Exhibit 99.1
Viking Systems, Inc.
Form 8-K/A
File No. 000-49636
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Viking Systems, Inc.
We have audited the accompanying balance sheet of the Vista Medical Technologies
Visualization Business Segment (the Segment), a segment of Vista Medical
Technologies, Inc., as of December 31, 2003 and 2002, and the related statements
of operations, equity, and cash flows for the years then ended. These financial
statements are the responsibility of the Segment's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Vista Medical Technologies
Visualization Business Segment as of December 31, 2003 and 2002, and the results
of its operations and its cash flows for the years then ended in conformity with
U.S. generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Segment will continue as a going concern. The Segment has incurred substantial
losses from operations. As discussed in Note 1 to the financial statements,
there is substantial doubt about the ability of the Segment to continue as a
going concern. Management's plans in regard to that matter are also described in
Note 1. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
Salt Lake City, Utah
May 21, 2004
VISTA MEDICAL TECHNOLOGIES VISUALIZATION
BUSINESS SEGMENT
Balance Sheet
December 31,
- --------------------------------------------------------------------------------
Assets 2003 2002
------------------------------
Current assets:
Cash and cash equivalents $ - $ 17,842
Short-term investments - 369,745
Accounts receivable, net 693,725 1,026,816
Inventories, net 1,113,931 1,478,668
Prepaids and other current assets 5,925 -
------------------------------
Total current assets 1,813,581 2,893,071
Property and equipment, net - 77,431
Patents and other assets, net - 3,061
------------------------------
Total assets $ 1,813,581 $ 2,973,563
==============================
- --------------------------------------------------------------------------------
Liabilities and Equity
Current liabilities:
Accounts payable $ 557,302 $ 739,037
Current portion of long-term debt 7,467 11,788
Payable to affiliate 84,941 -
Accrued compensation 106,658 145,504
Other accrued expenses 31,169 101,741
Deferred revenue 37,500 -
------------------------------
Total current liabilities 825,037 998,070
Long-term debt - 7,467
------------------------------
Total liabilities 825,037 1,005,537
Commitments and contingencies
Equity:
Contributed capital 67,947,643 67,939,199
Accumulated deficit (66,959,099) (65,971,173)
------------------------------
Total equity 988,544 1,968,026
------------------------------
Total liabilities and equity $ 1,813,581 $ 2,973,563
==============================
- --------------------------------------------------------------------------------
See accompany notes to financial statements. F-1
VISTA MEDICAL TECHNOLOGIES VISUALIZATION
BUSINESS SEGMENT
Statement of Operations
Years Ended December 31,
- -------------------------------------------------------------------------------
2003 2002
-------------------------------
Revenues $ 6,220,091 $ 7,477,540
-------------------------------
Costs and expenses:
Cost of revenues 5,048,878 5,084,550
Research and development 739,017 1,626,607
Sales and marketing 330,612 249,996
General and administrative 1,091,005 1,065,779
-------------------------------
Total costs and expenses 7,209,512 8,026,932
-------------------------------
Loss from operations (989,421) (549,392)
-------------------------------
Other income (expense):
Interest expense (134) -
Other income 1,629 17,367
-------------------------------
Total other income 1,495 17,367
-------------------------------
Net loss before income taxes (987,926) (532,025)
Income tax benefit - -
-------------------------------
Net loss $ (987,926) $ (532,025)
===============================
- --------------------------------------------------------------------------------
See accompany notes to financial statements. F-2
VISTA MEDICAL TECHNOLOGIES VISUALIZATION
BUSINESS SEGMENT
Statement of Equity
Years Ended December 31, 2003 and 2002
- --------------------------------------------------------------------------------
Contributed Accumulated
Capital Deficit Total Equity
--------------------------------------------
Balance, January 1, 2002 $ 67,868,537 $ (65,439,148) $ 2,429,389
Contribution of capital 70,662 - 70,662
Net loss - (532,025) (532,025)
--------------------------------------------
Balance, December 31, 2002 67,939,199 (65,971,173) 1,968,026
Contribution of capital 8,444 - 8,444
Net loss - (987,926) (987,926)
--------------------------------------------
Balance, December 31, 2003 $ 67,947,643 $ (66,959,099) $ 988,544
============================================
- --------------------------------------------------------------------------------
See accompany notes to financial statements. F-3
VISTA MEDICAL TECHNOLOGIES VISUALIZATION
BUSINESS SEGMENT
Statement of Cash Flows
Years Ended December 31,
- --------------------------------------------------------------------------------
2003 2002
------------------------------
Cash flows from operating activities:
Net loss $ (987,926) $ (532,025)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 138,759 430,107
Change in operating assets and liabilities:
Accounts receivable 333,091 101,467
Inventories 364,737 (384,094)
Prepaids and other current assets (5,925) -
Accounts payable (181,735) 58,035
Accrued compensation (38,846) (29,909)
Deferred revenue 37,500 -
Other accrued expenses (70,572) (269,578)
------------------------------
Net cash used in
operating activities (325,976) (625,997)
------------------------------
Cash flows from investing activities:
Maturities of short-term investments 369,745 147,110
Purchase of property and equipment (58,267) (96,123)
------------------------------
Net cash provided by
investing activities 311,478 50,987
------------------------------
Cash flows from financing activities:
Payments of long-term debt (11,788) (562)
Contribution of capital 8,444 70,662
Payable to affiliate 84,941 -
------------------------------
Net cash (used in) provided by
financing activities (3,344) 70,100
------------------------------
Net decrease in cash and cash equivalents (17,842) (504,910)
Cash and cash equivalents at beginning of year 17,842 522,752
------------------------------
Cash and cash equivalents at end of year - 17,842
==============================
Supplemental disclosure of cash flow information:
Cash paid for interest $ 134 $ -
==============================
Cash paid for income taxes $ - $ -
==============================
- --------------------------------------------------------------------------------
See accompany notes to financial statements. F-4
Vista Medical Technologies Visualization Business Segment
Notes to Financial Statements
December 31, 2003 and 2002
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS ACTIVITY
Vista Medical Technologies Visualization Business Segment (the Segment), based
in Westborough, MA, was a segment of Vista Medical Technologies, Inc. The
Segment develops, manufactures, and markets products that provide information to
physicians performing minimally invasive general surgical, cardiac surgical and
other selected endoscopic and interventional procedures. The Segment's
technology products combine a head mounted display with video cameras to provide
surgeons with critical visual information during complex minimally invasive
procedures, and also incorporate the benefit of viewing complementary
information in a voice-controlled, picture-in-picture format, to facilitate
real-time decision making during surgery. The Segment also manufactures compact,
high resolution endoscopic cameras for original equipment manufacturer customers
and strategic partners.
Subject to shareholder approval, on December 22, 2003, Vista Medical
Technologies, Inc. entered into an Asset Purchase Agreement with Viking Systems,
Inc. (Viking) regarding the sale of all the assets of the Segment, as more fully
discussed in Note 7 to the financial statements.
The Segment has incurred operating losses in 2002 and 2003, and at December 31,
2003, had an accumulated deficit of approximately $67 million. At December 31,
2003, the Segment had cash, cash equivalents and short-term investments of $0.
These factors raise substantial doubt about the Segment's ability to continue as
a going concern. Management is pursuing several alternatives to address this
situation, including raising additional funding, increasing sales through
expanded sales and marketing efforts and the release of new products. However,
there can be no assurance that the requisite fundings will be consummated in the
necessary time frame or on terms acceptable to the Segment or that the expanded
sales and marketing efforts and the release of new products will produce the
cashflow necessary to sustain the operations of the Segment. Should the Segment
be unable to raise sufficient funds, the Segment may be required to curtail its
operating plans and possibly relinquish rights to portions of the Segment's
technology or products. In addition, increases in expenses or delays in product
development may adversely impact the Segment's cash position and require further
cost reductions. No assurance can be given that the Segment will be able to
operate profitably on a consistent basis, or at all, in the future.
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The financial statements do not
include any adjustments relating to the recoverability and classification of
assets or the amounts and classification of liabilities that might be necessary
should the Segment be unable to continue as a going concern.
USE OF ESTIMATES
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and disclosures made in the accompanying notes to the financial
statements. Actual results could differ from those estimates.
F-5
Vista Medical Technologies Visualization Business Segment
Notes to Financial Statements (continued)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
The Segment recognizes revenue pursuant to Staff Accounting Bulletin ("SAB") No.
104 "Revenue Recognition". Accordingly, revenue is recognized when all four of
the following criteria are met: (i) persuasive evidence of an arrangement
exists; (ii) delivery of the product and/or services has occurred; (iii) the
selling price is fixed or determinable and; (iv) collectibility is reasonably
assured. Sales returns are estimated based on the historical experience and
management's expectations and are recorded at the time product revenue is
recognized. Shipping and handling costs are included in cost of sales.
The Segment's revenues are derived from the sale of technology products to end
users, distributors and original equipment manufactures and extended warranty
sales. Product revenue is recognized upon shipment, provided all the criteria of
SAB 104 are met. Warranty revenue is recognized ratably over the term of the
warranty.
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Cash equivalents and short-term investments consist of money market funds,
certificates of deposit and commercial paper. The Segment considers all highly
liquid investments with maturities of three months or less when purchased to be
cash equivalents. The Segment evaluates the financial strength of institutions
at which significant investments are made and believes the related credit risk
is limited to an acceptable level.
The Segment accounts for its investments in accordance with Statement of
Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities", and has classified its short-term
investments as available-for-sale in accordance with that standard.
Available-for-sale securities are carried at fair value, with unrealized gains
and losses, net of tax, reported in a separate component of equity. At December
31, 2003 and 2002, the cost of short-term investments was equivalent to fair
value and the Segment had no unrealized gains or losses.
As of December 31, 2003 and 2002, the Segment's cash, cash equivalents and
short-term investments consisted of:
2003 2002
------------ -----------
Cash $ - $ 17,842
Money market funds - -
Certificates of deposit - 369,745
------------ -----------
$ - $ 387,587
============ ===========
F-6
Vista Medical Technologies Visualization Business Segment
Notes to Financial Statements (continued)
ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS
The Segment provides credit, in the normal course of business, to commercial
entities that meet specified credit requirements. The Segment's principal
customers consist of original equipment manufacturers and distribution partners.
The Segment provides for losses from uncollectible accounts and such losses have
historically not exceeded management's expectations. As of December 31, 2003,
three customers comprised $275,000, $173,000 and $116,000 or 40%, 25% and 17%,
respectively, of the outstanding trade receivables. As of December 31, 2002,
three customers comprised $277,000, $223,000 and $199,000 or 15%, 12% and 11%,
respectively, of the outstanding trade receivables.
Sales to individual customers exceeding 10% or more of revenues in the years
ended December 31, were as follows: during 2003, Richard Wolf GmbH, Aesculap AG,
and Richard Wolf Medical Instruments Co. accounted for 28%, 23% and 12% of
revenues, respectively; during 2002, Aesculap AG , Jomed, Richard Wolf, GmbH and
Richard Wolf Medical Instruments Co. accounted for 20%, 14% 12% and 11% of
revenues, respectively.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Segment's financial instruments, which include cash
and cash equivalents, short-term investments, accounts receivable, accounts
payable, capital leases and short-term bank borrowings, approximate their fair
values at December 31, 2003 and 2002, due to the short-term nature of these
financial instruments.
INVENTORIES
Inventories are stated at lower of cost (determined on a first-in, first-out
basis) or market.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. The Segment provides for depreciation
on property and equipment using the straight-line method over the estimated
useful lives of the assets, generally two to five years. Marketing demonstration
equipment is amortized over its estimated useful life of one year. Depreciation
expense for the years ended 2003 and 2002 was approximately $136,000 and
$396,000, respectively.
F-7
Vista Medical Technologies Visualization Business Segment
Notes to Financial Statements (continued)
PATENTS
Patents are carried at cost and amortized over five years commencing on the date
the patent is issued. The Segment reviews its patents for impairment on an
annual basis or whenever events or changes in circumstances indicate that the
carrying value of the asset would not be recoverable. Amortization expense for
the years ended 2003 and 2002 was approximately $3,000 and $34,000,
respectively.
IMPAIRMENT OF LONG-LIVED ASSETS
The Segment evaluates its long-lived assets for impairment in accordance with
SFAS No. 144, Accounting for the Disposal or Impairment of Long-Lived Assets.
The Segment records impairment losses on long-lived assets used in operations
when indicators of impairment are present and the undiscounted cash flows
estimated to be generated by those assets are less than the carrying value of
the assets. There have not been any impairments of long-lived assets to date.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed in the period incurred.
INCOME TAXES
The Segment uses the asset and liability accounting method whereby deferred tax
assets and liabilities are recognized based on temporary differences between the
financial statements and tax bases of assets and liabilities using current
statutory tax rates. A valuation allowance against net deferred tax assets is
recorded if, based on the available evidence, it is more likely than not that
some or all of the deferred tax assets will not be realized. Management
evaluates on a quarterly basis the ability to recover the deferred tax assets
and the level of the valuation allowance.
COMPREHENSIVE INCOME / (LOSS)
Comprehensive income / (loss) is comprised of net loss and other comprehensive
income/ (loss). Other comprehensive income/(loss) includes certain changes in
equity that are excluded from net loss. For the years ended December 31, 2003
and 2002, the Segment had no items of comprehensive income (loss) other than its
net loss.
STOCK-BASED COMPENSATION
The Segment accounts for stock-based compensation under the recognition and
measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations. The Segment has adopted SFAS No. 123,
"Accounting for Stock-Based Compensation". In accordance with the provisions of
SFAS 123, the Segment has elected to continue to apply Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB Opinion
No. 25"), and related interpretations in accounting for its stock option plans.
As of December 31, 2003, the Segment did not have any stock options outstanding.
F-8
Vista Medical Technologies Visualization Business Segment
Notes to Financial Statements (continued)
NEW ACCOUNTING STANDARDS
In January 2003 FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities" was issued. This interpretation requires a company to consolidate
variable interest entities ("VIE") if the enterprise is a primary beneficiary
(holds a majority of the variable interest) of the VIE and the VIE passes
specific characteristics. It also requires additional disclosures for parties
involved with VIEs. In December, 2003, the FASB issued a revision of
Interpretation No. 46 (the Revised Interpretation 46). Revised Interpretation 46
codifies both the proposed modifications and other decisions previously issued
through certain FASB Staff Positions (FSPs) and supersedes the original
Interpretation No. 46 to include: (1) deferring the effective date of the
Interpretation's provisions for certain variable interests, (2) providing
additional scope exceptions for certain other variable interests, (3) clarifying
the impact of troubled debt restructurings on the requirement to reconsider (a)
whether an entity is a VIE or (b) which party is the primary beneficiary of a
VIE, and (4) revising Appendix B of the Interpretation to provide additional
guidance on what constitutes a variable interest. Accordingly, the Segment will
adopt Revised Interpretation No. 46 effective the first quarter 2004 and does
not expect the adoption of this interpretation will have an impact on its
financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. Many
of these instruments were previously classified as equity. SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise was effective at the beginning of the first interim period
beginning after June 15, 2003. The adoption of this Statement did not have an
effect on the Segment's financial statements.
2. BALANCE SHEET COMPONENTS
Accounts receivable consist of the following:
December 31,
2003 2002
------------------------------
Gross accounts receivable $ 693,725 $ 1,143,592
Less: Allowance for
doubtful accounts - (116,776)
------------- -------------
$ 693,725 $ 1,026,816
============= =============
Inventories consist of the following:
December 31,
2003 2002
------------------------------
Raw materials $ 1,279,958 $ 1,243,304
Work in process 340,502 375,414
Finished goods 796,041 904,734
------- -------
2,416,501 2,523,452
Less: Reserve for excess and
obsolete inventory (1,302,570) (1,044,784)
------------------------------
$ 1,113,931 $ 1,478,668
------------------------------
F-9
Vista Medical Technologies Visualization Business Segment
Notes to Financial Statements (continued)
2. BALANCE SHEET COMPONENTS (CONTINUED)
Property and equipment consists of the following:
December 31,
2003 2002
--------------- ---------------
Machinery and equipment $ 1,007,497 $ 1,009,702
Office computers, furniture and 451,611 428,314
equipment 163,444 111,340
Marketing demonstration equipment 27,885 27,885
------------ ------------
Leasehold improvements 1,650,437 1,577,241
------------ ------------
Less: Accumulated depreciation (1,650,437) (1,499,810)
------------ ------------
$ - $ 77,431
=============== ===============
3. COMMITMENTS
At December 31, 2003, the Segment is obligated under an operating lease,
principally related to real estate. Additionally, the Segment is obligated under
capital leases related to computer hardware. The following is a schedule of
future minimum payments, excluding taxes and other operating costs, as of
December 31, 2003:
YEAR ENDING DECEMBER 31, Operating Capital
Leases Leases
2004 $ 133,878 $8,234
-----------
Less - Amounts representing interest (767)
-----------
Principal capital lease obligation $ 7,467
-----------
At December 31, 2003 and 2002, the Company had equipment under capital leases
with costs of $19,817 for both years and accumulated depreciation of $19,817 and
$9,502, respectively.
Rent expense was $268,000 for the years ended December 31, 2003 and 2002.
4. INCOME TAXES
Significant components of the Company's deferred tax assets as of December 31,
2003 and 2002 are shown below. A valuation allowance has been established to
offset the deferred tax assets, as realization of such assets is uncertain.
December 31,
2003 2002
-------------- ---------------
Deferred tax assets:
Inventory reserve $ 390,000 $ 486,000
Other 109,000 25,000
-------------- ---------------
Total deferred tax assets 499,000 511,000
Valuation allowance for deferred tax assets (499,000) (511,000)
-------------- ---------------
Net deferred taxes - -
============== ===============
F-10
Vista Medical Technologies Visualization Business Segment
Notes to Financial Statements (continued)
4. INCOME TAXES (CONTINUED)
All federal and state tax net operating loss carry forwards incurred prior to
the sale described in Note 7 are retained by Vista Medical Technologies, Inc.
The difference between the income tax at statutory rates and the income tax
benefit is as follows:
Years Ended
December 31,
-----------------------
2003 2002
-----------------------
Federal income tax benefit at statutory rate $ 336,000 $ 181,000
State income tax benefit 33,000 18,000
Loss carryforward retained by parent (381,000) (226,000)
Change in valuation allowance (12,000) 27,000
-----------------------
$ - $ -
=======================
5. GEOGRAPHIC INFORMATION
Geographic information: Net sales by major geographical area, determined on the
basis of destination of the goods, are as follows:
2003 2002
------------ -----------
United States $ 2,755,721 $ 3,885,214
Europe 3,464,370 3,592,326
------------ -----------
Total $ 6,220,091 $ 7,477,540
------------ -----------
6. RELATED PARTY TRANSACTION
The Segment was a segment of Vista Medical Technologies, Inc. As of December 31,
2003 the Segment had advances payable to Vista Medical Technologies, Inc. of
$84,941.
F-11
Vista Medical Technologies Visualization Business Segment
Notes to Financial Statements (continued)
7. SUBSEQUENT EVENT
On April 15, 2004, Vista Medical Technologies, Inc. (Vista) sold all of the
assets of the Segment to Viking Systems, Inc. (Viking). Pursuant to the terms of
the Asset Purchase Agreement, Viking purchased all assets related to the Segment
in exchange for a combination of cash, common stock and assumed liabilities.
Specifically, at closing, Viking paid Vista cash of approximately $159,000 and
issued shares of its common stock equal to ten percent (10%) of the
fully-diluted common shares of Viking stock. Additionally, at closing, Vista
entered into a License Agreement with Viking pursuant to which Vista will
exclusively license to Viking all intellectual property and product rights used
in the operation of the Segment. In exchange for this license grant, Viking will
pay Vista royalties over the next five (5) years based on sales of the products
of the Segment by Viking. The License Agreement will contain minimum royalties
of $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 under the License
Agreement are capped at $4,500,000, in the aggregate, over the five year period.
Vista will retain ownership of all intellectual property and product rights
under the License Agreement until these royalty obligations have been satisfied,
at which time Vista will transfer ownership of such intellectual property and
product rights to Viking. Lastly, Vista will consign to Viking at closing its
current inventory of products and parts. Viking will reimburse Vista the value
of that inventory, if and when sold, over the course of the next year.
F-12