**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-K**

 

**ý                    ANNUAL REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)**

 

**For fiscal year endedDecember 31, 2004**

 

**OR**

 

**TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF1934 (NO FEE REQUIRED)**

 

**For the transition period from          to         .**

 

**Commission File Number:  0-22743**

 

**iVOW,INC.**

(Exact name of Registrant as specified in its charter)

 

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

 

**2101 Faraday Avenue,Carlsbad, California 92008**

(Address of principal executive offices)

 

**(760) 603-9120**

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:  **None**

 

Securities registered pursuant to Section 12(g)  of the Act: **Common Stock, par value $.01 per share**

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes  ý  No  o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).   Yes  o  No  ý

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 of RegulationS-K is not contained herein, and will not be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K.  o

 

Theaggregate market value of the voting stock held by nonaffiliates of theregistrant as of****June 30, 2004 wasapproximately $12,300,000.  For thepurposes of this calculation, shares owned by officers, directors and 10%stockholders known to the registrant have been deemed to be owned byaffiliates. This determination of affiliate status is not necessarily aconclusive determination for other purposes.

 

Thenumber of shares outstanding of the registrant’s Common Stock as of February28, 2005 was 11,048,022

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Certainexhibits filed with the Registrant’s prior registration statements and forms10-Q and 10-K are incorporated herein by reference into Part III of thisReport.

 

 

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**IVOW, Inc.**

**(formerly Vista Medical Technologies, Inc. and Subsidiary)Form 10-K For the Fiscal Year Ended December 31, 2004**

 

**TABLE OF CONTENTS**

 
| Part I    |                                                                                                                    |   |
|-----------|-------------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.   | Business                                                                                                                |   |
| Item 2.   | Properties                                                                                                              |   |
| Item 3.   | Legal Proceedings                                                                                                       |   |
| Item  4.  | Submission  of Matters to a Vote of Security Holders                                                                    |   |
|      |                                                                                                                    |   |
| Part II   |                                                                                                                    |   |
| Item  5.  | Market  for the Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities |   |
| Item 6.   | Selected Financial Data                                                                                                 |   |
| Item  7.  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                             |   |
| Item  7A. | Quantitative  and Qualitative Disclosures About Market Risk                                                             |   |
| Item  8.  | Financial  Statements and Supplementary Data                                                                            |   |
| Item  9.  | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure                                   |   |
| Item 9A   | Controls and  Procedures                                                                                                |   |
| Item 9B   | Other Information                                                                                                       |   |
|      |                                                                                                                    |   |
| Part  III |                                                                                                                    |   |
| Item  10. | Directors  and Executive Officers of the Registrant                                                                     |   |
| Item 11.  | Executive Compensation                                                                                                  |   |
| Item  12. | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                        |   |
| Item  13. | Certain  Relationships and Related Transactions                                                                         |   |
| Item  14. | Principal  Accountant Fees and Services                                                                                 |   |
|      |                                                                                                                    |   |
| Part IV   |                                                                                                                    |   |
| Item  15. | Exhibits  and Financial Statements                                                                                      |   |
|      | Signatures                                                                                                              |   |
|      | Index to  Consolidated Financial Statements                                                                             |   |

 

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PART I

 

ForwardLooking Statements

 

Fromtime to time we have made and may continue to make “forward looking statements”within the meaning of the federal securities laws.  This report on Form 10-K may containforward-looking statements.  Thesestatements, which represent our expectations or beliefs concerning variousfuture events, may contain words such as “expects,” “anticipates,” “intends,” “plans,”“believes,” “estimates,” or other words indicating future results.  Actual results may differ materially fromresults anticipated in such forward-looking statements.  We assume no obligation to update anyforward-looking statements to reflect events or circumstances arising after thedate of this report.

 

Youshould carefully review and consider the various disclosures in this reportregarding factors that could cause actual results to differ materially fromanticipated results, including those factors under the caption “Risks andUncertainties” at pages 11 through 17 below, and elsewhere in this report.

 

 

**Item1.  BUSINESS**

 

**OVERVIEW OF OUR BUSINESS**

 

        Our company, iVOW,Inc., formerly Vista Medical Technologies, Inc., was founded in 1993 primarilyto develop advanced visualization technologies for complex minimally invasivesurgical procedures. It was through the application of this technology inlaparoscopic gastric bypass surgery that we subsequently developed a suite ofconsulting products and services for the initiation, operation and managementof obesity surgery programs.  Starting inearly 2003, our Visualization Technology business, located in Westborough,Massachusetts, and our Obesity Surgery Management Services business unit (VOWSolutions, Inc.), located in Carlsbad, California, functioned asindividual business units. In April 2004, we sold the VisualizationTechnology business to concentrate on the obesity surgery services market.  We changed our name to iVOW, Inc. in February2005, after merging our wholly owned subsidiary VOW Solutions, Inc., to alignour corporate name with the brand name of our chronic and morbid obesitydisease management business, which is now our exclusive focus.

 

        We originally beganoffering training and consulting services to the obesity surgery market in2001.   As a result of the disposition ofour Visualization Technology business, we are now a pure play company in thebariatric market. We develop and market products and services for the bariatricsurgery market. Bariatrics is the medical science of weight reduction andnutrition; bariatric surgery, a specialized area of general surgery, is focusedon surgical weight reduction solutions for the very severely or morbidlyobese.  iVOW is exclusively focused on implementing diseasemanagement strategies for the control of chronic and severe obesity. The visionof our iVOW business is to enable healthcare providers and organizations in theongoing evolution of the highest standards of treatment and services tooptimize the quality of life for chronic and morbidly obese patients. Our missionis to deliver the leading management portfolio of services and products for theclinical and business development of continually successful medical andsurgical programs for the treatment of chronic and morbid obesity.

 

        Since 2001, through ourLaparoscopic Bariatric Surgical (LBS) Preceptorship program, we have assistedin the development, for others, of 60 bariatric surgical centers based inhospitals across the United Sates and provided consulting products to some 35others. These centers provide surgical treatment, specifically the minimallyinvasive roux en-y gastric bypass procedure, to morbidly obese patients. Theproducts and services we have supplied this customer base include: ourBlueprint study, a customized feasibility analysis for bariatric programdevelopment; our clinical training program which provides surgical teams with acomprehensive introduction to the performance of minimally invasive gastricbypass surgery; our implementation and consulting services, which facilitatethe initiation and efficient operation of bariatric surgical programs; andmarketing tools, such as a radio commercial, which clients may customize foruse in their local markets to inform prospective patients about theavailability of gastric bypass surgery at their hospital. UntilApril 2004, when we sold our Visualization Technology business, we alsosupplied our 3-D endoscopic visualization system for use in the performance ofminimally invasive gastric bypass surgery.

 

        Patientdemand for an effective and proven surgical solution to the chronic healthconditions caused by morbid obesity has accelerated the number of surgicalprocedures performed from approximately 16,000 a decade ago to approximately140,000 in 2004, according to the American Society for Bariatric Surgery. Webelieve that, by building upon the expertise, market position and relationshipswe developed in our initial business line described above, we now have thefoundation to become a leading provider of (i) disease-specific program managementin bariatric medicine and surgery and (ii) an expanded suite of relatedconsulting services. Our business model is to develop a network of bariatricdisease management centers, under our management, but each one owned by ourclient hospital, which will provide patients with all necessary medical andsurgical services. As manager of the program we will

 

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co-ordinate all the administrative andmarketing functions on behalf of our client and provide patient services asappropriate, particularly in the long-term monitoring of care after surgery.The revenue model is based upon a monthly management fee and a per-patient fee.We also intend to develop the iVOW brand name to provide a national identityfor our locally managed programs and to leverage the centralized provision of certain servicesto our clients, such as for example, the processing of medical insuranceapproval. Additionally, we will continue to develop our consulting services asdescribed above, targeted at those clients which do not require a completemanagement package but which need specific assistance with individualcomponents of their bariatric surgical programs. The revenue model for ourconsulting business is fee-for-service.

 

        We believe that ourcompany is appropriately positioned to execute this business model; we havehelped develop successful bariatric surgical programs since 2001 and, sinceSeptember 2003, have strengthened our management team to includeexecutives with relevant healthcare services experience in general, andbariatric program management experience in particular. However, as a company,we do not have extensive experience in the management of programs and,therefore, until we can demonstrate success, our ability to execute ourbusiness model will remain uncertain. The rapid growth of bariatric surgery isa recent trend and there are many organizational issues which are subject todebate within the hospital and surgical community. It is reasonable to say thatthere is not yet a consensus on how to manage best practice protocols. While webelieve there is a sound rationale for the systemization provided by aprofessional management company, as evidenced in other disciplines such aschronic wound care, it is as yet unclear whether hospitals will adopt thissolution for bariatric surgery.

 

                Ourgoal is to become the leading disease management and consulting company focusedon chronic and morbid obesity. Our initial focus on the severely obese patient,and gastric bypass surgery as the solution, is the platform upon which we willexpand service to new obesity therapies as they are developed. We also plan tointegrate a bariatric medical model into our surgical protocols, both tofacilitate the long term care of post-surgical patients, and in due course, totreat obese patients who are not qualified for surgery.

 

 

**BusinessOverview**

 

Wehave been a key participant in the rapid development of the bariatric surgerymarket over the past three years. Bariatrics is the medical science of weightreduction and nutrition; bariatric surgery, a sub-specialty of general surgery,is focused on surgical weight reduction solutions for the severely, ormorbidly, obese.  Since 2001, our companyhas played a role in the development of more than 95 bariatric surgicalcenters, based in hospitals across the United States, which providestate-of-the-art treatment, specifically the minimally invasive gastric bypassroux en-y procedure, to morbidly obese patients.  We have provided this customer base withfeasibility analysis, customized projections, implementation support, clinicaltraining, marketing and general consulting services.  Demand from hospitals and surgeons wishing tostart or expand bariatric surgical programs is driven by surging patient demandfor a viable, long-term solution to the problem of chronic morbid obesity(defined as at least 100 pounds above ideal body weight).  Patient demand, fortified by the very publicsuccess in weight loss of several celebrities, has driven the number of gastricbypass procedures from 60,000 in 2001 to 103,000 in 2003, and 140,000 in2004.  By 2005 there will beapproximately 750,000 post-surgical gastric bypass patients.  Obesity is now formally a disease state; itis classified as an epidemic by the Centers for Disease Control and described,in company with its frequent co-morbidity, Type II Diabetes, as “the epidemicdisease of the 21st Century.” And the data keep getting worse: In October 2003, the Archives of Internal Medicine published anarticle showing that the number of extremely obese Americans (those morethan 100 pounds above ideal body weight — the prime candidates for surgicalintervention) has quadrupled since the mid-1980s, accelerating at twice therate of “ordinary” obesity.

 

Webelieve that, to meet the demand for the present form of obesity surgery, andto offer patients the choice of many new therapies which either have beenrecently introduced or are in development, requires a rapid expansion of highquality surgical programs and related patient medical and wellnessservices.  This comprehensive approach isnot the present organizational norm and we believe, based on both marketunderstanding and research, that there is an opportunity to leverage iVOW’spresent expertise, market position and relationships, into a turnkey programmanagement solution.  This represents anatural extension of our current business model into the direct management ofthe infrastructure of obesity surgical care via a national network of company-ownedclinical programs, established initially in partnership with hospitals,surgeons and physicians, and, in due course, with insurance companies, managedcare and employers.  In addition, pre andpost surgical patients require specific medical treatment, as well as theapproximately 45 million American adults who are classified as clinicallyobese.  We are therefore developingmedical, as well as surgical, disease management strategies to be incorporatedinto our programs under management.

 

**MarketOpportunity**

 

Obesityis defined as an excessively high amount of body fat or adipose tissue inrelation to lean body mass.  Weightstandards are most often determined by the Body Mass Index (BMI), a measureexpressing the ratio of weight-to-height. Individuals with a BMI of 25 to 29.9 are considered overweight; a BMI of30 or more is considered obese, and 40 or more is severely, or morbidly,obese.  The Centers for Disease Controland Prevention (CDC) speak of “an epidemic of obesity” in the United States,with

 

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prevalenceincreasing to 24% of the adult population in 2003, from 12% in 1991.  The increase in obesity cuts across all ages,racial and ethnic groups, and both genders. Obesity, which studies show is associated with an increased risk ofdiabetes, as well as other serious co-morbidities, is a major cause ofmortality.  It is estimated that 365,000adults in the United States die each year from causes related to obesity.  The Surgeon-General, in a Call to Action,estimates that the economic cost of obesity in the United States was about $117billion in 2000.  A recent Rand Corp.study found that the health care costs linked to obesity are now approachingthose related to smoking or alcohol abuse and “is like aging 20 years” whenmeasured by the onset of chronic medical problems.  The fact that obesity is a major healthproblem, and is increasing at an alarming rate has been well publicized in themedia.  Also, the IRS has declared thatobesity is a disease in its own right and that the cost of physician-directedweight loss programs may be included as a deductible medical expense.  Given that medical expenses may be deductedonly to the extent that they exceed 7.5% of adjusted gross income, and thatless than 5% of taxpayers deduct medical expenses, the ruling is probablysignificant more as an indicator of governmental concern over obesity than as afinancial incentive to individuals.  As afurther example of this, the federal agency in charge of Medicaid and Medicarehas concluded that obesity is a disease in its own right.  Furthermore, in November 2004, a MedicareCoverage Advisory Committee meeting found that there is satisfactory evidenceto indicate that obesity surgery is a safe and effective way for many patientsto lose weight and improve their health. However, the principle that obesity itself is a disease, and not merelya symptom or precursor of a disease, is still a contentious issue, and such aclassification is resisted by private insurers.

 

Amongother issues which attract attention in terms of market awareness, perhaps theone with the most serious implications for the future, is the rate of growth ofobesity in the young, which manifests itself as an acceleration of theincidence of diabetes and other serious health conditions, such as early onsetof heart disease. Also, obesity is becoming recognized outside the UnitedStates as a looming problem; for example, the rate of growth of obesity inGermany and the United Kingdom is the same as the U.S.  The problem is not yet epidemic, because eachcountry’s starting point was lower than the U.S., but the trend is clear andinexorable.  The World HealthOrganization has coined the term “globesity” to highlight the problem.

 

Forthe morbidly obese, the most significant factor is that virtually every weightloss remedy, apart from weight loss surgery, has been proven to be ineffectiveon a consistent basis over time.  Theplain fact is that once a person is morbidly obese, reversing the trend, withan adequate and permanent result, has been nearly impossible in mostcases.  It is this reality which accountsfor the growth trajectory of gastric bypass surgery, as it is the only optionwith a long-term, proven track record of success.  And, it is the refinement of the procedureover recent years, most notably the patient benefits of a minimally invasiveapproach, which are helping to convince increasing numbers of the morbidlyobese that it is the only valid option. The surgical community has also embraced bariatric surgery, which itoriginally questioned as a legitimate procedure.  The discipline is now endorsed by theNational Institute of Health Consensus Conference and the American Society ofBariatric Surgery (ASBS) is recognized by the American College ofSurgeons.  The outcome is that modernbariatric surgery, while not risk-free, has a complication rate similar toother major abdominal operations, and, of course, offers patients dramatic andsustained weight loss.  While bariatricsurgery is effective, there is also demand for more effective medical programsfor clinically obese people, who are not heavy enough to qualify for surgery,but suffer many of the same risk factors.

 

Insummary, approximately 60 million American adults are clinically obese, and ofthese as many as 13-16 million are potential candidates for a surgicalweight-loss procedure.  That is,according to the National Institutes of Health (NIH) guideline, they have a BMIof 40 or above, (5-6 million) or a BMI of 35 or above, with seriouscomplicating conditions such as diabetes, hypertension, cardiopulmonaryproblems, asthma, sleep apnea, or arthritis and joint problems (8-10million).  The balance of 45 million arecandidates for an improved medical treatment model.

 

**OurStrategy**

 

Ourgoal over the next five years (2005-2009) is to become a leading provider ofconsulting and management services to bariatric medical and surgical programsthus becoming a national leader in the provision of state-of-the-art care tothe chronic and morbidly obese patient seeking a medical or surgical solutionto effectively lose, and maintain the loss of, an adequate amount ofweight.  We then plan to leverage themarket platform that our surgical centers provide to extend our provision ofcare to obese patients who are not candidates for surgery, and therefore offera complete chronic obesity disease management model.  We intend to realize these objectives throughthe execution of the following strategies:

 

•                  Fast-track iVOW Center roll-out by offeringan outsource formula to hospitals and surgeons that reduces their risk,minimizes their direct investment in program infrastructure, and maximizesprofitable patient flow.

 

•                  Institute best-practicesurgical protocols as a consistent, uniform standard and maintain rigorousclinical oversight.

 

•                  Build a reputation forpatient-friendly organizational efficiency, contributing to an extremelyvaluable national image under the iVOW brand name.

 

•                  Developa complete disease management model, including medical protocol.

 

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•                  Maximize the administrativeefficiencies inherent in the centralizing of key back-office functions withstandardized operating systems.

 

•                  Continue to build ourmanagement consulting products and services, both as a profitable source ofincreased revenues and as a means of further developing stature in bariatrics,and thereby generating referrals.

 

•                  Build a consumer-basedbusiness, initially focused or nutritional supplements specific for post-surgicalgastric bypass patients.

 

***Fast-track i******VOW******center roll-out by offering hospitals and surgeons a reduced-risk outsourceformula. ***We plan tooffer a fast-track approach to the initial set-up of a top-class bariatricsurgical center; or the takeover of management of an existing program, with afully developed operating plan ready for implementation.  Our approach covers everything necessary tomaximize operations in the shortest possible time; our experience shows thatthe ramp-up time for surgeons and hospitals to initiate operation of a newbariatric surgical program can be as long as six months, and even after thatprogress can be slow because of the organizational complexity of the task.  The iVOW concept simplifies and standardizes theformula, leaving our partner surgeons and hospitals and affiliated surgeons todo what they do best — operate on and provide in-patient care.  Of course, the start up time for existingprograms is considerably shorter since there are usually patients already inprocess.  We feel that existing programsthat have managed to attain a moderate patient volume (100-200 cases a year),and which want to grow faster, will be our primary near-term targets.

 

***Institute best-practice surgical protocols***.  Our experience with the LaparoscopicBariatric Surgical (LBS) Preceptorship has permitted us, under the direction ofour Clinical Faculty, to offer the most comprehensive surgical training coursein state-of-the-art laparoscopic gastric bypass surgery which is availableanywhere.  This training program will beavailable to surgeons who affiliate with iVOW; the training process will also includesubsequent proctoring by our faculty during cases.

 

***Maximizing operating efficiencies***.  This is key to leveraging economies of scale,and we will devote considerable resources to the further development of astandardized operating system.  Also,many of the functions of a bariatric surgical program are common and can becentralized for efficiency and cost-saving reasons.  We believe that independent programs willneed to generate very high patient volumes to justify the infrastructurenecessary to operate efficiently and that significant savings can be made byhandling them centrally as in the iVOW model.  We believe thatin a very short time low volume programs will simply be unable to competeeffectively with high-volume centrally managed programs.

 

***Build a brand image of efficient empathy***.  We believe that this element of our strategyis extremely important.

Ourpatients come from a group that has suffered psychologically because of theirillness, often at the hands of the medical profession.  We have learned by our experience to datethat the provision of a sensitive and supportive environment is vital to success.  At the same time, the process towards surgerymust be efficient.  There are many stepsin the process, and it is easy for patients to become lost or discouraged ifthe system, and the staff dealing with them, are haphazard in their approach.  Standardized systems across all managed programsare designed to shepherd patients through the process with efficient empathy.

 

***Developa complete disease management business model. ***Ourultimate objective is to incorporate a medical model with our surgical model,to offer our clients (physicians, hospitals, payors) a complete diseasemanagement service, treating the entire chronic obese population with medicalor surgical care as appropriate.

 

***Develop and leverage our consulting business***.  Our consulting business, originally based onprovision of clinical training in laparoscopic gastric bypass surgery, hasexpanded to include management, operational, financial and marketingservices.  It is this business that hascreated our reputation within bariatrics and has given us a total customer baseof approximately 95 hospitals (including some 60 LBS Centers).  We are currently developing new and valuableproducts to meet the emerging needs of the maturing developing market.  We expect our consulting business to act as afertile source of referrals for VOW partnerships.

 

***Build our patient-consumer business***.  Gastric bypass patients have a lifelong needfor *specialized* vitamins and nutritionalsupport.  We are already marketingVistaVitamins as a specific solution to the bariatrics-vitamin issue and intendto increase marketing and distribution efforts and extend the productline.  With 750,000 post-surgical gastricbypass patients by 2005, we estimate that the total available annual market forthis patient category alone is $400 million.

 

**OurSolution: ****i****VOW****Centers (Obesity to Wellness Solutions)**

 

Thenumber of physicians who are treating bariatric patients is growing, in boththe medical and the surgical arena.  Forexample, it is estimated that there are now between 1,200 to 1,500 activebariatric surgeons.  However, theexpertise essential for high-volume patient acquisition, and the infrastructurerequired for quality patient care at these levels are often beyond the scope,or the willingness to invest, of many programs. Even when bariatric centers are established in conjunction with asupportive hospital, the

 

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properstaffing, knowledge and time required to efficiently market, educate, collect acomprehensive medical and diet history, verify insurance and obtain thenecessary authorizations can be a management challenge, one that many simplycannot handle cost-effectively.  Many ofthese functions are much more efficiently and effectively handled in acentralized fashion (where one centralized department handles the work fordozens of programs).  A focused team ofprofessionals with centralized support is necessary to properly handle all theunique and multifaceted issues involved in securing and serving large numbers(400 — 500 cases per year) of bariatric patients.

 

Itis for this reason that we have seen increasing interest from hospitals andphysicians in an outsourced management solution, which brings together theresources necessary for establishment and/or operation of successful medicaland surgical bariatric programs.  Ourplan is to offer ongoing hands-on management support to such medical providersby delivering a cost-effective outsourced solution to the provision ofmulti-disciplinary medical and surgical care to a high volume of morbidly obesepatients.

 

TheiVOW Center conceptis designed to overcome the traditional barriers experienced by physicians andhospitals when attempting to put into operation new, or to maximize existing,niche product lines.  Our approach willfree physicians from nearly all administrative functions, allowing them todevote all their time and energy to patient care and the operating suite.  Similarly, the iVOW Center will assist and/orprovide the hospital with the expertise, personnel and core infrastructureneeded to operate a fast track, successful, high-volume bariatric center.

 

Weplan to enter into strategic partnership agreements with physicians andhospitals to establish iVOW Centers.  To date, we have entered into one strategicpartnership agreement.

 

**i****VOW****Consulting Services**

 

**OurSolution:**

 

Ourconsulting services are organized as specific “products” which offer clients abasic standardized set of deliverables, with several customizable options.  Our primary consulting products are asfollows:

 

*Blueprint*

 

Anexpert iVOW team conductsa detailed assessment and evaluation of an existing, or projected, bariatricsurgery program and provides recommendations for improvement.  A comprehensive written report, the “Blueprint,”examines a program’s vision, sensitivity, operational capabilities,business/financial model, marketing potential and information management,offering a firm feasibility analysis. Our proprietary financial model projects program-related revenue,expenses, reimbursement and capitalization requirements under current operatingconditions.  The recommendations includemarketing strategies derived from the National Health and Nutrition ExaminationSurvey and the United States Census, customized to a bariatric program’sgeographic location and patient population.

 

*Implementation Consulting Service*

 

Ourimplementation team spends up to 2 days on-site educating a hospital andprogram staff on the five fundamental phases of a successful bariatric surgeryprogram.  This preparation emphasizespatient introduction, the pre-admission/operative period, the peri-operativeperiod, post-operative recovery and discharge, and post-discharge care.  Included in the service are templates, toolsand training components integral to the ongoing viability of a program.  These include informed consent, sensitivityand in-patient/office training, insurance authorization strategies, marketingtools, patient education, diet counseling, physical therapy and exercise plansand support group coaching.  Subsequentto this service, a program’s staff will be educated in delivering efficient,best-practice care in a sensitive environment.

 

*Laparoscopic Bariatric Surgery (LBS) Preceptorship*

 

TheLBS Preceptorship allows a hospital team to more quickly implement minimallyinvasive laparoscopic gastric bypass surgery into a hospital and surgicalpractice.  The 3-4 day course includesclinical observation, laboratory training, surgical lecture and didactictraining that incorporates cadaver experience. The Preceptorship includes observation by the entire operating room team(primary surgeon, first assistant, surgical technician and nursing circulator)and is a CME and CEU accredited event.

 

*Optimization Consulting Service*

 

iVOW’s Optimization ConsultingService concentrates on improving an existing bariatric surgery program’sefficiency, effectiveness and profitability. Recommendations focus on optimizing the finance, operations andmarketing of a bariatric program.  Thework-up of a program’s financial performance will facilitate an institutionalability to resolve issues pertaining to revenue,

 

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expenseattribution, capital investments and payor environment.  Operational recommendations target a patient’smigration through the program and improved efficiency between surgeons and thehospital.  The comprehensive marketingassessment analyzes referral patterns, per-patient cost of acquisition andoverall effectiveness.

 

*Marketing Materials*

 

TheBariatric Surgery Marketing Materials help to create and/or enhance a hospital’sidentity as a Bariatric Center, lending credibility and fostering communitysupport.  The media tools enable ahospital to capitalize on varying marketing venues including public speaking,print publications, radio and television. The package includes a customizable “Decision of a Lifetime” video andtelevision advertisement, a 60-second radio advertisement, a printadvertisement, a patient brochure and a community lecture template onPowerPoint.  The message focuses on theexperience of a diverse group of actual patients, their life-long struggle withobesity, and the satisfaction they have realized through gastric bypasssurgery.

 

**Strategic Alliances**

 

***Ethicon Endo-Surgery, Inc.***

*** ***

***In June 2001, we entered into an agreement with EthiconEndo-Surgery, Inc. (EES) under which we worked together with EES in developingthe surgical weight reduction market. This alliance primarily involved sales and marketing support by EES ofour Laparascopic Bariatric Surgery (LBS) program and other iVOW products andservices related to the surgical weight reduction market.  Also, we received payments in return for ourcommitment to promote use of EES equipment in certain training programssponsored by us for the benefit of our customers with no obligation by ourcustomers or us to purchase***anyEES equipment. The agreement expired in December 2004.

 

 

**Visualization Technology Business**

 

Weentered into an Asset Purchase Agreement with Viking Systems Inc. (“Viking”)regarding the sale of all the assets of the Visualization Technology businesson December 22, 2003 and closed the transaction on April 15, 2004 afterobtaining stockholder approval.  Vikingand its principals are not affiliated with us or our officers, directors, and,to our knowledge, principal stockholders. Viking formerly conducted a software business, but those operations wereunsuccessful.  Recently, a group ofinvestors purchased control of Viking, with the approval of Viking’s Board ofDirectors, and Viking’s current business plan, as stated in its public filingswith the SEC, is to engage in the medical device market.

 

Themost material terms of the Asset Purchase Agreement are as follows:

 

•                  Viking purchased all assets(and assumed most liabilities) related to the Visualization Technology businessin exchange for a combination of cash, stock, and future royalty payments.  Specifically:

 

•      Viking paid us $159,000 of cash atclosing.

 

•                  Viking issued to us3,054,000 shares of its common stock representing approximately ten percent(10%) of the fully diluted shares of Viking’s stock.

 

•                  We entered into a LicenseAgreement with Viking pursuant to which we will exclusively license to Vikingall intellectual property and product rights used in operation of the licensedbusiness.  In exchange for this licensegrant, Viking will pay us royalties over the next five (5) years based on salesof the licensed products by Viking.  TheLicense Agreement contains minimum royalties of $150,000 in year one, $300,000 ineach of years two, three and four, and $375,000 in year five.  The royalties payable by Viking have aminimum value of $1,425,000 and are capped at a maximum of $4,500,000 in theaggregate over the five year period.  Wewill retain ownership of all intellectual property and product rights under theLicense Agreement until at least the minimum royalty obligations have beensatisfied, at which point we will transfer ownership to Viking.

 

•                  At closing we consigned ourcurrent inventory of products and parts to Viking and will be reimbursed for thevalue of that inventory, if and when used, over the course of the twelve monthsafter closing.  Any inventory not sold byViking during this one-year period will be sold to Viking for $1.

 

Weoperated the Visualization Technology business entirely out of our Westborough,Massachusetts location.  As a result,this entire facility, less a few selected assets of minimal dollar value, wastransferred to Viking in connection with the Asset Purchase Agreement.

 

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Wehave agreed to indemnify Viking for any breach of the representations andwarranties made by us in the Asset Purchase Agreement and for any liability notassumed by Viking.

 

Weintend to use the proceeds from the sale to fund our Obesity Surgery and MedicalServices business.  We have used some ofthe proceeds (other than cash received at closing) to redeem shares of ourSeries A Preferred Stock.

 

 

**Governmental Regulation: Health Care Services**

 

As a participant in the health care servicesindustry we are, and the iVOWCenters, if any, will be subject to extensive and frequently changingregulation under many laws administered by governmental entities at thefederal, state and local levels.  Although we believe we are in compliancein all material respects with such laws, rules and regulations, if adetermination is made that we are in material violation of such laws, rules orregulations, its business, financial position or results of operations could bematerially adversely affected. Furthermore,  our participatingsurgeons and hospitals are also subject to a wide variety of laws andregulations that could affect the nature and scope of their relationships withus.

 

Laws regulating health care providers cover abroad array of subjects.  For example, the confidentiality of patientmedical information and the circumstances under which such information may bereleased for inclusion in our databases, or released by us to third parties,are subject to substantial regulation by the federal and state authorities. These laws and regulations govern both the disclosure and the use ofconfidential patient medical information and are evolving rapidly.  Wehave established an implementation plan that it believes complies with theexisting federal and state laws and regulations.

 

In addition, provisions of the Social Security Actprohibit, among other things, paying or offering to pay any remuneration inexchange for the referral of patients to a person participating in, or for theorder, purchase or recommendation of items or services that are subject toreimbursement by Medicare, Medicaid and similar other federal or state healthcare programs.  Sanctions for violation of these provisions includecriminal penalties and civil sanctions, including fines and possible exclusionfrom federal and state health care programs. Most states have also enacted illegal remuneration laws that are similarto the federal laws, but typically apply to referrals for services reimbursedby all third-party payors, not just federal or state health programs. These laws are applicable to our financial relationships with, and anymarketing or other promotional activities involving, our participating surgeonsand hospitals.

 

Moreover, all states regulate the provision ofhealth care services, including those to be provided at the Centers, andrequire participating surgeons and hospitals to be licensed and to comply withapplicable laws and regulations.  It is also possible that some statescurrently, or in the future may, require licensure or registration of certainof our operations, and may further regulate how we do business.  Finally,various states regulate the operations of an advertising and referral servicefor physicians, and may require registration of such services with a state agencyas well as compliance with various requirements on how they conduct businessand structure their relationships with participating providers.

 

We are unable to predict the future course of suchfederal, state and local regulation or legislation.  Changes in the regulatory framework couldhave a material adverse effect on our business, financial position or resultsof operation.

 

 

**Marketing and Sales**

 

OuriVOW programmanagement and consulting business, markets directly to hospitals andsurgeons via our in-house sales and marketing departments.

 

***International sales***

 

OuriVOW businesscurrently does not market outside the United States, although we are evaluatingopportunities in international markets for future expansion.

 

**Competition**

 

Our iVOW businesscompetes in a developing marketplace with a variety of companies, none ofwhich, to our knowledge, has an identical mix of products and services.  However, there are companies, which haveproducts and services which compete with some part of our offering includingthe Weight Intervention and Surgical Healthcare (WISH) Center, whichspecializes in the advanced surgical treatment and long-term management ofpatients suffering from morbid obesity and CORI Centers (Centers for ObesityRelated Illness), operated by MSO Medical, Inc., which contracts with acutecare hospitals to establish Bariatric Surgery

 

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Centers.  We expect competition to increase in theobesity disease management market as companies recognize the potential of themarket.  We believe that we have a uniquebusiness model, but there can be no assurance that we can prevent othercompanies from adopting it or that we will be successful in competing with suchcompanies.

 

 

**Clinical Advisory Board**

 

Weconsult frequently with physicians and surgeons in the obesity diseasemanagement area and we are in the process of creating a formal Clinical AdvisoryBoard to provide regular advice and feedback.

 

**Employees**

 

Asof February 28, 2005, we had 20 full-time employees, four of whom hold advanceddegrees.  None of our employees isrepresented by a collective bargaining agreement, nor have we experienced workstoppages.  We believe our relations withour employees are good.

 

**Web Site Access to SEC Filings**

 

We maintain an Internetwebsite at *www.ivow.com*.  We make available free of charge on ourInternet website our annual reports on Form 10-K, quarterly reports on Form10-Q, current reports on Form 8-K, and amendments to those reports filed orfurnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soonas reasonably practicable after we electronically file such material with, orfurnish it to, the SEC.

 

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RISKS ANDUNCERTAINTIES

 

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

 

**Risks Related to our Business and Industry**

 

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

 

As a company we do nothave direct experience in the management of bariatric surgical programs.  Although we have been involved in thedevelopment of bariatric surgical programs since 2000, we have never directlymanaged these programs.  As such, we haveonly a limited and indirect operating history upon which an evaluation of ourprospects can be based.  In addition, thebariatric surgical market is relatively new and is expanding rapidly, which cancause changes in the way clients react to the services offered.  We have yet to prove that our managementmodel is appropriate for the market we are addressing.  To be successful, it is crucial that we developstrong affiliations with hospitals and surgical centers, and we have not yetproven our ability to do so.  We haveestablished only two****significantoperating agreements with hospitals to date. To successfully implement our business plan, we must establish many moresuch relationships.

 

Also, we must respond tocompetitive developments and attract, retain and motivate experiencedstaff.  There can be no assurance that wewill be successful in addressing those market conditions or in implementing ourbusiness strategy.  There can be noassurance that we will be able to achieve or sustain revenue growth orprofitability.

 

**Our revenue model relies solely on theprovision of services and we have no ownership stake in surgical centers.**

 

Our business model is toprovide management services to owners of surgical programs.  As a result, we will not have an ownershipinterest in those programs, which will make it more difficult to sustainrevenues.  We will not enjoy directlyincreased revenue based on the profitability or increased value of particularsurgical centers.  Likewise, without anownership interest in surgical centers, we are subject to all the risks of anyservice provider; our services could be terminated at the end of any contractperiod.

 

**Roll-out of our iVOW Centersdepends on our entering into agreements with hospitals and surgeons; the timeto conclude these agreements may be extended and thereby delay or prevent theimplementation of our strategy.**

 

We plan to set up ouriVOW Centers in conjunction with hospitals and surgeons.  There can be no assurance that we will beable to negotiate the establishment of these Centers in a timely manner or onterms satisfactory to us, if at all.  Ourexperience to date is limited to one existing management contract in placesince February 2004 and one contract entered into in August 2004.  We are in active negotiation for others;however, we cannot accurately predict the time and expense involved in thesenegotiations, and any unexpected delays could negatively impact the executionof our strategic plan.  Any inability totimely establish additional iVOW Centers will harm our cash position andincrease our need to raise additional capital.

 

**We need to increase marketawareness and acceptance of our new business model.**

 

To our company’sknowledge, the comprehensive services offered by our new iVOW business modelhave not been available to date on a national level.  While we have previously supplied clinicaltraining and consulting services to various clients, we have only begun topromote our program management services. As a result, providers of bariatric surgery are not yet generally awareof the services we offer.  In order toaccomplish our strategic and business plans, we will have to quickly andeffectively increase market awareness of our management model and the iVOWbrand name, and convince doctors, hospitals and patients of the benefits ofthese services.  Among other things, thiswill require that we:

 

•                  increase awareness of our complete service offering;

•                  strengthen our brand name to increase visibility;

•                  continue to upgrade and expand our services; and

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

 

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We cannot assure you thatwe will be able to accomplish these objectives with the limited operatingcapital we currently have available, if at all.

 

**After establishing iVOWCenters, we must continue to prove our value proposition.**

 

In order to successfullynegotiate and complete agreements with doctors and hospitals to establish iVOWCenters, we will need to present them with our projected revenues andoperational metrics.  We cannot assureyou that our projections will prove accurate or that we will be able to providethe anticipated metrics.  Our projectionsare based on limited input and operational history and failure to meet suchprojections will negatively impact our relationships with surgical centers andour ability to attract business from additional centers.

 

**The provision of health careservices is subject to considerable regulation by state and federal agencies,including regulations under HIPAA and Stark.**

 

The Centers we intend toestablish in cooperation with surgery providers, which we refer to as centers,will need to comply with many laws and regulations, both state and federal,which govern the provision of health care services.  If they fail to comply with any such laws andregulations, then the penalties involved could be serious, time-consuming formanagement and expensive.  Inexperiencein health care services could contribute to an inadvertent breach of laws orregulations.

 

There are numerousfederal and state regulations addressing patient information privacy andsecurity concerns.  In particular, thefederal regulations issued under the Health Insurance Portability andAccountability Act of 1996, or HIPAA, contain provisions that:

 

•                  protect individual privacy by limiting theuses and disclosures of patient information;

•                  require the implementationof security safeguards to ensure the confidentiality,integrity and availability of individually identifiable health information inelectronic form; and

•                  prescribe specific transaction formats and datacode sets for certain electronic transactions.

Compliance with theseregulations is costly and requires our management to spend substantial time andresources when working with our clients. We are unable to estimate the total financial impact of our continuingcompliance with HIPAA requirements or of any future changes in theserequirements.

 

In addition, the federalStark Law restricts referrals by physicians of Medicare, Medicaid and othergovernment-program patients to providers of a broad range of designated healthservices with which they have ownership or certain other financialarrangements.  Many states have adoptedor are considering similar legislative proposals to prohibit the payment orreceipt of remuneration for the referral of patients and physician self-referrals,regardless of the source of the payment for the care.  These laws and regulations are extremelycomplex, and little judicial or regulatory interpretation exists.  If the activities of a client of ours orother entity with which we have a business relationship were found to constitutea violation of anti-referral laws, and we were found to have knowinglyparticipated in such activities, we could be subject to sanction or liabilityunder such law.

 

**We operate in a competitivemarket; new technologies, procedures, or pharmaceuticals could radically changethe modality of treatment of morbid obesity and negatively impact the economicsof our obesity surgery business.**

 

The market for productsand services that address morbid obesity is attractive and thereforecompetitive and new offerings and technologies are in development by severalcompanies.  For example, we are aware ofdevelopments, primarily involving stimulation or balloon technology, which maycome to the market in the next few years. These devices would be implanted in a relatively simple endoscopicprocedure.  These alternatives may proveto be more effective, less risky and/or cheaper than gastric bypass.  If this turns out to be the case, our abilityto generate revenues will be negatively affected. Also, many pharmaceuticalcompanies are researching drug therapies for combating obesity.  If they prove successful in finding a moreeffective solution for morbid obesity, then demand for a surgical option islikely to decline substantially.  Wecannot guarantee that we will compete successfully against our current orpotential competitors, especially those with significantly greater financialresources or brand name recognition.

 

**We expect to compete withseveral companies that have the same objectives as us.**

 

There are several companieswhich intend to provide services to the morbid obesity market; while theirbusiness model is not identical to ours, the end result is likely to be that wewill compete with each other in offering consulting and program managementservices.  Three of these companies, toour knowledge, include bariatric surgeons in their management orownership.  This may prove to be anadvantage over us in gaining access to potential clients because we do not havebariatric surgeons on our staff.  Other

 

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companies have only a partialservice offering, which may allow them, because of lower overhead, to operatein their niche at a price advantage to full-service companies such asours.  In any case, we expect that themarket will continue to be attractive and that new entrants are likely.

 

**If we fail to retain our keypersonnel and hire, train and retain additional qualified and experiencedemployees, we may not be able to compete effectively, or expand our consultingbusiness and the number of Centers as planned, both of which could result inreduced revenues.**

 

Our future success willdepend to a large extent on retaining our core operating management team andrecruiting sufficient qualified employees to manage and staff our Centers.  There is likely to be a competitive labormarket for such staff and there is no assurance that we will be able to attractand retain an adequate number of suitable employees.  If we are unable to do this, then we may notbe able to operate and expand our Centers as planned, which may reduce ourrevenues.

 

To be successful, we muststrengthen awareness of our services through our marketing efforts and throughestablishment of additional iVOW Centers. We have a limited marketing and business development force through whichthe efforts will be conducted, and we will rely heavily on each of theseindividuals.  We cannot assure you thatwe will be able to attract and retain sufficient qualified personnel.

 

Our current key employeesare John R. Lyon, Chief Executive Officer; Michael H. Owens, M.D., Presidentand Chief Medical Officer; Howard Sampson, Chief Financial Officer; Stephen F.Sedlock, Vice President of Marketing; Mary Lou Walen, Associate Vice President,Customer Relations; and Aimee Johnston, Associate Vice President, Sales andBariatric Management Services.  We do notmaintain key personnel life insurance policies on any of these individuals.

 

**If we are not able toattract and retain key doctors to participate in our advisory board, it mayadversely affect our ability to develop our products and services and expandour business.**

 

Members of our clinicaladvisory board consult with us exclusively but are free to consult with othernon-competing companies and are employed elsewhere on a full-time basis.  As a result, they only spend a limited amountof time on our business.  Although wehave entered into consulting agreements, including confidentiality provisionswith each of the members of our clinical advisory board, the consulting and confidentialityagreements between us and each of the members of our clinical advisory board may be terminated or breached.

 

**Our failure to effectivelymanage our growth could have a material adverse effect on our business.**

 

Growth in our businesswill place a significant strain on our management systems and resources.  We have only recently begun to focus onproviding management services, and we have hired persons with appropriateskills.  However, these people have notpreviously worked together, and it will take time and effort to developefficient working processes and relationships. We will need to continue to improve our operational and financialsystems and managerial controls and procedures, and we will need to continue toexpand, train and manage our workforce. We are a small company with limited resources, so we lack the ability toincrease our capacity to provide services prior to assurances that thoseservices will be paid for by customers. As a result, each new management contract will require significantoperational efforts as we hire personnel to staff the new project.  We will have to maintain close coordinationamong our technical, accounting, finance, marketing and sales departments.

 

**Now that we have disposed ofour Visualization Technology business, our future success will depend solely onour ability to establish and grow our obesity disease state managementbusiness.**

 

The sale of ourVisualization Technology business closed on April 15, 2004 and our futuresuccess as a company will depend on our ability to execute on the establishmentand growth of our obesity disease state management business.  As a company, we have limited experience inthe provision of surgical services.  Wewill also be required to build this business from a relatively small base,finding partners and surgeons willing to participate.  We cannot assure you that we will be able tobuild a successful services business in the long term.

 

**RisksRelated to our Financial Results and Need for Financing**

 

**We will require additionalfunding to continue development of our business and support our futureoperating plans.  These funds may not beavailable on acceptable terms, if at all.**

 

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At December 31, 2004, wehad cash and cash equivalents of $1,970,000. We believe that our cash and cash equivalents, together with anticipated2005 product revenues and interest income, will be sufficient to meet ouranticipated capital requirements through at least June 2005. ** **Thisis a very serious cash crisis and has created a need for us to increaserevenues and secure additional funding to continue operations and developmentof our business. If we are unable to secure additional capital, we may beunable to sustain operations beyond June 2005.

 

We expect that the cashflows produced by our iVOW business will be unpredictable in the near term,increasing our immediate need for additional funding.  There can be no assurance that such capitalwill be available to the extent required, or at all, and such capital may notbe available on commercially reasonable terms. The amount of additional capital which we may need to raise will dependon many factors, including:

 

•                  theextent to which the iVOW Centers and other services gain market acceptance,

•                  thespeed with which we can execute our plan;

•                  thelevels of reimbursement for procedures performed; and

•                  theextent of competition.

The amount of additionalcapital we will need will depend on many factors, including the extent to whichwe strive to expand our business.  Mostof the additional funding will be used for marketing our services to increasemarket awareness and acceptance.  If weare unable to raise these additional funds, our ability to expand our businesswill be harmed.

In addition, our cashcrisis has forced us to curtail activities designed to grow our business, suchas sales and marketing. These cutbacks may negatively affect our ability togrow our business.

 

**We have a history of lossesand may not become profitable.**

 

Since our formation inJuly 1993, and as of December 31, 2004, we have incurred cumulative net lossesof $72.0 million. ** **Specifically, we incurred netlosses of $1.1 million in 2002, $2.2 million in 2003 and $3.9 million in2004.  We expect to incur losses for theforeseeable future.  We may never achieveor sustain profitability in the future. Even if we achieve profitability, we may not be able to sustain it on anongoing basis.

 

**Our future financial resultswill fluctuate significantly.**

 

As a result of ourlimited operating history and the short period of time during which we havefocused on the provision of obesity surgery management services, we cannotpredict our future revenues or operating results.  We expect our future revenues and operatingresults to fluctuate unpredictably due to a combination of factors, includingthe potential costs of establishing additional iVOW Centers.

 

Our future operatingexpenses are expected to increase in future periods as we intend to establishiVOW Centers, expand our sales and marketing operations, expand our servicecapabilities, improve our internal operating and financial systems, andcontinue to comply with the stringent requirements of the Sarbanes-Oxley Act of2002 (including Section 404 thereof).  Inaddition, our operating expenses are based on our expectations of futurerevenues, and are relatively fixed in the short term.  We may be unable to adjust spending quicklyenough to offset any unexpected revenue shortfall.  If we have a shortfall in revenues inrelation to our expenses, or if our expenses increase before our revenues do,then our business for a particular period would be materially adverselyaffected.

 

Because of all of thesefactors and the other risks discussed in this section, we believe that ourquarterly and annual revenues, expenses and operating results likely will varysignificantly in the future.  If thisoccurs, any or all of the following may result:

 

•                  themarket trading price of our common stock may fluctuate, negatively impactingthe ability of stockholders to buy and sell our shares at consistent prices;

•                  wemay have difficulty raising funds in the future at prices that are acceptableto us; and

•                  investors may be less willing to purchase our sharesfor lack of consistent operating results.

 

**Collection of amounts due to us from VikingSystems is uncertain.**

 

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

 

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amounts due us are at risk.

 

In addition, we received1,654,000 shares of common stock of Viking Systems in connection with the saleof our Visualization Technology business. We currently value those shares at atotal of $1,306,660, which represents the trading price of Viking common stockat December 31, 2004. Viking's common stock is very thinly traded and sales ofeven small numbers of shares can significantly affect the trading price.Because of this, the trading price of Viking's common stock is likely tofluctuate substantially over time, and this will affect the value we ascribe toour shares.  A significant drop in thetrading price of Viking's common stock would negatively affect our financialposition and, specifically, our stockholders' equity balance. As discussedelsewhere, we have repeatedly been the subject of delisting proceedings fromthe Nasdaq SmallCap Market because of our failure to maintain sufficientstockholders' equity. Any reduction associated with a drop in the trading priceof Viking common stock would exacerbate this problem.

 

**Our liquidity and capitalrequirements will be difficult to predict.**

 

Our liquidity and capitalrequirements will depend upon other numerous factors, including the following:

 

•                  The extent to which our products and services gain market acceptance;

•                  Costs associated with establishing marketing, and operating our obesityrelated programs and disease state management business, including the iVOWCenter;

•                  The timing and costs of product and services introductions;

•                  The extent of our ongoing product and service development programs;

•                  The costs of sponsorship training of the physicians to become proficientin the use of our products and procedures; and

•                  The costs of developing marketing and distribution capabilities for ourconsumer products.

Even if we are successfulin raising additional funds, circumstances, including slow rate of market acceptanceof our services or our inability to efficiently manage our operations, wouldaccelerate our use of proceeds from any offering we might do and require us toseek additional funds to support our operating requirements.

 

**Risks Related to the Securities Markets and Ownership of ourCommon Stock**

 

**Our common stock may besubject to delisting from the Nasdaq SmallCap Marketbecause we fail to maintain compliance with continued listing criteria.**

 

The quantitative standards for continued listing on the Nasdaq SmallCap Marketrequires a company to have stockholders’ equity of at least $2,500,000(or satisfy alternative requirements). Failure to comply with these requirements subjects a company tode-listing proceedings.  We have twiceover the past 3 years been subjected to delisting proceedings from Nasdaq for failure to meet the minimum stockholders’ equityrequirement.  Each time we eventuallyregained compliance by raising additional operating capital.

 

We expect that ourstockholders’ equity balance will be below $2,500,000 as of March 31, 2005,which will likely subject us to delisting from the Nasdaq SmallCap Market yetagain.  If we choose to take steps tomaintain our listing, we will be required to attend a hearing and develop aplan to regain compliance.  These stepswill be costly, both in terms of direct expenses and diversion of managementtime and resources as our officers seek additional financing and communicatewith Nasdaq.

 

If we are unable tomaintain continued compliance, our securities will be delisted from the NasdaqSmallCap Market. The delisting of our common stock from the Nasdaq SmallCapMarket may materially impair our stockholders’ ability to buy and sell sharesof our common stock and could have an adverse effect on the market price of,and the efficiency of the trading market for, our common stock.  In addition, the delisting of our commonstock could significantly impair our ability to raise capital should we desireto do so in the future.  The continuedlisting of our common stock on the Nasdaq SmallCap Market is therefore veryimportant to us.

 

**The terms of our March 2003,preferred stock financing confer senior rights on the holders of Series A Convertible Preferred Stock, and these rights may impairthe interests of our common stockholders or impact our results of operations.**

 

We issued 1,000,000shares of our Series A Convertible Preferred Stock(the “Series A Shares”) in March 2003, which were created pursuant to the termsof a Certificate of Designations, for an aggregate of $950,000 in cash.  In connection with this financing, thepurchasers of Series A Shares were granted severalsignificant rights senior to the rights of holders of our common stock.  Among other rights, in the event of aliquidation, dissolution or winding up of our company (includingconsolidations, mergers or other sales), holders of Series A Shares will beentitled to receive up to $3.80 per share held by them, in preference to anydistribution to the holders of common stock. Also, pursuant to the Certificate of Designations, we must obtain theconsent of the holders of at least two-thirds of the outstanding Series A Shares in order to undertake certain actions, includingsignificant capital expenditures and the issuance of securities.  Additionally, for so long as any Series AShares remain outstanding after three hundred ninety (390) days following theinitial issuance of any Series A Shares, the holders of Series A Shares will beentitled to elect the greater of (i) two members of our Board of Directors or(ii) twenty-five percent (25%) of the total members of our Board of Directors.

 

We redeemed 85,000 SeriesA Shares in June 2004, and have the right to redeem anadditional 300,000 at any time on or before January 15, 2006 in exchange for$500,000.  If we choose to redeem theadditional 300,000 Series A Shares, we will use cash

 

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that would otherwise fund ourbusiness operations.  Although we maybelieve that such redemption is the best available business option, valuablecash would nonetheless be consumed, which would impact our ability to fundoperations or grow our business.

 

**There is a limited marketfor our common stock and therefore investors may not be able to liquidate theirinvestment in the foreseeable future, if at all.**

 

There is a limited marketfor our common stock even though it is publicly quoted, and the market is notexpected to increase significantly in the foreseeable future.  For example, we only have approximately 190shareholders of record and the average daily trading volume in our stock isapproximately 50,000****shares.  The limited trading market for our commonstock may cause fluctuations in the market value of our common stock to beexaggerated, leading to price volatility in excess of that which would occur ina more active trading market.  The lackof an active trading market in our stock may also cause investors to be unableto sell all of their desired shares of common stock on short notice and thesale of a large number of shares at onetime could temporarily depress the market price. An investment in our companyis highly speculative, and an investor should be able to withstand a total lossof the investment.

 

**Our stock price couldcontinue to be volatile and your investment in our common stock could suffer adecline in value, adversely affecting our ability to raise additional capital.**

 

The market prices andtrading volumes for securities of emerging companies, like ours, havehistorically been highly volatile and have experienced significant fluctuationsunrelated to the operating performance. The market price of our common stock has historically been highlyvolatile.  For example, between July 2004and February 2005, the trading price of our common stock ranged from $0.82 to$3.00.  The trading price of our commonstock may continue to be significantly affected by factors such as:

 

•                  actualor anticipated fluctuations in our operating results,

•                  ourability to remain listed on Nasdaq,

•                  changes in financial estimates by securities analysts,

•                  announcementsof technological innovations,

•                  newproducts or new contracts by us or our competitors,

•                  regulatoryannouncements,

•                  developmentswith respect to patents or proprietary rights,

•                  conditionsand trends in the medical device and other technology industries,

•                  adoptionof new accounting standards affecting the medical device industry, and

•                  generalmarket conditions.

 

In addition, the stockmarket has from time to time experienced significant price and volumefluctuations that have particularly affected the market prices for shares ofearly stage companies.  These broadmarket fluctuations may adversely affect the market price of our commonstock.  In the past, following periods ofvolatility in the market price of a particular company’s securities, securitiesclass action litigation has often been brought against that company.  Such litigation, if brought against us, couldresult in substantial costs and a diversion of management’s attention andresources.

 

**Anti-takeover provisions inour organizational documents and Delaware law may discourage or prevent achange of control, even if an acquisition would be beneficial to ourstockholders, which could affect our stock price adversely and prevent attemptsby our stockholders to replace or remove our current management.**

 

Our certificate ofincorporation and bylaws contain provisions that could delay or prevent achange of control of our company or changes in our board of directors that ourstockholders might consider favorable. Some of these provisions:

 

•                  authorize the issuance of preferred stock which can be created and issuedby the board of directors without prior stockholder approval, with rightssenior to those of the common stock;

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

 

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•                  prohibit our stockholders from filling board vacancies, calling specialstockholder meetings, or taking action by written consent;

•                  prohibiting our stockholders from making certain changes to our restatedcertificate of incorporation or restated bylaws except with 66 2/3% stockholderapproval; and

•                  require advance written notice of stockholder proposals and directornominations.

In addition, we are subjectto the provisions of Section 203 of the Delaware General Corporation Law, whichmay prohibit certain business combinations with stockholders owning 15% or moreof our outstanding voting stock. These and other provisions in our certificateof incorporation, bylaws and Delaware law could make it more difficult forstockholders or potential acquirers to obtain control of our board of directorsor initiate actions that are opposed by our then-current board of directors,including delay or impede a merger, tender offer, or proxy contest involvingour company. Any delay or prevention of a change of control transaction orchanges in our board of directors could cause the market price of our commonstock to decline.

 

**Risks Related to our Intellectual Property and PotentialLitigation**

 

**We depend on ourintellectual property for the establishment and operation of our iVOW Centers.**

 

We rely on a combination of trade secrets, know-howand confidentiality restrictions for the establishment and operation of our iVOWCenters.  We have expended significantefforts devising the types of products and services we will offer and themanner in which these will be delivered. Our ability to maintain the secrecy and confidentiality of our tradesecrets and internal knowledge are crucial to the success of our business.  Any failure to do so may negatively impactour prospects.

 

**We may be subject to productliability claims and have limited insurance coverage.**

 

We face an inherent andsignificant business risk of exposure to product liability claims in the eventthat the use of our products, which were sold by us prior to the sale of theVisualization Technology business, results in personal injury or death.  Also, in the event that any of those productsproves to be defective, we may be required to recall or redesign suchproducts.  Product liability insurance isexpensive and in the future may not be available to us on acceptable terms, ifat all.  A successful product liabilityclaim or series of claims brought against us in excess of our insurancecoverage would negatively impact our business.

 

**If we are unable to protectour intellectual property, we may be unable to prevent other companies fromusing our technology in competitive products.**

 

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

 

In addition to patents,we rely on unpatented trade secrets to protect our business and our proprietarytechnology.  Others may independentlydevelop or otherwise acquire the same or substantially equivalent plans ortechnologies or otherwise gain access to our proprietary technology or discloseour plans or technology.  It is difficultto protect rights to unpatented ideas, plans or proprietary technology.  Third parties may obtain patent rights tothese unpatented trade secrets, which patent rights could be used to assertclaims against us.  We also rely onconfidentiality agreements with our collaborators, employees, advisors, vendorsand consultants to protect our proprietary technology.  These agreements may be breached, we may nothave adequate remedies for any breach and our trade secrets may otherwisebecome known or be independentlydeveloped by competitors.  In addition,our agreements with employees and consultants require disclosure of ideas,developments, discoveries or inventions conceived during employment orconsulting, as the case may be, and assignment to us of proprietary rights tosuch matters related to our business and technology.  The extent to which efforts by others willresult in patents and the effect on us of the issuance of such patents isunknown.

 

17

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Item 2. PROPERTIES

 

Ourfacilities consist of approximately 5,000 square feet of subleased office spacelocated in Carlsbad, California.  In addition,we maintained a facility of approximately 17,850 square feet in Westborough,Massachusetts in which the development, engineering, manufacturing operationsand customer service personnel of our Visualization Technology Business waslocated.  In April 2004 we subleased thefacility to Viking Systems, Inc. through the term of our lease.  The lease under which we had acquired theright to occupy the Westborough facilities expired in October 2004.  The sublease of the Carlsbad premises expiredin January 2005 and was executed with a related party.  We currently sublease the facility on a monthto month basis.  We believe that suitableadditional space will be available to us, when needed, on commerciallyreasonable terms.

 

Item3. LEGALPROCEEDINGS

 

Fromtime to time, we may be involved in litigation relating to claims arising outof our operations in the normal course of business.  There are no material legal proceedingspending against us.  We have beennotified that a party intends to include us as a party to a medical malpracticelawsuit in Florida, but we have not yet been formally included or served, andwe are contesting the issue.

 

Item4. SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

 

None.

 

18

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PART II

 

Item 5. MARKET FORREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES

 

(a)                                  Market Price of andDividends on the Registrant’s Common Equity.

 

OurCommon Stock is traded on the over-the-counter market and prices are quoted onthe Nasdaq SmallCap Market under the symbol “IVOW.”  The following table sets forth the high andlow sale prices for our Common Stock on the Nasdaq SmallCap Market fromJanuary 1, 2003 through December 31, 2004.

 

| **Quarter**      | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------|------------|----------|------------|---------|------------|
|             |       |     |       |    |       |
| 1st Quarter 2003 |       | $        | 2.57       |    | $          | 1.34 |   |
|             |       |     |       |    |       |
| 2nd Quarter 2003 |       | $        | 4.18       |    | $          | 0.77 |   |
|             |       |     |       |    |       |
| 3rd Quarter 2003 |       | $        | 3.30       |    | $          | 1.71 |   |
|             |       |     |       |    |       |
| 4th Quarter 2003 |       | $        | 3.20       |    | $          | 1.07 |   |
|             |       |     |       |    |       |
| 1st Quarter 2004 |       | $        | 2.99       |    | $          | 1.10 |   |
|             |       |     |       |    |       |
| 2nd Quarter 2004 |       | $        | 2.20       |    | $          | 1.00 |   |
|             |       |     |       |    |       |
| 3rd Quarter 2004 |       | $        | 3.00       |    | $          | 1.34 |   |
|             |       |     |       |    |       |
| 4th Quarter 2004 |       | $        | 1.92       |    | $          | 0.82 |   |

 

OnMarch 11, 2005 the last reported sale price of our Common Stock was$1.01.  As of March 11, 2005, therewere approximately 190 holders of record of our Common Stock.

 

Wehave never declared or paid any cash dividends on our capital stock.  We currently do not intend to pay any cashdividends in the foreseeable future and intend to retain our earnings, if any,for the operation of our business.

 

                The information required to bedisclosed by Item 201(d) of Regulation S-K, “Securities authorized for Issuanceunder Equity Compensation Plans”, is incorporated by reference within Item 12of Part III of this Annual Report on Form 10-K.

 

19

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Item 6. SELECTED FINANCIAL DATA

SELECTED FINANCIAL DATA

                The selectedfinancial data set forth below should be read in conjunction with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andour consolidated financial statements and notes thereto appearing elsewhere inthis Form 10-K.  This data has beenrestated, for all periods prior to 2004, to reflect the VisualizationTechnology business as a discontinued operation.  Also cost and expenses for 2002 and 2003 havebeen reclassified.  See “Reclassification”in Management’s Discussion and Analysis that follows.
| ** **                                                        | ** ** | **Years ended December 31,**                         | ** ** |
|-------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                        | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **STATEMENT OF OPERATIONS DATA:**                                 | ** ** | **2000**                                             | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                                        | ** ** | **(Restated)**                                       | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
| ** **                                                        | ** ** | **(in thousands, except share and  per share data)** | ** ** |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Revenues                                                          |       | $                                                    | —     |   | $ | — |   | $ | 3,543 |   | $ | 2,489 |   | $ | 1,651 |   |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Cost and expenses:                                                |       |                                                 |       |   |   |   |   |   |   |   |   |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Cost of revenues                                                  |       | —                                               |       | — |   | 1,174 |   | 1,155 |   | 1,193 |   |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Product development                                               |       |                                                 |       |   |   | 158 |   | 167 |   | 406 |   |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Sales and marketing                                               |       | —                                               |       | — |   | 1,604 |   | 1,007 |   | 1,197 |   |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| General and administrative                                        |       | 892                                                  |       | 1,003 |   | 1,082 |   | 1,226 |   | 1,798 |   |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Total costs and expenses                                          |       | 892                                                  |       | 1,003 |   | 4,018 |   | 3,555 |   | 4,594 |   |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Loss from continuing operations                                   |       | (892                                                 | )          | (1,003 | ) | (475 | ) | (1,066 | ) | (2,943 | ) |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Other income, net                                                 |       | 213                                                  |       | 70 |   | 17 |   | 32 |   | (28 | ) |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Loss from continuing operations                                   |       | (679                                                 | )          | (933 | ) | (458 | ) | (1,034 | ) | (2,971 | ) |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Loss from discontinued operations                                 |       | (2,935                                               | )          | (2,289 | ) | (689 | ) | (1,014 | ) | (633 | ) |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Less dividends on preferred stock                                 |       | —                                               |       | — |   | — |   | (119 | ) | (268 | ) |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Net loss applicable to common stockholders                        |       | $                                                    | (3,614     | ) | $ | (3,222 | ) | $ | (1,147 | ) | $ | (2,167 | ) | $ | (3,872 | ) |
| Loss per share basic and diluted:                                 |       |                                                 |       |   |   |   |   |   |   |   |   |
| Continuing operations                                             |       | $                                                    | (0.15      | ) | $ | (0.19 | ) | $ | (0.09 | ) | $ | (0.23 | ) | $ | (0.37 | ) |
| Discontinued operations                                           |       |                                                 | (0.65      | ) |   | (0.47 | ) |   | (0.14 | ) |   | (0.20 | ) |   | (0.07 | ) |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Basic and diluted net loss per share                              |       | $                                                    | (0.80      | ) | $ | (0.66 | ) | $ | (0.23 | ) | $ | (0.43 | ) | $ | (0.44 | ) |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Shares used in computing basic and diluted loss  per common share |       | 4,495,000                                            |       | 4,906,000 |   | 4,969,000 |   | 5,004,000 |   | 8,726,000 |   |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| ** **                                                        | ** ** | **December 31,**                                     | ** ** |
| ** **                                                        | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **BALANCE SHEET DATA:**                                           | ** ** | **2000**                                             | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                                        | ** ** | **(Restated)**                                       | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
| ** **                                                        | ** ** | **(in thousands)**                                   | ** ** |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Cash, cash equivalents and short-term investments                 |       | $                                                    | 2,934      |   | $ | 1,317 |   | $ | 829 |   | $ | 636 |   | $ | 1,970 |   |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Working capital                                                   |       | 2,934                                                |       | 1,317 |   | 2,073 |   | 1,093 |   | 1,895 |   |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Total assets                                                      |       | 7,155                                                |       | 4,823 |   | 4,182 |   | 2,991 |   | 3,985 |   |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Long-term portion of capital leases                               |       | -                                                    |       | - |   | 7 |   | 19 |   | 11 |   |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Accumulated deficit                                               |       | (61,555                                              | )          | (64,777 | ) | (65,925 | ) | (68,092 | ) | (71,964 | ) |
|                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Total stockholders’ equity                                   |       | 6,151                                                |       | 3,091 |   | 2,081 |   | 1,108 |   | 3,223 |   |
|                                                                   |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

20

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Item7.    MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

                Thisannual report may contain predictions, estimates and other forward-lookingstatements that involve a number of risks and uncertainties, including thosediscussed earlier under “Risks and Uncertainties” in Item 1of Part I of thisannual report.  While this outlookrepresents our current judgment on the future direction of our business, suchrisks and uncertainties could cause actual results to differ materially fromany future performance suggested below. We undertake no obligation to release publicly the results of anyrevisions to these forward-looking statements to reflect events orcircumstances arising after the date of this annual report.  The following discussion should be read in conjunctionwith our consolidated financial statements and the notes thereto.

 

**Overviewof our Business**

 

Ourcompany, iVOW, Inc., formerly Vista Medical Technologies, Inc., was founded in1993 primarily to develop advanced visualization technologies for complexminimally invasive surgical procedures. It was through the application of thistechnology in laparoscopic gastric bypass surgery that we subsequentlydeveloped a suite of consulting products and services for the initiation,operation and management of obesity surgery programs. Starting in early 2003,our Visualization Technology business, located in Westborough, Massachusetts,and our Obesity Surgery Management Services business unit, located in Carlsbad,California, functioned as individual business units.  In April 2004, we sold the VisualizationTechnology business to concentrate on the obesity surgery services market.  We changed our name to iVOW, Inc. in February2005, after merging our wholly owned subsidiary VOW Solutions, Inc., to alignour corporate name with the brand name of our chronic and morbid obesitydisease management business, which is now our exclusive focus.

Weoriginally began offering training and consulting services to the obesitysurgery market in 2001.   As a result ofthe disposition of our Visualization Technology business, we are now a pureplay company in the bariatric market. We develop and market products andservices for the bariatric surgery market. Bariatrics is the medical science ofweight reduction and nutrition; bariatric surgery, a specialized area ofgeneral surgery, is focused on surgical weight reduction solutions for the veryseverely or morbidly obese.  We are exclusively focused on implementingdisease management strategies for the control of chronic and severe obesity.  Our vision is to enable healthcare providersand organizations in the ongoing evolution of the highest standards oftreatment and services to optimize the quality of life for chronic and morbidlyobese patients. Our mission is to deliver the leading management portfolio ofservices and products for the clinical and business development of continuallysuccessful medical and surgical programs for the treatment of chronic andmorbid obesity.

Ourgoal is to become the leading disease management and consulting company focusedon chronic and morbid obesity. Our initial focus on the severely obese patient,and gastric bypass surgery as the solution, is the platform upon which we willexpand service to new obesity therapies as they are developed. We also plan tointegrate a bariatric medical model into our surgical protocols, both tofacilitate the long term care of post-surgical patients, and in due course, totreat obese patients who are not qualified for surgery.

In February 2004, we sold to a group of accreditedinvestors 439,000 shares of common stock and warrants to purchase up to 219,500shares of common stock, for a total of $588,260 as part of a unitoffering.  We sold 219,500 units; eachunit consisted of two (2) shares of common stock priced at $1.34 per share anda warrant to purchase one share of common stock. The 219,500 warrant shares areexercisable at a price of $1.97 per share and expire inFebruary 2009.  The proceeds wereused to fund our obesity disease state management business unit and ourVisualization Technology business unit until it was sold in April 2004.

In April 2004, we sold our Visualization Technologybusiness unit to Viking Systems, Inc. (“Viking”) under an Asset PurchaseAgreement signed on December 22, 2003.  The financial results of this business have been reported separately asdiscontinued operations and the financial statements for all prior periods havebeen restated accordingly.   See Lossfrom discontinued operations below and Note 2 to our financial statements.

In May 2004, we sold to a group of accreditedinvestors 5,454,544 units of our securities for $0.85 per unit, each unitconsisting of one share of common stock and one warrant to purchase one-halfshare of common stock, for aggregate gross proceeds of approximately $4.6million, or $4.1 million net of expenses. The 2,272,272 warrant shares are exercisable at a price of $0.95 pershare and expire in May 2009.  As part ofthe May 2004 unit sale, we issued warrants to the placement agent to purchaseup to 818,181 shares of our common stock of which 545,454 of these warrants areexercisable at a price of $1.02 per share and the remaining 272,727 warrantsare exercisable at a price of $0.95 per share. The warrants expire in May 2009.

InJune 2004, we amended our Series A Certificate of Designations to allow usthe right to issue equity securities for a price under $2.00.  For that right, the Series A holders received1,400,000 shares of Viking common stock that we held valued at $28,000.  As part of the amendment, we were required toredeem 85,000 Series A Shares for $200,000. In addition, we have the right to redeem an additional 300,000 Series AShares at any time on or before January 15, 2006 in exchange for $500,000.If we choose to redeem the additional 300,000 Series A Shares, we will use cashthat would otherwise fund our business operations.

 

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In August 2004, we announced the signing of thefirst full management contract for an iVOW Center, which covers the launch andongoing management of an obesity surgery program.  The agreement is a 3-year renewable contractwith Pioneers Memorial Healthcare District of Brawley, CA.

In October 2004, at a special meeting of thestockholders we received approval to increase the aggregate number of shares ofcommon stock available for issuance under our 1997 Stock Option/Stock IssuancePlan from 1,092,500 to 2,592,500.

Our discussion of our results of operations will befocused on our remaining business, which is now exclusively focused on our chronic and morbid obesity diseasemanagement business.

 

**CriticalAccounting Policies**

 

**               **The discussionand analysis of our financial condition and results of operations are basedupon our consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the UnitedStates.  The presentation of thesefinancial statements requires us to make estimates and judgments that affectthe reported amounts of assets and liabilities, revenues and expenses, andrelated disclosure at the date of our financial statements.  The significant accounting policies, which webelieve are most critical in gaining an understanding of our financialstatements, include policies and judgments relating to reclassification,revenue recognition, and inventories. Actual results could differ materially from these estimates.  Our significant accounting policies aresummarized in the notes to our consolidated financial statements.  The significant accounting policies which webelieve are the most critical in gaining full understanding and evaluating ourreported financial results include the following:

 

**Reclassification/Restatement**

 

In late September 2004 wefiled an Amendment to our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2003 to restate our previously issued financial statementsfor the year ended December 31, 2003 to reflect our Visualization Technologybusiness as a discontinued operation. Additionally in 2004, we have reclassified costs and expenses of ourcontinuing operations in the statements of operations for the years 2002 and2003, and the first three quarters of 2004, to be on a comparative basis with2004.  The change in reportingimplemented for 2004 is the direct result of the sale of our technologybusiness and the transitioning from a manufacturing business to a managementand consulting business. Reclassifications were made based on our estimate of time spent onvarious activities along with estimates of related indirect costs.  The table below presents the amountspreviously reported in the 10-K/A for 2003 and balances after reclassificationsfor 2002 and 2003.

 

| ** **                 | ** ** | **As previously reported  in the 2003 10-K/A** | ** ** | **After reclassification**             | ** ** |
|----------------------------|------------|------------------------------------------------|------------|----------------------------------------|------------|
| ** **                 | ** ** | **2002**                                       | ** ** | **2003**                               | ** ** | **2002** | ** ** | **2003** | ** ** |
| Cost and expenses          |       |                                           |       |                                   |       |   |   |   |   |
| Cost of revenue            |       | $                                              | 797,528    |                                   | $          | 574,599 |   | $ | 1,174,447 |   | $ | 1,155,234 |   |
| Product development        |       | —                                         |       | —                                 |       | 158,073 |   | 167,610 |   |
| Sales and marketing        |       | 2,138,639                                      |       | 1,755,215                              |       | 1,603,647 |   | 1,006,970 |   |
| General and administrative |       | 1,082,003                                      |       | 1,226,145                              |       | 1,082,003 |   | 1,226,145 |   |
| Total cost and expenses    |       | $                                              | 4,018,170  |                                   | $          | 3,555,959 |   | $ | 4,018,170 |   | $ | 3,555,959 |   |
|                       |       |                                           |       |                                   |       |   |   |   |   |
|                       |       |                                           |       |                                   |       |   |   |   |   |
|                       |       | **As  previously reported**                    | ** ** | **After  reclassification**            |       |
|                       |       | **Quarter ended  June 30, 2004**               | ** ** | **Quarter  ended  September 30, 2004** | ** ** | **Quarter  ended  June 30, 2004** | ** ** | **Quarter  ended  September 30, 2004** |   |
| Cost and expenses          |       |                                           |       |                                   |       |   |   |   |   |
| Cost of revenue            |       | $                                              | 61,706     |                                   | $          | 45,177 |   | $ | 253,241 |   | $ | 217,583 |   |
| Product development        |       | —                                         |       | —                                 |       | 96,865 |   | 96,376 |   |
| Sales and marketing        |       | 626,288                                        |       | 619,364                                |       | 249,247 |   | 352,165 |   |
| General and administrative |       | 281,732                                        |       | 507,780                                |       | 370,373 |   | 506,197 |   |
| Total cost and expenses    |       | $                                              | 969,726    |                                   | $          | 1,172,321 |   | $ | 969,726 |   | $ | 1,172,321 |   |
|                            |            |                                                |            |                                        |            |  |  |  |  |  |  |  |  |  |

 

22

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**RevenueRecognition**

 

Revenue generated from ourdisease state management of morbid obesity business is recognized (i) withregard to management services, upon completion of the service period and (ii)with regard to training services or other consulting services, upon completionof the related training or consulting component, provided that a contractexists, there are no uncertainties regarding customer acceptance, the salesprice is fixed or determinable and collectibility is reasonably assured.  Any payments received in advance ofcompletion of the service are recorded as deferred revenue.  Sales of vitamins are similarly recognizedupon shipment provided that a purchase order has been received, there are nouncertainties regarding customer acceptance, the sales price is fixed ordeterminable and collectibility is reasonably assured.

 

Sales returns are estimatedbased on the historical experience and management’s expectations and arerecorded at the time product revenue is recognized.

 

We receivedsemiannual payments as a result of fulfilling certain obligations related toour strategic alliance agreement with Ethicon Endo-Surgery, Inc. (EES).  These payments are recognized as revenue on astraight-line basis over the related contract term, provided that we have compliedwith all contractual obligations.  Thestrategic alliance agreement ended in December 2004.

 

**Inventory**

 

Inventories are stated atthe lower of cost (determined on a first-in, first-out basis) or market andinclude only finished goods related to our disease state management of morbidobesity business.

 

**Due from Viking**

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

Viking is a relatively new company that hasnot raised substantial funds and may be unable to raise sufficient funds tosustain its operations or fund its growth plan. Additionally, there can be no assurance that Viking’s business willsucceed.  As a result, all contractualamounts due us are at risk.

 

**Investment in Equity Securities of Viking Systems,Inc.**

As part of the sale of ourVisualization Technology business in April 2004, we were issued 3,054,000shares of Viking common stock (see Note 4) valued at $0.02 per share or$61,080, which reflected the fair value of the shares at the time the shareswere acquired.  In June 2004, 1,400,000of these shares valued at $0.02 per share, or $28,000, were used to obtaincertain rights from our Series A holders (see Note 9) with the remaining1,654,000 shares valued at $33,080.   InOctober 2004, the Viking common stock began trading on the Over The CounterBulletin Board and, accordingly, has been adjusted to fair value.  Viking is a relatively new company and thereis a limited market for Viking common stock even though it is publiclyquoted.   The limited trading market forViking common stock may cause fluctuations in the market value of the commonstock to be exaggerated, leading to price volatility in excess of that whichwould occur in a more active trading market which could have an effect on boththe carrying value and our stockholders’ equity.  There is a significant risk of adjustment tothe carrying value due to possible market fluctuations in their stock price.

 Theinvestment in Viking Systems, Inc. common stock is classified as available forsale as of December 31, 2004.  The costand fair value of the equity securities at December 31, 2004 are as follows:

 

| **Corporate Equity Securities:** | ** ** | **Cost** | ** ** | **Unrealized Gain** | ** ** | **Fair Value** | ** ** |
|----------------------------------|------------|----------|------------|---------------------|------------|----------------|------------|
| Viking Systems, Inc.             |       | $        | 33,080     |                | $          | 1,273,580      |       | $ | 1,306,660 |   |
|                                  |            |          |            |                     |            |                |            |  |  |  |

 

 

**OurResults of Operations**

 

**Year ended December 31, 2004compared with year ended December 31, 2003**

 

**Revenues**

 

Revenues from continuingoperations were $1,651,000 for the year ended December 31, 2004 as compared torevenues from continuing operations of $2,489,000 for the year ended December31, 2003, representing a decrease of $838,000 or 34%. The decrease

 

23

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inrevenue was associated with lower training and consulting services and contractrevenue from a strategic partner. While revenues decreased, our most importantbusiness indicator, VOW program management fees, increased as a result ofsigning up our first, full-fledged VOW center in the third quarter of2004.  We also saw an increase in vitaminsales for both periods.  We anticipatethat revenues will increase slightly over current levels with greater quarterlygrowth expected in 2005.  However, nocontract revenue is projected for 2005.

| **Increase/(decrease) over prior year** | ** ** | **2004** | ** ** |
|-----------------------------------------|------------|----------|------------|
| Management fees                         |       | $        | 248,000    |   |
| Training and consulting fees            |       | (727,000 | )          |
| Vitamins sales                          |       | 58,000   |       |
| Contract revenue                        |       | (417,000 | )          |
|                                    |       | $        | (838,000   | )  |
|                                         |            |          |            |  |  |

 

The decrease associated withlower clinical training services and to a lesser degree consulting services wasthe result of a change in the market as demand shifted from the requirement tobe trained to more of a focus on the operational aspects of bariatric programsin 2004.  The decrease was furtheraffected by events during the first half of 2004, including the sale of thetechnology business and the raising of new capital, which required asignificant focus on non-operational business activities.  This diverted focus affected the third andfourth quarters by providing a lower revenue base to begin our transition to apure play disease state management business.  Other factors that contributed to the decrease in training andconsulting services in 2004 included some market slowing because of payoruncertainty, and the difficulty in hiring of key sales personnel.  For the year ended December 31, 2004, twocustomers made up 30% and 11% of total revenues, respectively.

 

**Cost andexpenses**

 

The following analysis of costs and expensesis based on a reclassification of cost and expenses.  See “Reclassification/Restatement” underCritical Accounting Policies.  

| ** **                 | ** ** | **2003**  | ** ** | **2004**  | ** ** |
|----------------------------|------------|-----------|------------|-----------|------------|
| Cost of revenues           |       | $         | 1,155,000  |      | $          | 1,193,000 |   |
| Product development        |       | 168,000   |       | 406,000   |       |
| Sales and marketing        |       | 1,007,000 |       | 1,197,000 |       |
| General and administrative |       | 1,226,000 |       | 1,798,000 |       |
|                       |       |      |       |      |       |
| Total costs and expenses   |       | $         | 3,556,000  |      | $          | 4,594,000 |   |
|                            |            |           |            |           |            |  |  |  |

 

Cost of revenues.  Our cost of revenues increased by $38,000 in2004 as gross margins decreased from 54% in 2003 to 28% in 2004.  The gross margins were 27% in 2003 and (4%)in 2004, when backing out the strategic partners contract revenue.  Cost of revenues includes the fully burdenedcost associated with management, consulting and training services and the costof goods and related expenses for vitamins. The increase in cost and the decrease in gross margin for 2004 wereassociated with the expansion of our workforce to set up and manage iVOWcenters; there were no centers under management in 2003, and two (2) centers bythe end of 2004.  Also, staff was hiredto work on consulting assignments.  Whileit would be more economical to have a reduced workforce, it is not possible tohire experienced quality part time professional staff to perform the level ofwork required to maintain existing customers or to obtain new customers.  We do expect our gross margins to improve inthe future based on an increase in management and consulting contracts;however, gross margins are expected to fluctuate in the future due to productmix.

 

Product development.  Product and development expenses increased by$238,000, or 142% in 2004 over 2003. This increase is due to an expanded work force and the related expensesassociated with identifying and developing new and complimentary products.  This is a result of our efforts throughoutthe year to expand our capabilities to become a complete chronic and morbidobesity disease management business and rather than a consulting practicefocused on surgical treatment for morbid obesity as we were in 2003.

 

Sales and marketingexpenses.  Our sales and marketingexpenses were up slightly in 2004, by $190,000, or 19%, over 2003.  The increase in sales and marketing expensesduring 2004 was primarily attributable to increased efforts to sign up new iVOWcenters during the second half of 2004.  Wedo expect a slight steady increase in sales and marketing expenses during 2005as we continue to expand our field activities in the chronic and morbid obesitydisease management business.

 

General and administrativeexpenses.  Our general and administrativeexpenses were up $572,000, or 47%, to $1,798,000 in 2004.  The increase in general and administrativeexpenses during 2004 was primarily attributable to increased professionalservices

 

24

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for legal and audit along with salaries andrelated expenses.  We expect our generaland administrative expenses to increase in future years to support our businessgrowth efforts and to comply with the requirements of the Sarbanes-Oxley Act.

 

**Other income and losses**

 

Other income, net.  Our other income, net, was ($28,000) in 2004compared to $32,000 in 2003.  Thedecrease in other income is due to lower interest on investments, $27,000 for 2004and $37,000 for 2003, and higher interest expense on equipment leasing, $7,000in 2004 and $5,000 in 2003, due to having a full year of interest in 2004 asopposed to less than a full year in 2003. Also included in the decrease in other income is an expense of $48,000in 2004 associated with S-3 filing related fees paid in the third quarter.

 

Loss from discontinuedoperations.  The loss from discontinuedoperations resulted from the sale of our technology business in April2004.  The decrease in revenue andexpenses in 2004 when compared to 2003 is directly related to having only threeand one-half months of operations in 2004 (29% of a full year of operations)and a full year of operations in 2003. When proportionately comparing the two years, revenue was off by 80%,which is greater than the 71% expected, due to lower than expected marketpenetration.  Expenses were in line in2004 a partial year comparison.  Themajor reason that expenses were not reduced further was due to the portion offixed expenses compared to variable expenses at these operating levels.

 

| ** **                        | ** ** | **2003  (12 months  of operations)** | ** ** | **2004  (3 1⁄2 months  of operation)** | ** ** | **2004 %  Change  (29% of  full year)** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| Revenues                          |       | $                                    | 6,220,000  |                                      | $          | 1,227,000                               |       | (80 | )% |
|                              |       |                                 |       |                                      |       |                                    |       |
| Cost of revenues                  |       | 4,610,000                            |       | 1,036,000                                 |       | (78                                     | )%         |
| Research and development          |       | 1,178,000                            |       | 330,000                                   |       | (72                                     | )%         |
| Sales and marketing               |       | 323,000                              |       | 79,000                                    |       | (76                                     | )%         |
| General and administrative        |       | 1,123,000                            |       | 415,000                                   |       | (63                                     | )%         |
| Total cost and expenses           |       | 7,234,000                            |       | 1,860,000                                 |       | (74                                     | )%         |
| Loss from discontinued operations |       | $                                    | (1,014,000 | )                                         | $          | (633,000                                | )          | (37 | )% |

 

**IncomeTaxes**

 

                AtDecember 31, 2004, we have federal and state tax net operating losscarryforwards of approximately $59,192,000 and $8,403,000, respectively. Thefederal tax loss carryforwards will begin to expire in 2010.  Approximately $1,081,000 of the state taxloss carryforwards expired in 2004, and will continue to expire in futureperiods unless previously utilized.  AtDecember 31, 2004, we also have federal and state research tax creditcarryforwards of approximately $2,277,000 and $130,000, respectively, whichwill begin to expire in 2010 unless previously utilized.  We have retained the federal and state taxloss carryforwards and other tax attributes of the Visualization Technologybusiness.  We have provided a fullvaluation allowance on the deferred tax assets, as realization of such assetsis uncertain.

 

 

**Year ended December 31, 2003compared with year ended December 31, 2002**

 

**Revenues**

 

                Revenuesfrom continuing operations were $2,489,000 for the year ended December 31, 2003as compared to revenues from continuing operations of $3,543,000 for the yearended December 31, 2002, representing a decrease of $1,054,000 or 30%.  This decease in revenues in 2003 wasprimarily due to fewer training programs related to our bariatric surgerypreceptorships along with lower contract revenues and offset by an increase invitamin sales.  For the year endedDecember 31, 2003, revenues from one customer represented 37% of totalrevenues.  

| **Increase/(decrease) over prior year** | ** ** | **2003**   | ** ** |
|-----------------------------------------|------------|------------|------------|
| Management fees                         |       | $          | —     |   |
| Training and consulting fees            |       | (1,057,000 | )          |
| Vitamin sales                           |       | 86,000     |       |
| Contract revenue                        |       | (83,000    | )          |
|                                    |       | $          | (1,054,000 | )  |

 

25

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**Cost andexpenses**

 

The following analysis ofcosts and expenses is based on a reclassification of cost and expenses.  See “Reclassification/Restatement” underCritical Accounting Policies.

 

 

| ** **                 | ** ** | **2002**  | ** ** | **2003**  | ** ** |
|----------------------------|------------|-----------|------------|-----------|------------|
| Cost of revenues           |       | $         | 1,174,000  |      | $          | 1,155,000 |   |
| Product development        |       | 158,000   |       | 168,000   |       |
| Sales and marketing        |       | 1,604,000 |       | 1,007,000 |       |
| General and administrative |       | 1,082,000 |       | 1,226,000 |       |
| Total cost and expenses    |       | $         | 4,018,000  |      | $          | 3,556,000 |   |

 

Cost of revenues.  Our gross margins decreased from 67% in 2002to 54% in 2003 even though our cost of revenues decreased by $19,000 in2003.  The gross margins were 50% in 2002and 27% in 2003, when backing out the strategic partners contract revenue,which was somewhat unchanged from year to year. Cost of revenues includes the fully burdened cost associated withmanagement, consulting and training services and the cost of goods and relatedexpenses for vitamins.  While costsremained somewhat flat, the decrease in gross margin for 2003 was primarilyassociated with the reduction in the number of training programs that weconducted during 2003 due to competition.

 

Product development.  Product and development expenses increased by$10,000 in 2004 over 2003, or 6%.  Thisincrease was due to an expanded effort late in the year to identifying and developingnew and complimentary products.

 

Sales and marketingexpenses.  Our sales and marketingexpenses decreased in 2003, by $597,000 or 37%, over 2002.  The decrease in sales and marketing expensesduring 2003 was primarily attributable to lower consulting services as well aslower promotional and advertising expenses.

 

General and administrativeexpenses.  Our general and administrativeexpenses were up $144,000, or 13%, to $1,226,000 in 2003.  The increase in general and administrativeexpenses during 2004 was primarily attributable to increased professionalservices for legal and audit along with salaries and related expenses.

 

**Otherincome and losses**

 

Interest income. Our netinterest income was $32,000 and $17,000 for the years ended December 31, 2003and 2002, respectively. The increase in 2003 was due primarily to interest recordedon notes receivable from stockholders, partially offset by decreasing averagecash balances and lower interest rates.

 

Loss from discontinuedoperations

 

| ** **                 | ** ** | **2002**  | ** ** | **2003**  | ** ** |
|----------------------------|------------|-----------|------------|-----------|------------|
| Revenues                   |       | $         | 7,563,000  |      | $          | 6,220,000 |   |
|                       |       |      |       |      |       |
| Cost of revenues           |       | 5,191,000 |       | 4,610,000 |       |
| Research and development   |       | 1,710,000 |       | 1,178,000 |       |
| Sales and marketing        |       | 551,000   |       | 323,000   |       |
| General and administrative |       | 800,000   |       | 1,123,000 |       |
| Total cost and expenses    |       | 8,252,000 |       | 7,234,000 |       |
|                       |       | $         | (689,000   | )         | $          | (1,014,000 | )  |

 

Revenues.  Revenues were $6,220,000 for the year endedDecember 31, 2003, down from $7,563,000 for the year ended December 31,2002.   This decrease was primarily dueto a $1,000,000 write off associated with the bankruptcy of a customer and adecrease in camera sales to our original equipment manufacturer customers.

 

26

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Cost of revenues.  Our cost of revenues were $4,610,000 and$5,191,000 for the years ended December 31, 2003 and 2002, respectively.  Our gross margins were 26% and 31% for theyears ended December 31, 2003 and 2002, respectively.  The decrease in gross margin was primarilydue to lower sales of higher margin equipment.

 

Research anddevelopment.  Our research anddevelopment expenses were $1,178,000 and $1,709,000 for the years endedDecember 31, 2003 and 2002, respectively, representing a decrease of $531,000or 31%.  The decrease in research anddevelopment expenses during 2003 was primarily attributable to higher spendingon the next generation product development in 2002 as compared to 2003.

 

Sales and marketing.  The decrease in sales and marketing expenseto $323,000 in 2003 from  $551,000 in2002 was primarily due to a reduced selling and marketing effort in the sale ofequipment.

 

General andadministrative.  The increase in generaland administrative expenses from $800,000 in 2002 to $1,123,000 in 2003 was dueto higher professional fees.

 

**Liquidityand Capital Resources**

 

Our principal sources ofliquidity have been funds raised from public and private placements of ourcapital stock and, to a lesser degree, cash flows generated from operations andthe sale of our technology business to Viking System, Inc.  At December 31, 2004, we had cash and cashequivalents of $1,970,000.

 

Net cash used in operatingactivities was approximately $542,000, $1,321,000 and $3,492,000, in 2002, 2003and 2004, respectively.  The increase innet cash used in operating activities of $2,171,000 during 2004 over 2003 wasprimarily attributable to increased net loss of $1,555,000 due to a decrease inrevenues of $838,000, an increase in operating expenses of $1,038,000 and areduction in the level of deferred revenues of $411,000 in 2004, which is cashreceived in prior years and recognized as revenue in 2004.  The increase in net cash used in operatingactivities during 2003 compared to 2002 was primarily attributable toincreasing net losses due to lower revenues and an increase in the change inassets and liabilities related to discontinued operations.

 

Net cash provided frominvesting activities was approximately $128,000, $163,000 and $641,000 in 2002,2003 and 2004, respectively.  Theincrease in cash provided from investing activities for 2004 of $478,000 wasprimarily attributed to the $497,000 in proceeds received during the year fromthe sale of our technology business in April 2004.  The increase in cash in 2003 of $35,000 wasprimarily attributable to $40,000 in maturities of short-term investments.

 

Cash flows from financingactivities were $71,000,  $1,150,000 and$4,372,000 in 2002, 2003 and 2004, respectively.  The increase in net cash flows provided byfinancing activities of $3,222,000 in 2004 was principally attributable to$3,693,000 more received from the sale of our common stock in 2004 over 2003,$4,651,000 in 2004 compared to $958,000 in 2003.   Also during 2004, we redeemed 85,000 sharesof our Series A Convertible Preferred Stock for $200,000, paid off our 2003short-term bank borrowings of $200,000 and issued  $202,000 in short term notes to finance ourannual insurance premiums, which were paid down by $74,000 in 2004.  The cash flows from financing activities in2003 were primarily attributable to proceeds from a private placement ofpreferred stock for approximately $950,000 and short term bank borrowings of$200,000.

 

We incurred net losses andnegative net cash flows from operating activities in 2002, 2003 and 2004, andat December 31, 2004, had an accumulated deficit of $72.0 million.  At December 31, 2004, we had cash and cashequivalents of $1,970,000.   We believethat our cash and cash equivalents, together with anticipated 2005 productrevenues and interest income, will be sufficient to meet our anticipatedcapital requirements through at least June 2005.  These factors raise substantial doubt aboutour ability to continue as a going concern. We are pursuing several alternatives to address this situation,including raising additional funding. However, there can be no assurance that the requisite fundings will beconsummated in the necessary time frame or on terms acceptable to us.  Should we be unable to raise sufficientfunds, we may be required to curtail our operating plans and possiblyrelinquish rights to portions of our technology or products.  In addition, increases in expenses or delaysin product development may adversely impact our cash position and requirefurther cost reductions.  No assurancecan be given that we will be able to operate profitably on a consistent basis,or at all, in the future.

 

Theaccompanying consolidated financial statements have been prepared on a goingconcern basis, which contemplates the realization of assets and thesatisfaction of liabilities in the normal course of business.  The consolidated financial statements do notinclude any adjustments relating to the recoverability and classification ofassets or the amounts and classification of liabilities that might be necessaryshould we be unable to continue as a going concern.

 

27

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**ContractualObligations**

** **

At December 31, 2004, we areobligated under an operating lease, principally related to real estate.  Additionally, we are obligated under capitalleases related to computer hardware.  Thefollowing is a schedule of future minimum payments, excluding taxes and otheroperating costs, as of December 31, 2004:

 

| **Year ending December 31,**                        | ** ** | **Operating Leases** | ** ** | **Capital Leases** | ** ** |
|-----------------------------------------------------|------------|----------------------|------------|--------------------|------------|
| 2005                                                |       | $                    | 11,000     |               | $          | 20,530 |   |
| 2006                                                |       | —               |       | 11,146             |       |
|                                                |       | $                    | 11,000     |               | 31,676     |   |
| Less - amounts representing interest                |       |                 |       | (4,191             | )          |
| Principal of capital lease obligation               |       |                 |       | 27,485             |       |
| Less - current portion of capital lease obligations |       |                 |       | (16,969            | )          |
| Long term portion of capital lease obligations      |       |                 |       | $                  | 10,516     |   |
|                                                     |            |                      |            |                    |            |  |  |  |  |

 

**Related Party Transactions**

 

Wehave a sublease agreement for our California office space.  The sublease agreement has been executed withanother company, of which our former Chairman of the Board is also aDirector.  Total rental payments of$118,000 were paid to this company in 2004. As of December 31, 2004 we had $35,659 payable to our directors andofficers.

 

**Off-Balance Sheet Arrangements**

 

We currently do not haveany material off-balance sheet arrangements other than the operating leasecommitments described above.

 

**Inflation**

 

Webelieve that the effects of inflation generally do not have a material adverseimpact on our operations****or financialcondition.

 

**New Accounting Pronouncements**

 

InDecember 2004, the FASB issued SFAS No. 123(R) (revised 2004), *Share-Based Payment*, which amends SFAS 123and will be effective for public companies for interim or annual periodsbeginning after June 15, 2005. The new standard will require us to expenseemployee stock options and other share-based payments. The FASB believes theuse of a binomial lattice model for option valuation is capable of more fullyreflecting certain characteristics of employee share options compared to theBlack-Scholes options pricing model.  The new standard may be adopted inone of three ways - the modified prospective transition method, a variation ofthe modified prospective transition method or the modified retrospectivetransition method. We are currently evaluating how we will adopt the standardand evaluating the effect that the adoption of SFAS 123(R) will have on ourfinancial position and results of operations.

 

InNovember 2004, the FASB issued SFAS No. 151, *Inventory Costs, an amendment of ARB No. 43,Chapter 4.*This statement amends the guidance in ARBNo. 43, Chapter 4, *InventoryPricing*, to clarify the accounting for abnormal amounts of idlefacility expense, freight, handling costs, and wasted material (spoilage).Paragraph 5 of ARB No. 43, Chapter 4, previously stated “...undersome circumstances, items such as idle facility expense, excessive spoilage,double freight, and rehandling costs may be so abnormal as to require treatmentas current period charges...” SFAS 151 requires that those items be recognizedas current-period charges regardless of whether they meet the criterion of “soabnormal.” In addition, this statement requires that allocation of fixedproduction overheads to the costs of conversion be based on the normal capacityof the production facilities. The provisions of SFAS 151 shall be appliedprospectively and are effective for inventory costs incurred during fiscalyears beginning after June 15, 2005, with earlier application permittedfor inventory costs incurred during fiscal years beginning after the date thisstatement was issued. The adoption of SFAS 151 is not expected to have amaterial impact on our financial position and results of operations.

 

28

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InDecember 2004, the FASB issued SFAS No. 153, *Exchanges of Nonmonetary Assets, an amendment of APBOpinion No. 29*. The guidance in APB Opinion No. 29, *Accounting for Nonmonetary Transactions*,is based on the principle that exchanges of nonmonetary assets should bemeasured based on the fair value of assets exchanged. The guidance in APB 29,however, included certain exceptions to that principle. SFAS 153 amends APB 29to eliminate the exception for nonmonetary exchanges of similar productiveassets that do not have commercial substance. A nonmonetary exchange hascommercial substance if the future cash flows of the entity are expected tochange significantly as a result of the exchange. SFAS 153 is effective fornonmonetary exchanges occurring in fiscal periods beginning after June 15,2005. The adoption of SFAS 153 is not expected to have a material impact on ourfinancial position and results of operations.

 

 

 

Item7A.                           QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK

 

AtDecember 31, 2004, our investment portfolio included no fixed-incomesecurities.

 

At December 31,2004, our investment in equity securities of Viking Systems, Inc. is held asavailable for sale securities. Accordingly, there is a significant risk ofadjustment to the carrying value due to possible market fluctuations in theirstock price.

 

 

 

Item8.                                     FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA

 

Theconsolidated financial statements and supplementary data required by this itemare set forth at the pages indicated in Item 15(a)(1).

 

 

 

Item9.                                     CHANGES IN AND DISAGREEMENTSWITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

Not applicable.

 

 

 

Item 9A.       CONTROLS ANDPROCEDURES

 

As required by the Securities and Exchange CommissionRule 13a-15(b), we carried out an evaluation, under the supervision and withparticipation of our management, including our chief executive officer andchief financial officer, of the effectiveness of our disclosure controls andprocedures as of the end of the year covered by this report.  Based on the foregoing, our executive officerand chief financial officer concluded that as of December 31, 2004, ourdisclosure controls and procedures were effective at the reasonable assurancelevel.

 

In connection with the audit of our 2004 financialstatements, management, together with J. H. Cohn LLP, our independentregistered public accounting firm, identified the existence of severalsignificant deficiencies related to the preparation of our financial statementsand notes thereto.  These significantdeficiencies collectively amount to a material weakness in our internal controlover financial reporting.

 

In response to the matters identified, we have takensteps to strengthen our internal control over financial reporting to remediatethe significant deficiencies. Specifically, we have taken, or intend to take, the following steps,among others:

 

•   Wehave expanded and enhanced our accounting and reporting staff by adding a fulltime accountant and have begun training our financial analyst in financialreporting;

 

•   Weintend to expand our financial disclosure and reporting knowledge through continuingeducation courses so as to minimize our financial reporting deficiencies in thefuture.

 

Otherthan as set forth above, there has been no other change in our internal controlover financial reporting during our most recent fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

Item 9B.       OTHER INFORMATION

 

                                                None

 

29

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PARTIII

 

 
| Item 10. |   | DIRECTORS  AND EXECUTIVE OFFICERS OF THE REGISTRANT |
|----------|--------|-----------------------------------------------------|

                                                (a)                                  Identificationof Directors.  The information under thecaption “Proposal 1 - Election of Directors,” appearing in our Proxy Statementrelated to the Annual Meeting of Stockholders to be held on June 1, 2005, isincorporated herein by reference.

                                                (b)                                 Identificationof Executive Officers.  The informationunder the headings “Executive Officers and Key Employees,” appearing in ourProxy Statement related to the Annual Meeting of Stockholders to be held onJune 1, 2005, is incorporated herein by reference.

                                                (c)                                  Compliance withSection 16(a) of the Exchange Act.  Theinformation under the caption “Compliance with Section 16(a) of the SecuritiesExchange Act of 1934,” appearing in our Proxy Statement related to the AnnualMeeting of Stockholders to be held on June 1, 2005, is incorporated herein byreference.
| Item 11. |   | EXECUTIVE  COMPENSATION |
|----------|--------|-------------------------|

                                                The informationunder the headings “Executive Compensation and Other Information,” appearing inour Proxy Statement related to the Annual Meeting of Stockholders to be held onJune 1, 2005, is incorporated herein by reference.
| Item 12. |   | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS |
|----------|--------|--------------------------------------------------------------------------------------------------|

                                                The informationrequired under this item is incorporated herein by reference to our ProxyStatement related to the Annual Meeting of Stockholders to be held on June 1,2005.
| Item 13. |   | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS |
|----------|--------|-------------------------------------------------|

                                                The informationunder the heading “Certain Relationships and Related Transactions,” appearingin our Proxy Statement related to the Annual Meeting of Stockholders to be heldon June 1, 2005, is incorporated herein by reference.
| Item 14. |   | PRINCIPAL ACCOUNTANT FEES  AND SERVICES |
|----------|--------|-----------------------------------------|

 

                             The information under theheading “Proposal No. 3 — Ratification of Independent Auditor”, appearing inour Proxy Statement related to our Annual Meeting of stockholders to be held onJune 1, 2005, is incorporated herein by reference.

 

30

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PART IV

 

Item15.                                                       EXHIBITS AND FINANCIALSTATEMENTS

 

(a)                                  (1)                                  FinancialStatements

 

Thefinancial statements required by this item are submitted in a separatesection beginning on Page F-1 of this report.

 
| Report of J.H. Cohn LLP, Independent Registered  Public Accounting Firm                                           |   |
|-------------------------------------------------------------------------------------------------------------------|--------|
| Report  of Ernst & Young LLP, Independent Registered Public Accounting Firm                                   |   |
|                                                                                                              |   |
| CONSOLIDATED  FINANCIAL STATEMENTS                                                                                |   |
|                                                                                                              |   |
| Consolidated Balance Sheets at December 31,  2003 and 2004                                                   |   |
| Consolidated Statements of  Operations for the years ended  December 31, 2002, 2003, and 2004                |   |
| Consolidated Statements of  Comprehensive Income for the years ended  December 31, 2002, 2003, and 2004      |   |
| Consolidated Statements of  Stockholders’ Equity for the years ended  December 31, 2002, 2003, and 2004 |   |
| Consolidated Statements of  Cash Flows for the years ended  December 31, 2002, 2003, and 2004                |   |
| Notes to Consolidated  Financial Statements                                                                       |   |
|                                                                                                              |   |

 

(b)           Exhibits

 
| **NUMBER EXHIBIT** | ** ** | **DESCRIPTION**                                                                                                                                                               |
|--------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|               |       |                                                                                                                                                                          |
| 3.1(1)             |       | Second  Restated Certificate of Incorporation                                                                                                                                 |
| 3.4(2)             |       | Restated  Bylaws.                                                                                                                                                             |
| 3.2(14)            |       | Certificate  of Amendment of Second Restated Certificate of Incorporation                                                                                                     |
| 3.3(15)            |       | Certificate  of Designations of Series A Convertible Preferred Stock                                                                                                          |
| 4.1(2)             |       | Form  of certificate for common stock.                                                                                                                                        |
| 4.2(15)            |       | Registration  Rights Agreement dated March 3, 2003, with the parties listed  on Exhibit A thereto.                                                             |
| 10.1(2)            |       | Series  A-1 Preferred Stock Purchase Agreement with the purchasers listed on  Schedule A thereto, dated July 27, 1995.                                    |
| 10.2*(2)           |       | Manufacturing  Supply Agreement with Kaiser Electro-Optics, Inc., dated  July 19, 1995.                                                                   |
| 10.3(2)            |       | Amended  and Restated Investors’ Rights Agreement with the stockholders listed on  Schedule A thereto, dated November 27, 1996.                      |
| 10.4(2)            |       | Amendment  to the Amended and Restated Investors’ Rights Agreement with Heartport and  the stockholders listed on Exhibit A thereto, dated  February 22, 1997. |
| 10.5(2)            |       | Letter  Agreement regarding Investment Representations and Registration Rights  between us and Urohealth Systems, Inc., dated December 13, 1996.                    |
| 10.5(b)(15)        |       | Preferred  Stock Purchase Agreement dated March 3, 2003, with the parties listed on  Schedule A thereto.                                                            |
| 10.6*(2)           |       | Consulting  Agreement with Harry R. McKinley, dated September 15, 1995, as  amended.                                                                                |
| 10.7(2)            |       | Form  of Professional Services Agreement.                                                                                                                                     |
| 10.8(2)            |       | Form  of Non-Disclosure Agreement for Proprietary or Business Confidential  Information.                                                                                      |
| 10.9(2)            |       | Non-Competition,  Non-Disclosure and Patent and Inventions Assignment Agreement among Harry R.  McKinley, McKinley Optics, Inc. and AST, dated December 18, 1991.   |

 

31

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| 10.10*(2)  |   | License  and Development Agreement among Harry R. McKinley, McKinley Optics, Inc. and  AST, dated December 18, 1991, as amended on June 28, 1994.                                                                                                   |
|------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.11*(2)  |   | License  Agreement with Allen Newman, dated September 2, 1994, as amended  December 13, 1996.                                                                                                                                                       |
| 10.12*(2)  |   | Agreement  to Amend License and Development Agreement with Harry R. McKinley and  McKinley Optics, Inc., dated September 15, 1995.                                                                                                                       |
| 10.13*(2)  |   | License  Agreement with Kaiser Aerospace, dated July 19, 1995.                                                                                                                                                                                           |
| 10.14*(2)  |   | Technology  Strategic Alliance: Memorandum of Understanding with Kaiser Electro Optics,  Inc., dated July 19, 1995.                                                                                                                                 |
| 10.15*(2)  |   | Non-Exclusive  License Agreement with Fuji Photo Film Co., Ltd. and Fuji Photo Film Optical  Co., Ltd., dated June 25, 1996.                                                                                                                             |
| 10.16(2)   |   | Lease  dated April 14, 1994, as amended by a certain First Amendment to Lease  dated March 29, 1996 and a Second Amendment to Lease dated  October 22, 1996 with Robert F. Tambone, as Trustee of MAT Realty Trust,  u/d/t dated June 4, 1986. |
| 10.17(2)   |   | Standby  Letter of Credit from Silicon Valley Bank, dated August 9, 1996.                                                                                                                                                                                     |
| 10.18(2)   |   | 1995  Stock Option Plan.                                                                                                                                                                                                                                           |
| 10.19(2)   |   | 1995  Stock Option Plan Form of Notice of Grant.                                                                                                                                                                                                                   |
| 10.20(2)   |   | 1995  Stock Option Plan Form of Stock Option Agreement.                                                                                                                                                                                                            |
| 10.21(2)   |   | 1995  Stock Option Plan Form of Stock Purchase Agreement.                                                                                                                                                                                                          |
| 10.22(2)   |   | 1997  Stock Option/Stock Issuance Plan, as amended.                                                                                                                                                                                                                |
| 10.23(2)   |   | 1997  Stock Option/Stock Issuance Plan Form of Notice of Grant.                                                                                                                                                                                                    |
| 10.24(2)   |   | 1997  Stock Option/Stock Issuance Plan Form of Stock Option Agreement.                                                                                                                                                                                             |
| 10.25(2)   |   | 1997  Stock Option/Stock Issuance Plan Form of Stock Purchase Agreement.                                                                                                                                                                                           |
| 10.26(2)   |   | 1997  Employee Stock Purchase Plan.                                                                                                                                                                                                                                |
| 10.27(2)   |   | Form  of Indemnification Agreement between us and each of our directors.                                                                                                                                                                                           |
| 10.28(2)   |   | Form  of Indemnification Agreement between us and each of our officers.                                                                                                                                                                                            |
| 10.29(2)   |   | Form  of Waiver of Registration Rights, dated February 28, 1997.                                                                                                                                                                                              |
| 10.30(2)   |   | 1997  Stock Option/Stock Issuance Plan Form of Stock Issuance Agreement.                                                                                                                                                                                           |
| 10.31(2)   |   | Stock  Issuance Agreement dated March 3, 1997 with those purchasers set forth  in Schedule A.                                                                                                                                                            |
| 10.32(4)   |   | Common  Stock Purchase Warrant with Silicon Valley Bank, dated October 23, 1997.                                                                                                                                                                              |
| 10.33(4)   |   | Second  Amendment to the Amended and Restated Investor’s Rights Agreement with  Silicon Valley Bank and the Stockholders listed on Exhibit A thereto, dated  October 22, 1997.                                                                           |
| 10.38(5)   |   | Amended  and Restated Sales Agreement with Medtronic, Inc., dated June 26, 1998  (with certain confidential portions omitted).                                                                                                                                |
| 10.39(6)   |   | Vista  Medical Technologies, Inc., Industrial Real Estate Lease with Ocean Point  Tech Centre dated July 7, 1998.                                                                                                                                        |
| 10.40(7)   |   | Amendment  Number One to License Agreement with Imagyn Medical Technologies, Inc., dated  October 2, 1998.                                                                                                                                               |
| 10.41(7)   |   | Employment  Agreement with John Lyon dated December 28, 1998.                                                                                                                                                                                                 |
| 10.42(7)   |   | Employment  Agreement with Koichiro Hori dated December 28, 1998.                                                                                                                                                                                             |
| 10.43(7)   |   | Employment  Agreement with Allen Newman dated December 28, 1998.                                                                                                                                                                                              |
| 10.44(7)   |   | Employment  Agreement with Robert De Vaere dated December 28, 1998.                                                                                                                                                                                           |
| 10.45(8)   |   | Fifth  Amendment to Lease dated April 30, 1999.                                                                                                                                                                                                               |
| 10.46(8)   |   | Sofamor  Danek letter Amendment dated April 1999.                                                                                                                                                                                                             |
| 10.47(9)   |   | Agreement  with John Lyon dated July 20, 1999.                                                                                                                                                                                                                |
| 10.48(9)   |   | Agreement  with Koichiro Hori dated July 20, 1999.                                                                                                                                                                                                            |
| 10.49(9)   |   | Agreement  with Allen Newman dated July 20, 1999.                                                                                                                                                                                                             |
| 10.50(9)   |   | Agreement  with Robert De Vaere dated July 20, 1999.                                                                                                                                                                                                          |
| 10.51*(10) |   | Sales  Agreement with Richard Wolf, GmbH, dated December 22, 1999.                                                                                                                                                                                            |
| 10.52(11)  |   | Termination  Agreement with Medtronic, Inc., dated March 27, 2000.                                                                                                                                                                                            |
| 10.53(11)  |   | Transition  Agreement with Medtronic,Inc., dated March 27, 2000.                                                                                                                                                                                              |
| 10.54(11)  |   | Common  Stock purchase Agreement with John Kennedy, dated as of August 2, 2000.                                                                                                                                                                               |
| 10.55(12)  |   | Amendment  Two to Industrial Real Estate Lease with Ocean Pacific Tech Centre, dated  January 30, 2001.                                                                                                                                                  |
| 10.56(12)  |   | Exclusive  Distribution Agreement with Jomed International, dated as of  May 19, 2000.                                                                                                                                                                   |
| 10.57(12)  |   | Cooperative  Technology Agreement with Jomed International, dated as of May 19, 2000.                                                                                                                                                                              |
| 10.58*(13) |   | Exclusive  Supply and Promotion Agreement with Ethicon Endo-Surgery, Inc., dated as of  June 22, 2001.                                                                                                                                                        |
| 10.59(16)  |   | Asset  Purchase Agreement with Viking Systems, Inc. dated as of December 22,  2003.                                                                                                                                                                           |
|       | 23.1** |                                                                                                                                                                                                                                                               | Consent  of J. H. Cohn LLP, Independent Registered Public Accounting Firm |
|       | 23.2** |                                                                                                                                                                                                                                                               | Consent  of Ernst & Young LLP, Independent Registered Public Accounting Firm |
|            |        |                                                                                                                                                                                                                                                                    |  |

 

32

----

 
| 31.1** |   | Certification  of Principal Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.         |
|--------|--------|------------------------------------------------------------------------------------------------------------------------|
| 31.2** |   | Certification  of Principal Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.         |
| 32.1** |   | Certification  pursuant to 18 U.S.C. 1350, as adapted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

 

(1)                                                                    Incorporated byreference to our Form 10-K/A, filed on September 10, 1998.

 

(2)                                                                    Incorporated byreference to our Registration Statement on Form S-1, as amended, filed onJuly 2, 1997.

 

(3)                                                                    Incorporated byreference to our Form 10-Q, filed on November 13, 1997.

 

(4)                                                                    Incorporated byreference to our Form 10-K, filed on March 30, 1998.

 

(5)                                                                    Incorporated byreference to our Form 10-Q, filed on August 13, 1998.

 

(6)                                                                    Incorporated byreference to our Form 10-Q, filed on November 13, 1998.

 

(7)                                                                    Incorporated byreference to our Form 10-K, filed on March 29, 1999, as amended onSeptember 7, 1999.

 

(8)                                                                    Incorporated byreference to our Form 10-Q, filed on August 13, 1998, as amended onSeptember 7, 1999.

 

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

 

(10)                                                              Incorporated byreference to our Form 10-K, filed on March 29, 2000.

 

(11)                                                              Incorporated byreference to our Form 10-Q, filed May 12, 2000.

 

(12)                                                              Incorporated byreference to our Form 10-K filed April 2, 2001.

 

(13)                                                              Incorporated byreference to our Form 10-Q, filed August 3, 2001.

 

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

 

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

 

(16)                                                              Incorporated byreference to our Form 10-K, filed March 30, 2004.

----

*                                         Certainconfidential portions of this exhibit were omitted by means of redacting aportion of the text (the “Mark”).  Thisexhibit has been filed separately with the Secretary of the Securities andExchange Commission without the Mark pursuant to our application requestingconfidential treatment under Rule 406 under the Securities Act.

 

**                                  Filed herewith

 

 

SUPPLEMENTAL INFORMATION

 

Copiesof the Registrant’s Proxy Statement for the Annual Meeting of Stockholders tobe held June 1, 2005 and copies of the form of proxy to be used for such AnnualMeeting will be furnished to the Commission prior to the time they aredistributed to the Stockholders.

 

33

----

 

SIGNATURES

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities Exchange Actof 1934, the Registrant has duly caused this report to be signed on its behalfby the undersigned, thereunto duly authorized.

 

 
|                  | iVOW,  INC. |                     |
|-----------------------|-------------|--------------------------|
|                  |        |                     |   |
|                  |        |                     |   |
| Date:  March 31, 2005 | By:         | /s/  John R. Lyon        |   |
|                  |        | John  R. Lyon            |   |
|                  |        | Chief  Executive Officer |   |

 

                Know all men by these presents,that each person whose signature appears below constitutes and appoints John R.Lyon or Howard Sampson, his or her attorney-in-fact, with power of substitutionin any and all capacities, to sign any amendments to this Annual Report on Form10-K, and to file the same with exhibits thereto, and other documents inconnection therewith, with the Securities and Exchange commission, herebyratifying and confirming all that the attorney-in-fact or his or hersubstitutes may do or cause to be done by virtue hereof.

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this Report hasbeen signed below by the following persons on behalf of the Registrant in thecapacities and on the dates indicated.

 
| **SIGNATURE**        | ** ** | **TITLE**                                                             | ** ** | **DATE**        |
|----------------------|------------|-----------------------------------------------------------------------|------------|-----------------|
|                 |       |                                                                  |       |            |
| /s/  John R. Lyon    |       | Chief Executive Officer                                               |       | March  31, 2005 |
| (John R. Lyon)       |       | and Chairman of the Board  (Principal Executive Officer)              |       |            |
|                 |       |                                                                  |       |            |
| /s/  Howard Sampson  |       | Vice President of Finance and                                         |       | March  31, 2005 |
| (Howard Sampson)     |       | Chief Financial Officer (Principal  Financial and Accounting Officer) |       |            |
|                 |       |                                                                  |       |            |
| /s/ George B. DeHuff |       | Director                                                              |       | March  31, 2005 |
| (George B. DeHuff)   |       |                                                                  |       |            |
|                 |       |                                                                  |       |            |
| /s/ James Durham     |       | Director                                                              |       | March  31, 2005 |
| (James Durham)       |       |                                                                  |       |            |
|                 |       |                                                                  |       |            |
| /s/ James Hornthal   |       | Director                                                              |       | March  31, 2005 |
| (James Hornthal)     |       |                                                                  |       |            |
|                 |       |                                                                  |       |            |
| /s/ Michael Owens    |       | Director and President                                                |       | March  31, 2005 |
| (Michael Owens)      |       |                                                                  |       |            |
|                 |       |                                                                  |       |            |
| /s/ Scott Pancoast   |       | Director                                                              |       | March  31, 2005 |
| (Scott Pancoast)     |       |                                                                  |       |            |
|                 |       |                                                                  |       |            |
| /s/ Fred Toney       |       | Director                                                              |       | March  31, 2005 |
| (Fred Toney)         |       |                                                                  |       |            |

 

34

----

 

IVOW, Inc.

(formerly Vista Medical Technologies, Inc. and Subsidiary)

Index to Consolidated Financial Statements

 
| Report of J. H. Cohn LLP, Independent Registered  Public Accounting Firm                                          |   |   |
|-------------------------------------------------------------------------------------------------------------------|--------|--------|
| Report  of Ernst & Young LLP, Independent Registered Public Accounting Firm                                   |   |   |
|                                                                                                              |   |   |
| CONSOLIDATED  FINANCIAL STATEMENTS                                                                                |   |   |
|                                                                                                              |   |   |
| Consolidated Balance Sheets at December 31,  2003 and 2004                                                   |   |   |
| Consolidated Statements of  Operations for the years ended December 31, 2002, 2003, and 2004                 |   |   |
| Consolidated Statements of  Comprehensive Income for the years ended December 31, 2002, 2003, and  2004      |   |   |
| Consolidated Statements of  Stockholders’ Equity for the years ended December 31, 2002, 2003, and  2004 |   |   |
| Consolidated Statements of  Cash Flows for the years ended December 31, 2002, 2003, and 2004                 |   |   |
| Notes to Consolidated  Financial Statements                                                                       |   |   |

 

F-1

----

 

Report of Independent Registered Accounting Firm

 

The Board of Directors and Stockholders

iVOW, Inc.

 

We have audited the accompanying consolidated balance sheet of iVOW,Inc. (formerly Vista Medical Technologies, Inc. and Subsidiary) as of December31, 2004, and the related consolidated statements of operations, comprehensiveincome (loss), stockholders’ equity and cash flows for the year thenended.  These consolidated financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audit.

 

We conducted our audit in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe consolidated financial statements are free of material misstatement. Anaudit includes examining, on a test basis, evidence supporting the amounts anddisclosures in the consolidated financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of iVOW, Inc. asof December 31, 2004, and its results of operations and cash flows for theyear then ended, in conformity with accounting principles generally accepted inthe United States.  

 

As discussed in Note 1 to the consolidated financial statements, theCompany has incurred recurring net losses and negative net cash flows fromoperating activities from its inception. As of December 31, 2004, the Company had an accumulated deficit, and itsmanagement believes that the Company will require additional financing to fundits operations beyond June 2005, but cannot assure that such financing will beavailable. Such matters raise substantial doubt about the Company’s ability tocontinue as a going concern. Management’s plans concerning these matters are also discussed in Note1. The 2004 consolidated financial statements referred to above do not includeany adjustments related to the recoverability and classification of assets orthe amounts and classification of liabilities that may result from the outcomeof this uncertainty.

 
| /s/ J. H. Cohn LLP    |   |
|-----------------------|--------|
| San Diego, California |   |
| February 16, 2005     |   |

 

F-2

----

 

**Report of Independent****Registered Public Accounting Firm**

 

 

TheBoard of Directors and Stockholders

iVOW,Inc.

 

Wehave audited the accompanying consolidated balance sheets of iVOW, Inc. (f/k/aVista Medical Technologies, Inc.) as of December 31, 2003 and the relatedconsolidated statements of operations, stockholders’ equity, and cash flows foreach of the two years in the period ended December 31, 2003.  Our audit also included the financialstatement schedule listed in the index at Item 15(a) for the two years in theperiod ended December 31, 2003.  Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for ouropinion.

 

Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of iVOW, Inc. atDecember 31, 2003, and the consolidated results of its operations and its cashflows for each of the two years in the period ended December 31, 2003, inconformity with accounting principles generally accepted in the UnitedStates.  Also, in our opinion, therelated financial statement schedule for the two years in the period endedDecember 31, 2003, when considered in relation to the basic financialstatements taken as a whole, presents fairly in all material respects theinformation set forth therein.

 

Asdiscussed in Note 1 to the financial statements, iVOW, Inc. continues toexperience losses from operations and has accumulated losses totaling $68.1million through December 31, 2003.  AtDecember 31, 2003, the Company had cash, cash equivalents and short-terminvestments of $636,000.  The Companywill require additional financing to fund its operations through January 2005.These factors raise substantial doubt about the Company’s ability to continueas a going concern.  Management’s plan asto this matter is described in Note 1. The 2003 financial statements do notinclude any adjustments to reflect the possible future effects on therecoverability and classification of assets or the amounts and classificationof liabilities that may result from the outcome of this uncertainty.

 
|                  | /s/ Ernst & Young  LLP |   |
|-----------------------|----------------------------|--------|
|                  |                       |
|                  |                       |
| Boston, Massachusetts |                       |
| September 22, 2004    |                       |

 

F-3

----

 

iVOW, Inc.

(formerly VistaMedical Technologies, Inc. and Subsidiary)

ConsolidatedBalance Sheets

 
| ** **                                                                                                                                                                         | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
|                                                                                                                                                                               | ** ** | **2003**         | ** ** | **2004** | ** ** |
|                                                                                                                                                                               |       | **Restated**     |       |   |   |
| ASSETS                                                                                                                                                                             |       |             |       |   |   |
| Current assets:                                                                                                                                                                    |       |             |       |   |   |
| Cash and cash equivalents                                                                                                                                                          |       | $                | 448,943    |   | $ | 1,969,561 |   |
| Short-term investments                                                                                                                                                             |       | 187,209          |       | — |   |
| Accounts receivable                                                                                                                                                                |       | 286,152          |       | 176,291 |   |
| Due from Viking System, Inc.                                                                                                                                                       |       | —           |       | 188,797 |   |
| Inventories                                                                                                                                                                        |       | 45,275           |       | 62,094 |   |
| Assets related to discontinued operations                                                                                                                                          |       | 1,881,237        |       | — |   |
| Prepaid insurance                                                                                                                                                                  |       | 98,823           |       | 197,551 |   |
| Other current assets                                                                                                                                                               |       | 9,499            |       | 51,812 |   |
| Total current assets                                                                                                                                                               |       | 2,957,138        |       | 2,646,106 |   |
| Equipment, net of accumulated depreciation of $47,752 for 2003 and  $92,988 for 2004                                                                                               |       | 34,023           |       | 31,743 |   |
| Investment in marketable equity securities of Viking Systems, Inc,  available for sale                                                                                             |       | —           |       | 1,306,660 |   |
| Total assets                                                                                                                                                                       |       | $                | 2,991,161  |   | $ | 3,984,509 |   |
|                                                                                                                                                                               |       |             |       |   |   |
| LIABILITIES AND  STOCKHOLDERS' EQUITY                                                                                                                                              |       |             |       |   |   |
| Current liabilities:                                                                                                                                                               |       |             |       |   |   |
| Accounts payable                                                                                                                                                                   |       | $                | 141,631    |   | $ | 288,083 |   |
| Current portion of capital lease obligations                                                                                                                                       |       | 16,517           |       | 16,969 |   |
| Short-term bank borrowings                                                                                                                                                         |       | 200,000          |       | — |   |
| Short-term notes                                                                                                                                                                   |       | —           |       | 128,219 |   |
| Accrued compensation                                                                                                                                                               |       | 134,156          |       | 164,937 |   |
| Related party liabilities                                                                                                                                                          |       | 58,591           |       | 35,659 |   |
| Deferred revenue                                                                                                                                                                   |       | 442,500          |       | 31,250 |   |
| Liabilities related to discontinued operations                                                                                                                                     |       | 755,550          |       | — |   |
| Accrued liabilities                                                                                                                                                                |       | 115,428          |       | 85,896 |   |
| Total current liabilities                                                                                                                                                          |       | 1,864,373        |       | 751,013 |   |
| Long-term portion of capital lease obligations                                                                                                                                     |       | 18,624           |       | 10,516 |   |
| Total liabilities                                                                                                                                                                  |       | 1,882,997        |       | 761,529 |   |
|                                                                                                                                                                               |       |             |       |   |   |
| Commitments and contingencies                                                                                                                                                      |       |             |       |   |   |
|                                                                                                                                                                               |       |             |       |   |   |
| Stockholders’ equity:                                                                                                                                                         |       |             |       |   |   |
| Preferred stock, $.01 par value:  Authorized shares – 5,000,000 issued and outstanding shares – 1,000,000 in  2003 and 915,000 in 2004 (Liquidation value of $3,477,000) |       | 1,068,686        |       | 1,108,592 |   |
| Common stock, $.01 par value:  Authorized shares – 35,000,000 issued and outstanding shares – 5,007,918 in  2003 and 10,946,264 in 2004                                  |       | 50,079           |       | 109,462 |   |
| Additional paid-in capital                                                                                                                                                         |       | 68,111,244       |       | 72,702,851 |   |
| Accumulated other comprehensive income                                                                                                                                             |       | —           |       | 1,273,580 |   |
| Deferred compensation                                                                                                                                                              |       | (29,856          | )          | (7,896 | ) |
| Accumulated deficit                                                                                                                                                                |       | (68,091,989      | )          | (71,963,609 | ) |
| Total stockholders' equity                                                                                                                                                         |       | 1,108,164        |       | 3,222,980 |   |
| Total liabilities and stockholders' equity                                                                                                                                         |       | $                | 2,991,161  |   | $ | 3,984,509 |   |
|                                                                                                                                                                                    |            |                  |            |  |  |  |  |  |

 

SEEACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

F-4

----

 

iVOW, Inc.

(formerlyVista Medical Technologies, Inc. and Subsidiary)

Consolidated Statementsof Operations

 

 
| ** **                                                           | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                           | ** ** | **2002**                    | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                                           | ** ** | **Restated**                | ** ** | **Restated** | ** ** | ** ** | ** ** |
| Revenues                                                             |       | $                           | 3,542,883  |   | $ | 2,489,117 |   | $ | 1,650,735 |   |
| Cost and expenses:                                                   |       |                        |       |   |   |   |   |
| Cost of revenues                                                     |       | 1,174,447                   |       | 1,155,234 |   | 1,193,417 |   |
| Product development                                                  |       | 158,073                     |       | 167,610 |   | 405,612 |   |
| Sales and marketing                                                  |       | 1,603,647                   |       | 1,006,970 |   | 1,196,883 |   |
| General and administrative                                           |       | 1,082,003                   |       | 1,226,145 |   | 1,797,985 |   |
| Total costs and expenses                                             |       | 4,018,170                   |       | 3,555,959 |   | 4,593,897 |   |
|                                                                 |       |                        |       |   |   |   |   |
| Loss from operations                                                 |       | (475,287                    | )          | (1,066,842 | ) | (2,943,162 | ) |
| Other income, net                                                    |       | 17,426                      |       | 32,390 |   | (28,035 | ) |
| Loss from continuing operations                                      |       | (457,861                    | )          | (1,034,452 | ) | (2,971,197 | ) |
| Loss from discontinued operations                                    |       | (689,290                    | )          | (1,014,251 | ) | (632,516 | ) |
| Net loss                                                             |       | (1,147,151                  | )          | (2,048,703 | ) | (3,603,713 | ) |
| Accretion of dividends on preferred stock                            |       | —                      |       | (118,686 | ) | (135,922 | ) |
| Deemed dividend on redemption of preferred stock                     |       | —                      |       | — |   | (131,985 | ) |
|                                                                 |       |                        |       |   |   |   |   |
| Net loss applicable to common stockholders                           |       | $                           | (1,147,151 | ) | $ | (2,167,389 | ) | $ | (3,871,620 | ) |
|                                                                 |       |                        |       |   |   |   |   |
| Loss per share basic and diluted:                                    |       |                        |       |   |   |   |   |
| Continuing operations                                                |       | $                           | (0.09      | ) | $ | (0.23 | ) | $ | (0.37 | ) |
| Discontinued operations                                              |       |                        | (0.14      | ) |   | (0.20 | ) |   | (0.07 | ) |
| Net loss per common share applicable to common stockholders          |       | $                           | (0.23      | ) | $ | (0.43 | ) | $ | (0.44 | ) |
|                                                                 |       |                        |       |   |   |   |   |
| Shares used in computing basic and diluted net loss per common share |       | 4,968,519                   |       | 5,004,126 |   | 8,725,701 |   |

 

SEE ACCOMPANYING NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

F-5

----

 

iVOW, Inc.

(formerly Vista MedicalTechnologies, Inc. and Subsidiary)

Consolidated Statementsof Comprehensive Income (Loss)

 
| ** **                                       | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **2002**                    | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                             |       | **Restated**                |       | **Restated** |   |   |   |
| Net loss                                         |       | $                           | (1,147,151 | ) | $ | (2,048,703 | ) | $ | (3,603,713 | ) |
|                                             |       |                        |       |   |   |   |   |
| Unrealized gain on available-for-sale securities |       | —                      |       | — |   | 1,273,580 |   |
|                                             |       |                        |       |   |   |   |   |
| Total comprehensive loss                         |       | $                           | (1,147,151 | ) | $ | (2,048,703 | ) | $ | (2,330,133 | ) |

 

SEE ACCOMPANYING NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

F-6

----

iVOW, Inc.

(formerly Vista Medical Technologies, Inc. andSubsidiary)

ConsolidatedStatements Stockholders’ Equity

 
| ** **                                                   | **Additional  paid-in  capital** | ** **           | **Accumulated  other  comprehensive  income** | ** **        | **Notes  receivable  from  Stockholders** | ** ** | **Deferred  compensation** | ** ** | **Accumulated  deficit** | ** ** | **Total** | ** ** |
|--------------------------------------------------------------|----------------------------------|----------------------|-----------------------------------------------|-------------------|-------------------------------------------|------------|----------------------------|------------|--------------------------|------------|-----------|------------|
| ** **                                                   |
| ** **                                                   | ** **                       | **Preferred  stock** | ** **                                    | **Common  stock** | ** **                                |
| ** **                                                   | ** **                       | **Shares**           | ** **                                    | **Amount**        | **Shares**                                | ** ** | **Amount**                 |
|                                                         |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      |       |   |   |   |   |   |   |   |   |   |
| Balance at  December 31, 2001                           |                             |                 |                                          |              |                                      | 4,913,031  |                       | $          | 49,130                   |       | $         | 67,974,087 |   |   |   | $ | (78,375 | ) | $ | (76,305 | ) | $ | (64,777,449 | ) | $ | 3,091,088 |   |
|                                                         |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      |       |   |   |   |   |   |   |   |   |   |
| Exercise of stock  options and warrants for cash             |                             |                 |                                          |              |                                      | 64,808     |                       | 649        |                     | 34,982     |      |       |   |   |   |   |   |   |   | 35,631 |   |
| Issuance of stock  under employee stock purchase plan        |                             |                 |                                          |              |                                      | 23,910     |                       | 239        |                     | 34,792     |      |       |   |   |   |   |   |   |   | 35,031 |   |
| Deferred  compensation- issuance of options to consultants   |                             |                 |                                          |              |                                      |       |                       |       |                     | 36,000     |      |       |   |   |   | (36,000 | ) |   |   | — |   |
| Amortization of  deferred compensation                       |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      |       |   |   |   | 66,358 |   |   |   | 66,358 |   |
| Net loss                                                     |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      |       |   |   |   |   |   | (1,147,151 | ) | (1,147,151 | ) |
|                                                         |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      |       |   |   |   |   |   |   |   |   |   |
| Balance at  December 31, 2002                           |                             |                 |                                          |              |                                      | 5,001,749  |                       | 50,018     |                     | 68,079,861 |      |       |   | (78,375 | ) | (45,947 | ) | (65,924,600 | ) | 2,080,957 |   |
|                                                         |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      |       |   |   |   |   |   |   |   |   |   |
| Exercise of stock  options for cash                          |                             |                 |                                          |              |                                      | 1,333      |                       | 13         |                     | 1,986      |      |       |   |   |   |   |   |   |   | 1,999 |   |
| Issuance of stock  under employee stock purchase plan        |                             |                 |                                          |              |                                      | 4,836      |                       | 48         |                     | 6,397      |      |       |   |   |   |   |   |   |   | 6,445 |   |
| Deferred  compensation - issuance of options to consultants  |                             |                 |                                          |              |                                      |       |                       |       |                     | 23,000     |      |       |   |   |   | (23,000 | ) |   |   | — |   |
| Amortization of  deferred compensation                       |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      |       |   |   |   | 39,091 |   |   |   | 39,091 |   |
| Issuance of stock  – Series A preferred stock financing |                             | 1,000,000            |                                          | $                 | 950,000                                   |       |                       |       |                     |       |      |       |   |   |   |   |   |   |   |   | 950,000 |   |
| Forgiveness of  notes receivable                             |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      |       |   | 78,375 |   |   |   |   |   | 78,375 |   |
| Accretion of  preferred stock dividends                      |                             |                 |                                          | 118,686           |                                      |       |                       |       |                     |       |      |       |   |   |   |   |   | (118,686 | ) | — |   |
| Net loss                                                     |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      |       |   |   |   |   |   | (2,048,703 | ) | (2,048,703 | ) |
|                                                         |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      |       |   |   |   |   |   |   |   |   |   |
| Balance at  December 31, 2003                           |                             | 1,000,000            |                                          | 1,068,686         |                                      | 5,007,918  |                       | 50,079     |                     | 68,111,244 |      |       |   | — |   | (29,856 | ) | (68,091,989 | ) | 1,108,164 |   |
|                                                         |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      |       |   |   |   |   |   |   |   |   |   |
| Exercise of stock  options for cash                          |                             |                 |                                          |              |                                      | 37,333     |                       | 373        |                     | 29,793     |      |       |   |   |   |   |   |   |   | 30,166 |   |
| Issuance of stock  under employee stock purchase plan        |                             |                 |                                          |              |                                      | 7,469      |                       | 75         |                     | 10,248     |      |       |   |   |   |   |   |   |   | 10,322 |   |
| Unrealized gain  on available for sale securities            |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      | $          | 1,273,580 |   |   |   |   |   |   |   | 1,273,580 |   |
| Amortization of  deferred compensation                       |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      |       |   |   |   | 21,960 |   |   |   | 21,960 |   |
| Issuance of stock                                            |                             |                 |                                          |              |                                      | 5,893,544  |                       | 58,935     |                     | 4,551,566  |      |       |   |   |   |   |   |   |   | 4,610,501 |   |
| Redemption of  preferred stock                               |                             | (85,000              | )                                             | (96,016           | )                                         |       |                       |       |                     |       |      |       |   |   |   |   |   |   |   | (96,016 | ) |
| Accretion of  preferred stock dividends                      |                             |                 |                                          | 135,922           |                                      |       |                       |       |                     |       |      |       |   |   |   |   |   | (135,922 | ) | — |   |
| Deemed dividend  on redemption of preferred stock            |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      |       |   |   |   |   |   | (131,985 | ) | (131,985 | ) |
| Net loss                                                     |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      |       |   |   |   |   |   | (3,603,713 | ) | (3,603,713 | ) |
|                                                         |                             |                 |                                          |              |                                      |       |                       |       |                     |       |      |       |   |   |   |   |   |   |   |   |   |
| Balance at  December 31, 2004                           |                             | 915,000              |                                          | $                 | 1,108,592                                 |       | 10,946,264                 |       | $                        | 109,462    |      | $          | 72,702,851 |   | $ | 1,273,580 |   | $ | — |   | $ | (7,896 | ) | $ | (71,963,609 | ) | $ | 3,222,980 |   |

 

SEE ACCOMPANYING NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

F-7

----

 

iVOW, Inc.

(formerly Vista Medical Technologies, Inc. andSubsidiary)

Consolidated Statementsof Cash Flows

 
| ** **                                                                                            | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                            | ** ** | **2002**                    | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                                                                            |       | **Restated**                |       | **Restated** |   |   |   |
| **OPERATING ACTIVITIES**                                                                              |       |                        |       |   |   |   |   |
| Net loss                                                                                              |       | $                           | (1,147,151 | ) | $ | (2,048,703 | ) | $ | (3,603,713 | ) |
|                                                                                                  |       |                        |       |   |   |   |   |
| Adjustments to reconcile net loss to net cash used in operating  activities:                          |       |                        |       |   |   |   |   |
| Depreciation and amortization                                                                         |       | 8,488                       |       | 39,264 |   | 45,236 |   |
| Forgiveness of notes receivable                                                                       |       | —                      |       | 78,375 |   | — |   |
| Amortization of deferred compensation                                                                 |       | 66,358                      |       | 39,091 |   | 21,960 |   |
| Changes in operating assets and liabilities:                                                          |       |                        |       |   |   |   |   |
| Accounts receivable                                                                                   |       | (647,884                    | )          | 361,732 |   | 109,861 |   |
| Inventories                                                                                           |       | (57,421                     | )          | 12,146 |   | (16,819 | ) |
| Other current assets                                                                                  |       | (60,148                     | )          | (48,174 | ) | (141,041 | ) |
| Accounts payable                                                                                      |       | 177,189                     |       | (35,558 | ) | 146,452 |   |
| Accrued compensation                                                                                  |       | 109,618                     |       | 24,538 |   | 30,781 |   |
| Deferred revenue                                                                                      |       | 494,167                     |       | (51,667 | ) | (411,250 | ) |
| Other liabilities                                                                                     |       | 288,747                     |       | (114,728 | ) | (52,464 | ) |
| Changes in assets and liabilities related to discontinued operations                                  |       | 225,590                     |       | 422,409 |   | 379,073 |   |
| Net cash flows used in operating activities                                                           |       | (542,447                    | )          | (1,321,275 | ) | (3,491,924 | ) |
|                                                                                                  |       |                        |       |   |   |   |   |
| **INVESTING ACTIVITIES**                                                                              |       |                        |       |   |   |   |   |
| Maturity of short-term investments                                                                    |       | 144,535                     |       | 185,111 |   | 187,209 |   |
| Purchase of property and equipment                                                                    |       | (16,245                     | )          | (22,375 | ) | (42,956 | ) |
| Proceeds from the sale of business                                                                    |       | —                      |       | — |   | 496,736 |   |
| Net cash flows provided by investing activities                                                       |       | 128,290                     |       | 162,736 |   | 640,989 |   |
|                                                                                                  |       |                        |       |   |   |   |   |
| **FINANCING ACTIVITIES**                                                                              |       |                        |       |   |   |   |   |
| Issuance of common stock, net                                                                         |       | 70,662                      |       | 8,444 |   | 4,650,990 |   |
| Issuance of Series A preferred stock                                                                  |       | —                      |       | 950,000 |   | — |   |
| Redemption of Series A preferred stock                                                                |       |                        |       |   |   | (200,000 | ) |
| Issuance of short-term notes                                                                          |       |                        |       |   |   | 202,406 |   |
| Payment on short-term notes                                                                           |       |                        |       |   |   | (74,187 | ) |
| Short-term bank borrowings (repayments)                                                               |       | —                      |       | 200,000 |   | (200,000 | ) |
| Payments on capital leases.                                                                           |       | —                      |       | (8,014 | ) | (7,656 | ) |
| Net cash flows provided by financing activities                                                       |       | 70,662                      |       | 1,150,430 |   | 4,371,553 |   |
|                                                                                                  |       |                        |       |   |   |   |   |
| Net increase (decrease) in cash and cash equivalents                                                  |       | (343,495                    | )          | (8,109 | ) | 1,520,618 |   |
| Cash and cash equivalents at beginning of year                                                        |       | 800,547                     |       | 457,052 |   | 448,943 |   |
| Cash and cash equivalents at end of year                                                              |       | $                           | 457,052    |   | $ | 448,943 |   | $ | 1,969,561 |   |
|                                                                                                  |       |                        |       |   |   |   |   |
| Non-cash transactions:                                                                                |       |                        |       |   |   |   |   |
| Acquisition of equipment through capital leases                                                       |       | $                           | 23,514     |   | $ | 43,141 |   | $ | — |   |
| Accretion of cumulative dividends on preferred stock                                                  |       | —                      |       | $ | 118,686 |   | $ | 135,922 |   |
| Common shares of Viking Systems, Inc. received for the sale of the  Visualization Technology business |       |                        |       |   |   | $ | 61,080 |   |
| Common shares of Viking Systems, Inc. distributed to preferred  stockholders                          |       |                        |       |   |   | $ | (28,000 | ) |
| Supplementary cash flow information:                                                                  |       |                        |       |   |   |   |   |
| Interest paid                                                                                         |       | $                           | —     |   | $ | 4,992 |   | $ | 7,103 |   |

 

SEE ACCOMPANYING NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

F-8

----

 

iVOW, Inc.

(formerly Vista Medical Technologies, Inc. and Subsidiary)

Notes to ConsolidatedFinancial Statements

 

1. ORGANIZATIONAND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND BUSINESS ACTIVITY

 

iVOW, Inc., formerlyVista Medical Technologies, Inc., was founded in 1993 primarily to developadvanced visualization technologies for complex minimally invasive surgicalprocedures. It was through the application of this technology in laparoscopicgastric bypass surgery that we subsequently developed a suite of consultingproducts and services for the initiation, operation and management of obesitysurgery programs. Starting in early 2003, our Visualization Technologybusiness, located in Westborough, Massachusetts, and our Obesity SurgeryManagement Services business unit, located in Carlsbad, California, functionedas individual business units.  InApril 2004, we sold the Visualization Technology business to concentrateon the obesity surgery services market. We changed our name to iVOW, Inc. in February 2005, after merging ourwholly owned subsidiary VOW Solution, Inc., to align our corporate name withthe brand name of our chronic and morbid obesity disease management business,which is now our exclusive focus.

We originally beganoffering training and consulting services to the obesity surgery market in2001.   As a result of the disposition ofour Visualization Technology business, we are now a pure play company in thebariatric market. We develop and market products and services for the bariatricsurgery market. Bariatrics is the medical science of weight reduction andnutrition; bariatric surgery, a specialized area of general surgery, is focusedon surgical weight reduction solutions for the very severely or morbidlyobese.  We are exclusively focused on implementingdisease management strategies for the control of chronic and severeobesity.  Our vision is to enablehealthcare providers and organizations in the ongoing evolution of the higheststandards of treatment and services to optimize the quality of life for chronicand morbidly obese patients. Our mission is to deliver the leading managementportfolio of services and products for the clinical and business development ofcontinually successful medical and surgical programs for the treatment ofchronic and morbid obesity.

Our goal is to become theleading disease management and consulting company focused on chronic and morbidobesity. Our initial focus on the severely obese patient, and gastric bypasssurgery as the solution, is the platform upon which we will expand service tonew obesity therapies as they are developed. We also plan to integrate abariatric medical model into our surgical protocols, both to facilitate thelong term care of post-surgical patients, and in due course, to treat obesepatients who are not qualified for surgery.

 

We incurred net losses and negative net cashflows from operating activities in 2002, 2003 and 2004, and at December 31,2004, had an accumulated deficit of $72.0 million.  At December 31, 2004, we had cash and cash equivalentsof $1,970,000.  We believe that our cashand cash equivalents, together with anticipated 2005 product revenues andinterest income, will be sufficient to meet our anticipated capitalrequirements through at least June 2005. These factors raise substantial doubt about our ability to continue as agoing concern.  We are pursuing severalalternatives to address this situation, including raising additional funding,but cannot assure that we will be successful. Should we be unable to raise sufficient funds, we may be required tocurtail our operating plans and possibly relinquish rights to portions of ourintellectual property or products.  Inaddition, increases in expenses and delays in signing new management andconsulting contract may adversely impact our cash position and require furthercost reductions.  No assurance can begiven that we will be able to operate profitably on a consistent basis, or atall, in the future.

 

The accompanyingconsolidated financial statements have been prepared on a going concern basis,which contemplates the realization of assets and the satisfaction ofliabilities in the normal course of business. The consolidated financial statements do not include any adjustmentsrelating to the recoverability and classification of assets or the amounts andclassification of liabilities that might be necessary should we be unable tocontinue as a going concern.

 

PRINCIPLES OF CONSOLIDATION

 

In February 2005, our subsidiary, VOWSolutions, Inc., was merged with Vista Medical Technologies, Inc., as part ofthe name change to IVOW, Inc.  Theconsolidated financial statements include the accounts of our wholly ownedsubsidiary, VOW Solutions, Inc. (“VOW”) prior to the merger and us.  Significant intercompany accounts andtransactions have been eliminated.

 

F-9

----

 

RECLASSIFICATIONS/RESTATEMENT

 

Certain account balances for the prior years have been reclassified toconform to the current year financial statement presentation.

 

In late September 2004 we filed an Amendmentto our Annual Report on Form 10-K for the fiscal year ended December 31,2003 to restate our previously issued financial statements for the year endedDecember 31, 2003 to reflect our Visualization Technology business as a discontinuedoperation.  Additionally in 2004, we havereclassified costs and expenses of our continuing operations in the statementsof operations for the years 2002 and 2003, and the first three quarters of2004, to be on a comparative basis with 2004. The change in reporting implemented for 2004 is the direct result of thesale of our technology business and the transitioning from a manufacturingbusiness to a management and consulting business.  Reclassifications were made based on ourestimate of time spent on various activities along with estimates of relatedindirect costs.  The table below presentsthe amounts previously reported for continuing operations for 2002 and 2003 inthe 10-K/A for 2003 and balances after reclassifications for 2002 and 2003.

 

 

| ** **                 | ** ** | **As previously reported  in the 2003 10-K/A** | ** ** | **After reclassification** | ** ** |
|----------------------------|------------|------------------------------------------------|------------|----------------------------|------------|
| ** **                 | ** ** | **2002**                                       | ** ** | **2003**                   | ** ** | **2002** | ** ** | **2003** | ** ** |
| Cost and expenses          |       |                                           |       |                       |       |   |   |   |   |
| Cost of revenue            |       | $                                              | 797,528    |                       | $          | 574,599 |   | $ | 1,174,447 |   | $ | 1,155,234 |   |
| Product development        |       | —                                         |       | —                     |       | 158,073 |   | 167,610 |   |
| Sales and marketing        |       | 2,138,639                                      |       | 1,755,215                  |       | 1,603,647 |   | 1,006,970 |   |
| General and administrative |       | 1,082,003                                      |       | 1,226,145                  |       | 1,082,003 |   | 1,226,145 |   |
| Total cost and expenses    |       | $                                              | 4,018,170  |                       | $          | 3,555,959 |   | $ | 4,018,170 |   | $ | 3,555,959 |   |

 

USE OF ESTIMATES

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe amounts reported in the consolidated financial statements and disclosuresmade in the accompanying notes to the consolidated financial statements.  Actual results could differ from thoseestimates.  See Reclassifications/Restatementabove for a description of estimates used in the reclassification of expensesfor 2002 and 2003.

 

REVENUE RECOGNITION

 

Revenue generated from our disease statemanagement of morbid obesity business is recognized (i) with regard tomanagement services, upon completion of the service period and (ii) with regardto training services or other consulting services, upon completion of therelated training or consulting component, provided that a contract exists,there are no uncertainties regarding customer acceptance, the sales price isfixed or determinable and collectibility is reasonably assured.  Any payments received in advance ofcompletion of the service are recorded as deferred revenue.  Sales of vitamins are similarly recognizedupon shipment provided that a purchase order has been received, there are no uncertaintiesregarding customer acceptance, the sales price is fixed or determinable andcollectibility is reasonably assured.

 

Sales returns are estimated based on thehistorical experience and management’s expectations and are recorded at thetime product revenue is recognized.

 

We received semiannual payments as a resultof fulfilling certain obligations related to our strategic alliance agreementwith Ethicon Endo-Surgery, Inc. (EES). These payments are recognized as revenue on a straight-line basis overthe related contract term, provided that we have complied with all contractualobligations.  The strategic allianceagreement ended in December 2004.

 

F-10

----

 

CASH, CASH EQUIVALENTS AND SHORT-TERMINVESTMENTS

 

Cash equivalents and short-term investmentsconsist of money market funds and certificates of deposit. We consider allhighly liquid investments with maturities of three months or less whenpurchased to be cash equivalents. We evaluate the financial strength ofinstitutions at which significant investments are made and believe the relatedcredit risk is limited to an acceptable level.

 

FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The carrying amounts of the our financialinstruments, which include cash and cash equivalents, accounts receivable,accounts payable, capital leases, short-term bank borrowings and short termnotes, approximate their fair values at December 31, 2003 and 2004, due to theshort-term nature of these financial instruments.

 

MARKETABLE SECURITIES

 

We have classified marketable securities asavailable for sale in accordance with Statement of Financial AccountingStandards No. 115, *Accounting for CertainInvestments in Debt and Equity Securities*(“SFAS 115”).  In accordance with SFAS 115, marketablesecurities are recorded at fair value and any unrealized gains and losses areexcluded from earnings and reported as a separate component of stockholders’equity until realized.  The fair value ofour marketable securities at December 31, 2004 is based on quoted marketprices.  For the purpose of computingrealized gains and losses, cost is identified on a specific identificationbasis.

 

ACCOUNTSRECEIVABLE

 

Inthe normal course of business, we extend unsecured credit to hospitals locatedthroughout the United States. The Company routinely assesses the financialstrength of its customers and believes that its trade accounts receivablecredit risk exposure is limited.

 

INVENTORIES

 

Inventories are stated at the lower of cost(determined on a first-in, first-out basis) or market and include finishedgoods inventory at December 31, 2003 and 2004.

 

PROPERTY AND EQUIPMENT

 

Property and equipment is stated at cost andinclude office computers, furniture and equipment at December 31, 2003 and2004. We provide for depreciation on property and equipment using thestraight-line method over the estimated useful lives of the assets, generallytwo to five years.  Depreciation expenserelated to continuing operations for the years ended 2002, 2003 and 2004 was$8,488, $39,264 and $45,236, respectively.

 

IMPAIRMENT OF LONG-LIVED ASSETS

 

We evaluate our long-lived assets forimpairment in accordance with SFAS No. 144, *Accounting for theDisposal or Impairment of Long-Lived Assets*.  We record impairment losses on long-livedassets used in operations when indicators of impairment are present and theundiscounted cash flows estimated to be generated by those assets are less thanthe carrying value of the assets. There have not been any impairments oflong-lived assets to date.

 

INCOME TAXES

 

We and our wholly owned subsidiaries file a consolidated federal incometax return.  Income taxes are providedfor the tax effects of transactions reported in the financial statements andconsist of taxes currently due plus deferred income taxes.  Deferred income taxes are recognized fortemporary differences between the financial statement and tax bases of assetsand liabilities that will result in taxable or deductible amounts in thefuture.  Deferred income taxes are alsorecognized for net operating loss carryforwards that are available to offsetfuture taxable income and research and development credits.  Valuation allowances are established whennecessary to reduce deferred tax assets to the amount expected to be realized.

 

F-11

----

 

COMPREHENSIVE INCOME (LOSS)

 

Comprehensive income  (loss) is comprised of net loss and othercomprehensive income (loss). Other comprehensive income (loss) includes certainchanges in equity that are excluded from net loss.  For the year ended December 31, 2004,comprehensive income (loss) other than our net loss, was comprised of anunrealized gain on available for sale securities.

 

LOSS PER SHARE

 

Basic net loss per share is calculated basedon the weighted average number of common shares outstanding during the period.Diluted net loss per share incorporates the dilutive effect of potentialdilutive shares of common stock, including shares attributable to stockoptions, warrants and other convertible securities.  Potentially dilutive shares of common stockhave been excluded from the calculation of weighted average number of dilutedcommon shares, as their effect would be antidilutive for all periodspresented.  For the purpose ofdetermining basic and diluted net loss per share, dividends accreted on preferredstock and the deemed dividend with respect to the preferred stock redemption(see Note 9) have been deducted from the net loss to arrive at net lossapplicable to common stockholders. Potentially dilutive shares of common stock that have been excluded fromthe calculation of the weighted average number of dilutive common shares forthe year ended December 31, 2002 include shares attributed to options topurchase up to 689,328 shares of common stock, For the year ended December 31,2003, potentially dilutive shares of common stock that have been excluded fromthe calculation of the weighted average number of dilutive common shares were1,806,286 shares, comprised of 1,000,000 convertible preferred shares andoptions to purchase up to 806,286 shares of common stock.  For the year ended December 31, 2004,potentially dilutive shares of common stock that have been excluded from thecalculation of the weighted average number of dilutive common shares were5,750,865 shares, comprised of 3,764,953 warrant shares, 915,000 convertiblepreferred shares and options to purchase up to 1,070,912 shares of commonstock.

 

STOCK-BASED COMPENSATION

 

SFAS No. 123, “*Accountingfor Stock-Based Compensation*,” establishes a fair value basedapproach for valuing stock options.  Wefollow the disclosure-only alternative afforded by SFAS 123.  However, we account for stock-basedcompensation to non-employees using the fair value method prescribed by SFAS123.

 

We apply the principles of AccountingPrinciples Board Opinion No. 25, “*Accounting for StockIssued to Employees*,” and related interpretations in accounting forits employee stock option compensation plans. Under APB No. 25, compensationexpense is measured using the intrinsic value method as the difference, if any,between the option exercise price and the fair value of our common stock at thedate of grant.  We have historicallygranted options to employees and directors at exercise prices equal to the fairvalue of the Company’s common stock. Accordingly, no compensation expense hasbeen recognized for its employee stock-based compensation plans.

 

Hadcompensation costs for stock options issued to employees and directors beendetermined based on the estimated fair value at the grant dates as calculatedin accordance with SFAS 123 and amortized over the vesting period, our reportednet loss and basic and diluted net loss per common share for the years endedDecember 31, 2002, 2003 and 2004 would have been adjusted to the pro formaamounts indicated below: 

 

| ** **                                             | ** ** | **For the years ended December 31,**      | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                             | ** ** | **2002**                                  | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                             | ** ** | **In thousands except per share amounts** | ** ** |
| Net loss applicable to common stockholders:            |       |                                      |       |   |   |   |   |
| As reported                                            |       | $                                         | (1,147     | ) | $ | (2,167 | ) | $ | (3,872 | ) |
| Stock based compensation expense included in net loss  |       | 66                                        |       | 39 |   | 22 |   |
| Pro forma compensation expense using fair value method |       | (344                                      | )          | (262 | ) | (296 | ) |
| Pro forma net loss                                     |       | $                                         | (1,425     | ) | $ | (2,390 | ) | $ | (4,146 | ) |
|                                                   |       |                                      |       |   |   |   |   |
| Basic and diluted net loss per share:                  |       |                                      |       |   |   |   |   |
| As reported                                            |       | $                                         | (0.23      | ) | $ | (0.43 | ) | $ | (0.44 | ) |
| Pro forma                                              |       | $                                         | (0.29      | ) | $ | (0.48 | ) | $ | (0.48 | ) |

 

F-12

----

 

The fair value of each option granted under our stock option plans isestimated on the date of grant using the Black-Scholes option-pricing modelwith the following weighted average assumptions:

 
| ** **                      | ** ** | **2002** | ** ** | **2003**  | ** ** | **2004**   | ** ** |
|---------------------------------|------------|----------|------------|-----------|------------|------------|------------|
| Dividend Yield                  |       | None     |       | None      |       | None       |       |
| Volatility                      |       | 106%     |       | 124%      |       | 126%       |       |
| Risk-free interest rate         |       | 2.6-6.5% |       | 1.0-2.29% |       | 1.94-3.32% |       |
| Expected life (years)           |       | 5        |       | 3         |       | 3          |       |
| Per share grant date fair value |       | $3.47    |       | $1.09     |       | $1.38      |       |

 

The Black-Scholes option-pricing model wasdeveloped for use in estimating the fair value of traded options that have novesting restrictions and are fully transferable. In addition, option-pricingmodels require the use of highly subjective assumptions, including the expectedstock price volatility. Because our employee stock options have characteristicssignificantly different from those of traded options, and because changes inthe subjective assumptions can materially affect the fair value estimates, inour opinion, the existing models do not necessarily provide a reliable singlemeasure of the fair value of its employee stock-based compensation.

 

We account for stock-based compensation tonon-employees using the fair value method prescribed by SFAS 123.  As a result of stock options issued tonon-employee, we recognized $36,000 and $23,000 in non-employee deferredcompensation for the years ended December 31, 2002 and 2003, respectively.  The fair value of the non-employee stockoptions was derived from the Black-Scholes option-pricing model using thefollowing weighted-average assumptions:

 
| ** **              | ** ** | **2002**     | ** ** | **2003** | ** ** |
|-------------------------|------------|--------------|------------|----------|------------|
| Dividend Yield          |       | None         |       | None     |       |
| Volatility              |       | 231%         |       | 124%     |       |
| Risk-free interest rate |       | 3.05  - 3.5% |       | 1.3%     |       |
| Expected life (years)   |       | 3            |       | 3        |       |

 

ADVERTISING COSTS

 

Advertising costs are expensed as they areincurred.  Total advertising expenses for2002, 2003 and 2004 were $33,003, $33,258 and $23,708, respectively.

 

NEW ACCOUNTING STANDARDS

 

In December 2004, theFASB issued SFAS No. 123(R) (revised 2004), *Share-BasedPayment*, which amends SFAS 123 and will be effective for publiccompanies for interim or annual periods beginning after June 15, 2005. The newstandard will require us to expense employee stock options and othershare-based payments. The FASB believes the use of a binomial lattice model foroption valuation is capable of more fully reflecting certain characteristics ofemployee share options compared to the Black-Scholes options pricing model. The new standard may be adopted in one of three ways - the modifiedprospective transition method, a variation of the modified prospectivetransition method or the modified retrospective transition method. We arecurrently evaluating how we will adopt the standard and evaluating the effectthat the adoption of SFAS 123(R) will have on our financial position andresults of operations.

 

In November 2004,the FASB issued SFAS No. 151, *InventoryCosts, an amendment of ARB No. 43, Chapter 4.*Thisstatement amends the guidance in ARB No. 43, Chapter 4, *Inventory Pricing*, to clarify theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts, and wasted material (spoilage). Paragraph 5 of ARB No. 43,Chapter 4, previously stated “...under some circumstances, items such asidle facility expense, excessive spoilage, double freight, and rehandling costsmay be so abnormal as to require treatment as current period charges...” SFAS151 requires that those items be recognized as current-period chargesregardless of whether they meet the criterion of “so abnormal.” In addition,this statement requires that allocation of

 

F-13

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fixed productionoverheads to the costs of conversion be based on the normal capacity of theproduction facilities. The provisions of SFAS 151 shall be appliedprospectively and are effective for inventory costs incurred during fiscalyears beginning after June 15, 2005, with earlier application permittedfor inventory costs incurred during fiscal years beginning after the date thisstatement was issued. The adoption of SFAS 151 is not expected to have amaterial impact on our financial position and results of operations.

 

In December 2004,the FASB issued SFAS No. 153, *Exchangesof Nonmonetary Assets, an amendment of APB Opinion No. 29*. Theguidance in APB Opinion No. 29, *Accountingfor Nonmonetary Transactions*, is based on the principle thatexchanges of nonmonetary assets should be measured based on the fair value ofassets exchanged. The guidance in that Opinion, however, included certainexceptions to that principle. SFAS 153 amends Opinion 29 to eliminate theexception for nonmonetary exchanges of similar productive assets that do nothave commercial substance. A nonmonetary exchange has commercial substance ifthe future cash flows of the entity are expected to change significantly as aresult of the exchange. SFAS 153 is effective for nonmonetary exchangesoccurring in fiscal periods beginning after June 15, 2005. The adoption ofSFAS 153 is not expected to have a material impact on our financial positionand results of operations.

 

### ***2.  DISCONTINUEDOPERATIONS***

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

Underthe Asset Purchase Agreement, we sold all the operating assets and relatedliabilities of the Visualization Technology business to Viking.  In return, Viking agreed to (a) pay us$159,000 at closing, (b) issue to us 3,054,000 shares of Viking common stock,representing approximately 10% of its common shares outstanding on a fullydiluted basis, and (c) remit to us the value of any former VisualizationTechnology inventory sold by Viking before April 15, 2005.  We also entered into a license agreement withViking that will pay us royalties over the next five years based on sales ofthe acquired products of the Visualization Technology business with minimumroyalties during the five year period as follows: first year $150,000, yearstwo through four $300,000 and year five $375,000 with a maximum aggregateroyalties of $4,500,000 over the five year period.  We will maintain ownership rights of allintellectual property and product rights under the license agreement withViking until at least the minimum royalty obligations have been satisfied, atwhich time we will transfer such ownership rights to Viking.

Thenet operating assets sold to Viking and the total consideration paid orcontractually due from Viking, exclusive of any proceeds from the subsequentsale of Visualization Technology inventory by Viking, are as follows:

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

 

F-14

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Under accounting principles generally accepted in the United States ofAmerica, the transaction is principally the exchange of non-monetary assetsbetween Viking and us.  As a result, thevalue of the net assets sold, $746,614, is considered to be equal to the valueof the net assets received and a gain is not recognized at the time of thetransaction.  The Viking consideration,exclusive of cash, is considered non-monetary because Viking is a relativelynew company that has not raised substantial funds and may be unable to raisesufficient funds and to sustain its operations or fund its growth plan.  Additionally, there can be no assurance thatViking’s business will succeed, accordingly, all contractual amounts due us areat risk.  All proceeds received fromViking will be first credited against the Due from Viking Systems, Inc.account.  As of December 31, 2004, thebalance Due from Viking Systems, Inc. is $188,797.  All proceeds in excess of the balance Duefrom Viking Systems, Inc. will be recorded as a gain from discontinuedoperations when received.  During theyear ended December 31, 2004, we received from Viking $496,736 in proceeds fromthe sale of inventory by Viking.

Ourfinancial results for the years ended December 31, 2002, 2003 and 2004have been reclassified to show the results of operations for the VisualizationTechnology business as a discontinued operation.  The operating results of the discontinuedoperations were as follows:

 

 

| ** **                        | ** ** | **For the years ended December 31,** | ** ** |
|-----------------------------------|------------|-------------------------------------------|------------|
| ** **                        | ** ** | **2002**                                  | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenues                          |       | $                                         | 7,563,247  |   | $ | 6,220,091 |   | $ | 1,227,672 |   |
| Cost and Expenses                 |       |                                      |       |   |   |   |   |
| Cost of sales                     |       | 5,191,353                                 |       | 4,610,239 |   | 1,035,667 |   |
| Research and development          |       | 1,709,534                                 |       | 1,177,656 |   | 330,014 |   |
| Sales and marketing               |       | 551,393                                   |       | 323,177 |   | 78,678 |   |
| General and administrative        |       | 800,257                                   |       | 1,123,270 |   | 415,829 |   |
| Total cost and expenses           |       | 8,252,537                                 |       | 7,234,342 |   | 1,860,188 |   |
| Loss from discontinued operations |       | $                                         | (689,290   | ) | $ | (1,014,251 | ) | $ | (632,516 | ) |

 

The equipment financing costs associated withthe equipment sold to Viking have been included in discontinued operations.

 

Thecomponents of the net assets and liabilities of the discontinued operationswere as follows:
| ** **                        | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------|------------|------------------------|------------|
| Assets                            |       |                   |       |
| Accounts receivable               |       | $                      | 693,725    |   |
| Inventory                         |       | 1,113,932              |       |
| Prepaid expenses                  |       | 66,144                 |       |
| Property and equipment, net       |       | 7,436                  |       |
| Total assets                      |       | $                      | 1,881,237  |   |
|                              |       |                   |       |
| Liabilities                       |       |                   |       |
| Accounts payable                  |       | $                      | 561,207    |   |
| Current portion of capital leases |       | 7,467                  |       |
| Accrued compensation              |       | 101,837                |       |
| Deferred revenue                  |       | 37,500                 |       |
| Accrued liabilities               |       | 47,539                 |       |
| Total liabilities                 |       | $                      | 755,550    |   |

 

F-15

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We have a severance agreement with a formeremployee who became an employee of Viking upon the sale of the VisualizationTechnology business.  Under theagreement, we may be required to pay the employee one year’s compensation(approximately $200,000) if the employee is terminated under certaincircumstances within 18 months following the sale of the business or prior toOctober 2005.  No provision for suchpayment has been included in the results of discontinued operations and willnot be provided for until such payment is probable.

 

3. CASH, CASH EQUIVALENTS AND SHORT TERM INVESTMENTS

 

As of December 31, 2003 and 2004, the Company’scash, cash equivalents and short-term investments consisted of:

| ** **              | ** ** | **2003** | ** **    | **2004**  | ** ** |
|-------------------------|------------|----------|---------------|-----------|------------|
| Cash Money              |       | $        | 319,790  |      | $          | 89,916  | ** ** |
| market funds            |       | 129,153  |          | 1,879,645 | ** ** |
| Certificates of deposit |       | 187,209  |          | —    | ** ** |
|                    |       |     |          |      | ** ** |
|                    |       | $        | 636,152       |      | $          | 1,969,561 |   |

 

Allof the Company’s certificates of deposit held at December 31, 2003 matured in2004.

 

4.  INVESTMENT IN EQUITYSECURITIES OF VIKING SYSTEMS, INC.

Aspart of the sale of our Visualization Technology business in April 2004, wewere issued 3,054,000 shares of Viking common stock (see Note 2) valued at$0.02 per share or $61,080, which reflected the fair value of the shares at thetime the shares were acquired.  In June2004, 1,400,000 of these shares valued at $0.02 per share, or $28,000, wereused to obtain certain rights from our Series A holders (see Note 9) with theremaining 1,654,000 shares valued at $33,080.  In October 2004, the Viking common shares began trading on the Over TheCounter Bulletin Board and, accordingly, the carrying value of the availablefor sale marketable equity securities has been adjusted to fair value and the unrealized gain hasbeen offset against stockholders’ equity at December 31, 2004.  There is a significant risk of adjustment tothe carrying value due to possible market fluctuations in their stock price.

Thecost and fair value of the equity securities at December 31, 2004 are asfollows:

| **Corporate Equity Securities:** | ** ** | **Cost** | ** ** | **Unrealized Gain** | ** ** | **Fair Value** | ** ** |
|----------------------------------|------------|----------|------------|---------------------|------------|----------------|------------|
| Viking Systems, Inc.             |       | $        | 33,080     |                | $          | 1,273,580      |       | $ | 1,306,660 |   |
|                                  |            |          |            |                     |            |                |            |  |  |  |

 

 

5.ACCRUED LIABILITIES

Accrued liabilities consist of the following:

| ** **              | ** ** | **2003** | ** ** | **2004** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|
| Audit fees              |       | $        | 41,420     |     | $          | 31,473 |   |
| Legal fees              |       | 32,610   |       | 9,908    |       |
| Consulting fee          |       | —   |       | 30,000   |       |
| Public company expenses |       | 17,081   |       | —   |       |
| Other                   |       | 24,317   |       | 14,515   |       |
| Total                   |       | $        | 115,428    |     | $          | 85,896 |   |

 

F-16

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6. PROMOTION AGREEMENT

 

In June 2001, we enteredinto a Supply and Promotion Agreement with Ethicon Endo-Surgery, Inc. (EES).Under the agreement, we received payments in return for our commitment topromote use of EES equipment in certain training programs sponsored by us forthe benefit of our customers with no obligation by our customers or us topurchase any EES equipment.  Theagreement granted EES with the right of first negotiation to acquire certaintechnology of ours.  The agreement had afive year term, but could be terminated by EES upon 90 days notice.  This agreement expired in November 2003.  A new promotion agreement was executed inDecember 2003 under which $500,000 was received in 2003 and 2004 foroptimization services provided, of which $250,000 was included in deferredrevenue at December 31, 2003.  Theagreement expired at the end of 2004 and no further payments are expected fromEES after this point.  We recognizedrevenue ratably over the term of the agreement. We recognized $1,000,000, $917,000 and $500,000 of revenue in each ofthe years 2002, 2003 and 2004, respectively, related to the EES agreement.

 

7. COMMITMENTS

 

At December 31, 2004, we are obligated underan operating lease, principally related to real estate.  Additionally, we are obligated under capitalleases related to computer hardware.  Thefollowing is a schedule of future minimum payments, excluding taxes and otheroperating costs, as of December 31, 2004:

 

| **Year ending December 31,**                        | ** ** | **Operating  Leases** | ** ** | **Capital  Leases** | ** ** |
|-----------------------------------------------------|------------|-----------------------|------------|---------------------|------------|
| 2005                                                |       | $                     | 11,000     |                | $          | 20,530 |   |
| 2006                                                |       | —                |       | 11,146              |       |
|                                                |       | $                     | 11,000     |                | 31,676     |   |
| Less - amounts representing interest                |       |                  |       | (4,191              | )          |
| Principal of capital lease obligation               |       |                  |       | 27,485              |       |
| Less - current portion of capital lease obligations |       |                  |       | (16,969             | )          |
| Long-term portion of capital lease obligations      |       |                  |       | $                   | 10,516     |   |

 

At December 31, 2003 and 2004, we hadequipment under capital leases with costs of $72,687 and $44,505, respectively,and accumulated depreciation of $41,163 and $35,233, respectively.

 

Rent expense related to continuing operationswas $128,000, $104,000 and **$**149,813for the years ended December 31, 2002, 2003 and 2004, respectively.  The operating lease expired inJanuary 2005 and it is now month to month.

 

From time to time, we may be involved in litigation relating to claimsarising out of our operations in the normal course of business.  There areno material legal proceedings pending against us.  We have been notifiedthat a party intends to include us as a party to a medical malpractice lawsuitin Florida, but we have not yet been formally included or served, and we arecontesting the issue.

 

8. SAVINGS PLANS

 

We maintain a 401(k) plan for U.S. employees,which includes retirement income features consisting of employee tax deferredcontributions. Contributions under all plans are invested in professionallymanaged portfolios.  Our contributionsare discretionary.  We made nocontributions in 2002, 2003 and 2004.

 

9. STOCKHOLDERS’ EQUITY

 

PREFERRED STOCK

 

In March 2003, we authorized and issued 1,000,000 shares of SeriesA Convertible Preferred Stock (the “Series A Shares”), which were createdpursuant to the terms of a Certificate of Designations, for an aggregate of$950,000 in cash.  In connection withthis financing, the purchasers of Series A Shares were granted several significantrights senior to the rights of holders of our common stock. Among other rights,in the event of a liquidation, dissolution or winding up of our Company(including consolidations, mergers or other sales), holders of Series A Shareswill be entitled to receive $3.80 per share, in preference to any distributionto the holders of common stock.  Also,pursuant to the Certificate of Designations, we must obtain the consent of theholders of at least

 

F-17

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two-thirds of the outstanding Series A Shares in order to undertakecertain actions, including significant capital expenditures and the issuance ofequity securities.  Additionally, for aslong as Series A Shares remain outstanding beyond April 2004, the holdersof Series A Shares will be entitled to elect the greater of (i) two members ofour Board of Directors or (ii) 25% of the total members of our Board ofDirectors.

 

InJune 2004, we amended theSeries A Certificate of Designations to allow us the right to issue equitysecurities for less than $2.00 per share. For that right, the Series A holders received 1,400,000 shares of Vikingcommon stock valued at $28,000, and we redeemed 85,000 Series A Shares for$200,000.  In addition, we have obtainedthe right to redeem an additional 300,000 Series A Shares at any time on orbefore January 15, 2006 for $500,000. The fair value of the Viking sharesdistributed of $28,000 and the $103,985 excess of the $200,000 payment over theprior contractual redemption value of the Series A shares have been accountedfor as a deemed dividend of $131,985.

Theholders of the outstanding Series A Shares have the right to one vote for eachshare of common stock into which such Series A Shares could then be converted,and with respect to such vote, such holder shall have full voting rights andpowers equal to the voting rights and powers of the holders of common stock.

The holders of Series A Shares are entitledto receive dividends, out of any assets legally available therefore, prior andin preference to any declaration or payment of any cash dividend on the commonstock, at the rate of $0.1425 per share per annum.

 

COMMONSTOCK

In February 2004, we sold to a group ofaccredited investors 439,000 shares of common stock and warrants to purchase upto 219,500 shares of common stock, for a total of $588,260 as part of a unitoffering. The warrants are exercisable at a price of $1.97 per share and expirein February 2009.

 

In February 2004, our former subsidiaryVOW Solutions, Inc., adopted the VOW Solutions, Inc. 2004 Stock Option/StockIssuance Plan (the “VOW Plan”) for the benefit of VOW’s eligible employees,consultants, and directors. The VOW Plan initially reserved 150,000 shares ofcommon stock of VOW for issuance.  During2004, options to purchase up to an aggregate of 112,500 shares of common stockhad been issued to officers and one director under the VOW Plan, none of whichhad been exercised.  In December 2004, the VOW options were exchanged forVista Medical Technologies, Inc. options at identical terms.** **VOWhad 1,000,000 shares of common stock outstanding as of December 31, 2004**. **InFebruary 2005, VOW Solutions, Inc. was merged with the parent Vista MedicalTechnologies, Inc.

 

In May 2004, we sold to a group of accreditedinvestors 5,454,544 units of our securities for $0.85 per unit, each unitconsisting of one share of common stock and one warrant to purchase one-halfshare of common stock, for aggregate gross proceeds of approximately $4.6million, or $4.1 million net of expenses. The 2,727,272 warrant shares are exercisable at a price of $0.95 pershare and expire in May 2009.  As part ofthe May 2004 unit sale, we issued warrants to the placement agent to purchaseup to 818,181 shares of our common stock of which 545,454 of these warrants areexercisable at a price of $1.02 per share and the remaining 272,727 warrantsare exercisable at a price of $0.95 per share and expire in May 2009.

 

COMMON STOCK RESERVED

 

At December 31, 2004, we have reserved thefollowing shares of common stock for future issuance:

 

 

| Conversion of Series A Convertible Preferred Stock                 |   | 915,000   |   |
|--------------------------------------------------------------------|--------|-----------|--------|
| Exercise of outstanding warrants                                   |   | 3,764,953 |   |
| Exercise of outstanding options                                    |   | 1,070,912 |   |
| Options available for grant                                        |   | 1,208,924 |   |
| Available for issuance under the 1997 Employee Stock Purchase Plan |   | 55,289    |   |
|                                                               |   | 7,015,078 |   |

 

F-18

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1995 STOCKOPTION PLAN

 

We reserved 221,607 shares of common stockunder the 1995 Stock Option Plan (the “1995 Plan”) for issuance to eligibleemployees, officers, directors, advisors and consultants. The 1995 Planprovides for the grant of incentive and nonstatutory stock options. The Boardof Directors determines terms of the stock option agreements, including vestingrequirements, subject to the provisions of the 1995 Plan. Options granted by usgenerally vest over four to five years and are exercisable from the date ofgrant for a period of ten years.

 

The exercise price of the incentive stockoptions must equal at least the fair market value of the stock on the date ofgrant. The exercise price of nonstatutory stock options must equal at least 85%of the fair market value of the stock on the date of grant. We have the option,in the event of termination of employment, to repurchase unvested shares issuedunder the 1995 Plan at the original issue price.  No additional shares are available forissuance under the 1995 Plan.

 

1997 STOCK OPTION PLAN/ STOCK ISSUANCE PLAN

 

In February 1997, we adopted the 1997 StockOption Plan/Stock Issuance Plan (the “1997 Plan”). The 1997 Plan incorporatesthe outstanding options under the 1995 Plan and no further options will begranted under the 1995 Plan.  At December31, 2004, we had a total of 2,592,500 shares authorized for issuance under the 1997Stock Option/Stock Issuance Plan, which is an increase of 1,500,000 sharesapproved by the stockholders in October 2004, and 1,208,924 options wereavailable for future grant.  Optionsgranted by us generally vest over three to five years and are exercisable fromthe date of grant for a period of ten years.

 

The following tables summarizes stock optionactivity under all option plans:

 
| ** **                   | ** ** | **Number of   Shares** | ** ** | **Exercise Price per  Share** | ** ** | **Weighted  Average  Exercise Price per Share** | ** ** |
|------------------------------|------------|------------------------|------------|-------------------------------|------------|------------------------------------------------------|------------|
| Balance at December 31, 2001 |       | 564,130                |       | $0.80                         | -          | $                                                    | 57.50      |   | $ | 5.50 |   |
| Granted                      |       | 183,700                |       | $3.12                         | -          | $                                                    | 4.00       |   | $ | 3.76 |   |
| Exercised                    |       | (15,003                | )          | $0.80                         | -          | $                                                    | 2.50       |   | $ | 2.24 |   |
| Canceled                     |       | (43,499                | )          | $2.50                         | -          | $                                                    | 45.25      |   | $ | 19.09 |   |
|                         |       |                   |       |                          |       |                                                 |       |   |   |
| Balance at December 31, 2002 |       | 689,328                |       | $0.80                         | -          | $                                                    | 57.50      |   | $ | 4.25 |   |
| Granted                      |       | 185,050                |       | $0.89                         | -          | $                                                    | 1.84       |   | $ | 1.56 |   |
| Exercised                    |       | (1,333                 | )          | $1.50                         | -          | $                                                    | 1.50       |   | $ | 1.50 |   |
| Canceled                     |       | (66,759                | )          | $0.89                         | -          | $                                                    | 39.50      |   | $ | 5.13 |   |
|                         |       |                   |       |                          |       |                                                 |       |   |   |
| Balance at December 31, 2003 |       | 806,286                |       | $0.80                         | -          | $                                                    | 57.50      |   | $ | 3.56 |   |
| Granted                      |       | 630,000                |       | $1.00                         | -          | $                                                    | 2.30       |   | $ | 1.38 |   |
| Exercised                    |       | (37,333                | )          | $0.80                         | -          | $                                                    | 0.89       |   | $ | 0.81 |   |
| Canceled                     |       | (328,041               | )          | $0.80                         | -          | $                                                    | 39.50      |   | $ | 2.88 |   |
|                         |       |                   |       |                          |       |                                                 |       |   |   |
| Balance at December 31, 2004 |       | 1,070,912              |       | $0.80                         | -          | $                                                    | 57.50      |   |   | $ | 2.35 |   |

 

 

F-19

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| ** **                  | ** ** | **OUTSTANDING STOCK OPTIONS** | ** ** | **EXERCISABLE STOCK OPTIONS**                             | ** ** |
|-----------------------------|------------|-------------------------------|------------|-----------------------------------------------------------|------------|
| **RANGE OF EXERCISE PRICE** | ** ** | **SHARES**                    | ** ** | **WEIGHTED- AVERAGE REMAINING CONTRACTUAL LIFE (MONTHS)** | ** ** | **WEIGHTED- AVERAGE EXERCISE PRICE** | ** ** | **SHARES** | ** ** | **WEIGHTED- AVERAGE EXERCISE PRICE** | ** ** |
| ** **                  | ** ** | ** **                    | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| $                           | .80        | -                             | $          | 2.50                                                      |       | 858,200 |   | 105 |   | $ | 1.41 |   | 255,194 |   | $ | 1.50 |   |
| $                           | 3.00       | -                             | $          | 4.00                                                      |       | 159,587 |   | 78 |   | $ | 3.67 |   | 143,873 |   | $ | 3.66 |   |
| $                           | 4.62       | -                             | $          | 6.12                                                      |       | 27,500 |   | 65 |   | $ | 4.93 |   | 27,500 |   | $ | 4.93 |   |
| $                           | 9.00  | -                             | $          | 9.75                                                      |       | 10,500 |   | 48 |   | $ | 9.13 |   | 10,500 |   | $ | 9.13 |   |
|                        | $          | 20.25                         |       | 7,500                                                     |       | 42 |   | $ | 20.25 |   | 7,500 |   | $ | 20.25 |   |
| $                           | 39.50      | -                             | $          | 45.50                                                     |       | 6,625 |   | 34 |   | $ | 41.58 |   | 6,625 |   | $ | 41.58 |   |
|                        | $          | 57.50                         |       | 1,000                                                     |       | 34 |   | $ | 57.50 |   | 1,000 |   | $ | 57.50 |   |
|                        |       |                          | 1,070,912  |                                                      | 99         |   | $ | 2.35 |   | 452,192 |   | $ | 3.59 |   |
|                             |            |                               |            |                                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The weighted average remaining life of theoptions outstanding at December 31, 2003 and 2004 was 63 and 99 months,respectively.

 

1997 EMPLOYEE STOCK PURCHASE PLAN

 

In February 1997, we adopted the 1997Employee Stock Purchase Plan (the “Purchase Plan”), which permits eligibleemployees of ours to purchase shares of common stock, at semi-annual intervals,through periodic payroll deductions. Payroll deductions may not exceed 10% of the participant’s base salary,and the purchase price per share will not be less than 85% of the lower of thefair market value of the common stock at either the beginning or the end of thesemi-annual intervals.  We haveauthorized and reserved 150,000 shares of common stock for issuance under thePurchase Plan.  There were 23,910, 4,836and 7,469 shares issued under the Purchase Plan in 2002, 2003 and 2004,respectively.   There were 55,289 sharesavailable for issuance at December 31, 2004.

 

10. INCOME TAXES

 

Significant components ofour deferred tax assets as of December 31, 2003 and 2004 are shown below. Avaluation allowance has been established to offset the deferred tax assets, asrealization of such assets is uncertain.

 

| ** **                                  | ** ** | **December 31,**       | ** ** |
|---------------------------------------------|------------|------------------------|------------|
| ** **                                  | ** ** | **2003**               | ** ** | **2004** | ** ** |
| Deferred tax assets:                        |       |                   |       |   |   |
| Net operating loss carryforwards            |       | $                      | 21,207,000 |   | $ | 21,460,000 |   |
| Research and development credits       |       | 2,843,000              |       | 2,407,000 |   |
| Capitalized research and development        |       | 665,000                |       | 571,000 |   |
| Depreciation                                |       | 138,000                |       | 19,000 |   |
| Inventory reserve                           |       | 520,000                |       | 562,000 |   |
| Other                                       |       | 285,000                |       | 30,000 |   |
| Total deferred tax assets                   |       | 25,658,000   |       | 25,049,000 |   |
| Deferred tax liability:                     |       |                   |       |   |   |
| Investment in equity securities             |       | —                 |       | (558,000 | ) |
| Net deferred tax assets                     |       | 25,658,000             |       | 24,491,000 |   |
| Valuation allowance for deferred tax assets |       | (25,658,000            | )          | (24,491,000 | ) |
|                                        |       |                   |       |   |   |
| Net deferred taxes                          |       | $                      | —     |   | $ | — |   |

 

F-20

----

 

The followingreconciles the tax provision with the expected provision obtained by applyingstatutory rates to pretax income from continuing operations:

| ** **                              | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|------------------|------------|
| ** **                              | ** ** | **2003**         | ** ** | **2004** | ** ** |
| Expected tax at federal statutory rates |       | $                | (352,000   | ) | $ | (1,010,000 | ) |
| Change in valuation allowance           |       | 190,000          |       | 1,167,000 |   |
| Other                                   |       | 162,000          |       | (157,000 | ) |
| Tax provision                           |       | $                | —     |   | $ | — |   |

 

At December 31, 2004, we have federal andstate tax net operating loss carryforwards of approximately $59,192,000 and$8,403,000, respectively. The federal tax loss carryforwards will begin to expirein 2010.  Approximately $1,081,000 of thestate tax loss carryforwards expired in 2004, and will continue to expire infuture periods unless previously utilized. At December 31, 2004, we also havefederal and state research tax credit carryforwards of approximately $2,277,000and $130,000, respectively, which will begin to expire in 2010 unlesspreviously utilized.  We have retainedthe federal and state tax loss carryforwards and other tax attributes of theVisualization Technology business.

 

The difference between the federal and statetax loss carryforwards is primarily attributable to the expiration of certainstate net operating loss carryforwards, which have a shorter life than federalcarryforwards.

 

In accordance with Sections 382 and 383 ofthe Internal Revenue Code, a change in ownership of greater than 50% of acorporation within a three-year period will place an annual limitation on ourability to utilize our existing tax loss and tax credit carryforwards.

  

11. RELATED PARTY TRANSACTIONS

 

Wehad a sublease agreement for our California office space.  The sublease agreement has been executed withanother company, of which our former Chairman of the Board is also aDirector.  Total rental payments of$104,500 and  $118,000 were paid to thiscompany in 2003 and 2004, respectively.

 

AtDecember 31, 2004, we have payables to directors for services and relatedexpenses of $35,629.  At December 31,2003, we had $58,591 in severance payable to a former officer.

 

12. CONCENTRATIONS

 

CASH

 

The Company maintains its cash deposits withbanks. At times, such deposits may exceed Federally insured limits. At December31, 2004, the Company had no cash deposits that exceeded applicable insuredlimits. The Company has not experienced any losses in such accounts andbelieves it is not exposed to any significant credit risk on cash and cashequivalents.

 

CUSTOMERS

 

In 2004, the Company had two majorcustomers.  Sales to these customerstotaled approximately $500,000 and $180,000 or 30% and 11% of revenue,respectively.  At December 31, 2004,accounts receivable from these customers amounted to approximately $0 and$63,000 or 0% and 36% of total accounts receivable, respectively.  In 2003, the Company had one majorcustomer.  Sales to this customer totaledapproximately $917,000 or 37% of revenue. At December 31, 2003, accounts receivable from this customer amounted to$0.

 

SUPPLIERS

 

During 2003 and 2004, the Company had one major vendor, purchases fromwhich totaled approximately $67,000 and $83,700, respectively.  There were no accounts payable to thesevendors at December 31, 2003 and 2004, respectively

 

F-21

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13. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

 

The following is a summary of the quarterlyresults of operations for the years ended December 31, 2003 and 2004 afterproviding for the effects of the 10-K/A restatement for the year ended December31, 2003 and the reclassifications for the year ended December 31, 2003, thesecond 2004 and third quarters of 2004.  See“Reclassification/Restatement” under footnote 1.

 
| ** **                                  | ** ** | **2003**     | ** ** |
|---------------------------------------------|------------|--------------|------------|
| **2003 as currently reported**              | ** ** | **March 31** | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| Revenues                                    |       | $            | 668,274    |   | $ | 637,279 |   | $ | 750,635 |   | $ | 432,929 |   |
| Cost of revenues                            |       | 319,848      |       | 290,930 |   | 346,158 |   | 198,298 |   |
| Loss from continuing operations             |       | (164,709     | )          | (237,459 | ) | (141,742 | ) | (490,542 | ) |
| Income (loss) from discontinued operations  |       | 118,968      |       | (220,845 | ) | (555,834 | ) | (356,540 | ) |
| Basic and diluted net loss per common share |       |         |       |   |   |   |   |   |   |
| Continuing operations                       |       | $            | (0.03      | ) | $ | (0.05 | ) | $ | (0.03 | ) | $ | (0.10 | ) |
| Discontinued operations                     |       | $            | 0.02       |   | $ | (0.04 | ) | $ | (0.12 | ) | $ | (0.08 | ) |
| Total                                       |       | $            | (0.01      | ) | $ | (0.09 | ) | $ | (0.15 | ) | $ | (0.18 | ) |

 
| ** **                                  |   | **2004**     |       |
|---------------------------------------------|--------|--------------|------------|
| **2004 as  currently reported**             |   | **March 31** | ** ** | **June 30** | ** ** | **September  30** | ** ** | **December  31** |   |
| Revenues                                    |   | $            | 599,804    |   | $ | 302,911 |   | $ | 374,777 |   | $ | 373,234 |   |
| Cost of revenues                            |   | 378,873      |       | 253,241 |   | 217,583 |   | 343,720 |   |
| Loss from continuing operations             |   | (402,881     | )          | (663,238 | ) | (836,608 | ) | (1,068,470 | ) |
| Loss from discontinued operations           |   | (499,304     | )          | (133,212 | ) | — |   | — |   |
| Basic and diluted net loss per common share |   |         |       |   |   |   |   |   |   |
| Continuing operations                       |   | $            | (0.08      | ) | $ | (0.09 | ) | $ | (0.08 | ) | $ | (0.10 | ) |
| Discontinued operations                     |   | $            | (0.09      | ) | $ | (0.02 | ) | $ | — |   | $ | — |   |
| Total                                       |   | $            | (0.17      | ) | $ | (0.10 | ) | $ | (0.08 | ) | $ | (0.10 | ) |

 
| ** **                                     | ** ** | **2003**     | ** ** |
|------------------------------------------------|------------|--------------|------------|
| **2003 as  previously reported in our 10-K/A** | ** ** | **March 31** | ** ** | **June 30** | ** ** | **September  30** | ** ** | **December  31** | ** ** |
| Revenues                                       |       | $            | 668,274    |   | $ | 637,279 |   | $ | 750,635 |   | $ | 432,929 |   |
| Cost of revenues                               |       | 167,346      |       | 130,570 |   | 224,584 |   | 52,099 |   |
| Loss from continuing operations                |       | (164,709     | )          | (237,459 | ) | (141,742 | ) | (490,542 | ) |
| Income (loss) from discontinued operations     |       | 118,968      |       | (220,845 | ) | (555,834 | ) | (356,540 | ) |
| Basic and diluted net loss per common share    |       |         |       |   |   |   |   |   |   |
| Continuing operations                          |       | $            | (0.03      | ) | $ | (0.05 | ) | $ | (0.03 | ) | $ | (0.10 | ) |
| Discontinued operations                        |       | $            | 0.02       |   | $ | (0.04 | ) | $ | (0.12 | ) | $ | (0.08 | ) |
| Total                                          |       | $            | (0.01      | ) | $ | (0.09 | ) | $ | (0.15 | ) | $ | (0.18 | ) |

 
| ** **                                   | ** ** | **2004**     | ** ** |
|----------------------------------------------|------------|--------------|------------|
| **2004 as  previously reported in our 10-Q** | ** ** | **March 31** | ** ** | **June 30** | ** ** | **September  30** | ** ** |
| Revenues                                     |       | $            | 1,711,431  |   | $ | 302,911 |   | $ | 374,777 |   |
| Cost of revenues                             |       | 1,132,539    |       | 61,706 |   | 45,177 |   |
| Loss from continuing operations              |       |         |       | (663,238 | ) | (836,608 | ) |
| Loss from discontinued operations            |       |         |       | (133,212 | ) | — |   |
| Basic and diluted net loss per common share  |       |         |       |   |   |   |   |
| Continuing operations                        |       |         |       |   | $ | (0.09 | ) | $ | (0.08 | ) |
| Discontinued operations                      |       |         |       |   | $ | (0.02 | ) | $ | — |   |
| Total                                        |       | $            | (0.18      | ) | $ | (0.10 | ) | $ | (0.08 | ) |

 

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