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                                  Exhibit 10.4


December 28, 1998

Mr. John Lyon
540 Idaho Drive
Escondido, CA 92025

Dear Mr. Lyon:

                  We are pleased to inform you that the Company's Board of
Directors has recently approved a special severance benefit program for you. The
purpose of this letter agreement is to set forth the terms and conditions of
your severance benefits.

                  Your severance package will become payable if within eighteen
(18) months following a substantial change in ownership or control of the
Company either (i) your employment is terminated by the Company other than for
cause or (ii) you resign following a material reduction in your compensation or
duties or a substantial relocation of your principal place of employment. To
understand the full scope of your benefits, you should familiarize yourself with
the definitional provisions of Part One of this letter agreement. The benefits
comprising your severance package are detailed in Part Two, and other applicable
restrictions are specified in Part Three. Part Four deals with ancillary matters
affecting your severance arrangement.

                             PART ONE -- DEFINITIONS

                  For purposes of this letter agreement, the following
definitions will be in effect:

                  BASE SALARY means the monthly rate of base salary in effect
for you immediately prior to the Change in Control or (if greater) the monthly
rate of base salary in effect at the time of your Involuntary Termination.

                  BOARD means the Company's Board of Directors.

                  CHANGE IN CONTROL means a change in the ownership or control
of the Company effected through any of the following transactions:

                           (i) a merger or consolidation approved by the
                  Company's stockholders in which securities possessing more
                  than fifty percent (50%) of the total combined voting power of
                  the Company's outstanding securities are transferred to a
                  person or persons different from the persons holding those
                  securities immediately prior to such transaction; or


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                           (ii) any stockholder-approved sale, transfer or other
                  disposition of all or substantially all of the Company's
                  assets in complete liquidation or dissolution of the Company.

                  CODE means the Internal Revenue Code of 1986, as amended.

                  COMMON STOCK means the Company's common stock.

                  COMPANY means Vista Medical Technologies, Inc., a Delaware
corporation, or any successor corporation, whether or not resulting from a
Change in Control.

                  DISABILITY means your inability to perform the normal and
usual duties of your position with the Company by reason of any physical or
medical impairment which is expected to result in death or continue for a period
of twelve (12) consecutive months or more.

                  HEALTH CARE COVERAGE means the continued coverage to which you
will be entitled under the Company's insured health care (medical/dental/vision)
plans during any Salary Continuation Period in effect for you under this letter
agreement.

                  INVOLUNTARY TERMINATION means (i) the involuntary termination
of your employment with the Company other than a Termination for Cause or (ii)
your voluntary resignation following (A) a change in your position with the
Company which materially reduces your duties and responsibilities or the level
of management to which you report, (B) a reduction in your level of compensation
(including Base Salary, fringe benefits and target bonus under any
corporate-performance based bonus or incentive programs) by more than ten
percent (10%), other than in connection with a cost reduction program
implemented by the Company for the members of management and other highly
compensated employees, or (C) a relocation of your principal place of employment
by more than fifty (50) miles, provided and only if such change, reduction or
relocation is effected by the Company without your consent.

                  A reduction in the level of compensation imposed An
Involuntary Termination will not be deemed to occur in the event your employment
terminates by reason of your death or Disability or a Termination for Cause.

                  SALARY CONTINUATION PERIOD means the period for which payment
of your Base Salary may, pursuant to Part Two of this letter agreement, be
continued following an Involuntary Termination of your employment within a
specified period following a Change in Control.

                  TERMINATION FOR CAUSE means the Company's termination of your
employment for any of the following reasons: (i) your commission of any act of
fraud, embezzlement or dishonesty, (ii) your unauthorized use or disclosure of
any confidential information or trade secrets of the Company, (iii) any
intentional misconduct by you which has a materially adverse


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effect upon the Company's business or reputation or (iv) your continued
failure to perform the major duties, functions and responsibilities of your
position after written notice from the Company identifying the deficiencies
in your performance.

                     PART TWO -- CHANGE IN CONTROL BENEFITS

                  Should your employment with the Company terminate by reason of
an Involuntary Termination within eighteen (18) months after a Change in
Control, then you will become entitled to receive the severance benefits
provided under this Part Two. However, those benefits will in all events be
subject to the restrictive covenants of Part Three of this letter agreement and
will be in lieu of all other severance benefits to which you might otherwise be
entitled upon such termination of your employment.

                  1.       SEVERANCE PAYMENT.

                  You will be entitled to salary continuation payments at one
hundred percent (100%) of your applicable rate of Base Salary for a Salary
Continuation Period of twelve (12) months following your Involuntary
Termination. These salary continuation payments will be made to you at
bi-monthly intervals in accordance with the Company's normal payroll practices.

                  2.       HEALTH CARE COVERAGE.

                  Should you elect continued health care coverage under the
Company's insured medical/dental/vision plan pursuant to your rights under Code
Section 4980B ("COBRA"), the Company will provide such COBRA coverage, without
charge, to you and your eligible dependents. Such Company-paid coverage will
continue until the EARLIER of (i) twelve (12) months after the date of your
Involuntary Termination or (ii) the first date that the you are covered under
another employer's health benefit program which provides substantially the same
level of benefits without exclusion for pre-existing medical conditions. Any
additional health care coverage to which you and your dependents may be entitled
under COBRA following the period of such Company-paid coverage will be at your
sole cost and expense.

                  3.       UNPAID BENEFITS.

                  You will receive an immediate lump sum payment of all unpaid
vacation days which you have accrued through the date of your Involuntary
Termination. Payment will be made on the basis of the same rate of Base Salary
taken into account for purposes of your Paragraph 1 salary continuation
payments.



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                  4.       INDEMNIFICATION.

                  The indemnification provisions for Officers and Directors
under the Company By-Laws will (to the maximum extent permitted by law) be
extended to you, during the period following your Involuntary Termination, with
respect to any and all matters, events or transactions occurring or effected
during your employment with the Company.

                  5.       GENERAL CONDITIONS.

                  Your payments and benefits under this Part Two will
immediately terminate in the event you fail to abide by the restrictive
covenants set forth in Part Three of this letter agreement. The payments to be
made to you pursuant to Paragraph 1 and Paragraph 2 of this Part Two will be
subject to the Company's collection of all applicable federal, state and local
income and employment withholding taxes.

       PART THREE -- CONSULTING SERVICES AND SPECIAL RESTRICTIVE COVENANTS

                  1.       CONSULTING SERVICES.

                  In consideration for the salary continuation payments to which
you become entitled under Part Two, you will make yourself available during the
Salary Continuation Period to render such consulting services to the Company
within your area of expertise as may reasonably be requested by the Company, but
in no event may more than ten (10) hours of such services will be required of
you per month.

                  2.       CESSATION OF BENEFITS.

                  Your Salary Continuation Period will immediately terminate,
and all salary continuation payments and Company-paid Health Care Coverage will
immediately cease, should you:

                  (a) own, manage, operate, join, control or participate in the
ownership, management, operation or control of, or be employed by or connected
in any manner with, any enterprise which is engaged in any business directly
competitive with that of the Company; PROVIDED, however, that such restriction
will not apply to any passive investment representing an interest of less than
two percent (2%) of an outstanding class of publicly-traded securities of any
corporation or other enterprise;

                  (b) encourage or solicit any of the Company's employees to
leave the Company's employ for any reason or interfere in any other manner with
employment relationships at the time existing between the Company and its
employees; or


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                  (c) induce any of the Company's clients, customers, suppliers,
vendors, distributors, licensors or licensees to terminate their existing
business relationships with the Company or interfere in any other manner with
any existing business relationship between the Company and any client, customer,
supplier, vendor, distributor, licensor, licensee or other third party.

                           PART FOUR -- MISCELLANEOUS

                  1.       TERMINATION FOR CAUSE.

                  Should your employment cease by reason of a Termination for
Cause or should you voluntarily resign under circumstances which would otherwise
constitute grounds for a Termination for Cause, then the Company will only be
required to pay you (i) any unpaid compensation earned for services previously
rendered through the date of such termination and (ii) any accrued but unpaid
vacation benefits or sick days, and no other benefits will be payable to you
under Part Two of this letter agreement.

                  2.       DEATH.

                  Should you die before receipt of one or more salary
continuation payments to which you become entitled under this letter agreement,
then those payments will be made to the executors or administrators of your
estate in installments over the remainder of your Salary Continuation Period.

                  3.       GENERAL CREDITOR STATUS.

                  All cash payments to which you become entitled hereunder will
be paid, when due, from the general assets of the Company, and no trust fund,
escrow arrangement or other segregated account will be established as a funding
vehicle for such payment. Accordingly, your right (or the right of the personal
representatives or beneficiaries of your estate) to receive such cash payments
hereunder will at all times be that of a general creditor of the Company and
will have no priority over the claims of other general creditors.

                  4.       MISCELLANEOUS.

                  This letter agreement will be binding upon the Company, its
successors and assigns (including, without limitation, the surviving entity in
any Change in Control) and is to be construed and interpreted under the laws of
the State of California. This letter agreement supersedes all prior agreements
between you and the Company relating to the subject of severance benefits
payable in connection with your termination of employment following a change in
control or ownership of the Company, and you will not be entitled to any other
severance benefits upon such a termination other than those that are provided in
this letter


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agreement. This letter may only be amended by written instrument signed by
you and an authorized officer of the Company. If any provision of this letter
agreement as applied to you or the Company or to any circumstance should be
adjudged by a court of competent jurisdiction to be void or unenforceable for
any reason, the invalidity of that provision will in no way affect (to the
maximum extent permissible by law) the application of such provision under
circumstances different from those adjudicated by the court, the application
of any other provision of this letter agreement, or the enforceability or
invalidity of this letter agreement as a whole. Should any provision of this
letter agreement become or be deemed invalid, illegal or unenforceable in any
jurisdiction by reason of the scope, extent or duration of its coverage, then
such provision will be deemed amended to the extent necessary to conform to
applicable law so as to be valid and enforceable or, if such provision cannot
be so amended without materially altering the intention of the parties, then
such provision will be stricken and the remainder of this letter agreement
will continue in full force and effect.

                  5.       AT WILL EMPLOYMENT.

                  Nothing in this letter agreement is intended to provide you
with any right to continue in the employ of the Company (or any subsidiary) for
any period of specific duration or interfere with or otherwise restrict in any
way your rights or the rights of the Company (or any subsidiary), which rights
are hereby expressly reserved by each, to terminate your employment at will or
as otherwise specified in your employment contract.

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                  Please indicate your acceptance of the foregoing by signing
the enclosed copy of this letter and returning it to the Company.

                                             Very truly yours,

                                             VISTA MEDICAL TECHNOLOGIES, INC.


                                             By:    /s/ Robert DeVaere
                                                    ---------------------------

                                             Title: Chief Financial Officer
                                                    ---------------------------



                                   ACCEPTANCE

                  I hereby agree to all the terms and provisions of the
foregoing letter agreement governing the special benefits to which I may
become entitled upon an involuntary termination of my employment under
certain prescribed circumstances following a substantial change in control or
ownership of the Company.

                                        Signature: /s/ John Lyon
                                                   ----------------------------

                                        Dated:     December 28, 1998
                                                   ----------------------------