**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-KSB**

 

**ý****                                                                                ****ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For fiscal year ended December 31, 2005**

 

**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.) |

 

**11455 El Camino Real, Suite 140 San Diego, California 92130**

(Address of principal executive offices)

 

**(858) 703-2820**

(Registrant’s telephone number, including area code)

 

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

 

Securities registered pursuant to Section 12(g)  of theAct:  **CommonStock, par value $.01 per share**

 

Check whether the issuer is not required to filereports pursuant to Section 13 or 15(d) of the Exchange Act.  o

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes  ý    No  o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-KSB or anyamendment to this Form 10-KSB. o

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). o

 

The registrants revenuesfor the fiscal year ended December 31, 2005 were $1,287,848

 

Theaggregate market value of the voting stock held by nonaffiliates of theregistrant as of****February 28,2006 was approximately $11,900,000. For the purposes of this calculation,shares owned by officers, directors and 10% stockholders known to the registranthave been deemed to be owned by affiliates. This determination of affiliatestatus is not necessarily a conclusive determination for other purposes.

 

Thenumber of shares outstanding of the registrant’s Common Stock as of February 28,2006 was 2,657,663.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Certainexhibits filed with the Registrant’s prior registration statements and Forms 10-Q,10-QSB,10-K and 8-K are incorporated herein by reference into Part III of thisReport.

 

Transitional Small Business Disclosure Format (Checkone): Yes  o    No  ý

 

 

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**IVOW, Inc.**

**Form 10-KSB For the Fiscal Year Ended December 31,2005**

 

**TABLE OF CONTENTS**

 
| Part I   |                                                                                                                        |   |
|---------------|-----------------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.       | Description of Business                                                                                                     |   |
| Item 2.       | Description of Property                                                                                                     |   |
| Item 3.       | Legal Proceedings                                                                                                           |   |
| Item 4.       | Submission of Matters to a Vote of Security Holders                                                                         |   |
|          |                                                                                                                        |   |
| Part II  |                                                                                                                        |   |
| Item 5.       | Market for Common Equity and Related Stockholder  Matters                                                                   |   |
| Item 6.       | Management’s Discussion and Analysis or Plan of  Operation                                                             |   |
| Item 7.       | Financial Statements                                                                                                        |   |
| Item 8.       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                                       |   |
| Item 8A       | Controls and Procedures                                                                                                     |   |
| Item 8B       | Other Information                                                                                                           |   |
|          |                                                                                                                        |   |
| Part III |                                                                                                                        |   |
| Item 9.       | Directors, Executive Officers,  Promoters and Control Persons, Compliance with Section 16(a) of the  Exchange Act |   |
| Item 10.      | Executive Compensation                                                                                                      |   |
| Item 11.      | Security Ownership of Certain  Beneficial Owners and Management and Related Stockholder Matters                             |   |
| Item 12.      | Certain Relationships and Related  Transactions                                                                             |   |
| Item 13       | Exhibits                                                                                                                    |   |
| Item 14.      | Principal Accountant Fees and Services                                                                                      |   |
|          |                                                                                                                        |   |
|          | Signatures                                                                                                                  |   |
|          | Index to  Consolidated Financial Statements                                                                                 |   |

 

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PART I

 

Forward LookingStatements

 

Fromtime to time we have made and may continue to make “forward lookingstatements” within the meaning of the federal securities laws. This report on Form 10-KSBmay contain forward-looking statements. These statements, which representour expectations or beliefs concerning various future events, may containwords such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,”or other words indicating future results. Actual results may differmaterially from results anticipated in such forward-looking statements. Weassume no obligation to update any forward-looking statements to reflect eventsor circumstances arising after the date 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 13 through 20 below, and elsewhere in this report.

 
| Item 1. | DESCRIPTION OF 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 in early 2003, our VisualizationTechnology business, located in Westborough, Massachusetts, and our ObesitySurgery Management Services business unit (VOW Solutions, Inc.), locatedin San Diego, California, functioned as individual business units. In April 2004,we sold the Visualization Technology business to concentrate on the obesity surgeryservices market. We changed our name to iVOW, Inc. in February 2005,after merging with our wholly owned subsidiary VOW Solutions, Inc., toalign our corporate name with the brand name of our chronic and morbid obesitydisease management business, which is now our exclusive focus.

 

We began offeringtraining and consulting services to the obesity surgery market in 2001. As aresult of the disposition of our Visualization Technology business, we are nowa pure play company in the bariatric market. We develop and market products andservices for the bariatric clinical, medical and surgical markets. Bariatricsis the medical science of weight reduction and nutrition; bariatric surgery, aspecialized area of general surgery, is focused on surgical weight reductionsolutions for the very severely or morbidly obese. iVOW is focused onimplementing disease management strategies for the control of chronic andsevere obesity. The vision of our iVOW business is to provide services thatenable affiliated customers, 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. Ourmission is to deliver the leading management portfolio of services and productsfor the clinical and business development of effective, continually successfulclinical, medical and surgical programs for the treatment of chronic and morbidobesity.

 

**LaparoscopicBariatric Surgical (LBS) Preceptorship Program**

 

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 States and provided consulting products to someadditional 51 bariatric surgical centers (collectively, “iVOW Surgical Centers”).These iVOW Surgical Centers provide surgical treatment, specifically openand  minimally invasive roux en-y gastricbypass procedures and laparoscopic gastric banding, to morbidly obese patients.The products 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 witha comprehensive 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 commercials, which clients may customizefor use in their local markets to inform prospective patients about theavailability of gastric bypass surgery at their hospitals. Until April 2004,when we sold our Visualization Technology business, we also supplied our 3-Dendoscopic visualization system for use in the performance of minimallyinvasive gastric bypass surgery.

 

**SoundHealth Solutions, Inc.**

 

On November 1, 2005,iVOW acquired Sound Health Solutions, Inc. (“SHS”), aSeattle-based healthcare provider specializing in the multidisciplinary medicaltreatment of obesity SHS operates as a wholly-owned subsidiary of iVOW. SHShas pioneered the development of multidisciplinary medically anchored weightloss programs since 1998. Through a pilot program with

 

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Microsoft Corporation,SHS has produced what we consider to be the best validated, statisticallysignificant data on multidisciplinary medically anchored weight loss programsin the country. In the summer of 2005, Microsoft and Premera Blue Cross ofWashington received a national award for innovation in obesity management fromthe National Institute of Health Care Management, which prominently featuredthe program designed by SHS and its two physician co-founders, Drs. FrancisGough and Teresa Girolami. 

 

We anticipate that theaddition of SHS to iVOW will improve and expand our business model. Prior toour acquisition of SHS, our business model focused principally upon workingwith hospitals and surgeons to provide consultations on a fee-for-service basisor to operate their bariatric surgical programs for a management fee, while thehospitals and surgeons held the contracts with insurance providers and otherthird-party payors and employers. Under that model, even if the volume ofpatients increased, our revenue did not. In contrast, SHS, through its “owner-operator”model, contracts directly with employers, payors and unions to facilitateweight loss programs on a direct per patient basis, thus generating incrementalrevenue as patient volume increases. While we intend to focus on capitalizingupon SHS’s owner-operator model, we also will continue to pursue strategicoutsourced management opportunities. We now have two platforms on which to growour business: the employer/payor medically anchored platform and thehospital/provider surgically anchored platform.

 

Insurance providers andother third-party payors consistently require medical or other documentedweight loss management failure or attempts prior to approving patients forbariatric surgery. Such requirements are developing into a de facto gating requirementfor bariatric surgery. 

 

We believe that SHS offers a platform from which to integrateclinical, medical and surgical weight loss programs into a seamless diseasemanagement strategy for obesity. We anticipate that expansion of our SHS modelwill generate market opportunities for our iVOW Surgical Centers and, dependingon how the market opportunity evolves, other affiliated bariatric centers. Correspondingly,we anticipate that iVOW’s surgical model will generate market opportunities forour SHS model.

 

**OurBusiness Model**

 

Patient demand for aneffective and proven surgical solution to the chronic health conditions causedby morbid obesity has accelerated the number of surgical procedures performedfrom approximately 16,000 a decade ago to approximately 170,000 in 2005,according to the American Society for Bariatric Surgery. The number of patientsthat underwent bariatric surgery in 2005 represents less than one (1) percentof the total population with a body mass index (BMI) that qualifies for theprocedure. An additional 45 million Americans are obese, and many meet BMIqualification criteria for our SHS model. We believe that, by building upon theexpertise, market position and relationships developed in our combined businesslines described above, we now have the foundation to become a leading providerof (i) disease-specific program management in bariatric clinical, medicaland surgical care and (ii) a commensurately expanded suite of relatedconsulting services. 

 

Our business model is todevelop a network of bariatric disease management centers that we directly own oroperate based upon our current SHS model as well as to outsource managementthrough both our historical iVOW Surgical Center model and new SHS outsourcedmodel, which are able to provide patients with all necessary clinical, medicaland surgical services. As owner/operator of our current SHS modeled centers wewill have full administrative control and contract directly with insuranceproviders and other third-party payors. As manager of the outsourced program wewill coordinate all the administrative and marketing functions on behalf of ourclients and provide patient services, particularly in assessing whether thereis a suitable clinical alternative to surgery, as well as in assuring thefulfillment of payor mandated pre-surgical weight loss management requirementsand appropriate long-term post operative care and monitoring of patients. Our revenuemodel is based upon a monthly management fee for our outsourced managedprograms, a per-patient fee for our SHS owner-operator program, andfee-for-service for our consulting business. 

 

We intend to develop theiVOW brand name with the iVOW Sound Health tag line to provide a nationalidentity for our programs. We believe that the centralized provision of certainservices to our own centers as well as to our managed clients, for example, theprocessing of medical insurance approval, information technology support andcontracting, will benefit our internal expense management structure andincrease our appeal to customers. Additionally, we will continue to develop andexpand our consulting services as described above to include SHS products thatcomplement the historical iVOW products, targeted at those clients that do notrequire a complete management package but that need specific assistance withindividual components of their bariatric clinical, medical or surgical programs.We hope that such efforts will encourage our market branding as well ascultivate a pipeline vehicle for our centers. 

 

We believe that ourcompany is appropriately positioned to execute our business model; we havehelped develop successful bariatric surgical programs since 2001 and, since September 2003,have strengthened our management team to include executives with relevanthealthcare services experience in general, and bariatric program managementexperience in particular. Over the past two years we have tested our ability torun outsourced programs through the three programs we currently operate. Inaddition, the 

 

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co-founders of SHS bringover seven years of experience as owner-operators of the SHS centers. However,as a company, we do not have extensive experience in effectively andeconomically replicating either the SHS model or the management of programsand, therefore, until we can demonstrate further success, our ability toexecute our expanded business model will remain uncertain. The rapid growth ofbariatric surgery is a recent trend and there are many organizational issueswhich are being evaluated within the employer, payor, hospital andmedical/surgical community. It is reasonable to say that there is not yet aconsensus on how to manage best practice protocols. While we believe there is asound rationale for the systemization provided by a professional managementcompany, as evidenced in other disciplines such as chronic wound care, it is asyet unclear to what extent employers, payors, and  hospitals will adopt our recommendedsolutions for bariatric clinical disease management.

 

Our goal is to become the leadingdisease management and consulting company focused on chronic and morbidobesity. Our initial focus was on the severely obese patient with gastricbypass surgery as the solution. We have expanded our focus to include thechronically obese through our SHS multidisciplinary medically anchored weightmanagement platform. It is these singular and combined platforms upon which wehope to expand service to new obesity therapies as they are developed. We arecurrently aggressively integrating our SHS bariatric medical model into ouriVOW surgical protocols to fulfill the pre-operative weight managementrequisites of employers and payors, the long term care of post-surgicalpatients and the treatment of obese patients who either are not qualified forsurgery or prefer a non-surgical alternative treatment modality.

 

**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 company has played a role in the developmentof more than 95 bariatric surgical centers, based in hospitals across theUnited States, which provide state-of-the-art treatment, specifically theminimally invasive gastric bypass roux en-y procedure, to morbidly obesepatients. We have provided this customer base with feasibility analysis,customized projections, implementation support, clinical training, marketingand 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). Through our SHSsubsidiary, we believe that we are positioned to become a market leader in theevolution of multidisciplinary medically anchored weight management programswith documented, demonstrable clinical effectiveness and a financial return.Patient demand, fortified by the very public success in weight loss of severalcelebrities, has driven the number of gastric bypass procedures from 60,000 in2001 to 105,000 in 2003, and 170,000 in 2005. By 2006 there will beapproximately 750,000 post-surgical bariatric patients. Obesity is now formallya disease state; it is classified as an epidemic by the Centers for DiseaseControl and described, in company with its frequent co-morbidity, Type IIDiabetes, as “the epidemic disease of the 21st Century.”  And the number of obese individuals continuesto grow:  In October 2003, theArchives of Internal Medicine published an article showing that the numberof extremely obese Americans (those more than 100 pounds above ideal bodyweight — the prime candidates for surgical intervention) has quadrupled sincethe mid-1980s, accelerating at twice the rate of “ordinary” obesity.

 

On November 1,2005, iVOW acquired Sound Health Solutions, Inc. (“SHS”), a Seattle-basedhealthcare provider specializing in the multidisciplinary medically anchored treatmentof obesity, as a wholly-owned subsidiary. SHS offers medically supervisedweight reduction programs designed by physicians specialized in internalmedicine. SHS’s programs have demonstrated results in reducing the healthcarecosts to businesses by managing “high risk” employees. SHS’s multidisciplinarymedically anchored weight management program consists of medical supervision,exercise testing and exercise program prescription, nutrition counseling, andbehavioral health counseling. SHS’s programs consist of an initial intensivephase followed by a monitored secondary phase, which ensures success throughthe development of positive habits. A distinguishing feature of the SHS programallows the patient to continue the program using the Internet. The web-basedprogram is monitored and serves to encourage the patient by continuing toprovide positive, personalized feedback and online access to a therapist,registered dietician or trainer. The addition of SHS to iVOW’s bariatricsurgical model means iVOW now is equipped to provide a complete continuum ofcare for bariatric clinical services. One indicator of the value of the SHSacquisition is that iVOW has had more feasible leads, both solicited andunsolicited, in the quarter following the acquisition than we had in the priorthree quarters. Many of these leads are from mature, well-established programslooking for a credible medical model in order to satisfy the virtuallyubiquitous requirements being put in place by payors and employers asqualifying criteria for evaluating and progressing patients to any of themodalities for bariatric surgery.

 

Webelieve that to meet the demand for the evolving market for chronic and morbidobesity and to offer patients the choice of many new therapies which eitherhave been recently introduced or are in development, requires a rapid expansionof high quality clinical, medical and surgical programs and related patientlifestyle and wellness services. This comprehensive approach is not the presentorganizational norm and we believe, based on both market understanding andresearch, that there is an opportunity to leverage iVOW’s present expertise,market position and relationships, into owned and operated as well as turnkeyprogram management solutions. This represents a natural extension of ourcurrent business model into the direct management of the infrastructure of

 

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obesity clinical care viaa national network of company-owned clinical programs with insurance companies,managed care and employers to provide options for the pre- and post-surgicalpatients medical treatment of the morbidly obese, as well as to providetreatment options for the approximately 45 million American adults who areclassified as clinically obese and who are not surgical candidates. This willbe supplemented by our outsourced managed programs established in partnershipwith hospitals, surgeons and physicians. We are therefore intent on developinga true continuum of care disease management strategy for chronic and morbidobesity to be incorporated into our existing programs.

 

**MarketOpportunity**

** **

Obesityis defined as an excessively high amount of body fat or adipose tissue inrelation to lean body mass. Weight standards are most often determined by theBody Mass Index (BMI), a measure expressing the ratio of weight-to-height. Individualswith a BMI of 25 to 29.9 are considered overweight; a BMI of 30 or more isconsidered obese, and 40 or more is severely, or morbidly, obese. The Centersfor Disease Control and Prevention (CDC) speak of “an epidemic of obesity” inthe United States, with prevalence increasing to 24% of the adult population in2003, from 12% in 1991. The increase in obesity cuts across all ages, racialand ethnic groups, and both genders. Obesity, which studies show is associatedwith an increased risk of diabetes, as well as other serious co-morbidities, isa major cause of mortality. The Surgeon General, in a Call to Action, estimatesthat the economic cost of obesity in the United States was about $117 billionin 2000. A recent Rand Corp. study found that the health care costs linked toobesity are now approaching those related to smoking or alcohol abuse and thatobesity “is like aging 20 years” when measured by the onset of chronic medicalproblems. The fact that obesity is a major health problem, and is increasing atan alarming rate has been well publicized in the media. Also, the IRS hasdeclared that obesity is a disease in its own right and that the cost of physician-directedweight loss programs may be included as a deductible medical expense. Giventhat medical expenses may be deducted only to the extent that they exceed7.5% of adjusted gross income, and that fewer than 5% of taxpayers deductmedical expenses, the IRS’s ruling is probably significant more as an indicatorof governmental concern over obesity than as a financial incentive toindividuals. As a further example of this, the federal agency in charge ofMedicaid and Medicare has concluded that obesity is a disease in its own right.Furthermore, in November 2004, a Medicare Coverage Advisory Committee(MCAC) meeting found that there is satisfactory evidence to indicate thatobesity surgery is a safe and effective way for many patients to lose weight andimprove their health. However, the principle that obesity itself is a disease,and not merely a symptom or precursor of a disease, is still a contentiousissue, and such a classification is resisted by private insurers. The abilityfor private insurers to resist may be coming to an end. In November 2005,the Centers for Medicare and Medicaid Services (CMS) issued a Proposed NationalCoverage Determination for bariatric Surgery that affirmed the MCAC findingsand recommended coverage for the procedure. The Federal Register comment periodhas now passed and a final favorable National Coverage Determination was issuedin February 2006. It was more broad and favorable than we anticipated inthat three weight loss surgical procedures were covered and there was not anage ceiling placed on potential candidates. Additionally the CMS embraced theuse of Bariatirc Centers of Excellence as the desired venue for theseprocedures. 

 

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 yetepidemic, because each country’s starting point was lower than the U.S., butthe trend is clear and inexorable. The World Health Organization has coined theterm “globesity” to highlight the problem.

 

Forthe morbidly obese, the most significant factor is that virtually every weightloss remedy, apart from weight loss surgery, had been proven to beineffective on a consistent basis over time. The plain fact is that once aperson is morbidly obese, reversing the trend, with an adequate and permanentresult, has been nearly impossible in most cases, particularly if the personlacked access to a program such as the one provided through our SHS subsidiary.It is this reality which accounts for the growth trajectory of gastric bypasssurgery, as it is the best documented option with a long-term, proven trackrecord of success. And, it is the refinement of the procedure over recentyears, most notably the development of a minimally invasive approach, which ishelping to convince increasing numbers of the morbidly obese that gastricbypass surgery is their best option. The surgical community has also embracedbariatric surgery, which it originally questioned as a legitimate procedure. Thediscipline is now endorsed by the National Institute of Health ConsensusConference and the American Society of Bariatric Surgery (ASBS) is recognizedby the American College of Surgeons. The outcome is that modern bariatricsurgery, while not risk-free, has a complication rate similar to other majorabdominal operations, and, of course, offers patients dramatic and sustainedweight loss. While bariatric surgery is effective, there is also demand formore effective medical programs for clinically obese people, who are not heavyenough 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 BMI of 40 or above, (5-6 million) or a BMI of 35or above, with serious complicating conditions such as diabetes, 

 

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hypertension,cardiopulmonary problems, asthma, sleep apnea, or arthritis and joint problems(8-10 million). The balance of 45 million are candidates for an improvedmedical treatment model ala SHS.

 

## **Our Strategy**

## ** **

Ourgoal over the next five years (2006-2010) is to become a leading provider ofconsulting and management services to bariatric clinical, medical and surgicalprograms thus becoming a national leader in the provision of state-of-the-artcare to the chronic and morbidly obese patient seeking a clinical, medical orsurgical solution to effectively lose, and maintain the loss of, an adequateamount of weight. We thus plan to leverage the market platform that oursurgical centers  provide to extend ourprovision of care to obese patients who are not candidates for surgery via SHSand to use SHS to market our surgical platform, and therefore offer a completechronic obesity disease management model. We intend to realize these objectivesthrough the execution of the following strategies:

 

•                  Sound Health Center geographicexpansion and subsequent roll-out by offering a formula to payors and employersthat reduces their risk, minimizes their direct investment into program  management, and provides them a measurableROI and facilitates quality verification.

 

•                  Fast-track iVOW Center roll-out byoffering an outsource formula to hospitals and surgeons that reduces theirrisk, minimizes their direct investment in program infrastructure, andmaximizes profitable patient flow.

 

•                  Capitalize on the favorable CMSNational Coverage Determination for bariatric surgery.

 

•                  Institute best-practice surgicalprotocols as a consistent, uniform standard and maintain rigorous clinicaloversight.

 

•                  Institute best-practice clinical andmedical 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.

 

•                  Develop a complete disease managementmodel.

 

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

 

•                  Continue to build our managementconsulting products and services, both as a profitable source of increasedrevenues and as a means of further developing stature in bariatrics, andthereby generating Center development referrals.

 

•                  Build a consumer-based business,initially focused on nutritional supplements specific for post-surgical gastricbypass patients.

 

***Sound Health Center local geographic expansion and subsequentroll-out  offering.***SHShas capacity for organic growth in its current centers. Current centers haveoperated at roughly break-even without any meaningful market investment orstrategic marketing effort, both of which we are now contributing.Additionally, we plan to offer a fast-track approach to the initial set-up of atop-class bariatric multidisciplinary medically anchored weightmanagement  centers; or the assumption ofmanagement of existing programs while we either generate the cash flow  toorganically develop owned and operated centers or raise the funds to capitalizethem. Our experience shows that the time to initiate operation of a newbariatric SHS type program can be as long as six months, and even after thatprogress can be slow because of the organizational complexity of the task. TheSHS concept simplifies and standardizes the process, providing our partneremployer and payor customers a platform with a measurable ROI and greaterease of quality verification.

 

***Fast-track iVOW center roll-out by offering hospitals and surgeons areduced-risk outsource formula.***We plan to offer afast-track approach to the initial set-up of a top-class bariatricsurgical center; or the assumption of management of an existing program, with afully developed operating plan ready for implementation. Our approach coverseverything necessary to maximize operations in the shortest possible time; ourexperience shows that the ramp-up time for surgeons and hospitals to initiateoperation of a new bariatric surgical program can be as long as six months, andeven after that progress can be slow because of the organizational complexityof the task. The iVOW concept simplifies and standardizes the process, leavingour partner surgeons and hospitals and affiliated surgeons to do what they dobest — perform surgery and provide in-patient care. Of course, the startup time for existing 

 

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programs is considerablyshorter since there are usually patients already in process. We feel thatexisting programs that have managed to attain a moderate patient volume (100-300cases a year), and which want to grow faster, represent our primary near-termtargets.

 

***Institute best-practice surgical protocols***. Ourexperience with the Laparoscopic Bariatric Surgical (LBS) Preceptorship haspermitted us, under the direction of our Clinical Faculty, to offer the mostcomprehensive cadaveric surgical training course in state-of-the-artlaparoscopic gastric bypass surgery which is available anywhere. This trainingprogram will be available to surgeons who affiliate with iVOW. The trainingprocess will also include subsequent proctoring by our faculty during surgical cases.Malpractice data indicates that there are two experience-related risk levelsfor surgeons performing bariatric surgery. The first is at twenty surgeries andthe latter at 100. We have recently developed an Extended BariatricPreceptorship product for the proctoring and teaching of laparoscopicallytrained general surgeons who wish to do bariatric surgery. This Preceptorshipcovers 25 cases. It has been well received by our Clinical Advisory Group andwe currently have a surgeon enrolled in the program. 

 

***Maximize operating efficiencies***. This is key toleveraging economies of scale, and we will devote considerable resources to thefurther development of a standardized operating system. Also, many of thefunctions of a bariatric clinical, medical or surgical programs are common andcan be centralized for efficiency and cost-saving reasons. We believe thatindependent programs will need to generate very high patient volumes to justifythe infrastructure necessary to operate efficiently and that significantsavings can be made by handling them centrally as in the iVOW model. We believethat in a short time low volume programs will simply be unable to compete effectivelywith high-volume centrally managed programs.

 

***Build a brand image of efficient empathy***. Webelieve that this element of our strategy is extremely important. Our patientscome from a group that has suffered psychologically because of theirillness  We have learned by ourexperience to date that the provision of a sensitive and supportive environmentis vital to success. At the same time, the process towards surgery  or the selection of  credible alternative must be efficient. Thereare many steps in the process, and it is easy for patients to become lost ordiscouraged if the system, and the staff dealing with them, are haphazard intheir approach. Standardized systems across all managed programs are designedto shepherd patients through the process with efficient empathy.

 

***Develop a 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***. Ourconsulting business, originally based on provision of clinical training inlaparoscopic gastric bypass surgery, has expanded to include management,operational, financial and marketing services. 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 currentlydeveloping new and valuable products to meet the emerging needs of the maturingdeveloping market. We expect our consulting business to act as a fertile sourceof referrals for iVOW partnerships.

 

***Build our patient-consumer business***. Gastricbypass patients have a lifelong need for *specialized*vitamins and nutritional support. We are already marketing VistaVitamins as aspecific solution to the bariatrics-vitamin issue and intend to increasemarketing and distribution efforts and extend the product line. With 750,000post-surgical gastric bypass patients by 2005, we estimate that the totalavailable annual market for this patient category alone is $400 million.

 

**iVOW****Surgical Centers (Obesity to Wellness Solutions)**

 

Thenumber of physicians who are treating bariatric patients is growing, in boththe medical and the surgical arena. However, the expertise essential forhigh-volume patient acquisition, and the infrastructure required for qualitypatient care at these levels are often beyond the scope, or the willingness toinvest, of many programs. Even when bariatric centers are established inconjunction with a supportive hospital, the proper staffing, knowledge and timerequired to efficiently market, educate, collect a comprehensive medical anddiet history, verify insurance and obtain the necessary authorizations can be amanagement challenge, one that many simply cannot handle cost-effectively. Manyof these functions are much more efficiently and effectively handled in acentralized fashion (where one centralized department handles the work fordozens of programs). A focused team of professionals with centralized supportis necessary to properly handle all the unique and multifaceted issues involvedin securing and serving large numbers (400 — 500 cases per year) of bariatricpatients.

 

It isfor 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. Our plan is to offer ongoing hands-onmanagement support to such medical providers by delivering a cost-effectiveoutsourced solution to the provision of multi-disciplinary medical and surgicalcare to a high volume of morbidly obese patients.

 

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TheiVOW Center concept is designed to overcome the traditional barriersexperienced by physicians and hospitals when attempting to put into operationnew, or to maximize existing, niche product lines. Our approach will freephysicians from nearly all administrative functions, allowing them to devoteall their time and energy to patient care and the operating suite. Similarly,the iVOW Center will assist and/or provide the hospital with the expertise,personnel and core infrastructure needed to operate a fast track, successful,high-volume bariatric center.

 

Weplan to enter into strategic partnership agreements with physicians andhospitals to establish iVOW Surgical Centers. 

 

**iVOW****Consulting Services**

 

**OurSolution:**

 

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

 

*Blueprint*

 

Anexpert iVOW team conducts a detailed assessment and evaluation of an existing,or projected, bariatric surgery program and provides recommendations forimprovement. A comprehensive written report, the “Blueprint,” examines aprogram’s vision, sensitivity, operational capabilities, business/financialmodel, marketing potential and information management, offering a firmfeasibility analysis. Our proprietary financial model projects program-relatedrevenue, expenses, reimbursement and capitalization requirements under currentoperating conditions. The recommendations include marketing strategies derivedfrom the National Health and Nutrition Examination Survey and the United StatesCensus, customized to a bariatric program’s geographic location and patientpopulation.

 

*ImplementationConsulting 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 emphasizes patient introduction, thepre-admission/operative period, the peri-operative period, post-operativerecovery and discharge, and post-discharge care. Included in the service aretemplates, tools and training components integral to the ongoing viability of aprogram. These include informed consent, sensitivity and in-patient/officetraining, insurance authorization strategies, marketing tools, patienteducation, diet counseling, physical therapy and exercise plans and supportgroup coaching. Subsequent to this service, a program’s staff will be educatedin delivering efficient, best-practice care in a sensitive environment.

 

*LaparoscopicBariatric Surgery (LBS) Preceptorship and the Extended Bariatric 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 includes clinical observation, laboratorytraining, surgical lecture and didactic training that incorporates cadaverexperience. 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. Malpractice data indicates that thereare two experience-related risk levels for surgeons performing bariatricsurgery. The first is at twenty surgeries and the latter at 100. We very haverecently developed an Extended Bariatric Preceptorship product for theproctoring and teaching of laparascopically trained general surgeons who wishto do bariatric surgery. This Preceptorship covers 25 cases.

 

*OptimizationConsulting Service*

 

iVOW’sOptimization Consulting Service concentrates on improving an existing bariatricsurgery program’s efficiency, effectiveness and profitability. Recommendationsfocus on optimizing the finance, operations and marketing of a bariatricprogram. The work-up of a program’s financial performance will facilitate aninstitutional ability to resolve issues pertaining to revenue, expense attribution,capital investments and payor environment. Operational recommendations target apatient’s migration through the program and improved efficiency betweensurgeons and the hospital. The comprehensive marketing assessment analyzesreferral patterns, per-patient cost of acquisition and overall effectiveness.

 

*MarketingMaterials*

 

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 a hospital to capitalize on varying marketingvenues including public speaking, print publications, radio and television. Thepackage includes a customizable “Decision of a Lifetime” video and 

 

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television advertisement,a 60-second radio advertisement, a print advertisement, a patient brochure anda community lecture template on PowerPoint. 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.

 

Webelieve that our future is principally in owned and operated programs.Consequently we currently do not have any plans to develop a corollary series ofconsulting products for SHS. We will respond to any strategic consultingopportunities that have the potential to generate near term revenue, but willotherwise stay focused on owned and operated programs. 

 

**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, 2004after obtaining stockholder approval. Viking and its principals are notaffiliated with us or our officers, directors, and, to our knowledge, principalstockholders. Viking formerly conducted a software business, but thoseoperations were unsuccessful. Recently, a group of investors purchased controlof Viking, with the approval of Viking’s Board of Directors, and Viking’scurrent business plan, as stated in its public filings with the SEC, is toengage in the medical device market.

 

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

 

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

 

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

 

•                  Viking issued to us 3,054,000 sharesof its common stock representing approximately ten percent (10%) of the fullydiluted shares of Viking’s stock.

 

•                  We entered into a License Agreementwith Viking pursuant to which we will exclusively license to Viking allintellectual property and product rights used in operation of the licensedbusiness. In exchange for this license grant, Viking will pay us royalties overa five (5) year period that began on April 15, 2004 based on sales of thelicensed products by Viking. The License Agreement contains minimum royaltiesof $150,000 in year one, $300,000 in each of years two, three and four, and$375,000 in year five. The royalties payable by Viking have a minimum value of$1,425,000 and are capped at a maximum of $4,500,000 in the aggregate over thefive year period. We will retain ownership of all intellectual property andproduct rights under the License Agreement until at least the minimum royaltyobligations have been satisfied, at which point we will transfer ownership toViking. In 2005 we received royalties of $225,000.

 

•                  At closing we consigned our currentinventory of products and parts to Viking and were reimbursed for the value ofthat inventory over the course of the twelve months after closing. Anyinventory not sold by Viking during this one-year period was be sold to Vikingfor $1. During the years ended December 31, 2004 and 2005, we receivedfrom Viking $496,736 and $7,644 in proceeds from the sale of inventory byViking, respectively.

 

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

 

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.

 

**Governmental Regulation: Health Care Services**

 

As aparticipant in the health care industry, we are, and the iVOW Centers will be,subject to extensive and frequently changing regulation under many lawsadministered by governmental entities at the federal, state and local levels. Furthermore,our participating surgeons and hospitals are also subject to a wide variety oflaws and regulations that could affect the nature and scope of theirrelationships with us.

 

Laws regulating health care providers cover a broad array of subjects. Forexample, the confidentiality of patient medical information and the circumstancesunder which such information may be released for inclusion in ourdatabases, or released by us to third parties, are subject to substantialregulation by the federal and state governments. These laws and regulationsgovern both the disclosure and the use of confidential patient medicalinformation and are evolving rapidly. In addition, provisions of the Social 

 

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SecurityAct prohibit, 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. Most states have also enacted illegal remuneration laws that aresimilar to the federal laws. These laws are applicable to our financialrelationships with, and any marketing or other promotional activitiesinvolving, our participating surgeons and hospitals. All states regulate theprovision of health care services, including those to be provided at the iVOWCenters, and require participating physicians, surgeons, clinicians andhospitals to be licensed and to comply with applicable laws and regulations. Itis also possible that some states currently, or in the future may, requirelicensure or registration of certain of iVOW’s operations, and may furtherregulate how the company does business. Finally, various states regulate theoperations of an advertising and referral service for physicians, and may requireregistration of such services with a state agency as well as compliance withvarious requirements on how they conduct business and structure theirrelationships with participating providers. Violations of any of these laws orregulations could subject us to a variety of civil and criminal sanctions whichcould materially adversely affect our business and revenue.

 

**Marketing and Sales**

 

OuriVOW program management and consulting business, markets directly to hospitalsand surgeons via our in-house sales and marketing departments.

 

***Internationalsales***

 

OuriVOW business currently does not market outside the United States, although weare evaluating opportunities in international markets for future expansion.

 

**Competition**

 

Thenumber of surgeons performing bariatric surgery is difficult to quantify. Bestestimates are that there are approximately 1,500 surgeons performing bariatricsurgery in the United States, although a substantial proportion also continues toperform other general surgeries. The American Hospital Associationdatabank previously listed that there are approximately 500 dedicated bariatricprograms, although fewer than 100 are estimated to be high volume. It isestimated that 75% of all bariatric surgeons are laparoscopically qualified. Virtually100% of new surgeons entering the field are laparoscopically qualified.

 

Insome measure, all bariatric surgical programs and medical programs and genericweight management programs are competitive with iVOW, but there are certaintrends that represent more directly comparable competition:

 

•                  High volume surgeons expanding theirpractice into multiple sites. An example of this is the Weight Intervention andSurgical Healthcare (WISH) program. This program has recently undergone Chapter11 reorganization and had a significant diminution in its client base. Itnonetheless possesses significant intellectual, if not managerial, talent to becompetitive.

 

•                  BARIX(formerly Bariatric Treatment Centers of America) model is acquisition of asmall hospital and its operation exclusively as a bariatric surgery center. Thereare ten current BARIX hospitals; they appear to have had good patient flow and tobe highly profitable, but no specific financial information is available. Allprocedures in BARIX are currently open surgeries, although a conversion to thelaparoscopic approach is believed to be under consideration. 

 

•                  Specialist outsource managementcompanies: These are the most directly competitive with the iVOW model,although there are variations with each of them. There are three that are mostrelevant:

 

|   | (SHSM)     |   | Specialty Health  Services Management                              |
|--------|------------|--------|--------------------------------------------------------------------|
|   | (LL)       |   | Liv Lite  Surgical Weight Loss Program                             |
|   | (CORI/MSO) |   | Centers for  Obesity Related Illness (2 programs under management) |

 

CORIis partially owned by surgeons and focuses mainly on open bariatric surgery. CORIcurrently operates in two centers. The historic CORI model appears to be acombination of the WISH formula (see above) combined with program management. Itfaced established competition from WISH, for the physician sector of itsbusiness. The historically very hands-on involvement of its practicing surgeonowners impacted the speed and nimbleness with which CORI was able to operate. Itappears that CORI is changing its business model to pursue a generic diseasemanagement model and is migrating away from morbid obesity. 

 

LL isprobably the oldest bariatric management company. In reality it appears thatits main ostensible success is not in center operations, consultation ormanagement, but in patient acquisition for surgical programs. 

 

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SHSMappears to be a professionally managed organization, founded by two of theoriginal founders of  Bariatric TreatmentCenters of America (see above). SHSM is positioning, we believe, to becompetitive long term. The experience of its owners is almost exclusively inopen bariatric surgery, with a bricks and mortar orientation. 

 

TheiVOW management team has bariatric experience, health care consultancyexperience, managed care experience, hospital administrative and clinicalleadership experience, health service programmatic development experience,hands on bariatric clinical management expertise, as well as the financial andentrepreneurial experience that we believe positions the Company todifferentiate itself from the competition and to attain and sustain aleadership position for our business model.  

 

Also,consideration should be given to the situation posed by the LAP-BAND®, aproduct cleared for marketing by the Food and Drug Administration in 2001. TheLAP-BAND® is laparoscopically placed around the stomach and inflated toconstrict available space. The attraction of this device for patients is theless traumatic surgical procedure involved, and the fact that it is adjustableand reversible; these characteristics could represent perceived advantages overgastric bypass surgery. The product is a strong factor in the European market,where it has been available for many years. The LAP-BAND® is gaining increasingfavorability with the morbidly obese patients electing bariatric surgery., it may changethe economics of bariatric care. LAP-BAND® may not require an overnightstay in hospital, for example. Therefore, we believe that the most likelymedium-term outcome is that an increasingly greater subset of patients will optfor LAP-BAND® (or eventual competitors of LAP-BAND®). The rate of growth ofLAP-BAND® procedures is faster than the incidence of new gastric bypass procedures.Experienced surgeons at iVOW clinics offer this option and we will incorporateit into new centers as recommended by our Clinical Advisory Group and agreed toby participating surgeons and hospitals. A final point to be noted is that,whatever the surgical outcome, LAP-BAND® patients need to be selected andfollowed in the context of a full-scale bariatric surgical program, such asiVOW. We believe our iVOW Centers will be positioned to embrace and incorporatenew and emerging surgical treatments for obesity as they become approved andaccepted by the bariatric community.

 

Thereare also several other “less traumatic” surgical therapies under development;iVOW management is remaining closely current with these and plans toincorporate them into the iVOW model when and as appropriate.

 

**Clinical Advisory Board**

 

Wehave a formal Clinical Advisory Board to provide regular advice and feedback. Wealso consult frequently with physicians and surgeons in the obesity diseasemanagement area.

 

**Employees**

 

As of February 28,2006, we had 24 full-time employees, of whom nine are involved in hands onclinical services provision, six are located on site at iVOW Surgical Centersor in center operational management, three work in sales and marketing and,three provide support functions, and two employees in corporate management. Noneof our employees is represented by a collective bargaining agreement, nor havewe experienced work stoppages. We believe our relations with our employees aregood.

 

**Web Site Access to SEC Filings**

 

We maintain an Internetwebsites at *www.ivow.com*. We make available free ofcharge on our Internet website our annual reports on Form 10-KSB,quarterly reports on Form 10-QSB, current reports on Form 8-K, andamendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Exchange Act as soon as reasonably practicable after weelectronically file such material with, or furnish it to, the SEC.

 

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RISKS AND UNCERTAINTIES

 

*You shouldcarefully consider the following risks and uncertainties before you invest inour common stock. Investing in our common stock involves risk. If any of thefollowing risks or uncertainties actually occur, our business, financialcondition or results of operations could be materially adversely affected. Additionalrisks and uncertainties of which we are unaware or which we currently believeare immaterial could also materially adversely affect our business, financialcondition or results of operations. In any case, the trading price of ourcommon stock could decline, and you could lose all or part of yourinvestment.*

 

**Risks Related to our Business and Industry**

 

**We needto raise additional funds immediately to support our operations. These funds may notbe available on acceptable terms, if at all, and we may be forced to ceaseour operations.**

 

At December 31, 2005, we had cash and cashequivalents of $851,315. We believe that our cash and cash equivalents plusmonies received in a financing completed in February 2006 will besufficient to meet our anticipated capital requirements through the secondquarter of 2006. However, we will need to raise additional capital to fund ouroperations beyond June 2006. Any future funding transaction may requireus to relinquish rights to some of our intellectual property or products, andwill be dilutive to our existing stockholders. We cannot guarantee that we willbe able to complete any such transaction or secure additional funds on a timelybasis, or at all, and we cannot assure that such transaction will be onreasonable terms. If we are unable to secure additional capital, we may beunable to sustain operations beyond June 2006, and you may lose yourentire investment in our company.

 

We expect that the cash flows produced by ourbusiness will be unpredictable in the near term, and we expect to continue toexperience operating losses for the foreseeable future, which increases ourneed for significant additional funding. The amount of additional capital thatwe need to raise will depend on many factors, including:

 

•                  the extent to which the iVOW Surgical Centers and other services gainmarket acceptance;

 

•                  the extent to which our SHS Centers and other services can be effectivelyand economically replicated;

 

•                  the speed with which we can execute our business plan, including oursales and marketing activities and the costs to establish iVOW SurgicalCenters; 

 

•                  the speed with which we can execute our business plan, including oursales and marketing activities and the costs to establish SHS modeled centers;

 

•                  the per patient revenue available via the SHS model;

 

•                  the levels of reimbursement for procedures performed; and

 

•                  the extent of competition.

 

**We havea history of losses and may never become profitable.**

 

Since our formation in July 1993, and as of December 31,2005, we have incurred cumulative net losses of $74 million. Specifically, weincurred net losses of $3.9 million in 2004 and $2.5 million in 2005. We expectto incur losses for the next several quarters as we continue to implement ourbusiness plan. However, we may never achieve or sustain profitability inthe future. Even if we achieve profitability, we may not be able tosustain it on an ongoing basis.

 

**Ourfuture financial results will fluctuate significantly.**

 

As a result of our limited operating history and theshort period of time during which we have focused on the provision of obesitysurgery management services, we cannot predict our future revenues or operatingresults. We expect our future revenues and operating results to fluctuateunpredictably due to a combination of factors, including the potential costs ofestablishing additional iVOW Surgical Centers and SHS Centers.

 

Our future operating expenses are expected toincrease in future periods as we intend to establish iVOW Surgical Centers andSHS 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. In addition, our operating expenses are based on our expectations offuture revenues, and are relatively fixed in the short term. We may beunable to adjust spending quickly enough to offset any unexpected revenueshortfall. If we have a shortfall in revenues in relation to our

 

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expenses, or if our expenses increase before our revenues do, then ourbusiness for a particular period would be materially adversely affected.

 

Because of all of these factors and the other risksdiscussed in this section, we believe that our quarterly and annual revenues,expenses and operating results likely will vary significantly in the future. Ifthis occurs, any or all of the following may result:

 

•                  the market trading price of our common stock may fluctuate,negatively impacting the ability of stockholders to buy and sell our shares atconsistent prices;

 

•                  we may have difficulty raising funds in the future at prices thatare acceptable to us and our stockholders; and

 

•                  investors may be less willing to purchase our shares for lack ofconsistent operating results.

 

**Thelicense fees Viking Systems, Inc. owes us may not exceed the minimumroyalty amounts.**

 

As part of the sale of our Visualization Technologybusiness unit to Viking Systems, Inc. (“Viking”), we entered a licenseagreement with Viking under which Viking agreed to pay us royalties over thenext five years based on sales from this business unit, with minimum royaltiesduring the five-year period. Viking paid us the minimum royalty of $150,000 forthe first year of the license. Viking is a relatively new company, and there isno assurance that it will be successful in selling a significant number ofproducts based on the Visualization Technology business. As a result, there canbe no assurance that Viking will owe us more than the minimum royalties setforth in the license agreement. Additionally, if Viking’s business does notsucceed, it may not have sufficient funds in the future to pay us theminimum royalty amounts owed to us under the license agreement.

 

**Ourliquidity and capital requirements will be difficult to predict.**

 

Our liquidity and capital requirements will dependupon 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 iVOWSurgical Centers;

 

•                  the timing and costs of product and services introductions;

 

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

 

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

 

Even if we are successful in raising additionalfunds, circumstances, including slow rate of market acceptance of our servicesor our inability to efficiently manage our operations, would accelerate our useof proceeds from any offering we might do and require us to seek additionalfunds to support our operating requirements.

 

**As acompany, we have limited experience in the management of health care servicesbusinesses.**

 

Over the past two yearswe have tested our ability to run outsourced programs through the threeprograms we currently operate. In addition, the co-founders of SHS bring overseven years of experience as owner-operators of SHS Centers. Nonetheless, wehave only a limited and indirect operating history upon which an evaluation ofour prospects can be based. In addition, the bariatric surgical managementmarket is relatively new and is evolving rapidly, which can cause changes inthe way clients react to the services offered. We have yet to prove that ourmanagement model is appropriate for the market we are addressing. To besuccessful, it is crucial that we develop strong affiliations with employers,payors, hospitals and providers, and we have as yet limitedly proven ourability to do so. We have established only three****significant operating agreements with hospitals to date andoperate only two SHS Centers. To successfully implement our business plan, wemust establish many more such relationships.

 

Prior to the favorableruling by CMS in February 2006, we believe our business had been adverselyimpacted by changes in reimbursement and uncertainty concerning CMS’s decisionon whether to provide coverage for gastric bypass surgery. Doctors, hospitals,surgical practices and those companies that support the obesity surgery marketwill adapt their businesses to the evolving reimbursement and payor policies.We believe that for many of these parties CMS’s decision on the coverage ofgastric bypass surgery is a critical step in their business analysis. However,since CMS only recently announced its decision, it is too early to determinewhat impact this decision will have on our business.

 

Also, we must respond tocompetitive developments and attract, retain and motivate experienced staff.There can be no 

 

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assurance that we will besuccessful in addressing those market conditions or in implementing ourbusiness strategy. There can be no assurance that we will be able to achieve orsustain revenue growth or profitability.

 

**On November 1, 2005, weacquired SHS as a wholly-owned subsidiary. We may not realize the expectedbenefits of the acquisition because of integration and other challenges, whichcould adversely affect our business.**

 

We have limitedexperience in acquisition activities and integrating the operations,technologies, products, services and personnel of iVOW and SHS may be acomplex, time consuming and expensive process that could significantly disruptthe business of the combined company. Employees and management of each of iVOWand SHS have played a key role in creating each company and the integration ofthese two companies will alter prior relationships and may affectproductivity. If we fail to successfully meet the challenges involved inintegration or otherwise fail to realize any of the anticipated benefits of theacquisition, then the results of operations of the combined company could beseriously harmed. Realizing the benefits of the acquisition, if any, willdepend in part on the successful integration of products, services,operations and personnel.

 

We may notsuccessfully integrate the operations of SHS and iVOW in a timely manner, or atall, and the combined company may not realize the anticipated benefits ofthe acquisition to the extent, or in the timeframe, anticipated. Theanticipated benefits of the acquisition are based on projections andassumptions, including successful integration, not actual experience. Inaddition to the integration risks discussed above, the combined company’sability to realize those benefits could be adversely effected by practical orlegal constraints on its ability to combine operations.

 

**Ourrevenue model related to the iVow Surgical Centers relies on the provision ofservices and we have no ownership stake in the iVow Surgical Centers.**

** **

Our business modelincludes the ownership and operation of our SHS Centers as well as theprovision of management services to owners of medical and surgical programs. Withrespect to our iVow Surgical Center program, we will not have an ownershipinterest in the iVow Surgical Centers, which will make it more difficult tosustain revenues from these Centers. We will not enjoy directly increasedrevenue based on the profitability or increased value of particular iVowSurgical Centers and, without an ownership interest in the iVow SurgicalCenters, we are subject to all the risks of any service provider; our servicescould be terminated at the end of any contract period for such centers.

 

**Roll-outof our iVow Surgical Centers and our SHS Centers depends on our entering intoagreements with employers, payors, hospitals and physicians; the time toconclude these agreements may be extended and thereby delay or prevent theimplementation of our strategy.**

** **

We plan to set up ouriVow Surgical Centers and SHS Centers in conjunction with employers, payors,hospitals and surgeons. There can be no assurance that we will be able tonegotiate the establishment of these Centers in a timely manner or on termssatisfactory to us, if at all. Our experience to date is limited to threeexisting management contracts for iVow Surgical Centers and two SHS Centers. Weare in active negotiation for other iVow Surgical Centers and SHS Centers;however, we cannot accurately predict the time and expense involved in thesenegotiations, and any unexpected delays could negatively impact the execution ofour strategic plan. Any inability to timely establish additional iVOW SurgicalCenters and SHS Centers will harm our cash position and increase our need toraise additional capital.

 

**We need toincrease market awareness 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 previouslysupplied clinical training and consulting services to various clients, we haveonly recently begun to promote our program management services and have juststarted to promote our owner operator model. As a result, employers, payors andproviders of bariatric clinical services are not yet generally aware of theservices we offer. In order to accomplish our strategic and business plans, wewill have to quickly and effectively increase market awareness of ourmanagement model and the iVOW brand name, and convince employers, payors,doctors, hospitals and patients of the benefits of these services. Among otherthings, this will require that we:

 

•              increaseawareness of our complete service offering;

 

•              strengthenour brand name to increase visibility;

 

•              continueto upgrade and expand our services; 

 

•              increase awareness of the availability ofsurgery as a means of treating morbid obesity; and

 

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•              increase awareness of the availability of ourmultidisciplinary medically anchored weight management program as a means oftreating chronic and morbid obesity.

 

We cannot assure you that we will be able to accomplish these objectiveswith the limited operating capital we currently have available, if at all.

 

**Afterestablishing iVow Surgical Centers and SHS Centers, we must continue to proveour value proposition.**

** **

In order to successfullynegotiate and complete agreements with employers, payors, doctors and hospitalsto establish iVow Surgical Centers and SHS Centers, we will need to presentthem with their anticipated return on investment (ROI), our projected revenuesand operational metrics. We cannot assure you that our projections will proveaccurate or that we will be able to provide the anticipated metrics. Ourprojections are based on limited input and operational history and failure tomeet such projections will negatively impact our relationships with employers,payors, doctors and hospitals and our ability to attract additional business.

 

**Theprovision of health care services is subject to considerable regulation bystate and federal agencies, including regulations under HIPAA and Stark.**

** **

Our iVow Surgical Centersand SHS Centers will need to comply with many laws and regulations, both stateand federal, which govern the provision of health care services. If they failto comply with any such laws and regulations, then the penalties involved couldbe serious, time-consuming for management and expensive. Inexperience in healthcare services could contribute to an inadvertent breach of laws or regulations.

 

There are numerousfederal and state regulations addressing patient information privacy andsecurity concerns. In particular, the federal regulations issued under theHealth Insurance Portability and Accountability Act of 1996, or HIPAA, containprovisions that:

 

•              protect individual privacy by limiting the uses and disclosures of patientinformation;

 

•              require the implementation of securitysafeguards to ensure the confidentiality,integrity and availability of individually identifiable health information inelectronic form; and

 

•              prescribe specific transaction formats and data code sets for certainelectronic transactions.

 

Compliance withthese regulations is costly and requires our management to spend substantialtime and resources when working with our clients. We are unable to estimate thetotal financial impact of our continuing compliance with HIPAA requirements orof any future changes in these requirements.

 

In addition, thefederal Stark Law restricts referrals by physicians of Medicare, Medicaid andother government-program patients to providers of a broad range of designatedhealth services with which they have ownership or certain other financialarrangements. Many states have adopted legislative proposals to prohibit thepayment or receipt of remuneration for the referral of patients and physicianself-referrals, regardless of the source of the payment for the care. Theselaws and regulations are extremely complex, and little judicial or regulatoryinterpretation exists. If the activities of a client of ours or other entitywith which we have a business relationship were found to constitute a violationof anti-referral laws, and we were found to have knowingly participated in suchactivities, we could be subject to sanction or liability under such law.

 

**We operatein a competitive market; new technologies, procedures, or pharmaceuticals couldeventually radically change the modality of treatment of morbid obesity andnegatively impact the economics of 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 of developments, primarily involvingstimulation or balloon technology, which may come to the market in thenext several years. These devices would be implanted in a relatively simpleendoscopic procedure. These alternatives may prove to be more effective,less risky and/or cheaper than gastric bypass. If this turns out to be thecase, our ability to generate revenues from the surgical model will benegatively affected. Also, many pharmaceutical companies are researching drugtherapies 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. We cannot guarantee that we will competesuccessfully against our current or potential competitors, especially anypharmaceutical companies with significantly greater financial resources orbrand name recognition.

 

**We expectto compete with other companies that have the same objectives as us.**

** **

There are a few 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 management 

 

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services. Three of thesecompanies, to our knowledge, include bariatric surgeons in their management orownership. This may prove to be an advantage over us in gaining access topotential clients because we do not have bariatric surgeons on our staff. Othercompanies have only a partial service offering, which may allow them,because of lower overhead, to operate in their niche at a price advantage tofull-service companies such as ours. In any case, we expect that the marketwill continue to be attractive and that new entrants are likely.

 

**If we failto retain our key personnel and hire, train and retain additional qualified andexperienced employees, we may not be able to compete effectively, orexpand our consulting business and the number of Centers as planned, both ofwhich could result in reduced 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. Thereis likely to be a competitive labor market for such staff and there is noassurance that we will be able to attract and retain an adequate number ofsuitable employees. If we are unable to do this, then we may not be ableto 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 Surgical Centers and SHS Centers. We have alimited marketing and business development force through which the efforts willbe conducted, and we will rely heavily on each of these individuals. We cannotassure you that we will be able to attract and retain sufficient qualifiedpersonnel.

 

Our current key employeesare Michael H. Owens, M.D., Chief Executive Officer, President and ChiefMedical Officer; Richard Gomberg, Vice President of Finance and Chief FinancialOfficer; Joann Harper, Vice President, Program Development, Implementation, andOperations; Mary Pat Finn, Vice President of Sales; Mary Lou Walen, AssociateVice President, Customer Relations; and Aimee Johnston, Associate VicePresident, Marketing Management Services. Key employees of our wholly-ownedsubsidiary SHS are Steve Martin, M.D., Assistant Vice President, BehavioralServices; Jeannette Beatty, Manager of Nutrition; and Pamela Adkins, Manager,Exercise and Testing. We also have entered into long-term consultingengagements with the co-founders of SHS, Dr. Frances Gough and Dr. TeresaGirolami. We do not maintain key personnel life insurance policies on any ofthese individuals. 

 

**If we arenot able to attract and retain key doctors to participate in our advisoryboard, it may adversely affect our ability to develop our products andservices and expand our 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 aresult, they only spend a limited amount of time on our business. Although wehave entered into consulting agreements, including confidentiality provisionswith each of the members of our clinical advisory board, the consulting andconfidentiality agreements between us and each of the members of our clinical advisory board may beterminated or breached.

 

**Ourfailure to effectively manage our growth could have a material adverse effecton our business.**

** **

Growth in our businesswill place a significant strain on our management systems and resources. Wehave only recently begun to focus on providing management services, and we havehired persons with appropriate skills. However, these people have not previouslyworked together, and it will take time and effort to develop efficient workingprocesses and relationships. We will need to continue to improve ouroperational and financial systems and managerial controls and procedures, andwe will need to continue to expand, train and manage our workforce. We are asmall company with limited resources, so we lack the ability to increase ourcapacity to provide services prior to assurances that those services will bepaid for by customers. As a result, each new management contract will requiresignificant operational efforts as we hire personnel to staff the new project. Wewill have to maintain close coordination among our technical, accounting,finance, marketing and sales departments.

 

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

 

**Our commonstock may be subject to delisting from the Nasdaq Capital Market becausewe fail to maintain compliance with continued listing criteria.**

 

Thequantitative standards for continued listing on the Nasdaq Capital Marketrequires a company to maintain a bid price for its stock of $1.00 per share andmaintain a stockholders’ equity of at least $2,500,000 (or satisfy alternativerequirements). Failure to comply with these requirements subjects a company todelisting proceedings. We have twice over the past 3 years been subjected todelisting proceedings from Nasdaq for failure to meet the minimum stockholders’equity requirement. Each time we eventually regained compliance by raisingadditional operating capital.

 

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We cannot assure you thatwe will be able to maintain our stockholders’ equity above $2,500,000 ormaintain our stock price above $1.00 per share.  In addition, we received 1,654,000 shares of commonstock of Viking in connection with the sale of our Visualization Technologybusiness. We currently value those shares at a total of $661,600, whichrepresents the trading price of Viking common stock at December 31, 2005. Viking’scommon stock is thinly traded and sales of even small numbers of shares cansignificantly affect the trading price. Because of this, the trading price ofViking’s common stock is likely to fluctuate substantially over time, and thiswill affect the value we ascribe to our shares. A significant drop in thetrading price of Viking’s common stock would negatively affect our financialposition and, specifically, our stockholders’ equity balance. Any reduction inour stockholders’ equity associated with a drop in the trading price of Vikingcommon stock could subject us to delisting proceedings by Nasdaq.

 

If we are unable tocomply with Nasdaq’s continued listing requirements, our securities will bedelisted from the Nasdaq Capital Market. The delisting of our common stock fromthe Nasdaq Capital Market may materially impair our stockholders’ abilityto buy and sell shares of our common stock and could have an adverse effect onthe market price of, and the efficiency of the trading market for, our commonstock. In addition, the delisting of our common stock could significantlyimpair our ability to raise capital should we desire to do so in the future.

 

**Future sales of our common stock in the public market couldcause our stock price to fall.**

 

In the private placementfinancing we completed on February 23, 2006, we issued 290,000 shares ofcommon stock and warrants to purchase 145,000 shares of common stock. We alsoissued 23,200 shares of common stock and a warrant to purchase 11,600 shares ofcommon stock to our placement agent, Dawson James Securities. In the privateplacement financing we completed on July 26, 2005, we issued 833,328shares of common stock and warrants to purchase 833,328 shares of common stock.We also issued  a warrant to purchase83,332 shares of common stock to our placement agent, Dawson James Securities.In connection with the private placement,  we issued 177,252 shares ofcommon stock and warrants to purchase 124,608 shares of common stock inexchange for the 826,447 outstanding shares of Series A preferred stock(the “Series A exchange”). In total, we issued 1,010,580 shares of commonstock and warrants to purchase 1,041,268 shares of common stock in the privateplacement and the Series A exchange.

 

As of February 28,2006 we had 2,657,663 shares of outstanding common stock. As part of theabove transactions, we have filed a registration statement for the July 26,2005 financing and will be filing a registration statement by April 8,2006 related to the February 23, 2006 financing. Sales of these shares of commonstock, or the perception that such sales might occur, could cause the marketprice of our common stock to decline.

 

**There is alimited market for our common stock and therefore investors may not beable to liquidate their investment 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, weonly have approximately 190 stockholders of record and the average dailytrading volume in our stock is approximately 12,500****shares. The limited trading market for our common stock may causefluctuations in the market value of our common stock to be exaggerated, leadingto price volatility in excess of that which would occur in a more activetrading market. The lack of an active trading market in our stock may alsocause investors to be unable to sell all of their desired shares of commonstock on short notice and the sale of a large number of shares at one time could temporarily depress the market price. Aninvestment in our company is highly speculative, and an investor should be ableto withstand a total loss of the investment.

 

**Our stockprice could continue to be volatile and your investment in our common stockcould suffer a decline in value, adversely affecting our ability to raiseadditional capital.**

** **

The market prices 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 stockhas historically been highly volatile. For example, between March 2005 andFebruary 2006, the trading price of our common stock ranged from $2.30 to$13.90. The trading price of our common stock may continue to besignificantly affected by factors such as:

 

•              actualor anticipated fluctuations in our operating results,

 

•              ourability to remain listed on Nasdaq,

 

•              changesin financial estimates by securities analysts,

 

•              announcementsof technological innovations,

 

•              newproducts or new contracts by us or our competitors,

 

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•              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, thestock market has from time to time experienced significant price and volumefluctuations that have particularly affected the market prices for shares ofearly stage companies. These broad market fluctuations may adverselyaffect the market price of our common stock. 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. Suchlitigation, if brought against us, could result in substantial costs and adiversion of management’s attention and resources.

 

**We intendto issue additional shares of our equity securities in the future to raisefunds to support our operations.**

** **

We intend to seek toraise additional capital through the sale of our equity or other securities tosupport our financial needs. Potential investors should be aware that anysecurity issuance may result in reduction of the book value or marketprice, if any, of the outstanding shares of common stock. If we issue anyadditional shares of common stock or preferred stock, such issuance will reducethe proportionate ownership and voting power of each other stockholder. Further,any new issuance of shares may result in a change of control of ourmanagement or the Company.

 

**Anti-takeoverprovisions in our organizational documents and Delaware law may discourageor prevent a change of control, even if an acquisition would be beneficial toour stockholders, which could affect our stock price adversely and preventattempts by 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:

 

•              authorizethe issuance of preferred stock which can be created and issued by the board ofdirectors without prior stockholder approval, with rights senior to those ofthe common stock;

 

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

 

•              prohibitour stockholders from filling board vacancies, calling special stockholdermeetings, or taking action by written consent;

 

•              prohibitingour stockholders from making certain changes to our restated certificate of incorporationor restated bylaws except with 66 2/3% stockholder approval; and

 

•              requireadvance written notice of stockholder proposals and director nominations.

 

In addition, weare subject to the provisions of Section 203 of the Delaware GeneralCorporation Law, which may prohibit certain business combinations withstockholders owning 15% or more of our outstanding voting stock. These andother provisions in our certificate of incorporation, bylaws and Delaware lawcould make it more difficult for stockholders or potential acquirers to obtaincontrol of our board of directors or initiate actions that are opposed by ourthen-current board of directors, including delay or impede a merger, tenderoffer, or proxy contest involving our company. Any delay or prevention of achange of control transaction or changes in our board of directors could causethe market price of our common stock to decline.

 

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

 

**We depend on our intellectual property for the establishmentand operation of our iVOW Surgical Centers and SHS Centers.**

 

We rely on a combinationof trade secrets, know-how and confidentiality restrictions for theestablishment and operation of our iVOW Surgical Centers and SHS Centers.Despite these precautions, it may be possible for unauthorized parties tocopy our intellectual property or otherwise obtain and use information that weregard as proprietary. We do not have any patent protection for our business,and existing intellectual property laws provide only limited protection. Wehave expended significant efforts devising the types of products and serviceswe will offer and the manner in which these will be delivered. Our ability tomaintain the secrecy and confidentiality of our trade secrets and internalknowledge is crucial to the success of our business. Any failure to do so may negativelyimpact our prospects. We also may not be able to detect unauthorized useand take appropriate steps to enforce our 

 

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intellectual propertyrights.

 

**We may besubject to product liability 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 products proves to be defective, we may berequired to recall or redesign such products. Product liability insurance isexpensive and in the future may not be available to us on acceptableterms, if at all. A successful product liability claim or series of claimsbrought against us in excess of our insurance coverage would negatively impactour business.

 

**If we areunable to protect our intellectual property related to the technologytransferred to Viking, we may be unable to prevent other companies fromusing such technology in competitive products.**

** **

We maintain ownership ofthe technology transferred to Viking in connection with the sale of ourVisualization Technology business in April 2004. In the event Viking doesnot make the required royalty payments to us, their rights in the technologywill be terminated. In such case, we will be able to continue to commercializethat technology. To the extent we decide to incorporate that technology intoour business, our future success will depend, in part, on our ability tocontinue developing patentable products, enforcing our patents and obtainingpatent protection for our products both in the United States and in othercountries. The patent positions of medical device companies, however, aregenerally uncertain and involve complex legal and factual questions. Patents may neverissue from any patent applications owned by or licensed to us. Even if patentsdo issue, the claims allowed may not be sufficiently broad to protect ourtechnology. In addition, issued patents owned by or licensed to us may bechallenged, invalidated or circumvented, or the rights granted thereunder may notprovide us with competitive advantages. Further, the medical device industryhas been characterized by extensive litigation regarding patents and otherintellectual property rights. Litigation, which would result in substantialexpense, may be necessary to enforce any patents issued or licensed to usand/or to determine the scope and validity of proprietary rights of thirdparties or whether our products, processes or procedures infringe any suchthird-party proprietary rights. In addition to patents, we rely on unpatentedtrade secrets to protect our business and our proprietary technology. 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 difficult to 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 on confidentiality agreements with ourcollaborators, employees, advisors, vendors and consultants to protect ourproprietary 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 andconsultants require disclosure of ideas, developments, discoveries orinventions conceived during employment or consulting, as the case may be,and assignment to us of proprietary rights to such matters related to ourbusiness and technology. The extent to which efforts by others will result inpatents and the effect on us of the issuance of such patents is unknown.

 
| Item 2. | DESCRIPTION OF  PROPERTY |
|---------|--------------------------|

 

Our currentfacilities consist of approximately 2,800 square feet of subleased office spacelocated in San Diego, California under a 36 month lease commencing February 2006.Previously, we subleased approximately 5,000 square feet in Carlsbad, CA whichexpired in January 2006. 

 

Ourwholly-owned subsidiary Sound Health Solutions has two facilities consisting ofapproximately 12,000 total square feet of subleased space located in theSeattle, Washington metropolitan area under leases that run through November 2008and June 2009.

 

Webelieve that our existing space is adequate for our current operations. Webelieve that suitable replacement and additional space will be available in thefuture on commercially reasonable terms.

 
| Item 3. | LEGAL  PROCEEDINGS |
|---------|--------------------|

 

Fromtime to time, we may be involved in litigation relating to claims arisingout of our operations in the normal course of business. There are no materiallegal proceedings pending against us. 

 
| Item 4. | SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS |
|---------|------------------------------------------------------|

 

None.

 

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PART II

 
| Item 5. | MARKET FOR  COMMON EQUITY AND RELATED STOCKHOLDER MATTERS |
|---------|-----------------------------------------------------------|

 

(a)                                  Marketfor Common Equity and Related Stockholder Matters.

 

OurCommon Stock is traded on the over-the-counter market and prices are quoted onthe Nasdaq Capital Market under the symbol “IVOW.”  The following table sets forth the high andlow sale prices for our Common Stock on the Nasdaq Capital Market from January 1,2004 through December 31, 2005.

 

On July 19,2005, the stockholders of the Company voted to grant authority to the Board tofile an amendment to the Company’s Second Restated Certificate of Incorporationto effect, at the discretion of the Board, a reverse stock split of the issuedand outstanding common stock in a ratio for such split that is not less than1:2 nor greater than 1:10. On October 6, 2005, the Board acted on itsauthority to effect the split of all common stock issued and outstanding at arate of 1:10. As a result of the split, all share information below has beenretroactively adjusted. 

 
| **Quarter**      | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------|------------|----------|------------|---------|------------|
|             |       |     |       |    |       |
| 1st Quarter 2004 |       | $        | 29.90      |    | $          | 11.00 |   |
|             |       |     |       |    |       |
| 2nd Quarter 2004 |       | $        | 22.00      |    | $          | 10.00 |   |
|             |       |     |       |    |       |
| 3rd Quarter 2004 |       | $        | 30.00      |    | $          | 13.40 |   |
|             |       |     |       |    |       |
| 4th Quarter 2004 |       | $        | 19.20      |    | $          | 8.20 |   |
|             |       |     |       |    |       |
| 1st Quarter 2005 |       | $        | 13.90      |    | $          | 7.20 |   |
|             |       |     |       |    |       |
| 2nd Quarter 2005 |       | $        | 9.00       |    | $          | 3.10 |   |
|             |       |     |       |    |       |
| 3rd Quarter 2005 |       | $        | 5.70       |    | $          | 2.90 |   |
|             |       |     |       |    |       |
| 4th Quarter 2005 |       | $        | 5.23       |    | $          | 2.30 |   |

 

On March 8,2006 the last reported sale price of our Common Stock was $5.08. As of March 8,2006, there were approximately 192  holders of record of our Common Stock notincluding holders who hold their stock in “street name”.

 

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

 

Theinformation required to be disclosed by Item 201(d) of Regulation S-K, “Securitiesauthorized for Issuance under Equity Compensation Plans”, is incorporated byreference within Item 12 of Part III of this Annual Report on Form 10-KSB.

 

(a)(ii)                    Recent Salesof Unregistered Securities.  See theCompany’s previously filed reports on Form 8-K.

 

(b)                                 Notapplicable.

 

(c)                                  Notapplicable.

 

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| Item 6. | MANAGEMENT’S  DISCUSSION AND ANALYSIS OR PLAN OF OPERATION |
|---------|-----------------------------------------------------------------|

 

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 1 of Part I ofthis annual report. While this outlook represents our current judgment on thefuture direction of our business, such risks and uncertainties could causeactual results to differ materially from any future performance suggested below.We undertake no obligation to release publicly the results of any revisions tothese forward-looking statements to reflect events or circumstances arisingafter the date of this annual report. The following discussion should be readin conjunction with our consolidated financial statements and the notesthereto.

 

**Overviewof our Business**

 

Our Company,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, wesold the Visualization Technology business to concentrate on the obesitysurgery services market. We changed our name to iVOW, Inc. in February 2005,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 focused on implementing disease managementstrategies for the control of chronic and severe obesity. Our vision is toenable healthcare providers and organizations in the ongoing evolution of thehighest standards of treatment and services to optimize the quality of life forchronic and morbidly obese patients. Our mission is to deliver the leadingmanagement portfolio of services and products for the clinical and businessdevelopment of continually successful medical and surgical programs for thetreatment of chronic and morbid obesity.

 

iVOW acquired SoundHealth Solutions, Inc. (“SHS”), a Seattle-based healthcare providerspecializing in the multidisciplinary medical treatment of obesity, as awholly-owned subsidiary. SHS has pioneered the development of multidisciplinarymedically anchored weight loss programs since 1998. Through a pilot programwith Microsoft Corporation, SHS has produced what we consider to be the bestvalidated, statistically significant data on multidisciplinary medicallyanchored weight loss programs in the country. In the summer of 2005, Microsoftand Premera Blue Cross of Washington received a national award for innovationin obesity management from the National Institute of Health Care Management,which prominently featured the program designed by SHS and its two physicianco-founders, Drs. Francis Gough and Teresa Girolami. 

 

We anticipate that theaddition of SHS to iVOW will improve and expand our business model. Prior toour acquisition of SHS, our business model focused principally upon workingwith hospitals and surgeons to provide consultations on a fee-for-service basisor to operate their bariatric surgical programs for a management fee, while thehospitals and surgeons held the contracts with insurance providers and other third-partypayors and employers. Under that model, even if the volume of patientsincreased, our revenue did not. In contrast, SHS, through its “owner-operator”model, contracts directly with employers, payors and unions to facilitateweight loss programs on a direct per patient basis, thus generating incrementalrevenue as patient volume increases. While we intend to focus on capitalizingupon SHS’s owner-operator model, we also will continue to pursue strategicoutsourced management opportunities. We now have two platforms on which to growour business: the employer/payor medically anchored platform and thehospital/provider surgically anchored platform.

 

Insurance providers andother third-party payors consistently require medical or other documented weightloss management failure or attempts prior to approving patients for bariatricsurgery. Such requirements are developing into a de facto gating phenomenon forbariatric surgery. As a result, we believe that organizations that offernon-surgical weight loss programs will not only have the opportunity to succeedbut also could potentially influence, if not determine, where patients receivebariatric surgery. 

 

We believe that SHSoffers a platform from which to integrate clinical, medical and surgicalweight loss programs into a seamless disease management strategy for obesity.We anticipate that expansion of our SHS model will generate marketopportunities for our iVOW Surgical Centers and, depending on how the marketopportunity evolves, other affiliated bariatric centers.

 

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Patient demand for aneffective and proven surgical solution to the chronic health conditions causedby morbid obesity has accelerated the number of surgical procedures performedfrom approximately 16,000 a decade ago to approximately 170,000 in 2005,according to the American Society for Bariatric Surgery. The number of patientsthat underwent bariatric surgery in 2005 represents less than one (1) percentof the total population with a body mass index (BMI) that qualifies for theprocedure. An additional 45 million Americans are obese, and many meet BMIqualification criteria for our SHS model. We believe that, by building upon theexpertise, market position and relationships developed in our combined businesslines described above, we now have the foundation to become a leading providerof (i) disease-specific program management in bariatric clinical, medicaland surgical care and (ii) a commensurately expanded suite of relatedconsulting services. 

 

Our business model is todevelop a network of bariatric disease management centers that we directly ownor operate based upon our current SHS model as well as to outsource managementthrough both our historical iVOW Surgical Center model and new SHS outsourcedmodel, which are able to provide patients with all necessary clinical, medicaland surgical services. As owner/operator of our current SHS modeled centers wewill have full administrative control and contract directly with insurance providersand other third-party payors. As manager of the outsourced program we willcoordinate all the administrative and marketing functions on behalf of ourclients and provide patient services, particularly in assessing whether thereis a suitable clinical alternative to surgery, as well as in assuring thefulfillment of payor mandated pre-surgical weight loss management requirementsand appropriate long-term post operative care and monitoring of patients. Ourrevenue model is based upon a monthly management fee for our outsourced managedprograms, a per-patient fee for our SHS owner-operator program, andfee-for-service for our consulting business. 

 

Weintend to develop the iVOW brand name with the iVOW Sound Health tag line toprovide a national identity for our programs. We believe that the centralizedprovision of certain services to our own centers as well as to our managedclients, for example, the processing of medical insurance approval, informationtechnology support and contracting, will benefit our internal expensemanagement structure and increase our appeal to customers. Additionally, wewill continue to develop and expand our consulting services as described aboveto include SHS products that complement the historical iVOW products, targeted atthose clients that do not require a complete management package but that needspecific assistance with individual components of their bariatric clinical,medical or surgical programs. We hope that such efforts will encourage ourmarket branding as well as cultivate a pipeline vehicle for our centers.

 

Our goal is to become the leadingdisease management and consulting company focused on chronic and morbidobesity. Our initial focus was on the severely obese patient with gastricbypass surgery as the solution. We have expanded our focus to include thechronically obese through our SHS multidisciplinary medically anchored weightmanagement platform. It is these singular and combined platforms upon which wehope to expand service to new obesity therapies as they are developed. We arecurrently aggressively integrating our SHS bariatric medical model into ouriVOW surgical protocols to fulfill the pre-operative weight managementrequisites of employers and payors, the long term care of post-surgicalpatients and the treatment of obese patients who either are not qualified forsurgery or prefer a non-surgical alternative treatment modality.

 

In February 2004,we sold to a group of accredited investors 43,900 shares of common stock andwarrants to purchase up to 21,950 shares of common stock, for a total of$588,260 as part of a unit offering. We sold 21,950 units; each unitconsisted of two (2) shares of common stock priced at $13.40 per share anda warrant to purchase one share of common stock. The 21,950 warrants areexercisable at a price of $19.70 per share and expire in February 2009. Theproceeds were used to fund our obesity disease state management business unitand our Visualization Technology business unit until it was sold in April 2004.

 

In April 2004,we sold our Visualization Technology business unit to Viking Systems, Inc.(“Viking”) under an Asset Purchase Agreement signed on December 22, 2003.  The financial results of this business havebeen reported separately as discontinued operations and the financialstatements for all prior periods have been restated accordingly. See gain(loss) from discontinued operations below and Note 2 to our consolidated financialstatements.

 

In May 2004,we sold to a group of accredited investors 545,454 units of our securities for$8.50 per unit, each unit consisting of one share of common stock and onewarrant to purchase one-half share of common stock, for aggregate grossproceeds of approximately $4.6 million, or $4.1 million net of expenses. The 272,727warrant shares are exercisable at a price of $9.50 per share and expire in May 2009.As part of the May 2004 unit sale, we issued warrants to theplacement agent to purchase up to 81,817 shares of our common stock of which 54,545of these warrants are exercisable at a price of $10.20 per share and theremaining 27,272 warrants are exercisable at a price of $9.50 per share. Thewarrants expire in May 2009.

 

In June 2004,we amended our Series A Certificate of Designations to allow us the rightto issue equity securities for a price under $2.00. For that right, the Series Aholders received 1,400,000 shares of Viking common stock that we held valued at$28,000. As part of the amendment, we were required to redeem 85,000 Series AShares for $200,000. In addition, we had the right to redeem an additional300,000 Series A Shares at any time on or before January 15, 2006 inexchange for $500,000. 

 

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In August 2004,we announced the signing of the first full management contract for an iVOWCenter, which covers the launch and ongoing management of an obesity surgeryprogram. The agreement is a 3-year renewable contract with Pioneers MemorialHealthcare District of Brawley, CA.

 

In October 2004,at a special meeting of the stockholders we received approval to increase theaggregate number of shares of common stock available for issuance under our1997 Stock Option/Stock Issuance Plan from 109,250 to 259,250.

 

In April 2005,we signed a three year Administrative Services Agreement with Lenox HillHospital and the Manhattan Minimally Invasive Bariatric Surgical PC to provideservices for the administration and evolution of their bariatric surgicalpractice into an obesity disease management program. The program providesservices to assist clients to transition from obesity to wellness. TheAgreement runs through April 2008.

 

In April 2005,Nasdaq notified the Company that the bid price of its common stock did notsatisfy the $1.00 per share minimum bid price required by Marketplace Rule 4310(c)(2)(B).This notice indicated that the Company will be provided until October 2005to regain compliance with the minimum bid price requirement by having the bidprice of its common stock close at $1.00 per share or more for a minimum of 10consecutive trading days prior to such date.  As a result of a 1:10 reverse stock split in October 2005(see below), the Company regained compliance with the the $1.00 per shareminimum bid price.

 

In May 2005,the Company received a second letter from Nasdaq indicating that the Companywas not in compliance with Marketplace Rule 4310(c)(2)(B), which requiresthe Company to have a minimum of $2,500,000 in stockholders’ equity,$35,000,000 market value of listed securities or $500,000 of net income fromcontinuing operations for the most recently completed fiscal year or two of thethree most recently completed fiscal years. Nasdaq also requested the Companyto submit a detailed plan regarding its proposal to achieve and subsequentlycomply with all of the continued listing requirements of the Nasdaq Capital Market.

 

In July 2005,we sold to a group of accredited investors 833,328 units of our securities for$3.00 per unit, each unit consisting of one share of common stock and onewarrant to purchase one share of common stock, for aggregate gross proceeds ofapproximately $2.2 million net of expenses. The warrants are exercisable at aprice of $3.00 per share and expire in July 2010. Under the terms of theprivate placement, the Company and the holders of the Company’s Series APreferred Stock converted the 826,447 outstanding shares of Series APreferred Stock into 124,608 Units, 52,644 shares of common stock and $126,174in cash. With the completion of this private placement, the Company’sstockholders’ equity exceeded $2,500,000. As a result, the Company regainedcompliance with the stockholders’ equity requirement for continued listing onthe Nasdaq Capital Market. 

 

In July 2005, at theannual meeting of the stockholders we received approval to increase the aggregatenumber of shares of common stock available for issuance under our 1997 StockOption/Stock Issuance plan from 259,250 to 400,000, to increase the aggregatenumber of shares of common stock available for issuance under our 1997 EmployeeStock Purchase Plan from 15,000 to 30,000 and to amend our Second RestatedCertificate of Incorporation to increase the authorized shares of common stockfrom 35,000,000 to 70,000,000. 

 

In July 2005,the stockholders of the Company voted to grant authority to the Board to filean amendment to the Company’s Second Restated Certificate of Incorporation toeffect, at the discretion of the Board, a reverse stock split of the issued andoutstanding common stock in a ratio for such split that was not less than 1:2nor greater than 1:10. In October 2005, the Board acted on its authorityto effect the reverse split of all common stock issued and outstanding at arate of 1:10. As a result of the reverse split, all common share and per shareinformation in this discussion has been retroactively adjusted.

 

In August 2005,Howard Sampson tendered his resignation as the Vice President and ChiefFinancial Officer of iVOW, Inc. J. Bradford Hanson became the Company’snew Vice President and Chief Financial Officer, replacing Howard Sampson. 

 

In November 2005,we completed the acquisition of SHS. SHS operates as a wholly-owed subsidiaryof iVOW. Under the terms of the Merger Agreement, iVOW paid $125,500, in cash assumedapproximately $317,000 of liabilities and agreed to issue up to 294,278 sharesof its common stock (the “Merger Shares”), of which 184,477 shares with a fairvalue of $427,987 were issued as of the closing and the remaining 109,801shares are subject to holdback based on contingencies set forth in the MergerAgreement. iVOW has a repurchase right for up to 71,128 of the Merger Shares tothe extent that SHS fails to satisfy certain revenue and net income targets in2006 and 2007. 

 

In February 2006,J. Bradford Hanson tendered his resignation as the Vice President and Chief FinancialOfficer of iVOW, Inc. Richard Gomberg became the Company’s new VicePresident and Chief Financial Officer, replacing J. Bradford Hanson. 

 

In February 2006,the Company completed a private placement of the Company’s common stock andwarrants in which it sold 290,000 units at a purchase price of $3.18 per unit. Eachunit consisted of one share of the Company’s common stock and a 

 

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warrant to purchaseone-half share of the Company’s common stock. The warrants have an exerciseprice of $3.18 per share and have a five-year term. The private placementresulted in gross proceeds of $922,200.

 

**CriticalAccounting Policies**

 

Thediscussion and analysis of our financial condition and results of operationsare based upon our consolidated financial statements, which have been preparedin accordance with accounting principles generally accepted in the UnitedStates. The presentation of these financial statements requires us to makeestimates and judgments that affect the reported amounts of assets andliabilities, revenues and expenses, and related disclosure at the date of ourfinancial statements. The significant accounting policies, which we believe aremost critical in gaining an understanding of our financial statements, includepolicies and judgments relating to reclassification, revenue recognition, andinventories. Actual results could differ materially from these estimates. Oursignificant accounting policies are summarized in the notes to our consolidatedfinancial statements. The significant accounting policies which we believe arethe most critical in gaining full understanding and evaluating our reportedfinancial results include the following:

 

**ReverseStock Split**

 

On July 19,2005, at its Annual Meeting of Stockholders, iVOW’s stockholders approved toeffect a reverse split of the Company’s outstanding common stock in a ratio ofnot less than one-for-two or greater than one-for-ten (the “Reverse Split”). OnOctober 6, 2005, iVOW’s Board of Directors set the exact ratio of theReverse Split at one-for-ten and the Reverse Split was effective as of October 11,2005. 

 

Allreferences to common share and per-share data for all periods presented havebeen adjusted to give effect to the Reverse Split.

 

**RevenueRecognition**

 

Revenuegenerated from our disease state management of morbid obesity business isrecognized (i) with regard to management services, upon completion of theservice period and (ii) with regard to training services or otherconsulting services, upon completion of the related training or consultingcomponent, provided that a contract exists, there are no uncertaintiesregarding customer acceptance, the sales price is fixed or determinable andcollectibility is reasonably assured. Any payments received in advance ofcompletion of the service are recorded as deferred revenue. Sales of vitaminsare similarly recognized upon shipment provided that a purchase order has beenreceived, there are no uncertainties regarding customer acceptance, the salesprice is fixed or determinable and collectibility is reasonably assured. Revenuesfrom SHS services are recognized based on a straight-line amortization for thelife of the service contract provided that there are no uncertainties regardingcustomer acceptance, the sale price is fixed or determinable and collectabilityis reasonably assured.

 

Salesreturns are estimated based on our historical experience and management’sexpectations and are recorded at the time product revenue is recognized.

 

**Inventory**

 

Inventoriesare stated at the lower of cost (determined on a first-in, first-out basis) ormarket and include only finished goods related to our disease state managementof morbid obesity business.

 

**Duefrom Viking**

 

Thisaccount represents the consideration due from Viking as a result of the sale ofour Visualization Technology business. Although we may receive amounts inexcess of the account balance, realization of the balance is not assured.

 

Vikingis a relatively new company that has not raised substantial funds and may beunable to raise sufficient funds to sustain its operations or fund its growthplan. Additionally, there can be no assurance that Viking’s business willsucceed. As a result, all contractual amounts due us are at risk.

 

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

 

As part ofthe sale of our Visualization Technology business in April 2004, we wereissued 3,054,000 shares of Viking common stock (see Notes 2 and 6) valued at$0.02 per share or $61,080, which reflected the fair value of the shares at thetime the shares were acquired. In June 2004, 1,400,000 of these sharesvalued at $0.02 per share, or $28,000, were used to obtain certain rights fromour Series A holders (see Note 12) with the remaining 1,654,000 sharesvalued at $33,080.  In October 2004,the Viking common 

 

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stock began trading onthe Over The Counter Bulletin Board and, accordingly, has been adjusted to fairvalue. Viking is a relatively new company and there is a limited market forViking common stock even though it is publicly quoted.  The limited trading market for Viking commonstock may cause fluctuations in the market value of the common stock to beexaggerated, leading to price volatility in excess of that which would occur ina more active trading market which could have an effect on both the carryingvalue and our stockholders’ equity. There is a significant risk of adjustmentto the carrying value due to possible market fluctuations in their stock price.

 

Theinvestment in Viking Systems, Inc. common stock is classified as availablefor sale as of December 31, 2005. The cost and fair value of the equitysecurities at December 31, 2004 and 2005 are as follows:

 
| ** **                                 | ** ** | ** ** | ** ** | **2004**             | ** ** | **2005**        | ** ** |
|--------------------------------------------|------------|------------|------------|----------------------|------------|-----------------|------------|
| **Corporate Equity Securities:** | ** ** | **Cost**   | ** ** | **Unrealized  Gain** | ** ** | **Fair  Value** | ** ** | **Unrealized  Gain** | ** ** | **Fair  Value** | ** ** |
| Viking Systems, Inc                        |       | $          | 33,080     |                 | $          | 1,273,580       |       | $ | 1,306,660 |   | $ | 628,520 |   | $ | 661,600 |   |
|                                            |            |            |            |                      |            |                 |            |  |  |  |  |  |  |  |  |  |

 

**Acquisitionof Sound Health Solutions**

 

Wepurchased the business and substantially all of the assets of SHS, aSeattle-based healthcare provider specializing in the multidisciplinary medicaltreatment of obesity. We paid $125,500 in cash assumed approximately $317,000of SHS liabilities and agreed to issue up to 294,278 shares of common stock, ofwhich 184,477 shares valued at $427,987 were issued as of the closing. Theremaining 109,801 shares, valued at $254,738, are subject to holdback based oncertain contingencies. Holdback shares are not recorded and, therefore, notincluded in the cost of the acquisition and the purchase price allocation untilthe contingencies are resolved. We have a repurchase right for up to 71,128 ofthe shares to the extent that SHS fails to satisfy certain revenue and netincome targets.

 

The total purchase pricefor the acquisition of SHS initially recorded by the Company was approximately$1,184,000, which was comprised of the cash paid, the liabilities assumed, thefair value of the 184,477 shares issued at the closing and other acquisitioncosts (such as legal and finders fees) totaling $314,064. The fair value of theholdback shares has not been included in the purchase price recorded as of December 31,2005 and will not be recorded until the contingencies are resolved.

 

Theacquisition of SHS has been accounted for by the Company under the purchasemethod of accounting in accordance with Statement of Financial AccountingStandard No. 141, *Business Combinations*.Under the purchase method, assets acquired and liabilities assumed are recordedat their estimated fair values. Goodwill is recorded to the extent the purchaseprice, including certain acquisition and closing costs, exceeds the fair valueof the net identifiable tangible and intangible assets acquired at the date ofacquisition.

 

Thetotal initial purchase price for the acquisition of SHS of $1,184,000 wasallocated as follows:

 

 
| ** **                  | ** ** | **(in thousands)** | ** ** |
|-----------------------------|------------|-------------------------|------------|
| Cash and cash equivalents   |       | $                       | 9          |   |
| Accounts receivable, net    |       | 76                      |       |
| Property and equipment      |       | 241                     |       |
| Goodwill                    |       | 915                     |       |
| Intangible assets           |       | 204                     |       |
| Other assets                |       | 31                      |       |
| Accounts payable            |       | (26                     | )          |
| Other note payable          |       | (23                     | )          |
| Accrued liabilities         |       | (26                     | )          |
| Deferred revenue            |       | (161                    | )          |
| Other long-term liabilities |       | (56                     | )          |
|                        |       |                    |       |
| Total net assets            |       | $                       | 1,184      |   |

 

Inconnection with the purchase, SHS entered into independent contractoragreements and noncompetition agreements with two physicians, for the provisionof medical services to SHS. The agreements have a term of three years, subjectto earlier termination. Under the contractor agreements, we agreed to issuestock options to purchase 10,667 shares of common stock to the physicians.

 

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**Goodwill**

 

TheCompany follows Statement of Financial Accounting Standards No. 142 (“SFAS142”), *Goodwill and Other Intangible Assets*. Goodwillrepresents the excess of cost over the fair value of net assets of an acquiredbusiness. Under SFAS 142, goodwill is deemed to have an indefinite life and isnot subject to amortization over an estimated finite useful life but is testedfor impairment annually under a two-step approach, or more frequently, ifevents or changes in circumstances indicate that the asset might be impaired. 

 

Thefirst step of the impairment test is used to identify potential impairment bycomparing the carrying amount of the reporting unit to its fair value. If thefair value of a reporting unit exceeds its book value, goodwill of thereporting unit is not considered impaired and the second step of the impairmenttest is not required.  If the carryingamount of the reporting unit exceeds its fair value, the second step of theimpairment test is performed to measure the amount of impairment loss, if any. Thesecond step of the impairment test compares the implied fair value of thereporting unit’s goodwill with the book value of that goodwill. When the carryingamount of the reporting unit’s goodwill exceeds the implied fair value of thegoodwill, an impairment loss is recognized in an amount equal to the excess.The implied fair value of goodwill is determined in the same manner as theamount of goodwill recognized in a business combination. The Company completedits annual goodwill impairment test for 2005 during the fourth quarter anddetermined there was no impairment of existing goodwill. 

 

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**OurResults of Operations**

 

**Yearended December 31, 2005 compared with year ended December 31, 2004**

 

**Revenues**

 

Revenuesfrom continuing operations were $1,288,000 for the year ended December 31,2005 as compared to revenues from continuing operations of $1,651,000 for theyear ended December 31, 2004, representing a decrease of $363,000 or 22%.The decrease in revenue was associated with lower training and consultingservices and contract revenue from a strategic partner. While revenuesdecreased, our most important business indicator, iVOW program management fees,increased as a result of having three centers by the end of 2005. We also saw a20% increase in vitamin sales in 2005 relative to 2004. The reduction incontract revenue is due to a strategic alliance agreement that ended in 2004. Nocontract revenue is projected for 2006. An additional $209,000 in revenues in2005 are from the acquisition of SHS. These revenues are associated withservices provided for medical weight loss and add to the array of products thatiVOW offers to battle chronic or morbid obesity.

 
| **Increase/(decrease) over prior year** | ** ** | **2005** | ** ** |
|--------------------------------------------------------|------------|----------|------------|
| Management fees                                        |       | $        | 349,000    |   |
| Training and consulting fees                           |       | (481,000 | )          |
| Vitamins sales                                         |       | 60,000   |       |
| Contract revenue                                       |       | (500,000 | )          |
| SHS clinical services                                  |       | 209,000  |       |
|                                                   |       | $        | (363,000   | ) |

 

Thedecrease associated with lower clinical training services and consultingservices was the result of a change in the market as demand shifted from therequirement to be trained to more of a focus on the operational aspects ofbariatric programs in both 2004 and 2005. The decrease was further affected byevents during 2005, including the acquisition of the medical weight lossbusiness of SHS and the raising of new capital, which required a significantfocus on non-operational business activities. This diverted focus affected thethird and fourth quarters by providing a lower revenue base to begin ourtransition to a full turnkey disease state management business.  Other factors that contributed to the decreasein training and consulting services in 2005 included some market slowingbecause of payor uncertainty associated with the highly anticipated medicareruling on bariatric surgery, and the difficulty in hiring of key salespersonnel. 

 

**Costsand expenses**

 

Belowis a summary of costs and expenses:

 
| ** **                 | ** ** | **2004**  | ** ** | **2005**  | ** ** |
|----------------------------|------------|-----------|------------|-----------|------------|
| Cost of revenues           |       | $         | 1,193,000  |      | $          | 1,229,000 |   |
| Product development        |       | 406,000   |       | 121,000   |       |
| Sales and marketing        |       | 1,197,000 |       | 913,000   |       |
| General and administrative |       | 1,798,000 |       | 1,986,000 |       |
|                       |       |      |       |      |       |
| Total costs and expenses   |       | $         | 4,594,000  |      | $          | 4,249,000 |   |

 

Costof revenues. Our cost of revenues increased by $36,000 in 2005 as gross marginsdecreased from 28% in 2004 to 5% in 2005. The gross margins were -3% in 2004and 3% in 2005, when backing out the strategic partners contract revenue andthe revenues associated with the acquisition. Cost of revenues includes thefully burdened cost associated with management, consulting and trainingservices and the cost of goods and related expenses for vitamins. Excluding thestrategic partners contract revenue and SHS acquisition, our costs decreasedand gross margins increased in 2005 due to a reduction of our workforce in thesecond quarter to better optimize operations for the current market conditions.SHS had a gross margin of 15%. 

 

Productdevelopment. Product development expenses decreased by $285,000, or 71% in 2005over 2004. This decrease is due to a reduced work force and the relatedexpenses associated with identifying and developing new and complimentaryproducts in 2005. In 2004, we increased efforts throughout the year to expandour capabilities to become a complete chronic and morbid obesity diseasemanagement business and rather than a consulting practice focused on surgicaltreatment for morbid obesity as we were in 2003. In 2005, we refocused ourefforts on operations and the acquisition of SHS and with a correspondingreduction in the work force.

 

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Salesand marketing expenses. Our sales and marketing expenses were down in 2005, by$284,000, or 24%, over 2004. The decrease in sales and marketing expensesduring 2005 was primarily attributable to a decreased work force and the effortto acquire SHS. We do expect an increase in sales and marketing expenses during2006 as we continue to expand our field activities in the chronic and morbidobesity disease management business and to promote iVOW’s new productsassociated with the SHS acquisition.

 

Generaland administrative expenses. Our general and administrative (“G&A”) expenseswere up $188,000, or 11%, to $1,986,000 in 2005. Approximately $76,000 of thiswas G&A expenses that SHS incurred in November and December of2005. The increase in G&A expenses during 2005 was primarily attributableto increased professional services for legal and audit along with salaries andassociated expenses related to the acquisition of SHS. 

 

**Otherincome (expense) and gain/loss from discontinued operations**

 

Otherincome (expense), net. Our other income (expense), net, was ($28,000) in 2004compared to $39,000 in 2005. The increase in other income is due to higherinterest on investments, $27,000 for 2004 and $45,000 for 2005, and lowerinterest expense on equipment leasing and short-term debt, $7,000 in 2004 and$6,000 in 2005. 

 

Gain/Lossfrom discontinued operations. The gain from discontinued operations result ofhaving recognized and collected payments from the buyer, Viking Systems, Inc. For 2005, we collected and recognized$225,000 of royalty payments and miscellaneous payments of $8,000. We will recognizeadditional gains in the future as minimum royalties are received. The loss fromdiscontinued operations for 2004 was $633,000 representing three and one-halfmonths of operations.

 

**IncomeTaxes**

 

At December 31,2005, we have federal and state tax net operating loss carryforwards ofapproximately $63,538,000 and $13,432,000, respectively. The federal tax losscarryforwards will begin to expire in 2010. Approximately $753,000 of the statetax loss carryforwards expired in 2005 and will continue to expire in futureperiods unless utilized. At December 31, 2005, we also have federal andstate research tax credit carryforwards of approximately $2,264,000 and $121,000,respectively, which will begin to expire in 2010 unless previously utilized. Wehave retained the federal and state tax loss carryforwards and other taxattributes of the Visualization Technology business. We have provided a fullvaluation allowance on the deferred tax assets, as realization of such assetsis uncertain.

 

**Liquidityand Capital Resources**

 

Ourprincipal sources of liquidity have been funds raised from public and privateplacements of our capital stock and, to a lesser degree, cash flows generatedfrom operations and the royalty from our agreement with Viking System, Inc.At December 31, 2005, we had cash and cash equivalents of $851,000.

 

Netcash used in operating activities was approximately $3,492,000 and $2,589,000in 2004 and 2005, respectively. The decrease in net cash used in operatingactivities of $903,000 during 2005 over 2004 was primarily attributable todecreased net loss of $914,000. The majority of this is due to an $865,000change in net gain (loss) from discontinued operations in 2005 over 2004 asthere were no expenses in 2005. Also, other income added approximately $67,000in 2005 over 2004. SHS contributed a $50,000 decrease in net cash in 2005.

 

Netcash provided by (used in) investing activities was approximately $641,000 and($941,000) in 2004 and 2005, respectively. The increase in net cash used ininvesting activities for 2005 of $1,582,000 was primarily attributed to theacquisition of SHS in November 2005. Furthermore, proceeds from VikingSystems, decreased by $308,000 in 2005 over 2004.

 

Cashflows from financing activities were $4,372,000 and $2,412,000 in 2004 and2005, respectively. The decrease in net cash flows provided by financingactivities of $1,960,000 in 2005 was principally attributable to $2,382,000less received from the sale of our common stock in 2005 over 2004. Also during2005, we converted 915,000 shares of our Series A Convertible PreferredStock into 186,107 shares of common stock and paid $126,000 in cash. We nolonger have any outstanding Series A Preferred Stock outstanding. We alsoborrowed  $317,000 from a bank to pay offcertain liabilities assumed in the acquisition of SHS.

 

Weincurred net losses and negative net cash flows from operating activities in2004 and 2005, and at December 31, 2005, had an accumulated deficit of$74.4 million. At December 31, 2005, we had cash and cash equivalents of$851,000. We believe that our cash and cash equivalents, plus monies receivedin a financing completed in February 2006 together with anticipated 2006 product revenues and interest income, may notbe sufficient to meet our anticipated capital requirements through at least December 31, 2006.These factors raise substantial doubt about our ability to continue as a goingconcern. We are pursuing several alternatives to address this situation,including raising additional funding. However, there can be no assurance thatthe requisite fundings will be

 

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consummated in thenecessary time frame or on terms acceptable to us. Should we be unable to raisesufficient funds, we may be required to curtail our operating plans andpossibly relinquish rights to portions of our technology or products. Inaddition, increases in expenses or delays in product development may adverselyimpact our cash position and require further cost reductions. No assurance canbe given that we will be able to operate profitably on a consistent basis, orat all, in the future.

 

Theaccompanying consolidated financial statements have been prepared on a goingconcern basis, which contemplates the realization of assets and the satisfactionof liabilities in the normal course of business. The consolidated financialstatements do not include any adjustments relating to the recoverability andclassification of assets or the amounts and classification of liabilities thatmight be necessary should we be unable to continue as a going concern.

 

**ContractualObligations**

 

At December 31,2005, we are obligated under operating leases, principally related to realestate. Additionally, we are obligated under capital leases related to computerhardware. The following is a schedule of future minimum payments,excluding taxes and other operating costs, as of December 31, 2005:

 
| **Year ending December 31,**         | ** ** | **Operating Leases** | ** ** | **Capital Leases** | ** ** |
|-----------------------------------------------------|------------|---------------------------|------------|-------------------------|------------|
| 2006                                                |       | $                         | 263,480    |                    | $          | 11,145 |   |
| 2007                                                |       | 263,739                   |       |                    |       |
| 2008                                                |       | 261,003                   |       |                    |       |
| 2009                                                |       | 57,626                    |       |                    |       |
|                                                |       | $                         | 845,848    |                    | 11,145     |   |
| Less - amounts representing interest                |       |                      |       | (5,342                  | )          |
| Principal of capital lease obligation               |       |                      |       | 5,803                   |       |
| Less - current portion of capital lease obligations |       |                      |       | (5,803                  | )          |
| Long term portion of capital lease obligations      |       |                      |       | $                       | —     |   |

 

Subsequent to year end,we entered into a new operating lease for our California office space. Thefuture minimum payments excluding taxes and other operating costs are $85,880,$96,263, $99,151 and $8,283 for years 2006 through 2009, respectively.

 

**RelatedParty Transactions**

 

Wehad a sublease agreement for our California office space which expired in 2006.The sublease agreement has been executed with another company, of which ourformer Chairman of the Board is also a Director. Total rental payments of$118,000 and  $132,000 were paid to thiscompany in 2004 and 2005, respectively.

 

**Off-BalanceSheet Arrangements**

 

We currently do not have any material off-balancesheet arrangements other than the operating lease commitments described above.

 

**Inflation**

 

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

 

**NewAccounting Pronouncements**

 

In December 2004,the FASB issued SFAS No. 123 (R) (“SFAS 123(R)”), *Accountingfor Stock-Based Compensation* which establishes standards for theaccounting for transactions in which an entity exchanges its equity instrumentsfor goods or services. SFAS 123(R) focuses primarily on accounting fortransactions in which an entity obtains employee services in share-basedpayment transactions. SFAS 123(R) requires that the fair value of suchequity instruments be recognized as expense in the historical financialstatements as services are performed. Prior to SFAS 123(R), only certain proforma disclosures of fair value were required. SFAS 123(R) shall beeffective for all of the Company’s interim and annual reporting periodscommencing on January 1, 2006 and is expected to have a material impact onthe consolidated financial statements of the Company during the fiscal year 2006and thereafter.

 

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In November 2004,the FASB issued SFAS No. 151 (“SFAS 151”), *Inventory Costs, an amendment of ARB No. 43, Chapter 4.*SFAS151 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...”SFAS 151 requires that those items be recognized as current-period charges regardlessof whether they meet the criterion of “so abnormal.” In addition, SFAS 151requires that allocation of fixed production overheads to the costs ofconversion be based on the normal capacity of the production facilities. Theprovisions of SFAS 151 shall be applied prospectively and are effective forinventory costs incurred during fiscal years beginning after June 15,2005, with earlier application permitted for inventory costs incurred duringfiscal years beginning after the date this statement was issued. The adoptionof SFAS 151 is not expected to have a material impact on our consolidated financialposition and results of operations.

 

In December 2004,the FASB issued SFAS No. 153 (“SFAS 153”), *Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29*.The guidance in APB Opinion No. 29 (“APB 29”), *Accounting for Nonmonetary Transactions*, is based on theprinciple that exchanges of nonmonetary assets should be measured based on thefair value of assets exchanged. The guidance in APB 29, however, includedcertain exceptions to that principle. SFAS 153 amends APB 29 to eliminate theexception for nonmonetary exchanges of similar productive assets that do nothave commercial substance.  A nonmonetaryexchange has commercial substance if the future cash flows of the entity areexpected to change significantly as a result of the exchange. SFAS 153 iseffective for nonmonetary exchanges occurring in fiscal periods beginning afterJune 15, 2005. The adoption of SFAS 153 is not expected to have a materialimpact on our consolidated financial position and results of operations.

 

In May 2005,the FASB issued SFAS No. 154 (“SFAS 154”) *AccountingChanges and Reporting Accounting Changes in Interim Financial Statements*for the accounting for and reporting of a change in accounting principle. SFAS154 applies to all voluntary changes in accounting principle. It also appliesto changes required by an accounting pronouncement in the unusual instance thatthe pronouncement does not include specific transition provisions. Under theprovisions of APB Opinion 20, most accounting changes were recognized byincluding in net income of the period of the change the cumulative effect ofchanging to the newly adopted accounting principle. SFAS 154 improves financialreporting because its requirement to report voluntary changes in accountingprinciples via retrospective application, unless impracticable, enhances theconsistency of financial information between periods. That improved consistencyenhances the usefulness of the financial information, especially byfacilitating analysis and understanding of comparative accounting data. Theadoption of SFAS 154 is not expected to have a material impact on our consolidatedfinancial position and results of operations.

 
| Item 7. | FINANCIAL  STATEMENTS |
|---------|-----------------------|

 

The consolidatedfinancial statements with related notes and Report of Independent RegisteredPublic Accounting Firm are attached hereto as pages F-1 to F-22 and filedas part of this Annual Report.

 
| Item 8. | CHANGES IN AND  DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
|---------|---------------------------------------------------------------------------------------|

 

Not applicable.

 
| Item 8A. | CONTROLS AND PROCEDURES |
|----------|-------------------------|

 

As required by the Securities and Exchange Commission Rule 13a-15(b),we carried out an evaluation, under the supervision and with participation ofour management, including our chief executive officer and chief financialofficer, of the effectiveness of our disclosure controls and procedures as ofthe end of the year covered by this report. Based on the foregoing, our chief executiveofficer and chief financial officer concluded that other than for theaccounting issue discussed in the following paragraph as of December 31, 2005, our disclosure controls and procedures wereeffective.

 

The Company’s management prepared the 2005 financialstatements for audit by J.H. Cohn LLP, our independent registered publicaccounting firm. During the first quarter of the year ending December 31, 2006,in connection with their audit of our 2005 consolidated financial statements,J. H. Cohn LLP notified management that the 2005 financial statements containeda misapplication of Statement of Financial Accounting Standards No. 141(“SFAS 141”) *Business Combinations,*to theacquisition of SHS, which the Company completed in November 2005. Tocorrect the misapplication of SFAS 141, we revised the 2005 financialstatements to (i) reduce goodwill and stockholders equity by approximately$255,000 relating to contingent consideration which should not have beenincluded in the initial allocation of the purchase price, and, (ii) reallocatea portion of the purchase price we had initially classified as goodwill on ourconsolidated balance sheets to intangible assets of approximately $204,000. Thisresulted in an increase of approximately $11,000 to amortization expense on our2005 consolidated statement of operations to account for the amortization ofthe intangible assets. Additionally, in connection with the audit of our 2005financial statements, management and J. H. Cohn LLP noted errors in certain disclosuresin the footnotes to the financial statements*.*We believethese financial reporting deficiencies amount to a material

 

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weaknessin our internal controls over financial reporting. The financial statementsincluded in this Form 10-KSB reflect the appropriate application of SFAS 141and disclosures in the revised footnotes.

 

In response to the matters identified, we have takensteps beginning with the first quarter of 2006 to strengthen our financialreporting capabilities. Specifically, we have expanded, and will continue toexpand, our financial disclosure and reporting knowledge through continuingeducation courses so as to minimize our financial reporting deficiencies in thefuture.

 

Therehas been no change in our internal control over financial reporting during ourmost recent fiscal quarter that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

TheCompany, including its principal executive officer and principal financialofficer, does not expect that its disclosure controls or internal controls overfinancial reporting will prevent all errors or all instances of fraud. Acontrol system, no matter how well designed and operated, can provide only reasonable,not absolute, assurance that the control system’s objectives will be met.Further, the design of a control system must reflect the fact that there areresource constraints, and the benefits of controls must be considered relativeto their costs. Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within the Company can be detected.

 
| Item 8B. | OTHER  INFORMATION |
|----------|--------------------|

 

None

 

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PART III

 
| Item 9. | DIRECTORS,  EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS, COMPLIANCE WITH SECTION 16(a) OF  THE EXCHANGE ACT |
|---------|-----------------------------------------------------------------------------------------------------------------------------|

 

(a)           Identification ofDirectors.  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 2, 2006,is incorporated 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 on June 2,2006, is incorporated herein by reference.

 

(c)           Compliancewith Section 16(a) of the Exchange Act.  The information under the caption “Compliancewith Section 16(a) of the Securities Exchange Act of 1934,” appearingin our Proxy Statement related to the Annual Meeting of Stockholders to be heldon June 2, 2006, is incorporated herein by reference.

 
| Item 10. | EXECUTIVE  COMPENSATION |
|----------|-------------------------|

 

The information under the headings “ExecutiveCompensation and Other Information,” appearing in our Proxy Statement relatedto the Annual Meeting of Stockholders to be held on June 2, 2006, isincorporated herein by reference.

 
| Item 11. | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS |
|----------|--------------------------------------------------------------------------------------------------|

 

The information required under this item isincorporated herein by reference to our Proxy Statement related to the AnnualMeeting of Stockholders to be held on June 2, 2006.

 
| Item 12. | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS |
|----------|-------------------------------------------------|

 

The information under the heading “CertainRelationships and Related Transactions,” appearing in our Proxy Statementrelated to the Annual Meeting of Stockholders to be held on June 2, 2006,is incorporated herein by reference.

 
| Item 13. | EXHIBITS |
|----------|----------|

 
| **NUMBER  EXHIBIT** | ** ** | **DESCRIPTION**                                                                             |
|---------------------|------------|---------------------------------------------------------------------------------------------|
|                |       |                                                                                        |
| 3.1(1)              |       | Second Restated  Certificate of Incorporation                                               |
| 3.2(3)              |       | Certificate of  Amendment of Second Restated Certificate of Incorporation                   |
| 3.3(9)              |       | Certificate of  Amendment of Second Restated Certificate of Incorporation                   |
| 3.4(2)              |       | Restated Bylaws.                                                                            |
| 3.5(4)              |       | Certificate of  Designations of Series A Convertible Preferred Stock                   |
| 4.1(2)              |       | Form of  certificate for common stock.                                                 |
| 4.2*                |       | Form of  Warrant February 2004 Financing                                          |
| 4.3(6)              |       | Form of  Warrant May 2004 Financing                                               |
| 4.4(6)              |       | Form of  Selling Agent’s Warrant May 2004 Financing                          |
| 4.5(7)              |       | Form of  Warrant 2005 Financing                                                        |
| 4.6(7)              |       | Form of  Selling Agent’s Warrant 2005 Financing                                   |
| 4.7*                |       | Form of  Warrant February 2006 Financing                                          |
| 4.8*                |       | Form of  Selling Agent’s Warrant 2006 Financing                                   |
| 10.1(2)             |       | 1995 Stock  Option Plan                                                                     |
| 10.2(2)             |       | 1997 Stock  Option/Stock Issuance Plan, as amended                                          |
| 10.3(2)             |       | 1997 Stock  Option/Stock Issuance Plan Form of Notice of Grant                         |
| 10.4 (2)            |       | 1997 Stock  Option/Stock Issuance Plan Form of Stock Option Agreement                  |
| 10.5(2)             |       | 1997 Stock  Option/Stock Issuance Plan Form of Stock Purchase Agreement                |
| 10.6(2)             |       | 1997 Employee  Stock Purchase Plan                                                          |
| 10.7(10)            |       | Amendment to  1997 Employee Stock Purchase Plan                                             |
| 10.8(2)             |       | 1997 Stock  Option/Stock Issuance Plan Form of Stock Issuance Agreement.               |
| 10.9(10)            |       | Amendment to  1997 Stock Option/Stock Issuance Plan                                         |
| 10.10(2)            |       | 1997 Stock  Option/Stock Issuance Plan Form of Stock Issuance Agreement                |
| 10.11*              |       | Form of  Indemnification Agreement between us and each of our officers/directors.      |
| 10.12(5)            |       | Asset Purchase  Agreement with Viking Systems, Inc. dated as of December 22, 2003 |

 

33

----

 
| 10.13(8)   |   | Merger  Agreement, dated as of October 7, 2005, by and among iVOW. Inc., iSGS  Merger Sub, Inc. and Sound Health Solutions, Inc.                        |
|------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.14*     |   | Office Lease,  dated April 28, 2003, between Overlake Office Building LLC and Sound  Health Solutions, Inc., as amended on May 19, 2005                 |
| 10.15*     |   | Lease, dated March 31,  2004, between MSI 83 King L.L.C. and Sound Health Solutions, Inc., as  amended on July 13, 2004                                 |
| 10.16*     |   | Sublease  Agreement, dated January 12, 2006, between us and Insurance Company of  the West                                                                        |
| 10.17(7)   |   | Form of  Subscription Agreement 2005 Financing                                                                                                                    |
| 10.18*     |   | Form of  Subscription Agreement February 2006 Financing                                                                                                      |
| 10.19(9)** |   | Bariatric  Administrative Services Agreement, dated April 20, 2005, with Lenox Hill  Hospital and Manhattan Minimally Invasive & Bariatric Surgery, P.C. |
| 23.1*      |   | Consent of J. H.  Cohn LLP, Independent Registered Public Accounting Firm                                                                                              |
| 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 by reference toour Form 10-K/A, filed on September 10, 1998.

 

(2)           Incorporated by reference toour Registration Statement on Form S-1, as amended, filed on July 2,1997.

 

(3)           Incorporated by reference toour Form 10-Q, filed November 14, 2001.

 

(4)           Incorporated by reference toour Form 10-K, filed March 31, 2003.

 

(5)           Incorporated by reference toour Form 10-K, filed March 30, 2004.

 

(6)           Incorporatedby reference to our Form 8-K, filed May 26, 2004.

 

(7)           Incorporatedby reference to our Form 10-QSB filed on August 15, 2005, as amended.

 

(8)           Incorporatedby reference to our Form 8-K, filed October 7, 2005.

 

(9)           Incorporatedby reference to our Form 10-QSB filed on May 16, 2005.

 

(10)         Incorporatedby reference to our Definitive Proxy Statement filed on June 27, 2005. 

 

*          Filed herewith.

 

**       Certain confidential portions of thisexhibit were omitted by means of redacting a portion of the text (the “Mark”).This exhibit 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.

 

SUPPLEMENTAL INFORMATION

 

Copiesof the Registrant’s Proxy Statement for the Annual Meeting of Stockholders tobe held June 2, 2006 and copies of the form of proxy to be used for suchAnnual Meeting will be furnished to the Commission prior to the time they aredistributed to the Stockholders.

 
| Item  14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES |
|-----------|----------------------------------------|

 

Theinformation required under this item is incorporated herein by reference to ourProxy Statement related to the Annual Meeting of Stockholders to be held on June 2,2006.

 

34

----

 

SIGNATURES

 

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

 

 
|                       | iVOW, INC. |
|----------------------------|------------|
|                       |       |   |
|                       |       |   |
| Date:  March 31, 2006 | By:        | /s/ Michael H.  Owens |   |
|                       |       | Michael H. Owens |
|                       |       | Chief Executive  Officer |

 

Knowall men by these presents, that each person whose signature appears belowconstitutes and appoints Michael H. Owens or Richard M. Gomberg, his or herattorney-in-fact, with power of substitution in any and all capacities, to signany amendments to this Annual Report on Form 10-KSB, and to file the samewith exhibits thereto, and other documents in connection therewith, with theSecurities and Exchange commission, hereby ratifying and confirming all thatthe attorney-in-fact or his or her substitutes may do or cause to be done byvirtue 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/ Michael H.  Owens    |       | Chief Executive Officer and Director                                   |       | March 31,  2006 |
| (Michael H. Owens, M.D.) |       | (Principal  Executive Officer)                                         |       |                 |
|                     |       |                                                                   |       |                 |
| /s/ Richard M.Gomberg    |       | Vice President of Finance and                                          |       | March 31,  2006 |
| (Richard M. Gomberg)     |       | Chief  Financial Officer (Principal  Financial and Accounting Officer) |       |                 |
|                     |       |                                                                   |       |                 |
| /s/ George B. DeHuff     |       | Director                                                               |       | March 31,  2006 |
| (George B. DeHuff)       |       |                                                                   |       |                 |
|                     |       |                                                                   |       |                 |
| /s/ John R. Lyon         |       | Director and Chairman of the Board                                     |       | March 31,  2006 |
| (John R. Lyon)           |       |                                                                   |       |                 |
|                     |       |                                                                   |       |                 |
| /s/ James Durham         |       | Director                                                               |       | March 31,  2006 |
| (James Durham)           |       |                                                                   |       |                 |
|                     |       |                                                                   |       |                 |
| /s/ William Nydam        |       | Director                                                               |       | March 31,  2006 |
| (William Nydam)          |       |                                                                   |       |                 |
|                     |       |                                                                   |       |                 |
| /s/ Scott Pancoast       |       | Director                                                               |       | March 31,  2006 |
| (Scott Pancoast)         |       |                                                                   |       |                 |
|                     |       |                                                                   |       |                 |
| /s/ Fred Toney           |       | Director                                                               |       | March 31,  2006 |
| (Fred Toney)             |       |                                                                   |       |                 |

 

35

----

 

iVOW, Inc. and Subsidiary

Index toConsolidated Financial Statements

 
| Report of J. H. Cohn LLP, Independent  Registered Public Accounting Firm                                    |   |
|-------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                        |   |
| CONSOLIDATED  FINANCIAL STATEMENTS                                                                          |   |
|                                                                                                        |   |
| Consolidated  Balance Sheets at December 31, 2004 and 2005                                             |   |
| Consolidated  Statements of Operations for the years ended December 31, 2004, and 2005                 |   |
| Consolidated  Statements of Comprehensive Loss for the years ended December 31, 2004,  and 2005        |   |
| Consolidated  Statements of Stockholders’ Equity for the years ended December 31,  2004, and 2005 |   |
| Consolidated  Statements of Cash Flows for the years ended December 31, 2004 and 2005                  |   |
| Notes  to Consolidated Financial Statements                                                                 |   |

 

F-1

----

 

Report of IndependentRegistered Public Accounting Firm

 

The Board of Directorsand Stockholders

iVOW, Inc.

 

We have audited theaccompanying consolidated balance sheets of iVOW, Inc. and Subsidiary asof December 31, 2005 and 2004, and the related consolidated statements ofoperations, comprehensive loss, stockholders’ equity and cash flows for theyears then ended.  These consolidatedfinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudits to obtain reasonable assurance about whether the consolidated financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the consolidatedfinancial 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.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of iVOW, Inc. and Subsidiary asof December 31, 2005 and 2004, and their results of operations and cashflows for the years then ended, in conformity with accounting principlesgenerally accepted in the United States. 

 

As discussed in Note 1 tothe consolidated financial statements, the Company has incurred recurring netlosses and negative net cash flows from operating activities from its inception.  As of December 31, 2005, the Company hadan accumulated deficit.  Management believesthat the Company will require additional financing to fund its operations throughat least December 31, 2006, but cannot assure that such financing will beavailable. Such matters raise substantial doubt about the Company’s ability tocontinue as a going concern.  Management’splans concerning these matters are also discussed in Note 1. The consolidatedfinancial statements referred to above do not include any adjustments relatedto the recoverability and classification of assets or the amounts andclassification of liabilities that may result from the outcome of thisuncertainty.

 
| /s/ J. H. Cohn LLP    |   |
|-----------------------|--------|
| San Diego, California |
| March 20, 2006   |

 

F-2

----

 

iVOW, Inc. and Subsidiary

ConsolidatedBalance Sheets

 
| ** **                                                                                                                                    | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                    | ** ** | **2004**              | ** ** | **2005** | ** ** |
| ASSETS                                                                                                                                        |       |                  |       |   |   |
| Current assets:                                                                                                                               |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                                    |       | $                     | 1,969,561  |   | $ | 851,315 |   |
| Restricted cash                                                                                                                               |       | —                |       | 358,444 |   |
| Accounts  receivable                                                                                                                          |       | 176,291               |       | 159,115 |   |
| Due from Viking  Systems, Inc.                                                                                                                |       | 188,797               |       | — |   |
| Inventories                                                                                                                                   |       | 62,094                |       | 43,493 |   |
| Prepaid  insurance                                                                                                                            |       | 197,551               |       | 160,170 |   |
| Other current  assets                                                                                                                         |       | 51,812                |       | 121,210 |   |
| Total current  assets                                                                                                                         |       | 2,646,106             |       | 1,693,747 |   |
| Property and  equipment, net                                                                                                                  |       | 31,743                |       | 252,880 |   |
| Investment in  marketable equity securities of Viking Systems, Inc, available for sale                                                        |       | 1,306,660             |       | 661,600 |   |
| Other assets                                                                                                                                  |       | —                |       | 31,414 |   |
| Goodwill                                                                                                                                      |       | —                |       | 915,116 |   |
| Intangible  assets, net                                                                                                                       |       | —                |       | 193,051 |   |
| Total assets                                                                                                                                  |       | $                     | 3,984,509  |   | $ | 3,747,808 |   |
|                                                                                                                                          |       |                  |       |   |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                    |       |                  |       |   |   |
| Current  liabilities:                                                                                                                         |       |                  |       |   |   |
| Accounts payable                                                                                                                              |       | $                     | 288,083    |   | $ | 216,951 |   |
| Current portion  of capital lease obligations                                                                                                 |       | 16,969                |       | 5,803 |   |
| Short-term bank  borrowings                                                                                                                   |       | —                |       | 316,621 |   |
| Short-term notes                                                                                                                              |       | 128,219               |       | 103,845 |   |
| Accrued  compensation                                                                                                                         |       | 200,596               |       | 254,522 |   |
| Deferred revenue                                                                                                                              |       | 31,250                |       | 177,325 |   |
| Current portion  of deferred rent                                                                                                             |       | —                |       | 26,497 |   |
| Accrued  liabilities                                                                                                                          |       | 85,896                |       | 114,532 |   |
| Total current  liabilities                                                                                                                    |       | 751,013               |       | 1,216,096 |   |
| Other note  payable                                                                                                                           |       | —                |       | 22,071 |   |
| Long-term  portion of deferred rent                                                                                                           |       | —                |       | 30,321 |   |
| Long-term  portion of capital lease obligations                                                                                               |       | 10,516                |       | — |   |
| Total  liabilities                                                                                                                            |       | 761,529               |       | 1,268,488 |   |
|                                                                                                                                          |       |                  |       |   |   |
| Commitments and  contingencies                                                                                                                |       |                  |       |   |   |
|                                                                                                                                          |       |                  |       |   |   |
| Stockholders’ equity:                                                                                                                    |       |                  |       |   |   |
| Preferred stock,  $.01 par value:                                                                                                             |       |                  |       |   |   |
| Authorized  shares – 5,000,000 issued and outstanding shares - 915,000 in 2004 and 0 in  2005                                            |       | 1,108,592             |       | — |   |
| Common stock,  $.01 par value:                                                                                                                |       |                  |       |   |   |
| Authorized  shares – 35,000,000 in 2004 and 70,000,000 in 2005 issued and outstanding   shares - 1,094,626 in 2004 and 2,303,469 in 2005 |       | 10,946                |       | 23,035 |   |
| Additional  paid-in capital                                                                                                                   |       | 72,801,367            |       | 76,241,906 |   |
| Accumulated  other comprehensive income                                                                                                       |       | 1,273,580             |       | 628,520 |   |
| Deferred  compensation                                                                                                                        |       | (7,896                | )          | — |   |
| Accumulated  deficit                                                                                                                          |       | (71,963,609           | )          | (74,414,141 | ) |
| Total  stockholders’ equity                                                                                                              |       | 3,222,980             |       | 2,479,320 |   |
| Total  liabilities and stockholders’ equity                                                                                              |       | $                     | 3,984,509  |   | $ | 3,747,808 |   |

 

SEE ACCOMPANYING NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

F-3

----

 

iVOW, Inc. and Subsidiary

ConsolidatedStatements of Operations

 
| ** **                                                        | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                        | ** ** | **2004**                                   | ** ** | **2005** | ** ** |
| Revenues                                                          |       | $                                          | 1,650,735  |   | $ | 1,287,848 |   |
| Cost and  expenses:                                               |       |                                       |       |   |   |
| Cost of revenues                                                  |       | 1,193,417                                  |       | 1,229,124 |   |
| Product  development                                              |       | 405,612                                    |       | 121,205 |   |
| Sales and  marketing                                              |       | 1,196,883                                  |       | 913,104 |   |
| General and  administrative                                       |       | 1,797,985                                  |       | 1,986,173 |   |
| Total costs and  expenses                                         |       | 4,593,897                                  |       | 4,249,606 |   |
|                                                              |       |                                       |       |   |   |
| Loss from  operations                                             |       | (2,943,162                                 | )          | (2,961,758 | ) |
| Other income  (expense), net                                      |       | (28,035                                    | )          | 39,241 |   |
| Loss from  continuing operations                                  |       | (2,971,197                                 | )          | (2,922,517 | ) |
| Gain (loss) from  discontinued operations                         |       | (632,516                                   | )          | 232,644 |   |
| Net loss                                                          |       | (3,603,713                                 | )          | (2,689,873 | ) |
| Accretion of  dividends on preferred stock                        |       | (135,922                                   | )          | (67,170 | ) |
| Reversal of  dividends previously accreted                        |       |                                       |       | 306,511 |   |
| Deemed dividend  on redemption of preferred stock                 |       | (131,985                                   | )          |   |   |
|                                                              |       |                                       |       |   |   |
| Net loss  applicable to common stockholders                       |       | $                                          | (3,871,620 | ) | $ | (2,450,532 | ) |
|                                                              |       |                                       |       |   |   |
| Income (loss)  per common share basic and diluted:                |       |                                       |       |   |   |
| Continuing  operations                                            |       | $                                          | (3.71      | ) | $ | (1.71 | ) |
| Discontinued  operations                                          |       | (0.73                                      | )          | 0.15 |   |
| Net loss per  common share applicable to common stockholders      |       | $                                          | (4.44      | ) | $ | (1.56 | ) |
|                                                              |       |                                       |       |   |   |
| Shares used in  computing basic and diluted loss per common share |       | 872,570                                    |       | 1,570,882 |   |

 

SEE ACCOMPANYING NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

F-4

----

 

iVOW, Inc. and Subsidiary

ConsolidatedStatements of Comprehensive Loss

 
| ** **                                               | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                               | ** ** | **2004**                                   | ** ** | **2005** | ** ** |
|                                                     |       |                                       |       |   |   |
| Net loss                                                 |       | $                                          | (3,603,713 | ) | $ | (2,689,873 | ) |
|                                                     |       |                                       |       |   |   |
| Unrealized gain  (loss) on available-for-sale securities |       | 1,273,580                                  |       | (645,060 | ) |
|                                                     |       |                                       |       |   |   |
| Total  comprehensive loss                                |       | $                                          | (2,330,133 | ) | $ | (3,334,933 | ) |

 

SEE ACCOMPANYING NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

F-5

----

 

iVOW, Inc. and Subsidiary

Consolidated Statements of Stockholders’ Equity

 
| ** **                                                        | ** ** | ** **               | ** ** | ** **            | ** ** | ** **  | ** ** | ** **        | ** ** | ** **     | ** ** | **Accumulated** | ** **       | ** **       | ** ** | ** **  | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------|------------|-----------------------|------------|-------------|------------|-------------------|------------|----------------|------------|-----------------|------------------|------------------|------------|-------------|------------|------------|------------|
| ** **                                                        | ** ** | ** **               | ** ** | ** **            | ** ** | ** **  | ** ** | ** **        | ** ** | **Additional** | ** ** | **other**       | ** **       | ** **       | ** ** | ** **  | ** ** | ** ** | ** ** |
| ** **                                                        | ** ** | **Preferred stock** | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **comprehensive** | ** ** | **Deferred**   | ** ** | **Accumulated** | ** **       | ** **       | ** ** |
| ** **                                                        | ** ** | **Shares**               | ** ** | **Amount**            | ** ** | **Shares**  | ** ** | **Amount**        | ** ** | **capital**    | ** ** | **income**      | ** **       | **compensation** | ** ** | **deficit** | ** ** | **Total**  | ** ** |
| Balance  at December 31, 2003                                |       | 1,000,000                |       | $                     | 1,068,686  |        | 500,792    |              | $          | 5,008          |       | $               |  68,156,315 |             |       |        | $          | (29,856    | )          | $ | (68,091,989 | ) | $ | 1,108,164 |   |
|                                                              |       |                     |       |                  |       |        |       |              |       |           |       |            |             |             |       |        |       |       |       |
| Exercise  of stock options for cash                               |       |                     |       |                  |       | 3,733       |       | 37                |       | 30,129         |       |            |             |             |       |        |       | 30,166     |       |
| Issuance  of stock under employee stock purchase plan             |       |                     |       |                  |       | 747         |       | 7                 |       | 10,316         |       |            |             |             |       |        |       | 10,323     |       |
| Unrealized  gain on available for sale securities                 |       |                     |       |                  |       |        |       |              |       |           |       | $               | 1,273,580        |             |       |        |       |       | 1,273,580  |   |
| Amortization  of deferred compensation                            |       |                     |       |                  |       |        |       |              |       |           |       |            |             | 21,960           |       |        |       | 21,960     |       |
| Issuance  of stock and warrants through private placements        |       |                     |       |                  |       | 589,354     |       | 5,894             |       | 4,604,607      |       |            |             |             |       |        |       | 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             |       | 1,094,626   |       | 10,946            |       | 72,801,367     |       | 1,273,580       |             | (7,896           | )          | (71,963,609 | )          | 3,222,980  |       |
|                                                              |       |                     |       |                  |       |        |       |              |       |           |       |            |             |             |       |        |       |       |       |
|                                                              |       |                     |       |                  |       |        |       |              |       |           |       |            |             |             |       |        |       |       |       |
| Accretion  of preferred stock dividends                           |       |                     |       | 67,170                |       |        |       |              |       |           |       |            |             |             |       | (67,170     | )     | —     |       |
| Reversal  of dividends on preferred stock previously accreted     |       |                     |       | (306,511              | )          |        |       |              |       |           |       |            |             |             |       | 306,511     |       | —     |       |
| Preferred  stock exchanged for common stock                       |       | (915,000                 | )          | (743,077              | )          | 186,107     |       | 1,862             |       | 741,215        |       |            |             |             |       |        |       | —     |       |
| Preferred  stock redeemed for cash                                |       |                     |       | (126,174              | )          |        |       |              |       |           |       |            |             |             |       |        |       | (126,174   | )          |
| Exercise  of warrants for cash                                    |       |                     |       |                  |       | 1,340       |       | 14                |       | 12,687         |       |            |             |             |       |        |       | 12,701     |       |
| Issuance  of stock for purchase of Sound Health Solutions, Inc.   |       |                     |       |                  |       | 184,477     |       | 1,845             |       | 426,142        |       |            |             |             |       |        |       | 427,987    |       |
| Issuance  of stock under employee stock purchase plan             |       |                     |       |                  |       | 3,652       |       | 36                |       | 15,591         |       |            |             |             |       |        |       | 15,627     |       |
| Unrealized  loss on available for sale securities                 |       |                     |       |                  |       |        |       |              |       |           |       | (645,060        | )                |             |       |        |       | (645,060   | )          |
| Amortization  of deferred compensation                            |       |                     |       |                  |       |        |       |              |       |           |       |            |             | 7,896            |       |        |       | 7,896      |       |
| Issuance  of stock and warrants through private placements        |       |                     |       |                  |       | 833,328     |       | 8,333             |       | 2,232,497      |       |            |             |             |       |        |       | 2,240,830  |       |
| Cash  paid for fractional shares in connection with reverse split |       |                     |       |                  |       | (61         | )          | (1                | )          | (191           | )          |            |             |             |       |        |       | (192       | )          |
| Stock-based  compensation                                         |       |                     |       |                  |       |        |       |              |       | 12,598         |       |            |             |             |       |        |       | 12,598     |       |
| Net  loss                                                         |       |                     |       |                  |       |        |       |              |       |           |       |            |             |             |       | (2,689,873  | )          | (2,689,873 | )          |
|                                                              |       |                     |       |                  |       |        |       |              |       |           |       |            |             |             |       |        |       |       |       |
|                                                              |       |                     |       |                  |       |        |       |              |       |           |       |            |             |             |       |        |       |       |       |
| Balance  at December 31, 2005                                |       | —                   |       | —                |       | 2,303,469   |       | $                 | 23,035     |           | $          | 76,241,906      |             | $                | 628,520    |        | $          | —     |       | $ | (74,414,141 | ) | $ | 2,479,320 |   |
|                                                                   |            |                          |            |                       |            |             |            |                   |            |                |            |                 |                  |                  |            |             |            |            |            |  |  |  |  |  |  |  |  |

 

SEE ACCOMPANYING NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

F-6

----

 

iVOW, Inc. and Subsidiary

Consolidated Statementsof Cash Flows

 
| ** **                                                                                             | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2004**                                   | ** ** | **2005** | ** ** |
| **OPERATING  ACTIVITIES**                                                                              |       |                                       |       |   |   |
| Net loss                                                                                               |       | $                                          | (3,603,713 | ) | $ | (2,689,873 | ) |
|                                                                                                   |       |                                       |       |   |   |
| Adjustments to  reconcile net loss to net cash used in operating activities:                           |       |                                       |       |   |   |
| Depreciation and  amortization                                                                         |       | 45,236                                     |       | 55,084 |   |
| Bad debt expense                                                                                       |       | —                                     |       | 13,000 |   |
| Amortization of  deferred compensation                                                                 |       | 21,960                                     |       | 7,896 |   |
| Stock-based  compensation                                                                              |       |                                       |       | 12,598 |   |
| Changes in  operating assets and liabilities:                                                          |       |                                       |       |   |   |
| Accounts  receivable                                                                                   |       | 109,861                                    |       | 78,944 |   |
| Inventories                                                                                            |       | (16,819                                    | )          | 8,601 |   |
| Prepaid  insurance                                                                                     |       | (98,728                                    | )          | 37,381 |   |
| Other current  assets                                                                                  |       | (42,313                                    | )          | (57,899 | ) |
| Accounts payable                                                                                       |       | 146,452                                    |       | (93,269 | ) |
| Accrued  compensation                                                                                  |       | 7,849                                      |       | 53,926 |   |
| Deferred revenue                                                                                       |       | (411,250                                   | )          | (14,695 | ) |
| Other  liabilities                                                                                     |       | (29,532                                    | )          | (931 | ) |
| Effect of  discontinued operations on operating activities                                             |       | 379,073                                    |       | — |   |
| Net cash used in  operating activities                                                                 |       | (3,491,924                                 | )          | (2,589,237 | ) |
|                                                                                                   |       |                                       |       |   |   |
| **INVESTING  ACTIVITIES**                                                                              |       |                                       |       |   |   |
| Maturities of  short-term investments                                                                  |       | 187,209                                    |       | — |   |
| Purchases of  property and equipment                                                                   |       | (42,956                                    | )          | (24,364 | ) |
| Payments for  acquistion                                                                               |       | —                                     |       | (747,032 | ) |
| Restricted cash                                                                                        |       | —                                     |       | (358,444 | ) |
| Proceeds from  the sale of business                                                                    |       | 496,736                                    |       | 188,797 |   |
| Net cash  provided by (used in) investing activities                                                   |       | 640,989                                    |       | (941,043 | ) |
|                                                                                                   |       |                                       |       |   |   |
| **FINANCING  ACTIVITIES**                                                                              |       |                                       |       |   |   |
| Issuance of  common stock and warrants, net                                                            |       | 4,650,990                                  |       | 2,268,970 |   |
| Redemption of  Series A preferred stock                                                                |       | (200,000                                   | )          | (126,174 | ) |
| Proceeds from  short-term bank borrowings                                                              |       | —                                     |       | 316,621 |   |
| Issuance of short-term  notes                                                                          |       | 202,406                                    |       | 223,779 |   |
| Payment on  short-term notes                                                                           |       | (74,187                                    | )          | (249,480 | ) |
| Short-term bank  borrowings (repayments)                                                               |       | (200,000                                   | )          | — |   |
| Payments on  capital leases                                                                            |       | (7,656                                     | )          | (21,682 | ) |
| Net cash  provided by financing activities                                                             |       | 4,371,553                                  |       | 2,412,034 |   |
|                                                                                                   |       |                                       |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                                  |       | 1,520,618                                  |       | (1,118,246 | ) |
| Cash and cash  equivalents at beginning of year                                                        |       | 448,943                                    |       | 1,969,561 |   |
| Cash and cash  equivalents at end of year                                                              |       | $                                          | 1,969,561  |   | $ | 851,315 |   |
|                                                                                                   |       |                                       |       |   |   |
| Non-cash transactions:                                                                                 |       |                                       |       |   |   |
| Net accretion  (reversal) of cumulative dividends on preferred stock                                   |       | $                                          | 135,922    |   | $ | (239,341 | ) |
| 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    | ) | — |   |
| Common shares  issued for acquistion                                                                   |       | —                                     |       | $ | 427,987 |   |
| Preferred shares  exchanged for common shares                                                          |       | —                                     |       | $ | 743,077 |   |
| Supplementary  cash flow information:                                                                  |       |                                       |       |   |   |
| Interest paid                                                                                          |       | $                                          | 7,103      |   | $ | 11,770 |   |

 

SEE ACCOMPANYINGNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

F-7

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iVOW, Inc. and Subsidiary

Notes toConsolidated Financial Statements

 

1. ORGANIZATION ANDSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

ORGANIZATION AND BUSINESSACTIVITY

 

iVOW, Inc., isincorporated under the laws of the State of Delaware.  Collectively, with its subsidiary SoundHealth Solutions, Inc., the terms “we,” “us,” “our,” and the “Company”refer to iVOW, Inc. as a combined entity, except where noted or where thecontext makes clear the reference is only to iVOW, Inc. or Sound HealthSolutions, Inc.

 

The Company was foundedin 1993 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 February 2005,after merging our wholly owned subsidiary, VOW Solution, Inc., to alignour corporate name with the brand name of our chronic and morbid obesitydisease management business, which is now our exclusive focus.  In November 2005, we acquired SoundHealth Solutions, Inc. (“SHS”), a Seattle-based healthcare providerspecializing in the multidisciplinary medical treatment of obesity, as awholly-owned subsidiary (see Note 16).

 

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 onimplementing disease management strategies for the control of chronic andsevere obesity.  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.

 

SHS has pioneered thedevelopment of multidisciplinary medically anchored weight loss programs since1998.  We anticipate that the addition ofSHS to iVOW will significantly improve and expand our business model. Prior toour acquisition of SHS, our business model focused principally upon workingwith hospitals and surgeons to provide consultations on a fee-for-service basisor to operate their bariatric surgical programs for a management fee, while thehospitals and surgeons held the contracts with insurance providers and otherthird-party payors and employers.  Underthat model, even if the volume of patients increased, our revenue did not.  In contrast, SHS, through its “owner-operator”model, contracts directly with employers, payors and unions to facilitateweight loss programs on a direct per patient basis, thus generating incrementalrevenue as patient volume increases. While we intend to focus on capitalizing upon SHS’s owner-operatormodel, we also will continue to pursue strategic outsourced managementopportunities.  We now have two platformson which to grow our business: the employer/payor medically anchored platformand the hospital/provider surgically anchored platform.

 

Our goal is to become the leadingdisease management and consulting company focused on chronic and morbidobesity. Our initial focus was on the severely obese patient with gastricbypass surgery as the solution. We have expanded our focus to include thechronically obese through our SHS multidisciplinary medically anchored weightmanagement platform. It is these singular and combined platforms upon which wehope to expand service to new obesity therapies as they are developed.  We are currently aggressively integrating ourSHS bariatric medical model into our iVOW surgical protocols to fulfill thepre-operative weight management requisites of employers and payors, the long-termcare of post-surgical patients and the treatment of obese patients who eitherare not qualified for surgery or prefer a non-surgical alternative treatmentmodality.

 

We incurred net lossesand negative net cash flows from operating activities in  2004 and 2005, and at December 31, 2005,had an accumulated deficit of $74.4 million. At December 31, 2005, we had cash and cash equivalents of $851,000.  We believe that our cash and cashequivalents, plus monies received in a financing completed in February 2006(see Note 17) together with anticipated 2006 product revenues and interestincome, may not be sufficient to meet our anticipated capital requirementsthrough at least December 31, 2006. 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 to curtailour operating plans and possibly relinquish rights to portions of ourintellectual property or products.  Inaddition, increases in expenses and delays in signing new management andconsulting contracts

 

F-8

----

 

may adversely impact ourcash position and require further cost reductions.  No assurance can be given that we will beable to operate profitably on a consistent basis, or at all, in the future.  The accompanying consolidated financialstatements have been prepared on a going concern basis, which contemplates therealization of assets and the satisfaction of liabilities in the normal courseof business.  The consolidated financialstatements do not include any adjustments relating to the recoverability andclassification of assets or the amounts and classification of liabilities thatmight be necessary should we be unable to continue as a going concern.

 

PRINCIPLES OFCONSOLIDATION

 

In February 2005,our subsidiary, VOW Solutions, Inc. (“VOW”), was merged with Vista MedicalTechnologies, Inc., as part of the name change to iVOW, Inc (“iVOW”).  In November 2005, iVOW acquired SHS, asa wholly-owned subsidiary.  Theconsolidated financial statements include the accounts of our wholly-ownedsubsidiaries, VOW prior to the merger and SHS. Significant intercompany accounts and transactions have been eliminated.

 

REVERSE STOCK SPLIT

 

On July 19, 2005, the stockholders of the Company voted to grantauthority to the Board to file an amendment to the Company’s Second RestatedCertificate of Incorporation to effect, at the discretion of the Board, areverse stock split of the issued and outstanding common stock in a ratio forsuch split that was not less than 1:2 nor greater than 1:10. On October 6,2005, the Board acted on its authority to effect the reverse split of allcommon stock issued and outstanding (the “Reverse Split”) at a rate of 1:10. Asa result of the Reverse Split, all share and per share information in theaccompanying consolidated financial statements and these notes has beenretroactively adjusted.

 

USE OF ESTIMATES

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the amounts reported in the consolidated financialstatements and disclosures made in the accompanying notes to the consolidatedfinancial statements.  Actual resultscould differ from those estimates.

 

REVENUE RECOGNITION

 

Revenue generated fromour disease state management of morbid obesity business is recognized (i) withregard to management services, upon completion of the service period and (ii) withregard to training services or other consulting services, upon completion ofthe related training or consulting component, provided that a contract exists,there are no uncertainties regarding customer acceptance, the sales price isfixed or determinable and collectability is reasonably assured.   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 collectability is reasonably assured.  Revenues from SHS’s medically supervisedweight reduction programs are recognized based on a straight-line amortizationover the life of the service contract provided that there are no uncertaintiesregarding customer acceptance, the sale price is fixed or determinable andcollectability is reasonably assured. Any payments received in advance of completion of the service arerecorded as deferred revenue.  Salesreturns are estimated based on our historical experience and management’sexpectations and are recorded at the time product revenue is recognized.

 

CASH AND CASH EQUIVALENTS

 

Cash equivalents consistof money market funds and certificates of deposit. We consider all highlyliquid investments with maturities of three months or less when purchased to becash equivalents. We evaluate the financial strength of institutions at whichsignificant investments are made and believe the related credit risk is limitedto an acceptable level.

 

FAIR VALUE OF FINANCIALINSTRUMENTS

 

The carrying amounts ofour financial instruments, which include cash and cash equivalents, accountsreceivable, accounts payable, capital leases, short-term bank borrowings andshort term notes, approximate their fair values at December 31, 2004 and2005, due to the short-term nature of these financial instruments.

 

F-9

----

 

MARKETABLE SECURITIES

 

We have classifiedmarketable securities as available for sale in accordance with Statement ofFinancial Accounting Standards No. 115, *Accountingfor Certain Investments 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, 2005 is based on quoted marketprices.  For the purpose of computingrealized gains and losses, cost is identified on a specific identificationbasis.

 

ACCOUNTSRECEIVABLE

 

In the normal course ofbusiness, we extend unsecured credit to hospitals, corporations and individualslocated throughout the United States. The Company routinely assesses thefinancial strength of its customers and believes that its trade accountsreceivable credit risk exposure is limited. The Company periodically reviews its receivables and records an allowanceas an estimate of uncollectibles.  All trade receivables are shown net ofan allowance for uncollectibles.  Amountsconsidered to be uncollectible are based on the type and age of the relatedreceivable.

 

INVENTORIES

 

Inventories are stated atthe lower of cost (determined on a first-in, first-out basis) or market andinclude finished goods inventory at December 31, 2004 and 2005.

 

PROPERTY AND EQUIPMENT

 

Property and equipmentare stated at cost and depreciated on a straight-line basis over the estimateduseful lives of the assets. Such lives vary from two to five years.  Leasehold improvements are amortized over thelesser of the life of the lease or the life of the asset.

 

GOODWILL

 

The Company follows Statement of Financial Accounting Standards No. 142 (“SFAS142”), *Goodwill and Other Intangible Assets*.  Goodwill represents the excess of cost overthe fair value of net assets of an acquired business.  Under SFAS 142, goodwill is deemed to have anindefinite life and is not subject to amortization over an estimated finiteuseful life but is tested for impairment annually under a two-step approach, ormore frequently, if events or changes in circumstances indicate that the assetmight be impaired.  

 

The first step of theimpairment test is used to identify potential impairment by comparing thecarrying amount of the reporting unit to its fair value.  If the fair value of a reporting unit exceedsits book value, goodwill of the reporting unit is not considered impaired andthe second step of the impairment test is not required.   If the carrying amount of the reporting unitexceeds its fair value, the second step of the impairment test is performed tomeasure the amount of impairment loss, if any. The second step of the impairment test compares the implied fair valueof the reporting unit’s goodwill with the book value of that goodwill.  When the carrying amount of the reportingunit’s goodwill exceeds the implied fair value of the goodwill, an impairmentloss is recognized in an amount equal to the excess. The implied fair value ofgoodwill is determined in the same manner as the amount of goodwill recognizedin a business combination.  The Companycompleted its annual goodwill impairment test for 2005 during the fourthquarter and determined there was no impairment of existing goodwill. 

 

INTANGIBLE ASSETS

 

As of December 31,2005, intangible assets consist of the value of customer contracts in theamount of $204,407 which are amortized over a three year life.  Accumulated amortization was $11,356.Amortization expense is expected to be $68,136, $68,136 and $56,779 in theyears ending December 31, 2006, 2007 and 2008, respectively. 

 

IMPAIRMENT OF LONG-LIVEDASSETS

 

We evaluate ourlong-lived assets with definite lives, such as property and equipment andcustomer contracts, for impairment in accordance with Statement of FinancialAccounting Standards 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.

 

F-10

----

 

DEFERRED RENT

 

The leases for SHS’sfacilities include scheduled rent increases over their terms and included freerental periods.  The total amount of therent payments for these operating leases is being charged to offset rentexpense on a straight-line basis over the terms of the respective leases.  The Company recorded deferred rent to reflectthe excess of rent expense and the value of tenant improvements over cashpayments since the inception of the leases. Deferred rent expense is being amortized on a straight-line basis overthe terms of the respective lease.

 

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 basis 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.

 

COMPREHENSIVE LOSS

 

Comprehensive loss iscomprised of net loss and other comprehensive income (loss). Othercomprehensive income (loss) includes certain changes in equity that areexcluded from net loss.  For the yearsended December 31, 2004 and 2005, comprehensive income (loss) other thanour net loss, was comprised of an unrealized gain (loss) on available for salesecurities.

 

LOSS PER SHARE

 

Basic net loss per shareis calculated based on the weighted average number of common shares outstandingduring the period.  Diluted net loss pershare incorporates the dilutive effect of potential dilutive shares of commonstock, including shares attributable to stock options, warrants and otherconvertible securities.  Potentiallydilutive shares of common stock have been excluded from the calculation of the weightedaverage number of diluted common shares, as their effect would be antidilutivefor all periods presented.  For the purposeof determining basic and diluted net loss per share, dividends accreted onpreferred stock and the deemed dividend with respect to the preferred stockredemption (see Note 12) have been deducted from loss from continuingoperations and net loss to arrive at net loss applicable to commonstockholders.  For the year ended December 31,2004, potentially dilutive shares of common stock that have been excluded fromthe calculation of the weighted average number of dilutive common shares were 575,086shares, comprised of warrants to purchase 376,495 shares, 91,500 sharesissuable on conversion of preferred shares and options to purchase up to107,091 shares of common stock.  For theyear ended December 31, 2005, potentially dilutive shares of common stockthat have been excluded from the calculation of the weighted average number ofdilutive common shares were 1,702,044 shares, comprised of 109,801 holdbackshares (see Note 16), warrants to purchase 1,417,762 and options to purchase upto 174,481 shares of common stock.

 

STOCK-BASED COMPENSATION

 

Statement of FinancialAccounting Standards No. 123 (“SFAS 123”), *Accountingfor Stock-Based Compensation*, establishes a fair value basedapproach for valuing stock options.  Wefollow the disclosure-only alternative afforded by SFAS 123 for employee stockoptions.  However, we account forstock-based compensation to non-employees using the fair value methodprescribed by SFAS 123.

 

We apply the principlesof Accounting Principles Board Opinion No. 25 (“APB 25”), *Accounting for Stock Issued to Employees*, and relatedinterpretations in accounting for our employee stock option compensation plans.Under APB 25, compensation expense is measured using the intrinsic value methodas the difference, if any, between the option exercise price and the fair valueof our common stock at the date of grant which is deferred and amortized overthe vesting period.  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 our 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 ended December 31,2004 and 2005 would have been adjusted to the pro forma amounts indicatedbelow: 

 

F-11

----

 
| ** **                                              | ** ** | **For the years ended Dec. 31,**          | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **2004**                                                           | ** ** | **2005** | ** ** |
| ** **                                              | ** ** | **In thousands except per share amounts** | ** ** |
| Net loss  applicable to common stockholders:            |       |                                                               |       |   |   |
| As reported                                             |       | $                                                                  | (3,872     | ) | $ | (2,451 | ) |
| Pro forma  compensation expense using fair value method |       | (296                                                               | )          | (314 | ) |
| Pro forma net  loss                                     |       | $                                                                  | (4,168     | ) | $ | (2,765 | ) |
|                                                    |       |                                                               |       |   |   |
| Basic and  diluted net loss per share:                  |       |                                                               |       |   |   |
| As reported                                             |       | $                                                                  | (4.44      | ) | $ | (1.56 | ) |
| Pro forma                                               |       | $                                                                  | (4.78      | ) | $ | (1.76 | ) |

 

The fair value of each optiongranted under our stock option plans is estimated on the date of grant usingthe Black-Scholes option-pricing model with the following assumptions:

 

| ** **               | ** ** | **2004**  | ** ** | **2005**   | ** ** |
|--------------------------|------------|-----------|------------|------------|------------|
| Dividend Yield           |       | None      |       | None       |       |
| Volatility               |       | 126       | %          | 115% - 126 | %          |
| Risk-free  interest rate |       | 1.94-3.32 | %          | 3.16-4.45  | %          |
| Expected life  (years)   |       | 3         |       | 1-4        |       |

 

The Black-Scholesoption-pricing model was developed for use in estimating the fair value oftraded options that have no vesting restrictions and are fully transferable. Inaddition, option-pricing models require the use of highly subjectiveassumptions, including the expected stock price volatility. Because ouremployee stock options have characteristics significantly different from thoseof traded options, and because changes in the subjective assumptions canmaterially affect the fair value estimates, in our opinion, the existing modelsdo not necessarily provide a reliable single measure of the fair value of itsemployee stock-based compensation.

 

Options issued to non-employees forservices are accounted for in accordance with Emerging Issues Task Force (“EITF”)Issue No. 96-18, *Accounting for EquityInstruments that are Issued to Other Than Employees for Acquiring or InConjunction with Selling Goods or Services*. Such securities arerecorded in expense and additional paid-in capital in stockholders’equity over the applicable service periods using variable accounting throughthe vesting date based on the fair value of the securities at the end of eachperiod.  As a result of stockoptions issued to non-employees, we recognized $21,960 and $20,494 innon-employee compensation for the years ended December 31, 2004 and 2005,respectively.  We derived the fair valueusing the Black-Scholes option-pricing model based on the following assumptions:

 

| ** **               | ** ** | **2004** | ** ** | **2005** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Dividend Yield           |       | None     |       | None     |       |
| Volatility               |       | 126      | %          | 112      | %          |
| Risk-free  interest rate |       | 2.8      | %          | 4.33     | %          |
| Expected life  (years)   |       | 3        |       | 1-4      |       |

 

ADVERTISING COSTS

 

Advertising costs areexpensed as they are incurred.  Totaladvertising expenses for  2004 and 2005were $23,708 and $9,483, respectively.

 

NEW ACCOUNTING STANDARDS

 

In December 2004,the FASB issued SFAS No. 123(R) (“SFAS 123(R)”), *Accountingfor Stock-Based Compensatio*n.   SFAS 123(R) establishes revised standards forthe accounting for transactions in which an entity exchanges its equityinstruments for goods or services.  SFAS 123(R) focuses primarily onaccounting for transactions in which an entity obtains employee services inshare-based payment transactions. SFAS 123(R) requires that the fair valueof such equity instruments be recognized as expense in the historical financialstatements as services are performed. Prior to the required adoption of SFAS123(R), we have been allowed to use the intrinsic value method and required toprovide only certain pro forma disclosures of fair value. SFAS 123(R)shall be effective for all of the

 

F-12

----

 

Company’s interim andannual reporting periods commencing on January 1, 2006 and is expected tohave a material impact on the consolidated financial statements of the Companyduring the fiscal year 2006 and thereafter.

 

In November 2004, the FASB issued SFAS No. 151(“SFAS 151”), *Inventory Costs, an amendmentof ARB No. 43, Chapter 4.*This statement amends theguidance in ARB No. 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 consolidated financial position and results ofoperations.

 

In December 2004, the FASB issued SFAS No. 153(“SFAS 153”), *Exchanges of NonmonetaryAssets, an amendment of APB Opinion No. 29*. The guidance in APBOpinion No. 29 (“APB 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 APB 29, however, included certain exceptionsto that principle. SFAS 153 amends APB 29 to eliminate the exception fornonmonetary exchanges of similar productive assets that do not have commercialsubstance. A nonmonetary exchange has commercial substance if the future cashflows of the entity are expected to change significantly as a result of theexchange.  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 ourconsolidated financial position and results of operations.

 

In May 2005, theFASB issued SFAS No. 154 (“SFAS 154”), *Accounting Changes andReporting Accounting Changes in Interim Financial Statements* for theaccounting for and reporting of a change in accounting principle. SFAS 154applies to all voluntary changes in accounting principle. It also applies tochanges required by an accounting pronouncement in the unusual instance thatthe pronouncement does not include specific transition provisions. Under theprovisions of APB Opinion 20, most accounting changes were recognized byincluding in net income of the period of the change the cumulative effect ofchanging to the newly adopted accounting principle. SFAS 154 improves financialreporting because its requirement to report voluntary changes in accountingprinciples via retrospective application, unless impracticable, enhances theconsistency of financial information between periods. That improved consistencyenhances the usefulness of the financial information, especially byfacilitating analysis and understanding of comparative accounting data.  SFAS 154 is effective for fiscal yearsbeginning after February 15, 2005.  Theadoption of SFAS 154 is not expected to have a material impact on our consolidatedfinancial position and results of operations.

 

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

### *** ***

On April 15, 2004,we sold our Visualization Technology business unit to Viking Systems, Inc.(“Viking”) under an Asset Purchase Agreement (the “Asset Purchase Agreement”)signed on December 22, 2003.  Inaccordance with SFAS No. 144 *Accountingfor the Impairment or Disposal of Long-Lived Assets*, the financialresults of this business have been reported separately as discontinuedoperations and the financial statements for all prior periods have beenrestated accordingly.  Prior to the salewe conducted our operations through two separate business units.  The Obesity Surgical and Medical ManagementServices business unit (operated via our wholly-owned subsidiary, VOW Solutions, Inc.),based in Carlsbad, CA, provides services to physicians and hospitals involvedin the surgical treatment of morbid obesity. In addition, our former Visualization Technology business unit, based inWestborough, Massachusetts, developed, manufactured and marketed products thatprovide information to physicians performing minimally invasive generalsurgical, cardiac surgical and other selected endoscopic and interventionalprocedures.

 

Under the Asset PurchaseAgreement, we sold all the operating assets and related liabilities of theVisualization Technology business to Viking. In return, Viking agreed to (a) pay us $159,000 at closing, (b) issueto us 3,054,000 shares of Viking common stock, representing approximately 10%of its common shares outstanding on a fully diluted basis, and (c) remitto us the value of any former Visualization Technology inventory sold by Vikingbefore April 15, 2005.  We alsoentered into a license agreement with Viking that will pay us royalties overthe five year period that began April 15, 2004 based on sales of theacquired 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.

 

The net operating assetssold to Viking and the total consideration paid or contractually due fromViking, exclusive of any proceeds from the subsequent sale of VisualizationTechnology inventory by Viking, are as follows:

 

F-13

----

 

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

 

Under accountingprinciples generally accepted in the United States of America, the transactionis principally the exchange of non-monetary assets between Viking and us. As a result, the carrying value of the net assets sold of $746,614 wasconsidered to be equal to the value of the net assets received and a gain wasnot recognized at the time of the transaction.  The Viking consideration,exclusive of cash, was considered non-monetary because Viking was a relativelynew company that had not raised substantial funds and may have been unable toraise sufficient funds to sustain its operations or fund its growth plan. All proceeds received, including payments derived by the sale of inventory,from Viking were initially credited against the Due from Viking Systems, Inc.account.  During theyears ended December 31, 2004 and 2005, we received from Viking $496,736and $232,644, respectively.  As of December 31,2004, the balance Due from Viking Systems, Inc. was $188,797.  As of December 31, 2005, the balance Duefrom Viking Systems, Inc. was repaid in full. 

 

Ourfinancial results for the years ended December 31, 2004 and 2005 have beenreclassified to show the results of operations for the Visualization Technologybusiness as a discontinued operation. The operating results of the discontinued operations were as follows:

 

| ** **                         | ** ** | **2004**  | ** ** |
|------------------------------------|------------|-----------|------------|
| Revenues                           |       | $         | 1,227,672  |   |
| Cost and  Expenses                 |       |      |       |
| Cost of sales                      |       | 1,035,667 |       |
| Research and  development          |       | 330,014   |       |
| Sales and  marketing               |       | 78,678    |       |
| General and  administrative        |       | 415,829   |       |
| Total cost and  expenses           |       | 1,860,188 |       |
| Loss from  discontinued operations |       | $         | (632,516   | ) |

 

For 2005, the gain fromdiscontinued operations of $232,644 was comprised of royalty payments under thelicense agreement of $225,000 and miscellaneous revenue of $7,644.

 

We have a severanceagreement with a former employee who became an employee of Viking upon the saleof the Visualization Technology business. Under the agreement, we may be required to pay the employee one year’scompensation (approximately $200,000) if the employee is terminated undercertain circumstances within 18 months following the sale of the business orprior to October 2005.  We are notaware of the employee being terminated as of December 31, 2005 and,accordingly, no provision for such payment has been included in the results ofdiscontinued operations.

 

3.  CASH AND CASH EQUIVALENTS 

 

As of December 31,2004 and 2005, the Company’s cash and cash equivalents consisted of:

 

| ** **          | ** ** | **2004**   | ** ** | **2005**   | ** ** |
|---------------------|------------|------------|------------|------------|------------|
| Cash                |       | $          | 89,916     |       | $          | 106,751 |   |
| Money market  funds |       | 1,879,645  |       | 744,564    |       |
| ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
|                |       | $          | 1,969,561  |       | $          | 851,315 |   |

 

F-14

----

 

4.  RESTRICTED CASH

 

The Company pledged a $356,000certificate of deposit together with all accrued interest as collateral for anote at a bank (see Note 9).  Thecertificate of deposit matures in October 2006 in conjunction with thenote.  Accordingly, the balance has beenexcluded from cash and cash equivalents.

 

5.  OTHERCURRENT ASSETS

 

As of December 31, 2004 and 2005, other currentassets consisted of the following:

 

| ** **                    | ** ** | **2004** | ** ** | **2005** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Interest  receivable          |       | $        | 3,365      |     | $          | 11,941 |   |
| Prepaid expenses              |       | 22,304   |       | 70,932   |       |
| Client  reimbursable expenses |       | 11,400   |       | 25,853   |       |
| Other                         |       | 14,743   |       | 12,484   |       |
| Totals                        |       | $        | 51,812     |     | $          | 121,210 |   |

 

6.  INVESTMENTIN EQUITY SECURITIES OF VIKING SYSTEMS, INC.

 

As part of the sale ofour Visualization Technology business in April 2004, we were issued3,054,000 shares of Viking common stock (see Note 2) valued at $0.02 per shareor $61,080, which reflected the fair value of the shares at the time the shareswere acquired.  In June 2004,1,400,000 of these shares valued at $0.02 per share, or $28,000, were used toobtain certain rights from our Series A holders (see Note 12) with theremaining 1,654,000 shares valued at $33,080.  In October 2004, the Viking common shares began trading on the OverThe Counter Bulletin Board and, accordingly, the carrying value of theavailable for sale marketable equity securities has been adjusted to fair valueand the unrealized gain has been offset against stockholders’ equity at December 31,2004 and  2005 and the changes in theunrealized gain have been included in other comprehensive loss.  There is a significant risk of adjustment tothe carrying value due to possible market fluctuations in their stock price.

 

The cost and fair valueof the equity securities at December 31, 2004 and 2005 are as follows:

 
| ** **                                 | ** ** | ** ** | ** ** | **2004**             | ** ** | **2005**        | ** ** |
|--------------------------------------------|------------|------------|------------|----------------------|------------|-----------------|------------|
| **Corporate Equity Securities:** | ** ** | **Cost**   | ** ** | **Unrealized  Gain** | ** ** | **Fair  Value** | ** ** | **Unrealized  Gain** | ** ** | **Fair  Value** | ** ** |
| Viking Systems,  Inc                       |       | $          | 33,080     |                 | $          | 1,273,580       |       | $ | 1,306,660 |   | $ | 628,520 |   | $ | 661,600 |   |
|                                            |            |            |            |                      |            |                 |            |  |  |  |  |  |  |  |  |  |

 

7.  PROPERTY AND EQUIPMENT

 

Property and equipment consists of the following items:

 

| ** **                                       | ** ** | **2004** | ** ** | **2005** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Leasehold  improvements                          |       | $        | —     |     | $          | 116,759 |   |
| Computer  hardware and software                  |       | 124,731  |       | 167,600  |       |
| Gym equipment                                    |       | —   |       | 61,663   |       |
| Office  equipment, furniture, fixtures and other |       | —   |       | 43,574   |       |
|                                             |       | 124,731  |       | 389,596  |       |
| Less:  accumulated depreciation and amortization |       | 92,988   |       | 136,716  |       |
| Totals                                           |       | $        | 31,743     |     | $          | 252,880 |   |

 

F-15

----

 

8.  ACCRUED LIABILITIES

 

Accruedliabilities consist of the following:

 

| ** **               | ** ** | **2004** | ** ** | **2005** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Audit fees               |       | $        | 31,473     |     | $          | 47,997 |   |
| Consulting fee           |       | 30,000   |       | 30,000   |       |
| Public company  expenses |       | —   |       | 17,367   |       |
| Other                    |       | 24,423   |       | 19,168   |       |
| Totals                   |       | $        | 85,896     |     | $          | 114,532 |   |

 

9.  SHORT-TERM BANK BORROWINGS

 

The Company has a notewith a bank to borrow up to $350,000 which matures in October 2006.  The note is secured by a certificate ofdeposit (see Note 4).  Interest is paidmonthly at  6.25%.  At December 31,2005,  the principal balance outstandingis $316,321.

 

10.  COMMITMENTS

 

At December 31, 2005,we are obligated under operating leases, principally related to real estate.One lease has an option to extend for a five year period.  Additionally, we are obligated under capitalleases related to computer hardware.  Thefollowing is a schedule of future minimum payments, excluding taxes andother operating costs, as of December 31, 2005:

 

| **Year ending December 31,**          | ** ** | **Operating Leases** | ** ** | **Capital Leases** | ** ** |
|------------------------------------------------------|------------|---------------------------|------------|-------------------------|------------|
| 2006                                                 |       | $                         | 263,480    |                    | $          | 11,145 |   |
| 2007                                                 |       | 263,739                   |       |                    |       |
| 2008                                                 |       | 261,003                   |       |                    |       |
| 2009                                                 |       | 57,626                    |       |                    |       |
|                                                 |       | $                         | 845,848    |                    | 11,145     |   |
| Less - amounts  representing interest                |       |                      |       | (5,342                  | )          |
| Principal of  capital lease obligations              |       |                      |       | 5,803                   |       |
| Less - current  portion of capital lease obligations |       |                      |       | (5,803                  | )          |
| Long term  portion of capital lease obligations      |       |                      |       | $                       | —     |   |

 

At December 31, 2004and 2005, we had equipment under capital leases with costs of $44,505 andaccumulated depreciation of $35,233 and $44,505, respectively.

 

Rent expense related tocontinuing operations was $149,813 and **$**174,794for the years ended December 31, 2004 and 2005, respectively.  

 

Subsequent to year-end weentered a new operating lease for real estate (see Note 17).

 

From time to time, we maybe involved in litigation relating to claims arising out of our operations inthe normal course of business.  There are no material legal proceedingspending against us.

 

11.  SAVINGS PLANS

 

We maintain a 401(k) planfor U.S. employees, which includes retirement income features consisting ofemployee tax deferred contributions. Contributions under all plans are investedin professionally managed portfolios. Our contributions are discretionary. We made no contributions in 2004 and 2005.

 

F-16

----

 

12. STOCKHOLDERS’ EQUITY

 

PREFERRED STOCK

 

In March 2003, we authorized and issued 1,000,000 shares of Series AConvertible 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.  Series A Shares wereconvertible into an equal number of common shares subject to certainadjustments.  The holders of Series AShares were entitled to receive dividends, out of any assets legally availabletherefore, prior and in preference to any declaration or payment of any cashdividend on the common stock, which were accreted at the rate of $0.1425 pershare per annum.  The holders of theoutstanding Series A Shares had the right to one vote for each share ofcommon stock into which such Series A Shares could then be converted, andwith respect to such vote, such holder had full voting rights and powers equalto the voting rights and powers of the holders of common stock.  In connection with this financing, thepurchasers of Series A Shares were granted several significant rightssenior to the rights of holders of our common stock. Among other rights, in theevent of a liquidation, dissolution or winding up of our Company (includingconsolidations, mergers or other sales), holders of Series A Shares wereentitled to receive $3.80 per share, in preference to any distribution to theholders of common stock.  Also, pursuantto the Certificate of Designations, we had to obtain the consent of the holdersof at least two-thirds of the outstanding Series A Shares in order toundertake certain actions, including significant capital expenditures and theissuance of equity securities. Additionally, for as long as Series A Shares remained outstandingbeyond April 2004, the holders of Series A Shares were entitled toelect the greater of (i) two members of our Board of Directors or (ii) 25%of the total members of our Board of Directors. 

 

In June 2004, we amended the Series ACertificate of Designations to allow us the right to issue equity securitiesfor less than $2.00 per share.  For thatright, the Series A holders received 1,400,000 shares of Viking commonstock valued at $28,000, and we redeemed 85,000 Series A Shares for$200,000.  In addition, we obtained theright 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 beenaccounted for as a deemed dividend of $131,985.

 

In January 2005, 88,553Series A Shares, with a carrying value of $107,669 including accreted dividends,were converted by one holder for 8,855 shares of our common stock. 

 

In connection with theprivate placement closed on July 26, 2005, we completed an exchange withthe holders of the outstanding Series A Shares.  In this transaction,the holders of Series A Shares exchanged their 826,447 shares of Series AShares for 124,608 Units, 52,644 shares of common stock and $126,174 in cash.Each unit was identical to the units sold in the private placement describedbelow and accordingly, we issued 177,252 shares of common stock and warrants topurchase 124,608 shares of common stock in the exchange. As a result of thisexchange, there was $306,511 in previously accreted dividends reversed againstnet loss available to common stockholders. The value of the consideration paidapproximated the fair value of the preferred stock surrendered, includingaccreted but unpaid dividends and therefore no gain or loss was recorded.  Following this exchange, we have nooutstanding Series A Shares. 

 

COMMON STOCK

 

In February 2004, wesold to a group of accredited investors 43,900 shares of common stock andwarrants to purchase up to 21,950 shares of common stock, for a total of$588,260 as part of a unit offering. The warrants are exercisable at a price of$19.70 per share and expire in February 2009.

 

In February 2004,our former subsidiary VOW Solutions, Inc., adopted the VOW Solutions, Inc.2004 Stock Option/Stock Issuance Plan (the “VOW Plan”) for the benefit of VOW’seligible employees, consultants, and directors. The VOW Plan initially reserved15,000 shares of common stock of VOW for issuance.  During 2004, options to purchase up to anaggregate of 11,250 shares of common stock had been issued to officers and onedirector under the VOW Plan, none of which had been exercised.  In December 2004,the VOW options were exchanged for Vista Medical Technologies, Inc.options at identical terms.** **VOW had 100,000 shares of commonstock outstanding as of December 31, 2004**. **In February 2005, VOWSolutions, Inc. was merged with the parent Vista Medical Technologies, Inc.

 

In May 2004, we soldto a group of accredited investors 545,454 units of our securities for $8.50per unit, each unit consisting of one share of common stock and one warrant topurchase one-half share of common stock, for aggregate gross proceeds ofapproximately $4.6 million, or $4.1 million net of expenses.  The 272,727 warrant shares are exercisable ata price of $9.50 per share and expire in May 2009.  As part of the May 2004 unit sale, weissued warrants to the placement agent to purchase up to 81,817 shares of ourcommon stock of which 54,545 of these warrants are exercisable at a price of $10.20per share and the remaining 27,272 warrants are exercisable at a price of $9.50per share and expire in May 2009.

 

F-17

----

 

In July 2005, wesold to a group of accredited investors 833,328 units of our securities for $3.00per unit, each unit consisting of one share of common stock and one warrant topurchase one share of common stock, for aggregate gross proceeds ofapproximately $2.2 million net of expenses. The warrants are exercisable at a price of $3.00 per share and expire inJuly 2010.  Under the terms of theprivate placement, the Company and the holders of the Company’s Series A Sharesconverted the 826,447 outstanding shares of Series A Shares into 124,608Units, 52,644 shares of common stock and $126,174 in cash.  As part of the July 2005 unit sale, we issuedwarrants to the placement agent to purchase up to 83,332 shares of our commonstock exercisable at $3.00 per share.

 

In July 2005, at theannual meeting of the stockholders we received approval to amend our SecondRestated Certificate of Incorporation to increase the authorized shares ofcommon stock from 35,000,000 to 70,000,000.

 

In November 2005 underthe terms of a merger agreement with SHS (See Note 16), iVOW paid $125,500 incash, assumed approximately $317,000 of liabilities of SHS and agreed to issueup to 294,278 shares of its common stock to the SHS shareholders (the “MergerShares”), of which 184,477 shares with a fair value of $427,987 were issued asof the closing and the remaining 109,801 shares are subject to holdback andsubject to release based on the resolutions of the determinations of actualliabilities of SHS and other contingencies set forth in the merger agreement. iVOW has a repurchase right for up to 71,128 of the Merger Shares to the extentthat SHS fails to satisfy certain revenue and net income targets in 2006 and2007. 

 

COMMON STOCK RESERVED

 

At December 31, 2005,we have reserved the following shares of common stock for future issuance:

 

| Common stock  holdback related to acquisition                       |   | 109,801   |   |
|---------------------------------------------------------------------|--------|-----------|--------|
| Exercise of  outstanding warrants                                   |   | 1,417,762 |   |
| Exercise of  outstanding options                                    |   | 174,481   |   |
| Options  available for grant                                        |   | 194,244   |   |
| Available for  issuance under the 1997 Employee Stock Purchase Plan |   | 16,877    |   |
|                                                                |   | 1,913,165 |   |

 

WARRANTS

 

The Company hasoutstanding warrants to purchase 376,494 and 1,417,762 shares of common stockas of December 31, 2004 and 2005, respectively. The warrants expire through February 2011.  A summary of outstanding warrants to purchasecommon stock at December 31, 2005 is as follows:

 

| **Exercise Prices** | ** ** | **Shares** | ** ** | **Weighted Average  Remaining Contractual Life  (Months)** | ** ** |
|--------------------------|------------|------------|------------|---------------------------------------------------------------------------|------------|
|                     |       |       |       |                                                                      |       |
| $3.00                    |       | 1,041,268  |       | 54.78                                                                     |       |
| $9.50 - $10.20           |       | 354,544    |       | 41.44                                                                     |       |
| $19.70                   |       | 21,950     |       | 37.30                                                                     |       |
|                     |       | 1,417,762  |       |                                                                      |       |

 

1997 STOCK OPTION PLAN/STOCK ISSUANCE PLAN

 

In February 1997, weadopted the 1997 Stock Option Plan/Stock Issuance Plan (the “1997 Plan”). The1997 Plan incorporates the outstanding options under the 1995 Stock Option Plan(the “1995 Plan”) and no further options will be granted under the 1995Plan.  In July 2005, at the annualmeeting of the stockholders we received approval to increase the aggregatenumber of shares of common stock available for issuance under our 1997 Planfrom 259,250 to 400,000 and to extend the life of the plan an additional tenyears.  At December 31, 2005, we had194,244 options available for grant.  Optionsgranted by us generally vest over three to five years and are exercisable fromthe date of grant for a period of ten years.

 

F-18

----

 

The following tablessummarizes stock option activity under all option plans:

 
| ** **                         | ** ** | **Number of  Shares** | ** ** | **Exercise Price per  Share** | ** **  | **Weighted  Average  Exercise Price  per Share** | ** ** |
|------------------------------------|------------|----------------------------|------------|-----------------------------------------|-------------|------------------------------------------------------------|------------|
| Balance at  December 31, 2003 |       | 80,629                     |       | $                                       | 8.00        | -                                                          | $575.00    |   | $ | 35.60 |   |
| Granted                            |       | 65,220                     |       | $                                       | 10.00  | -                                                          | $23.00     |   | $ | 13.78 |   |
| Exercised                          |       | (3,733                     | )          | $                                       | 8.00        | -                                                          | $8.90      |   | $ | 8.10 |   |
| Canceled                           |       | (32,804                    | )          | $                                       | 8.00        | -                                                          | $395.00    |   | $ | 28.75 |   |
|                               |       |                       |       |                                    |        |                                                       |       |   |   |   |
| Balance at  December 31, 2004 |       | 109,312                    |       | $                                       | 8.00        | -                                                          | $575.00    |   | $ | 23.46 |   |
| Granted                            |       | 102,516                    |       | $                                       | 2.32        | -                                                          | $10.30     |   | $ | 5.93 |   |
| Exercised                          |       |                       |       |                                    |        |                                                       |       |   | $ |   |   |
| Canceled                           |       | (37,347                    | )          | $                                       | 8.00        | -                                                          | $455.00    |   | $ | 28.90 |   |
|                               |       |                       |       |                                    |        |                                                       |       |   |   |   |
| Balance at  December 31, 2005 |       | 174,481                    |       | $                                       | 2.32        | -                                                          | $575.00    |   | $ | 11.86 |   |
|                                    |            |                            |            |                                         |             |                                                            |            |  |  |  |  |  |

 
| ** **                                 | ** ** | ** ** | ** ** | **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** | ** ** |
| ** **                                 | ** ** | ** ** | ** ** | ** **                                                         | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| $2.32                                      | -          | $4.60      |       |                                                               | 68,867     |                                        | 116        |   | $ | 3.97 |   | 0 |   | $ | 0 |   |
| $8.00                                      | -          | $10.30     |       |                                                               | 41,070     |                                        | 92         |   | $ | 9.62 |   | 16,584 |   | $ | 9.25 |   |
| $11.80                                     | -          | $14.70     |       |                                                               | 33,750     |                                        | 100        |   | $ | 12.60 |   | 19,506 |   | $ | 12.75 |   |
| $15.50                                     | -          | $24.00     |       |                                                               | 18,574     |                                        | 95         |   | $ | 17.64 |   | 12,828 |   | $ | 17.70 |   |
| $25.00                                     | -          | $46.24     |       |                                                               | 9,908      |                                        | 63         |   | $ | 36.65 |   | 9,794 |   | $ | 36.64 |   |
| $50.00                                     | -          | $575.00    |       |                                                               | 2,312      |                                        | 45         |   | $ | 123.55 |   | 2,312 |   | $ | 123.55 |   |
|                                       |       |       |       | 174,481                                                            |       | 101                                         |       | $ | 11.86 |   | 61,024 |   | $ | 20.87 |   |
|                                            |            |            |            |                                                                    |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |

 

The weighted averageremaining life of the options outstanding at December 31, 2004 and 2005was 99 and 101 months, respectively.

 

1997 EMPLOYEE STOCKPURCHASE PLAN

 

In February 1997, weadopted the 1997 Employee Stock Purchase Plan (the “Purchase Plan”), whichpermits eligible employees of ours to purchase shares of common stock, atsemi-annual intervals, through periodic payroll deductions.  Payroll deductions may not exceed 10% of theparticipant’s base salary, and the purchase price per share will not be lessthan 85% of the lower of the fair market value of the common stock at eitherthe beginning or the end of the semi-annual intervals.  In July 2005, at the annual meeting ofthe stockholders we received approval to increase the aggregate number ofshares of common stock available for issuance under our 1997 Employee StockPurchase Plan from 15,000 to 30,000 and to extend the term of the plan anadditional ten years.  There were 747 and3,652 shares issued under the Purchase Plan in 2004 and 2005,respectively.  There were 16,877 sharesavailable for issuance at December 31, 2005. 

 

13.  INCOME TAXES

 

Significant components ofour deferred tax assets as of December 31, 2004 and 2005 are shown below.  A valuation allowance has been established tooffset the deferred tax assets, as realization of such assets is uncertain.

 

F-19

----

 

| ** **                                   | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Deferred tax  assets:                        |       |                  |       |   |   |
| Net operating  loss carryforwards            |       | $                     | 21,460,000 |   | $ | 23,426,000 |   |
| Research and  development credits            |       | 2,407,000             |       | 2,385,000 |   |
| Capitalized  research and development        |       | 571,000               |       | 236,000 |   |
| Depreciation                                 |       | 19,000                |       | 304,000 |   |
| Inventory  reserve                           |       | 562,000               |       | — |   |
| Other                                        |       | 30,000                |       | 117,000 |   |
| Total deferred  tax assets                   |       | 25,049,000            |       | 26,468,000 |   |
| Deferred tax  liabilities:                   |       |                  |       |   |   |
| Investment in  equity securities             |       | (558,000              | )          | (276,000 | ) |
| Goodwill and  intangibles                    |       | —                |       | (379,000 | ) |
| Total deferred  tax liabilities              |       | (558,000              | )          | (655,000 | ) |
|                                         |       |                  |       |   |   |
| Net deferred tax  assets                     |       | 24,491,000            |       | 25,813,000 |   |
| Valuation  allowance for deferred tax assets |       | (24,491,000           | )          | (25,813,000 | ) |
|                                         |       |                  |       |   |   |
| Net deferred tax  assets                     |       | $                     | —     |   | $ | — |   |

 

The following reconcilesthe expected tax provision obtained by applying statutory rates to pretaxincome from continuing operations with the actual tax provision:

 

| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Expected tax at  federal statutory rates |       | $                     | (1,010,000 | ) | $ | (1,023,000 | ) |
| Change in  valuation allowance           |       | 1,167,000             |       | 1,322,000 |   |
| Other                                    |       | (157,000              | )          | (299,000 | ) |
| Tax provision                            |       | $                     | —     |   | $ | — |   |

 

At December 31, 2005,we have federal and state tax net operating loss carryforwards of approximately$63,538,000 and $13,432,000, respectively. The federal tax loss carryforwardswill begin to expire in 2010.  Approximately$753,000 of the state tax loss carryforwards expired in 2005 and will continueto expire in future periods unless previously utilized. At December 31,2005, we also have federal and state research tax credit carryforwards ofapproximately $2,264,000 and $121,000, respectively, which will begin to expirein 2010 unless previously utilized.  Wehave retained the federal and state tax loss carryforwards and other taxattributes of the Visualization Technology business.

 

The difference betweenthe federal and state tax loss carryforwards is primarily attributable to theexpiration of certain state net operating loss carryforwards, which have ashorter life than federal carryforwards.

 

In accordance withSections 382 and 383 of the Internal Revenue Code, a change in ownership ofgreater than 50% of a corporation within a three-year period will place anannual limitation on our ability to utilize our existing tax loss and taxcredit carryforwards.

 

14. RELATED PARTYTRANSACTIONS

 

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 $118,000and  $132,000 were paid to this companyin 2004 and 2005, respectively.

 

15. CONCENTRATIONS

 

CASH

 

The Company maintains itscash deposits with banks. At times, such deposits may exceed Federally insuredlimits. At December 31, 2005, the Company had cash deposits that exceededapplicable insured limits by $126,317.  Asof December 31, 2005, the Company also had a money market account of$745,000 that is not insured.  TheCompany reduces its exposure to credit risk by maintaining such balances withfinancial institutions that have high credit ratings. 

 

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CUSTOMERS

 

In 2005, the Company hadthree major customers.  Sales to thesecustomers totaled approximately $647,000 or 50% of revenue.  At December 31,2005, accounts receivable from these customers amounted to approximately$64,000 or 40% of total accounts receivable.

 

In 2004, the Company hadtwo major customers.  Sales to thesecustomers totaled approximately $680,000 or 41% of  revenue. At December 31, 2004, accounts receivable from these customersamounted to approximately $63,000 or 36% of total accounts receivable.

 

SUPPLIERS

 

During 2004 and 2005, the Company had one major vendor, purchases fromwhich totaled approximately $83,700 and $104,600, respectively.  There were no accounts payable to this vendorat December 31, 2004 and 2005.

 

16. ACQUISITION

 

On November 1, 2005,the Company purchased the business and substantially all assets of SHS and,accordingly, the results of operations of SHS have been included in theaccompanying consolidated financial statements from that date.  Under the terms of the merger Agreement, iVOWpaid the SHS stockholders $125,500 in cash, assumed $317,000 of liabilities ofSHS and agreed to issue up to 294,278 shares of common stock (the “MergerShares”) to the SHS stockholders, of which 184,477 shares with a fair value of$427,987 (based on the closing price of the Company’s stock on November 1,2005) were issued as of the closing and the remaining 109,801 shares are effectivelybeing held in escrow (the “Holdback Shares”) and are subject to release basedon the resolution of the determination of the actual liabilities of SHS andother contingencies set forth in the Merger Agreement.  iVOW has a repurchase right for up to 71,128of the Merger Shares to the extent that SHS fails to achieve certain revenueand net income targets in 2006 and 2007. SHS offers a platform from which to integrate clinical, medical andsurgical weight loss programs into a seamless disease management strategy forobesity.  The Company anticipates thatexpansion of the SHS model will generate market opportunities for the iVOWSurgical Centers and, depending on how the market opportunity evolves, otheraffiliated bariatric centers.  

 

The total purchase pricefor the acquisition of SHS initially recorded by the Company was approximately$1,184,000, which was comprised of the cash paid, the liabilities assumed, thefair value of the 184,477 shares issued at the closing and other acquisitioncosts (such as legal and finders fees) totaling $314,064.  The fair value of the Holdback Shares has notbeen included in the purchase price recorded as of December 31, 2005 andwill not be recorded until the contingencies are resolved.

 

The acquisition of SHShas been accounted for by the Company under the purchase method of accounting inaccordance with Statement of Financial Accounting Standard No. 141, *Business Combinations*. Under the purchase method, assetsacquired and liabilities assumed are recorded at their estimated fair values.  Goodwill is recorded to the extent the purchaseprice, including certain acquisition and closing costs, exceeds the fair valueof the net identifiable tangible and intangible assets acquired at the date ofacquisition.

 

The total initialpurchase price for the acquisition of SHS of $1,184,000 was allocated as follows:

 

| ** **                   | ** ** | **(in thousands)** | ** ** |
|------------------------------|------------|-------------------------|------------|
| Cash and cash  equivalents   |       | $                       | 9          |   |
| Accounts  receivable         |       | 76                      |       |
| Property and  equipment      |       | 241                     |       |
| Goodwill                     |       | 915                     |       |
| Intangible assets            |       | 204                     |       |
| Other assets                 |       | 31                      |       |
| Accounts payable             |       | (26                     | )          |
| Other note  payable          |       | (23                     | )          |
| Accrued  liabilities         |       | (26                     | )          |
| Deferred revenue             |       | (161                    | )          |
| Other long-term  liabilities |       | (56                     | )          |
|                         |       |                    |       |
| Total net assets             |       | $                       | 1,184      |   |

 

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The goodwill representsthe expected benefit that the Company will realize by integrating SHS into itsproduct portfolio.  Furthermore, theexpected demand for the new products created by the acquisition, such as a newmedically managed weight loss and surgical center, is also reflected in thegoodwill amount.

 

Assuming the acquisitionhad taken place on the first day of the years ended December 31, 2004 and2005, unaudited revenue would have been approximately $3,459,000 and $2,542,000,respectively, while unaudited loss from continuing operations would have been$3,664,000 and $3,018,000, respectively. The unaudited basic loss per common share from continuing operations forthe years ended December 31, 2004 and 2005 would have been ($3.47) and ($1.75),respectively.

 

In connection with thepurchase, SHS entered into independent contractor agreements and noncompetitionagreements with two physicians, for the provision of medical services toSHS.  The agreements have a term of threeyears, subject to earlier termination. Under the contractor agreements, the Company agreed to issue stockoptions to purchase 10,667 shares of common stock to the physicians.

 

17. SUBSEQUENT EVENTS

 

In January 2006, the Company entered into an operating lease forits new headquarters in San Diego, California. The lease is for three years and provides us with an option to extendthe lease for an additional three years. The future minimum payments excluding taxes and other operating costsare $85,880, $96,263, $99,151 and $8,283 for years 2006 through 2009,respectively.

 

In February 2006, the Company issued 64,194 shares valued at$148,930 relating to a portion of the holdback shares associated withthe SHS acquisition.   Upon issuance ofthe stock, the value of goodwill was increased by $148,930.

 

In February 2006,the Company completed a private placement of the Company’s common stock andwarrants in which it sold 290,000 Units at a purchase price of $3.18 per unit.  Each unit consisted of one share of theCompany’s common stock and a warrant to purchase one-half share of the Company’scommon stock. The warrants have an exercise price of $3.18 per share and have afive-year term.  The private placementresulted in gross proceeds of $922,200. 

 

The placement agentreceived a selling commission equal to 8% of the gross proceeds ($74,008),along with an expense allotment of $25,000. The placement agent also received awarrant to purchase 23,200 units at a purchase price of $0.001 per unit. Thiswarrant has an exercise price of $3.18 per unit and has a five-year term. 

 

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