<PAGE>
 
                     SECURITIES AND EXCHANGE COMMISSION
                           Washington, D.C.  20549
________________________________________________________________________________


                                  FORM 10-Q

[ X ]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                             EXCHANGE ACT OF 1934

          For the periods ended June 30, 1997 and September 30, 1997
                                     OR
[   ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                            EXCHANGE ACT OF 1934
                 For the transition period from ___ to ___

                       Commission File Number 0-22229

             ___________________________________________________


                             VITAL IMAGES, INC.
           (Exact name of Registrant as specified in its charter)

          Minnesota                                  42-1321776
(State or other jurisdiction of        (I.R.S. Employer Identification No.)
 incorporation or organization)

3100 West Lake Street, Suite 100                        55416
  Minneapolis, Minnesota                             (Zip Code)
  (Address of principal
    executive offices)

                               (612) 915-8000
            (Registrant's telephone number, including area code)
             ___________________________________________________


Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.  Yes  X   No 
                                        ---     ---

                _________________________________________   
  
On November 11, 1997, there were 4,780,425 shares of the Registrant's common
stock, par value $.01 per share, outstanding.

                                       1
<PAGE>
 
                             VITAL IMAGES, INC.
                                  Form 10-Q
                             September 30, 1997



                              Table of Contents

                                                                      Page
                                                                     Number

PART I.  FINANCIAL INFORMATION

  Item 1.  Financial Statements (Unaudited)

     Balance Sheets as of September 30, 1997 and October 31, 1996 ..... 3

     Statements of Operations for the Two Months Ended
       June 30, 1997 and 1996 and the Three and Nine Months Ended
       September 30, 1997 and 1996..................................... 4

     Statements of Cash Flows for the Two Months Ended
       June 30, 1997 and 1996 and the Nine Months Ended
       September 30, 1997 and 1996..................................... 5

     Notes to Financial Statements .................................... 6

  Item 2.  Management's Discussion and Analysis of Financial
       Condition and Results of Operations ............................ 9


PART II.  OTHER INFORMATION

  Item 6.  Exhibits and Reports on Form 8-K .......................... 16


SIGNATURES ........................................................... 17


INDEX TO EXHIBITS .................................................... 18

  Exhibit 11.1 - Computation of Net Loss and Pro Forma Net Loss Per Share

  Exhibit 27 - Financial Data Schedule

                                       2
<PAGE>
 
_______________________________________________________________________________ 

                        PART I.  FINANCIAL INFORMATION
_______________________________________________________________________________ 

ITEM 1.  FINANCIAL STATEMENTS

VITAL IMAGES, INC.
BALANCE SHEETS
AS OF SEPTEMBER 30, 1997 AND OCTOBER 31, 1996
_______________________________________________________________________________ 

<TABLE> 
<CAPTION> 
                                                          September 30,     October 31,
                                                               1997             1996
                                                         --------------   -------------
                                                           (Unaudited)
<S>                                                      <C>               <C> 
ASSETS                                                    
Current assets:                                           
     Cash and cash equivalents...........................  $  3,262,566    $        -
     Marketable securities...............................     4,470,255             -
     Accounts receivable, net............................       107,068          190,807
     Prepaid expenses and other current assets...........       385,506           92,114
                                                          -------------    -------------
               Total current assets......................     8,225,395          282,921
Equipment and leasehold improvements, net................     1,136,835          651,351
Patent costs, net........................................        26,421            8,639
                                                          -------------    -------------

               TOTAL ASSETS..............................  $  9,388,651    $     942,911
                                                           ============    =============


LIABILITIES AND EQUITY
Current liabilities:
     Accounts payable....................................  $    272,121    $      59,533
     Accrued expenses....................................       412,193          196,850
     Deferred revenue....................................       164,446          285,027
                                                          -------------    -------------
               Total current liabilities.................       848,760          541,410
Deferred revenue.........................................       172,097          227,097
                                                          -------------    -------------
               Total liabilities.........................     1,020,857          768,507
                                                          -------------    -------------

Equity:
     Common stock: $.01 par value;  20,000,000 shares
     authorized and 4,780,425 shares issued and
     outstanding at September 30, 1997; 1,000 shares
     authorized, issued and outstanding at October 31,
     1996 ...............................................        47,804               10
     Additional paid-in capital..........................    17,963,256        3,003,047
     Deferred compensation...............................      (352,877)        (460,000)
     Net investment by Bio-Vascular, Inc.................        -             3,138,520
     Accumulated deficit.................................    (9,290,389)      (5,507,173)
                                                           ------------    -------------
               Total equity..............................     8,367,794          174,404
                                                           ------------    -------------

                    TOTAL LIABILITIES AND EQUITY.........  $  9,388,651    $     942,911
                                                           ============    =============

</TABLE>


(The accompanying notes are an integral part of the financial statements.)

                                       3
<PAGE>
 
VITAL IMAGES, INC.
STATEMENTS OF OPERATIONS
FOR THE TWO MONTHS ENDED JUNE 30, 1997 AND 1996 AND THE THREE AND 
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
-------------------------------------------------------------------------------
<TABLE> 
<CAPTION> 

                                               For the Two               For the Three             For the Nine
                                              Months Ended               Months Ended              Months Ended 
                                                June 30,                 September 30,             September 30,
                                      --------------------------  -------------------------  ---------------------------
                                          1997           1996          1997        1996          1997            1996        
                                      ------------  ------------  ------------  -----------  ------------   ------------
                                              (Unaudited)               (Unaudited)                  (Unaudited)

<S>                                   <C>           <C>            <C>          <C>          <C>             <C>         

License fee revenue..................   $   8,000    $   30,020   $   188,265   $  129,672   $   319,391    $   406,573
Maintenance and services revenue.....      43,388        49,340        63,949      100,171       209,322        256,017
Hardware revenue.....................         -             -             -         32,325           -           32,325
                                      ------------  ------------  ------------  -----------  ------------   ------------
     Total revenue...................      51,388        79,360       252,214      262,168       528,713        694,915
Cost of revenue......................      28,621        20,441        25,455       53,200        94,271        128,415
                                      ------------  ------------  ------------  -----------  ------------   ------------
     Gross margin....................      22,767        58,919       226,759      208,968       434,442        566,500

Operating expenses:
Selling, general and administrative..     559,164       330,714       833,341      388,119     2,397,065      1,418,801
Research and development.............     468,884       229,534       593,727      451,686     1,644,864      1,121,906
                                      ------------  ------------  ------------  -----------  ------------   ------------
     Operating loss..................  (1,005,281)     (501,329)   (1,200,309)    (630,837)   (3,607,487)    (1,974,207)

Other income, net....................      82,872         1,120       113,568           75       344,974          1,390
                                      ------------  ------------  ------------  -----------  ------------   ------------

Net loss.............................  $ (922,409)   $ (500,209)  $(1,086,741)  $ (630,762)  $(3,262,513)   $(1,972,817)
                                      ============  ============  ============  ===========  ============   ============

Net loss per share...................  $    (0.19)   $    (0.11)  $    (0.23)   $   (0.13)   $    (0.68)   $     (0.42)
                                      ============  ============  ============  ===========  ============   ============

Weighted average number of
   common shares outstanding.........   4,772,422     4,719,742     4,772,509    4,727,155     4,764,526      4,716,353
                                      ============  ============  ============  ===========  ============   ===========
</TABLE> 


(The accompanying notes are an integral part of the financial statements.)

                                       4
<PAGE>
 
VITAL IMAGES, INC.
STATEMENTS OF CASH FLOWS
FOR THE TWO MONTHS ENDED JUNE 30, 1997 AND 1996 AND THE NINE MONTHS 
ENDED SEPTEMBER 30, 1997 AND 1996
-------------------------------------------------------------------------------

<TABLE> 
<CAPTION> 

                                                           For the Two                     For the Nine
                                                           Months Ended                    Months Ended
                                                             June 30,                      September 30,
                                                    ---------------------------    ----------------------------
                                                       1997            1996            1997           1996
                                                    -----------    ------------    -------------   -------------
                                                            (Unaudited)                     (Unaudited)

<S>                                                 <C>             <C>             <C>            <C> 
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net loss                                         $ (922,409)     $ (500,209)     $(3,262,513)   $ (1,972,817)
   Adjustments to reconcile net loss to                                                            
      net cash used in operating activities:                                                       
         Depreciation and amortization                  48,539          32,601          225,133         135,549
         Non-cash compensation                          19,219          25,515           87,957          98,769
         Provision for uncollectible accounts           (6,300)         18,767           (2,698)         35,492
         Changes in operating assets and 
          liabilities:                                              
            Accounts receivable                           (105)        118,641          (15,006)        117,600
            Prepaid expenses and other 
             current assets                               (593)           (217)        (186,191)        (65,607)
            Accounts payable                           143,790          44,474          184,591         (11,825)
            Accrued expenses                           127,906          45,619          223,434          77,101
            Deferred revenues                          (27,928)         (3,398)        (160,317)        324,087
                                                   -----------     -----------      -----------     -----------
             Net cash used in operating activities    (617,881)       (218,207)      (2,905,610)     (1,261,651)
                                                                                                   
CASH FLOWS FROM INVESTING ACTIVITIES:                                                              
   Purchase of equipment                              (168,307)        (81,873)        (648,764)       (232,477)
   Patent additions                                         -               -            (3,165)             -
   Purchase of marketable securities                (2,934,046)             -        (5,373,299)             -
   Maturities of marketable securities                 971,843              -         3,903,044              -
                                                   -----------     -----------      -----------     -----------
        Net cash used in investing activities       (2,130,510)        (81,873)      (2,122,184)       (232,477)
                                                                                                   
CASH FLOWS FROM FINANCING ACTIVITIES:                                                              
   Investment by Bio-Vascular, Inc.                  1,844,864         300,080        1,797,814       1,494,128
   Employee stock purchases                                 -               -            11,479              -
                                                   -----------     -----------      -----------     -----------
        Net cash provided by financing activities    1,844,864         300,080        1,809,293       1,494,128
                                                                                                   
NET DECREASE IN CASH AND CASH EQUIVALENTS             (903,527)             -        (3,218,501)             -
                                                                                                   
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD     5,114,127              -         6,481,067              -
                                                   -----------     -----------      -----------     -----------

CASH AND CASH EQUIVALENTS AT END OF PERIOD          $4,210,600      $       -       $ 3,262,566     $        -
                                                   ===========     ===========      ===========     ===========
</TABLE> 


(The accompanying notes are an integral part of the financial statements.)

                                       5
<PAGE>
 
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

(1) BASIS OF PRESENTATION:

On July 17, 1997, the Board of Directors of the Company adopted a resolution
changing the Company's fiscal year end from October 31 to December 31 of each
year. This quarterly report on Form 10-Q includes unaudited financial
statements as of September 30, 1997 and for the two-month period ended June
30, 1997 and the comparable periods of the prior calendar year. The Company
will include the audited financial information for the transition period
(November 1, 1996 to December 31, 1996) in its annual report on Form 10-K for
the year ending December 31, 1997.

The accompanying unaudited financial statements of Vital Images, Inc. ("Vital
Images" or "the Company") have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments considered necessary, including items
of a normal recurring nature, for a fair presentation have been included. The
results of operations for any interim period are not necessarily indicative of
results for the full year. These financial statements should be read in
conjunction with the financial statements and footnotes thereto included in
the Company's registration statement on Form 10 filed with the United States
Securities and Exchange Commission on May 1, 1997.


(2) SPIN-OFF OF VITAL IMAGES:

On October 28, 1996, the Board of Directors of Bio-Vascular, Inc. ("Bio-
Vascular"), the parent company of Vital Images, approved the spin-off (the
"Distribution") of Vital Images to the shareholders of Bio-Vascular.  On May 12,
1997 (the "Distribution Date"), Bio-Vascular distributed all of the outstanding
shares of Vital Images to Bio-Vascular shareholders and on that date Vital
Images began operating as an independent, publicly-owned company.  All Bio-
Vascular shareholders of record as of May 5, 1997 received one share of Vital
Images common stock for each two shares of Bio-Vascular stock held on that date,
and cash in lieu of fractional shares.

In anticipation of the Distribution, Bio-Vascular assigned to Vital Images
$10,000,000 in cash, cash equivalents and marketable securities, effective
November 1, 1996.  On the Distribution Date, Bio-Vascular contributed to Vital
Images an additional $1,845,000 in cash equivalents in order to increase Vital
Images' cash, cash equivalents and marketable securities balances to
$10,000,000.  Additionally, Bio-Vascular made capital contributions to Vital
Images of approximately $3,200,000 representing net advances of cash over the
period beginning May 24, 1994, the date on which Vital Images was acquired by
Bio-Vascular, and ending May 11, 1997, the last date on which Vital Images was a
part of Bio-Vascular. The accompanying unaudited financial statements reflect
the effect of the spin-off and the additional cash equivalents and net advances
contributed on the Distribution Date.

                                       6
<PAGE>
 
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS--CONTINUED
-------------------------------------------------------------------------------

(3) MAJOR CUSTOMERS:

                            Significant                       Percentage of
                             Customer            Revenue      Total Revenue
                     ------------------------  ----------     ------------- 
Nine months ended      CogniSeis Development    $ 142,498          27%
September 30, 1997 

Nine months ended    Advanced Technology Labs   $  70,903          10%
September 30, 1996 

The Company's accounts receivable are generally concentrated with a small base
of customers. As of September 30, 1997, four customers accounted for 70% of
accounts receivable, while as of October 31, 1996, five customers accounted
for 69% of accounts receivable.

Export revenue amounted to 22% and 29% of total revenue for the nine months
ended September 30, 1997 and 1996, respectively.  Substantially all of the
Company's export revenue is negotiated, invoiced and paid in U.S. dollars.
Gross export revenue by geographic area is summarized as follows:


                                                        Nine Months Ended
                                                          September 30,  
                                                      ----------------------
                                                         1997         1996
                                                      ---------    ---------
Europe and Middle East...............................  $49,551     $ 66,838
Asia and Pacific Region..............................   41,831      128,090
Canada, Mexico and others............................   25,579        9,617

(4) NEW ACCOUNTING STANDARD:

In March 1997, Statement of Financial Accounting Standards No. 128 (SFAS No.
128), Earnings per Share, was issued by the Financial Accounting Standards
Board. This standard, which the Company must adopt effective for its 1997 year-
end reporting, requires dual presentation of basic and diluted EPS on the face
of the statement of operations. Pro forma net loss and net loss per common
share currently presented by the Company is equivalent to the basic loss per
share required under SFAS 128. Diluted loss per share for the Company would be
calculated based on both common shares outstanding and consideration of the
dilutive effects of common stock equivalents.

                                       7
<PAGE>
 
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS--CONTINUED
-------------------------------------------------------------------------------

(5) PRO FORMA NET LOSS PER SHARE

Pro forma net loss per share is calculated as if the Distribution occurred at
the beginning of each of the periods for which the pro forma net loss per share
is presented and is based on the number of shares of Bio-Vascular stock
outstanding, as adjusted for the distribution ratio of one share of the
Company's Common Stock for each two shares of Bio-Vascular Common Stock held.

The net loss per share and weighted average number of common shares outstanding
included in the Company's Statements of Operations are presented on a pro forma
basis for the two months ended June 30, 1997, the nine months ended September
30, 1997 and all periods in 1996 because prior to May 12, 1997 the Company was a
wholly-owned subsidiary of Bio-Vascular, Inc.

                                       8
<PAGE>
 
ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
           AND RESULTS OF OPERATIONS

Overview

On October 28, 1996, the Board of Directors of Bio-Vascular, Inc. ("Bio-
Vascular"), the parent company of Vital Images, Inc. (the "Company" or "Vital
Images"), approved a plan to spin off and establish Vital Images as an
independent, publicly-owned company.  On May 12, 1997 (the "Distribution Date"),
Bio-Vascular distributed all of the shares of Vital Images to the shareholders
of Bio-Vascular (the "Distribution"), and on that date Vital Images began
operating as an independent public company. All Bio-Vascular shareholders of
record as of May 5, 1997 received one share of Vital Images common stock for
each two shares of Bio-Vascular stock held on that date, and cash in lieu of
fractional shares.  As a result of Bio-Vascular's spin-off of Vital Images,
Vital Images' financial statements and notes thereto report the business of
Vital Images as an independent company. Vital Images is currently traded on the
OTC Bulletin Board under the symbol VTAL.

In anticipation of the Distribution, Bio-Vascular assigned to Vital Images,
$10,000,000 in cash, cash equivalents and marketable securities, effective
November 1, 1996.  On the Distribution Date, Bio-Vascular contributed to Vital
Images an additional $1,845,000 in cash equivalents in order to increase Vital
Images' cash, cash equivalents and marketable securities balance to $10,000,000.
Additionally, Bio-Vascular made capital contributions to Vital Images of
approximately $3,200,000 representing net advances of cash over the period
beginning May 24, 1994, the date on which Vital Images was acquired by Bio-
Vascular, and ending May 11, 1997, the last date on which Vital Images was a
part of Bio-Vascular. The accompanying unaudited financial statements reflect
the effect of the spin-off and the additional cash equivalents and net advances
contributed on the Distribution Date.


On July 17, 1997, the Board of Directors of the Company adopted a resolution
changing the Company's fiscal year end from October 31 to December 31 of each
year. This quarterly report on Form 10-Q contains unaudited financial
statements as of September 30, 1997 and for the two-month period ended June
30, 1997 and the comparable periods of the prior calendar year. The Company
will include the audited financial information for the transition period
(November 1, 1996 to December 31, 1996) in its annual report on Form 10-K for
the year ending December 31, 1997.


Comparison of the Two Months Ended June 30, 1997 with the Two Months Ended June
30, 1996

Total revenue decreased from $79,000 to $51,000, a decline of 35%.  The
decrease was due primarily to a decrease in license fee revenue for the
Company's current product, VoxelView(R), which decreased from $30,000 to $8,000.

The gross margin percentage decreased from 74% to 44%, primarily due to
additional costs related to a customer site.

                                       9
<PAGE>
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS-CONTINUED
-------------------------------------------------------------------------------

Selling, general and administrative expenses increased 69% from $331,000 to
$559,000. General and administrative expenses incurred in the two months ended
June 30, 1997 as compared to the two months ended June 30, 1996 included
increased compensation costs related to an increase in general and
administrative personnel, including a Chief Financial Officer. Also, as a result
of the Company becoming a stand-alone entity after the spin-off from Bio-
Vascular, general and administrative expenses relating to facilities, legal, and
investor relations increased in 1997 from the comparable period in 1996.
Selling expenses increased as a result of increased marketing activity related
to the release of Vitrea(TM) and the employment costs of additional marketing
personnel, including a Vice President of Marketing and Business Development
during the two months ended June 30, 1997.

Research and development expenses increased from $230,000 to $469,000, or 104%,
primarily due to increased compensation costs associated with the hiring of
additional personnel intended to grow the Company's development capabilities, as
well as increased clinical collaboration costs related to the Vitrea product.

The increased expenses attributable to the continuing development of the
Company's management team and infrastructure and the development and promotion
of Vitrea, resulted in an operating loss of $1,005,000 for the two months ended
June 30, 1997, compared to an operating loss of $501,000 for the two months
ended June 30, 1996.

Other income, consisting primarily of interest income, was $83,000 for the two
months ended June 30, 1997, compared to other income of $1,000 for the two
months ended June 30, 1996. The $10,000,000 in cash, cash equivalents and
marketable securities assigned by Bio-Vascular to the Company, effective
November 1, 1996, as well as the $1,845,000 contributed on the Distribution
Date, less cash used for operations subsequent to those dates, resulted in the
increase in interest income during the two months ended June 30, 1997.


Comparison of the Three Months Ended September 30, 1997 with the Three Months
Ended September 30, 1996

Revenue was $252,000 compared to $262,000, a 4% decrease. This decrease was
primarily the result of decreased maintenance and hardware revenue
substantially offset by increased license fee revenue from VoxelView. It is
expected that license fee revenue will increase in the future due to the
release of the Company's new product, Vitrea, in October 1997. However, actual
results could vary materially from the foregoing forward-looking statement as
a result of lower than expected demand for Vitrea or the timing of future
releases of Vitrea.

Gross margin percentages increased from 80% to 90%. This increase was
primarily due to the fact that the Company had no hardware sales in 1997.
Hardware sales generally provide lower margins than software license revenues.
If Vitrea systems revenue increases as a proportion of the Company's total
revenue, the Company expects that the overall gross margin percentage will
decrease due to lower margins anticipated on the third party hardware
component of Vitrea systems. However, actual results could vary materially
from the foregoing forward-looking statement due to significant fluctuations
in gross margins on the proprietary and third party components of the Vitrea
system and on the Company's anticipated product mix.

                                       10
<PAGE>
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS-CONTINUED
-------------------------------------------------------------------------------

Selling, general and administrative expenses were $833,000 compared to
$388,000. This 115% increase was the result of the Company's marketing
activities for Vitrea and the building of an infrastructure to support Vitrea
customers. This includes significant increases in compensation due to
additional personnel, consulting, depreciation and travel expenses. The
compensation costs in 1997 include the incremental costs of a Chief Financial
Officer as well as a Vice President of Marketing and Business Development both
of whom were hired earlier in the year. The Company anticipates that selling,
general and administrative costs will increase in future periods as additional
personnel are hired for Vitrea sales, customer support and administrative
infrastructure.

Research and development expenses increased from $452,000 to $594,000 a 31%
increase. The primary reason for the increase was increased compensation costs
related to the hiring of additional personnel intended to grow the Company's
development capabilities. The Company anticipates that research and
development costs will continue to increase in future periods as additional
personnel are hired.

The increased expenses attributable to the continuing development of the
Company's management team and infrastructure and the development and promotion
of Vitrea, resulted in an operating loss of $1,200,000 for the three months
ended September 30, 1997, compared to an operating loss of $631,000 for the
three months ended September 30, 1996.

Other income consisting primarily of interest income was $114,000 for the
three months ended September 30, 1997 compared to nominal other income for the
comparable period in 1996. The $10,000,000 in cash, cash equivalents and
marketable securities assigned by Bio-Vascular to the Company, effective
November 1, 1996, as well as the $1,845,000 contributed on the Distribution
Date, less cash used for operations subsequent to those dates, resulted in the
increase in interest income during the three months ended September 30, 1997.

Comparison of the Nine Months Ended September 30, 1997 with the Nine Months
Ended September 30, 1996

Total revenue decreased 24% from $695,000 to $529,000. Decreases in both
license fee revenue and maintenance revenue for VoxelView were primarily
responsible for this decline.

The gross margin percentage remained flat at 82% for both periods. This 
occurred despite the hardware sales discussed in the three month comparison 
due to the fact that the lower margin hardware sales all occurred in the three
months ended September 30, 1996 and comprised a small percentage of the 
revenue for the nine months ended September 30, 1996.

Selling, general and administrative expenses increased to $2,397,000 from
$1,419,000, a 69% increase. The increase was primarily due to increased
compensation costs, including the addition of a Chief Financial Officer and a
Vice President of Marketing and Business Development, as well as promotional
expenses and travel expenses related to the release of Vitrea. As a result of
the building of the Company's infrastructure, and the incremental costs
associated with being a stand-alone company, rent, depreciation, legal and
investor relation expenses all increased from comparable 1996 levels.

                                       11
<PAGE>
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS-CONTINUED
-------------------------------------------------------------------------------

Research and development expenses were up 47% to $1,645,000 from the 1996
level of $1,122,000. The increase was primarily due to increased compensation
costs related to increased staffing for the development of the Vitrea product.
In addition travel, rent and depreciation expenses all increased due to
increased development efforts on Vitrea. The Company anticipates that such
costs will continue as future releases of Vitrea are developed.

The increased expenses attributable to the continuing development of the
Company's management team and infrastructure and the development and promotion
of Vitrea, resulted in an operating loss of $3,607,000 for the nine months ended
September 30, 1997, compared to an operating loss of $1,974,000 for the nine
months ended September 30, 1996.

There was $345,000 of other income, consisting primarily of interest income,
for the nine months ended September 30, 1997 compared to other income of
$1,000 for the nine months ended September 30, 1996. The $10,000,000 in cash,
cash equivalents and marketable securities assigned by Bio-Vascular to the
Company, effective November 1, 1996, as well as the $1,845,000 contributed on
the Distribution Date, less cash used for operations subsequent to those
dates, resulted in the increase in interest income during the nine months
ended September 30, 1997.


Liquidity and Capital Resources

At October 31, 1996, Vital Images had no cash and participated in Bio-Vascular's
centralized funding and cash management.  When Bio-Vascular acquired Vital
Images on May 24, 1994, Vital Images had $286,000 in cash.  Within a month,
Vital Images had effectively used its cash and Bio-Vascular began financing the
Company's activities.  Bio-Vascular conducted the investing activities and
continued to finance the activities of Vital Images.  The advances of cash by
Bio-Vascular to Vital Images had no payment requirements and were interest-free,
as Vital Images had, substantially, no ability to repay these advances.
Accordingly, the net cash received from Bio-Vascular through intercompany
advances was considered to be a contribution of capital.

In anticipation of the Distribution, Bio-Vascular agreed to assign to Vital
Images $10,000,000 in cash, cash equivalents and marketable securities effective
November 1, 1996.   Subsequent to November 1, 1996, Bio-Vascular's Board of
Directors determined to make such additional capital contributions as necessary
to increase Vital Images' cash, cash equivalents and marketable securities to
$10,000,000, effective as of the Distribution Date. Accordingly, on the
Distribution Date, Bio-Vascular transferred an additional $1,845,000 in cash
equivalents to Vital Images in order to increase Vital Images' cash, cash
equivalents and marketable securities to an aggregate of $10,000,000.

                                       12
<PAGE>
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS--CONTINUED
-------------------------------------------------------------------------------

If Vital Images' operations progress as anticipated, of which there can be no
assurance, management believes that its cash, cash equivalents and marketable
securities should be sufficient to satisfy its cash requirements for at least
two years from the Distribution Date.  The timing of Vital Images' future
capital requirements, however, will depend on a number of factors, including the
ability of Vital Images to launch successfully its Vitrea product line; the
ability and willingness of physicians to use three-dimensional visualization
software in clinical diagnosis, surgical planning patient screening and other
diagnosis and treatment protocols; the impact of competition in the medical
visualization business; and the ability to enhance existing products and develop
new products on a timely basis.  To the extent that Vital Images' operations do
not progress as anticipated, additional capital will be required sooner.  There
can be no assurance that any required additional capital will be available on
acceptable terms or at all, and the failure to obtain any such required capital
would have a material adverse effect on Vital Images' business.

For the nine months ended September 30, 1997 and 1996, cash used by operating
activities was $2,906,000 and $1,262,000, respectively.  The Company invested
$649,000 and $232,000 in equipment and improvements during the nine months ended
September 30, 1997 and 1996, respectively, primarily for the acquisition of
computer equipment. The Company used $5,373,000 to purchase marketable 
securities and had $3,903,000 of marketable securities mature during the nine 
months ended September 30, 1997.

The Company has no material commitments at this time other than facility leases
and expected employment contracts, but will be using cash in the near term as it
continues to develop the infrastructure to support its business and develop the
market for its products.


Foreign Currency Transactions

Substantially all of the Company's foreign transactions are negotiated, invoiced
and paid in U.S. dollars.


New Accounting Standard

In March 1997, Statement of Financial Accounting Standards No. 128 (SFAS No.
128), Earnings per Share, was issued by the Financial Accounting Standards
Board. This standard, which the Company must adopt effective with its for its
1997 year-end reporting, requires dual presentation of basic and diluted EPS
on the face of the statement of operations. Pro forma net loss and net loss
per common share currently presented by the Company is equivalent to the basic
loss per share required under SFAS 128. Diluted loss per share for the Company
would be calculated based on both common shares outstanding and consideration
of the dilutive effects of common stock equivalents.

                                       13
<PAGE>
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS--CONTINUED
-------------------------------------------------------------------------------

Certain Important Factors

This Form 10-Q contains certain forward-looking statements and information that
are based on management's beliefs as well as on assumptions made by, and upon
information currently available to, management.  When used in this Form 10-Q,
the words "expect," "anticipate," "intend," "plan," "believe," "seek," and
"estimate" or similar expressions are intended to identify such forward-looking
statements. However, this Form 10-Q also contains other forward-looking
statements.  Forward-looking statements are not guarantees of future performance
and are subject to certain risks, uncertainties and assumptions, including, but
not limited to, the following factors, which could cause the Company's future
results and shareholder values to differ materially from those expressed in any
forward-looking statements made by or on behalf of the Company:  the early stage
of the industry and business in which the Company operates, the Company's
transition to an independent medical visualization business, the extent to which
the Company's products gain market acceptance, litigation regarding patent and
other intellectual property rights, the introduction of competitive products by
others, the progress of product development, the availability of third-party
reimbursement, and the receipt and timing of regulatory approvals, among others.


ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

                                       14
<PAGE>
 
_______________________________________________________________________________

     PART II.  OTHER INFORMATION
_______________________________________________________________________________

ITEM 1.     LEGAL PROCEEDINGS

None.


ITEM 2.    CHANGES IN SECURITIES

None.


ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

None.


ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.


ITEM 5.    OTHER INFORMATION

None.

                                       15
<PAGE>
 
ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits.   The exhibits to this quarterly report on Form 10-Q are listed
     ---------
     in the exhibit index beginning on page 18.

(b)  Form 8-K. The Company filed no reports on Form 8-K during the period ended
     ---------
     June 30, 1997. The Company filed an 8-K on July 25, 1997, which reported
     that on July 17, 1997, the Board of Directors of the Company adopted a
     resolution changing the Company's fiscal year end from October 31 to
     December 31 of each year.

                                       16
<PAGE>
 
SIGNATURES


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



                                        VITAL IMAGES, INC.



November 13, 1997                 

                                        /s/  Gregory S. Furness
                                        -----------------------------
                                        Gregory S. Furness
                                        Vice President of Finance and
                                        Chief Financial Officer
                                        (Principal Financial Officer)

                                       17
<PAGE>
 
VITAL IMAGES, INC.
INDEX TO EXHIBITS
-------------------------------------------------------------------------------

11.1  Computation of Net Loss and Pro Forma Net Loss Per Share (filed herewith
      electronically).

27.1  Financial Data Schedule for the Two Months Ended June 30, 1997 and
      Three Months Ended September 30, 1997 (filed herewith
      electronically).

                                       18
[{"type": "10-Q", "sequence": "1", "description": "FORM 10-Q", "secsgml_size_bytes": 43475}]
{"company-data": {"conformed-name": "VITAL IMAGES INC", "cik": "0000912888", "assigned-sic": "3842", "irs-number": "421321776", "state-of-incorporation": "MN", "fiscal-year-end": "1231"}, "filing-values": {"form-type": "10-Q", "act": "34", "file-number": "000-22229", "film-number": "97716393"}, "business-address": {"street1": "3100 W LAKE ST STE 100", "city": "MINNEAPOLIS", "state": "MN", "zip": "55415", "phone": "6129158000"}, "mail-address": {"street1": "3100 WEST LAKE ST STE 100", "city": "MINNEAPOLIS", "state": "MN", "zip": "55416"}}
SECURITIES AND EXCHANGE COMMISSION
                           Washington, D.C.  20549
________________________________________________________________________________

                                  FORM 10-Q

[ X ]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                             EXCHANGE ACT OF 1934

          For the periods ended June 30, 1997 and September 30, 1997
                                     OR
[   ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                            EXCHANGE ACT OF 1934
                 For the transition period from ___ to ___

                       Commission File Number 0-22229

             ___________________________________________________

                             VITAL IMAGES, INC.
           (Exact name of Registrant as specified in its charter)

          Minnesota                                  42-1321776
(State or other jurisdiction of        (I.R.S. Employer Identification No.)
 incorporation or organization)

3100 West Lake Street, Suite 100                        55416
  Minneapolis, Minnesota                             (Zip Code)
  (Address of principal
    executive offices)

                               (612) 915-8000
            (Registrant's telephone number, including area code)
             ___________________________________________________

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.  Yes  X   No 
                                        ---     ---

                _________________________________________   
  
On November 11, 1997, there were 4,780,425 shares of the Registrant's common
stock, par value $.01 per share, outstanding.

                                       1
VITAL IMAGES, INC.
                                  Form 10-Q
                             September 30, 1997

                              Table of Contents

                                                                      Page
                                                                     Number

PART I.  FINANCIAL INFORMATION

  Item 1.  Financial Statements (Unaudited)

     Balance Sheets as of September 30, 1997 and October 31, 1996 ..... 3

     Statements of Operations for the Two Months Ended
       June 30, 1997 and 1996 and the Three and Nine Months Ended
       September 30, 1997 and 1996..................................... 4

     Statements of Cash Flows for the Two Months Ended
       June 30, 1997 and 1996 and the Nine Months Ended
       September 30, 1997 and 1996..................................... 5

     Notes to Financial Statements .................................... 6

  Item 2.  Management's Discussion and Analysis of Financial
       Condition and Results of Operations ............................ 9

PART II.  OTHER INFORMATION

  Item 6.  Exhibits and Reports on Form 8-K .......................... 16

SIGNATURES ........................................................... 17

INDEX TO EXHIBITS .................................................... 18

  Exhibit 11.1 - Computation of Net Loss and Pro Forma Net Loss Per Share

  Exhibit 27 - Financial Data Schedule

                                       2
_______________________________________________________________________________ 

                        PART I.  FINANCIAL INFORMATION
_______________________________________________________________________________ 

ITEM 1.  FINANCIAL STATEMENTS

VITAL IMAGES, INC.
BALANCE SHEETS
AS OF SEPTEMBER 30, 1997 AND OCTOBER 31, 1996
_______________________________________________________________________________
September 30,     October 31,
                                                               1997             1996
                                                         --------------   -------------
                                                           (Unaudited)
ASSETS                                                    
Current assets:                                           
     Cash and cash equivalents...........................  $  3,262,566    $        -
     Marketable securities...............................     4,470,255             -
     Accounts receivable, net............................       107,068          190,807
     Prepaid expenses and other current assets...........       385,506           92,114
                                                          -------------    -------------
               Total current assets......................     8,225,395          282,921
Equipment and leasehold improvements, net................     1,136,835          651,351
Patent costs, net........................................        26,421            8,639
                                                          -------------    -------------

               TOTAL ASSETS..............................  $  9,388,651    $     942,911
                                                           ============    =============

LIABILITIES AND EQUITY
Current liabilities:
     Accounts payable....................................  $    272,121    $      59,533
     Accrued expenses....................................       412,193          196,850
     Deferred revenue....................................       164,446          285,027
                                                          -------------    -------------
               Total current liabilities.................       848,760          541,410
Deferred revenue.........................................       172,097          227,097
                                                          -------------    -------------
               Total liabilities.........................     1,020,857          768,507
                                                          -------------    -------------

Equity:
     Common stock: $.01 par value;  20,000,000 shares
     authorized and 4,780,425 shares issued and
     outstanding at September 30, 1997; 1,000 shares
     authorized, issued and outstanding at October 31,
     1996 ...............................................        47,804               10
     Additional paid-in capital..........................    17,963,256        3,003,047
     Deferred compensation...............................      (352,877)        (460,000)
     Net investment by Bio-Vascular, Inc.................        -             3,138,520
     Accumulated deficit.................................    (9,290,389)      (5,507,173)
                                                           ------------    -------------
               Total equity..............................     8,367,794          174,404
                                                           ------------    -------------

                    TOTAL LIABILITIES AND EQUITY.........  $  9,388,651    $     942,911
                                                           ============    =============
(The accompanying notes are an integral part of the financial statements.)

                                       3
VITAL IMAGES, INC.
STATEMENTS OF OPERATIONS
FOR THE TWO MONTHS ENDED JUNE 30, 1997 AND 1996 AND THE THREE AND 
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
-------------------------------------------------------------------------------
For the Two               For the Three             For the Nine
                                              Months Ended               Months Ended              Months Ended 
                                                June 30,                 September 30,             September 30,
                                      --------------------------  -------------------------  ---------------------------
                                          1997           1996          1997        1996          1997            1996        
                                      ------------  ------------  ------------  -----------  ------------   ------------
                                              (Unaudited)               (Unaudited)                  (Unaudited)
License fee revenue..................   $   8,000    $   30,020   $   188,265   $  129,672   $   319,391    $   406,573
Maintenance and services revenue.....      43,388        49,340        63,949      100,171       209,322        256,017
Hardware revenue.....................         -             -             -         32,325           -           32,325
                                      ------------  ------------  ------------  -----------  ------------   ------------
     Total revenue...................      51,388        79,360       252,214      262,168       528,713        694,915
Cost of revenue......................      28,621        20,441        25,455       53,200        94,271        128,415
                                      ------------  ------------  ------------  -----------  ------------   ------------
     Gross margin....................      22,767        58,919       226,759      208,968       434,442        566,500

Operating expenses:
Selling, general and administrative..     559,164       330,714       833,341      388,119     2,397,065      1,418,801
Research and development.............     468,884       229,534       593,727      451,686     1,644,864      1,121,906
                                      ------------  ------------  ------------  -----------  ------------   ------------
     Operating loss..................  (1,005,281)     (501,329)   (1,200,309)    (630,837)   (3,607,487)    (1,974,207)

Other income, net....................      82,872         1,120       113,568           75       344,974          1,390
                                      ------------  ------------  ------------  -----------  ------------   ------------

Net loss.............................  $ (922,409)   $ (500,209)  $(1,086,741)  $ (630,762)  $(3,262,513)   $(1,972,817)
                                      ============  ============  ============  ===========  ============   ============

Net loss per share...................  $    (0.19)   $    (0.11)  $    (0.23)   $   (0.13)   $    (0.68)   $     (0.42)
                                      ============  ============  ============  ===========  ============   ============

Weighted average number of
   common shares outstanding.........   4,772,422     4,719,742     4,772,509    4,727,155     4,764,526      4,716,353
                                      ============  ============  ============  ===========  ============   ===========
(The accompanying notes are an integral part of the financial statements.)

                                       4
VITAL IMAGES, INC.
STATEMENTS OF CASH FLOWS
FOR THE TWO MONTHS ENDED JUNE 30, 1997 AND 1996 AND THE NINE MONTHS 
ENDED SEPTEMBER 30, 1997 AND 1996
-------------------------------------------------------------------------------
For the Two                     For the Nine
                                                           Months Ended                    Months Ended
                                                             June 30,                      September 30,
                                                    ---------------------------    ----------------------------
                                                       1997            1996            1997           1996
                                                    -----------    ------------    -------------   -------------
                                                            (Unaudited)                     (Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net loss                                         $ (922,409)     $ (500,209)     $(3,262,513)   $ (1,972,817)
   Adjustments to reconcile net loss to                                                            
      net cash used in operating activities:                                                       
         Depreciation and amortization                  48,539          32,601          225,133         135,549
         Non-cash compensation                          19,219          25,515           87,957          98,769
         Provision for uncollectible accounts           (6,300)         18,767           (2,698)         35,492
         Changes in operating assets and 
          liabilities:                                              
            Accounts receivable                           (105)        118,641          (15,006)        117,600
            Prepaid expenses and other 
             current assets                               (593)           (217)        (186,191)        (65,607)
            Accounts payable                           143,790          44,474          184,591         (11,825)
            Accrued expenses                           127,906          45,619          223,434          77,101
            Deferred revenues                          (27,928)         (3,398)        (160,317)        324,087
                                                   -----------     -----------      -----------     -----------
             Net cash used in operating activities    (617,881)       (218,207)      (2,905,610)     (1,261,651)
                                                                                                   
CASH FLOWS FROM INVESTING ACTIVITIES:                                                              
   Purchase of equipment                              (168,307)        (81,873)        (648,764)       (232,477)
   Patent additions                                         -               -            (3,165)             -
   Purchase of marketable securities                (2,934,046)             -        (5,373,299)             -
   Maturities of marketable securities                 971,843              -         3,903,044              -
                                                   -----------     -----------      -----------     -----------
        Net cash used in investing activities       (2,130,510)        (81,873)      (2,122,184)       (232,477)
                                                                                                   
CASH FLOWS FROM FINANCING ACTIVITIES:                                                              
   Investment by Bio-Vascular, Inc.                  1,844,864         300,080        1,797,814       1,494,128
   Employee stock purchases                                 -               -            11,479              -
                                                   -----------     -----------      -----------     -----------
        Net cash provided by financing activities    1,844,864         300,080        1,809,293       1,494,128
                                                                                                   
NET DECREASE IN CASH AND CASH EQUIVALENTS             (903,527)             -        (3,218,501)             -
                                                                                                   
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD     5,114,127              -         6,481,067              -
                                                   -----------     -----------      -----------     -----------

CASH AND CASH EQUIVALENTS AT END OF PERIOD          $4,210,600      $       -       $ 3,262,566     $        -
                                                   ===========     ===========      ===========     ===========
(The accompanying notes are an integral part of the financial statements.)

                                       5
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

(1) BASIS OF PRESENTATION:

On July 17, 1997, the Board of Directors of the Company adopted a resolution
changing the Company's fiscal year end from October 31 to December 31 of each
year. This quarterly report on Form 10-Q includes unaudited financial
statements as of September 30, 1997 and for the two-month period ended June
30, 1997 and the comparable periods of the prior calendar year. The Company
will include the audited financial information for the transition period
(November 1, 1996 to December 31, 1996) in its annual report on Form 10-K for
the year ending December 31, 1997.

The accompanying unaudited financial statements of Vital Images, Inc. ("Vital
Images" or "the Company") have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments considered necessary, including items
of a normal recurring nature, for a fair presentation have been included. The
results of operations for any interim period are not necessarily indicative of
results for the full year. These financial statements should be read in
conjunction with the financial statements and footnotes thereto included in
the Company's registration statement on Form 10 filed with the United States
Securities and Exchange Commission on May 1, 1997.

(2) SPIN-OFF OF VITAL IMAGES:

On October 28, 1996, the Board of Directors of Bio-Vascular, Inc. ("Bio-
Vascular"), the parent company of Vital Images, approved the spin-off (the
"Distribution") of Vital Images to the shareholders of Bio-Vascular.  On May 12,
1997 (the "Distribution Date"), Bio-Vascular distributed all of the outstanding
shares of Vital Images to Bio-Vascular shareholders and on that date Vital
Images began operating as an independent, publicly-owned company.  All Bio-
Vascular shareholders of record as of May 5, 1997 received one share of Vital
Images common stock for each two shares of Bio-Vascular stock held on that date,
and cash in lieu of fractional shares.

In anticipation of the Distribution, Bio-Vascular assigned to Vital Images
$10,000,000 in cash, cash equivalents and marketable securities, effective
November 1, 1996.  On the Distribution Date, Bio-Vascular contributed to Vital
Images an additional $1,845,000 in cash equivalents in order to increase Vital
Images' cash, cash equivalents and marketable securities balances to
$10,000,000.  Additionally, Bio-Vascular made capital contributions to Vital
Images of approximately $3,200,000 representing net advances of cash over the
period beginning May 24, 1994, the date on which Vital Images was acquired by
Bio-Vascular, and ending May 11, 1997, the last date on which Vital Images was a
part of Bio-Vascular. The accompanying unaudited financial statements reflect
the effect of the spin-off and the additional cash equivalents and net advances
contributed on the Distribution Date.

                                       6
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS--CONTINUED
-------------------------------------------------------------------------------

(3) MAJOR CUSTOMERS:

                            Significant                       Percentage of
                             Customer            Revenue      Total Revenue
                     ------------------------  ----------     ------------- 
Nine months ended      CogniSeis Development    $ 142,498          27%
September 30, 1997 

Nine months ended    Advanced Technology Labs   $  70,903          10%
September 30, 1996 

The Company's accounts receivable are generally concentrated with a small base
of customers. As of September 30, 1997, four customers accounted for 70% of
accounts receivable, while as of October 31, 1996, five customers accounted
for 69% of accounts receivable.

Export revenue amounted to 22% and 29% of total revenue for the nine months
ended September 30, 1997 and 1996, respectively.  Substantially all of the
Company's export revenue is negotiated, invoiced and paid in U.S. dollars.
Gross export revenue by geographic area is summarized as follows:

                                                        Nine Months Ended
                                                          September 30,  
                                                      ----------------------
                                                         1997         1996
                                                      ---------    ---------
Europe and Middle East...............................  $49,551     $ 66,838
Asia and Pacific Region..............................   41,831      128,090
Canada, Mexico and others............................   25,579        9,617

(4) NEW ACCOUNTING STANDARD:

In March 1997, Statement of Financial Accounting Standards No. 128 (SFAS No.
128), Earnings per Share, was issued by the Financial Accounting Standards
Board. This standard, which the Company must adopt effective for its 1997 year-
end reporting, requires dual presentation of basic and diluted EPS on the face
of the statement of operations. Pro forma net loss and net loss per common
share currently presented by the Company is equivalent to the basic loss per
share required under SFAS 128. Diluted loss per share for the Company would be
calculated based on both common shares outstanding and consideration of the
dilutive effects of common stock equivalents.

                                       7
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS--CONTINUED
-------------------------------------------------------------------------------

(5) PRO FORMA NET LOSS PER SHARE

Pro forma net loss per share is calculated as if the Distribution occurred at
the beginning of each of the periods for which the pro forma net loss per share
is presented and is based on the number of shares of Bio-Vascular stock
outstanding, as adjusted for the distribution ratio of one share of the
Company's Common Stock for each two shares of Bio-Vascular Common Stock held.

The net loss per share and weighted average number of common shares outstanding
included in the Company's Statements of Operations are presented on a pro forma
basis for the two months ended June 30, 1997, the nine months ended September
30, 1997 and all periods in 1996 because prior to May 12, 1997 the Company was a
wholly-owned subsidiary of Bio-Vascular, Inc.

                                       8
ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
           AND RESULTS OF OPERATIONS

Overview

On October 28, 1996, the Board of Directors of Bio-Vascular, Inc. ("Bio-
Vascular"), the parent company of Vital Images, Inc. (the "Company" or "Vital
Images"), approved a plan to spin off and establish Vital Images as an
independent, publicly-owned company.  On May 12, 1997 (the "Distribution Date"),
Bio-Vascular distributed all of the shares of Vital Images to the shareholders
of Bio-Vascular (the "Distribution"), and on that date Vital Images began
operating as an independent public company. All Bio-Vascular shareholders of
record as of May 5, 1997 received one share of Vital Images common stock for
each two shares of Bio-Vascular stock held on that date, and cash in lieu of
fractional shares.  As a result of Bio-Vascular's spin-off of Vital Images,
Vital Images' financial statements and notes thereto report the business of
Vital Images as an independent company. Vital Images is currently traded on the
OTC Bulletin Board under the symbol VTAL.

In anticipation of the Distribution, Bio-Vascular assigned to Vital Images,
$10,000,000 in cash, cash equivalents and marketable securities, effective
November 1, 1996.  On the Distribution Date, Bio-Vascular contributed to Vital
Images an additional $1,845,000 in cash equivalents in order to increase Vital
Images' cash, cash equivalents and marketable securities balance to $10,000,000.
Additionally, Bio-Vascular made capital contributions to Vital Images of
approximately $3,200,000 representing net advances of cash over the period
beginning May 24, 1994, the date on which Vital Images was acquired by Bio-
Vascular, and ending May 11, 1997, the last date on which Vital Images was a
part of Bio-Vascular. The accompanying unaudited financial statements reflect
the effect of the spin-off and the additional cash equivalents and net advances
contributed on the Distribution Date.

On July 17, 1997, the Board of Directors of the Company adopted a resolution
changing the Company's fiscal year end from October 31 to December 31 of each
year. This quarterly report on Form 10-Q contains unaudited financial
statements as of September 30, 1997 and for the two-month period ended June
30, 1997 and the comparable periods of the prior calendar year. The Company
will include the audited financial information for the transition period
(November 1, 1996 to December 31, 1996) in its annual report on Form 10-K for
the year ending December 31, 1997.

Comparison of the Two Months Ended June 30, 1997 with the Two Months Ended June
30, 1996

Total revenue decreased from $79,000 to $51,000, a decline of 35%.  The
decrease was due primarily to a decrease in license fee revenue for the
Company's current product, VoxelView(R), which decreased from $30,000 to $8,000.

The gross margin percentage decreased from 74% to 44%, primarily due to
additional costs related to a customer site.

                                       9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS-CONTINUED
-------------------------------------------------------------------------------

Selling, general and administrative expenses increased 69% from $331,000 to
$559,000. General and administrative expenses incurred in the two months ended
June 30, 1997 as compared to the two months ended June 30, 1996 included
increased compensation costs related to an increase in general and
administrative personnel, including a Chief Financial Officer. Also, as a result
of the Company becoming a stand-alone entity after the spin-off from Bio-
Vascular, general and administrative expenses relating to facilities, legal, and
investor relations increased in 1997 from the comparable period in 1996.
Selling expenses increased as a result of increased marketing activity related
to the release of Vitrea(TM) and the employment costs of additional marketing
personnel, including a Vice President of Marketing and Business Development
during the two months ended June 30, 1997.

Research and development expenses increased from $230,000 to $469,000, or 104%,
primarily due to increased compensation costs associated with the hiring of
additional personnel intended to grow the Company's development capabilities, as
well as increased clinical collaboration costs related to the Vitrea product.

The increased expenses attributable to the continuing development of the
Company's management team and infrastructure and the development and promotion
of Vitrea, resulted in an operating loss of $1,005,000 for the two months ended
June 30, 1997, compared to an operating loss of $501,000 for the two months
ended June 30, 1996.

Other income, consisting primarily of interest income, was $83,000 for the two
months ended June 30, 1997, compared to other income of $1,000 for the two
months ended June 30, 1996. The $10,000,000 in cash, cash equivalents and
marketable securities assigned by Bio-Vascular to the Company, effective
November 1, 1996, as well as the $1,845,000 contributed on the Distribution
Date, less cash used for operations subsequent to those dates, resulted in the
increase in interest income during the two months ended June 30, 1997.

Comparison of the Three Months Ended September 30, 1997 with the Three Months
Ended September 30, 1996

Revenue was $252,000 compared to $262,000, a 4% decrease. This decrease was
primarily the result of decreased maintenance and hardware revenue
substantially offset by increased license fee revenue from VoxelView. It is
expected that license fee revenue will increase in the future due to the
release of the Company's new product, Vitrea, in October 1997. However, actual
results could vary materially from the foregoing forward-looking statement as
a result of lower than expected demand for Vitrea or the timing of future
releases of Vitrea.

Gross margin percentages increased from 80% to 90%. This increase was
primarily due to the fact that the Company had no hardware sales in 1997.
Hardware sales generally provide lower margins than software license revenues.
If Vitrea systems revenue increases as a proportion of the Company's total
revenue, the Company expects that the overall gross margin percentage will
decrease due to lower margins anticipated on the third party hardware
component of Vitrea systems. However, actual results could vary materially
from the foregoing forward-looking statement due to significant fluctuations
in gross margins on the proprietary and third party components of the Vitrea
system and on the Company's anticipated product mix.

                                       10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS-CONTINUED
-------------------------------------------------------------------------------

Selling, general and administrative expenses were $833,000 compared to
$388,000. This 115% increase was the result of the Company's marketing
activities for Vitrea and the building of an infrastructure to support Vitrea
customers. This includes significant increases in compensation due to
additional personnel, consulting, depreciation and travel expenses. The
compensation costs in 1997 include the incremental costs of a Chief Financial
Officer as well as a Vice President of Marketing and Business Development both
of whom were hired earlier in the year. The Company anticipates that selling,
general and administrative costs will increase in future periods as additional
personnel are hired for Vitrea sales, customer support and administrative
infrastructure.

Research and development expenses increased from $452,000 to $594,000 a 31%
increase. The primary reason for the increase was increased compensation costs
related to the hiring of additional personnel intended to grow the Company's
development capabilities. The Company anticipates that research and
development costs will continue to increase in future periods as additional
personnel are hired.

The increased expenses attributable to the continuing development of the
Company's management team and infrastructure and the development and promotion
of Vitrea, resulted in an operating loss of $1,200,000 for the three months
ended September 30, 1997, compared to an operating loss of $631,000 for the
three months ended September 30, 1996.

Other income consisting primarily of interest income was $114,000 for the
three months ended September 30, 1997 compared to nominal other income for the
comparable period in 1996. The $10,000,000 in cash, cash equivalents and
marketable securities assigned by Bio-Vascular to the Company, effective
November 1, 1996, as well as the $1,845,000 contributed on the Distribution
Date, less cash used for operations subsequent to those dates, resulted in the
increase in interest income during the three months ended September 30, 1997.

Comparison of the Nine Months Ended September 30, 1997 with the Nine Months
Ended September 30, 1996

Total revenue decreased 24% from $695,000 to $529,000. Decreases in both
license fee revenue and maintenance revenue for VoxelView were primarily
responsible for this decline.

The gross margin percentage remained flat at 82% for both periods. This 
occurred despite the hardware sales discussed in the three month comparison 
due to the fact that the lower margin hardware sales all occurred in the three
months ended September 30, 1996 and comprised a small percentage of the 
revenue for the nine months ended September 30, 1996.

Selling, general and administrative expenses increased to $2,397,000 from
$1,419,000, a 69% increase. The increase was primarily due to increased
compensation costs, including the addition of a Chief Financial Officer and a
Vice President of Marketing and Business Development, as well as promotional
expenses and travel expenses related to the release of Vitrea. As a result of
the building of the Company's infrastructure, and the incremental costs
associated with being a stand-alone company, rent, depreciation, legal and
investor relation expenses all increased from comparable 1996 levels.

                                       11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS-CONTINUED
-------------------------------------------------------------------------------

Research and development expenses were up 47% to $1,645,000 from the 1996
level of $1,122,000. The increase was primarily due to increased compensation
costs related to increased staffing for the development of the Vitrea product.
In addition travel, rent and depreciation expenses all increased due to
increased development efforts on Vitrea. The Company anticipates that such
costs will continue as future releases of Vitrea are developed.

The increased expenses attributable to the continuing development of the
Company's management team and infrastructure and the development and promotion
of Vitrea, resulted in an operating loss of $3,607,000 for the nine months ended
September 30, 1997, compared to an operating loss of $1,974,000 for the nine
months ended September 30, 1996.

There was $345,000 of other income, consisting primarily of interest income,
for the nine months ended September 30, 1997 compared to other income of
$1,000 for the nine months ended September 30, 1996. The $10,000,000 in cash,
cash equivalents and marketable securities assigned by Bio-Vascular to the
Company, effective November 1, 1996, as well as the $1,845,000 contributed on
the Distribution Date, less cash used for operations subsequent to those
dates, resulted in the increase in interest income during the nine months
ended September 30, 1997.

Liquidity and Capital Resources

At October 31, 1996, Vital Images had no cash and participated in Bio-Vascular's
centralized funding and cash management.  When Bio-Vascular acquired Vital
Images on May 24, 1994, Vital Images had $286,000 in cash.  Within a month,
Vital Images had effectively used its cash and Bio-Vascular began financing the
Company's activities.  Bio-Vascular conducted the investing activities and
continued to finance the activities of Vital Images.  The advances of cash by
Bio-Vascular to Vital Images had no payment requirements and were interest-free,
as Vital Images had, substantially, no ability to repay these advances.
Accordingly, the net cash received from Bio-Vascular through intercompany
advances was considered to be a contribution of capital.

In anticipation of the Distribution, Bio-Vascular agreed to assign to Vital
Images $10,000,000 in cash, cash equivalents and marketable securities effective
November 1, 1996.   Subsequent to November 1, 1996, Bio-Vascular's Board of
Directors determined to make such additional capital contributions as necessary
to increase Vital Images' cash, cash equivalents and marketable securities to
$10,000,000, effective as of the Distribution Date. Accordingly, on the
Distribution Date, Bio-Vascular transferred an additional $1,845,000 in cash
equivalents to Vital Images in order to increase Vital Images' cash, cash
equivalents and marketable securities to an aggregate of $10,000,000.

                                       12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS--CONTINUED
-------------------------------------------------------------------------------

If Vital Images' operations progress as anticipated, of which there can be no
assurance, management believes that its cash, cash equivalents and marketable
securities should be sufficient to satisfy its cash requirements for at least
two years from the Distribution Date.  The timing of Vital Images' future
capital requirements, however, will depend on a number of factors, including the
ability of Vital Images to launch successfully its Vitrea product line; the
ability and willingness of physicians to use three-dimensional visualization
software in clinical diagnosis, surgical planning patient screening and other
diagnosis and treatment protocols; the impact of competition in the medical
visualization business; and the ability to enhance existing products and develop
new products on a timely basis.  To the extent that Vital Images' operations do
not progress as anticipated, additional capital will be required sooner.  There
can be no assurance that any required additional capital will be available on
acceptable terms or at all, and the failure to obtain any such required capital
would have a material adverse effect on Vital Images' business.

For the nine months ended September 30, 1997 and 1996, cash used by operating
activities was $2,906,000 and $1,262,000, respectively.  The Company invested
$649,000 and $232,000 in equipment and improvements during the nine months ended
September 30, 1997 and 1996, respectively, primarily for the acquisition of
computer equipment. The Company used $5,373,000 to purchase marketable 
securities and had $3,903,000 of marketable securities mature during the nine 
months ended September 30, 1997.

The Company has no material commitments at this time other than facility leases
and expected employment contracts, but will be using cash in the near term as it
continues to develop the infrastructure to support its business and develop the
market for its products.

Foreign Currency Transactions

Substantially all of the Company's foreign transactions are negotiated, invoiced
and paid in U.S. dollars.

New Accounting Standard

In March 1997, Statement of Financial Accounting Standards No. 128 (SFAS No.
128), Earnings per Share, was issued by the Financial Accounting Standards
Board. This standard, which the Company must adopt effective with its for its
1997 year-end reporting, requires dual presentation of basic and diluted EPS
on the face of the statement of operations. Pro forma net loss and net loss
per common share currently presented by the Company is equivalent to the basic
loss per share required under SFAS 128. Diluted loss per share for the Company
would be calculated based on both common shares outstanding and consideration
of the dilutive effects of common stock equivalents.

                                       13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS--CONTINUED
-------------------------------------------------------------------------------

Certain Important Factors

This Form 10-Q contains certain forward-looking statements and information that
are based on management's beliefs as well as on assumptions made by, and upon
information currently available to, management.  When used in this Form 10-Q,
the words "expect," "anticipate," "intend," "plan," "believe," "seek," and
"estimate" or similar expressions are intended to identify such forward-looking
statements. However, this Form 10-Q also contains other forward-looking
statements.  Forward-looking statements are not guarantees of future performance
and are subject to certain risks, uncertainties and assumptions, including, but
not limited to, the following factors, which could cause the Company's future
results and shareholder values to differ materially from those expressed in any
forward-looking statements made by or on behalf of the Company:  the early stage
of the industry and business in which the Company operates, the Company's
transition to an independent medical visualization business, the extent to which
the Company's products gain market acceptance, litigation regarding patent and
other intellectual property rights, the introduction of competitive products by
others, the progress of product development, the availability of third-party
reimbursement, and the receipt and timing of regulatory approvals, among others.

ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

                                       14
_______________________________________________________________________________

     PART II.  OTHER INFORMATION
_______________________________________________________________________________

ITEM 1.     LEGAL PROCEEDINGS

None.

ITEM 2.    CHANGES IN SECURITIES

None.

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5.    OTHER INFORMATION

None.

                                       15
ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits.   The exhibits to this quarterly report on Form 10-Q are listed
     ---------
     in the exhibit index beginning on page 18.

(b)  Form 8-K. The Company filed no reports on Form 8-K during the period ended
     ---------
     June 30, 1997. The Company filed an 8-K on July 25, 1997, which reported
     that on July 17, 1997, the Board of Directors of the Company adopted a
     resolution changing the Company's fiscal year end from October 31 to
     December 31 of each year.

                                       16
SIGNATURES

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

                                        VITAL IMAGES, INC.

November 13, 1997                 

                                        /s/  Gregory S. Furness
                                        -----------------------------
                                        Gregory S. Furness
                                        Vice President of Finance and
                                        Chief Financial Officer
                                        (Principal Financial Officer)

                                       17
VITAL IMAGES, INC.
INDEX TO EXHIBITS
-------------------------------------------------------------------------------

11.1  Computation of Net Loss and Pro Forma Net Loss Per Share (filed herewith
      electronically).

27.1  Financial Data Schedule for the Two Months Ended June 30, 1997 and
      Three Months Ended September 30, 1997 (filed herewith
      electronically).

                                       18