was primarily attributable tomaturities of short term investments and proceeds from the sale of the VisualizationTechnology business of $219,000.

 

Net cash provided by financing activities was $4,260,000 for the six-months ended June 30, 2004, compared to $993,000 for the same period in2003.  The increase in net cash providedby financing activities during the 2004 period was primarily attributable tothe closing of two private placements of shares of our Common Stock foraggregate net proceeds of $4,660,000 in the first six months of 2004 comparedto $950,000 raised in the sale of our Series A Convertible Preferred Stock inthe first six months of 2003.  Alsoduring 2004, we redeemed 85,000 shares of our Series A Convertible PreferredStock for $200,000 and paid off our short-term bank borrowings of $200,000.

 

Since our formation in July 1993, and as of June 30, 2004 wehave incurred cumulative net losses of $70.0 million.  At June 30, 2004, we had cash andshort-term investments of $3,817,000.  InFebruary 2004, we sold $588,000 of common stock in a private placement andin May 2004 we sold and additional $4,072,000 of common stock in a privateplacement.  In addition, we have amountsavailable under a $2.0 million bank line of credit facility, which expires inOctober 2004 and is subject to annual renewals.  We believe that these cash resources,excluding revenues from operations, will not be sufficient resources to operateour business beyond 2005.  Unless wegenerate significant cash flow from operations, we will need additional fundingto continue development of

 

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our business. There can be no assurance that the requisite funding willbe consummated 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 services and products.  In addition, increases in expenses withoutincreasing revenues in the near term may adversely impact our cash position andrequire future cost reductions.  Noassurance can be given that we will be able to operate profitably on aconsistent 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 June 30, 2004.  At June 30,2004, we had no advances outstanding under this credit facility. The creditfacility can only be secured by qualified accounts receivable and only up to80% of qualified accounts receivable.  Ifwe were to draw under this facility, which is unlikely since the sale of theVisualization Technology business has left us with lower levels of accountsreceivable.  The facility expires inOctober 2004.

 

## Item 3                Quantitative and Qualitative Disclosures About MarketRisk

##  

At June 30, 2004, our investment portfolio included fixed-incomesecurities of $3.8 million.  Thesesecurities are subject to interest rate risk and will decline in value ifinterest rates increase.  Theseinvestments are not held for trading or other speculative purposes. Due to theshort duration of our investment portfolio, an immediate ten percent (10%)increase in interest rates would have no material impact on our financialcondition or results of operations.  Wegenerally conduct business in U.S. dollars and, as a result, have limitedforeign currency exchange rate risk.  Theeffect of an immediate ten percent (10%) increase in foreign currency exchangerates would have no material impact on our financial condition or results ofoperations.

 

## RISKSAND UNCERTAINTIES

##  

*You should carefully consider the following risks anduncertainties before you invest in our common stock.  Investing in our common stock involvesrisk.  If any of the following risks oruncertainties actually occurs, our business, financial condition or results ofoperations could be materially adversely affected.  Additional risks and uncertainties of whichwe are unaware or which we currently believe are immaterial could alsomaterially adversely affect our business, financial condition or results ofoperations.  In any case, the tradingprice of our common stock could decline, and you could lose all or part of yourinvestment.*

 

**Risks Related to our Business and Industry**

 

**As a company, we do not have directexperience in the management of health care service businesses.**

 

As a company we do not have direct experience in the management ofbariatric surgical programs.  We havebeen involved in the development of bariatric surgical programs since 2000, buthave never directly managed these programs. As such, we have only a limited and indirect operating history uponwhich an evaluation of our prospects can be based.  In addition, the bariatric surgical market is

 

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relatively new and is expanding rapidly, which can cause changes in theway clients react to the services offered. We believe that our management model is appropriate for the market, butwe have yet to prove it.  To besuccessful, it is crucial that we develop strong affiliations with hospitalsand surgical centers, and we have not yet proven our ability to do so.  Also, we must respond to competitivedevelopments and attract, retain and motivate experienced staff.  There can be no assurance that we will besuccessful in addressing those market conditions or in implementing ourbusiness strategy.  There can be noassurance that we will be able to achieve or sustain revenue growth orprofitability.

 

In addition, our business model is to provide management services toowners of surgical programs.  As aresult, we will not have an ownership interest in those programs, which willmake it more difficult to sustain revenues. Our services could be terminated due to this lack of ownership.

 

**Roll-out of our VOW Centers depends on ourentering into agreements with hospitals and surgeons; the time to concludethese agreements may be extended and thereby delay or prevent theimplementation of our strategy.**

 

We plan to set up our VOW Centers in conjunction with hospitals andsurgeons.  There can be no assurance thatnegotiations for the establishment of these Centers will not be protracted orimpossible to negotiate satisfactorily. Our experience to date is limited to one existing management contract inplace since February 2004 and one contract entered into in August2004.  We are in active negotiation forothers; however, we cannot accurately predict the time and expense involved inthese negotiations, and any unexpected delays could negatively impact theexecution of our strategic plan.

 

**We need to increase market awareness andacceptance of our new business model.**

 

To our company’s knowledge, the comprehensive services offered by ournew VOW Solutions business model have not been available to date on a nationallevel.  While we have previously suppliedclinical training services to some 60 clients and consulting services to some35 clients, we have not yet widely promoted our program management services.  As a result, providers of bariatric surgeryare not yet generally aware of the services we offer.  In order to accomplish our strategic andbusiness plans, we will have to quickly and effectively increase marketawareness of our management model and the VOW brand name, and convince doctors,hospitals and patients of the benefits of these services.  Among other things, this will require thatwe:

 

•                                          increaseawareness of our complete service offering;

•                                          strengthenour brand name to increase visibility;

•                                          continueto upgrade and expand our services; and

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

 

We cannot assure you that we will be able to accomplish theseobjectives.

 

**After establishing VOW Centers, we mustcontinue to prove our value proposition.**

 

In order to successfully negotiate and complete agreements with doctorsand hospitals to establish VOW Centers, we will present them with our projectedrevenues and operational metrics.  We

 

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cannot assure you that our projections will prove accurate or that wewill be able to provide the anticipated metrics.  Our projections are based on limited inputand operational history and failure to meet such projections will negativelyimpact our business.

 

**The provision of health care services issubject to considerable regulation by state and federal agencies.**

 

The Centers will need to comply with many laws and regulations, bothstate and federal, which govern the provision of health care services.  If they fail to comply with any such laws andregulations, then the penalties involved could be serious, time-consuming formanagement and expensive.  Inexperiencein health care services could contribute to an inadvertent breach of laws orregulations.

 

**We operate in a competitive market; newtechnologies, procedures, or pharmaceuticals could radically change themodality of treatment of morbid obesity and negatively impact the economics ofour obesity surgery business.**

 

The market for products and services that address morbid obesity is attractiveand therefore competitive and new offerings and technologies are in developmentby several companies.  For example, weare aware of developments, primarily involving stimulation or balloontechnology, which may come to the market in the next few years.  These devices would be implanted or placed ina relatively simple endoscopic procedure. These alternatives may prove to be more effective, less risky and/orcheaper than gastric bypass.  If thisturns out to be the case, our ability to generate revenues will be negativelyaffected. Also, many pharmaceutical companies are researching drug therapiesfor combating obesity.  If they provesuccessful in finding a more effective solution for morbid obesity, then demandfor a surgical option is likely to decline substantially.  We cannot guarantee that we will competesuccessfully against our current or potential competitors, especially thosewith significantly greater financial resources or brand name recognition.

 

**We expect to compete with several companieswhich have the same objectives as us.**

 

There are several companies which intend to provide services to themorbid obesity market; while their business model is not identical to ours, theend result is likely to be that we will compete with each other in offeringconsulting and program management services. Three of these companies, to the best of our knowledge, includebariatric surgeons in their management or ownership.  This may prove to be an advantage over us ingaining access to potential clients.  Othercompanies have only a partial service offering, which may allow them, becauseof lower overhead, to operate in their niche at a price advantage tofull-service companies such as ours.  Inany case, we expect that the market will continue to be attractive and that newentrants are likely.

 

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**If we fail to retain our key personnel andhire, train and retain additional qualified and experienced employees, we maynot be able to compete effectively, or expand our consulting business and thenumber of Centers as planned, both of which could result in reduced revenues.**

 

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

 

To be successful, we must strengthen awareness of our services throughour marketing efforts and through establishment of additional VOW Centers.  We have a limited marketing and businessdevelopment force through which the efforts will be conducted, and we will relyheavily on each of these individuals.  Wecannot assure you that we will be able to attract and retain sufficient qualifiedpersonnel.

 

Our current key employees are John R. Lyon, President and ChiefExecutive Officer; Michael H. Owens, M.D., Chief Medical Officer and Presidentof VOW Solutions Inc.; Howard Sampson, Chief Financial Officer; Joann Harper,PhD., Vice President Product Development, Implementation and Operations;Stephen F. Sedlock, Vice President of Marketing; Mary Lou Walen, Associate VicePresident, Customer Relations; Aimee Johnston, Assistant Vice President,Bariatric Management Services.  We do notmaintain key personnel life insurance policies on any of these individuals.

 

**If we are not able to attract and retain keydoctors to participate in our advisory board, it may adversely affect ourability to develop our products and services and expand our business.**

 

Members of our clinical advisory board consult with us exclusively butare free to consult with other non-competing companies and are employedelsewhere on a full-time basis.  As aresult, they only spend a limited amount of time on our business.  Although we have entered into consulting agreements,including confidentiality provisions with each of the members of our clinicaladvisory board, the consulting and confidentiality agreements between us andeach of the members of our clinical advisory board may be terminated orbreached.

 

**Our failure to effectively manage our growthcould have a material adverse effect on our business.**

 

Growth in our business will place a significant strain on ourmanagement systems and resources.  Wehave only recently begun to focus on providing management services, and we havehired persons with appropriate skills. However, these people have not previously worked together, and it willtake time and effort to develop efficient working processes and relationships.  We will need to continue to improve ouroperational and financial systems and managerial controls and procedures, andwe will need to continue to expand, train and manage our workforce.  We are a small company with limitedresources, so we lack the ability to increase our capacity to provide servicesprior to assurances that those services will be paid for by customers.  As a result, each new management contractwill require

 

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significant operational efforts as we hire personnel to staff the newproject.  We expect that the number ofour employees will continue to increase for the foreseeable future.  We will have to maintain close coordinationamong our technical, accounting, finance, marketing and sales departments.

 

**Now that we have disposed of our VisualizationTechnology business, our future success will depend solely on our ability toestablish and grow our obesity disease state management business.**

 

The sale of our Visualization Technology business closed onApril 15, 2004 and our future success as a company will depend on ourability to execute on the establishment and growth of our obesity disease statemanagement business.  As a company, wehave limited experience in the provision of surgical services.  We will also be required to build this businessfrom a relatively small base, finding partners and surgeons willing toparticipate.  We cannot assure you thatwe will be able to build a successful services business in the long term.

 

**We have only limited experience directlymarketing our service products overseas and may not be successful in exportingour business model into international markets.**

 

We have limited experience in directly marketing our servicesoverseas.  While the increase in severeobesity is a global health care problem, the individual complexity of foreignhealth care systems may prevent acceptance of our business model, which hasbeen originally designed for the United States market.  Also, changes in overseas economicconditions, currency exchange rates, foreign tax laws or tariffs or other traderegulations could negatively impact our efforts to expand business.  The anticipated international nature of ourbusiness is also expected to subject our representatives, agents anddistributors to laws and regulations of the foreign jurisdictions in which theyoperate or in which our services are sold.

 

**Risks Related to our Financial Results andNeed for Financing**

 

**We will likely require additional funding tocontinue development of our business and support our future operatingplans.  These funds may not be availableon acceptable terms, if at all.**

 

At June 30, 2004, we had cash, cash equivalents and short-terminvestments of $3,817,000.  We believethat these cash resources, excluding revenues from operations, will not besufficient resources to operate our business beyond 2005.  Unless we generate significant revenues fromoperations, we will need additional funding to continue development of ourbusiness.

 

We expect that the cash flows produced by our VOW business will beunpredictable in the near term, increasing our likely need for additionalfunding.  There can be no assurance thatsuch capital will be available to the extent required, or at all, and suchcapital may not be available on commercially reasonable terms.  The amount of additional capital which, wemay need to raise will depend on many factors, including:

 

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•                  the extent to which the VOW Centers and otherservices gain market acceptance,

•                  the speed with which we can execute our plan;

•                  the levels of reimbursement for proceduresperformed; and

•                  the extent of competition.

 

The amount of additional capital we will need will depend on manyfactors, including the extent to which we strive to expand our business.  Most of the additional funding we willrequire will go towards the marketing our services to increase market awarenessand acceptance.  If we are unable toraise these additional funds, our ability to expand our business will be harmed.

 

**We have a history of losses and may notbecome profitable.**

 

Since our formation in July 1993, and as of June 30, 2004, wehave incurred cumulative net losses of $70.0 million.  Specifically, we incurred net losses of $1.1million in 2002 and $2.2 million in 2003. We expect to incur losses for the foreseeable future.  We may never achieve or sustain profitabilityin the future.  Even if we achieveprofitability, we may not be able to sustain it on an ongoing basis.

 

**Our future financial results will fluctuatesignificantly.**

 

As a result of our limited operating history, we cannot predict ourfuture revenues or operating results.  Wedo, however, expect our future revenues and operating results to fluctuate dueto a combination of factors, including the potential costs of establishing VOW Centers.

 

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

 

Because of all of these factors and the other risks discussed in thissection, we believe that our quarterly and annual revenues, expenses andoperating results likely will vary significantly in the future.  If this occurs, any or all of the followingmay result:

 

•                  the market trading price of our common stockmay fluctuate, negatively impacting the ability of stockholders to buy and sellour shares at consistent prices;

•                  we may have difficulty raising funds in thefuture at prices that are acceptable to us; and

 

23

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•                  investors may be less willing to purchase ourshares for lack of consistent operating results.

 

In addition, we cannot be sure that theamounts potentially due to us from Viking Systems, Inc., which may be owed as aresult of the sale of our Visualization Technology business, will be paid tous.  This is because Viking is arelatively new company that has not raised substantial funds to date.  There is a significant risk that Viking maybe unable to raise sufficient funds to sustain its operations or fund itsgrowth plan.  Additionally, there can beno assurance that Viking’s business will succeed.  As a result, all contractual amounts due usare at risk.

** **

**Our liquidity and capital requirements willbe difficult to predict.**

 

Our liquidity and capital requirements will depend upon other numerousfactors, including the following:

 

•                  The extent to which our products and servicesgain market acceptance;

•                  Costs associated with establishing marketing,and operating our obesity related programs; disease state management business,including the VOW Center.

•                  The timing and costs of product and servicesintroductions;

•                  The extent of our ongoing product and servicedevelopment programs;

•                  The costs of sponsorship training of thephysicians to become proficient in the use of our products and procedures; and

•                  The costs of developing marketing anddistribution capabilities for our consumer products.

 

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

 

**Risks Related to the Securities Markets andOwnership of our Common Stock**

 

**The terms of our March 2003, preferredstock financing confer senior rights on the holders of Series A ConvertiblePreferred Stock, and these rights may impair the interests of our commonstockholders or impact our results of operations.**

 

We issued 1,000,000 shares of our Series A Convertible Preferred Stock(the “Series A Shares”) in March 2003, which were created pursuant to theterms of a Certificate of Designations, for an aggregate of $950,000 incash.  In connection with this financing,the purchasers of Series A Shares were granted several significant rightssenior to the rights of holders of our common stock.  Among other rights, in the event of aliquidation, dissolution or winding up of our company (including consolidations,mergers or other sales), holders of Series A Shares will be entitled to receiveup to $3.80 per share held by them, in preference to any distribution to theholders of common stock.  Also, pursuantto the Certificate of Designations, we must obtain the consent of the holdersof at least two-thirds of the outstanding Series A Shares in order to undertakecertain actions, including

 

24

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capital expenditures and the issuance of securities.  Additionally, for so long as any Series AShares remain outstanding after three hundred ninety (390) days following theinitial issuance of any Series A Shares, the holders of Series A Shares will beentitled to elect the greater of (i) two members of our Board of Directors or(ii) twenty-five percent (25%) of the total members of our Board of Directors.

 

We redeemed 85,000 Series A Shares in June 2004, and have theright to redeem an additional 300,000 at any time on or before January 15,2006 in exchange for $500,000.  If wechoose to redeem the additional 300,000 Series A Shares, we will use cash thatwould otherwise fund our business operations. Although we may believe that such a redemption is the best availablebusiness option, valuable cash would nonetheless be consumed, which wouldimpact our ability to fund operations or grow our business.

 

**Our common stock is currently listed in TheNasdaq SmallCap Market pursuant to an exception from the continued listingrules and we must comply with the terms of that exception to maintain ourlisting.**

 

The quantitative standards for continued listing on the Nasdaq SmallCapMarket requires a company to have stockholders’ equity of at least $2,500,000(or satisfy alternative requirements). Failure to comply with these requirements subjects a company tode-listing proceedings.  We receivednotification on March 1, 2004 of a Nasdaq Staff Determination indicatingthat we fail to comply with the Stockholders’ Equity requirement for continuedlisting set forth in Marketplace Rule 4310(c)(2)(B), and that our common stock is,therefore, subject to delisting from the Nasdaq SmallCap Market.  We requested a hearing before a NasdaqListing Qualifications Panel to review the Staff Determination, which stayedthe delisting of our common stock pending the Panel’s decision.  On May 7, 2004 we received a decision fromthe Nasdaq Listing Qualifications Panel to continue the listing of our commonstock on the Nasdaq SmallCap Market pursuant to the following exceptions:  On or about June 1, 2004 we must havemade a public filing with the SEC and Nasdaq including disclosure that weraised at least $3,600,000 in additional equity, net of expenses, as well as adescription of the completed event or transaction(s) that enabled us to satisfythe $2,500,000 shareholders’ equity requirements; an affirmative statementthat, as of the date of the report, we believe we have regained compliance withthe $2,500,000 shareholders’ equity requirement based upon the event ortransaction(s) referenced therein; and a disclosure that the Panel will continueto monitor our ongoing compliance with the minimum shareholders’ equitythreshold until we have evidenced compliance with that requirement via apublicly filed balance sheet and demonstrated an ability to sustain compliancewith the minimum shareholders’ equity requirement over the long term.  With the closing of our recent financing, weachieved these requirements and made the required filings.

 

In addition, on or before August 16, and November 15, 2004 wemust file Forms 10-Q for the quarters ending June 30, andSeptember 30, 2004, respectively, with the SEC and Nasdaq, evidencing ourcontinued compliance with the $2,500,000 shareholders’ equity requirement.  In order to fully comply with the terms ofthis exception, we must be able to demonstrate compliance with all requirementsfor continued listing on the Nasdaq SmallCap Market.  If we are unable to do so, our securitieswill be delisted from the Nasdaq SmallCap Market.

 

25

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The delisting of our common stock from the Nasdaq SmallCap Market maymaterially impair our stockholders’ ability to buy and sell shares of ourcommon stock and could have an adverse effect on the market price of, and theefficiency of the trading market for, our common stock.  In addition, the delisting of our commonstock could significantly impair our ability to raise capital should we desireto do so in the future.  The continuedlisting of our common stock on the Nasdaq SmallCap Market is therefore veryimportant to us.

 

**There is a limited market for our commonstock and therefore investors may not be able to liquidate their investment inthe foreseeable future, if at all.**

 

There is a limited market for our common stock even though it ispublicly quoted, and the market is not expected to increase significantly inthe foreseeable future.  For example, weonly have approximately 190 shareholders of record and the average dailytrading volume in our stock is approximately 20,000 shares.  The limited trading market for our commonstock may cause fluctuations in the market value of our common stock to beexaggerated, leading to price volatility in excess of that which would occur ina more active trading market.  The lackof an active trading market in our stock may also cause investors to be unableto sell all of their desired shares of common stock on short notice and thesale of a large number of shares at one time could temporarily depress themarket price. An investment in our company is highly speculative, and aninvestor should be able to withstand a total loss of the investment.

 

**Our stock price could continue to be volatileand your investment in our common stock could suffer a decline in value,adversely affecting our ability to raise additional capital.**

 

The market prices and trading volumes for securities of emergingcompanies, like ours, have historically been highly volatile and haveexperienced significant fluctuations unrelated to the operatingperformance.  The market price of ourcommon stock has historically been highly volatile.  For example, between February 2002 andMay 2003, the trading price of our common stock ranged from $0.77 to$4.59.  The trading price of our commonstock may continue to be significantly affected by factors such as:

 

•                  actual or anticipated fluctuations in ouroperating results,

•                  our ability to remain listed on Nasdaq,

•                  changes in financial estimates by securitiesanalysts,

•                  announcements of technological innovations,

•                  new products or new contracts by us or ourcompetitors,

•                  regulatory announcements,

 

26

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•                  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 adverselyaffect the market price of our common stock. In the past, following periods of volatility in the market price of aparticular company’s securities, securities class action litigation has oftenbeen brought against that company.  Suchlitigation, if brought against us, could result in substantial costs and adiversion of management’s attention and resources.

 

**We are required to register for resalecertain outstanding shares of our common stock and failure to achieve andmaintain an effective registration statement may result in monetary penaltiesagainst us.**

 

The holders of approximately 10,573,497 shares of our common stock,including shares issuable upon exercise of outstanding warrants, have rights,subject to some conditions, to require us to file registration statementscovering their shares or to include their shares in registration statementsthat we may file for ourselves or other stockholders.  These registration rights impose monetarypenalties against us of up to approximately $50,000 per month if we do nottimely achieve an effective registration statement or if we are unable tomaintain the effectiveness of a registration statement for one year.  Because of our cash position, these penaltieswould negatively impact our ability to finance our operations.

 

**Anti-takeover provisions in ourorganizational documents and Delaware law may discourage or prevent a change ofcontrol, even if an acquisition would be beneficial to our stockholders, whichcould affect our stock price adversely and prevent attempts by our stockholdersto replace or remove our current management.**

 

Our certificate of incorporation and bylaws contain provisions thatcould delay or prevent a change of control of our company or changes in our boardof directors that our stockholders might consider favorable. Some of theseprovisions:

 

•                  authorize the issuance of preferred stockwhich can be created and issued by the board of directors without priorstockholder approval, with rights senior to those of the common stock;

•                  provide for a classified board of directors,with each director serving a staggered three-year term;

 

27

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•                  prohibit our stockholders from filling boardvacancies, calling special stockholder meetings, or taking action by writtenconsent;

•                  prohibiting our stockholders from makingcertain changes to our restated certificate of incorporation or restated bylawsexcept with 66 2/3% stockholder approval; and

•                  require advance written notice of stockholderproposals and director nominations.

 

In addition, we are subject to the provisions of Section 203 ofthe Delaware General Corporation Law, which may prohibit certain businesscombinations with stockholders owning 15% or more of our outstanding votingstock. These and other provisions in our certificate of incorporation, bylawsand Delaware law could make it more difficult for stockholders or potentialacquirers to obtain control of our board of directors or initiate actions thatare opposed by our then-current board of directors, including delay or impede amerger, tender offer, or proxy contest involving our company. Any delay orprevention of a change of control transaction or changes in our board ofdirectors could cause the market price of our common stock to decline.

 

**Risks Related to our Intellectual Propertyand Potential Litigation**

 

**We depend on our intellectual property forthe establishment and operation of our VOW Centers.**

 

We rely on a combination of trade secrets, know-how and confidentialityrestrictions for the establishment and operation of our VOW Centers.  We have expended significant efforts devisingthe types of products and services we will offer and the manner in which thesewill be delivered.  Our ability tomaintain the secrecy and confidentiality of our trade secrets and internalknowledge are crucial to the success of our business.  Any failure to do so may negatively impactour prospects.

 

Our obesity disease state management business may be difficult toinsure against professional liability.

 

With the sale of our Visualization Technology business we need tochange the type of liability insurance which we carry.  We are in the process of seeking amendedinsurance coverage, but may not be able to secure it on acceptable terms, or atall.

 

**We may be subject to product liability claimsand 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, which weresold by us prior to the sale of the Visualization Technology business, resultsin personal injury or death.  Also, inthe event that any of those products proves to be defective, we may be requiredto recall or redesign such products.  Weare in the process of negotiating insurance coverage to cover suchcircumstances.  However, we may not beable to obtain such coverage or our coverage limits may not be adequate toprotect us from any liabilities we might incur. Product liability insurance isexpensive and in the future may not be available to us on

 

28

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acceptable terms, if at all.  Asuccessful product liability claim or series of claims brought against us inexcess of our insurance coverage would negatively impact our business.

 

**If we are unable to protect our intellectualproperty, we may be unable to prevent other companies from using our technologyin competitive products.**

 

We maintain ownership of the technology transferred to Viking Systems,Inc. in connection with the sale of our Visualization Technology business inApril 2004.  In the event VikingSystems does not make the required royalty payments to us, their rights in thetechnology will be terminated.  In suchcase, we will be able to continue to commercialize that technology.  To the extent we decide to incorporate thattechnology into our business, our future success will depend, in part, on ourability to continue developing patentable products, enforcing our patents andobtaining patent protection for our products both in the United States and inother countries.  The patent positions ofmedical device companies, however, are generally uncertain and involve complexlegal and factual questions.  Patents maynever issue from any patent applications owned by or licensed to us.  Even if patents do issue, the claims allowedmay not be sufficiently broad to protect our technology.  In addition, issued patents owned by orlicensed to us may be challenged, invalidated or circumvented, or the rightsgranted thereunder may not provide us with competitive advantages.  Further, the medical device industry has beencharacterized by extensive litigation regarding patents and other intellectualproperty rights.  Litigation, which wouldresult in substantial expense, may be necessary to enforce any patents issuedor licensed to us and/or to determine the scope and validity of proprietaryrights of third parties or whether our products, processes or proceduresinfringe any such third-party proprietary rights.

 

In addition to patents, we rely on unpatented trade secrets to protectour business and our proprietary technology. Others may independently develop or otherwise acquire the same orsubstantially equivalent plans or technologies or otherwise gain access to ourproprietary technology or disclose our plans or technology.  It is difficult to protect rights tounpatented ideas, plans or proprietary technology.  Third parties may obtain patent rights tothese unpatented trade secrets, which patent rights could be used to assertclaims against 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.

 

## Item4                Controls and Procedures

 

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As required by Securities and Exchange Commission Rule 13a-15(b), wecarried out an evaluation, under the supervision and with the participation ofour management, including our chief executive officer and chief financialofficer, of the effectiveness of our disclosure controls and procedures as ofthe end of the quarter covered by this report. Based on the foregoing, our chief executive officer and chief financialofficer concluded that our disclosure controls and procedures were effective asof June 30, 2004.

 

There has been no change in our internal controls over financialreporting during our most recent fiscal quarter that has materially affected,or is reasonably likely to materially affect, our internal controls overfinancial reporting.

 

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# ***PART II.*****                                               ****OTHER INFORMATION**

# * *

## Item1.             Legal Proceedings

##  

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

 

We have been notified of a Notice of Intent to Initiate Litigationagainst us regarding a medical malpractice lawsuit in process in Florida.  We are contesting the Notice of Intent andhave not yet been included in the litigation.

 

## Item2.             Changes in Securities, Use of Proceeds and IssuerPurchases of Equity Securities

##  

*Recent Sales of Unregistered Securities.*

 

On May 26, 2004, pursuant to the exemption provided in Rule 506 ofRegulation D of the rules promulgated under the Securities Act of 1933, wesold to a group of accredited investors led by MedCap Management and ResearchLLP, 5,454,544 units of our securities, each unit consisting of one shareof common stock and one warrant to purchase one-half share of commonstock.  The purchase price per unit was$0.85 and the warrants carry an exercise price of $0.95 per share.  This financing generated aggregate grossproceeds of approximately $4.6 million. In addition to the units purchased by investors, we issued a warrant toViewTrade Financial, our exclusive placement agent for the financing, topurchase up to 818,181 shares of our common stock as follows:  545,454 shares at an exercise price of $1.02per share and 272,727 shares at an exercise price of $0.95 per share.

 

*Changes in Securities.*

 

On May 26, 2004, we filed an amendment to the Certificate ofDesignations of Series A Convertible Preferred Stock to amend the redemptionand conversion terms of our existing Series A Convertible Preferred Stock (the“Series A Shares”) such that (i) within 10 days of the closing of thefinancing led by MedCap Management and Research LLP, we were required to redeem85,000 shares of the Series A Shares in exchange for $200,000 and (ii) wehave the right, exercisable at any time on or prior to January 15, 2006,to redeem an additional 300,000 shares of Series A Shares in exchange for$500,000.  In the event both redemptionsare effected, all remaining shares of Series A Shares will automaticallyconvert to common stock on a one-for-one basis (subject to adjustments).

 

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*Issuer Purchases of Equity Securities*

 
| **Period**                              | ** ** | **Total No. of Shares  Purchased** | ** ** | **Average Price  Paid per Share** | ** ** | **Total No. of Shares  Purchased as Part  of Publicly  Announced Plan** | ** ** | **Maximum No. of  Shares that May  Yet Be Purchased  Under the Plan** | ** ** |
|-----------------------------------------|------------|------------------------------------|------------|-----------------------------------|------------|-------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| April 1 – April 30, 2004 |       | 0                                  |       | n/a                               |       | n/a                                                                     |       | n/a                                                                   |       |
|                                    |       |                               |       |                              |       |                                                                    |       |                                                                  |       |
| May 1 – May 31, 2004               |       | 0                                  |       | n/a                               |       | n/a                                                                     |       | n/a                                                                   |       |
|                                    |       |                               |       |                              |       |                                                                    |       |                                                                  |       |
| June 1 – June 30, 2004   |       | 85,000                             | *          | $                                 | 2.35       |                                                                    | n/a        |                                                                  | n/a        |   |
|                                         |            |                                    |            |                                   |            |                                                                         |            |                                                                       |            |  |

 

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*                 We purchased 85,000 shares of ourSeries A Convertible Preferred Stock in exchange for an aggregate of $200,000pursuant to the redemption provisions in the Amended Certificate ofDesignations of Series A Convertible Preferred Stock, as filed with theDelaware Secretary of State on May 26, 2004. We have the right to redeem an additional 300,000 shares of our Series AConvertible Preferred Stock, exercisable any time on or prior toJanuary 15, 2006, in exchange for a total of $500,000.

 

## Item 3.             Defaults upon Senior Securities

 

None.

 

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

 

*Annual Meeting of Stockholders*

 

At our 2004 Annual Meeting of Stockholders, held May 24, 2004,stockholders voted to elect the director nominees, approve the issuance ofshares of our common stock representing more than 20% of the outstanding sharesour common stock, ratify the selection of Ernst & Young LLP as ourindependent auditors for the fiscal year ending December 31, 2004, andapprove a change of our corporate name (subject to Board authority to implementsuch name change).

 

32

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| ** **                                                                                                                                                                                 | ** ** | **Number of Shares** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                                                                                                 | ** ** | **Vote For**         | ** ** | **Voted Against/  Abstain** | ** ** | **Broker  Non-Votes** | ** ** |
|                                                                                                                                                                                       |       |                 |       |   |   |   |   |
| 1.          To elect 2 Class III directors for a term  of 3 years or until their respective successors are duly elected and  qualified:* |       |                 |       |   |   |   |   |
|                                                                                                                                                                                       |       |                 |       |   |   |   |   |
| James C. Blair                                                                                                                                                                             |       | 3,376,762            |       | 14,312 |   | 0 |   |
|                                                                                                                                                                                       |       |                 |       |   |   |   |   |
| John R. Lyon                                                                                                                                                                               |       | 3,376,512            |       | 14,562 |   | 0 |   |

 

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*  Scott R. Pancoast and Larry M.Osterink, whose terms as directors of our company expire at our 2005 AnnualMeeting of Stockholders, and George B. DeHuff and Michael H. Owens, whose termsas Directors of our company expire at our 2006 Annual Meeting of Stockholders,continue to serve as directors of our company until their respective termsexpire and were not voted upon at the 2004 Annual Meeting.

 
| ** **                                                                                                                                                            | ** ** | **Number of Shares** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                                                                            | ** ** | **Vote For**         | ** ** | **Voted Against** | ** ** | **Abstentions** | ** ** | **Broker  Non-Votes** | ** ** |
| ** **                                                                                                                                                            | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| 2.          To approve the issuance of shares of our  common stock representing more than 20% of the outstanding shares. |       | 3,375,700            |       | 15,224 |   | 150 |   | 0 |   |
|                                                                                                                                                                  |       |                 |       |   |   |   |   |   |   |
| 3.          To ratify the selection of Ernst &  Young LLP as our independent auditors for fiscal year 2004.          |       | 3,362,154            |       | 28,758 |   | 162 |   | 0 |   |
|                                                                                                                                                                  |       |                 |       |   |   |   |   |   |   |
| 4.          To approve our name change to  Vista Health Systems, Inc.                                               |       | 3,390,274            |       | 775 |   | 25 |   | 0 |   |

 

*Special Meeting of Stockholders*

 

At our Special Meeting of Stockholders, held April 15, 2004,stockholders voted upon a proposal to sell all of the assets of the ourVisualization Technology business to Viking Systems, Inc. pursuant to an AssetPurchase Agreement, dated as of December 22, 2003.  The stockholders did not consider or voteupon any other matters at this Special Meeting.

 

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| ** **                                                                                                                                                                                                     | ** ** | **Number of Shares** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                                                                                                                     | ** ** | **Vote For**         | ** ** | **Voted Against** | ** ** | **Abstentions** | ** ** | **Broker  Non-Votes** | ** ** |
| 1.          To approve the sale of all of the assets of  our Visualization Technology Business to Viking Systems, Inc. pursuant to the  Asset Purchase Agreement. |       | 4,616,111            |       | 6,291 |   | 2,100 |   | — |   |

 

## Item5.             Other Information

##  

None.

 

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

##  

(a)                                  Exhibits

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                               |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1  (1)   |       | Second  Restated Certificate of Incorporation.                                                                                                |
|            |       |                                                                                                                                          |
| 3.2  (2)   |       | Certificate  of Amendment of Second Restated Certificate of Incorporation.                                                                    |
|            |       |                                                                                                                                          |
| 3.3  (3)   |       | Certificate  of Designations of Series A Convertible Preferred Stock.                                                                         |
|            |       |                                                                                                                                          |
| 3.4  (4)   |       | Amended  Certificate of Designations of Series A Convertible Preferred Stock, as filed  with the Delaware Secretary of State on May 26, 2004. |
|            |       |                                                                                                                                          |
| 3.5  (1)   |       | Restated  Bylaws.                                                                                                                             |
|            |       |                                                                                                                                          |
| 4.1  (5)   |       | Form  of Certificate for Common Stock.                                                                                                        |
|            |       |                                                                                                                                          |
| 10.1  (6)  |       | Patent  and Technology License Agreement between us and Viking Systems, Inc., dated  April 15, 2004.                                     |
|            |       |                                                                                                                                          |
| 10.2  (6)  |       | Registration  Rights Agreement between us and Viking Systems, Inc., dated April 15,  2004.                                               |
|            |       |                                                                                                                                          |
| 10.3   (4) |       | Selling  Agent’s Warrant issued by us to ViewTrade Financial, dated May 26, 2004                                                    |
|            |       |                                                                                                                                          |
| 10.4   (4) |       | Form  of Subscription Agreement between us and each investor in our financing that  closed May 26, 2004.                                      |
|            |       |                                                                                                                                          |
| 10.5   (4) |       | Form  of Common Stock Purchase Warrant issued to each investor in our financing  that closed May 26, 2004.                                    |

 

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| 31.1  * |   | Certification  of Principal Executive Officer pursuant to Rules 13a-14 and 15d-14  promulgated under the Securities Exchange Act of 1934.                                                                 |
|--------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |                                                                                                                                                                                                      |
| 31.2  * |   | Certification  of Principal Financial Officer pursuant to Rules 13a-14 and 15d-14  promulgated under the Securities Exchange Act of 1934.                                                                 |
|         |   |                                                                                                                                                                                                      |
| 32  *   |   | Certifications  of Principal Executive Officer and Principal 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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*                                         Filedherewith.

 

(1)                                  Incorporated byreference to our Registration Statement on Form S-1, as amended, filedMarch 7, 1997.

 

(2)                                  Incorporated byreference to our Form 10-Q, filed November 14, 2001.

 

(3)                                  Incorporated byreference to our Form 10-K, filed March 31, 2003.

 

(4)                                  Incorporated byreference to our Form 8-K, filed May 28, 2004.

 

(5)                                  Incorporated byreference to our Registration Statement on Form S-1, as amended, filedJune 25, 1997.

 

(6)                                  Incorporated byreference to our Form 8-K, filed April 20, 2004.

 

(b)                                 Reportson Form 8-K

 

1.                                       OnApril 20, 2004, we filed a Form 8-K, which attached a press releaseannouncing completion of the sale of all assets related to our VisualizationTechnology business to Viking Systems, Inc.

 

2.                                       On May 6, 2004,we furnished on Form 8-K a press release relating to our financial results forthe three months ended March 31, 2004.

 

3.                                       On May 28, 2004,we filed a Form 8-K, which attached a press release announcing completion of aprivate placement of our securities and belief that we regained compliance withthe continued listing requirements of the Nasdaq SmallCap Market.

 

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#### **SIGNATURES**

 

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

 

 
|                             | VISTA MEDICAL TECHNOLOGIES,INC.                                                                                                 |
|----------------------------------|---------------------------------------------------------------------------------------------------------------------------------|
|                             |                                                                                                                            |
|                             |                                                                                                                            |
| Date:  August 16, 2004 | /s/ JOHN R. LYON                                                                                                                |   |
|                             | John R. Lyon  President, Chief Executive Officer and  Director                                                                  |
|                             |                                                                                                                            |
| Date:  August 16, 2004 | /s/ HOWARD SAMPSON                                                                                                              |   |
|                             | Howard Sampson  Vice President of Finance,  Chief Financial Officer and Secretary  (Principal financial and accounting officer) |
|                                  |                                                                                                                                 |  |  |

 

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