Financial Statement SchedulesAS FILED WITH THE
QuickLinks-- Click here to rapidly navigate through this documentAs filed with the Securities and Exchange Commission on June 4, 2004
Registration No. 333-113760
SECURITIES AND EXCHANGE COMMISSION
ON AUGUST 24, 2001 REGISTRATION NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON,
Washington, D.C. 20549------------------------AMENDMENT NO. 4
to
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933------------------------DIGIRAD CORPORATION
(Exact
(Exact Name of Registrant as Specified in its Charter)
DELAWAREDelaware 3845 33-0145723 (State(State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer
Incorporation or Organization)(Primary Standard Industrial
Classification Code Number)(I.R.S. Employer
Identification Number)
13950 Stowe Drive
Poway, California 92064
(858) 726-1600
(Address, including zip code, and telephone number, including
area code, of Registrant's principal executive offices)
David M. Sheehan
Chief Executive Officer
Digirad Corporation
13950 Stowe Drive
Poway, California 92064
(858) 726-1600
(Name, address, including zip code, and telephone number, including area code, of agent for service)-------------------------- 9350 TRADE PLACE SAN DIEGO, CA 92126-6334 (858) 578-5300 (Address, Including Zip Code, and Telephone Number, Including Area Code,
Copies to:John A. de Groot, Esq.
Taylor L. Stevens, Esq.
Kristopher L. Hanson, Esq.
Morrison & Foerster LLP
3811 Valley Centre Drive, Suite 500
San Diego, California 92130
(858) 720-5100Vera P. Pardee, Esq.
Vice President and General Counsel
Digirad Corporation
13950 Stowe Drive
Poway, California 92064
(858) 726-1600Charles K. Ruck, Esq.
Scott N. Wolfe, Esq.
B. Shayne Kennedy, Esq.
Latham & Watkins LLP
12636 High Bluff Drive, Suite 300
San Diego, California 92130
(858) 523-5400Approximate date of
Registrant's Principal Executive Offices) -------------------------- R. SCOTT HUENNEKENS CHIEF EXECUTIVE OFFICER DIGIRAD CORPORATION 9350 TRADE PLACE SAN DIEGO, CALIFORNIA 92126-6334 (858) 578-5300 (Name, Address, Including Zip Code, and Telephone Number, Including Area Code,commencement ofAgent for Service) -------------------------- COPIES TO:
MARTIN C. NICHOLS, ESQ. J. VAUGHAN CURTIS, ESQ. BROBECK, PHLEGER & HARRISON LLP ALSTON & BIRD LLP 12390 EL CAMINO REAL 90 PARK AVENUE SAN DIEGO, CALIFORNIA 92130 NEW YORK, NY 10016 (858) 720-2500 (212) 210-9511-------------------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT. --------------------------proposed sale to the public:
As soon as practicable after this Registration Statement becomes effective.If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.
/ /oIf this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.
/ /oIf this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.
/ /oIf this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.
/ /oIf delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box.
/ / -------------------------- CALCULATION OF REGISTRATION FEE
PROPOSED MAXIMUM AGGREGATE OFFERING AMOUNT OF TITLE OF EACH CLASS OF SECURITIES TO BE REGISTERED PRICE(1) REGISTRATION FEECommon Stock, $0.001 par value per share.................... $69,000,000 $17,250(1) EstimatedoThe Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to
Rule 457(o) solely for the purpose of calculating the amount ofsaid Section 8(a), may determine.The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration
fee. ------------------------------ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(a), MAY DETERMINE. - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------THE INFORMATION IN THISstatement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting offers to buy these securities in any state where the offer or sale is not permitted.Subject to Completion
Preliminary Prospectus dated June 4, 2004PROSPECTUS
IS NOT COMPLETE AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.PRELIMINARY PROSPECTUS SUBJECT TO COMPLETION AUGUST 24, 2001 - --------------------------------------------------------------------------------5,500,000 Shares
[LOGO] DIGIRAD CORPORATIONCommon Stock
- ----------------------------------------------------------------------This is our initial public offering of shares of our common stock.
No public market currently exists for our common stock.Wecurrently anticipateare offering 5,500,000 shares. We expect the initial public offering price to be between$$12.00 and$$14.00 per share.We have applied to have our common stock approvedCurrently, no public market exists for
quotationthe shares. After pricing of the offering, we expect that the shares will be quoted on the Nasdaq National Market under the symbol "DRAD."BEFORE BUYING ANY SHARES, YOU SHOULD READ THE DISCUSSION OF MATERIAL RISKS OF INVESTING IN OUR COMMON STOCK IN "RISK FACTORS" BEGINNING ON PAGE 6. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.Investing in the common stock involves risks that are described in the "Risk Factors" section beginning on page 7 of this prospectus.
PER SHARE TOTAL- -------------------------------------------------------------------------------------Per Share Total Public offering price $ $ - -------------------------------------------------------------------------------------Underwriting discounts and commissions $ $ - -------------------------------------------------------------------------------------Proceeds, before expenses, to us $ $ - -------------------------------------------------------------------------------------The underwriters may also purchase up to an additional 825,000 shares of common stock from us at the public offering price, less the underwriting discounts and commissions, within 30 days from the date of this
prospectus. Ifprospectus to cover over-allotments.Neither the
underwriters exerciseSecurities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to theoption in full, the total underwriting discounts and commissions will be $ , and our total proceeds before expenses will be $ .contrary is a criminal offense.The
underwriters are offering the common shares as set forth under "Underwriting." Delivery of theshares will bemadeready for delivery on or about ,2001. UBS WARBURG FIRST UNION SECURITIES, INC. - ------------------------------------------------------------2004.
Merrill Lynch & Co. JPMorgan
Banc of America Securities LLC William Blair & Company The date of this prospectus is ,
2001.MIDDLE TOP: The words "Charting the Future of Nuclear Medicine."2004.
TOP LEFT: TOP RIGHT: Graphic: PhotoProspectus Summary 1 Risk Factors 7 Special Note Regarding Forward-Looking Statements 28 Use of technician working at a Graphic: PhotoProceeds29 Dividend Policy 30 Capitalization 31 Dilution 33 Selected Consolidated Financial Data 35 Management's Discussion and Analysis of a DIGIRAD-TM- mobile nuclear wire-bonding machine. imaging services unit with technician standing between a Digirad SPECTour(SM) ChairFinancial Condition anda Digirad Imaging acquisitionResults of Operations37 Business 50 Management 71 Certain Relationships and processing system in frontRelated Transactions85 Principal Stockholders 90 Description of a van bearing the Digirad Imaging Solutions logo. CENTER LEFT: CENTER RIGHT: Graphic: Photo showing nuclear imaging Graphic: Photo of computer screen showing procedure being performed on patient using a vertical, horizontal and short access fuse of DIGIRAD-TM- acquisition and processing system the heart's left ventricle. and a DIGIRAD SPECTour(SM) Chair. BOTTOM RIGHT: Graphic: Photo of a DIGIRAD-TM- detector module.Capital Stock94 Shares Eligible for Future Sale 100 Underwriting 102 Legal Matters 105 Experts 105 Where You Can Find More Information 105 Index to Consolidated Financial Statements F-1 BOTTOM MIDDLE: DIGIRAD LOGO.- --------------------------------------------------------------------------------You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized
anyoneany other person to provide you withany otherdifferent information. If anyone provides you with different or inconsistent information, you should not rely on it. We areofferingnot, and the underwriters are not, making an offer to selland seeking offers to buy, our common shares onlythese securities injurisdictionsany jurisdiction wherethese offers and sales arethe offer or sale is not permitted.TheYou should assume that the information appearing in this prospectus is accurate only as of the date on the front cover of thisprospectus, regardlessprospectus. Our business, financial condition, results of operations and prospects may have changed since that date.i
This summary does not contain all of the
time of the delivery of this prospectus or of any saleinformation you should consider before buying shares of our common stock.TABLE OF CONTENTS - --------------------------------------------------------------------------------
Prospectus summary..................... 1 The offering........................... 4 Summary financial and operating data... 5 Risk factors........................... 6 Forward-looking information............ 19 Market and industry data and forecasts............................ 19 Use of proceeds........................ 20 Dividend policy........................ 20 Capitalization......................... 21 Dilution............................... 23 Selected historical financial and operating data....................... 25 Management's discussion and analysis of financial condition and results of operations........................... 27 Business............................... 35 Management............................. 57 Certain relationships and related transactions......................... 68 Principal stockholders................. 71 Description of capital stock........... 73 Shares eligible for future sale........ 78 Material United States federal tax consequences to non-United States holders of common stock.............. 80 Underwriting........................... 83 Legal matters.......................... 85 Experts................................ 85 Where you can find more information.... 85 Index to consolidated financial statements........................... F-1Through and including , 2001 (the 25th day after commencement of this offering), federal securities law may require all dealers selling our common stock, whether or not participating in this offering, to deliver a prospectus. This delivery requirement is in addition to the obligation of dealers to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions. We have filed applications for federal trademark registrations and claim rights in 2020TC Imager(TM), NOTEBOOK IMAGER(TM), FLEXIMAGING(SM), SPECTour(TM), DIGISPECT(SM), DIGIRAD(TM), DIGIRAD (and design)(TM) and DIGIRAD IMAGING SOLUTIONS(SM). This prospectus may also refer to trade names and trademarks of other companies. As used in this prospectus, references to "we," "our," "us" and Digirad refer to Digirad Corporation and its subsidiaries, unless the context otherwise requires.Prospectus summary This summary highlights information contained elsewhere in this prospectus.You should read the entire prospectus carefully, especially therisks"Risk Factors" section and our consolidated financial statements and the related notes appearing at the end ofinvestingthis prospectus, before deciding to invest in shares of our commonstock,stock. References in this prospectus to our certificate of incorporation and bylaws refer to the certificate of incorporation and bylaws that will be in effect upon completion of this offering.We are a leader in the development, manufacture and distribution of solid-state medical imaging products and services for the detection of cardiovascular disease and other medical conditions. We designed and commercialized the first solid-state gamma camera. Our initial focus is on nuclear cardiology imaging procedures performed with gamma cameras, which we
discuss underbelieve generate revenue of approximately $10.0 billion annually in theheading "Risk factors" beginning on page 6,United States. Our target markets are primarily physician practices and outpatient clinics, which we believe constitute approximately 25% of thefinancial statements and related notes before making an investment decision. OVERVIEW We are the first and only company to have developed and commercialized a solid-state, digital gamma camera for use in nuclear medicine. We believe this will allow us to become a leading provider oftotal market, or $2.5 billion.Our gamma cameras
and mobile nuclear cardiacuse small semiconductors to replace the bulky vacuum tubes used historically in gamma cameras. By utilizing solid-state technology, we believe that our imagingservices. Our patented solid-state camera offers manysystems maintain image quality while offering significant advantages overa conventionalvacuumtube camera, such as smallertube-based systems, including mobility through reduced sizeincreased mobility, increased durability,and weight, enhanced operability and reliability and improvedimage quality, expanded clinical applicationspatient comfort andenhanced patient comfort. All other gamma cameras on the market currently use conventional vacuum tube technology. We believe the features and benefits of our technology will encourage healthcare providers to choose our camera over conventional cameras for both initial and replacement purchases. In addition, because of our camera's increased mobility and durability, we believe it is ideally suited for use in a mobileutilization. Our imagingservices application that has not been widely available until now. We are initially focusing on the nuclear cardiology segment of the nuclear imaging market, which is the largest and fastest growing segment of that market. Our proprietary technology allows for both a significant reduction in the sizesystems, consisting of a gamma camera and accessories, easily fit into spaces as small as seven feet by eight feet. Due to the size and other limitations of vacuum tube cameras, nuclear imaging has traditionally been confined to dedicated and customized space within asignificant improvementhospital or imaging center. The mobility of our imaging systems enables us to deliver nuclear imaging procedures inspatial resolution. Conventional gamma camera photo-detectors are approximately four inchesa wide range of clinical settings—physician offices, outpatient clinics or within multiple departments inheight. Our photo-detectors are only 0.012 inches high, providing an approximate 350-to-1 reduction in detector size that makes the camera both thinnera hospital.We sell our imaging systems to physicians, outpatient clinics and
lighter. While conventional cameras use an average calculationhospitals. In addition, through our wholly-owned subsidiaries, Digirad Imaging Solutions, Inc. and Digirad Imaging Systems, Inc., which we refer toapproximate the location of the gamma rays used to create the image, our cameras determine the precise location of these gamma rays. This improves spatial resolution and allows our camera tocollectively as DIS, we also offer asignificant improvementcomprehensive and mobile imaging leasing service, called FlexImaging®, for physicians who wish to perform nuclear cardiology imaging procedures inimage qualitytheir offices but do not have the patient volume, capital or resources to justify purchasing a gamma camera. DIS provides our physician customers with an imaging system, certified personnel, required licensure and other support for the performance of nuclear imaging procedures under the supervision of our physician customers. Physicians enter into annual contracts for imaging services delivered on a per-day basis ranging from one day per month to several days per week. DIS currently operates 21 regional hubs and eight fixed sites and performs services in 17 states and the District of Columbia.Our unique dual sales and leasing distribution model offers physicians, clinics and hospitals versatile delivery options that appeal to medical establishments of all sizes, capabilities and imaging expertise. The mobility of our imaging systems and the flexibility of our DIS service allow cardiologists to provide nuclear imaging procedures in their offices to patients that they historically had to refer to hospitals or imaging centers. As a result, we provide physicians with more control over the
conventional vacuum tube technology. We are currently addressing the rapidly growing nuclear cardiology market in the following two ways: - - NUCLEAR CAMERA SALES--We are selling our cameradiagnosis andrelated products to physician offices, imaging centers, hospitalstreatment of their patients andresearch laboratories, thus providing customers with a technologically advanced alternative to conventional vacuum tube gamma cameras. - - MOBILE NUCLEAR CARDIAC IMAGING SERVICES--We are also providing mobile nuclear imaging services, as described in this prospectus, to physician offices, including cardiology and internal medicine practices. Our turn-key mobile imaging solution provides on-site access to all the benefits of our advanced diagnostic imaging technology, without requiring customers to make an up-front payment, hire additional personnel, obtain regulatory approval or establish a dedicated nuclear imaging suite. Our service model enablesenable physicians to capturetherevenue from procedures that wouldhaveotherwisebeen lost because the patient wasbe referredelsewhere. In addition, it provides us with a recurring revenue stream from the servicing of our customers on a routine basis. We began commercial production of our first solid-state, digital gamma camera product, marketed as the DIGIRAD-TM- 2020TC Imager-TM- camera, in January 2000to these hospitals andshipped our first unit in March 2000. From our first shipment through June 30, 2001, we had received orders for 117 cameras, 59 of which had been shipped. We established our mobile nuclear cardiacimagingservices operations in the second half of 2000. As of June 30, 2001, we were providing nuclear cardiac imaging services to approximately 101 physician offices in California, Delaware, Florida, Indiana, Maryland, New Jersey, North Carolina, Ohio and Pennsylvania. During the six month period ended June 30, 2001, our mobile imaging services business performed approximately 6,900 imaging procedures. 1INDUSTRY OVERVIEW NUCLEAR IMAGING Nuclear medicine is used primarily in cardiovascular, oncology and neurological applications.centers.Nuclear imaging
offers the ability to non-invasively measure varying degrees of physiological activity, including blood flow, organ function, metabolic activity, biochemical activity, and other functional activity within the body.is a clinical diagnostic tool, with established reimbursement codes, that has been in use for over 40 years. According toa 2001 study by Frost & Sullivan, a leading marketing consulting company, there wereindustry sources, approximately15.518.4 million nuclear imaging procedures were performed in theU.S.United States in2000. We believe over 252002, of which approximately 9.9 million were cardiac procedures,were performed worldwide. The market consists of two primary technologies, gamma cameras and dedicated positron emission tomography, or PET, machines. Frost & Sullivan statesa volume thatgamma cameras are currently the preferred choice for the majority of nuclear medicine procedures. The most widely used type of gamma camera is a single photon emission computed tomography, or SPECT, camera. TRENDS IN NUCLEAR CARDIAC IMAGING Nuclear cardiology is the largest and fastest growing segment of the nuclear imaging market. Frost & Sullivan reports that of the 15.5 million nuclear imaging procedures performed in the U.S. in 2000, 7.9 million, or 51%, were cardiology related procedures. The nuclear cardiology procedure volumeis expected to grow by approximately 25% annually over the next5three years.Increasingly, a nuclear cardiac imaging procedure isWe believe thefirst non-invasive, diagnostic imaging procedure performed on patients with suspected heart disease. Given the clinical advantages of nuclear cardiac images, many payors are requiring nuclear studies prior to the more invasive and expensive diagnostic and therapeutic procedures. Reasons for the rapidgrowth in nuclearcardiaccardiology imaging will be driven by an increase in coronary heart disease resulting from the aging of baby boomers and the record rate of obesity and diabetes in all age groups. We estimate that the growth rate in 2002 for nuclear imaging proceduresinclude: - - Valuable clinical information; - - Cost-effectiveness; - - Non-invasive nature; - - Established reimbursement;performed in physician offices was approximately 44% and- - An increaseinheart disease. Frost & Sullivan divideshospitals was approximately 6%. We expect the mobility of our imaging systemsto continue to allow us to capitalize on this shift in the delivery of nuclear cardiology imaging services from hospitals to physician offices.
The target market for our products is the approximately 30,000 cardiologists in the United States that perform or could perform nuclear cardiology procedures. To date, we have sold or provided imaging services through DIS to approximately 500 physicians. In 2003, DIS performed over 66,000 patient procedures.
We sold our first gamma camera in March 2000, and we established DIS in September 2000. We had consolidated revenues and net losses of $41.5 million and $12.8 million, respectively, in fiscal 2002, $56.2 million and $1.7 million, respectively, in fiscal 2003 and $15.9 million and $266,000, respectively, for the three months ended March 31, 2004. Revenues from DIS and from our camera sales constituted 62% and 38%, respectively, of our 2003 consolidated revenues and 66% and 34%, respectively, of our consolidated revenues for the three months ended March 31, 2004. We believe DIS will continue to provide us with recurring annual contractual revenue and comprise the largest component of our consolidated revenues.
Our Competitive Strengths
We believe that our position as a market leader in the nuclear cardiac imaging
proceduremarket is a product of the following competitive strengths:
- •
- Leading Solid-State Technology. We were the first company to develop and commercialize solid-state technology for nuclear imaging applications.
- •
- Mobile Applications Through Reduced Size and Weight. Our solid-state technology has allowed us to reduce the size and weight of gamma cameras, resulting in the only in-office mobile cardiac gamma camera on the market.
- •
- Image Quality. We believe our imaging systems maintain a high-quality image despite the rigors of a mobile environment.
- •
- Enhanced Operability and Reliability. We believe our imaging systems provide more convenient operation, better power efficiency and increased durability as compared to vacuum tube cameras.
- •
- Improved Patient Comfort and Utilization. We believe the upright and open architecture of our patient chair can reduce patient claustrophobia and increase patient comfort when compared to traditional vacuum tube-based systems and may increase patient utilization.
- •
- Unique Dual Distribution. We have implemented a unique dual distribution model by offering our physician and hospital customers the ability to either purchase or lease our imaging systems through DIS.
- •
- Intellectual Property Portfolio. We have developed an intellectual property portfolio that includes product, component and process patents covering various aspects of our imaging systems. Currently, we have 21 patents issued and 10 pending patent applications in the United States, and we have two patents issued and 21 pending patent applications internationally.
Our Business Strategy
We intend to continue to expand our business, improve our market position and increase our revenue and profits by pursuing the following business strategies:
- •
- Continued Innovation in Solid-State Imaging Technology. We intend to maintain our leadership position in solid-state imaging technology by continuing to invest resources in research and development.
- •
- Expand Our DIS Business. We plan to expand our DIS business into
four segments: hospital in-patient, hospital out-patient,several new states, add new hub locations in states in which we currently operate and increase hub utilization by adding physician customers and routes. We also intend to pursue cardiologypracticesopportunities for DIS in hospitals anddiagnostic imaging centers. Although a numbernew clinical applications for DIS in neurology, oncology and surgery.- •
- Increase Market Share in Camera Sales. We believe that we can grow our market share by capitalizing on the recent trend of
cardiology practices with more than five cardiologists have incorporated nuclear medicine into their practice setting, mostnuclear cardiology proceduresare currently referredshifting from the hospital tohospitalsthe physician office.- •
- Expand International Sales and
imaging centers, where the cardiologist loses clinical control and receives minimal or no economic benefit. DIGIRAD'S MARKET OPPORTUNITY Our technology allows usMarketing Presence. We intend toaddress the following two markets: - - NUCLEAR CAMERA SALES--Frost & Sullivan projects that the U.S. gamma camera market for nuclear imaging will be approximately $325 million in 2001, and is expected to grow at an average annual rate of approximately 5% from 2001 to 2007. We estimate that the non-U.S. gamma camera market is approximately $300 million. In addition, we estimate that the market for technical services is an additional 10% to 15% of a camera's purchase price per year over the life of the contract, which is typically 5 years. - - MOBILE NUCLEAR CARDIAC IMAGING SERVICES--We believe the market opportunity for our mobile nuclear imaging services business is approximately $2.6 billion. This market size is based on our target market of procedures performed in hospital, outpatient facilities, diagnostic imaging centers, physician offices and the following: 2- A report by Frost & Sullivan that approximately 7.9 million nuclear cardiac imaging procedures were performed in the U.S. in 2000; - Frost & Sullivan's estimate, based on a more limited study, that approximately 56% of U.S. nuclear cardiac imaging procedures were performed in a hospital outpatient facility, diagnostic imaging center or physician office in 2000; and - Our average net revenue of approximately $600 per procedure. Our proprietary technology enables physicians to perform office-based nuclear imaging procedures that were previously referred elsewhere, with limited disruption to their current practice. Therefore, we believe our solutions will accelerate the transition of nuclear cardiac imaging procedures to non-hospital sites, in particular cardiology and internal medicine practices. THE DIGIRAD ADVANTAGE Our proprietary technology has enabled us to develop a gamma camera with many unique features compared to conventional gamma cameras. Some of the major advantages of the DIGIRAD-TM- solid-state camera over conventional vacuum tube gamma cameras are outlined below: - - SMALLER SIZE--Our 425-pound camera and 350-pound SPECTour-TM- chair require only 7 feet by 9 feet of working space vs. a 1,500 to 5,000 pound vacuum tube SPECT camera that requires a dedicated room with reinforced floors. - - INCREASED MOBILITY--The mobility of our camera facilitates our imaging services business as opposed to vacuum tube cameras that are typically permanently installed in hospitals or imaging centers. - - INCREASED DURABILITY--Our camera is relatively insensitive to physical shock or temperature variations and should offer much greater reliability than a vacuum tube camera whose single scintillation crystal is easily damaged. - - IMPROVED IMAGE QUALITY--Images on the perimeter of our detector heads are as clear as images at the center while the best image quality on a vacuum tube camera is obtained only in the center. - - EXPANDED CLINICAL APPLICATIONS--Our smaller and lighter camera heads are more flexible than vacuum tube camera heads and can be used in multiple applications throughout the hospital. - - ENHANCED PATIENT COMFORT--With our camera, patients sit upright with their arms resting in front of them rather than having to lie and hold their arms above their head as vacuum tube cameras require. OUR BUSINESS STRATEGY Our goal is to rapidly expand our business andincrease ourrevenuespresence internationally byoffering a complete nuclear imaging solutionentering into relationships with distributors that have the experience, expertise and service network tophysician offices, imaging centers, hospitalssell andresearch laboratories. The key elements ofsupport ourbusiness strategy include: - - Leveragingproducts internationally.- •
- Drive Margin Improvements and Growth. We plan to enhance our
proprietary technology to increase sales of products and imaging services; - - Aggressively targeting the growing nuclear cardiology market; - - Expanding our integrated, direct sales force; - - Leveraging our proprietaryproduct margins by achieving operating efficiencies, reducing manufacturingprocesses to reducecosts andimprove performance; - - Expanding acceptance of additional clinical applications;increasing product reliability.Corporate Information
Our business was originally incorporated in California in November 1985 and
- - Continuing technological development.we reincorporated in Delaware in January 1997. Our principal executive offices are located at9350 Trade Place, San Diego, CA 92126-6334. Our13950 Stowe Drive, Poway, California 92064 and our telephone number is (858)578-5300.726-1600. We maintain aweb sitewebsite on the Internet atwww.digirad.com. Our web site, and thewww.digirad.com. The information containedtherein,in, or that can be accessed through, our website is not a part of this prospectus.------------------------ 3The offeringUnless the context requires otherwise, as used in this prospectus the terms "Digirad," "we," "us" and "our" refer to Digirad Corporation, a Delaware corporation, and its subsidiaries.We have trademark registrations in the United States for 2020tc Imager®, CardiusSST®, Digirad®, Digirad Logo®, Digirad Imaging Solutions®, FlexImaging® and SPECTour®. We have trademark applications pending in the United States for the following marks: Cardius™, DigiServSM, DigiSpectSM, DigiTechSM and SolidiumSM. We have obtained and sought trademark protection for some of the above listed marks in the European Community and Japan.
Common stock we are offering.................offering5,500,000 shares
Common stock to be outstanding after thisoffering...................................offering
17,998,646 shares
Use of proceeds
We expect to use a majority of the net proceeds of this offering to manufacture and market our gamma cameras, build our sales and marketing capabilities, expand our DIS business and repay outstanding lines of credit and notes payable of approximately $9.7 million. To a lesser extent, we anticipate using the remaining net proceeds of this offering for further research and development relating to our existing products and new product opportunities, to finance regulatory approval activities and for general corporate purposes. We may also use a portion of the net proceeds of this offering to acquire products, technologies or businesses that are complementary to our own.
Proposed Nasdaq National Marketsymbol.......symbol
DRADUse of proceeds.............................. Repayment of approximately $5.7 million of outstanding debt and general corporate purposes, including product development, marketing, capital expenditures and working capital. Risk factors................................. Investing in our common stock involves significant risks. See "Risk factors."The
totalnumber of shares of common stock to be outstanding after this offering is based on the shares of common stock outstanding as of March 31, 2004. This number excludes as of March 31, 2004:
- •
- 1,581,519 shares of our common stock
includes: - - 4,526,474subject to outstanding options under our 1991 Stock Option Program, our 1997 Stock Option/Stock Issuance Plan and our 1998 Stock Option/Stock Issuance Plan, having a weighted average exercise price of $2.42 per share;- •
- 58,904 shares of our common stock
outstanding asavailable for future issuance under our 1991 Stock Option Program, our 1997 Stock Option/Stock Issuance Plan and our 1998 Stock Option/Stock Issuance Plan; and- •
- 63,971 shares of
August 23, 2001; and - - 29,748,030 shares ofour common stock issuable upon exercise of outstanding warrants (including warrants to purchase preferred stock that are convertible into common stock), having a weighted average exercise price of $33.39 per share.In addition, except where we state otherwise, the information we present in this prospectus reflects:
- •
- the automatic conversion of all
shares ofour outstanding preferred stockoutstanding as of August 23, 2001 in connection with this offering. The total number of outstanding shares of our common stock above does not include: - - the issuance of up to 5,952,426into 12,444,294 shares of common stock upon theexercisecompletion ofstock options outstanding asthis offering;- •
- the adoption of
August 23, 2001 at a weighted average exercise priceour restated certificate of$0.64 per share; - - the issuance of upincorporation and restated bylaws to603,578 shares of common stockbe effective upon theexercise of warrants outstanding as of August 23, 2001 at a weighted average exercise price of $2.59 per share, of which warrants to purchase 65,875 shares will expire if not exercised at the timecompletion of thisoffering and warrants to purchase 60,000 shares will expire if a consulting agreement is terminated before July 31, 2002; - - the issuance of up to 250,000 shares of common stock, as well as additional shares of common stock issuable based upon future earnings results, as additional consideration in connection with our acquisitions of Nuclear Imaging Systems, Inc. and Florida Cardiology and Nuclear Medicine Group; - - the issuance of up to 4,725,883 shares of common stock reserved for future issuance under our stock option plans; and - - the issuance of 10,000 shares of common stock at fair market value for every three of our digital cameras sold by a consultant, up to a maximum of 40,000 shares, and thereafter 1,500 shares of common stock at fair market value for each of our digital cameras sold by the consultant, in each case upon the exercise of warrants issuable to the consultant. Unless we indicate otherwise, information throughout this prospectus reflects: - -offering;- •
- no exercise of the underwriters' over-allotment
option granted to the underwriters; - - the automatic conversion of all outstanding shares of preferred stock into shares of common stock in connection with this offering; and - -option;- •
- a
one-for-1-for-200 reverse stock split of ouroutstanding sharescapital stock effected in October 2002; and- •
- a 1-for-3.5 reverse stock split of our common stock,
to be effected in connection with this offering. 4Summary financial and operating datawhich was approved by our stockholders on April 30, 2004.
SUMMARY CONSOLIDATED FINANCIAL INFORMATIONThe following table summarizes our consolidated financial
data and provides selected operating data. The summary financial datainformation for theyears ended December 31, 1998, 1999, and 2000, are derived from our audited financial statements. We have also included data from our unaudited financial statements for the six months ended June 30, 2000 and 2001 and as of June 30, 2001.periods presented. You should read thisdatainformation together with our consolidated financial statements and the related notesincludedappearing elsewhere in this prospectus and the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of this prospectus. The summary financial data at March 31, 2004 and for the three months ended March 31, 2003 and 2004 are derived from our unaudited financial statements which are included elsewhere in this prospectus.
Years Ended December 31, Three Months Ended
March 31,Statement of Operations Data: 2001 2002 2003 2003 2004 (In thousands, except per share amounts) Revenues: DIS $ 10,239 $ 23,005 $ 34,848 $ 7,503 $ 10,407 Product 18,065 18,527 21,388 5,476 5,461 Total revenues 28,304 41,532 56,236 12,979 15,868
Cost of revenues:
DIS 8,344 16,599 24,463 5,642 7,265 Product 13,192 13,633 15,091 3,841 3,639 Stock-based compensation(1) 298 124 114 1 116 Total cost of revenues 21,834 30,356 39,668 9,484 11,020
Gross profit
6,470
11,176
16,568
3,495
4,848
Operating expenses:
Research and development 3,009 2,967 2,191 579 640 Sales and marketing 9,974 8,065 6,008 1,547 1,780 General and administrative 8,161 9,497 8,097 1,851 2,145 Amortization and impairment of intangible assets 991 1,011 444 119 16 Stock-based compensation(1) 1,281 483 112 1 188 Total operating expenses 23,416 22,023 16,852 4,097 4,769 Income (loss) from operations (16,946 ) (10,847 ) (284 ) (602 ) 79 Other income (expense), net (2,965 ) (1,925 ) (1,396 ) (325 ) (345 ) Net loss $ (19,911 ) $ (12,772 ) $ (1,680 ) $ (927 ) $ (266 ) Net loss applicable to common stockholders $ (20,041 ) $ (13,037 ) $ (2,006 ) $ (1,012 ) $ (354 ) Basic and diluted net loss per share(2): Historical $ (3,146.16 ) $ (1,432.31 ) $ (127.62 ) $ (74.63 ) $ (10.88 ) Pro forma (unaudited) $ (0.13 ) $ (0.02 )
Shares used to compute basic and diluted net loss per share(2):
Historical 6 9 16 14 33 Pro forma (unaudited) 12,460 12,477
As of March 31, 2004 Actual As Adjusted(3) (In thousands)
(unaudited)Balance sheet data: Cash and cash equivalents $ 8,902 $ 64,030 Working capital 829 65,956 Total assets 38,012 93,140 Total debt 15,841 6,169 Redeemable convertible preferred stock 84,367 — Total stockholders' equity (deficit) (75,709 ) 73,458
- (1)
- Please see our consolidated statement of operations on page F-4 and Note 1 to our consolidated financial statements for additional information
under "Selected historical financial and operating data" and "Management's discussion and analysis of financial condition and results of operations."
SIX MONTHS ENDED YEARS ENDED DECEMBER 31, JUNE 30, STATEMENT OF OPERATIONS DATA: ------------------------------------ ---------------------- 1998 1999 2000 2000 2001 (In thousands, except per share and selected operating data) - ------------------------------------------------------------------------------------------------------------------------Revenues: Products........................................ $ 340 $ 284 $ 5,815 $ 1,456 $ 9,802 Imaging services................................ -- -- 1,260 -- 4,217 Licensing and other............................. 1,581 -- -- -- -- ------- -------- -------- ------- ------- Total revenues................................ 1,921 284 7,075 1,456 14,019 Cost of revenues: Products........................................ 388 265 9,834 3,602 6,438 Imaging services................................ -- -- 839 -- 3,394 ------- -------- -------- ------- ------- Total cost of revenues........................ 388 265 10,673 3,602 9,832 ------- -------- -------- ------- ------- Gross profit (loss)............................... 1,533 19 (3,598) (2,146) 4,187 Operating expenses: Research and development........................ 5,426 10,063 2,372 1,083 1,327 Sales and marketing............................. 623 1,455 3,586 1,291 4,028 General and administrative...................... 2,533 1,967 2,878 1,072 2,899 Amortization of intangible assets............... -- -- 209 3 315 Stock-based compensation........................ -- -- 296 -- 1,063 ------- -------- -------- ------- ------- Total operating expenses...................... 8,582 13,485 9,341 3,449 9,632 ------- -------- -------- ------- ------- Loss from operations.............................. (7,049) (13,466) (12,939) (5,595) (5,445) Other income (expense), net....................... 857 274 (537) (97) (401) ------- -------- -------- ------- ------- Net loss.......................................... $(6,192) $(13,192) $(13,476) $(5,692) $(5,846) ======= ======== ======== ======= ======= Net loss applicable to common stockholders........ $(6,192) $(13,192) $(13,524) $(5,692) $(5,902) ======= ======== ======== ======= ======= Basic and diluted net loss per share(1)........... $ (1.87) $ (3.90) $ (3.61) $ (1.65) $ (1.35) ======= ======== ======== ======= ======= Shares used to compute basic and diluted net loss per share(1).................................... 3,306 3,381 3,745 3,455 4,366 ======= ======== ======== ======= ======= SELECTED OPERATING DATA: Product sales Number of gamma cameras sold to third parties... -- -- 23 6 36 Imaging services Number of imaging procedures performed.......... -- -- * -- 6,953
AS OF JUNE 30, 2001 ----------------------------------------- BALANCE SHEET DATA: PRO FORMA AS ACTUAL PRO FORMA(2) ADJUSTED(3) - -------------------------------------------------------------------------------------------------------Cash and cash equivalents................................... $ 3,510 11,920 Working capital............................................. $ 4,504 12,914 Total assets................................................ $ 28,557 36,967 Long-term debt.............................................. $ 5,811 5,811 Redeemable convertible preferred stock...................... $ 58,109 -- Total stockholders' equity (deficit)........................ $(48,111) 18,408- ------------ (1)on stock-based compensation.- (2)
- Please see Note 1 to our consolidated financial statements for an explanation of the method used to calculate the historical and pro forma net loss per share and the number of shares used in the computation of per share amounts.
(2)- (3)
- The
pro formaas adjusted column in the balance sheet datagive effect to the sale of 2,618,462 shares of Series F preferred stock in August 2001 andreflects the automatic conversion of allsharesof our preferred stock outstanding as ofAugust 23, 2001March 31, 2004 into29,748,03012,444,294 shares of our common stock in connection with thisoffering. (3) The pro forma as adjusted balance sheet data give effect tooffering, the sale of 5,500,000 shares of our common stockin this offeringat an assumed initial public offering price of$$13.00 per share, the mid-point of the range on the cover of this prospectus, after deducting the estimated underwriting discounts and commission and theapplicationestimated expenses payable by us in connection with this offering, and the repayment of $9.7 million due under our short-term lines of credit and notes payable.An investment in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below, together with all of the
net proceeds to repay a portionother information included in this prospectus, including the consolidated financial statements and the related notes appearing elsewhere in this prospectus, before making an investment decision. If any of the following risks actually occurs, our business, financial condition, results of operations and future prospects would likely be materially and adversely affected. In that event, the market price of ouroutstanding indebtedness. * Not available becausecommon stock could decline and you could lose all or part of your investment.Risks Related to Our Business and Industry
If our imaging systems and DIS services are not accepted by physicians or hospitals, we may be unable to develop a sustainable, profitable business.
We expect that substantially all of our revenue in the
methodology for trackingforeseeable future will be derived from sales of our products in thenumber of procedures performed in 2000 under acquired customer contracts was not consistent withnuclear imaging market and ourcurrent methodology. 5- -------------------------------------------------------------------------------- Risk factors IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, THE FOLLOWING RISK FACTORS SHOULD BE CAREFULLY CONSIDERED IN EVALUATING US AND OUR BUSINESS BEFORE PURCHASING ANY OF THE COMMON STOCK BEING OFFERED. INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK AND SHOULD BE REGARDED AS SPECULATIVE. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS COULD BE MATERIALLY HARMED, OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY AND ADVERSELY AFFECTED, AND THE MARKET PRICE OF OUR COMMON STOCK COULD DECLINE AND YOU COULD LOSE ALL OR A PART OF YOUR INVESTMENT. THE CAUTIONARY STATEMENTS MADE IN THIS PROSPECTUS SHOULD BE READ AS BEING APPLICABLE TO ALL RELATED FORWARD-LOOKING STATEMENTS WHEREVER THEY APPEAR IN THIS PROSPECTUS. RISKS RELATING TO OUR BUSINESS IF OUR SOLID-STATE, DIGITAL GAMMA CAMERA AND NUCLEAR IMAGING SERVICES ARE NOT ACCEPTED BY PHYSICIANS OR OTHER HEALTHCARE PROVIDERS, WE MAY BE UNABLE TO ACHIEVE PROFITABILITY.leasing services offered through our wholly owned subsidiaries, Digirad Imaging Solutions, Inc. and Digirad Imaging Systems, Inc., which we refer to collectively as DIS. Our solid-statedigitalgammacamera technologiescameras and DIS services represent a new approach in the nuclear imagingmarketmarket. We began full commercial release of our imaging systems in March 2000 and established DIS in September 2000. Because of the recent commercial introduction of our nuclear imaging systems, we havesoldlimited product and brand recognition and our imaging systems have been used by a limited number of physicians and hospitals. Physicians and hospitals may generally be slow to adopt our productsonly in limited quantities.and leasing services for a number of reasons, including:
- •
- perceived liability risks generally associated with the use of new technologies for nuclear imaging;
- •
- availability of reimbursement from health care payors for procedures using our system;
- •
- lack of experience with our products and services;
- •
- costs associated with the purchase or lease of our products and services;
- •
- the presence of competing products sold by companies with longer operating histories, more recognizable names and more established distribution networks;
- •
- the introduction or existence of competing products and services or technologies that may be more effective, easier to use or that produce better images; and
- •
- physician and hospital perceptions of our imaging systems as compared to those of competitors.
Our success in
thisthe nuclear imaging market depends on whetherpotential customersphysicians and hospitals view ournew technologyimaging systems and DIS services as effective and economically beneficial. Wedobelieve that physicians and hospitals will notknow the rate at which physicians or other healthcare providers willadopt ourproductsimaging systems orimaginglease our DIS servicesif at all, or the rate at whichunless theywill purchase them in the future, if at all. There can be no assurances that we can attract future customersdetermine, based onacceptable terms that will enable us to develop a sustainable, profitable business. If third-party payors do not accept our products and imaging services or deny adequate payment to physiciansexperience and otherhealthcare providers, usingfactors, that our imaging systems and DIS services are an attractive alternative to vacuum tube imaging systems. We also believe that recommendations and support of our products and services by influential physicians and other health care providers are essential for market acceptance and adoption. We cannot assure you that physicians or hospitals will adopt or accept our imaging systems or DIS services. If physicians and hospitals do not adopt our imaging systems or DIS services, our operating results and business will be harmed.We sell our imaging systems and provide our services in a highly competitive industry, and we often compete against large, well-established competitors that have significantly greater financial resources than we have.
The medical device industry, including the market for imaging systems and services, is highly competitive, subject to rapid change and significantly affected by new product introductions and market activities of other industry participants. Our primary competitors with respect to imaging systems include several large medical device manufacturers, including Philips Medical Systems, General Electric Healthcare, Siemens Medical Systems and Toshiba Medical Systems. All of these competitors offer a full line of imaging cameras for each diagnostic imaging technology, including x-ray, magnetic resonance
imaging, computerized tomography, ultrasound and nuclear medicine. The existing imaging systems sold by our competitors have been in use for a longer time than our products and are more widely recognized and used by physicians and hospitals for nuclear imaging. Many of our competitors and potential competitors enjoy significant competitive advantages over us, including:
- •
- significantly greater name recognition and financial, technical and marketing resources;
- •
- established relationships with healthcare professionals, customers and third-party payors;
- •
- established distribution networks;
- •
- additional lines of products and the ability to offer rebates or bundle products to offer discounts or incentives; and
- •
- greater resources for product development, sales and marketing.
The competitive nature of the nuclear imaging industry has had an impact on the price of our dual-head gamma cameras. For example, for the three months ended March 31, 2004 we experienced a moderate decline in the selling price for our dual-head gamma cameras when compared to the three months period ended March 31, 2003. While we anticipate demand for our dual-head gamma cameras to continue to increase, we believe these pricing pressures will continue to impact our gamma camera product revenue and gross profit.
In providing comprehensive mobile nuclear imaging solutions, we generally compete against small businesses employing traditional vacuum tube cameras that must be transported in large vehicles and cannot be moved in and out of physician offices.
We are aware of certain major medical device companies that are attempting to develop solid-state cameras and we believe these efforts will continue. In addition, we are aware of a privately-held company, Gamma Medica, which is currently marketing a solid-state gamma camera for breast imaging. We do not believe that this camera can be used in a cardiac application. However, we cannot assure you that Gamma Medica will not attempt to modify its existing camera for use in the cardiac segment in the future, or develop another gamma camera for cardiac applications. Because of the size of the potential market, we anticipate that companies will dedicate significant resources to developing competing products and services. Current or future competitors may develop technologies and products that demonstrate better image quality, ease of use or mobility than our imaging systems. Our ability to compete successfully will depend on our ability to develop proprietary products that reach the market in a timely manner, receive adequate reimbursement and are less expensive than alternatives available for the same purpose. If we are unable to compete effectively against our existing and future competitors our sales will decline and our business will be harmed.
Changes in domestic and international legislation, regulation, or coverage and reimbursement policies of third-party payors may adversely impact our ability to market and sell our products and services.
Physicians and hospitals purchasing and using our products rely on adequate third-party payor coverage and reimbursement to maintain their operations. Changes in domestic and international legislation, regulation or coverage and reimbursement policies of third-party payors may adversely affect
acceptancethe demand for our existing and future products and services and may limit our ability to market and sell our products and services on a profitable basis. For example, on December 8, 2003, President Bush signed into law the Medicare Prescription Drug, Improvement and Modernization Act ofour products. Acceptance2003, or the Medicare Modernization Act, which contains a wide variety of changes that impact Medicare reimbursement to physicians and hospitals. We cannot predict what additional changes will be made to such legislation, regulation, or coverage and reimbursement policies, but we believe that future coverage and reimbursement may be subject to increased restrictions both in the United States and in international markets. Additionally, we cannot be certain that under prospective payment systems, or established fee schedule payment formulas, under which healthcare providers may be reimbursed a fixed amount based on the patient's condition or the type of procedure performed, the costs of our products and services will bejustified and incorporated into the overall payment for the procedure. Third-party payors continue to act to contain or reduce healthcare costs through various means, including the movement to managed care systems where healthcare providers contract to provide comprehensive healthcare for a fixed fee per patient. These continued efforts to reduce healthcare costs may result in third-party payors refusing to reimburse patients or healthcare providers for our imaging services
by physicians, including physicians who do not currently use cardiac imaging products, is essentialor allowing only specific providers toour success and may require us to overcome resistance to a new technology for cardiacprovide imaging services.Our failureAs a result, sales of our gamma cameras would suffer and we may receive pressure from our customers todo so may prevent us from selling sufficient quantitiesterminate or otherwise modify the lease arrangements for our DIS services. Under such circumstances, our business, financial condition and results of operations could be materially adversely affected.Because our imaging systems and DIS services are not widely diversified, a decrease in sales of our products and
imagingleasing servicesto be profitable. WE HAVE RECENTLY INTRODUCED OUR PRODUCT INTO THE MARKETPLACE AND MAY NOT SUCCEED OR BECOME PROFITABLE. We have not been profitable sincecould seriously harm ourinception. We have incurred substantial costs to develop, introducebusiness.Our current product and
enhanceleasing service offerings consist primarily of oursolid-state, digitalline of gammacamera. Ascameras, including our Cardius-1, Cardius-2, 2020tc Imager and SPECTpak PLUS camera systems, each ofJune 30, 2001, we had an accumulated deficit of approximately $51.0 million. We shipped our first product in March 2000. We expect to incur substantial additional expenses in the future as we continue to conduct research and development efforts on newer generation products and increase sales and marketing efforts on our recently released first generation products. Furthermore, planned expansion of operations and expansionwhich is used in the nuclear imaging market segment and all of which utilize the same solid-state technology. In addition, we offer a mobile imaging leasing service through DIS, which includes an imaging system, certified personnel, required licensure and other support for nuclear imaging procedures. As such, our line of products and servicesmarket will result in significant expenses over the next several years that mayis notbe offset by significant revenues. We expect that a majorityas diversified as those of some of ourrevenuescompetitors. Consequently, if sales of our products or leasing services decline precipitously, our business would be seriously harmed, and it would likely be difficult for us to recover because we do not have thenear termbreadth of products or services that would enable us to sustain our business while seeking to develop new types of products or services or other markets for our existing products and services. In addition, because ourabilitytechnical know-how and intellectual property have limited applications, we may be unable toachieve profitability will depend uponleverage ourabilitytechnical know-how and intellectual property tosuccessfully marketdiversify oursolid-state, digital gamma cameraproducts andour successful expansion intoservices or to develop other products or sources of revenue outside of the nuclear imaging market.Our imaging systems and DIS services
market. We will need to begin generating significant revenues to achieve profitability. Due to our limited operating history, it is difficult to predict when, if ever, we will be profitable and to evaluate our business or prospects. Our business strategies, including our expansion in the nuclear imaging services market,maynot be successfulbecome obsolete, and we may not beprofitable in any future period. Evenable to timely develop new products, product enhancements or services that will be accepted by the market.Our nuclear imaging system and DIS services may become obsolete or unmarketable if
we do become profitable, weother products or services utilizing new technologies are introduced by our competitors or new industry standards emerge. We cannotensure investorsassure you that wecan sustainwill be able to successfully develop orincrease - -------------------------------------------------------------------------------- 6RISK FACTORS - -------------------------------------------------------------------------------- profitability on a quarterlymarket new products and services, orannual basis inenhancements to our existing products, or that our future products and enhancements will be accepted by our current or potential customers or thefuture. Ifthird-party payors who financially support many of the procedures performed with ourrevenues grow more slowly than anticipated, or if our operating expenses exceed our expectations,products. Any of these circumstances may cause us to lose customers, disrupt our businesswill be adversely affected. You should consideroperations and harm ourbusiness and prospects in light of the risks and uncertainties encountered by new technology companies in evaluating whether to invest in our common stock. WE MAY NOT HAVE THE RESOURCES REQUIRED TO SUCCESSFULLY COMPETE IN OUR HIGHLY COMPETITIVE INDUSTRY, WHICH MAY MAKE IT DIFFICULT TO PENETRATE THE PRODUCT AND SERVICES MARKETS. The existing market for nuclear imaging products, including cardiac imaging, is well established and intensely competitive. In addition, we are seeking to develop new markets for our solid-state, digital gamma camera products. In particular, we are working aggressively to further develop the mobile cardiac imaging services market. Our failure to diversify our revenue streams by successfully increasing bothproduct sales andmobile imagingservices. To be successful, we will need to enhance our products or servicescouldand to design, develop and market new products that successfully respond to competitive developments, all of which may be expensive and time consuming.The success of any new product offering or enhancement to an existing product will depend on several factors, including our ability to:
- •
- properly identify and anticipate physician and patient needs;
- •
- develop new products or enhancements in a timely manner;
- •
- obtain the necessary regulatory approvals or clearances for new products or product enhancements in a timely manner;
- •
- provide adequate training to users of our products;
- •
- price our products competitively;
- •
- obtain appropriate coverage and receive adequate reimbursement notifications and respond to them in a commercially viable way;
- •
- comply with changing or new regulatory requirements; and
- •
- develop an effective marketing, sales and distribution network.
If we do not develop and obtain regulatory approvals or clearances for new products, services or product enhancements in time to meet market demand, or if there is insufficient demand for these products, services or enhancements, our business, financial condition and results of operations will likely suffer. In addition, even if our customers acquire new products, services or product enhancements we may offer, the revenues from any such products, services or enhancements may not be sufficient to offset the significant costs associated with offering such products, services or enhancements to customers. In addition, any announcements of new products, services or enhancements may cause
significant volatilitycustomers to decline or cancel their purchasing decisions in anticipation of such products, services or enhancements.If we experience problems with the technologies used in our
overall results. Competitive pressure may make it difficult forimaging systems or if delivery of our DIS services are delayed, public perception of us could be harmed and cause us toacquire and retainlose customers andmay require us to reduce the price of our products and imaging services.revenue.Our
primary competitors have better name recognition, significantly greater financial resources and existing relationships with some of our potential customers, among other competitive advantages. Our competitors may be able to use their existing relationships to discourage customers from purchasing our products and imaging services. We expect competition to increase as potential and existing competitors begin to enter these new markets or modify their existing products and services to compete directly with ours. In addition, our competitors may be able to devote greater resources to the development, promotion and sale of new or existing products and services, thereby allowing them to respond more quickly to new or emerging technologies and changes in customer requirements. OUR PUBLIC PERCEPTION COULD BE HARMED IF WE EXPERIENCE TECHNICAL PROBLEMS WITH THE NEW TECHNOLOGIES USED IN OUR CAMERAS OR IF SHIPMENTS OF OUR PRODUCTS ARE DELAYED, WHICH WOULD CAUSE US TO LOSE CUSTOMERS AND REVENUES. Our solid-state, digitalgammacamera technologiescameras have only recently been introduced into the marketplace.As these technologiesMost of our cameras currently in use areincreasingly used by more customers,less than three years old. We have experienced some reliability issues with a prior version of our detector heads. In July 2003, we began selling most of our gamma cameras with a new version of our detector heads that we believe offers increased reliability. In addition, as the period of use of our cameras increases, other significant defects mayemerge. In addition, ifoccur. If significant defects do arise with our gamma cameras, our reputation among physicians and hospitals could be damaged.Additionally, physicians rely on our DIS services to provide nuclear imaging procedures to their patients on the dates and at the times they have requested. Many factors could prevent us from delivering our DIS services on a timely basis, including weather and the availability of staffing, transportation and necessary supplies. If we are
perceived as being difficultunable touseprovide physicians orcausing discomfort to patients,hospitals ourpublic image may be impaired. Public perception may also be impaired if we fail to deliver our productsDIS services in a timely and effective manner, our reputation among physicians and hospitals could be damaged.The performance and reliability of our products and services are critical to our reputation and to our ability to achieve market acceptance of those products and services. Widespread or other failures of our cameras and other products to consistently meet the expectations of purchasers or customers that use our DIS services could adversely affect our reputation, our ability to provide our DIS services, our relations with current customers and our business operations. Such failures could also reduce the attractiveness of our products and services to potential customers. Equipment failures could result from any number of causes, including equipment aging, ordinary wear and tear due to
difficulties with our suppliersregular transportation andvendorsrelocation, failure to perform routine maintenance and latent hardware ordue to our inability to efficiently manufacture and assemble products. A tarnished reputation could result in a loss of customers and revenues even after any quality or delivery problems are resolved. Additionally, we expect that problems or perceived problems with our products could adversely impact the commercial success of our imaging services component. WE MAY EXPERIENCE SIGNIFICANT FLUCTUATIONS IN OUR QUARTERLY RESULTS. Our future operating results will depend on numerous factors, manysoftware defects of which wedo not control. Changes in anyare unaware. Such failures, whether actual orallperceived, could adversely affect our business even if we correct the underlying problems.Our manufacturing operations are highly dependent upon third-party suppliers, making us vulnerable to supply problems and price fluctuations, which could harm our business.
We rely on a limited number of
these factors could cause our operating resultsthird parties tofluctuatemanufacture andincrease the volatilitysupply certain of themarket pricekey components of ourcommon stock. Someproducts. While many ofthese factors include: - - demand forthe components used in our products are available from multiple sources, we obtain some components from single sources. For example, key components of the detector heads and the acquisition and control software utilized in ourability to meet such demand; - - productgamma cameras are manufactured or supplied by a single source. To be successful, our contract manufacturers andprice competition; - - changes insuppliers must provide us with thecosts of components; - -------------------------------------------------------------------------------- 7RISK FACTORS - -------------------------------------------------------------------------------- - - successcomponents of oursalessystems in requisite quantities, in compliance with regulatory requirements, in accordance with agreed-upon specifications, at acceptable cost anddistribution channels; - - successful development and commercialization of new and enhanced productson a timelybasis; - - timingbasis. Segami Corporation, or Segami, has developed image acquisition and processing software for our camera under a non-exclusive license agreement. In the event that Segami attempts to terminate the license agreement, refuses to extend the term ofsignificant orders and shipments; - - timing of and possible delaythe license or seeks to impose unreasonable pricing or terms, we would have to find an alternative software system to use in ourreceiving approval for necessary regulatory licenses; - - timinggamma camera. Our reliance on these outside suppliers subjects us to a number ofnew product introductions and product enhancements by usrisks that could harm our business, including:
- •
- suppliers may make errors in manufacturing components that could adversely affect the efficacy or
our competitors; and - - timing and magnitudesafety of ourexpenditures. Accordingly, we believe that quarterly sales and operating results may vary significantlyproducts or cause delays inthe future and that period-to-period comparisonsshipment of ourresults of operations are not necessarily meaningful and should not be relied upon as indicators of future performance. We cannot assure you that our sales will increase or be sustained in future periods or thatproducts;
- •
- we
will be profitable in any future period. In addition, we experience seasonality in the service of our DIS customers. For example, our study volumes typically decline from our second fiscal quarter to our third fiscal quarter due to summer holidays and vacation schedules. We may also experience declining study volumes in December due to holidays and in the first quarter due to weather conditions in certain parts of the country. These seasonal factors may lead to fluctuations in our quarterly operating results. It is difficult for us to evaluate the degree to which the summer slowdown, winter holiday variations and weather conditions may make our revenues unpredictable in the future. Wemay not be able toreduceobtain adequate supply in a timely manner or on commercially reasonable terms;- •
- we may have difficulty locating and qualifying alternative suppliers for our
expenses, including our debt service obligations, quickly enoughcomponents;- •
- once we identify alternative suppliers, we could experience significant delays in production due to
respondthe need tothese declines in revenue, which would make our business difficultevaluate and test the products delivered by alternative suppliers and tooperate and would harm our financial results. If this happens, the priceobtain regulatory qualification for them;- •
- we are not a major customer of many of our
common stocksuppliers, and these suppliers maydecline. OUR RELIANCE ON A LIMITED NUMBER OF CUSTOMERS MAY CAUSE OUR SALES TO BE VOLATILE. We currently havetherefore give other customers' needs higher priority than ours;- •
- we use some suppliers that are small, privately-held companies, and these suppliers could encounter financial or other difficulties that could cause them to modify or discontinue their operations at any time;
- •
- our suppliers manufacture products for a
small numberrange of customers,whom we typically bill afterand fluctuations in demand for thedeliveryproducts those suppliers manufacture for others may affect their ability to deliver components to us in a timely manner; and- •
- our suppliers may encounter financial hardships unrelated to our demand for components, which could inhibit their ability to fulfill our orders and meet our requirements.
Any interruption or delay in the supply of components or materials, or our inability to obtain components or materials from alternate sources at acceptable prices in a timely manner, could impair our ability to meet the demand of our
productscustomers andimaging services. As of June 30, 2001, we had receivedcause them to cancel ordersfor 117 cameras, 58 of which have not yet been delivered and paid for, and we had signed contracts with 101 customersor switch touse our mobile imaging services. If these orders were to be cancelled, or our imaging service customers stopped using our service or do not renew their service agreements with us, our business would be harmed. Furthermore, in view of this small customer base, our failure to gain additional customers, the loss of any current customers or a significant reduction in the level of imaging services provided to any one customercompetitive procedures. These events could harm our businessfinancial conditionandresults of operations. THE SALES CYCLE FOR OUR PRODUCTS IS TYPICALLY LENGTHY, CAUSING SIGNIFICANT FLUCTUATIONS IN OUR REVENUE. Ouroperating results.We have limited marketing, sales and distribution capabilities, and our efforts
for our camerasin those areas are dependent in part onthe capital expenditures budgets ofthird parties.We began commercial production and shipped our
potential customers. Often our potential customers require a significant amount of time to plan for major purchases, such as our camera. We may expend substantial fundsfirst imaging products in 2000, andmanagement effort long before we actually selltherefore have limited experience in marketing, selling and distributing our products andwith no assurance thatservices. Additionally, while wewill ultimately be successful. Even if we are successful in such sales, a long sales cycle makes it more difficult for us to accurately evaluate and predict our sales and operating performance. Our revenues may fluctuate significantly from quarter to quarter and any shortfalls from estimates expected by securities or industry analysts couldhavean immediate and significant adverse effect on our stock price. - -------------------------------------------------------------------------------- 8RISK FACTORS - -------------------------------------------------------------------------------- WE CURRENTLY MANUFACTURE OUR PRODUCTS IN LIMITED QUANTITIES AND HAVE LIMITED SALES AND DISTRIBUTION CAPABILITIES. We currently manufacture our products in limited quantities, and to become profitable, we must manufacture our products in greater quantities. As we expand production, we may encounter difficulties in obtaining adequate supplies of components, additional employees and maintaining the high quality of our products. We may be unable to expand production and accomplish these objectives without incurring substantially increased costs, which may reduce our ability to become profitable or reduce our profitability. We have establisheda direct sales teamanfocused on domestic marketing, sales and distribution, we also use four independentdistributor networkdistributors in the United States andCanada,two independent, international sales distributors to market, sell anda corporate partner in Japan to selldistribute our products and services. As a result, we are dependent in part upon the marketing, sales and distribution efforts of our third-party distributors. To date, one of our domestic third-party distributors is permitted to market, sell and distribute competing imaging servicesboth domesticallyandinternationally.products. Additionally, one of our domestic third-party distributors, as well as one of our international distributors, is generally permitted to market, sell and distribute competing imaging products that are used or refurbished and meet specified age requirements. Our other international distributor is prohibited from promoting or distributing any other gamma camera product, but is not prohibited from offering competing services.Our future revenue growth will depend in large part on our success in maintaining and expanding
theseour marketing, sales and distribution channels, whichmaywill likely be an expensive and time-consuming process. We are highly dependent upon the efforts oftalentedour salesemployees in increasingforce and third-party distributors to increase our revenue. We face intense competition for qualified sales employees and may be unable toattracthire, train, manage and retain such personnel, whichwouldcould adversely affect our ability to maintain and expand our marketing, sales andmaintaindistribution network, which would negatively affect ourdistribution network.ability to compete effectively as a distributor of nuclear imaging devices. Additionally, even if we are able to expand our sales force and enter into agreements with additional third-party distributors on commercially reasonable terms, they may not commit the necessary resources to effectively market, sell and distribute our products and services domestically and internationally. If we are unable toexpandmaintain andmaintainexpand our direct and third-party marketing, salesteam orand distributionnetwork,networks, we may be unable to sell enough of our products and imaging services for our business to beprofitable. WE MAY BE HARMED BY HIGHER ENERGY COSTS AND INTERRUPTED POWER SUPPLIES RESULTING FROM THE ELECTRICAL POWER SHORTAGES CURRENTLY AFFECTING CALIFORNIA. Our corporate headquartersprofitable and our financial condition and results of operations will likely suffer accordingly.If we are unable to successfully operate and manage our manufacturing operations at our new facility, we may experience a decrease in sales.
We recently completed the transition of our manufacturing operations from several separate facilities to a single facility. As we scale-up operations at our new facility, we may encounter unforeseen circumstances, including:
- •
- inability to obtain critical equipment on a timely basis;
- •
- failure to obtain necessary regulatory approvals or operating permits in a timely fashion, if at all;
- •
- shortages of qualified personnel to operate equipment and manage manufacturing operations;
- •
- shortages of key raw materials or component inputs to the manufacturing process; and
- •
- difficulties associated with moving from smaller-scale production to higher volumes.
In addition, we may also experience difficulties in producing sufficient quantities or quality of products or in achieving sufficient quality and manufacturing
facilitiesyield levels. If we are unable to successfully operate and manage our manufacturing operations at our new facility or otherwise fail to meet our manufacturing needs, we may not be able to provide our customers with the quantity or quality of products they require, and we could lose customers and suffer reduced revenues.We are subject to the financial risks associated with providing services through our DIS business.
There are numerous risks associated with any leasing arrangement, including the possibility that physicians may fail to make the required payments under the terms and provisions of their lease commitments. Our DIS business is also affected by the ability of physicians to pay us, which in turn may be affected by general economic and business conditions and the availability of reimbursement for the physicians. Such circumstances could adversely affect our business and financial condition.
If we are unable to expand our DIS business, our business could be materially harmed.
We plan to grow our DIS business by expanding into several new states, adding new hub locations in states in which we currently operate and increasing hub utilization by adding physician customers and routes. As we undertake this expansion, we will need to hire, train and retain qualified personnel. We cannot assure you that physicians or hospitals in these new markets will accept our imaging products or services. Our expansion into additional domestic markets is subject to inherent risk, including the burden of complying with applicable state regulations, including but not limited to regulations concerning the use, storage, handling and disposal of radioactive materials, the difficulties in obtaining the necessary radioactive licensures and difficulties in staffing and managing operations. Furthermore, physician self-referral laws currently in effect in the State of New York do not allow the conduct of our DIS business as it is currently structured or at all, and we may find the laws of other states in which we do not currently operate to require us to change the structure of our DIS business to operate in such states.
A loss of key executives or failure to attract qualified managers, engineers and imaging technologists could limit our growth and adversely affect our business.
Our success is dependent on the efforts of our key technical, sales and managerial personnel and our ability to retain them, particularly David M. Sheehan, Paul J. Early, Herb Bellucci, Todd P. Clyde, Richard Conwell and Vera P. Pardee. The loss of any one or more of these individuals could place a significant strain on our remaining management team and we may have difficulty replacing any of these individuals. Furthermore, our future growth will depend in part upon our ability to identify, hire and retain additional key personnel, including nuclear imaging technologists, paramedics, nurses, radiation safety officers, engineers, management, sales personnel and other highly skilled personnel. Hiring qualified management and technical personnel will be difficult due to the limited number of qualified candidates. Competition for these types of employees, particularly nuclear imaging technologists and engineers, is intense in the medical imaging field. Given the competition for such qualified personnel, we cannot assure you that we
will be able to continue to attract, hire and retain the personnel necessary to maintain and develop our business. Failure to attract, hire and retain key personnel could have an adverse effect on our business, financial condition and results of operations. We do not have any employment agreements with, or key person insurance on, any of our employees.
If we choose to acquire new or complementary businesses, products or technologies instead of developing them ourselves, we may be unable to complete those acquisitions or to successfully integrate them in a cost-effective and non-disruptive manner.
Our success depends on our ability to continually enhance and broaden our product and service offerings in response to changing customer demands, competitive pressures and technologies. While we have no current plans or commitments regarding any acquisitions of new or complementary businesses, products or technologies, we may in the future choose to pursue such acquisitions instead of developing those businesses, products or technologies ourselves. We cannot assure you, however, that we would be able to successfully complete any acquisition we choose to pursue, or that we would be able to successfully integrate any acquired business, product or technology into our company in a cost-effective and non-disruptive manner. Furthermore, there is no certainty that we would be able to attract, hire or retain key employees associated with any acquired businesses, products or technologies.
Integrating any acquired businesses, products or technologies could be expensive and time consuming, disrupt our ongoing business and divert the attention and resources of our management. If we are unable to integrate any acquired businesses, products or technologies effectively, our business will likely suffer. Additionally, any amortization of assets or charges resulting from the costs of acquisitions could harm our business and operating results.
We will face additional risks as we expand into international markets.
We have sales distributors for our imaging systems in Canada and Russia and are beginning to build an international sales organization. As we expand internationally, we will need to hire, train and retain qualified personnel in countries where language, cultural or regulatory impediments may exist. We cannot assure you that distributors, physicians or other involved parties in foreign markets will accept our nuclear imaging products, services and business practices. Our international operations will be subject to inherent risks, including:
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- costs of localizing product and service offerings for foreign markets;
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- difficulties in staffing and managing foreign operations;
- •
- reduced protection for intellectual property rights in some countries;
- •
- difficulties and delays in enforcing agreements and in collecting receivables through the legal systems of foreign countries;
- •
- fluctuating currency exchange rates;
- •
- the possibility that foreign countries may impose additional withholding taxes or otherwise tax our foreign income, impose tariffs or adopt other restrictions on foreign trade;
- •
- changes in political, regulatory, or economic conditions in a country or region;
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- our ability to obtain U.S. export licenses and other required export or import licenses or approvals;
- •
- burdens of complying with a wide variety of foreign laws, regulations specific to the delivery of and payment for healthcare services, regulations and licensing requirements relating to the use, storage, handling and disposal of radioactive materials, labor practices; and
- •
- conforming our business model to operate under government-run healthcare systems.
Our manufacturing operations and executive offices will be located at a single facility that may be at risk from fire, earthquakes or other natural or man-made disasters or crises.
Our manufacturing operations and executive offices are located at a single facility in Poway, California, near known fire areas and earthquake fault zones. This facility is located a short distance from the recent wildfires that destroyed many homes and businesses in San Diego County, California.
ElectricalWe have taken precautions to safeguard our facilities, including insurance and health and safety protocols. However, any future natural disaster, such as a fire or an earthquake, could cause substantial delays in our operations, damage to or destroy our manufacturing equipment or inventory, and cause us to incur additional expenses. A disaster could significantly harm our business and results of operations. The insurance we maintain against fires, earthquakes and other natural disasters may not be adequate to cover our losses in any particular case.Additionally, electrical power is vital to our operations and we rely on a continuous power supply to conduct our
operations.business. Californiaishas experienced significant electrical power shortages and price volatility in recent years, and such shortages and price volatility may occur in themidst of a power crisis and has recently experienced significant power shortages.future. In the event of an acute power shortage, the California system operator has on some occasions implemented, and may in the futurecontinue toimplement, rolling blackouts throughout California. If our energy costs substantially increase or blackouts interrupt our power supply frequently or for more than a few days, we may have to reduce or temporarily discontinue our normal operations. In addition, the cost of our research and development efforts may increase because of the disruption to our operations. Any such reduction or disruption of our operations at our facilities could harm our business.WE FACE RISKS IN OUR INTERNATIONAL MARKETS. As we expand internationally, we will needWe are exposed to
hire, trainrisks relating to product liability, product recalls, property damage andretain qualified personnel in countries where language, cultural or regulatory impediments may exist. We cannot assure you that vendors, physicians or other involved parties in foreign markets will accept our products, imaging servicespersonal injury for which insurance coverage is expensive, limited andbusiness practices. International revenues are subject to inherent risks, including: - - costs of localizing productpotentially inadequate, andservice offerings for foreign markets; - - difficulties in staffing and managing foreign operations; - - reduced protection for intellectual property rights in some countries; - - difficulties and delays in accounts receivable collection; - - fluctuating currency exchange rates; - - changes in regulatory requirements; - -------------------------------------------------------------------------------- 9RISK FACTORS - -------------------------------------------------------------------------------- - - burdens of complying with a wide variety of foreign laws and labor practices; and - - conformingour businessmodel to operate under government-run health care systems. WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH COULD CAUSE US TO LOSE THOSE RIGHTS OR SUBJECT US TO INCREASED COSTS. Our success and ability to compete depends on our licensed and internally-developed technology. If we are unable to protect our proprietary rights, we could face increased competition from our competitors or incur increased costs. We protect our proprietary technology through a combination of patent, copyright, trade secret and trademark law. We also enter into confidentiality or license agreements with our employees, consultants and corporate partners, and generally control access to, and the distribution of, our products, designs, documentation and other proprietary information. We cannot be sure that our pending patent applications will result in issued patents. In addition, our issued patents or pending applicationsmay bechallenged or circumventedimpacted byour competitors. Despite our effortsincreased insurance costs.Our operations entail a number of risks, including risks relating to
protect our intellectualproduct liability claims, product recalls, propertyrights, unauthorized parties may attemptdamage and personal injury. We currently maintain insurance that we believe is adequate with respect to the nature of the risks insured against, including product liability insurance, professional liability insurance, automobile insurance, property insurance, workers compensation insurance and general liability insurance. In many cases such insurance is expensive and difficult to obtain, anduse information or technologies, which we regard as proprietary. Policing unauthorized use of our intellectual property willno assurance can bedifficult and we cannot be certaingiven that we will be able toprevent misappropriation ofmaintain ourtechnology, particularly in countries where the laws may not protect our proprietary rights as fully as in the United States. OUR COMPETITORS MAY CLAIM OUR TECHNOLOGY OR PRODUCTS INFRINGE UPON THE TECHNOLOGY COVERED BY THEIR PATENTS OR PATENT APPLICATIONS, WHICH COULD RESULT IN THE LOSS OF OUR RIGHTS, SUBJECT US TO LIABILITY AND DIVERT MANAGEMENT'S ATTENTION. Many of our competitors in the nuclear imaging business hold issued patents and have filed,current insurance ormay file, patent applications. Any claims by our competitors that we are infringing their technology, with or without merit, could be time-consuming to defend, result in costly litigation, divert management's attention and resources, cause product shipment delays, require us to enter into royalty or licensing agreements, prevent us from manufacturing or selling some or all of our products, or result in our liability to one or more of these competitors. If a third party makes a successful claim of patent infringement against us, we may be unable to license the infringed or similar technology on acceptable terms, if at all, which may prevent us from manufacturing or selling our products. If we are forced to enter into license agreements for infringed technology, royalties paid under these agreements may increase our costs to manufacture our products. If we cannot raise the price of our products to recover royalties that we have paid without losing customers, our financial results would be negatively impacted. WE RELY SIGNIFICANTLY ON THIRD-PARTY VENDORS TO MANUFACTURE COMPONENTS FOR OUR SOLID-STATE, DIGITAL GAMMA CAMERAS, WHICH COULD RESULT IN DELIVERY DELAYS, LOSS OF CUSTOMERS AND LOSS OF REVENUES. We contract with a limited number of independent subcontractors to produce components that we use in the manufacture of our products. If a specialized vendor experiences difficulty in the production of the necessary components or in meeting our standards, we may have delays in the production of our products. Our vendors could experience financial, operational, production or quality assurance difficulties or a catastrophic event that reduces or interrupts delivery of components to us. Establishing alternative arrangements could take several months. If we are required to switch vendors, the manufacture and delivery of our products could be interrupted for an extended period of time and - -------------------------------------------------------------------------------- 10RISK FACTORS - -------------------------------------------------------------------------------- may cause the loss of both customers and revenue. Deliveries from our third-party vendors may also be delayed because of the potential inability of these vendors to meet high demand for their products from their other customers. We do not know that alternative subcontracting sources will be able to meet our future requirements or that alternative sources will be available to us at favorable prices, if at all. Our ability to manufacture and deliver products in a timely manner could be harmed if these vendors fail to maintain an adequate supply of these components. OUR PRODUCTS MAY BECOME OBSOLETE, WHICH COULD CAUSE US TO LOSE CUSTOMERS OR INCUR SUBSTANTIAL COSTS. Our products could become obsolete or unmarketable if other products utilizing new technologies are introduced by our competitors or new industry standards emerge. If we are unable to react to these events we may lose customers and revenues. To be successful, we will need to continually enhance our products and to design, develop and market new products that successfully respond to any competitive developments, all of which may be expensive or time consuming. Our failure to do so could have a material adverse effect on our business, financial condition and results of operations. LOSS OF KEY EXECUTIVES AND FAILURE TO ATTRACT QUALIFIED MANAGERS, ENGINEERS AND SALES PERSONS COULD LIMIT OUR GROWTH AND NEGATIVELY IMPACT OUR OPERATIONS. Our future performance is dependent on the efforts of our key technical, sales and managerial personnel and our ability to retain them, particularly R. Scott Huennekens, Gary J.G. Atkinson, Richard L. Conwell, Robert E. Johnson, David M. Sheehan and John F. Sheridan. Furthermore, our future success will depend in part upon our ability to identify, hire and retain additional key management and sales personnel, engineers and technicians. Given the intense competition for such qualified personnel, there can be no assurancethat we will be able tocontinueobtain or maintain comparable or additional insurance in the future on reasonable terms, if at all. Additionally, we may be negatively affected by increased costs of insurance, including workers compensation insurance. For example, in October 2003, the Governor of California signed a bill which, if it takes effect, will require California businesses with 50 or more employees either toattractpay at least 80% of the premiums for a basic individual health insurance package for each of its employees andretaintheir families, or to pay a fee into a state pool for thepersonnel necessarypurchase of health insurance for uninsured, low income workers.Risks Related to Our Financial Results and Need for Financing
We have incurred significant and recurring operating losses since our inception in 1985 and we expect to incur increased operating expenses in the near term.
We have incurred significant net losses since our inception in November 1985, including losses of approximately $19.9 million in 2001, $12.8 million in 2002, $1.7 million in 2003, and $927,000 and $266,000 for the three months ended March 31, 2003 and 2004, respectively. As of March 31, 2004 we had an accumulated deficit of $80.5 million. We expect to incur increased operating expenses in the near term as we, among other things:
- •
- expand our manufacturing operations and DIS business;
- •
- increase marketing, sales and distribution of our current products; and
- •
- conduct research and development to develop next-generation products and to enhance our
business. Failureexisting products.As a result of these activities, we may not be able to
attractachieve profitability. If our revenue grows more slowly than anticipated, or if our operating expenses exceed our expectations, our ability to achieve our development andretain key personnel could have an adverse effect onexpansion goals would be adversely affected.Our quarterly financial results are difficult to predict and are likely to fluctuate significantly from period to period because our business
financial conditionprospects are uncertain and due to the seasonality of our DIS leasing services business.Our revenue and results of
operations. We do not haveoperations at anyemployment agreements with anygiven time will be primarily based on the following factors, many ofour employees. We do not maintain key person insurance on any of our employees. IF WE BECOME SUBJECT TO PRODUCT LIABILITY OR WARRANTY CLAIMS, WE MAY EXPERIENCE REDUCED DEMAND FOR OUR PRODUCTS OR BE REQUIRED TO PAY DAMAGES THAT EXCEED OUR INSURANCE LIMITATIONS. The salewhich we cannot control:
- •
- physician, healthcare provider and
supportpatient acceptance of our productsentails the risk of product liability or warranty claims, such as those based on claims that the failure of oneand services;- •
- demand and pricing of our products
resultedand services;- •
- success and timing of new product offerings, acquisitions, licenses or other significant events by us or our competitors;
- •
- our ability to establish and maintain a productive manufacturing, marketing, sales and distribution force;
- •
- the ability of our suppliers to timely provide us with an adequate supply of necessary components;
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- timing and magnitude of our expenditures;
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- our ability to reduce our expenses, including our debt service obligations, quickly enough to respond to any declines in revenue;
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- regulatory approvals and legislative changes affecting the products we may offer or those of our competitors;
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- the effect of competing technological and market developments;
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- our addition or termination of research programs or funding support;
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- levels of third-party reimbursement for our products and services;
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- interruption in the manufacturing or distribution of our products and services; and
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- changes in our ability to obtain FDA approval or clearance for our products.
Furthermore, we have experienced seasonality in the leasing services offered by DIS. While our physicians are obligated to pay us for all lease days to which they have committed, our contracts permit some flexibility in scheduling when services are to be performed. This accounts for some of the seasonality of our DIS revenues. For example, our daily services have typically declined from our second fiscal quarter to our third fiscal quarter due to summer holidays and vacation schedules. We have also experienced declining daily services in December due to holidays and in our first quarter due to weather conditions in certain parts of the United States. We cannot predict with certainty the degree to which seasonal circumstances such as the summer slowdown, winter holiday variations and weather conditions may make our revenue unpredictable or lead to fluctuations in our quarterly operating results in the future.
In addition, due to the way that customers in our target markets allocate and spend their budgeted funds for acquisition of our products, a
misdiagnosis, amonglarge percentage of our sales of gamma cameras is booked at the end of each quarterly accounting period. As such, a sales delay of only a few days may significantly impact our quarter-to-quarter comparisons.For these reasons, we believe that quarterly sales and operating results may vary significantly in the future and that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indicators of future performance. We cannot assure you that our sales will
increase or be sustained in future periods. Accordingly, we may experience significant, unanticipated quarterly losses. Because of these and other
issues.factors, our operating results in one or more future quarters may fail to meet the expectations of securities analysts or investors, which could cause our stock price to decline significantly.Our reliance on a limited number of customers may cause our sales to be volatile.
We currently have a small number of customers, whom we typically bill after the delivery of our products and imaging services. If orders for our gamma cameras were to be cancelled, or our leasing service customers stopped using us or do not renew their lease agreements with us, our business would be adversely affected. Furthermore, in view of our small customer base, our failure to gain additional customers, the loss of any current customers or a significant reduction in the level of leasing services provided to any one customer could disrupt our business, harm our reputation and adversely affect our sales.
The
medical instrument industrysales cycle for our gamma cameras is typically lengthy, which may result ingeneral has been subjectsignificant fluctuations in our revenue.Our sales efforts for our gamma cameras are dependent on the capital expenditures budgets of the physicians and hospitals to which we market. Often physicians and hospitals require a significant
medical malpractice litigation.amount of lead time to plan for a major acquisition such as the purchase of our imaging systems. We mayincurspend substantial time, effort and expense long before we actually consummate a sale of our cameras and with no assurance that we will ultimately be successful in achieving any such sales. As a result, we may experience significantliabilityfluctuations in our revenues. Furthermore, evaluating and predicting our future sales and operating performance is difficult and may not be as accurate as it could be if we had shorter sales cycles.Our future capital needs are uncertain and we may need to raise additional funds in the
event offuture, and suchlitigation. Although we maintain product liability insurance, we cannot be sure that this coverage is adequate or that it will continue tofunds may not be available on acceptable terms, if at all.We
alsobelieve that the net proceeds from this offering, together with our current cash, cash equivalents and short-term investments, will be sufficient to meet our projected operating requirements for at least the next 12 months. Our capital requirements will depend on many factors, including:
- •
- the revenue generated by sales of our products and services;
- •
- the costs associated with expanding our manufacturing, marketing, sales and distribution efforts;
- •
- the rate of progress and cost of our research and development activities;
- •
- the costs of obtaining and maintaining FDA and other regulatory clearance of our products and products in development;
- •
- the costs of obtaining and maintaining radioactive materials licenses and radiation safety procedures;
- •
- the effects of competing technological and market developments;
- •
- the number and timing of acquisitions and other strategic transactions; and
- •
- the costs associated with our expansion, if any.
As a result of these factors, we may
face warranty exposure, which could adversely affectneed to raise additional funds, and we cannot be certain that such funds will be available to us on acceptable terms, if at all. Furthermore, if we issue equity or debt securities to raise additional funds, ouroperating results. Any unforeseen warranty exposureexisting stockholders may experience dilution and the new equity orinsufficient insurance coulddebt securities may have rights, preferences and privileges senior to those of our existing stockholders. In addition, if we raise additional funds through collaboration, licensing or other similar arrangements, it may be necessary to relinquish potentially valuable rights to our future products or proprietary technologies, or grant licenses on terms that are not favorable to us. If we cannot raise funds on acceptable terms, we may not be able to expand our operations, develop new products, take advantage of future opportunities or respond to competitive pressures or unanticipated customer requirements.Risks Related to Government Regulation
We must be licensed to handle and use hazardous materials and may be liable for contamination or other harm
our business, financial condition and results of operations. WE MUST BE LICENSED TO HANDLE AND USE HAZARDOUS MATERIALS AND MAY BE LIABLE FOR CONTAMINATION OR OTHER HARM CAUSED BY HAZARDOUS MATERIALS THAT WE USE.caused by hazardous materials that we use.We use hazardous and radioactive materials in our research and development and manufacturing processes,
andas well as in the provision of our imagingservicesservices. We are subject to federal, state andmust belocal regulations governing use, storage, handling and disposal of these materials and waste products. We are currently licensed to handle suchmaterials. We are - -------------------------------------------------------------------------------- 11RISK FACTORS - -------------------------------------------------------------------------------- currently licensedmaterials in all states in which we operate,andbut there can be no assurances that we will be able to retainthesethose licensesindefinitely.in the future. In addition, we must become licensed in all states in which we plan to expand. Obtainingthesethose additional licenses is an expensive and time consuming process, and in some cases we may not be able to obtainthesethose licenses at all.We are subject to federal, state and local regulation governing theAlthough we believe that our procedures for use, handling,
storagestoring anddisposaldisposing ofhazardous materials. Wethese materials comply with legally prescribed standards, we cannot completely eliminate the risk of contamination or injury resulting from hazardous materials and we may incur liability as a result of any such contamination or injury. In the event of an accident, we could be held liable for damages or penalized with fines, and the liability could exceed our resources and any applicable insurance.We have also incurred and may continue to incur expenses related to compliance with environmental laws. Such future expenses or liability could have a significant negative impact on our business, financial condition and results of operations. Further, we cannot assure you that the cost of complying with these laws and regulations will not materially increase
materiallyin the future.WE MAY NOT BE ABLE TO ACHIEVE THE EXPECTED BENEFITS FROM ANY FUTURE ACQUISITIONS WHICH WOULD ADVERSELY AFFECT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Although we have no current plans for acquisitions, if we decideCompliance with extensive product regulations could be expensive and time consuming, and any failure to
acquire any other business and cannot successfully integrate such future acquisitions, we may not realize anticipated operating advantages and cost savings. The integration of companies that have previously operated separately involves a number of risks, including: - - demands on management related to the increase in our size after an acquisition; - - the diversion of our management's attention from the management of daily operations to the integration of operations; - - difficulties in the assimilation and retention of employees; - - potential adverse effects on operating results; and - - challenges in retaining clients. Successful integration of operations will depend uponcomply with those regulations could harm our ability tomanage those operationssell andto eliminate redundant and excess costs. Because of difficulties in combining operations, we may not be able to achieve the cost savings and other related benefits that we would hope to achieve after the completion of these acquisitions which could harm our financial condition and results of operations. RISKS RELATED TO GOVERNMENT REGULATION WE AND OUR CUSTOMERS DEPEND ON PAYMENTS FROM GOVERNMENT HEALTHCARE PROGRAMS AND THIRD-PARTY PAYORS. ANY FUTURE REDUCTION IN THESE PAYMENTS COULD CAUSE US TO LOSE CUSTOMERS AND REVENUES. We expect that substantially all of our revenues in the foreseeable future will be derived from the sale of products or the providing of imaging services in the nuclear imaging market. Our imaging services model consists of two primary delivery options. Under our first option, which we refer to as "mixed billing," we provide the technical component of nuclear imaging services and bill either the physician or the patient's third party payor, such as Medicare. We also bill the patient for any copayment. The physician performs and bills for the technical component, such as the interpretation of the test. Under our second option, we lease cameras, related equipment and technical personnel to physicians on a turn-key basis so that they may deliver imaging services to their patients. The physician then bills globally for both the technical and professional component. When we refer to "imaging services" in this prospectus, we are referring both to our mixed billing option and our leasing services option. - -------------------------------------------------------------------------------- 12RISK FACTORS - -------------------------------------------------------------------------------- Our success in the foreseeable future depends directly upon the financial success of the customers who either buy our cameras or use our imaging services, and their continued demand formarket our products and imaging services.These customers generally rely on third-party payors, principally federal Medicare, and private health insurance plans, to pay for all or a portion of the cost of imaging procedures. We also rely on these third-party payors for payment of the technical services component provided as part of our Digirad Imaging Solutions imaging services. Some third-party payors, including some state Medicaid programs, currently do not cover our services, and it is possible that other payors will adopt coverage restrictions that adversely affect us in the future. We may be unable to sell our products or imaging services on a profitable basis if third-party payors deny coverage or reduce current levels of payment. Third-party payors continue to undertake efforts to contain or reduce healthcare costs through various means, including the movement to managed care systems where healthcare providers contract to provide comprehensive healthcare for a fixed fee per patient. These efforts to reduce healthcare costs may make third-party payors unwilling to reimburse patients or healthcare providers for our imaging services or allow only specific providers to provide imaging services, which would reduce demand for our imaging services, and in turn, our products as well. To the extent that such efforts adversely affect the business, financial conditions and profitability of our customers, our customers may be less able to afford our products and our imaging services, which may cause our sales to decrease. COMPLIANCE WITH EXTENSIVE PRODUCT REGULATIONS COULD BE EXPENSIVE AND TIME-CONSUMING AND ANY FAILURE TO COMPLY WITH THESE REGULATIONS COULD HARM OUR ABILITY TO SELL AND MARKET OUR PRODUCTS AND IMAGING SERVICES.U.S. and foreign regulatory agencies, including the
United States Food and Drug Administration, or theFDA,and comparable international agencies,govern the testing, marketing and registration of new medical devices or modifications to medical devices, in addition to regulating manufacturing practices, reporting, labeling andrecord keepingrecordkeeping procedures. The regulatory process makes it longer, harder and more costly to bring our products to market, and we cannot assure you that any of our future products will be approved. All of our planned services, products and manufacturing activities, as well as the manufacturing activities ofourthird-party medical device manufacturers who supply components to us, are subject tothis regulation. Wethese regulations. Generally, we andsuchour third-party manufacturers are or will be required to:- -
- •
- undergo rigorous inspections by domestic and international agencies;
- -- •
- obtain the prior approval of
thesethose agencies before we can market and sell our medical device products; and- -- •
- satisfy content and format requirements for all of our sales and promotional materials.
Compliance with the regulations of
thesethose agencies may delay or prevent us from introducing new or improved products, which could in turn affect our ability to achieve or maintaina profitable level of sales.profitability. We may be subject to sanctions, including monetary fines and criminal penalties, the temporary or permanent suspension of operations, product recalls and marketing restrictions, if we fail to comply with the laws and regulationspertainingapplicable to our business. Our third-party component manufacturers may also be subject to the same sanctions and, as a result, may be unable to supply components for our products. Any failure to retain governmental approvals that we currently hold or obtain additional similar approvals could prevent us from successfully marketing our products and technology and could harm our operating results. Furthermore, changes in the applicable governmental regulations could prevent further commercialization of our products and technologies and could harm our business.Even if regulatory approval or clearance of a product is granted, regulatory agencies could impose limitations on uses for which the product may be labeled and promoted. Further, for a marketed
- -------------------------------------------------------------------------------- 13RISK FACTORS - --------------------------------------------------------------------------------product,its manufacturer and manufacturing facilities are subject to periodic review and inspection. Later discovery of problems with a product, manufacturer or facility may result in restrictions on the product, manufacturer or facility, including withdrawal of the product from the market or other enforcement actions.
WE WILL SPEND CONSIDERABLE TIME AND MONEY COMPLYING WITH FEDERAL AND STATE REGULATIONS AND, IF WE ARE UNABLE TO FULLY COMPLY WITH SUCH REGULATIONS, WE COULD FACE SUBSTANTIAL PENALTIES.Our products are subject to reporting requirements and recalls even after receiving FDA clearance or approval, which could harm our reputation, business and financial results.
We are subject to medical device reporting regulations that require us to report to FDA or similar governmental bodies in other countries if our products cause or contribute to a death or serious injury or malfunction in a way that would be reasonably likely to contribute to death or serious injury if the malfunction were to recur. In addition, the FDA and similar governmental bodies in other countries have the authority to require the recall of our products in the event of material deficiencies or defects in design or manufacture. A government mandated or voluntary recall by us could occur as a result of component failures, manufacturing errors or design defects, including defects in labeling. Any recall would divert management attention and financial resources and harm our reputation with customers. A recall involving our product could harm the reputation of the product and our company and would be particularly harmful to our business and financial results.
If we fail to obtain, or are significantly delayed in obtaining, FDA clearances or approvals for future products or product enhancements, or if we fail to comply with FDA's Quality System Regulation, our ability to commercially market and distribute our products will suffer.
Our products are subject to rigorous regulation by the FDA, and numerous other federal, state and foreign governmental authorities. In the U.S., the FDA regulates virtually all aspects of a medical device's testing, manufacture, safety, labeling, storage, recordkeeping, reporting, promotion and distribution. Our failure to comply with those regulations could lead to the imposition of administrative or judicial sanctions, including injunctions, suspensions or the loss of regulatory approvals, product recalls, termination of distribution, or product seizures. In the most egregious cases, criminal sanctions or closure of our manufacturing facilities are possible. The process of obtaining regulatory approvals to market a medical device, particularly from the FDA, can be costly and time consuming, and there can be no assurance that such approvals will be granted on a timely basis, if at all. In particular unless exempt, the FDA permits commercial distribution of a new medical device only after the device has received 510(k) clearance or is the subject of an approved Premarket Approval Application, or PMA. The FDA will clear marketing of a medical device through the 510(k) process if it is demonstrated that the new product is substantially equivalent to other 510(k)-cleared products. The PMA approval process is more costly, lengthy and uncertain than the 510(k) clearance process, and must be supported by extensive data, including data from preclinical studies and human clinical trials. Because we cannot assure you that any new products we develop, or any product enhancements, will be subject to the shorter 510(k) clearance process, significant delays in the introduction of any new products or product enhancements may occur. There is no assurance that the FDA will not require a new product or product enhancement go through the lengthy and expensive PMA approval process. Further, pursuant to FDA regulations, we can only market our products for approved uses. If our products are used for purposes other than those approved by the FDA, the FDA could object to such off-label uses.
Our manufacturing processes and those of our third-party manufacturers are required to comply with the FDA's Quality System Regulation, which covers the design, testing, production processes, controls, quality assurance, labeling, packaging, storage and shipping of our devices. In addition, we must engage in extensive recordkeeping and reporting and must make available our manufacturing facility and records for periodic unscheduled inspections by federal, state and foreign agencies, including the FDA. Our or our third-party manufacturers' failure to pass a Quality System Regulation inspection or to comply with these and other applicable regulatory requirements could result in disruption of our operations and manufacturing delays, and a failure to take adequate corrective action could result in, among other things,
withdrawal of our medical device clearances, seizure or recall of our devices, or other civil or criminal enforcement actions.
Foreign governmental authorities that regulate the manufacture and sale of medical devices have become increasingly stringent and, to the extent we now or in the future market and sell our products in foreign countries, we may be subject to rigorous regulation by those foreign governmental authorities. In such circumstances, we would rely significantly on our foreign independent distributors to comply with the varying regulations, and any failures on their part could result in restrictions on the sale of our products in foreign countries.
Modifications to our products may require new 510(k) clearances or premarket approvals, or may require us to cease marketing or recall the modified products until clearances are obtained.
Any modification to a 510(k)-cleared device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, design, or manufacture, requires a new 510(k) clearance or, possibly, approval of a PMA. The FDA requires every manufacturer to make this determination in the first instance, but the FDA may review any manufacturer's decision. The FDA may not agree with our decisions regarding whether new clearances or approvals are necessary. If the FDA requires us to seek 510(k) clearance or PMA for modification of a previously cleared product for which we have concluded that new clearances or approvals are unnecessary, we may be required to cease marketing or to recall the modified product until we obtain clearance or approval, and we may be subject to significant regulatory fines or penalties. Further, our products could be subject to recall if the FDA determines, for any reason, that our products are not safe or effective. Any recall or FDA requirement that we seek additional approvals or clearances could result in delays, fines, costs associated with modification of a product, loss of revenue and potential operating restrictions imposed by the FDA.
We will spend considerable time and money complying with federal, state and foreign regulations and, if we are unable to fully comply with such regulations, we could face substantial penalties.
We are directly or indirectly through our clients, subject to extensive regulation by both the federal government and the states and foreign countries in which we conduct our business. The laws that directly or indirectly affect our ability to operate our business include, but are not limited to, the following:
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- the federal Medicare and Medicaid Anti-Kickback Law, which prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in cash or in kind, to induce either the referral of an individual, or furnishing or arranging for a good or service, for which payment may be made under federal healthcare programs such as the Medicare and Medicaid Programs;
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- other Medicare laws and regulations that prescribe the requirements for coverage and payment for services performed by us and our DIS customers, including the amount of such payment;
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- the federal False Claims Act, which imposes civil and criminal liability on individuals and entities who submit, or cause to be submitted, false or fraudulent claims for payment to the government;
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- the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, which prohibits executing a scheme to defraud any healthcare benefit program, including private
payors; - -payors and, further, requires us to comply with standards regarding the privacy and security of individually identifiable health information and conduct certain electronic transactions using standardized code sets. In addition, regulations have been issued under HIPAA that will require us to comply with additional security regulations by April 2005 and to adopt unique health identifiers for use in filing and processing healthcare claims and other transactions by May 2007;- •
- the federal False Statements Statute, which prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false statement in connection with the delivery of or payment for healthcare benefits, items or services;
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- the federal physician self-referral prohibition, commonly known as the Stark Law, which, in the absence of a statutory or regulatory exception, prohibits the referral of Medicare
or Medicaidpatients by a physician to an entity for the provision of certain designated healthcare services, if the physician or a member of the physician's immediate family has a direct or indirect financial relationship, including an ownership interest in, or a compensation arrangement with, the entity and also prohibits that entity from submitting a bill to a federal payor for services rendered pursuant to a prohibited referral;- -- •
- the federal Food, Drug and Cosmetic Act, which regulates the manufacture, labeling, marketing, distribution and sale
manufacture,of prescription drugs and medical devices;- •
- state and foreign law equivalents of the foregoing;
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- federal and state radioactive materials laws, which govern the procurement, use, transfer and storage of radioactive materials;
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- state food and drug laws, pharmacy acts and state pharmacy board regulations, which govern the sale, distribution, use, administration and prescribing of prescription drugs;
- - state law equivalents of the foregoing; and - -- •
- state laws that prohibit the practice of medicine by non-physicians and fee-splitting arrangements between physicians and
non-physicians.non-physicians, as well as state law equivalents to the federal Medicare and Medicaid Anti-Kickback Law and the Stark Law, which may not be limited to government reimbursed items or services; and- •
- federal laws and regulations that permit physicians to bill and receive payment for certain diagnostic tests under the Medicare Physician Fee Schedule only if certain conditions are satisfied, including the requirement that the physician personally perform, or adequately supervise the performance of, the test using equipment they own or lease, and that prohibit physicians from marking up the cost of tests they "purchase," rather than perform or supervise, for Medicare patients.
We implemented a compliance program in 2002 to help assure that we remain in compliance with these laws. Like most companies with active and effective compliance programs, we occasionally discover compliance concerns. For example, we have discovered certain isolated arrangements that we entered into in good faith but that, upon review by our compliance personnel, raised some compliance concerns under these laws. In accordance with our compliance program, we took immediate remedial steps. We cannot assure you that these remedial steps will insulate us from liability associated with these isolated arrangements.
If our past or present operations are found to be in violation of any of the laws described above or the other governmental regulations to which we or our
clientscustomers are subject, we may be subject to the applicable penalty associated with the violation, including civil and criminal penalties, damages, fines, exclusion from the Medicare and Medicaid programs and the curtailment or restructuring of our operations. Similarly, if our customers are found non-compliant with applicable laws, they may be subject to sanctions, which could also have a negative impact on us. In addition, if we are required to obtain permits or licensure under these laws that we do not already possess, we may become subject to substantial additional regulation or incur significant expense. Any penalties, damages, fines, curtailment or restructuring of our operations would adversely affect our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety ofinterpretations.interpretations, and additional legal or regulatory change. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses, divert our- -------------------------------------------------------------------------------- 14RISK FACTORS - --------------------------------------------------------------------------------management's attention from the operation of our business and damage our reputation. For a more detailed discussion of the various state and federal regulations to which we are subject, and how they apply to our operations and activities, see"Business--Government Regulation."Business—Government Regulations."HEALTHCARE REFORM LEGISLATION COULD LIMIT THE PRICES WE CAN CHARGE FOR OUR IMAGING SERVICES, WHICH WOULD REDUCE OUR REVENUES AND HARM OUR OPERATING RESULTS.Legislative or regulatory reform of the healthcare system may affect our ability to sell our products profitably.
In
additionboth the United States and certain other foreign jurisdictions, there have been a number of legislative and regulatory proposals toextensive existing governmentchange the healthcareregulation, there are numerous initiatives atsystem in ways that could impact our ability to sell our products and services profitably. In the United States, federal and statelevelslawmakers regularly propose and, at times, enact new legislation establishing significant changes in the healthcare system. Recently, President Bush signed into law the Medicare Modernization Act, which contains a wide variety of reforms that impact Medicare reimbursements to hospitals and physicians including changes to Medicare payment methodologies forcomprehensive reforms affectingradiopharmaceuticals and other drugs dispensed by hospital outpatient departments and for drugs dispensed by physician offices and independent diagnostic testing facilities. These changes reduced payment amounts for some of the drugs used in conjunction with our imaging procedures, although the physician fee schedule payment rates applicable to nuclear cardiology increased slightly. Downward changes to Medicare reimbursement rates may adversely impact reimbursement to customers or potential customers that use or could use our cameras and services. We cannot predict the full impact that this new legislation will have nor whether new federal legislation will be enacted in the future. The potential forand availabilityadoption of healthcare reform proposals on a state-by-state basis could require us to develop state-specific marketing and sales approaches. In addition, we may experience pricing pressures in connection with the sale of our products and services due to additional legislative proposals or healthcare reform initiatives. Our results of operations and our business could therefore be adversely affected by future healthcare reforms.The impact of regulatory changes could have a negative impact on camera sales to and leases with hospitals desiring to use our cameras and services in their outpatient facilities.
In order for hospitals to receive certain payments for their outpatient facilities as hospital outpatient services, including services that utilize our products, these services must be furnished in a
number"provider-based" organization or facility or be covered services furnished "under arrangement" with the hospital. Failure to meet these requirements may result in reduced payments to the hospitals for their services. The Medicare program has published and revised rules establishing criteria for classifying a facility as "provider-based" or a service as furnished "under arrangement." These rules require an analysis ofproposals that would significantly limit reimbursement undertheMedicarefacts andMedicaid Programs. It is not clear at this time what proposals, if any, will be adopted or, if adopted, what effect these proposals would have on our business. Aspects of certain of these healthcare proposals, such as reductions incircumstances surrounding theMedicare and Medicaid Programs and containment of healthcare costs on an interim basisdelivery bymeans that could includeashort-term freeze on prices charged by healthcare providers, could limit the demand for our imaging services or affect the revenue per procedure that we can collect, which would harm our business and results of operations. THE IMPACT OF RECENTLY PROMULGATED FEDERAL REGULATIONS COULD HAVE A NEGATIVE IMPACT ON CAMERA SALES TO HOSPITALS DESIRING TO USE THE CAMERA IN OUT-PATIENT FACILITIES. Recently promulgated federal regulations affect the abilityhospital of aMedicare provider, such as a hospital,particular service, and hospitals that use our products or DIS services in their outpatient facilities will need toinclude a servicedetermine if they meet the applicable "provider-based" orfacility as provider-based for purposes of Medicare reimbursement. Historically, provider-based status has allowed a provider to obtain more comprehensive Medicare reimbursement for imaging services like the ones we provide. While the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000 offers some relief for facilities recognized as provider-based on October 1, 2000, under the regulations of the Act, some of our hospital customers may have difficulty qualifying their out-patient facilities for provider-based status. If a hospital customer"under arrangement" requirements. Hospitals that cannot obtainprovider-based statussufficient payments fortheir out-patient nuclear imaging facility, then the providerthese services may not purchase a camera fromus. THE APPLICATION OF STATE CERTIFICATE OF NEED REGULATIONS COULD HARM OUR BUSINESS AND FINANCIAL RESULTS.us or enter into arrangements with us for provision of services.The application of state certificate of need regulations could harm our business and financial results.
Some states currently require, or may require in the future, a certificate of need or similar regulatory approval prior to the acquisition of high-cost capital items, including diagnostic imaging systems, or provision of diagnostic imaging services by us or our clients. In many cases, a limited number of these certificates are available in a given state. If we or our clients are unable to obtain the applicable certificate or approval or additional certificates or approvals necessary to expand our operations, these regulations may limit or preclude our operations in the relevant jurisdictions.
IF WE FAIL TO COMPLY WITH VARIOUS LICENSURE, OR CERTIFICATION STANDARDS, WE MAY BE SUBJECT TO LOSS OF LICENSURE, OR CERTIFICATION WHICH WOULD ADVERSELY AFFECT OUR OPERATIONS.If we fail to comply with various licensure, or certification standards, we may be subject to loss of licensure or certification, which would adversely affect our operations.
All of the states in which we operate require that the imaging technicians that operate our
cameracameras be licensed or certified. Obtaining such licenses may take significant time as we expand into additional states. Further, we are currently enrolled by Medicare contractors, or"carriers","carriers," as an independent diagnostic testing facilityor IDTF,infive (5)nine states and are seeking such enrollment by Medicare contractors in one additionalstates.state. Enrollment is essential for us to receive payment for healthcare services- -------------------------------------------------------------------------------- 15RISK FACTORS - --------------------------------------------------------------------------------directly from Medicare. There can be no assurances we will be able to maintain such enrollment or that we will be able to gain suchenrollment in other states. Any lapse in our licenses or enrollment, or the licensure or certification of our technicians, could increase our costs and adversely affect our operations and financial results.
In the healthcare industry, various types of organizations are accredited to facilitate meeting certain Medicare certification requirements, expedite third-party payment and fulfill state licensure requirements. Some managed care providers prefer to contract with accredited organizations. Thus far, we have not found it necessary to seek or obtain accreditation from any established accreditation agency. If it becomes necessary for us to do so in the future in order to satisfy the requirements of
third partythird-party payors or regulatory agencies, there can be no assurances that we will be able to obtain or continuously maintain this accreditation.RISKS RELATED TO THIS OFFERING CONCENTRATION OF OWNERSHIP OF OUR COMMON STOCK AMONG OUR EXISTING EXECUTIVE OFFICERS, DIRECTORS AND PRINCIPAL STOCKHOLDERS MAY PREVENT NEW INVESTORS FROM INFLUENCING SIGNIFICANT CORPORATE DECISIONS. Upon completionAudits or denials of our claims, or claims submitted by our DIS customers, by government agencies or contractors could reduce our revenues or profits and expose us to claims.
Under our "mixed bill" model, we submit claims directly to and receive payments directly from the Medicare program. Therefore, we are subject to extensive government regulation, including requirements for maintaining certain documentation to support our claims. Government agencies and Medicare contractors also may conduct inspections or surveys of our facilities, payment reviews and other audits of our claims and operations. For example, as part of a national audit conducted pursuant to the 2003 work plan, the Office of the Inspector General of the U.S. Department of Health and Human Services, or the OIG, conducted a review of one of our independent diagnostic testing facilities in early 2003 to review the appropriateness of Medicare payments received. This audit was concluded without any action being taken by the OIG. While we believe this
offering,audit will have no impact on us, we cannot assure you that the OIG may not take some follow-up action. We may be subject to investigations, payment reviews and audits and cannot assure you that such scrutiny will not result in material delays in payment, as well as material recoupments or denials, which could reduce ourexecutive officers, directorsrevenue or profits. Our DIS customers also submit claims to Medicare andbeneficial ownersother third-party payors, are subject to the same types of5%regulation and scrutiny, and may experience the same types of problems. This could adversely affect our ability to market our leases and services and to maintain existing contracts.Risks Related to Our Intellectual Property and Potential Litigation
Our ability to protect our intellectual property and proprietary technology through patents and other means is uncertain.
Our success depends significantly on our ability to protect our proprietary rights to the technologies used in our products. We rely on patent protection, as well as a combination of copyright, trade secret and trademark laws, and nondisclosure, confidentiality and other contractual restrictions to protect our proprietary technology. However, these legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. Our pending U.S. and foreign patent applications, which include claims to material aspects of our products and procedures that are not currently protected by issued patents, may not issue as patents in a form that will be advantageous to us. Any patents we have obtained or do obtain may be challenged by re-examination or otherwise invalidated. Both the patent application process and the process of managing patent disputes can be time consuming and expensive. Competitors may attempt to challenge or invalidate our patents, or may be able to design alternative techniques or devices that avoid infringement of our patents, or develop products with functionalities that are comparable to ours. Although we have taken steps to protect our intellectual property and proprietary technology, including entering into confidentiality agreements and intellectual property assignment agreements with our employees, consultants, advisors and corporate partners, such agreements may not be enforceable or may not provide meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosure or other breaches of the agreements. Furthermore, the laws of some foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States.
In the event a competitor infringes upon our patent or other intellectual property rights, litigation to enforce our intellectual property rights or to defend our patents against challenge, even if successful, could be expensive and time consuming and could require significant time and attention from our management. We may not have sufficient resources to enforce our intellectual property rights or to defend our patents against challenges from others.
We have entered into a royalty-bearing license for one U.S. patent with a third-party for use in nuclear imaging, which license is co-exclusive with the U.S. government. We do not believe that our current products implement the licensed patent; however, the licensor does not agree. We are currently negotiating to amend the license to resolve our dispute with the licensor. If we were to terminate the license, the licensor or subsequent licensee may allege that our current product infringes the patent, or such third-party licensee may develop and commercialize a competitive photodiode for use in gamma cameras.
The medical device industry is characterized by patent litigation and we could become subject to litigation that could be costly, result in the diversion of our management's time and efforts, and require us to pay damages.
The medical device industry is characterized by extensive litigation and administrative proceedings over patent and other intellectual property rights. Whether a product infringes a patent involves complex legal and factual issues, the determination of which is often uncertain. Our competitors may assert that our products, their components or the methods we employ in the use of our products are covered by U.S. or foreign patents held by them. In addition, they may claim that their patents have priority over ours because their patents were filed or invented earlier. Because patent applications can take many years to issue, there may be applications now pending of which we are unaware, which may later result in issued patents that our products may infringe. There could also be existing patents that one or more components of our products may be infringing of which we are unaware. As the number of participants in our industry increases, the possibility of patent infringement claims against us also increases.
Any litigation or claims against us may cause us to incur substantial costs, could place a significant strain on our financial resources, divert the attention of our management from our core business and harm our reputation. If the relevant patents were upheld as valid and enforceable and we were found to be inadvertently infringing, we could be required to pay substantial damages and/or royalties and could be prevented from selling our products unless we could obtain a license or were able to redesign our system to avoid infringement. Any such license may not be available on reasonable terms, if at all. If we fail to obtain any required licenses or make any necessary changes to our products or technologies, we may be unable to commercialize one or more of our
common stockproducts.We rely significantly on a license agreement with Segami Corporation for the imaging acquisition and
their affiliates will,processing software for our digital gamma camera, and the loss of the license could result inaggregate, beneficially own approximately %delivery delays, loss of customers and loss of revenue.Segami Corporation, or Segami, has developed image acquisition and processing software for our
outstanding common stockcamera under a non-exclusive license agreement. In the event that Segami attempts to terminate the license agreement, refuses to extend the term of the license or% if the underwriters' over-allotment option is exercisedseeks to impose unreasonable pricing or terms, we would have to find an alternative software system to use infull.our gamma camera. To our knowledge, there are a limited number of companies that would be able to develop and implement a software system similar to what we use in our gamma camera. As a result,these persons, acting together,in the event that we were unable to continue to use the software under the license from Segami, we could have delays in the production of our gamma camera as we attempted to find a substitute software provider. Furthermore, we cannot guarantee that alternative software providers would be able to meet our requirements or that their software would be available to us at favorable prices, if at all. To the extent we were unable to find an alternative source for the software, we may have to develop our own software system. We cannot guarantee that we could internally develop such a software system or that such efforts would not divert resources away from the development of other features of our camera. As a result, locating an alternative softwaresystem or developing our own software system could interrupt the manufacture and delivery of our products for an extended period of time and may cause the loss of customers and revenue.
We may be subject to damages resulting from claims that we, or our employees, have wrongfully used or disclosed alleged trade secrets of their former employers.
Many of our employees were previously employed at other medical device companies, including our competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that we or our employees have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management. If we fail in defending such claims, in addition to paying money damages, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hinder or preclude our ability to
determine the outcome of matters submittedcommercialize our products, which could severely harm our business.If we become subject to product liability or warranty claims, we may experience reduced demand for our
stockholders for approval, including the electionproducts or be required to pay damages that exceed our insurance coverage.The sale and
removal of directors and any merger, consolidation or sale of all or substantially allsupport of ourassets. In addition,products entails the risk of product liability or warranty claims, suchpersons, acting together, may haveas those based on claims that theability to control the management and affairsfailure of one of ourcompany. Accordingly,products resulted in a misdiagnosis, among other issues. The medical device industry has been subject to significant products liability litigation. We may incur significant liability in the event of any such litigation, regardless of the merit of the action. Although we maintain product liability insurance, we cannot be sure that thisconcentrationcoverage is adequate or that it will continue to be available on acceptable terms, if at all. We also may face warranty exposure, which could adversely affect our operating results. Any unforeseen warranty exposure or insufficient insurance could harm our business, financial condition and results ofownershipoperations. Finally, even a meritless or unsuccessful product liability claim could harm our reputation in the industry, lead to significant legal fees and could result in the diversion of management's attention from managing our business.We may
harmbe subject to lawsuits and actions brought by our employees.We may from time to time be subject to employment claims or disputes. Recently one former and three present employees have retained counsel and have claimed that they are due overtime pay because of an alleged misclassification of their positions as non-exempt rather than exempt employees. These employees have claimed damages equal to back pay of up to thirty days, liquidated damages of twice the
market priceamount ofour common stock by: - - delaying, deferring or preventing a change in control of our company; - - impeding a merger, consolidation, takeover or other business combination involving our company; or - - discouraging a potential acquirer from making a tender offer or otherwise attemptingovertime pay found due and attorneys' fees. We deny any wrongdoing and intend toobtain control of our company. Please see "Principal stockholders" for additional information on concentration of ownership of our common stock. THERE MAY NOT BE AN ACTIVE, LIQUID TRADING MARKET FOR OUR COMMON STOCK. Wedefend against these claims vigorously. However, we cannot assure you thattherewe will be successful, or that additional former or present employees may not join in any such action. Any employment claims could significantly divert our management's time and attention and could materially affect our business.Risks Related to the Securities Markets and Ownership of Our Common Stock
There has been no prior public market for our common stock and an active trading market may not develop.
Prior to this offering, there has been no public market for our common stock. An active public trading market for our common stock
following this offering. Youmay not develop or beable to sell your shares quickly or atsustained after themarket price if trading in our stock is not active. Theoffering. We will negotiate and determine the initial public offering pricewas determined by negotiations between us and thewith representatives of the underwritersbased upon a number of factors. The initial public offeringand this price may not be indicative of prices that will prevail in the trading market.Please see "Underwriting"As a result, you may not be able to sell your shares of common stock at or above the offering price. An inactive market may also impair our ability to raise capital by selling shares and may impair our ability to acquire other businesses, products or technologies by using our shares as consideration.Future sales of our common stock may cause our stock price to decline.
Our current stockholders hold a substantial number of shares of our common stock that they will be able to sell in the public market in the near future. Significant portions of these shares are held by a small number of stockholders. Sales by our current stockholders of a substantial number of shares after this offering, or the expectation that such sale may occur, could significantly reduce the market price of our common stock. Moreover, after this offering, the holders of approximately 12,498,878 shares of common stock, including shares issued upon conversion of our preferred stock and shares issued upon the exercise of certain of our warrants, will have rights, subject to some conditions, to require us to file registration statements to permit the resale of their shares in the public market or to include their shares in registration statements that we may file for
more information regardingourselves or other stockholders. Although the holders of most of ourarrangementoutstanding capital stock have agreed with the underwriters of this offering to be bound by a 180-day lock-up agreement that prohibits these holders from selling or transferring their stock, other than in specific circumstances, Merrill Lynch, Pierce, Fenner & Smith Incorporated and J.P. Morgan Securities Inc., at their discretion, can waive the restrictions of the lock-up agreement at an earlier time without prior notice or announcement and allow our stockholders to sell their shares of our common stock in the public market. If the restrictions of the lock-up agreement are waived, shares of our common stock will be available for sale into the market, subject only to applicable securities rules and regulations, which may cause our stock price to decline.We also intend to register all common stock that we may issue under our 2004 Stock Incentive Plan and 2004 Non-Employee Director Stock Option Program. Once we register these shares, they can be freely sold in the public market upon issuance, subject to restrictions under the securities laws and the
factors consideredlock-up agreements described above. If any of these stockholders cause a large number of securities to be sold insettingtheinitialpublicoffering price. - -------------------------------------------------------------------------------- 16RISK FACTORS - -------------------------------------------------------------------------------- OUR STOCK PRICE COULD BE VOLATILE, AND YOUR INVESTMENT COULD SUFFER A DECLINE IN VALUE WHICH MAY PREVENT INVESTORS IN OUR COMMON STOCK FROM SELLING THEIR SHARES ABOVE THE INITIAL PUBLIC OFFERING PRICE. Themarket, the sales could reduce the trading price of our common stock. These sales also could impede our ability to raise future capital.Our stock price may be volatile, and you may lose all or a substantial part of your investment.
Following this offering, the market price for our common stock is likely to be
highlyvolatile,and could be subject to wide fluctuationsin part because our shares have not been traded publicly. In addition, the market price of our common stock may fluctuate significantly in response tovariousa number of factors,manymost of whichare beyondwe cannot control, including:
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- volume and timing of orders for our
control, including: - - actualproducts and services;- •
- the introduction of new products, product enhancements, services or
anticipated variations in quarterly operating results; - - announcements of technological innovationstechnologies by us or our competitors;- - new products or services introduced or announced by us- •
- quarterly variations in our or our
competitors; - - changes in financial estimates by securities analysts; - -competitors' results of operations;- •
- conditions or trends in the medical device industry and the imaging service industry;
- - changes in the- •
- disputes or other developments with respect to intellectual property rights;
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- our ability to develop, obtain regulatory clearance for, and market,
valuations ofnew and enhanced products on a timely basis;- •
- product liability claims or other
similar companies; - - announcements by us of significant acquisitions, strategic partnerships, joint ventures or capital commitments; - - adverse action by regulatory agencies or changes in law; - -litigation;- •
- additions or departures of key personnel;
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- sales of large blocks of our common stock, including sales by our executive officers and
- - salesdirectors;- •
- changes in governmental regulations or in the status of our regulatory approvals or applications;
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- changes in the availability of third-party reimbursement in the United States or other countries;
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- changes in earnings estimates or recommendations by securities analysts; and
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- general market conditions and other factors, including factors unrelated to our operating performance or the operating performance of our competitors.
Anti-takeover provisions in our organizational documents and Delaware law may discourage or prevent a change in control, even if an acquisition would be beneficial to our stockholders, which could affect our stock price adversely and prevent attempts by our stockholders to replace or remove our current management.
Our restated certificate of incorporation and restated bylaws contain provisions that may delay or prevent a change in control, discourage bids at a premium over the market price of our common stock and adversely affect the market price of our common stock and the voting and other rights of the holders of our common stock. These provisions include:
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- prohibiting our stockholders from calling a special meeting of stockholders unless they hold not less than 20% of the total number of votes to be cast at such a meeting;
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- permitting the issuance of additional shares of our common stock or preferred stock without stockholder approval;
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- prohibiting our stockholders from making certain changes to our restated certificate of incorporation or restated bylaws except with 662/3% stockholder approval; and
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- requiring advance notice for raising matters of business or making nominations at stockholders' meetings.
We are also subject to provisions of the Delaware corporation law that, in general, prohibit any business combination with a beneficial owner of 15% or more of our common stock for five years unless the holder's acquisition of our stock was approved in advance by our board of directors. Although we believe these provisions collectively provide for an opportunity to receive higher bids by requiring potential acquirors to negotiate with our board of directors, they would apply even if the offer may be considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management.
We may become involved in securities class action litigation that could divert management's attention and harm our business.
The stock market in general, and the Nasdaq National Market and the market for medical device companies in particular,
havehas experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance oflisted companies. Further, there has been particular volatilitythe companies inthe market prices of securities of medical device companies and imaging services companies. Thesethose markets. In addition to our performance, these broad market and industry factors mayseriouslymaterially harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market price of a particular company's securities, securitiesclass-actionclass action litigation has often beeninstitutedbrought against that company.SuchWe may become involved in this type of litigationif instituted against us, could resultinsubstantial coststhe future. Litigation often is expensive anda diversion ofdiverts management's attention and resources, which couldseriouslymaterially harm ourbusiness,financial condition and results of operations.THE LARGE NUMBER OF SHARES ELIGIBLE FOR PUBLIC SALE AFTER THIS OFFERING COULD CAUSE OUR STOCK PRICE TO DECLINE. SalesAs a new investor, you will experience immediate and substantial dilution as a result of
substantial amounts of our common stock in the public market afterthis offering and future equity issuances and, as a result of such dilution, our stock price couldseriously harm prevailing market prices for our common stock. These sales might make it difficult or impossible for us to sell additional securities when we need to raise capital. The number of additional shares available for sale in the public market will be affected by restrictions imposed by: - - the Securities Act of 1933, as amended, and related rules, including the volume and other restrictions of Rule 144; and - - the lock-up agreements between us and selected stockholders or between stockholders and the underwriters as described in "Underwriting." Please see "Shares eligible for future sale" for a description of the number of shares which may be sold by existing stockholders in the future. - -------------------------------------------------------------------------------- 17RISK FACTORS - -------------------------------------------------------------------------------- INVESTORS IN THIS OFFERING WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION.decline.The initial public offering price will be substantially higher than the pro forma net tangible book value per share of our outstanding common stock.
Purchasers ofAs a result, investors purchasing common stock in this offering willexperienceincur immediateand substantialdilutionin the pro forma net tangible book valueoftheir stock of $ per share, assuming an initial public offering price for our common stock of $$8.95 per share. This dilution is due in large part to earlier investors in our company having paid substantially less than thefact that prior investors paid an averageinitial public offering priceof $ per sharewhen they purchased their shares. Investors who purchase shares of common stock in this offering will contribute approximately 46% of the total amount we have raised to fund our operations but will own onlyapproximately 31% of our common stock. We believe that the net proceeds from this offering, together with our current cash, cash equivalents and short-term investments, will be sufficient to meet our projected operating requirements for at least the next 12 months. Because we may require additional funds to develop new products and continue to expand our business, however, we may conduct substantial future offerings of equity securities. The exercise of outstanding options and warrants and future equity issuances, including future public offerings or future private placements of equity securities and any additional shares issued in connection with acquisitions, will result in further dilution to investors.
If our officers, directors and principal stockholders choose to act together, they may be able to control our management and operations, acting in their best interests and not in the best interests of other stockholders.
After this offering, our officers, directors and holders of 5% or more of our outstanding common stock will beneficially own approximately 36.4% of our common stock, after giving effect to the conversion of all outstanding shares of our preferred stock, but assuming no exercise of the underwriters' over-allotment option and no exercise of outstanding options or warrants. As a result, these stockholders, acting together, will be able to significantly influence all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. The interests of this group of stockholders may not always coincide with our interests or the interests of other stockholders, and they may act in a manner that advances their best interests and not necessarily those of other stockholders. As a result of their actions or inactions our stock price may decline.
Our management team may invest or spend the proceeds of this offering in ways with which you may not agree or in ways which may not yield a return.
Our management will have considerable discretion in the application of the net proceeds of this offering. We expect to use a majority of the net proceeds from this offering to manufacture and market our gamma cameras, build our sales and marketing capabilities, expand our DIS business and repay outstanding lines of credit and notes payable of approximately $9.7 million as of March 31, 2004. To a lesser extent, we anticipate using the remaining net proceeds of this offering for further research and development relating to our existing products and new product opportunities, to finance regulatory approval activities and for general corporate purposes. We may also use a portion of the net proceeds of this offering to acquire or invest in complementary businesses, products, or technologies, or to obtain the right to use such complementary technologies, although we are not currently involved in any negotiations and have no commitments with respect to any such transactions. We cannot specify with certainty how we will use the net proceeds of this offering or our existing cash balance. The net proceeds may be used for corporate purposes that do not increase our operating results or market value. Until the net proceeds are used, we plan to invest such proceeds of this offering in short- and medium-term, interest-bearing obligations, investment-grade instruments, certificates of deposit or direct or guaranteed obligations of the U.S. government. These investments may not produce income or maintain their value.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTSThis prospectus contains forward-looking statements that are based on our management's beliefs and assumptions and on information currently available to our management. The forward-looking statements are contained principally in the sections entitled "Prospectus Summary," "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Use of Proceeds" and "Business." In some cases, you can identify forward-looking statements by terms such as "anticipates," "believes," "could," "estimates," "expects," "intends," "may," "plans," "potential," "predicts," "projects," "should," "will," "would" and similar expressions intended to identify forward-looking statements.
Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. We discuss many of these risks in this prospectus in greater detail under the heading "Risk Factors." Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management's beliefs and assumptions only as of the date of this prospectus. You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is
substantially less thana part, completely and with the understanding that our actual future results may be materially different from what we expect.Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.
We estimate that the net proceeds from this offering will be approximately $64.8 million, based upon an assumed initial public offering price of
$$13.00 pershare. WE HAVE NOT PAID DIVIDENDS AND DO NOT ANTICIPATE PAYING DIVIDENDS ON OUR COMMON STOCK IN THE FORESEEABLE FUTURE.share, the midpoint of the range on the cover of this prospectus, and after deducting estimated underwriting discounts and commissions and offering expenses. If the underwriters exercise their over-allotment option in full, we estimate that our net proceeds will be approximately $74.8 million.We expect to use a majority of the net proceeds of this offering to manufacture and market our gamma cameras, build our sales and marketing capabilities, expand our DIS business and repay outstanding lines of credit and notes payable of approximately $9.7 million.
To a lesser extent, we anticipate using the remaining net proceeds of this offering:
- •
- for further research and development relating to our existing products and new product opportunities and to finance regulatory approval activities; and
- •
- for general corporate purposes.
In addition, we may use a portion of the net proceeds from this offering to acquire products, technologies or businesses that are complementary to our own, but we currently have no commitments or agreements relating to any of these types of transactions.
Of the approximately $9.7 million of net proceeds that we intend to use to repay outstanding lines of credit and notes payable, we will use approximately $4.7 million to repay in full our outstanding balance as of March 31, 2004 under our secured credit facility with Silicon Valley Bank. The secured credit facility may be used to borrow against accounts receivable and fixed assets and our outstanding balance matures in October 2004. The secured credit facility bears an interest rate equal to the lender's prime rate, plus 1.75% per annum, but in no event less than 5.75%.
Additionally, of the approximately $9.7 million of net proceeds that we intend to use to repay outstanding lines of credit and notes payable, we will use approximately $4.5 million to repay in full our outstanding balance as of March 31, 2004 under our credit facility with GE Healthcare Financial Services. The total amount outstanding under the line of credit matures in December 2004 and the interest rate under such agreement is the greater of the lender's prime rate plus 1.25% per annum, or 6%.
Furthermore, of the approximately $9.7 million of net proceeds that we intend to use to repay outstanding lines of credit and notes payable, we intend to repay the principal amount outstanding under notes payable held by two of our stockholders which matures within 60 days of the completion of this offering. As of March 31, 2004, the outstanding principal amount under these notes was approximately $490,000 and the notes bear an interest rate of 6.35% per year. We may also enter into a similar agreement to repay the principal amount outstanding under a note held by another stockholder. As of March 31, 2004, the outstanding principal amount under such note, which bears an interest rate of 6.35% per year, was approximately $245,000.
As of the date of this prospectus, we cannot specify with certainty all of the particular uses for the net proceeds to be received upon the completion of this offering. The amount and timing of our expenditures will depend on several factors, including the amount of revenue generated from our operations, the progress of our commercialization efforts, and the amount of cash used in our operations. Accordingly, our management will have broad discretion in the application of the net proceeds and investors will be relying on the judgment of our management regarding the application of the proceeds of this offering. We reserve the right to change the use of these proceeds as a result of certain contingencies such as the results of our commercialization efforts, competitive developments, opportunities to acquire products, technologies or businesses and other factors.
Pending the uses described above, we plan to invest the net proceeds of this offering in short- and medium-term, interest-bearing obligations, investment-grade instruments, certificates of deposit or direct or guaranteed obligations of the U.S. government.
We have never declared or paid any cash dividends on our capital stock. We currently
anticipate that we willintend to retain all available funds and any future earningsif any,to support operations and finance the growth and development of our business and do notanticipate payingintend to pay cash dividends on our common stockinfor the foreseeable future. Anypayment of cash dividends will depend upon our financial condition, capital requirements, earnings and other factors deemed relevant by our board of directors. Under the terms of some of our credit agreements, we are restricted from paying cash dividends and making other distributionsfuture determination related to ourstockholders. ANTI-TAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW COULD MAKE A THIRD-PARTY ACQUISITION OF US DIFFICULT OR DECREASE THE PRICE INVESTORS MIGHT BE WILLING TO PAY FOR OUR COMMON STOCK IN THE FUTURE. The anti-takeover provisions in our certificate of incorporation, our bylaws and Delaware law could make it more difficult for a third party to acquire us without approval of our board of directors. As a result of these provisions, we could delay, deter or prevent a takeover attempt or third-party acquisition that our stockholders consider to be in their best interests, including a takeover attempt that results in a premium over the market price for the shares held by our stockholders. Please see "Description of capital stock" for more information on these anti-takeover provisions. - -------------------------------------------------------------------------------- 18- -------------------------------------------------------------------------------- Forward-looking information This prospectus may contain forward-looking statements relating to our operations and strategy that are based on our current expectations, estimates and projections. Words such as "expect," "intend," "plan," "project," "believe," "estimate" and other similar expressions are used to identify such forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Further, any forward-looking statements are based upon assumptions as to future events that may not prove to be accurate. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. We undertake no obligation to publicly update any forward-looking statement for any reason, even if new information becomes available or other events occur in the future. A number of important factors could cause actual results to differ materially from those indicated by such forward-looking statements. Such factors include, among others, those set forth in this prospectus under the heading "Risk factors." Market and industry data and forecasts This prospectus includes market and industry data and forecasts that we obtained from market research, consultant surveys, publicly available information and industry publications and surveys, and internal company surveys. Reports prepared or published by Frost & Sullivan were the primary sources for third-party industry data and forecasts. Industry surveys, publications, consultant surveys and forecasts generally state they obtain the information contained therein from sources believed to be reliable, but there can be no assurance as to the accuracy and completeness of such information. We have not independently verified any of the data from third-party sources nor have we ascertained the underlying economic assumptions relied upon therein. Similarly, independent sources have not verified internal company surveys, industry forecasts and market research, which we believe to be reliable based upon management's knowledge of the industry. In addition, we do not know what assumptions regarding general economic growth are used in preparing the forecasts we cite. - -------------------------------------------------------------------------------- 19- -------------------------------------------------------------------------------- Use of proceeds We expect to receive approximately $ million in net proceeds from the sale of shares of common stock in this offering at an assumed initial public offering price of $ per share, or approximately $ million if the underwriters' over-allotment option is exercised in full, after deducting underwriting discounts and commissions and estimated offering expenses, which we expect to be approximately $ million, or approximately $ million if the underwriters' over-allotment option is exercised in full. We intend to use approximately $5.7 million of the net proceeds of this offering to repay in full the following outstanding debt or financing obligations: - - approximately $2,500,000, including principal, accrued and unpaid interest and prepayment penalties, under working capital term loans, with interest rates ranging from 13.53% to 14.4%; - - approximately $2,500,000, including principal, accrued and unpaid interest and prepayment penalties, under a line of credit with an interest rate of prime plus 2% (which was 8% at June 30, 2001); and - - approximately $730,000, including principal, accrued and unpaid interest and prepayment penalties, under a line of credit with an interest rate at the greater of prime plus 1.25% or 10.25% (which was 10.25% at June 30, 2001). The working capital term loans that we are repaying with proceeds from this offering were issued under a loan and security agreement with MMC/GATX Partnership No. 1 dated October 1999, as amended in August 2000 and November 2000, and the proceeds were used to fund expansion of our manufacturing operations. These term loans require monthly amortization and the final payment is due November 2002. The lines of credit that we are repaying with proceeds from this offering were funded under various loan and security agreements, and the proceeds were used to fund general corporate working capital requirements. We intend to use the remainder of the net proceeds primarily for general corporate purposes, including product development, marketing, capital expenditures and working capital. We may also use a portion of the proceeds of this offering for acquisitions or investments in complementary businesses. We have no current plans, arrangements or understandings related to any acquisition or investment. The amounts and timing of any such use may vary significantly depending upon a number of factors, including our revenue growth, asset growth, cash flows and acquisition activities. Pending such uses, the net proceeds of this offeringdividend policy will beinvested in short-term, investment-grade, interest-bearing securities. We currently anticipate that the net proceeds to be received by us from this offering and existing cash balances will be sufficient to satisfy our operating cash needs for at least 12 months following the closing of this offering. See "Management's discussion and analysis of financial condition and results of operations--Liquidity and Capital Resources." Dividend policy We have never declared or paid any cash dividends on our common stock. We do not expect to pay any cash dividends for the foreseeable future. We currently intend to retain future earnings, if any, to finance the expansion of our business. Any future determination to pay cash dividends will bemade at the discretion of our board ofdirectors and will be dependent on our financial condition, operating results, capital requirements and other factors that our board deems relevant. - -------------------------------------------------------------------------------- 20- -------------------------------------------------------------------------------- Capitalizationdirectors.The following table sets forth our capitalization as of
June 30, 2001: - -March 31, 2004:
- •
- on an actual basis;
- -and- •
- on
a pro formaan as adjusted basis to give effect tothe issuance of 2,618,462 shares of Series F preferred stock in August 2001 and(1) the automatic conversion of all shares of preferred stock outstanding as ofAugust 23, 2001March 31, 2004 into29,748,03012,444,294 shares of common stockin connection withupon completion of thisoffering;offering, (2) the filing of our restated certificate of incorporation, which provides for authorized capital stock of 150,000,000 shares of common stock and- - on a pro forma as adjusted basis to give effect to10,000,000 shares of preferred stock, (3) the sale by us of 5,500,000 shares of our common stock in this offering at an assumed initial public offering price of$$13.00 per share, the midpoint of the range on the cover of this prospectus, and theapplicationreceipt of the estimated net proceedsto repay a portiontherefrom, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us and (4) the repayment ofour$9.7 million of outstandingindebtedness.short-term lines of credit and notes payable.You should read this table together with
"Use"Management's Discussion and Analysis ofproceeds," "Management's discussionFinancial Condition andanalysisResults offinancial condition and results of operations"Operations" and the consolidated financial statements andrelatedaccompanying notes included elsewhere in this prospectus.
JUNE 30, 2001 ----------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED (in thousands) - -------------------------------------------------------------------------------------------------Cash and cash equivalents................................... $ 3,510 $ 11,920 ======== ======== Total debt: Current portion of long-term debt......................... 5,614 5,614 Long-term debt, net of current portion.................... 5,076 5,076 Notes payable to stockholders............................. 735 735 Redeemable convertible preferred stock: Authorized shares--27,582,646 actual, 10,000,000 pro forma and pro forma as adjusted; Issued and outstanding shares--27,129,568 actual, none pro forma and pro forma as adjusted............................................. 58,109 -- Stockholders' equity (deficit): Common Stock: Authorized shares--38,091,807 actual, 250,000,000 pro forma and pro forma as adjusted; Issued and outstanding shares--4,574,603 actual, 34,322,633 pro forma and pro forma as adjusted................. 5 34 Additional paid-in capital................................ 4,707 71,197 Deferred compensation..................................... (1,713) (1,713) Notes receivable from stockholders........................ (112) (112) Accumulated deficit....................................... (50,998) (50,998) -------- -------- Total stockholders' equity (deficit)...................... (48,111) 18,408 -------- -------- Total capitalization...................................... $ 21,423 $ 29,833 ======== ========
As of March 31, 2004 Actual As Adjusted (In thousands, except share and per share amount) Cash and cash equivalents $ 8,902 $ 64,030 Total debt: Lines of credit $ 9,182 $ — Long-term debt 5,924 5,924 Notes payable to stockholders 735 245 15,841 6,169 Redeemable convertible preferred stock, $0.000001 par value: 46,023,000 shares authorized, 43,555,313 shares issued and outstanding, actual; no shares issued and outstanding, as adjusted 84,367 — Stockholders' equity (deficit): Preferred stock, $0.0001 par value: 10,000,000 shares authorized and no shares issued and outstanding, as adjusted — — Common stock, $0.001 par value: 53,000,000 shares authorized, 54,352 shares issued and outstanding, actual; $0.0001 par value: 150,000,000 shares authorized, 17,998,646 shares issued and outstanding, as adjusted — 2 Additional paid in capital 6,315 155,480 Deferred compensation (1,489 ) (1,489 ) Accumulated deficit (80,535 ) (80,535 ) Total stockholders' equity (deficit) (75,709 ) 73,458 Total capitalization $ 24,499 $ 79,627 The number of shares in the table above
does not include: - - the issuanceexcludes, as ofup to 5,952,426March 31, 2004:
- •
- 1,581,519 shares of our common stock
upon the exercise of stocksubject to outstanding optionsoutstanding as of August 23, 2001 atunder our 1991 Stock Option Program, our 1997 Stock Option/Stock Issuance Plan and our 1998 Stock Option/Stock Issuance Plan, having a weighted average exercise price of$0.64$2.42 per share;- - the issuance of up to 603,578- •
- 58,904 shares of our common stock available for future issuance under our 1991 Stock Option Program, our 1997 Stock Option/Stock Issuance Plan and our 1998 Stock Option/Stock Issuance Plan; and
- •
- 63,971 shares of our common stock issuable upon
theexercise of outstanding warrantsoutstanding as of August 23, 2001 at(including warrants to purchase preferred stock that are convertible into common stock), having a weighted average exercise price of$2.59$33.39 pershare, of which warrants - -------------------------------------------------------------------------------- 21CAPITALIZATION - -------------------------------------------------------------------------------- to purchase 65,875 shares will expire if not exercised at the time of this offering and warrants to purchase 60,000 shares will expire if a consulting agreement is terminated before July 31, 2002; - - the issuance of up to 250,000 shares of commonshare.A 1-for-3.5 reverse stock
as well as additional shares of common stock issuable based upon future earnings results, as additional consideration in connection with our acquisitions of Nuclear Imaging Systems, Inc. and Florida Cardiology and Nuclear Medicine Group; - - the issuance of up to 4,725,883 shares of common stock reserved for future issuance under our stock option plans; and - - the issuance of 10,000 shares of common stock at fair market value for every three of our digital cameras sold by a consultant, up to a maximum of 40,000 shares, and thereafter 1,500 shares of common stock at fair market value for each of our digital cameras sold by the consultant, in each case upon the exercise of warrants issuable to the consultant. - -------------------------------------------------------------------------------- 22- -------------------------------------------------------------------------------- Dilution If you invest in our common stock, your interest will be diluted to the extent of the difference between the initial public offering price per sharesplit of our common stockandwas approved by our stockholders on April 30, 2004. All share amounts in this prospectus have been adjusted to give effect to this stock split.As of March 31, 2004, we had a negative net tangible book value of $(76.2) million, or $(1,402.47) per share of common stock, not taking into account the conversion of our outstanding preferred stock. Net tangible book value per share is equal to our total tangible assets (total assets less intangible assets) less total liabilities (including redeemable convertible preferred stock), divided by the number of shares of our outstanding common stock. Our pro forma net tangible book value as of March 31, 2004 was approximately $8.1 million, or $0.65 per share of
ourcommonstock after this offering.stock. Pro forma net tangible book value per share represents the amount of our total tangible assets less our total liabilities, divided by the pro forma number of shares of common stockthen outstanding.outstanding as of March 31, 2004. Our pro forma net tangible book valueat June 30, 2001, would have been $15.9 million, or $and pro forma net tangible book value per share amounts give effect to the conversion of all outstanding shares of our convertible preferred stock into shares of common stock.Dilution in pro forma net tangible book value per share represents the difference between the amount per share paid by purchasers of shares of common stock in this offering and the pro forma net tangible book value per share of common stock immediately after
giving effect totheissuancecompletion of2,618,462 shares of Series F preferred stock in August 2001 and the automatic conversion of all shares of preferred stock outstanding as of August 23, 2001 into 29,748,030 shares of common stock in connection withthis offering. After givingfurthereffect totheour sale of 5,500,000 shares of common stock in this offering at an assumed initial public offering price of$$13.00 per share, the midpoint of the range set forth on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions andestimatedoffering expenses payable by us, our adjusted pro forma net tangible book valueat June 30, 2001,as of March 31, 2004 would have been$$72.9 million, or$$4.05 per share. This amount represents an immediate increase in pro forma net tangible book value of$$3.40 per share to our existing stockholders and an immediate dilution in pro forma net tangible book value of$$8.95 per share to newinvestors purchasing common stock in this offering.investors. The following table illustrates this per share dilution:
Assumed initial public offering price per share............. $ Pro forma net tangible book value per share before this offering................................................ $ Increase attributable to new investors in this offering... ------ Pro forma net tangible book value per share after this offering.................................................. $ ------ Dilution in pro forma net tangible book value per share to new investors after this offering......................... $ ======
Assumed initial public offering price per share $ 13.00 Net tangible book value per share at March 31, 2004 $ (1,402.47 ) Pro forma increase in tangible book value attributable to conversion of convertible preferred stock $ 1,403.12 Pro forma net tangible book value per share as of March 31, 2004 $ 0.65 Increase in pro forma net tangible book value per share attributable to new investors $ 3.40 Pro forma as adjusted net tangible book value per share after this offering 4.05 Dilution per share to new investors $ 8.95 If the underwriters exercise their over-allotment option to purchase additional shares in this offering, our adjusted pro forma net tangible book value at March 31, 2004 will be $82.9 million, or $4.40 per share, representing an immediate increase in pro forma net tangible book value of $3.75 per share to our existing stockholders and an immediate dilution in pro forma net tangible book value of $8.60 per share to new investors purchasing shares in this offering.
The following table summarizes,
as of June 30, 2001,onthea pro forma basisdescribed above,as of March 31, 2004, after giving effect to the conversion of all outstanding shares of our convertible preferred stock into common stock, the total number of shares of common stock purchased from us, the total consideration paid to us and the average price per share paid by existing stockholders and by new investors,purchasing shares of common stock from us in this offering atbased on an assumed initial public offering price of$$13.00 per share,andthe midpoint of the range set forth on the cover page of this prospectus,before deducting estimated underwriting discounts and commissions and
estimatedofferingexpenses:expenses payable by us (consideration in millions):
SHARES PURCHASED TOTAL CONSIDERATION ---------------------- ----------------------- AVERAGE PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE - ---------------------------------------------------------------------------------------------------------Existing stockholders.............. 34,322,633 % $68,071,703 % $1.98 New investors...................... $ ---------- ----- ----------- ----- ----- Total.............................. % $ % $ ========== ===== =========== ===== =====
Shares Purchased Total Consideration Average
Price Per
ShareNumber Percent Amount Percent Existing stockholders 12,498,646 69 % $ 85.3 54 % $ 6.83 New investors 5,500,000 31 71.5 46 13.00 Total 17,998,646 100.0 % $ 156.8 100.0 % If the underwriters exercise their over-allotment option in full,
the following will occur: - -ourpro forma net tangible book value after the offering will increase $ per share toexisting stockholders would own 66% and ourpro forma net tangible book value after the offering will be diluted $ per share tonewinvestors; - - the percentage of shares of our common stock held by existing stockholders will decrease to approximately %investors would own 34% of the total number of shares of our common stock outstanding after thisoffering;offering.The above discussion and
- - the numbertables assume no exercise of any stock options or warrants outstanding as of March 31, 2004. As of March 31, 2004, there were:
- •
- 1,581,519 shares of our common stock
held bysubject to outstanding options under our 1991 Stock Option Program, our 1997 Stock Option/Stock Issuance Plan and our 1998 Stock Option/Stock Issuance Plan, having a weighted average exercise price of $2.42 per share;- •
- 58,904 shares of our common stock available for future issuance under our 1991 Stock Option Program, our 1997 Stock Option/Stock Issuance Plan and our 1998 Stock Option/Stock Issuance Plan; and
- •
- 63,971 shares of our common stock issuable upon exercise of outstanding warrants (including warrants to purchase preferred stock that are convertible into common stock), having a weighted average exercise price of $33.39 per share.
After this offering and assuming the exercise of all in-the-money stock options and warrants outstanding as of March 31, 2004, our pro forma net tangible book value as of March 31, 2004 would be $3.83 per share, representing an immediate increase in pro forma net tangible book value of $3.18 per share to existing stockholders and an immediate dilution in pro forma net tangible book value of $9.17 per share to new
investors will increaseinvestors.The following table summarizes, on a pro forma basis as of March 31, 2004, after giving effect to
, or approximately %the conversion of all outstanding shares of our convertible preferred stock into common stock and the exercise of all outstanding in-the-money options and warrants, the total number of shares ofourcommon stockoutstanding after this offering. - -------------------------------------------------------------------------------- 23DILUTION - -------------------------------------------------------------------------------- The tablespurchased from us, the total consideration paid to us andcalculations above assume no issuancethe average price per share paid by existing stockholders and by new investors, based on an assumed initial public offering price of $13.00 per share, the midpoint of thefollowing shares described below: - -range set forth on theissuancecover page ofup to 5,952,426 sharesthis prospectus, before deducting estimated underwriting discounts and commissions and offering expenses payable by us (consideration in millions):
Shares Purchased Total Consideration Average
Price Per
ShareNumber Percent Amount Percent Existing stockholders 12,498,646 64 % $ 85.3 54 % $ 6.83 Shares subject to options and warrants 1,641,310 8 2.3 1 1.41 New investors 5,500,000 28 71.5 45 13.00 Total 19,639,956 100 % $ 159.1 100 % In April 2004, our board of
common stockdirectors approved, effective upon theexercise of stock options outstanding as of August 23, 2001 at a weighted average exercise price of $0.64 per share; - - the issuance of up to 603,578 shares of common stock upon the exercise of warrants outstanding as of August 23, 2001 at a weighted average exercise price of $2.59 per share, of which warrants to purchase 65,875 shares will expire if not exercised at the timecompletion of this offering,and warrants to purchase 60,000our 2004 Stock Incentive Plan, under which 1,400,000 shareswill expire if a consulting agreement is terminated before July 31, 2002; - - the issuance of up to 250,000 shares of common stock, as well as additional shares of common stock issuable based upon future earnings results, as additional consideration in connection with our acquisitions of Nuclear Imaging Systems, Inc. and Florida Cardiology and Nuclear Medicine Group; - - the issuance of up to 4,725,883 shares of common stockhave been reserved for futureissuance under our stock option plans; and - - the issuance of 10,000 shares of common stock at fair market value for every three of our digital cameras sold by a consultant, up to a maximum of 40,000 shares, and thereafter 1,500 shares of common stock at fair market value for each of our digital cameras sold by the consultant, in each case upon the exercise of warrants issuable to the consultant.issuance. To the extent that anyof theseoutstanding options or warrants are exercised or sharesof common stock are issued,acquired, there will be further dilution to new investors.See "Capitalization," "Management--Benefit Plans," andIn addition, we may choose to raise additional capital due to market conditions or strategic considerations even if we believe we have sufficient funds for our current or future operating plans. To the
notesextent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of these securities could result in further dilution to our stockholders.
SELECTED CONSOLIDATED FINANCIAL DATAThe selected consolidated
financial statements included elsewhere in this prospectus for further information. - -------------------------------------------------------------------------------- 24- -------------------------------------------------------------------------------- Selected historical financial and operating data Our selectedstatement of operations data for the years ended December 31,19962001, 2002 and1997,2003 andourthe selected balance sheet data as of December 31,1996, 19972002 and1998,2003, are derived fromour audited consolidated financial statements for such years and as of such dates, which are not included in this prospectus. Our selected statement of operations data fortheyears ended December 31, 1998, 1999 and 2000 and our selected balance sheet data as of December 31, 1999 and 2000, are derived from ouraudited financial statements for such years and as of such dates, which are included elsewhere in this prospectus.OurThe selected consolidated statement of operations data for thesix month periodsyears endedJune 30,December 31, 1999 and 2000, and2001, and ourthe selected balance sheet data as ofJune 30,December 31, 1999, 2000 and 2001, are derived from audited financial statements, which have been audited by Ernst & Young LLP, our independent auditors, for such years and as of such dates, which are not included in this prospectus. The selected consolidated statements of operations data for the three months ended March 31, 2003 and 2004 and the selected balance sheet data as of March 31, 2004 are derived from our unaudited financial statementsfor such years and as of such date, which areincluded elsewhere in this prospectus. The unaudited consolidated financial statements include, in the opinion of management, all adjustments, consisting only of normal, recurringaccruals, which we consideradjustments, that management considers necessary for a fairrepresentationstatement ofthe financial position andthe results ofoperations for thesethose periods.OperatingHistorical resultsfor the six months ended June 30, 2001are not necessarily indicative ofthe results that mayfuture results. The following selected financial data should beexpected for the entire year ending December 31, 2001. You shouldreadthe data set forth below in conjunctiontogether with "Management'sdiscussionDiscussion andanalysisAnalysis offinancial conditionFinancial Condition andresultsResults ofoperations"Operations" and ourconsolidatedfinancial statements and related notes included elsewhere in this prospectus.
SIX MONTHS YEARS ENDED DECEMBER 31, ENDED JUNE 30, STATEMENT OF OPERATIONS DATA: ---------------------------------------------------- ------------------- 1996 1997 1998 1999 2000 2000 2001 (In thousands, except per share and selected operating data) - --------------------------------------------------------------------------------------------------------------------------------Revenues: Products.......................................... $ 101 $ 167 $ 340 $ 284 $ 5,815 $ 1,456 $ 9,802 Imaging services.................................. -- -- -- -- 1,260 -- 4,217 Licensing and other............................... 487 252 1,581 -- -- -- -- ------- ------- ------- -------- -------- ------- ------- Total revenues.................................. 588 419 1,921 284 7,075 1,456 14,019 Cost of revenues: Products.......................................... 687 417 388 265 9,834 3,602 6,438 Imaging services.................................. -- -- -- -- 839 -- 3,394 ------- ------- ------- -------- -------- ------- ------- Total cost of revenues.......................... 687 417 388 265 10,673 3,602 9,832 ------- ------- ------- -------- -------- ------- ------- Gross profit (loss)................................. (99) 2 1,533 19 (3,598) (2,146) 4,187 Operating expenses: Research and development.......................... 1,602 4,073 5,426 10,063 2,372 1,083 1,327 Sales and marketing............................... 121 557 623 1,455 3,586 1,291 4,028 General and administrative........................ 609 1,198 2,533 1,967 2,878 1,072 2,899 Amortization of intangible assets................. -- -- -- -- 209 3 315 Stock-based compensation.......................... -- -- -- -- 296 -- 1,063 ------- ------- ------- -------- -------- ------- ------- Total operating expenses........................ 2,332 5,828 8,582 13,485 9,341 3,449 9,632 ------- ------- ------- -------- -------- ------- ------- Loss from operations................................ (2,431) (5,826) (7,049) (13,466) (12,939) (5,595) (5,445) Other income (expense), net......................... (71) (552) 857 274 (537) (97) (401) ------- ------- ------- -------- -------- ------- ------- Net loss............................................ $(2,502) $(6,378) $(6,192) $(13,192) $(13,476) $(5,692) $(5,846) ======= ======= ======= ======== ======== ======= ======= Net loss applicable to common stockholders.......... $(2,502) $(6,378) $(6,192) $(13,192) $(13,524) $(5,692) $(5,902) ======= ======= ======= ======== ======== ======= ======= Basic and diluted net loss per share(1)............. $ (0.77) $ (1.95) $ (1.87) $ (3.90) $ (3.61) $ (1.65) $ (1.35) ======= ======= ======= ======== ======== ======= ======= Shares used to compute basic and diluted net loss per share(1)...................................... 3,256 3,273 3,306 3,381 3,745 3,455 4,366 ======= ======= ======= ======== ======== ======= ======= SELECTED OPERATING DATA: Product sales Number of gamma cameras sold to third parties..... -- -- -- -- 23 6 36 Imaging services Number of imaging procedures performed............ -- -- -- -- * -- 6,953- ------------The selected financial data in this section is not intended to replace the financial statements.
Years Ended December 31, Three Months Ended
March 31,Statement of Operations Data: 1999 2000 2001 2002 2003 2003 2004 (In thousands, except per share data amounts) Revenues: DIS $ — $ 1,260 $ 10,239 $ 23,005 $ 34,848 $ 7,503 $ 10,407 Product 284 5,815 18,065 18,527 21,388 5,476 5,461 Total revenues 284 7,075 28,304 41,532 56,236 12,979 15,868
Cost of revenues:
DIS — 839 8,344 16,599 24,463 5,642 7,265 Product 265 9,834 13,192 13,633 15,091 3,841 3,639 Stock-based compensation — 65 298 124 114 1 116 Total cost of revenues 265 10,738 21,834 30,356 39,668 9,484 11,020 Gross profit (loss) 19 (3,663 ) 6,470 11,176 16,568 3,495 4,848
Operating expenses:
Research and development 10,063 2,372 3,009 2,967 2,191 579 640 Sales and marketing 1,455 3,586 9,974 8,065 6,008 1,547 1,780 General and administrative 1,967 2,878 8,161 9,497 8,097 1,851 2,145 Amortization and impairment of intangible assets — 194 991 1,011 444 119 16 Stock-based compensation — 246 1,281 483 112 1 188 Total operating expenses 13,485 9,276 23,416 22,023 16,852 4,097 4,769 Income (loss) from operations (13,466 ) (12,939 ) (16,946 ) (10,847 ) (284 ) (602 ) 79 Other income (expense), net 274 (537 ) (2,965 ) (1,925 ) (1,396 ) (325 ) (345 ) Net loss $ (13,192 ) $ (13,476 ) $ (19,911 ) $ (12,772 ) $ (1,680 ) $ (927 ) $ (266 ) Net loss applicable to common stockholders $ (13,192 ) $ (13,524 ) $ (20,041 ) $ (13,037 ) $ (2,006 ) $ (1,012 ) $ (354 ) Basic and diluted net loss per share(1): Historical $ (2,731.92 ) $ (2,527.80 ) $ (3,146.16 ) $ (1,432.31 ) $ (127.62 ) $ (74.63 ) $ (10.88 ) Pro forma (unaudited) $ (0.13 ) $ (0.02 ) Shares used to compute basic and diluted net loss per share(1): Historical 5 5 6 9 16 14 33 Pro forma (unaudited) 12,460 12,477 The composition of stock-based compensation is as follows: Cost of product revenue $ 54 $ 200 $ 72 $ 83 $ — $ 55 Cost of DIS revenue 10 98 52 31 1 61 Research and development 6 96 61 8 — 28 Sales and marketing 51 541 228 18 1 45 General and administrative 190 644 194 86 — 115 $ 311 $ 1,579 $ 607 $ 226 $ 2 $ 304
As of December 31,
As of March 31,
20041999 2000 2001 2002 2003 (In thousands) Balance Sheet Data: Cash and cash equivalents $ 2,626 $ 6,555 $ 1,967 $ 6,988 $ 7,681 $ 8,902 Working capital 801 5,481 (1,668 ) 3,781 2,578 829 Total assets 5,699 23,050 29,922 33,119 35,159 38,012 Total debt 2,570 8,614 14,469 13,932 16,441 15,841 Redeemable convertible preferred stock 32,259 52,255 66,531 83,952 84,278 84,367 Total stockholders' equity (deficit) (31,050 ) (43,479 ) (61,835 ) (73,928 ) (75,703 ) (75,709 )
- (1)
- Please see Note 1 to our consolidated financial statements for an explanation of the method used to calculate the historical and pro forma net loss per share
andthe number of shares used in the computation of per share amounts.* Not available because
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONSYou should read the
methodology for tracking the number of procedures performed in 2000 under acquired customer contracts was not consistent with our current methodology. - -------------------------------------------------------------------------------- 25SELECTED HISTORICAL FINANCIAL AND OPERATING DATA - --------------------------------------------------------------------------------
AS OF DECEMBER 31, BALANCE SHEET DATA ---------------------------------------------------- AS OF 1996 1997 1998 1999 2000 JUNE 30, 2001 (In thousands) - -------------------------------------------------------------------------------------------------------------------------Cash and cash equivalents........................ $ 5,634 $ 19,293 $ 13,680 $ 2,626 $ 6,555 $ 3,510 Working capital.................................. $ 5,344 $ 18,382 $ 12,636 $ 801 $ 5,481 $ 4,504 Total assets..................................... $ 6,576 $ 20,697 $ 16,365 $ 5,699 $ 23,207 $ 28,557 Long-term debt................................... $ 6,756 $ 735 $ 735 $ 2,156 $ 5,679 $ 5,811 Redeemable convertible preferred stock........... $ 4,759 $ 30,759 $ 32,259 $ 32,259 $ 52,255 $ 58,109 Total stockholders' equity (deficit)............. $(5,461) $(11,833) $(17,990) $(31,050) $(43,322) $(48,111)- -------------------------------------------------------------------------------- 26- -------------------------------------------------------------------------------- Management'sfollowing discussion and analysis of our financial condition and results of operationsYOU SHOULD READ THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS IN CONJUNCTION WITH THE FINANCIAL STATEMENTS AND THE NOTES TO THOSE STATEMENTS INCLUDED ELSEWHERE IN THIS PROSPECTUS. THIS DISCUSSION MAY CONTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. AS A RESULT OF MANY FACTORS, SUCH AS THOSE SET FORTH UNDER "RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS, OUR ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS. OVERVIEWtogether with our consolidated financial statements and the related notes appearing at the end of this prospectus. Some of the information contained in this discussion and analysis or set forth elsewhere in this prospectus, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. You should review the "Risk Factors" section of this prospectus for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.Overview
We are a leader in the development, manufacture and distribution of solid-state medical imaging products and services. We were the first
and onlycompany tohave developeddevelop andcommercializedcommercialize a solid-statedigitalmedical gamma camera forusethe detection of cardiovascular disease and other medical conditions. Our high performance imaging systems are mobile and provide enhanced operability and reliability and improved patient comfort and utilization when compared to traditional vacuum tube cameras. The cameras and accompanying equipment fit easily into spaces as small as seven feet by eight feet and facilitate the delivery of nuclear medicine procedures directly innuclear medicine. We sell our solid-state, digitala physician's office, an outpatient hospital setting or within multiple departments of a hospital. As of March 31, 2004, we had an installed base of 326 gamma cameras,and related equipment to physician practices, imaging centers, hospitals and research laboratoriesover 95% of which were in the United States,Canada and Japan. We also useincluding 59 cameras operated by ourproprietary technology to provide mobile nuclear imaging services to physician offices and imaging centers through ourwholly-owned subsidiaries, Digirad Imaging Solutions,business unit,Inc. and Digirad Imaging Systems, Inc., which we refer to collectively as DIS.According to industry reports, the growth rates in 2002 for procedures performed in physician offices was approximately 44% and in hospitals was approximately 6%. We believe this trend is driven by the desire of cardiologists to control their patients' diagnosis and treatment and to generate revenue that would otherwise be lost if the patient were referred to a hospital or
DIS. We incorporated as San Diego Semiconductorimaging center. The mobile feature of our technology also provides us with a significant advantage in1985. In 1994,the delivery of nuclear cardiology imaging services. Through DIS, wechangedoffer FlexImaging, ournamemobile and comprehensive leasing service for physicians who wish toDigirad Corporationperform nuclear cardiology andbegan developmentnuclear medicine procedures in their offices, but do not have the patient volume, capital or personnel to justify purchasing an imaging system. DIS is currently offered in 17 states and the District ofa solid-state gamma cameraColumbia. Physicians enter into annual contracts fornuclear imaging applications. Between 1994 and 1998, we developed and tested our proprietary technology, financing our research operations with equity investments. We began production of the current generation solid-state digital gamma camera in 1999, and commercial shipments commenced in March 2000. As of June 30, 2001, we had taken orders for 117 gamma cameras, of which 59 have been shipped. In the second half of 2000, we formed DIS to provide turn-key nuclear cardiacimaging services delivered on a per-day basis. Our annual lease contracts typically provide for one day of service per week. We sell our imaging systems to physicianoffices. We enteredpractices, outpatient clinics and hospitals primarily in theservice business via the strategic acquisitionUnited States and have sold a limited number ofcertain assets of two operators that provide us with both critical mass and platforms for growth of ourimagingservices business: - - During the third quarter of 2000, we acquired some of the customer contracts and select assets relating to the mobile nuclear imaging services of Florida Cardiology and Nuclear Medicine Group, a provider of mobile and fixed site nuclear imaging services in Florida. At the time of the acquisition, Florida Cardiology was operating two mobile routes. - - During the fourth quarter of 2000, we acquired some of the customer contracts and select assets relating to the mobile nuclear imaging services of Nuclear Imaging Systems, Inc. and Cardiovascular Concepts, P.C., which together provided mobile and fixed site nuclear imaging services in New Jersey, North Carolina, Maryland and Pennsylvania. At the time of the acquisition, these two companies were operating nine mobile routes. We have incurred substantial operating losses since our inception. As of June 30, 2001, our accumulated deficit was $51.0 million. We expect to spend substantial additional amounts to increase marketing, direct sales, imaging services, training and customer support needed to support our increasing revenues. We derive revenues both from selling our products and providing imaging services. We generated approximately 70% of our revenues for the six months ended June 30, 2001 from sales of our products.systems internationally. Our product revenue consists of sales of our solid-state gamma cameras, custom designed chairs and accessories, such as printers, viewing workstations, connectivity andcollimators. We generated approximately 30% of our revenues for - -------------------------------------------------------------------------------- 27MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- the six months ended June 30, 2001collimators and revenue from ourimaging services business. We derivemaintenance contracts.In 2000, we sold our
imaging services revenue from the provision of mobile nuclear imaging services. We provide mobile nuclear imaging services to physician offices, which include cardiology and internal medicine practices, on a turn-key basis utilizing our proprietary DIGIRAD(TM) 2020TC Imager(TM)first solid-state gamma camera and launched our DIS business. From 2000 to 2003, our consolidated revenues grew from $7.1 million to $56.2 million, and were $15.9 million for theSPECTour(TM) chair. We offer this imaging service on a contract basis, with the typical contract length being one tothreeyearsmonths ended March 31, 2004. DIS andcomprised of one day of service per week. As we continue to grow, we expect our imaging services revenue to accountproduct revenues accounted fora majority of total revenues. We sell our products to customers in North America62.0% andJapan. A relatively small number of customers account for a significant percentage38.0%, respectively, of ourrevenues. Forconsolidated revenues for the year ended December 31,2000, three customers accounted for 15.9%2003 and 65.6% and 34.4%,11.6% and 10.1%respectively, of our consolidatedrevenues. However,revenues for thesixthree months endedJune 30, 2001, no customers accounted for 10% or moreMarch 31, 2004. Given the recurring contractual revenue stream from our DIS business and our strategy to continue to expand the number of areas where we offer DIS services, we expect DIS revenue to continue to grow at a higher rate than product revenue and to continue to represent a large percentage of consolidated revenues. We attribute the overall growth of our business to geographical expansion, increased market penetration, awareness and acceptance, and the shift in the delivery of nuclear cardiology imaging procedures from hospitals to physician offices.We reduced our net loss by $11.1 million from $12.8 million in 2002 to $1.7 million in 2003 and from $927,000 for the three months ended March 31, 2003 to $266,000 for the three months ended March 31, 2004. Furthermore, we have incurred substantial operating losses since our inception. As of March 31, 2004, our accumulated deficit was $80.5 million. We believe that we will achieve our first full year of profitability in 2004, and intend to continue to enhance profitability through increased volume and improved margins, although we may incur losses in any given quarter.
We experience some seasonality in our DIS business as a result of winter holidays, inclement weather and summer slowdowns principally relating to vacations. Historically, these variables have had the
serviceleast impact on our second quarter operating results.In April 2004, we completed the transition of our manufacturing operations from several separate facilities to a single facility in Poway, California. We believe this will consolidate our operations and improve efficiencies. We currently purchase some components from sole source providers and are qualifying or seeking second source providers in an effort to diversify our providers.
Results Of Operations
The following table sets forth our results from operations, expressed as percentages of revenues for the years ended December 31, 2001, 2002 and 2003, and for the three months ended March 31, 2003 and 2004:
Three Months Ended
March 31,2001 2002 2003 2003 2004 Revenues: DIS 36.2 % 55.4 % 62.0 % 57.8 % 65.6 % Product 63.8 44.6 38.0 42.2 34.4 Total revenues 100.0 100.0 100.0 100.0 100.0 Cost of revenues: DIS 29.5 40.0 43.5 43.5 45.8 Product 46.5 32.8 26.8 29.6 22.9 Stock-based compensation 1.1 0.3 0.2 0.0 0.7 Total cost of revenues 77.1 73.1 70.5 73.1 69.4 Gross profit 22.9 26.9 29.5 26.9 30.6 Operating expenses: Research and development 10.6 7.1 3.9 4.5 4.1 Sales and marketing 35.3 19.4 10.7 11.9 11.2 General and administrative 28.9 22.9 14.4 14.2 13.5 Amortization and impairment of intangible assets 3.5 2.4 0.8 0.9 0.1 Stock-based compensation 4.5 1.2 0.2 0.0 1.2 Total operating expenses 82.8 53.0 30.0 31.5 30.1 Income (loss) from operations (59.9 ) (26.1 ) (0.5 ) (4.6 ) 0.5 Other income (expense) (10.4 ) (4.7 ) (2.5 ) (2.5 ) (2.1 ) Accretion of deferred issuance costs on preferred stock (0.5 ) (0.6 ) (0.6 ) (0.7 ) (0.6 ) Net loss applicable to common stockholders (70.8 )% (31.4 )% (3.6 )% (7.8 )% (2.2 )% Comparison of Three Months Ended March 31, 2004 and 2003
Revenues
Consolidated. Our revenues are divided between two primary operating segments: product sales and our DIS
customers. For example,business. Our product revenue consists primarily of selling ourstudy volumes typically decline fromsolid-state gamma cameras and accessories to physicians, outpatient clinics and hospitals. DIS revenue is comprised of performing oursecond fiscal quarterDIS services for physicians on a per day basis in accordance with a 12-month lease with annual commitmentlevels. Our standard lease terms provide for automatic renewals for an additional 12-month period if the lease is not terminated in writing by the customer generally 90 days or more prior to
our third fiscal quarter due to summer holidays and vacation schedules. We may also experience declining study volumes in December due to holidays and inthefirst quarter due to weather conditions in certain partsend of thecountry. These seasonal factors may lead to fluctuations in our quarterly operating results. It is difficult for us to evaluate the degree to which the summer slowdown, winter holiday variations and inclement weather may make our revenues unpredictable in the future. We may not be able to reduce our expenses, including our debt service obligations, quickly enough to respond to these declines in revenue, which would make our business difficult to operate and would harm our financial results. RESULTS OF OPERATIONS COMPARISON OF SIX MONTHS ENDED JUNE 30, 2001 AND 2000 REVENUES TOTAL REVENUES--Totalterm.Consolidated revenues increased to
$14.0$15.9 million for thesixthree months endedJune 30, 2001March 31, 2004 from$1.5$13.0 million for thecomparable period in 2000. PRODUCTS--Our product revenue increased to $9.8 million for the sixthree months endedJune 30, 2001 from $1.5March 31, 2003, which represents an increase of $2.9 million, or 22.3%, primarily as a result of increased demand forthe comparable period in 2000. This increaseour DIS services. We believe that this increased demand wasdue toa result of increasedsalescustomer awareness and acceptance of ourgamma cameras, from six in the first six months of 2000 to 36 in the comparable period in 2001. Our backlog of gamma camera orders was 58 as of June 30, 2001. Productproducts and services. DIS and product revenue accounted for70%65.6% and 34.4%, respectively, of total revenues for thefirst sixthree monthsof 2001 versus 100%ended March 31, 2004, compared to 57.8% and 42.2%, respectively, for thefirst sixthree months ended March 31, 2003. We expect DIS revenue to continue to grow at a higher rate than product revenue and to continue to represent a large percentage of2000. IMAGING SERVICES--Our imaging servicesconsolidated revenue.DIS. Our DIS revenue
was $4.2increased to $10.4 million for thesixthree months endedJune 30, 2001. We did not have any imaging services revenue duringMarch 31, 2004 from $7.5 million for thesixthree months endedJune 30, 2000, as we did not start this business untilMarch 31, 2003, which represents an increase of $2.9 million, or 38.7%. The increase in DIS revenue resulted from an increase in thesecond halfnumber of2000. We performed approximately 6,900 proceduresDIS service days from 2,010 for thesixthree months endedJune 30, 2001,March 31, 2003 to 2,734 for the three months ended March 31, 2004, which was primarily attributable to an increase in the number of physicians purchasing our DIS services. We deployed five additional mobile systems in the first quarter of 2004. Collectively, our DIS business operated 59 mobile andwere operating 18 mobile servicing routesfixed site systems as ofJune 30, 2001. Imaging servicesMarch 31, 2004 as compared to 46 as of March 31, 2003. We anticipate that our DIS revenueaccountedwill increase if we expand into new markets and continue to penetrate existing markets.Product. Our product revenue remained flat at $5.5 million for
30%the three months ended March 31, 2004 compared to the same period oftotalthe prior year. While the number of gamma cameras sold increased, our net product revenue decreased by approximately $15,000 primarily because of premiums received on international gamma camera sales for the three months ended March 31, 2003 and in part because of lower average selling prices on our dual-head gamma cameras for the three months ended March 31, 2004. Our Cardius product line represented 73.2% of our product revenues for thefirst sixthree months ended March 31, 2004, compared to 22.2% for the three months ended March 31, 2003. While we expect pricing pressures on our gamma cameras to continue, we also anticipate demand, particularly for our Cardius product line, will continue to increase, potentially more than offsetting the effects of2001. COST OF REVENUES TOTAL COST OF REVENUES--Total cost of revenuesthese pricing pressures.Gross Profit
Consolidated. Consolidated gross profit increased to
$9.8$4.8 million for thesixthree months endedJune 30, 2001March 31, 2004 from$3.6$3.5 million for thesame period in 2000. PRODUCTS--Costthree months ended March 31, 2003, which represents an increase ofproduct revenue consists primarily$1.4 million, or 38.7%. Consolidated gross profit as a percentage ofmaterials, labor and other costs associated with the products we sell. Our cost of productrevenue increased to$6.4 million30.6% for thesixthree months endedJune 30, 2001March 31, 2004 from$3.6 million26.9% for thecomparable period in 2000. Thethree months ended March 31, 2003, primarily as a result of an increase intherevenue, lower per unit DIS imaging service costs and product cost reductions.DIS. Cost of
- -------------------------------------------------------------------------------- 28MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- product revenue for the first six months of 2001 was due primarily to the increase in the volume of cameras and accessories sold. However, cost reductions in the manufacturing process partially offset the increase. As a percentage of product revenue, cost of product revenue was 66% in the first six months of 2001. IMAGING SERVICES--Cost of imaging servicesDIS revenue consists primarily of labor, radiopharmaceuticals, equipment depreciation and other costs associated with the provision of services. Ourcostclinical and regulatory headcount relating to our DIS business increased to 150 employees at March 31, 2004 from 121 employees at March 31, 2003. Cost ofimaging servicesDIS revenuewas $3.4increased to $7.3 million for thesixthree months endedJune 30, 2001. There was noMarch 31, 2004 from $5.6 million for the three months ended March 31, 2003, which represents an increase of $1.6 million, or 28.8%, primarily as a result of our increased direct headcount. DIS gross profit increased to $3.1 million for the three months ended March 31, 2004 from $1.9 million for the three months ended March 31, 2003, which represents an increase of $1.3 million, or 68.9%, as a result of increased volumes and reductions in the per unit cost of various items consumed in providing the imagingservices revenue for the comparable period in 2000. Asservices. DIS gross profit as a percentage ofimaging servicesrevenue increased to 30.2% for the three months ended March 31, 2004 from 24.8% for the three months ended March 31, 2003.Product. Cost of goods sold primarily consists of materials, labor and overhead costs associated with the manufacturing and warranty of our products. Warranty costs are charged to cost of
servicesgoods sold in theperiod our cameras are sold and are based on our historical experience with failure rates and repair costs. Warranty reserves are reviewed monthly and if necessary, warranty expense is adjusted. Cost of goods sold decreased to $3.6 million for the three months ended March 31, 2004 from $3.8 million for the three months ended March 31, 2003, which represents a decrease of $202,000, or 5.2%. Product gross profit increased to $1.8 million for the three months ended March 31, 2004 from $1.6 million for the three months ended March 31, 2003, which represents an increase of $186,000, or 11.4%, primarily as a result of the decrease in cost of goods sold and reduced costs per unit resulting from increased manufacturing volumes, fewer and lower-cost materials and more efficient manufacturing processes used to build our third-generation camera heads introduced in July 2003. Product gross profit as a percentage of revenue
was 81% inincreased to 33.4% for thefirst sixthree monthsof 2001. OPERATING EXPENSES RESEARCH AND DEVELOPMENT--Researchended March 31, 2004 from 29.9% for the three months ended March 31, 2003.Operating Expenses
Research and Development. Research and development expenses consist primarily of costs associated with the design, development, testing, deployment and enhancement of our products and manufacturing capabilities. The primary costs are salaries and fringe benefits, consulting fees, facilities and overhead charges and nonrecurring engineering costs, such as tooling and other one-time costs associated with manufacturing. Research and development expenses increased to
$1.3 million$640,000 for thesixthree months endedJune 30, 2001March 31, 2004 from$1.1 million in the comparable period in 2000. An increase in headcount, materials and other direct and indirect costs in support of our continued product development account primarily$579,000 for the three months ended March 31, 2003, which represents an increaseinof $61,000, or 10.5%. This increase was primarily attributable to increased employee headcount to develop new products. Research and development headcount increased to 17 employees at the end of March 31, 2004 from 15 employees at the end of March 31, 2003. In the future, we expect to continue to invest between approximately 10% and 12% of product revenue on research and developmentexpenses for the first six months of 2001. For the first six months of 2001, researchas we continue to improve our existing technology anddevelopment expenses amounted to 9% of total revenue. SALES AND MARKETING--Salesinnovate.Sales and Marketing. Sales and marketing expenses consist primarily of salaries, commissions, bonuses, recruiting costs, travel, marketing and collateral materials and
trade shows.tradeshow costs. Sales and marketing expenses increased to$4.0$1.8 million for thesixthree months endedJune 30, 2001March 31, 2004, from$1.3$1.5 million for the three months ended March 31, 2003, which represents an increase of $234,000, or 15.1%. This increase was primarily attributable to an increase in thecomparable period in 2000. Our continued developmentnumber of sales and marketing personnel and expansion of our marketing efforts. For the three months ended March 31, 2004, sales and marketing expenses were 11.2% of total revenue, compared to 11.9% for the three months ended March 31, 2003. We expect to increase our sales and marketingfunctions to support the salesefforts, as we focus on increasing market awareness of ourgamma cameraproducts andthe growth of our mobile nuclear imaging services business accounted primarily for the increase in salesofferings.General and
marketing expenses. For the first six months of 2001, sales and marketing expenses amounted to 29% of total revenue. GENERAL AND ADMINISTRATIVE--GeneralAdministrative. General and administrative expenses consist primarily of salaries and other related costs for finance and accounting, human resources and other personnel, as well asaccounting,legal and other professionalfees.fees and insurance. General and administrative expenses increased to$2.9$2.1 million for thesixthree months endedJune 30, 2001March 31, 2004 from$1.1$1.9 millionin the comparable period in 2000. Increased headcount and related costs account primarilyfor the three months ended March 31, 2003, which represents an increase of $294,000, or 15.9%. Increases in headcount, insurance costs, recruiting costs and DIS billing and collection fees, all contributed to increased general and administrative expenses.ForGeneral and administrative headcount was increased by seven employees by thefirst six monthsend of2001,March 31, 2004 to 40 employees from 33 employees at the end of March 31, 2003. At the end of March 31, 2004, general and administrative expenses amounted to21%13.5% of totalrevenue. AMORTIZATION OF INTANGIBLE ASSETS--Intangiblerevenue compared to 14.3% at the end of March 31, 2003. If the offering contemplated by this prospectus is completed, we will be required to incur additional general and administrative costs to meet various public reporting and compliance requirements.Amortization and Impairment of Intangible Assets. Intangible assets primarily represent
acquiredcustomer contractsa covenant not-to-compete, and the capitalized costs relatedrelating to our DIS business that we acquired from a third party in 2000 and capitalized patent and trademarkportfolio.portfolio costs, both of which are amortized over their respective useful life. Amortization and impairment of intangiblesincreaseddecreased to$315,000$16,000 for thesixthree months endedJune 30, 2001March 31, 2004 from$3,000$119,000 for the three months ended March 31, 2003. This decline was principally a result of impairmentcharges recorded during fiscal 2003, causing reduced amortization expense in future periods, beginning in the
comparable period in 2000. The acquisition of customer contracts from Florida Cardiology and Nuclear Imaging Systems, Inc. in the third and fourth quarters of 2000 primarily accountedfirst quarter ended March 31, 2004.Stock-Based Compensation Charges. Deferred compensation for
the increase in amortization of intangible assets. DEFERRED COMPENSATION AND OTHER NON-CASH STOCK COMPENSATION CHARGES--Deferredstockcompensation representsoptions granted has been determined as the difference between theestimatedexercise price and the fair value of our common stockand the exercise price of options aton the date of grant. Options or awards issued to non-employees are recorded at their fair value in accordance with SFAS No. 123 and periodically remeasured in accordance with EITF 96-18 and recognized over the respective service or vesting period. In connection with the grant of stock options to employees,and directors,we recorded deferred stock-based compensation of$2.0$1.2 million and zero for thesixthree months endedJune 30, 2001.March 31, 2004 and 2003, respectively. We recordedthis amountthese amounts as a component of stockholders' equity andwill amortizeare amortizing the amount, on an accelerated basis, as a non-cash charge to cost of revenues and operations over the vesting period of the options.We recorded amortization of deferred compensation and other non-cash compensation charges of $1.1 million for the six months - -------------------------------------------------------------------------------- 29MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- ended June 30, 2001. No deferred compensation was incurred or amortized during the six months ended June 30, 2000. INTEREST EXPENSE Interest expense increased to $545,000 for the six months ended June 30, 2001 from $221,000 for the comparable period in 2000. Increased borrowing under notes payable and capital leases in the latter part of 2000 and the first six months of 2001 account primarily for the increase in interest expense. INTEREST INCOME Interest income increased moderately to $145,000 for the six months ended June 30, 2001 from $124,000 for the comparable period in 2000 primarily due to slightly higher average cash balances. NET LOSS Net loss increased to $5.8 million for the six months ended June 30, 2001 from $5.7 million in the comparable period in 2000 as a result of the factors described above. COMPARISON OF YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 REVENUES TOTAL REVENUES--Total revenues increased to $7.1 million in 2000 from $0.3 million in 1999. Total revenues decreased in 1999 from $1.9 million in 1998. The decrease in 1999 from 1998 was due to $1.6 million of non-recurring license fees and milestone payments recognized in 1998 under a collaborative supply and development agreement. PRODUCTS--Our product revenue increased to $5.8 million in 2000 from $0.3 million in 1999 and $0.3 million in 1998. Sales of our gamma cameras, first sold in 2000, account for the increase in product revenue. Product revenue accounted for 82% of total revenues in 2000 versus 100% in 1999 and 18% in 1998. IMAGING SERVICES--Our imaging services revenue was $1.3 million in 2000. We did not have any imaging services revenue in 1999 or 1998. The 2000 imaging services revenue was the result of our entry into the mobile nuclear imaging services business. Imaging services revenue accounted for 18% of total revenues in 2000. COST OF REVENUES TOTAL COST OF REVENUES--Total cost of revenues increased to $10.7 million in 2000 from $0.3 million in 1999 and $0.4 million in 1998. PRODUCTS--Our cost of product revenue increased to $9.8 million in 2000 from $0.3 million in 1999 and $0.4 million in 1998. Costs associated with the launch of our gamma cameras were the primary reason for the increase in cost of product revenue in 2000. IMAGING SERVICES--Our cost of imaging services revenue was $0.8 million in 2000. There was no cost of service revenue for 1999 or 1998. As a percentage of imaging services revenue, cost of service revenue was 67% in 2000. OPERATING EXPENSES RESEARCH AND DEVELOPMENT--Research and development expenses decreased to $2.4 million in 2000 from $10.1 million in 1999. Research and development expenses increased in 1999 from $5.4 million in 1998. Our transition from development to production prior to the first shipments of our gamma cameras in the first quarter of 2000 was the primary reason for the decrease in research and development expenses. Most direct and indirect expenses charged to research and development - -------------------------------------------------------------------------------- 30MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- expenses in 1999 and 1998 were accounted for as manufacturing expenses in 2000 when we began commercial production. Research and development expenses amounted to 34% of total revenues in 2000. The increase in research and development expenses from 1998 to 1999 was related primarily to an increase in headcount, materials and other direct and indirect costs for the completion of alpha and beta units of our gamma camera. SALES AND MARKETING--Sales and marketing expenses increased to $3.6 million in 2000 from $1.5 million in 1999 and $0.6 million in 1998. These increases in sales and marketing expense were related primarily to the build out of our sales infrastructure to support the sales of our gamma camera and the start-up of our mobile nuclear imaging services business. Sales and marketing expenses amounted to 51% of total revenues in 2000. GENERAL AND ADMINISTRATIVE--General and administrative expenses increased to $2.9 million in 2000 from $2.0 million in 1999 and decreased in 1999 from $2.5 million in 1998. The changes in general and administrative expense were primarily due to corresponding changes in headcount and related costs. General and administrative expenses amounted to 41% of total revenues in 2000. AMORTIZATION OF INTANGIBLE ASSETS--Amortization of intangible assets was $209,000 in 2000. We had no significant intangible asset amortization in 1999 and 1998. The acquisition of customer contracts from Florida Cardiology and Nuclear Imaging Systems, Inc. primarily accounted for the increase. DEFERRED COMPENSATION AND OTHER NON-CASH STOCK COMPENSATION CHARGES--InIn connection with the grant of stock options to employees,and directors,we recordeddeferredas amortization of stock-based compensation of$0.8 million$304,000 and $2,000 for2000.the three months ended March 31, 2004 and 2003, respectively. Werecorded this amount as a component of stockholders' equity and will amortize the amount as a chargeexpect that charges tooperations over the vesting period of the options. We recordedbe recognized in future periods from amortization of deferred compensation related to employee stock options grants will be $293,000, $226,000 andother non-cash stock compensation charges$185,000 for the three months ended June 30, September 30 and December 31 of$0.3 million during 2000. INTEREST EXPENSE2004, respectively, and $996,000, $485,000, $231,000 and $70,000 for the years ending December 31, 2004, 2005, 2006 and 2007, respectively.Other Income (Expense)
Interest expense
increaseddecreased to$780,000 in 2000 from $87,000 in 1999 and $46,000 in 1998. The addition of $2.0 million in notes payable for general corporate purposes and working capital, as well as a $4.2 million increase in capital leases, were the primary reasons$323,000 for theincreasethree months ended March 31, 2004 from $336,000 for the three months ended March 31, 2003, which represents a decrease of $13,000, or 3.9%. The reduction is a result of a decrease in the variable interestexpense. INTEREST INCOME Interest incomerates on two accounts receivable credit lines and a reduction on capital leases.Other expenses for the three months ended March 31, 2004 represented a loss on disposals of assets.
Net Loss
Net loss decreased to
$243,000 in 2000 from $360,000 in 1999 and $903,000 in 1998. Declining average cash balances resulting from operational spending along with asset and property and equipment acquisitions are primarily responsible$266,000 for the three months ended March 31, 2004 from $927,000 for the three months ended March 31, 2003, which represents a decreasein interest income. NET LOSS Net loss increased to $13.5 million in 2000 from $13.2 million in 1999 and $6.2 million in 1998of $661,000, or 71.3%, as a result of the factors described above.LIQUIDITY AND CAPITAL RESOURCESComparison of Years Ended December 31, 2003 and 2002
Revenues
Consolidated. Consolidated revenues in 2003 increased to $56.2 million from $41.5 million in 2002, which represents an increase of $14.7 million, or 35.4%, primarily as a result of increased demand for our DIS services and our Cardius products.
DIS. Our DIS revenue increased to $34.8 million in 2003 from $23.0 million in 2002, which represents an increase of $11.8 million, or 51.5%. The increase in DIS revenue resulted from an increase in the number of DIS service days from 6,567 for the year ended December 31, 2002 to 9,425 for the year ended December 31, 2003, which was primarily attributable to an increase in the number of physicians purchasing our DIS services. To respond to this demand, we deployed eight additional mobile systems in the year ended December 31, 2003. DIS revenue accounted for 62.0% of total revenues in 2003 versus 55.4% in 2002. Collectively, our DIS business operated 54 mobile and fixed site systems as of December 31, 2003.
Product. Our product revenue increased to $21.4 million in 2003 from $18.5 million in 2002, which represents an increase of $2.9 million, or 15.4%. This increase was due to increased sales of our gamma cameras and maintenance contract revenue. We sold 79 cameras in 2003 compared to 75 cameras in 2002. Product revenue accounted for 38.0% of total revenues for 2003 versus 44.6% in 2002. Maintenance contract revenues were $2.1 million in 2003 and $521,000 in 2002.
Gross Profit
Consolidated. Consolidated gross profit increased to $16.6 million in 2003 from $11.2 million in 2002, which represents an increase of $5.4 million, or 48.2%. Consolidated gross profit as a percentage of revenue increased to 29.5% in 2003 from 26.9% in 2002 primarily as a result of an increase in revenue, lower per unit DIS imaging service cost and product cost reductions.
DIS. Our clinical and regulatory headcount relating to our DIS business increased to 137 employees at the end of 2003 from 112 employees at the end of 2002. Cost of DIS revenue increased to $24.5 million in 2003 from $16.6 million in 2002, which represents an increase of $7.9 million, or 47.4%. DIS gross profit increased to $10.4 million in 2003 from $6.4 million in 2002, which represents an increase of $4.0 million, or 62.1%, as a result of increased volumes and reductions in the per unit cost of various items consumed in providing the imaging services. DIS gross profit as a percentage of revenue increased to 29.8% in 2003 from 27.8% in 2002.
Product. Cost of goods sold increased to $15.1 million in 2003 from $13.6 million in 2002, which represents an increase of $1.5 million, or 10.7%. Product gross profit increased to $6.3 million in 2003 from $4.9 million in 2002, which represents an increase of $1.4 million, or 28.6%, as a result of the increase in the volume of cameras produced, fewer and lower-cost materials and more efficient manufacturing processes due to the introduction of our third-generation camera heads. Our third-generation camera heads consist of fewer and lower-cost materials than our earlier generation camera heads and are produced using more efficient processes that have reduced overhead and labor costs compared to historical rates. Product gross profit as a percentage of revenue increased to 29.4% in 2003 from 26.4% in 2002.
Operating Expenses
Research and Development. Research and development expenses decreased to $2.2 million in 2003 from $3.0 million in 2002, which represents a decrease of $776,000, or 26.2%, primarily as a result of our efforts to develop and launch our Cardius camera product line in 2002. Research and development headcount increased to 16 employees in 2003 from 14 employees in 2002.
Sales and Marketing. Sales and marketing expenses decreased to $6.0 million in 2003 from $8.1 million in 2002, which represents a decrease of $2.1 million, or 25.5%. In late 2002, we restructured the management of the sales organization and modified the compensation structure, resulting in a significant reduction in sales expense both in dollars and as a percent of revenue. In 2003, sales and marketing expenses were 10.7% of total revenue versus 19.4% in 2002.
General and Administrative. General and administrative expenses decreased to $8.1 million in 2003 from $9.5 million in 2002, which represents a decrease of $1.4 million, or 14.7%. Reduced outside legal expenses, which were partially offset by the addition of in-house general counsel, and a reduction in headquarters headcount, all contributed to lower general and administrative expenses. General and administrative headcount was reduced by one employee by the end of 2003 to 33 employees versus 34 employees at the end of 2002. In 2003, general and administrative expenses amounted to 14.4% of total revenue versus 22.9% in 2002.
Amortization and Impairment of Intangible Assets. Amortization and impairment of intangibles decreased to $444,000 in 2003 from $1.0 million in 2002. The significant decline from 2002 to 2003 was principally a result of impairment charges recorded in 2002 associated with these purchased contracts.
Stock-Based Compensation Charges. In connection with the grant of stock options to employees, we recorded as amortization of stock-based compensation of $226,000 and $606,000 for the years ended December 31, 2003 and 2002, respectively.
Other Income (Expense)
Interest expense decreased to $1.4 million in 2003 from $2.0 million in 2002, which represents a decrease of $558,000, or 28.1%. The reduction is a result of a decrease in the variable interest rates on two accounts receivable credit lines and a reduction on capital leases, and $243,000 of debt discount associated with our $1.9 million bridge financing in 2002.
Interest income decreased to $35,000 in 2003 from $65,000 in 2002, which represents a decrease of $30,000, or 45.6%, primarily due to lower interest rates in 2003 on cash and cash equivalent accounts.
Net Loss
Net loss decreased to $1.7 million in 2003 from $12.8 million in 2002, which represents a decrease of $11.1 million, or 86.8%, as a result of the factors described above.
Comparison of Years Ended December 31, 2002 and 2001
Revenues
Consolidated. Our consolidated revenues increased to $41.5 million in 2002 from $28.3 million in 2001, which represents an increase of $13.2 million, or 46.7%. This increase was due primarily to a significant increase in DIS imaging services volume as DIS began to achieve more market acceptance.
DIS. Our DIS revenue increased to $23.0 million in 2002 compared to $10.2 million in 2001, which represents an increase of $12.8 million, or 124.7%, resulting primarily from geographical expansion and market acceptance. Our DIS revenue accounted for 55.4% of total revenues in 2002 versus 36.2% in 2001.
Product. Our product sales revenue increased to $18.5 million in 2002 from $18.1 million in 2001, which represents an increase of $462,000, or 2.6%, in 2002. The minor increase was a result of our decision to flatten the sales and marketing organization, resulting in a low product sales growth rate over the prior year. Product revenue accounted for 44.6% of total revenues in 2002 versus 63.8% in 2001.
Gross Profit
Consolidated. Consolidated gross profit increased to $11.2 million in 2002 from $6.5 million in 2001, which represents an increase of $4.7 million, or 72.8%. Consolidated gross profit as a percentage of revenue increased to 26.9% in 2002 from 22.9% in 2001, primarily as a result of a year-to-year increase in revenue and lower cost per day to perform our DIS services.
DIS. Cost of DIS revenue increased to $16.6 million in 2002 from $8.3 million in 2001, which represents an increase of $8.3 million, or 98.9%. DIS gross profit increased to $6.4 million in 2002 from $1.9 million in 2001, which represents an increase of $4.5 million, or 238.1%, as a result of increased volume and other servicing efficiencies as DIS expanded geographically within the United States. DIS gross profit as a percentage of revenue increased to 27.8% in 2002 from 18.5% in 2001.
Product. Cost of goods sold increased to $13.6 million in 2002 from $13.2 million in 2001, which represents an increase of $440,000, or 3.3%. Product gross profit remained flat at $4.9 million from 2001 to 2002. Product gross profit as a percentage of revenue decreased to 26.4% in 2002 from 27.0% in 2001.
Operating Expenses
Research and Development. Research and development expenses were $3.0 million in both 2001 and 2002. Although we reduced the number of employees in 2002, the launch of the Cardius camera line and associated expenses offset any reductions in research and development expenses. We reduced our research and development headcount in 2002 to 14 employees from 25 employees at the end of 2001. Research and development expenses amounted to 7.1% of consolidated revenues in 2002 versus 10.6% in 2001.
Sales and Marketing. Sales and marketing expenses decreased to $8.1 million in 2002 from $10.0 million in 2001, which represents a decrease of $1.9 million, or 19.1%. The decrease in sales and marketing expense was related primarily to reductions in our sales and marketing personnel in early 2002 as we repositioned ourselves to focus on profitable growth. Sales and marketing headcount was reduced to 29 employees at the end of 2002 versus 50 employees at the end of 2001. Sales and marketing expenses amounted to 19.4% of consolidated revenues in 2002 compared to 35.2% in 2001.
General and Administrative. General and administrative expenses increased to $9.5 million in 2002 from $8.2 million in 2001, which represents an increase of $1.3 million, or 16.4%. The increase resulted primarily from increases in accounting, human resource and other administrative headcount expenses and settlement fees in 2002. General and administrative expenses amounted to 22.9% of consolidated revenues in 2002, compared to 28.8% in 2001.
Amortization and Impairment of Intangible Assets. Amortization of intangible assets is primarily amortization of capitalized costs associated with purchased contracts and capitalized patent and trademark costs; both are amortized over their respective useful life. Amortization and impairment of intangible assets was constant year-to-year, $1.0 million in 2002 and 2001.
Stock-Based Compensation Charges. Total stock-based compensation decreased to $606,000, or 62.7%, in 2002 from $1.6 million in 2001, which represents a decrease of $972,000, or 61.6%, as the remaining deferred compensation was recorded in 2002.
Other Income (Expense)
Interest expense increased to $2.0 million in 2002 from $1.4 million in 2001, which represents an increase of $551,000, or 38.3%. The increase was primarily attributable to increases in the accounts receivable credit line borrowings and an increase in capital equipment lease lines for DIS equipment. We also incurred $243,000 of expense in conjunction with our bridge financing in 2002.
Interest income decreased to $65,000 in 2002 from $118,000 in 2001, which represents a decrease of $53,000, or 44.9%, due to the termination of a sales-type lease in 2002. The lease was entered into in 2001 and is the only sales-type lease we have ever recorded. We have no intention to enter into other sales-type lease arrangements in our forseeable future.
Other expenses were $1.6 million in 2001, which were related to the costs incurred in connection for a proposed initial public offering which was not completed.
Net Loss
Net loss decreased to $12.8 million in 2002 from $19.9 million in 2001, which represents a decrease of $7.1 million, or 35.9%. Net loss in 2001 decreased as a result of the factors described above.
Liquidity And Capital Resources
General
We require capital principally for operating our DIS business, interest payments, working capital, debt service and capital expenditures. Our capital expenditures consist primarily of manufactured DIS cameras, computer hardware and software. Working capital is required principally to finance accounts receivable and inventory. Our working capital requirements vary from period to period depending on manufacturing volumes, the timing of deliveries and the payment cycles of our customers and payors.
We have historically funded our operations principally through private equity financings supplemented with
long-term debt andcredit lines, equipment financingarrangements. The equity investments were in the form of six seriesarrangements and cash from operations. We completed seven private placements of preferred stockofferingsbetween March 1995 andAugust 2001, which yieldedJune 2002, yielding aggregate net proceedstotalingof approximately$66$83.5 million. AtJune 30, 2001,March 31, 2004, our outstanding borrowingstotaled
$11.4$15.8 million.- --------------------------------------------------------------------------------Based upon our current level of expenditures, we believe proceeds from this offering, together with cash flows from operating activities, availability under our current or future revolving credit lines will be adequate to meet our anticipated cash requirements for interest payments, working capital, debt service and capital expenditures for the next 12 months.Our preferred stock is redeemable on or after July 31,
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - --------------------------------------------------------------------------------2004 upon the request of certain preferred stock investors. We must redeem all outstanding shares of our preferred stock by paying in cash its redemption value plus declared but unpaid dividends which, as of March 31, 2004, equaled a total of $119.4 million. No dividends have been declared through March 31, 2004. If the funds of our company that are legally available for redemption are insufficient to redeem the total number of preferred shares to be redeemed, those funds which are legally available must be used to redeem the maximum possible number of shares pro rata among the various series of preferred stock. Upon completion of this offering all of our outstanding shares of preferred stock automatically will convert into 12,444,294 shares of our common stock. If the offering contemplated by this prospectus is not completed, and the redeemable preferred shares remain outstanding, we do not anticipate having legally available funds to redeem any portion of the preferred shares in 2004.As of
June 30, 2001,March 31, 2004, cash and cash equivalents totaled$3.5$8.9 million compared to$6.6$7.7 million at December 31,2000.2003. We currently invest our cash reserves inUnited States investment grade corporate-debt securities with maturities not exceeding 12 months andmoney market funds.Net cash provided by operations was approximately $3.1 million for the three months ended March 31, 2004. Net cash used in operating activities amounted to approximately
$15.0 million, $12.1 million, $5.5$52,000 for the three months ended March 31, 2003. Net cash provided in operating activities for the three months ended March 31, 2004 was primarily a result of increases in accounts payable and accrued liabilities that were expensed and accrued in March 2004 but paid in April 2004, augmented by non-cash items such as depreciation and amortization of stock-based compensation. Cash used in operating activities for the three months ended March 31, 2003 resulted primarily from operating losses and net increases in accounts receivable resulting from the growth in our business.Net cash provided by operations was $158,000 in 2003. Net cash used in operating activities amounted to approximately $9.8 million and
$9.1$16.8 million for the years ended December 31,2000, 1999, 19982002 andfor the six months ended June 30,2001, respectively. For these periods, net cash used in operating activities resulted primarily from operating losses and net increases in accounts receivableand inventoriesresulting from the growth in our business.Accounts receivable were $12.6 million, $12.2 million, $7.9 million and $4.8 million at March 31, 2004 and December 31, 2003, 2002 and 2001, respectively. The $452,000 or 3.7% increase at the end of March 31, 2004 compared to the end of December 31, 2003, was as a result of increased DIS revenue. The $4.3 million or 55.0% increase at the end of 2003 compared to the end of 2002, was a result of revenue growth in DIS and increased product deliveries. The $3.1 million or 63.8% increase at the end of 2002 compared to the end of 2001 was attributable primarily to the increase in product deliveries, and the significant increase in DIS revenue. Inventories were $3.7 million, $3.7 million, $5.8 million and $8.6 million at March 31, 2004 and December 31, 2003, 2002 and 2001, respectively. The $2.0 million or 35.5% decrease at the end of 2003 compared to the end of 2002, was a result of the our efforts to reduce inventory levels during 2003 and the introduction of lower-cost key components that resulted in lower inventory carrying amounts. The $2.9 million, or 33.3%, decrease at the end of 2002 compared to the end of 2001 was due primarily to our carrying more inventories at the end of 2001 as we were ramping up for anticipated growth.
Net cash used in investing activities amounted to approximately
$7.2 million, $0.9 million, $1.7$1.3 million and$2.5$333,000 for the three months ended March 31, 2004 and 2003, respectively. Investing activities consist primarily of DIS servicing units and other capital expenditures.Net cash used in investing activities amounted to approximately $2.0 million, $1.8 million and $7.8 million for the years ended December 31,
2000, 1999, 19982003, 2002 andthe six months ended June 30,2001 respectively. Investing activities consist primarily of DIS servicing units and other capitalexpendituresexpenditures.Net cash used by financing activities amounted to approximately $584,000 and
asset acquisitions.$593,000 for the three months ended March 31, 2004 and 2003, respectively. Repayment of credit line borrowings and capital lease obligations were primarily responsible for the net cash used by financing activities.Net cash provided by financing activities amounted to approximately
$26.2$2.5 million,$2.0 million, $1.5$16.6 million and$8.6$20.0 million for the years ended December 31,2000, 1999, 19982003, 2002 andthe six months ended June 30,2001, respectively. Privateplacementplacements of our preferred stock and proceeds from bank borrowings,andlease financings and credit line borrowings were primarily responsible for the net cash provided by financing activities.Working Capital
We
raised $17.9 million in 2000believe that DIS and$5.8 millionproduct revenues will continue to increase. We believe that a majority of this increase will occur in thefirst six monthscardiology office market from the use of2001DIS service, which could increase the average collection period of our consolidated accounts receivable. The average collection period has historically been longer for DIS revenue than for product revenue. For the twelve-months ended March 31, 2004, our average days-sales-outstanding was approximately 75 days for our DIS revenue and approximately 50 days for our product revenue. During the twelve-month period ended March 31, 2004, we were able to reduce the DIS days-sales-outstanding by approximately 15 days. We improved our DIS collection efforts through theprivate placementadoption ofSeries E preferred stock.a number of policies and procedures focused on reducing the time following the performance of our services and invoicing the doctors or other payors. We anticipate continued reductions in collection times of DIS receivables; however, we expect DIS collection times to continue to be longer than product sales collection times based on our historical experience. If consolidated accounts receivable increase, we will use available cash on hand to fund the increase. We expect, without taking into account our receipt of the estimated net proceeds of this offering, that cash on hand, cash flow from operations and borrowings under our existing lines of credit will be sufficient to meet our working capital needs over the next twelve months.Debt Service
In
addition, we raised an additional $8.4 million in August 2001 through the private placement of Series F preferred stock. In JulyJanuary 2001, we entered into a loan and security agreement for a revolving line of credit to provide working capital for our DIS business. We are authorized to draw up to $5.0 million and the borrowings under the line of credit, as amended in March 2004, accrue interest at the higher of 6.0% or prime plus 1.25%. This revolving line of credit expires in December 2004. As of March 31, 2004, our outstanding balance under this loan and security agreement totaled $4.5 million. We intend to repay this loan in full with proceeds from this offering.In October 2003, we renewed an agreement
with a bankfor a$4.3$5.0 million revolving line of credit to provide working capital fortheour productbusiness.sales. Borrowings underthethis line of credit accrue interest at the bank's floating prime rate plus2%1.75% and are limited based on a formula that takes into account eligible amounts of accounts receivables, inventory and other factors. We are required to make monthly interest payments on this line of credit, which expires inJuly 2002October 2004, with any unpaid balance due upon expiration.At June 30, 2001, theAs of March 31, 2004, our outstanding balance under this facility was$2.4$4.7 million. We intend to repay this loan in full with proceeds from this offering.In
January 2001,the event weentered into a loanare unable to complete the offering, we believe we can renew our credit lines or access alternate sources of financing based on the improvement in our operating results andsecurity agreement for a revolving line of credit to provide working capital forourimaging services business. We are authorized to draw up to $2.5 million and can draw an additional $2.5 million upon approval by the lender's credit committee. The borrowings under the line of credit accrue interest at the higher of prime plus 1.25% or 10.25%. The revolving line of credit expires in January 2004. As of June 30, 2001, the outstanding balance under this loan and security agreement totaled $0.6 million. We intend to repay this loan in full with proceeds from this offering. In November 1999, we entered into a bank loan and security agreement to borrow up to $3.0 million. In August 2000, we modified the November 1999 loan agreement to borrow an additional $1.0 million. Borrowings under this agreement accrue interest at rates between 13.53% and 14.4%. We are required to make monthly principal and interest payments of $156,273 through November 2002. As of June 30, 2001, $2.4 million is outstanding under these loan and security agreements. We intend to repay this loan in full with proceeds from this offering.cash flow.We have notes payable to our stockholders totaling
$0.7 million,$735,000, which bear interest at 6.35% per year.TheBeginning March 31, 2004, we are obligated to repay these notesmatureequally over 12 quarters, with the first payment payable onDecember 31May 15, 2004 and subsequent payments due on the 45th day after the end of each following quarter. On May 7, 2004, we entered into an agreement with the holders of certain of theyear immediately followingnotes payable in which we agreed to make the firstyear in whichquarterly payment under their respective notes on May 10, 2004. We also agreed to repay theCompany generates cash from operations, which is expected to be after 2001.principal amount outstanding under their respective notes within 60 days of the completion of this offering. As ofJune 30, 2001,March 31, 2004, the outstanding principal balance under these notes was approximately $490,000. We may also enter into a similar agreement to repay the principalamount outstanding under a note held by another stockholder. As of March 31, 2004, the outstanding principal balance under this note was approximately $245,000.
As of March 31, 2004, we had capital lease obligations totaling
$5.5$5.9 million. These obligations are secured by the specific equipment financed under each lease and will be repaid monthly over the lease terms, which range from3648 to 63 months.- -------------------------------------------------------------------------------- 32MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- AsOur DIS subsidiary entered into the majority of these capital lease obligations.We are committed to making future cash payments on notes payable to our stockholders, capital leases (including interest), operating leases and lines of credit. We have not guaranteed the debt of any other party. The following table summarizes our contractual obligations as of December 31,
2000, we had federal and California income tax net operating loss carryforwards of approximately $39.9 million and $27.9 million, respectively. The difference between the federal and California tax operating loss carryforwards is primarily attributable to the 50% limitation2003 (dollars inthe utilization of California tax net operating loss carryforwards. The federal and California tax net operating loss carryforwards will begin to expire in 2006 and 2002, respectively, unless previously used. We also have federal and California research and development and other tax credit carryforwards of approximately $1.6 million and $1.3 million, respectively, which will begin to expire in 2005 unless previously used. We have provided a 100% valuation allowance against the related deferred tax assets as realization of such tax benefits is not assured. Our ability to use the net operating losses and credits may be subject to substantial annual limitations due to the "change of ownership" provisions of the Internal Revenue Code and similar state provisions. The annual limitation may result in the expiration of the net operating losses before utilization. We believe that our existing cash and cash equivalents, revenues to be derived from the sale of our products and imaging services, current and anticipated credit facilities and the net proceeds of this offering will be sufficient to fund our operations for at least twelve months. However, our future capital requirements will depend on numerous factors, including market acceptance of our products and imaging services, the resources we devote to expanding the market for our current products and imaging services and to developing new products, regulatory changes, competition and technological developments, and potential future merger and acquisition activity. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKthousands):
Payments Due by Period Contractual obligations Total Current 1-3 years 3-5 years More than
5 yearsNotes payable to stockholders $ 735 $ 245 $ 245 $ 245 $ — Capital lease obligations 7,505 2,741 4,197 567 — Operating lease obligations 3,861 696 1,376 1,170 619 Lines of credit 9,357 9,357 — — — Total $ 21,458 $ 13,039 $ 5,818 $ 1,982 $ 619 Quantitative And Qualitative Disclosures About Market Risk
Our exposure to market risk
fordue to changes in interest rates relates primarily to the increase or decrease in the amount of interest income we can earn on our investment portfolio and on the increase or decrease in the amount of interest expense we must paywith respect toon our various outstanding debt instruments. Our risk associated with fluctuating interest rates is limited, however, to certain of our long-term debt and capital lease obligations,theall of which have interest ratesunder whichthat are closely tied to market rates, and our investments in interest rate sensitive financial instruments. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. Weensureattempt to increase the safety and preservation of our invested principal funds by limiting default risk, market risk and reinvestment risk. We mitigate default risk by investing in investment grade securities. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our interest sensitive financial instruments. Declines in interest rates over time will, however, reduce our interest income while increases in interest rates over time will increase our interest expense.INFLATIONInflation
We do not believe that inflation has had a material impact on our business or operating results during the periods presented.
RECENT ACCOUNTING PRONOUNCEMENTS On January 1, 2001,Related Party Transactions
For a description of our related party transactions, see the section of this prospectus entitled "Certain Relationships and Related Transactions."
Critical Accounting Policies
The Securities and Exchange Commission defines critical accounting policies as those that are, in management's opinion, very important to the portrayal of our financial condition and results of operations and require our management's most difficult, subjective or complex judgments. In preparing our financial statements in accordance with generally accepted accounting principles in the United States, we
adoptedmust often make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expensesand related disclosures at the date of the financial statements and during the reporting period. Some of those judgments can be subjective and complex. Consequently, actual results could differ from our estimates. The accounting policies that are most subject to important estimates or assumptions include those described below.
Revenue Recognition
We recognize revenue in accordance with Staff Accounting Bulletin No. 101 when each of the following four criteria are met:
- 1.
- A contract or sales arrangement exists;
- 2.
- Products have been shipped and title has transferred or services have been rendered;
- 3.
- The price of the products or services is fixed or determinable; and
- 4.
- Collectibility is reasonably assured.
For our product revenue, these criteria are usually met upon delivery. Our DIS revenue is recorded once the services and disposables are provided and consumed, which is normally on the day of the service. Reductions to product revenue are recorded to provide for payment adjustments and credit memos and historically have not been significant. Reductions to our DIS revenue are recorded to provide for payment adjustments and credit memos. In addition, we establish reserves against our DIS revenue to allow for uncollectible items relating to patient co-payments and contractual allowances and other adjustments, based on historical collection experience.
Reserves for Doubtful Accounts, Billing Adjustments and Contractual Allowances
Historically, the need to estimate reserves for accounts receivable has been limited to our DIS business. We provide reserves for billing adjustments, contractual allowances and doubtful accounts. DIS payment adjustments and credit memos are adjustments for billing errors that are normally adjusted within the first 90 days subsequent to the performance of service, with the majority occurring within the first 30 days. Reserves are provided as a percentage of DIS revenue based on historical experience rate. We primarily bill the physicians under contract directly, and in a minority of cases, we are reimbursed under government programs, Medicare or by private insurance companies. We provide reserves for contractual allowances for billings to Medicare and insurance companies based on our collection experience rates. We use a combination of factors in evaluating the collectibility of accounts receivable. Each account is reviewed on at least a quarterly basis and a percentage varying from zero to 100% for each account is established. We do not establish reserves for accounts with a history of payment without disputes. We generally reserve between 20% and 50% of the outstanding balance for accounts that are more than 180 days late and under dispute. We reserve 100% of the outstanding balance for accounts that we believe constitute a high risk of default based on factors such as level of dispute, payment history and our knowledge of a customer's inability to meet its obligations. We also consider bad debt write-off history. Our estimates of collectibility could be reduced by material amounts by changed circumstances, such as a higher number of defaults or material adverse changes in a payor's ability to meet its obligations.
In 2003, we provided approximately 2% of our DIS revenues to establish our reserves. The provisions for billing adjustments and contractual allowances are charged against DIS revenues and the provision for doubtful accounts is charged to general and administrative expenses.
Long-Lived Assets
We state property and equipment and purchased contracts at cost. We capitalize betterments, which extend the useful life of the equipment. We calculate depreciation on property and equipment and purchased contracts on the straight-line method over the estimated useful live (three to seven years for property and equipment and five years for purchased contracts) of the assets. We follow Financial Accounting Standards Board ("FASB")Statement of Financial Accounting Standards ("SFAS") No. 144, Accounting for Impairment or Disposal of Long-Lived Assets, which requires impairment losses to be
recorded 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 assets' carrying amount. If such assets are considered to be impaired, we measure the impairment be recognized by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. We have taken impairment charges on certain customer contracts purchased during 2000 from Nuclear Imaging Systems, Inc. and Florida Cardiology, Inc. Assets are examined for impairment annually or more frequently if events occur that may indicate a potential asset impairment.
Inventory
We state inventories at the lower of cost (first-in, first-out) or market (net realizable value). Costs include material, labor and manufacturing overhead costs. Inventory expected to be converted into equipment to be used as mobile imaging units in DIS is classified as property and equipment. We review our inventory balances monthly for excess sale products or obsolete inventory levels. Except where firm orders are on-hand, we consider inventory quantities of sale products in excess of the last 12 months' demand as excess and reserve for them at levels between 20% and 50% of cost, depending on our knowledge and forecast for the product. We establish obsolescence reserves on an increasing basis from 0% for active, high-demand products, to 100% for obsolete products. We review the reserve periodically and, if necessary, make adjustments. We rely on historical information to support our reserve and utilize management's business judgment. Once the inventory is written down, we do not adjust the reserve balance until the inventory is sold.
Warranty
We provide a warranty on certain of our products and accrue the estimated cost at the time revenue is recorded. Historically, the warranty periods have ranged from up to 24 months. Since July 2002, substantially all of the warranty periods have been 12 months before customer-sponsored maintenance begins. Warranty reserves are established based on historical experience with failure rates and repair costs and the number of units at customers covered by warranty. We review warranty reserves monthly and, if necessary, make adjustments.
New Accounting Pronouncements
In November 2002, the FASB issued FIN 45,Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. This interpretation elaborates on the disclosures required in financial statements concerning obligations under certain guarantees. We adopted the disclosure requirements of this interpretation that were effective on December 31, 2002. The recognition provisions of the interpretation are effective in 2003 and are applicable only to guarantees issued or modified after December 31, 2002. We have not issued or modified any such guarantees and accordingly the interpretation did not have a material impact on our financial position, results of operations or cash flows for the fiscal year ended December 31, 2003.
In January 2003, the FASB issued FIN No. 46,Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN No. 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. In December 2003, the FASB issued FIN No. 46R, a revision to FIN No. 46. FIN No. 46R provides a broad deferral of the latest date by which all public entities must apply FIN No. 46 to certain variable interest entities to the first reporting period ending after March 15, 2004. We do not expect the adoption of FIN No. 46 or FIN No. 46R to have a material impact upon our financial position, cash flows or results of operations.
In May 2003, the FASB issued SFAS No.
133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This statement150,Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 establishesaccountingstandards for how an issuer classifies andreporting standards requiring that every derivative instrument, includingmeasures certainderivativefinancial instrumentsimbedded in other contracts, be recorded inwith characteristics of both liabilities and equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at thebalance sheet as either an asset or liability measured at its fair value.beginning of the first interim period beginning after June 15, 2003. Thestatement also requires that changes in the derivative's fair value be - -------------------------------------------------------------------------------- 33MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- recognized in earnings unless specific hedge accounting criteria are met. We believe theadoption of SFAS No.133 will150 did not haveana material effect on our consolidated financialstatements becausestatements.Overview
We are a leader in the development, manufacture and distribution of solid-state medical imaging products and services for the detection of cardiovascular disease and other medical conditions. We designed and commercialized the first solid-state gamma camera. Our initial focus is nuclear cardiology imaging procedures performed with gamma cameras, which we believe generate revenue of approximately $10.0 billion annually. Our target markets are primarily physician practices and outpatient clinics, which we believe constitute approximately 25% of this total market, or $2.5 billion.
By utilizing solid-state technology rather than bulky vacuum tubes, we believe that our imaging systems maintain image quality while offering significant advantages over vacuum tube-based systems, including mobility through reduced size and weight, enhanced operability and reliability, and improved patient comfort and utilization. Due to size and other limitations of vacuum tube cameras, nuclear imaging has traditionally been confined to dedicated and customized space within a hospital or imaging center. The mobility of our imaging systems enables us to deliver nuclear imaging procedures in a wide range of clinical settings—physician offices, outpatient clinics or within multiple departments in a hospital.
We sell our imaging systems to physicians, outpatient clinics and hospitals. In addition, through our wholly-owned subsidiaries, Digirad Imaging Solutions, Inc. and Digirad Imaging Systems, Inc., which we refer to collectively as DIS, we also offer a comprehensive and mobile imaging leasing and services program, called FlexImaging, for physicians who wish to perform nuclear cardiology imaging procedures in their offices but do not
engage in derivativehave the patient volume, capital orhedging activities. In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, BUSINESS COMBINATIONS, and SFAS No. 142, GOODWILL AND INTANGIBLE ASSETS. SFAS No. 141 is effective for all business combinations completed after June 30, 2001. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001; however, certain provisions of this Statement applyresources togoodwilljustify purchasing a gamma camera. DIS provides physician customers with an imaging system, certified personnel, required licensure and otherintangible assets acquired between July 1, 2001support for the performance of nuclear imaging procedures under the supervision of our physician customers. Physicians enter into annual contracts for imaging services delivered on a per-day basis. DIS currently operates 21 regional hubs and eight fixed sites and performs services in 17 states and theeffective dateDistrict ofSFAS No. 142. Major provisions of these statements and their effective dates for the Company are as follows: (i) all business combinations initiated after June 30, 2001 must use the purchase method of accounting.Columbia.The
pooling of interest method of accounting is prohibited except for transactions initiated before July 1, 2001; (ii) intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability; (iii) goodwill and intangible assets with indefinite lives acquired after June 30, 2001, will not be amortized. Effective January 1, 2002, all previously recognized goodwill and intangible assets with indefinite lives will no longer be subject to amortization; (iv) effective January 1, 2002, goodwill and intangible assets with indefinite lives will be tested for impairment annually and whenever there is an impairment indicator and (v) all acquired goodwill must be assigned to reporting units for purpose of impairment testing and segment reporting. The Company is currently evaluating the impact that SFAS Nos. 141 and 142 will have on its financial reporting requirements. - -------------------------------------------------------------------------------- 34- -------------------------------------------------------------------------------- Business OVERVIEW We are the first and only company to have developed and commercialized a solid-state, digital gamma camera for use in nuclear medicine. We believe this will allow us to become a leading provider of gamma cameras and mobile nuclear cardiac imaging services. Our patented solid-state camera offers many advantages over a conventional vacuum tube camera, such as smaller size, increasedmobilityincreased durability, improved image quality, expanded clinical applications and enhanced patient comfort. All other gamma cameras on the market currently use conventional vacuum tube technology. We believe the features and benefitsof ourtechnology will encourage healthcare providers to choose our camera over conventional cameras for both initialimaging systems andreplacement purchases. In addition, becausethe flexibility of ourcamera's increased mobility and durability, we believe it is ideally suited for use in a mobile imaging services application that has not been widely available until now. We are initially focusing on the nuclear cardiology segment of theleasing service allow cardiologists to provide nuclear imagingmarket, which is the largest and fastest growing segment ofprocedures in their offices to patients thatmarket. Our proprietary technology allows for boththey historically had to refer to hospitals or imaging centers. As asignificant reduction in the size of a gamma camera and a significant improvement in spatial resolution. Conventional gamma camera photo-detectors are approximately four inches in height. Our photo-detectors are only 0.012 inches high, providing an approximate 350-to-1 reduction in detector size that makes the camera both thinner and lighter. While conventional cameras use an average calculation to approximate the location of the gamma rays used to create the image, our cameras determine the precise location of these gamma rays. This improves spatial resolution and allows our camera to offer a significant improvement in image qualityresult, we provide physicians with more control over theconventional vacuum tube technology. We are currently addressing the rapidly growing nuclear cardiology market in the following two ways: - - NUCLEAR CAMERA SALES--We are selling our cameradiagnosis andrelated products to physician offices, imaging centers, hospitalstreatment of their patients andresearch laboratories, thus providing customers with a technologically advanced alternative to conventional vacuum tube gamma cameras. - - MOBILE NUCLEAR CARDIAC IMAGING SERVICES--We are also providing mobile nuclear imaging services, as described in this prospectus, to physician offices, including cardiology and internal medicine practices. Our turn-key mobile imaging solution provides on-site access to all the benefits of our advanced diagnostic imaging technology, without requiring customers to make an up-front payment, hire additional personnel, obtain regulatory approval or establish a dedicated nuclear imaging suite. Our service model enablesenable physicians to capturetherevenue from procedures that wouldhaveotherwise be referred to these hospitals and imaging centers.Nuclear imaging is a clinical diagnostic tool that has been
lost because the patient was referred elsewhere. In addition, it provides usin use for over 40 years witha recurring revenue stream from the servicing of our customers on a routine basis. We began commercial production of our first solid-state, digital gamma camera product, marketed as the DIGIRAD-TM- 2020TC Imager-TM- gamma camera, in January 2000 and shipped our first unit in March 2000. From our first shipment through June 30, 2001, we had received orders for 117 cameras, 59 of which had been shipped. In additionreimbursement codes established since 1971. According tonumerous independent cardiologists, customers that have purchased our cameras include hospitals, such as The University of Texas M.D. Anderson Cancer Center and Children's Hospital Boston and research laboratories, such as the Proctor & Gamble Company and Nihon Medi-Physics Co., Ltd. Of the 117 cameras, 111industry sources, approximately 18.4 million nuclear imaging procedures wereordered by customersperformed in the United States in 2002, of which 9.9 million procedures were cardiac applications, a volume that is expected to grow by approximately 25% annually over the next three years. We estimate that the growth rate in 2002 for nuclear imaging procedures performed in physician offices was approximately 44% andsix were purchased by customersinJapan.hospitals was approximately 6%. Weestablishedexpect the mobility of ourmobileimaging systems will continue to allow us to capitalize on this shift in the delivery of nuclearcardiaccardiology imaging servicesoperationsfrom hospitals to physician offices.The target market for our products is the approximately 30,000 cardiologists in
the third quarter of 2000. As of June 30, 2001, we were providing nuclear cardiac imaging services to approximately 101 physician - -------------------------------------------------------------------------------- 35BUSINESS - -------------------------------------------------------------------------------- offices in California, Delaware, Florida, Indiana, Maryland, New Jersey, North Carolina, Ohio and Pennsylvania, and were operating 18 mobile servicing routes, each of which is serviced by one van and one camera. During the six month period ended June 30, 2001, our mobile imaging services business performed approximately 6,900 imaging procedures. We intend to continue expanding our imaging services business throughoutthe United States that perform or could perform nuclear cardiology procedures. To date, we have sold or provided imaging services through DIS to approximately 500 physicians. In 2003, DIS performed over 66,000 patient procedures.We sold our first gamma camera in March 2000 and we
have completed license applicationsestablished DIS in September 2000. We had consolidated revenues and net losses of $41.5 million and $12.8 million, respectively, in fiscal 2002, $56.2 million and $1.7 million, respectively, in fiscal 2003 and $15.9 million and $266,000, respectively, in the three months ended March 31, 2004. Revenue from DIS and from our camera sales constituted 62% and 38%, respectively, of our 2003 consolidated revenues and 66% and 34%, respectively, of our consolidated revenues for the three months ended March 31, 2004. We believe DIS will continue toexpand into another 12 states. INDUSTRY OVERVIEW DIAGNOSTIC IMAGING Diagnosticprovide us with recurring annual contractual revenue and comprise the largest component of our consolidated revenue.
Market Opportunity
Nuclear Imaging
Nuclear imaging
technology generates representationsis a form of diagnostic imaging in which depictions of the internal anatomy or physiology are generated primarily through non-invasive means. Diagnostic imaging facilitates the early diagnosis of diseases and disorders, often minimizing the scope, cost and amount of care required and reducing the need for morecostly andinvasive procedures. Currently,there arefive major types of non-invasive diagnostic imaging technologies are available: x-ray; magnetic resonanceimaging, or MRI;imaging; computerizedtomography, or CT;tomography; ultrasound; and nuclear imaging.The first four of these technologies, x-ray, MRI, CT and ultrasound primarily allow the physician to see the anatomical structure of internal organs. Anatomical imaging offers the physician a limited structural assessment of the patient's anatomy.Nuclear imaging
however, offers the ability to non-invasively measuremeasures varying degrees of physiologicalactivity, including blood flow, organ function, metabolic activity, biochemical activity,activity. Physicians use the images andother functional activity within the body. This functionalrelated clinical informationallows for the earlier diagnosis of certain diseases than the informationto determine whether to refer patients to more invasive diagnostic or therapeutic treatments. Nuclear imaging is providedby anatomical imaging procedures. NUCLEAR IMAGING Nuclear medicine is used primarily in cardiovascular, oncology and neurological applications. According to a 2001 study by Frost & Sullivan, a leading marketing consulting company, there were approximately 15.5 million nuclear imaging procedures performed in the U.S. in 2000. We believe over 25 million procedures were performed worldwide. The nuclear imaging market consists ofthrough two primary technologies, gamma cameras and dedicated positron emission tomography, or PET, machines.Frost & Sullivan states thatAccording to industry sources, despite the improved image quality from PET machines, gamma cameras arecurrently the preferred choiceused forthea substantial majority of nuclearmedicineimaging procedures. We believe this preference is due to the lower purchase and maintenance costs, smaller physical footprint and easier service logistics of gamma cameras. The most widely usedtype ofimaging acquisition technology utilized in gammacameracameras isasingle photon emission computed tomography, orSPECT, camera. In a typical nuclearSPECT. All of our current cardiac gamma cameras utilize SPECT.Clinical Applications for Nuclear Imaging
Nuclear imaging
procedure,is used primarily in cardiovascular, oncological and neurological applications. Nuclear imaging involves thepatient is injected with a small amountintroduction of very low-level radioactivedrug, or radiopharmaceutical, which is quickly broken down bychemicals, called radiopharmaceuticals, into the patient's body.Depending onThe radiopharmaceuticals are specially formulated to concentrate temporarily in thecompositionspecific part of theradiopharmaceutical, the functionalitybody to be studied. A system comprised ofthe tissue and the procedure being used, the radiopharmaceutical localizes differently in normal versus abnormal tissues. The physician uses images taken froma gamma camera detector andrelated clinical informationcomputer is then used toevaluatedetect thephysiological performanceradiation signal emitted by the chemicals and to convert that signal into an image of the body part or organ. Nuclear imaging, in contrast to other diagnostic imaging modalities, shows not only the anatomy or structure of an organbeing examined. TRENDS IN NUCLEAR CARDIAC IMAGING Nuclear cardiology isor body part, but also its function—including blood flow, organ function, metabolic activity and biochemical activity. According to industry sources, thelargest and fastest growing segment of the nuclear imaging market. Frost & Sullivan reports that of the 15.5 millionfollowing nuclear imaging proceduresdonewere performed with gamma cameras in theU.S.United States in2000, 7.92002:
- •
- Cardiac Applications. Approximately 9.9 million
or 51%,procedures were performed in cardiologyrelated procedures. Nuclear imagingto provide diagnostic information concerning the flow ofthe heart provides healthcare professionals valuable information related tobloodflow,to, through and from the heart as well asinformation onthe condition of the heart muscle.Radiopharmaceuticals are unique- •
- Non-Cardiac Applications. Approximately 8.5 million procedures were performed in
their abilityoncology and organ imaging toremainprovide diagnostic information on tumor location and size or on the condition and function of various organs.Nuclear Cardiology
We believe that nuclear cardiology procedures performed annually in the United States with gamma cameras generate revenue of approximately $10.0 billion. Our target market for DIS services is primarily physician practices and outpatient clinics, which we believe constitute approximately 25% of this total market, or $2.5 billion. In addition, the market for gamma camera sales across all care settings in the United States is estimated to be approximately $440 million annually.
According to industry sources, nuclear cardiology procedures are expected to grow by approximately 25% annually over the next three years. We believe the growth of these procedures will be driven by the expected increase in coronary heart
muscle, enabling visualization during a nuclear cardiac imaging procedure. - -------------------------------------------------------------------------------- 36BUSINESS - --------------------------------------------------------------------------------disease. According to the American Heart Association, this increase inheart disease will result from the aging of baby boomers and the record rate of obesity and diabetes in all age groups.
Increasingly, a nuclear
cardiac imagingcardiology procedure is the first non-invasive, diagnostic imaging procedure performed on patients with suspected heart disease. Followinga nuclearthe imaging study,patients with suspected heart diseasethe physician willoften be referred todetermine the need for more invasive and expensive diagnostic procedures or therapeutic treatments. These treatmentssuch asmay include angiography, which is an x-ray procedure by which catheters are inserted into an artery or vein to take pictures of blood vessels; angioplasty, which is a procedure by which catheters with balloon tips are used to widen narrowed arteries; orcardiacopen heart surgery. Given the clinical advantages of nuclear cardiac images, many payorsare requiringrequire patients to complete a nuclearstudies prior to thecardiology procedure before undergoing more invasiveand expensivediagnostic procedures and therapeutic treatments.The target market for our gamma camera sales and the FlexImaging services offered by DIS are the approximately 30,000 cardiologists in the United States that perform nuclear cardiology procedures.
The number of nuclear cardiacWe have sold cameras or leased our services through DIS to approximately 500 physicians. In 2003, DIS performed over 66,000 patient procedures. We sell our imagingprocedures grew approximately 23% from 1999 to 2000,systems andis projected to grow 25% in 2001. Additionally, outpatient cardiology is projected to grow 25% annually from 2001 to 2005. Reasons for the rapid growth in nuclear cardiac imaging procedures include: - - Valuable clinical information; - - Cost-effectiveness; - - Non-invasive nature; - - Established reimbursement; and - - An increase in heart disease. Frost & Sullivan divides the nuclear cardiac imaging procedure market into four segments: hospital in-patient, hospital out-patient, cardiology practices and diagnostic imaging centers. Traditionally, nuclear medicine procedures have been performed in hospitals under the supervision of nuclear physicians. Although a number of cardiology practices with more than five cardiologists have incorporated nuclear medicine into their practice setting, most nuclear cardiac procedures are currently referredprovide our FlexImaging services to hospitals that provide nuclear cardiology procedures on either an outpatient or inpatient basis, andimaging centers, whereto physicians that provide these procedures in their offices. According to industry reports, thecardiologist loses clinical control and receives minimal or no economic benefit. DIGIRAD'S MARKET OPPORTUNITY Our technology allows us to address the following two markets: - - NUCLEAR CAMERA SALES--Frost & Sullivan projects that the U.S. gamma camera marketgrowth rate in 2002 fornuclear imaging will be approximately $325 million in 2001, and is expected to grow at an average annual rate of approximately 5% from 2001 to 2007. We estimate that the non-U.S. gamma camera market is approximately $300 million. In addition, we estimate that the market for technical services is an additional 10% to 15% of a camera's purchase price per year over the life of the contract, which is typically 4 to 5 years. - - MOBILE NUCLEAR CARDIAC IMAGING SERVICES--We believe the market opportunity for our mobile nuclear imaging services business is approximately $2.6 billion. This market size is based on our target market ofprocedures performed inhospital, outpatient facilities, diagnostic imaging centers,physician offices was approximately 44%, and in hospitals was approximately 6%. We believe this trend is driven by thefollowing: - A report by Frost & Sullivan that approximately 7.9 million nuclear cardiac imaging procedures were performed in the U.S. in 2000; - Frost & Sullivan's estimate, based on a more limited study, that approximately 56%desire ofU.S. nuclear cardiac imaging procedures were performed in a hospital outpatient facility, diagnostic imaging center or physician office in 2000;cardiologists to control their patients' diagnosis and- Our average net revenue of approximately $600 per procedure. - -------------------------------------------------------------------------------- 37BUSINESS - -------------------------------------------------------------------------------- Our proprietary technology enables physicianstreatment and toperform office-based nuclear imagingcapture revenues from procedures thatwere previously referred elsewhere, with limited disruption to their current practice. Therefore, we believe our solutions will accelerate the transition of nuclear cardiac imaging procedures to non-hospital sites, in particular cardiology and internal medicine practices. THE DIGIRAD ADVANTAGE Our proprietary technology has enabled us to develop a gamma camera with many unique features compared to conventional gamma cameras. The following chart summarizes some of the major advantages of the Digirad solid-state camera versus conventional vacuum tube gamma cameras:
DIGIRAD SOLID-STATE CAMERA VACUUM TUBE CAMERA -------------------------------------- --------------------------------------SMALLER SIZE 425-pound camera and 350-pound 1,500 to 5,000 pound SPECT camera is SPECTour-TM- chair requires only 7 large and virtually immobile. Requires feet by 9 feet of working space. Can a dedicated room, reinforced floorswould otherwise beused in physicians' offices without and extensive room renovations. requiring additional dedicated space. INCREASED The mobility of our camera facilitates Typically, cameras are permanently MOBILITY our imaging services business. In installed in hospitals or imaging addition, hospitals can use in centers, thus requiring a physician to examination rooms or easily roll it transfer patients there for their out for use in emergency rooms, nuclear cardiac imaging studies. operating rooms, intensive care units or critical care units for bedside applications. INCREASED Relatively insensitive to physical Single scintillation crystal is easily DURABILITY shock or temperature variations. damaged and/or destroyed by physical Lightweight detector head is easily shock and/or temperature variations, supported and should offer much leading to expensive and greater reliability and lower time-consuming replacement. Heavy maintenance costs. detector heads cause reliability issues because of the complicated supports required for such weight. Expensive to maintain. IMPROVED Images on the perimeter of the Best image quality obtained only in IMAGE detector head are as clear as images center of camera, or its "sweet spot." QUALITY at the center. Offers fixed intrinsic Spatial resolution is based on spatial resolution at any energy, and probabilistic algorithms that are a true digital positioning that function of gamma ray energy. pinpoints the source of gamma Intrinsic spatial resolution varies radiation. with gamma ray energy. EXPANDED Smaller and lighter camera head can Heads are less flexible and have a CLINICAL easily be shifted to various angles limited number of available positions. APPLICATIONS and positions, providing ability to use in multiple applications in many areas of the hospital. ENHANCED Patients sit upright with their arms Patients required to lie down for the PATIENT resting in front of them. procedure while holding their arms COMFORT above their heads for an extended period of time.- -------------------------------------------------------------------------------- 38BUSINESS - -------------------------------------------------------------------------------- OUR BUSINESS STRATEGY Our goal is to rapidly expand our business and increase our revenues by offering a complete nuclear imaging solution to physician offices, imaging centers, hospitals and research laboratories. The key elements of our business strategy include: - - LEVERAGE OUR PROPRIETARY TECHNOLOGY TO INCREASE SALES OF PRODUCTS AND IMAGING SERVICES--Our proprietary technology provides us with the unique opportunity to capitalize on both the camera sales and mobile imaging services market. We intend to increase sales of our camera and related products by capturing increased market share in existing channels and selling to physicians who can now for the first time place our camera into their practice with limited disruption. We also plan on increasing the number of routes and cardiologists served through our imaging services business, allowing office-based physicians to offer patients the convenience of receiving high quality nuclear imaging services in the office setting. In addition, our imaging services model, which includes a leasing services option, provides us with a recurring revenue stream through the servicing of our customers on a routine basis; - - AGGRESSIVELY TARGET THE GROWING NUCLEAR CARDIOLOGY MARKET--Our sales force is primarily focused on the cardiology market, the largest and fastest growing segment of the nuclear imaging market. While we also sell our products to hospitals and imaging centers, our main focus is to office-based cardiologists and internal medicine practices. We are currently the only company to commercially offer office-based cardiologists a small, mobile, solid-state, digital gamma camera solution. This allows cardiologists to capture business that is currentlyreferred to hospitals or imaging centers. The unique mobility of our imaging systems allows us to capitalize on this shift from hospital-based imaging to physician office-based imaging.Competitive Strengths
We believe that our position as a market leader in the nuclear cardiac imaging market is a product of the following competitive strengths:
- •
- Leading Solid-State Technology. We were the first company to develop and commercialize solid-state technology for nuclear imaging applications. We have continued to introduce new products and to develop our manufacturing capability and intellectual property. We believe the mobility of our imaging systems has accelerated the shift of nuclear cardiology procedures from hospitals and imaging centers to physician offices.
- •
- Mobile Applications Through Reduced Size and Weight. Our solid-state technology has allowed us to reduce the size and weight of gamma cameras, resulting in the only in-office mobile cardiac gamma camera on the market. Our cameras weigh less than 450 pounds and our imaging chairs weigh less than 350 pounds. Together they require a working space of only seven feet by eight feet, and generally can be employed without facility renovations. As a result, our imaging systems are capable of being easily moved within a hospital or imaging facility, or by van between physician offices. In contrast, vacuum tube cameras typically weigh 2,400 to 5,000 pounds, are very difficult to move and often require a dedicated room and facility renovations such as reinforced floors.
- •
- Image Quality. We believe our imaging systems maintain a high-quality image despite the rigors of a mobile environment. In addition, our imaging chair places the patient in an upright position, which reduces the potential for certain types of false indications of an organ defect. Most vacuum tube cameras require patients to be imaged while lying on their backs. In this position, the diaphragm does not descend and may push other organs up against the apex of the heart, which may result in false indications. We believe that we mitigate this problem through our upright patient positioning.
- •
- Enhanced Operability and Reliability. We believe our imaging systems provide more convenient operation, better power efficiency and increased reliability as compared to vacuum tube cameras. These cameras must be powered continuously to stabilize the temperature of multiple vacuum tubes. Our gamma cameras do not require continuous power and are ready to image minutes after
being turned on. In addition, our solid-state technology is more mechanically durable than vacuum tubes, which are more likely to change their performance characteristics if they sustain physical shocks during transportation. The small size and light weight of our detector heads and the modular design of our cameras also facilitate repairs and upgrades in the field, which are often accomplished by delivering replacement components overnight.
- •
- Improved Patient Comfort and Utilization. We believe the upright and open architecture of our patient chair can reduce patient claustrophobia and increase patient comfort when compared to traditional vacuum tube-based imaging systems. The majority of other imaging systems require the patient to lie flat and have detector heads rotate around the patient, creating a more confining environment and potentially increasing the time it takes the patient to enter and exit the system. Depending on the patients' physical condition, we believe the time savings available with our upright imaging may increase productivity by as much as one additional
income,patient per day.- •
- Unique Dual Distribution. We have implemented a unique dual distribution model by offering our physician and
improvinghospital customers alternatives for using our imaging systems. We sell imaging systems to physicians and hospitals that wish to perform nuclear imaging in their facilities and manage the related servicethey providelogistics. Through DIS, we also offer our FlexImaging services to physicians and hospitals on an annual basis in flexible increments ranging from one day per month to several days per week. DIS allows physicians and hospitals to offer nuclear imaging procedures to theirpatients; - - EXPAND OUR INTEGRATED, DIRECT SALES FORCE--Wepatients without the capital investment, certified personnel, required licensure and other logistics associated with operating a nuclear imaging site.- •
- Intellectual Property Portfolio. We have developed an intellectual property portfolio that includes product, component and process patents covering various aspects of our imaging systems. Currently, we own 21 patents issued in the United States and two patents issued internationally. We also have 10 additional patent applications pending in the United States and 21 pending applications internationally. In addition to our patent portfolio, we have developed proprietary manufacturing and business know-how and trade secrets that we believe provide us with a competitive advantage.
Our Technology
Conventional Vacuum Tube Technology
Most gamma cameras use a scintillation crystal, or scintillator, to convert the energy of a gamma ray photon into light. This light is then converted by means of a photodetector into an electrical signal which is reconstructed into a diagnostic image. Most traditional gamma cameras use a single crystal sheet as the scintillator and use vacuum tubes as their photodetectors, which are referred to as vacuum tube photomultipliers. This basic approach has not undergone any fundamental change in over 40 years.
Each vacuum tube is approximately the size of a soft drink can. Since a detector can consist of up to 60 vacuum tubes, the result is a camera with both a large detector enclosure and significant weight due to the lead shield that is required around the detector enclosure. In addition, vacuum tubes cannot be easily moved or used in a mobile environment because vibration may change the electrical properties of the tubes or break them. Further, vacuum tubes may lose their vacuum over time resulting in reduced reliability.
Our Solid-State Technology
We introduced the first solid-state gamma cameras to the nuclear imaging market in March 2000. Our imaging systems utilize a proprietary photodetector which incorporates a silicon semiconductor, or photodiode, that detects light and converts it into an electronic signal for reconstruction into a diagnostic image. Our photodiode replaces the vacuum tubes used in traditional gamma cameras. The size and thickness of our photodiodes is approximately that of a dime, which enables us to build detector heads that are significantly smaller and lighter than the detector heads in traditional gamma cameras. Our solid-state
photodiodes are durable and do not change their electrical properties as a result of vibration associated with transportation and are more reliable over time as compared with vacuum tubes. These properties allow our imaging systems to be mobile.
Although photodiodes have been used for many years in varying applications, their use in gamma cameras was previously unsuccessful because performance and functionality limitations prevented the development of a commercially viable product. When a gamma ray emitted from a patient strikes a scintillator, only a very small amount of light is generated, and an even smaller electrical signal is produced in the photodiode. Traditional photodiodes were able to detect these small electrical signals only at very low temperatures, typically less than -20° celsius, due to the electrical noise inherent in the photodiodes. The equipment and cost required to maintain this low temperature prohibited commercialization of a photodiode-based gamma camera. Our proprietary photodiode is capable of measuring these small electrical signals at near room temperature, which reduces cost and improves reliability.
Our photodiode is packaged with our segmented scintillation crystal and readout electronics into a patented detector module. The segmented scintillation crystal allows our module to achieve higher gamma ray detection rates than the single crystal sheet used in traditional gamma cameras. We believe the improved detection rates will be useful with new molecular imaging agents that we anticipate being introduced into the market. The entire module is designed so that it can be physically joined to other modules in varying sizes and shapes, allowing for the design of large field of view and application-specific imaging systems.
Our Products
We sell a line of solid-state gamma cameras and accessories offering both general medical imaging and specific clinical-application imaging. In a typical nuclear cardiology procedure, the physician acquires two images from the patient, one while the patient's heart rate is at rest and the other after the heart has been stressed. The procedure begins with the injection of a small amount of radiopharmaceutical. A patient imaged by our gamma camera sits in an imaging chair and places both arms on a shoulder-level armrest. The chair is adjusted to align the patient's heart on the axis of the chair's rotation.
Following positioning of the patient, image acquisition begins with the patient slowly rotating through a 180 degree arc in front of the camera's detector head, which also has been positioned at heart level. The duration of the acquisition is a function of the patient's body mass, whether the test is performed with the heart at rest or under stress, the amount of radiopharmaceutical and the number of camera detectors on the system.
Stress images are acquired by stressing the heart, either through exercise or the use of other pharmaceuticals, and then injecting the radiopharmaceutical at the peak stress level. The difference between a resting and stress image allows the physician to determine the level of cardiac function. At the conclusion of each image acquisition, the chair is rotated to the exit position and the patient steps out. After collecting the images, the technologist performs the image reconstruction, checks the quality of the images and further processes the images. The physician then reviews the images and determines whether more invasive diagnostic procedures or therapeutic treatments are necessary.
We currently offer the following products:
CardiusSM-2 is a stationary, dual-head gamma camera and patient chair designed for dedicated cardiology applications and high-procedure volumes. Expensive room modifications or electrical changes are generally not required to use this imaging system in an office setting. Further, the system offers the smallest footprint available today, fitting into a seven foot by eight foot room. The Cardius-2 features two proprietary third-generation detectors that accelerate the image acquisition process, resulting in higher patient throughput. The system is suited for larger cardiology practices, dedicated hospital-based cardiology systems, or imaging centers.
CardiusSM-1 is a stationary, single-head gamma camera and patient chair designed for dedicated cardiology applications and lower procedure volumes. A single detector head results in image acquisition times suited for physicians and hospitals with the lower patient volumes usually associated with smaller cardiology practices. The Cardius-1 also features our proprietary third-generation detector and can be upgraded in the physician's office to a dual-head Cardius-2 by using our upgrade kit. This upgrade feature allows physicians to expand imaging volume as their practices grow and imaging needs increase.
2020tc Imager® is a mobile, single-head gamma camera that is compact and lightweight. The camera is used for general purpose imaging procedures taken from a single point of view, referred to as planar, ranging from bone scans to thyroid imaging. The small pixel size in our 2020tc Imager provides improved imaging resolution over traditional planar cameras. We sell this camera as a secondary camera to hospitals to increase their capacity and flexibility to image within multiple departments using a single asset.
SPECTpak PLUS combines our 2020tc Imager and SPECTour patient chair and provides both general purpose nuclear imaging and cardiology imaging, with the added flexibility of mobility. DIS uses the SPECTpak PLUS to provide mobile imaging services to its physician customers.
Workstations, Connectivity and Accessories. We offer a line of high-performance workstations equipped with multiple software options for nuclear image interpretation. We also sell connectivity between imagers from the same or different manufacturers to physicians who wish to integrate studies from multiple imagers into one single workstation or archival. In addition, we offer a line of accessories including hot lab equipment required for the use of radiopharmaceuticals, and various other supplies.
Digirad Imaging Solutions (DIS)
DIS offers a comprehensive and mobile imaging leasing service, called FlexImaging, which includes an imaging system, certified personnel, required licensure and other logistics for the performance of nuclear imaging procedures under the supervision of physicians. DIS allows cardiologists to provide nuclear imaging procedures in their offices to patients they historically had to refer to hospitals or imaging centers. As a result, DIS provides physicians with more control over their patients' diagnosis and treatment as well as incremental revenue opportunities. Physicians can tailor their nuclear imaging expenses to their practice needs and patient volumes.
Under our FlexImaging program, we provide a mobile camera, a state-certified nuclear imaging technologist, a paramedic or nurse, radioactive materials and related licensure and supervision for radiation safety services, medical supplies, a quality control process, patient preparation, administrative forms and information brochures. All imaging procedures are administered under the physician's supervision. We also customize our program to allow physicians to lease only our personnel or only our imaging systems, depending on their own practice needs.
DIS currently performs services in 17 states and the District of Columbia and has approximately 300 contracts with physicians, most of whom are office-based cardiologists. DIS also provides leasing services to internists, hospitals and clinics. Our DIS operations use a "hub and spoke" model in which centrally located regional hubs anchor multiple van routes in the surrounding metropolitan areas. As of March 31, 2004, we had a total of 180 employees in our DIS business operating 21 hubs, eight fixed sites, and 59 cameras. We have invested substantial resources developing our service infrastructure, which includes radioactive materials licensing, a staff of radiation safety officers and licensed clinicians, coordinated billing services and standardized lease agreements. We believe that our service infrastructure and know-how will support additional routes and imaging modalities in the future.
DIS has policies and procedures for the handling of radioactive materials, purchasing relationships, clinical training and quality assurance that we believe maximize operational efficiency and improve customer satisfaction. We have implemented a compliance plan that requires strict adherence to applicable state and federal regulations, including Medicare regulations. We also have an active quality assurance and
control program designed to optimize service and follow strict radiation safety and training programs. Our management team has developed experience in hiring and training clinical staff as well as providing quality services to our customers. We utilize proprietary software management tools that monitor key performance metrics in each of our routes, hubs and regions.
At our DIS hubs, technicians load the equipment, radiopharmaceuticals and other supplies onto specially equipped vans for transport to the physician's office, where the technicians set up the equipment for the day. After quality assurance testing, and under the physician's supervision, a technician will gather patient information, inject the patient with a radiopharmaceutical and then acquire the images for review by the physician. The technicians furnish the physician with applicable paperwork and billing information for all patients and clean the utilized areas before departing.
As of March 31, 2004, we provided FlexImaging leasing services to more than approximately 95% of our DIS customers under annual contracts for services delivered on a per-day basis. These contracts decrease our immediate and direct dependence on physician reimbursement. Under these agreements, physicians pay us a fixed amount for each day that they lease our equipment and personnel, and they commit to the scheduling of a minimum number of lease days during the one-year lease term. The same fixed payment amount is due for each day regardless of the number of patients seen or the reimbursement obtained by the physician. As of March 31, 2004, the remaining 5% of our DIS business was provided under our "mixed bill" option. Under this type of agreement, we provide the technical component of our services and bill either the physician or the patient's third-party payor, and so remain at direct risk for reimbursement. We also bill the patient for any co-payment.
We believe DIS allows us to avoid the often lengthy and sometimes unpredictable sales cycle associated with capital equipment sales in a hospital or physician practice setting, and provides us with recurring contractual revenue. Occasionally, DIS customers purchase our imaging systems. In addition, because we own the product that we lease, we are often able to translate technical camera improvements into increased margins in our DIS business.
Business Strategy
We intend to continue to expand our business, improve our market position and increase our revenues and profits by pursuing the following business strategies:
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- Continued Innovation in Solid-State Imaging Technology. We intend to maintain our leadership position in solid-state imaging technology by continuing to invest resources in research and development. We believe we can continue to improve upon our existing technology to enhance image quality, maximize patient throughput, lower system cost and facilitate the ease of maintenance and repairs.
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- Expand Our DIS Business. We plan to expand our DIS business into several new states, add new hub locations in states in which we currently operate and increase hub utilization with additional physician customers and routes. We also intend to pursue cardiology opportunities for DIS in hospitals and new clinical applications for DIS in neurology, oncology and surgery.
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- Increase Market Share in Camera Sales. We believe that we can grow our market share by capitalizing on the recent trend of nuclear cardiology procedures shifting from the hospital to the physician office. We are also expanding our hospital sales and marketing efforts to capitalize on the increased demand for secondary mobile cameras.
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- Expand International Sales and Marketing Presence. We intend to increase our presence internationally by entering into relationships with distributors that have the experience, expertise and service network to sell and support our products internationally. To date, our international sales have represented less than 1% of our revenue.
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- Drive Margin Improvements and Growth. We plan to enhance our product margins by achieving operating efficiencies, reducing manufacturing costs and increasing product reliability. We also intend to leverage our technological advancements into improved performance and customer satisfaction in our DIS business.
Sales and Marketing
Our direct domestic sales organization consists of 26 sales representatives including 12 territory managers responsible for capital equipment sales and 14 imaging professionals responsible for DIS geographic regions. We select our sales representatives based on their expertise in nuclear imaging product sales and services. Each sales representative is subject to periodic performance reviews and is required to attend periodic sales and product training. We employ sales specialists to assist territory managers with in-office or on-site camera demonstrations. We intend to increase the number of sales representatives as we launch new products and services and to increase our marketing efforts with respect to existing products.
In addition to our direct sales force,
supplemented bywe also sell our imaging systems in five states and Puerto Rico through three distributorsinternationallyand one independent sales agent. We select our distributors based on their expertise in imaging systems and sales coverage. These relationships provide the distributor the right to sell our products within the sales territory, and their sales representatives typically attend the same sales and product training as our own sales representatives.We also have distributors in Canada and in
selected domestic geographies. This improves our abilityRussia and are beginning tocontrol our customer interface as well as focus and direct our sales efforts to a much greater extent than if we relied solely on third-party distributors. Investing in our own directbuild an international sales organization focused on camera sales. These international distribution arrangements are exclusive within the designated countries. We have hired a dedicated international sales executive to establish relationships with additional distributors.We often service our domestic customers remotely through high-speed Internet access and dial-up connections that facilitate system diagnosis without the need for field service or repair. When repair is required, our modular part replacement capability allows
usour field service engineers tobuildperform field repairs that minimize customer downtime. We also employ applications specialists and adistribution asset that can be of great value over time as we lookconnectivity engineer togrowtrain our customers or provide technical support on thebusiness by potentially providing additional products and services through this sales channel. Our direct sales force is integrated, in that there is a sales team within each geographic region that shares responsibility for customers and overall results. Although each member of the team has a particular focus, either selling cameras or imaging services, collectively, they are responsible for the success of the geographic region. This allows us to better forecast sales and manage the costuse of ourselling efforts, better meet the demandsproducts. We plan to engage outside service firms to support our international customers.Manufacturing
We have been manufacturing our cameras since March 2000. The key components of our
customers,camera's mechanical andtruly offer our customerselectrical systems are designed or configured by us, and include asolution tailored to their needs; - - LEVERAGE OUR PROPRIETARY MANUFACTURING PROCESSES--We believe our manufacturing process gives uspersonal computer (for both the camera and the stand alone workstations), cooling systems, liquid crystal display, controller boards and akey competitive advantage by enabling us to produce our proprietary technology in a cost efficient manner.data acquisition and communication system. Our manufacturing strategy combines our internal design expertise and proprietary process technology withthe advanced manufacturing capabilities and capacity of ourstrategicmanufacturing relationships. We have achieved, and anticipate additional, significant reductions in our manufacturing costs due to increased production volumes, improved yields and product design enhancements; - - EXPAND ACCEPTANCE OF ADDITIONAL CLINICAL APPLICATIONS--The design of our camera provides the capability to perform some nuclear imaging procedures that were not previously available. Additionally, our current technology allows nuclear imaging to be performed in locations within the hospital, including the operating room, emergency department, ICU, and bedside. We are - -------------------------------------------------------------------------------- 39BUSINESS - -------------------------------------------------------------------------------- working to facilitate validation of these new clinical applications. We believe this validation will increase the number of hospitals interested in purchasing our camera; and - - CONTINUE TECHNOLOGICAL DEVELOPMENT--We continue to refine and improve our proprietary solid-state detector technology. By improving our technology, we plan to improve the performance of our cameras while at the same time reduce manufacturing costs. We also plan on designing and building a large field of view gamma camera using our technology that will expand clinical applications for our product. In addition, we plan to expand our technology for other uses such as computed tomography and gamma cameras specifically designed for research. CURRENT PRODUCTS 2020TC IMAGER-TM- CAMERA--Our initial product is the 2020TC Imager camera, which has an imaging area of eight inches by eight inches. In significant contrast to conventional vacuum tube camera heads, which are typically greater than 14 inches thick and weigh upwards of 1,500 pounds, our imager heads are less than four inches thick and weigh about 60 pounds.outsourcing. TheDIGIRAD 2020TC Imager provides true camera mobility, solid-state reliability, excellent image quality and expanded clinical applications. Approximately 75% of all nuclear imaging procedures are organ-specific rather than whole body imaging. Our 2020TC Imager can perform all organ specific imaging as these procedures do not require the large field-of-view associated with the conventional gamma camera imaging heads. SPECTOUR(TM) CHAIR--Unlike conventional systems where the patient lies on their back with their left arm above their head while the camera circles around the patient, the DIGIRAD SPECTour chair allows the patient to be seated upright with their arms resting at shoulder level as they slowly rotate in front of the 2020TC Imager camera's head. The seated position produces improved image quality and is more comfortable to the patient. SPECTPAK-TM---This product was recently introduced in the second quarter of 2001 and is sold exclusively to the nuclear cardiology market. It combines a modified, feature enhanced version of our 2020TC Imager camera with our SPECTour chair, to provide a more optimal product for the cardiology market segment. We have developed an image acquisition and processing software system for the DIGIRAD 2020TC Imager camera and SPECTour chair under a license agreement with Segami Corporation. The image acquisition software is designed to take advantage of the unique characteristics of our solid-state detector technology. The processing software is Segami's industry popular Mirage-TM- package. It runs on a Microsoft NT platform and has a graphical user interface. PRODUCTS UNDER DEVELOPMENT We plan to introduce a next generation single platform device that incorporates our camera and chair into one unit in late 2002. This configuration is designed to enhance image quality in cardiac applications and requires less working space. We intend to introduce a multiple-head large field-of-view camera in 2003. This camera will be suitable for whole body imaging and will compete directly with the current large field of view vacuum tube designs. We believe that we will be able to offer significantly improved products based on solid-state detector technology such as a camera head that can be placed closer to the body and multiple heads that will decrease the processing time. - -------------------------------------------------------------------------------- 40BUSINESS - -------------------------------------------------------------------------------- OPERATIONS MANUFACTURING We have been manufacturing our cameras since March 2000. Our manufacturing strategy combines our internal design expertise and proprietary process technology with the advanced manufacturing capabilities and capacity of third parties. We believe our manufacturing processes give us a key competitive advantage by enabling us to produce our proprietary technology in a cost-efficient manner. The general manufacturing process for the detector module includes procurement of key components from key semiconductor manufacturers. We first perform electrical tests on these components and then we deliver these components to microelectronics packaging, either to our internal operation or to third parties, for component sub-assembly. We then perform final assembly of the detector module and test the detector module. The detector modules are then assembled into a motherboard that is mounted in the camera detector head. The camera's mechanical and electronics systems are assembled separately at Digirad. As is done with the modules, thekey components oftheour camera's mechanical and electrical systems are designed or configured by us, andeither outsourced or built internally. These key componentsinclude a personal computer, power supplies, cooling system, liquid crystal display, controller boards and a data acquisition and communicationsystem, and the mechanical structure of the camera.system. These components are either outsourced to qualified manufacturers or built internally. We perform sub-assembly tests and final system performance testsinpackaging and labeling at ourfacilities. All components used infacility. We provide connectivity solutions which include consulting, configured computers and outsourced electronic image management systems. We also sell accessories which are outsourced and include printers, equipment for handling and measuring radioactive materials and software for theproduct are available from multiple sources with the exception of the Segami image acquisition and processing software. All supplierscamera.Suppliers of critical materials, components and subassemblies undergo ongoing quality certification by
us, withus. Most components used in theobjectiveproduct are available from multiple sources; however, we do not currently maintain alternative manufacturing sources for certain components ofmaintaining strong relationships withthebest suppliers.detector or for the acquisition and control software. For those components for which we have only a single source supplier, weare currently qualifying or seeking secondary sources. We utilize
ERP softwareenterprise resource planning and collaborativeweb-basedsoftware toensure efficientincrease efficiency andsecuresecurity in handling of material and inventory, centralizing our purchasing procedures, monitoring our inventory supplies andmaterial.streamlining our billing methods. Our outsourcing strategy is targeted at companies that meet the standards of the FDA and the International Organization for Standardization, or ISO.We
successfully completed a certification audit performedand our third-party manufacturers are subject to the FDA's Quality System Regulation, state regulations such as the regulations promulgated by thestateCalifornia Department ofCalifornia's FoodHealth Services, andDrug Branchregulations promulgated by the European Union. We recently completed the process of relocating and consolidating our manufacturing to a new facility inthe first quarter of 2000. As part of this audit,nearby Poway, California that has been licensed by the California Food and DrugBranch recognizedBranch. Our facilities and the facilities of our third-party manufacturers are subject to periodic unannounced inspections by regulatory authorities, and may undergo compliancewith the "Good Manufacturing Practices" requirements of the federal Food and Drug Administration, or the FDA. The FDA has issued us an Establishment Registration. We have also obtained pre-market clearance frominspections conducted by the FDAenabling us to market our 2020TC Imager cameraandSPECTour chair. California's Food and Drug Branch also issued us a State of California Medical Device Manufacturing License. We also received regulatory approval from the Japanese Ministry of Health in October 2000 which is similar to our FDA Establishment Registration and expect to receive a Canadian Medical Device license in the third quarter of 2001.corresponding state agencies.In
conjunction with implementing Good Manufacturing Practices and product safety standards, we expect to obtain a product approval in the third quarter of 2001 from Underwriters Laboratories Inc. and the Canadian Standards Association. In early 2002,late 2004, we plan to initiatethe drive for ISO-9000our ISO-13485 quality certification program with the expectation of receiving certification inlate 2002. IMAGING SERVICES Our imaging services business2005. ISO-13485 isoperateda compilation of quality standards tailored for medical device manufacturers and promulgated byour Digirad Imaging Solutions business unit. We established our imaging services operationsthe ISO. A medical device manufacturer whose quality program has been certified to ISO requirements does not have to independently test each product that it sells in thethirdEuropean Union. ISO certification is required to sell our products in certain countries, however, we may not ever obtain such certification.Research and
fourth quarters of 2000 by acquiring certain assets of two regional providers of mobile nuclear imaging services. As of June 30, 2001, we were operating 18 mobile routes, each of which is serviced by one vanDevelopmentOur research and
camera, and were providing nuclear cardiac imaging services to approximately 101 physician offices in California, Delaware, Florida, Indiana, Maryland, New Jersey, North Carolina, Ohio, and Pennsylvania. In addition, we have completed licenses or license applications and plan to expand into another 12 states in 2001. - -------------------------------------------------------------------------------- 41BUSINESS - -------------------------------------------------------------------------------- Our imaging services modeldevelopment staff currently consists oftwo primary delivery options. Under17 employees. We have a long and extensive commitment to research and development, including an established history in developing innovative solid-state gamma cameras. In March 2000, we launched the first solid-state gamma camera for medical use and, in September 2002, we released the first dual-head, solid-state camera. In July 2003, we launched ourfirst option, which we refer to as "mixed billing," we providethird-generation detector that improved thetechnical componentreliability and sensitivity ofnuclear imaging services and bill either the physician or the patient's third party payor, such as Medicare, on a per procedure basis. When we bill some third party payors, such as Medicare, we also bill the patient for any copayment. The physician performs and bills for the technical component, such as the interpretation of the test. Underoursecond option, we lease cameras, related equipment and technical personnel to physicians on a turn-key basis so that they may deliver imaging services to their patients. The physician then bills globally for both the technical and professional component. The physician pays us on a fixed daily lease basis. When we refer to "imaging services" in this prospectus, we are referring both to our mixed billing option and our leasing services option. We provide services under a minimum one year contract. We intend to provide our imaging services in two ways: - - MOBILE ROUTES: Currently, all of our mobile imaging services are performed using mobile routes. We provide a 2020TC Imager camera, a SPECTour chair, hot lab equipment, nuclear technician and other services to a clinician's office on a daily lease basis or a combination of direct payor billing and fee per study basis; and - - FIXED SITES: We may, in the future, deliver services using fixed sites. We would install a 2020TC Imager camera, a SPECTour chair, and hot lab equipment in a clinician's office or other site. Also, we would provide the nuclear technician and other services to the clinician or site on a per month or other periodic basis. We seek to maximize revenue, cash flow and return on assets by actively managing our fleet to maximize utilization. We employ logistics management systems and typically schedule imaging services vans for one day per week at a particular physician's office. Generally, each van consists of a 2020TC Imager camera, a SPECTour chair, hot lab equipment, a nuclear medicine technician and a clinical assistant. The vans are typically operated from a regionally-centralized base location and stored at the base location each evening. Radiopharmaceuticals are ordered each day in sufficient quantity for the next day's scheduled procedures and are delivered in the morning before the van leaves for its scheduled appointments from the base location. SALES AND DISTRIBUTION We sell our camera products and our imaging services through a direct sales force, supplemented by two independent distributors in the United States, an independent distributor in Canada and a corporate partner in Japan. Our direct sales force in the United States is responsible for selling bothgamma cameras, andimaging services.reduced their cost. Weutilize a team selling approach with Territory Managers, and Sales Representatives. Our Territory Managers typicallyhaveover 10 years of experience selling sophisticated capital equipmentan established core competency in themedical market and focus primarily on selling our gamma cameras to end users. Our Sales Representatives typically have over five years of selling experience and focus primarily on selling the imaging services solutions, which are marketed under the Digirad Imaging Solutions name. In addition, our selling teams include Sales Specialists, which focus on pre-sales support, and Application Specialists, which focus on post-sales training and support. Both the Sales Specialist and Application Specialist positions require significant prior work experience as a Nuclear Medicine Clinical Technologist. We will maintain independent distributors in those territories where the distributor has demonstrated a commitment to our business by providing dedicated resources, and where acceptable performance metrics are met. Our target markets for the sale of our camera are cardiology practices, hospitals, and imaging centers. Our experience to date suggests the sales cycle for camera sales typically ranges from 90 to 180 days for a cardiology practice and from 180 to 365 days for a hospital, with imaging centers being - -------------------------------------------------------------------------------- 42BUSINESS - -------------------------------------------------------------------------------- somewhere in between. The complexity of the buying organization and their budgeting/purchasing process for capital equipment determine the length of the sales cycle. Our target markets for our mobile nuclear imaging services are primarily cardiology practices. Our experience to date indicates the sales cycle for these imaging services customers is generally between 21 and 90 days. Currently, our United States direct sales organization is made up of a Vice President of Sales, a Western Region Director, an Eastern Region Director, a Southern Region Director, eleven direct Territory Managers, eleven Sales Representatives, four Sales Specialists and three Application Specialists. Additionally, we have three direct technical service technicians that interact with our independent technical service provider around the country. Our independent technical service provider is Universal Service Trends, which has over 50 technicians covering the entire continental United States. Though our sales have been primarily focused on the domestic market, we have established sales channels for international expansion into Japan and Canada. In January 2000, we entered into a distribution agreement with Mitsui Corporation to distribute DIGIRAD-TM- products in Japan, primarily to hospitals. In conjunction with this distribution agreement, Mitsui made a $1 million equity investment in Digirad in March 2000. We received Japanese Ministry of Health regulatory approval in October 2000. Product shipments and sales started in Japan in the fourth quarter of 2000, and as of June 30, 2001, we had sold six units in Japan. In Canada, we currently have a distributor representing Digirad and expect Canadian sales and shipments to begin in the fourth quarter of 2001. All of our cameras are warranted for one year after shipment. The philosophy of our warranty service is to locate in the field and replace faulty assemblies with workable units from the service inventory. This approach is greatly facilitated by the design of the 2020TC Imager camera because all of our cameras are equipped with diagnostic software and a telephone modem enabling the diagnostic software to be accessed remotely. This capability allows us to assist field service personnel in rapidly locating a faulty assembly, and because no critical assembly weighs more than 50 pounds, shipping assemblies is easily accomplished via air courier. Service contracts incremental to the one year warranty for nuclear medicine equipment are typically four to five years in length, and cost the customer 10% to 15% of the purchase price of the cameras annually. MARKETING We formally launched the 2020TC Imager camera and the SPECTour chair at the Society of Nuclear Medicine meeting in June 1999 in Los Angeles. We began limited product shipments in March 2000, and began full product release in July 2000. Our continuing marketing efforts include the following: - - Establishing Centers of Excellence for demonstration sites and clinical studies; - - Participating in major trade show exhibits at meetings sponsored by organizations such as the American College of Cardiology, the American Heart Association, the Society of Nuclear Medicine, the Radiological Society of North America, the European Association of Nuclear Medicine and the Japanese Society of Nuclear Medicine; - - Advertising in key nuclear medicine and cardiology journals; - - Developing an active medical advisory board; - - Participating in clinical studies and authoring publications through the Digirad North American Working Group; - -------------------------------------------------------------------------------- 43BUSINESS - -------------------------------------------------------------------------------- - - Sending direct mailings to cardiology and nuclear medicine clinicians and decision makers; - - Preparing sales collateral material, including product brochures, product CDs, specification sheets, training materials, presentation materials, and image sheets; and - - Participating in the American College of Nuclear Physicians. We have been very active in the nuclear medicine community over the last five years and exhibited earlier prototypes of our product at the last five Society of Nuclear Medicine meetings. We plan to pursue strategic alliances and co-promotional efforts with appropriate partners. Such partners may be pharmaceutical companies selling radiopharmaceuticals, imaging companies, radiopharmacies, or cardiology companies. These partnerships may consist of marketing partnerships, jointdevelopmentefforts, or manufacturing alliances. TECHNOLOGY OVERVIEW The challenge of any camera system is to accurately map the spatial location of the objects in its field-of-view from the real world to the camera's world. Optical cameras use lenses to focus the light from a large real-world image field onto a small image plane where a detector (film or electronic) is located. However, since gamma rays cannot be focused, the area of the detector of a gamma camera must be approximately as large as the area of the object being imaged. CONVENTIONAL TECHNOLOGY It is very difficult to build a gamma detector that can directly convert the kinetic energy of a gamma ray photon into an electrical charge. Therefore, most gamma ray detectors employ a scintillation crystal, or scintillator, to convert the high energy of a single gamma ray photon into a large number of low energy optical photons. The vast majority of nuclear medicine gamma cameras in use today use a single, continuous planar sheet crystal as the scintillator. The area of this crystal defines the field of view of the camera. Typical fields of view range from 64 square inches to 300 square inches. Once the gamma rays are converted into optical photons, these photons are then converted into electrical charges by the next part of the detector, the photo-detector. Almost all gamma cameras in use today use vacuum tube devices called photomultiplier tubes, or PMTs, as their photo-detectors. The typical PMT has a photosensitive surface of approximately 7 square inches. In order to cover the entire field of view of the scintillation crystal, square or hexagonal shaped PMTs are packed together in an array of anywhere from nine to 100 tubes. Optical photons striking anywhere on the surfaces of the PMTs are converted into electrons which are then multiplied to produce a small electrical current output. These electronic charges are then passed to the final part of the detector, the readout electronics, and then into the camera's computer system to be processed into the digital images viewed by the physician. A problem with the conventional gamma camera is that it attempts to use an array of PMTs, to spatially resolve the point at which a gamma ray strikes the surface of the camera. Such a system can only estimate where the gamma ray strikes. It does so by combining the output signals of all of the PMTs and computing a position as a function of the weighted average of the individual PMT signals. - -------------------------------------------------------------------------------- 44BUSINESS - -------------------------------------------------------------------------------- This approach is called the Anger method and results in the guassian shaped spatial distribution function labeled "Anger Style" illustrated below. [Three dimensional chart showing spatial distribution function of Digirad camera versus Anger style camera.] As can be seen, there can be considerable discrepancies between where the gamma ray is reported to have struck the detector versus where it actually struck the detector. The industry-adopted standard for the measurement of the spatial resolution of a gamma camera is the full width of the spatial distribution at half its maximum height, or its full width half maximum, or FWHM. The very best Anger style cameras have intrinsic spatial resolutions of 3.5 millimeters FWHM. The effect of such uncertainty is image blurring, which in turn can impede the physician's ability to accurately read the image. While there has been a large amount of effort spent in improving the performance of Anger style gamma cameras, the underlying problem still exists: a single-scintillation crystal, multi-PMT based detector must rely upon probabilistic position estimation. DIGIRAD'S TECHNOLOGY Digirad has overcome the fundamental drawback of the Anger method by constructing a detector which provides total certainty of the spatial location of the gamma ray. We achieve this certainty by dividing or segmenting the detector into a large array of individual detection elements whose size equals the spatial resolution desired, in our case, 3 millimeters by 3 millimeters. A gamma ray emitted from a patient strikes the detector and the spatial location of this event is mapped directly to the image. The response function of our segmented detector is much more precise than that of the Anger style PMT. In a camera with 3 millimeter by 3 millimeter sampling, the resulting intrinsic spatial resolution of the output image is actually equal to an Anger style camera having a FWHM of 2.0 millimeters. This is a significant improvement over the 3.5 millimeter FWHM spatial resolutions which can be achieved with traditional systems. Furthermore, a segmented detector processes gamma ray events in parallel; each pixel is an independent detector. In a single-crystal, Anger style detector, events are processed in a series, one event at a time. In general, this means segmented gamma cameras can achieve much higher gamma ray detection rates than single-crystal gamma cameras. Previous attempts to construct a segmented detector by both industry groups and academics have been unsuccessful, primarily due to the Anger camera's photodetector. Given their relative size, instability, - -------------------------------------------------------------------------------- 45BUSINESS - -------------------------------------------------------------------------------- and numerous other factors, Anger style PMTs are unsuitable for use in a segmented detector. A more optimal photodetector is a high-performance silicon photodiode. Silicon photodiodes can be packed closer, provide solid-state reliability, and are more efficient at converting the scintillation photons coming from the scintillation crystal. However, technical difficulties in producing high quality photodiodes that are reliable and can be used for gamma cameras have been a major impediment to their use in this application. We have developed a photodiode that meets these stringent performance requirements. In addition, over the last 2 years, we have developed a patent pending manufacturing process for cost-effectively producing these photodiodes in volume. Our useof silicon photodiodesas photodetectors has, in turn, enabledand related scintillator assemblies and signaling processing electronics, which are theusecore ofa more efficient scintillation crystalour gamma cameras.Our research and development efforts are primarily focused in the
DIGIRAD-TM- detector module. A photomultiplier tube is at peak efficiency using blue wavelengths of light. Therefore, conventional gamma cameras use a single, planar crystal of thallium activated sodium iodide, or NaI(Tl), which emits blue wavelengths of light during scintillation. Silicon photodiodes, however, are most sensitivenear term on developing further enhancements tothe longer wavelengths of the visible spectrum. For this reason, thallium activated cesium iodide, or CsI(Tl), is a better scintillator for silicon photodiodes than NaI(Tl). Significantly, CsI(Tl) is also 36% more efficient than NaI(Tl) at converting the energy of the gamma ray to optical photons. In addition, CsI(Tl) is denser, and is therefore better at absorbing gamma rays, than NaI(Tl); a 6 millimeter thick CsI(Tl) detector absorbs the same number of 140 keV gamma raysour existing products asdoes a 9 millimeter thick NaI(Tl) scintillator. The DIGIRAD camera uses a six millimeter thick CsI(Tl) segmented scintillation crystal. The key components of the segmented CsI(Tl) scintillation crystal, silicon photodiode and readout electronics are all packaged into a detector module.well as developing our next-generation products. Ourdetector module is designed so that it can be tiled with several other modules to create a large area detector of essentially any shape. Digirad holds several patents covering this concept of modules than can be tiled. The current DIGIRAD 2020TC Imager camera uses 32 modules to create its 8 inch by 8 inch detection area. The array of detection modules is then placed behind a collimator and into a lead-shielded head case. A collimator is a device constructed from lead with thousands of small parallel holes that are aligned perpendicular to the camera's detector surface. The collimator's purposeobjective is toonly allow gamma rays that are perpendicular toincrease thecamera surface to be detected, thereby helping prevent blurred images. Below is a view of the 2020TC Imager camera detector head assemblysensitivity andillustrates the arrangement of the modules, collimator and lead-shielded head case. [Picture of detection head.] - -------------------------------------------------------------------------------- 46BUSINESS - -------------------------------------------------------------------------------- THE DIGIRAD CAMERA'S TECHNICAL ADVANTAGES SMALLER SIZE--The main advantage that our photodiode technology provides is a significant reduction in the size of a gamma camera. As previously described, a conventional gamma camera uses PMTs, 4 inches in height, as its photo-detectors. The photo-detectors in our camera are silicon photodiodes, 0.012 inches in height. This almost 350-to-1 reduction in the photo-detector size enables the DIGIRAD camera head to be significantly thinner than a conventional camera's head. Furthermore, because all gamma camera heads are lead-shielded, the much thinner DIGIRAD camera head is also much lighter. The smaller, lighter head of the DIGIRAD camera results in a smaller and lighter overall camera assembly, which increases the mobility of the camera and its scope of clinical applications. [Picture of photo multiplier tube versus Digirad photodiode.] IMAGE QUALITY--Digirad's segmented gamma camera offers significant improvement in intrinsic image quality compared to conventional Anger style cameras because the DIGIRAD camera's detector is segmented. Segmentation offers fixed intrinsic spatial resolution which provides for true digital positioning. Today, the word "digital" is used in virtually every gamma camera sold. While this can describe various aspects of the electronics and the stage at which the signals are converted from their inherent analog type to a digital signal, only a segmented detector has true digital event positioning. We call this process Digital Position Sensing(SM). LARGER USEFUL FIELD OF VIEW / LESS "DEAD SPACE"--Another advantage of the DIGIRAD camera is that our detector head has a larger useful field of view. In an Anger style camera, gamma rays that strike the perimeter of the scintillation crystal are viewed by fewer PMTs than those striking in the middle of the crystal. Because the Anger camera requires input from multiple PMTs in order to calculate an average spatial position, this creates an area of dead space around the edge of the detector head in which the image is not useful. As a result, the useful field of view on Anger style cameras is smaller than the area of the detector. However, Digital Position Sensing eliminates any dead space around the edge of the detector head, thus making the useful field of view on the DIGIRAD camera almost equal to the entire area of the detector surface. ENHANCED OPERABILITY AND RELIABILITY--In addition to a smaller size gamma camera, our solid-state technology enables a more convenient to operate, power efficient and more reliable gamma camera. - -------------------------------------------------------------------------------- 47BUSINESS - -------------------------------------------------------------------------------- Conventional Anger style gamma cameras must be powered continuously in order to temperature stabilize their vacuum PMTs, which complicates significantly the design and construction of portable Anger style cameras. Since Anger cameras draw electrical power 24 hours per day, they dissipate heat that must be removed by a heating and ventilation system. The DIGIRAD camera does not need to be powered continuously and is ready to image minutes after turn on. These qualities enable a DIGIRAD unit to be mobile and also saves on electrical power; less power is required to operate the camera and cool the room in which it is operated. Solid-state detectors are more mechanically rugged than PMTs. The shock of crossing a curb cut or a door threshold will not change the performance characteristicsreliability of oursolid-state detector as it can with a PMT. Our solid-state detectors also can tolerate more rapid changes in temperature than can an Anger style camera, another important capability for a portable camera that is moved inimaging systems andout of buildingstheir clinical andvehicles. INTELLECTUAL PROPERTY We have developed a broad intellectual property portfolio that includes overall product, component level and process patents. Currently, we have 15 patents issued and have eight additional patents pending in the United States. We also have one patent licensed from a third party for exclusive use in nuclear imaging. The Japanese and European equivalents for several of these United States patents are pending, with one Japanese and one Korean patent issued. In additioneconomic benefit to ourbroad solid-state detectorphysician customers andphotodiode technology patents,their patients.Competition
The medical device industry, including the market for nuclear imaging systems and services, is highly competitive, subject to rapid change and significantly affected by new product and service introductions and market activities of other industry participants. In selling and leasing our imaging systems, we
hold specific patents for an alternative solid-state method using Cadmium Zinc Telluride, or CZT, that we previously pursued for use in gamma cameras. While each of our patents apply to nuclear medicine, many also apply to the construction of area detectors for other types ofcompete against several large medicalimagers and imaging methods. A summary of our intellectual property portfolio is as follows: - - Fifteen United States patents issued; - - One Japanese patent issued; - - One Korean patent issued; - - Eight utility applications that are pending with the United States Patent and Trademark Office, with office actions having been received on two; and - - One provisional application is in progress. We believe it would be difficult to develop an economically viable competitive solid-state, digital gamma camera without infringing our patents. COMPETITION CAMERA SALES--The majordevice manufacturers,of nuclear medicine cameras, all of whose cameras are based on the conventional vacuum tube technology, includeincluding Philips Medical Systems,through its subsidiary ADAC Laboratories,General ElectricMedical Systems,Healthcare, Siemens Medical SystemsMarconi Medical Systems (pending acquisition by Phillips Medical Systems)and Toshiba Medical Systems. All of these competitors offer a full line of imaging cameras for each diagnostic imaging technology, including x-ray, MRI, CT, ultrasound and nuclear medicine. Thepossibility existsexisting nuclear imaging systems sold by our competitors have been in use for a longer period of time than our products and are more widely recognized and used by physicians and hospitals for nuclear imaging. Many of our competitors and potential competitors enjoy significant competitive advantages over us, including:
- •
- significantly greater name recognition and financial, technical and marketing resources;
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- established relationships with healthcare professionals, customers and third-party payors;
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- established distribution networks;
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- additional lines of products and the ability to offer rebates or bundle products to offer discounts or incentives; and
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- greater resources for product development, sales and marketing.
We are aware of certain major medical device companies that
one or more of these companies could decideare attempting to developits ownsolid-statedigitalgamma cameras, and we believe these efforts will continue. However, we are currently not aware of any other solid-state cardiac gamma camera. We are also aware of a privately-held company, Gamma Medica, which is currently marketing a solid-state gamma camera for breast imaging. We do not believe that this camera can be used in a cardiac application. However, webelieve it would be difficultcannot assure you that Gamma Medica will not attempt todevelop an economically viable competitivemodify its existing camerawithout infringing our patents. - -------------------------------------------------------------------------------- 48Business - -------------------------------------------------------------------------------- IMAGING SERVICES--Competitionfor use in the cardiac segment in the future or develop another gamma camera for cardiac applications.In providing our mobile
nuclear imagingleasing services,business is limited. Competitors tend to be small, undercapitalizedwe also compete against businesses employingconventionaltraditional vacuum tube cameras that must be transported in large trucks and cannot be moved in and out of physician offices. Competitive fixed-site services may require extensive or dedicated space and room renovations that result in increased start-up and ongoing costs.Because of the size of the potential market, we anticipate that companies will dedicate significant resources to developing competing products and services, including a mobile leasing service. Current or future competitors may develop technologies and products that demonstrate better image quality, ease of use or mobility than our nuclear imaging systems. Our nuclear imaging systems or leasing services may be rendered obsolete or non-competitive by technological advances developed by one or more of our competitors. Our ability to compete successfully will depend on our ability to develop proprietary products that reach the market in a timely manner, receive adequate reimbursement and are safer, less invasive and less expensive than alternatives available for the same purpose.
We
expectbelieve that the principal competitive factors in our market include:
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- improved outcomes for nuclear imaging procedures;
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- acceptance by physicians;
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- ease of use, reliability and mobility;
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- product price;
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- qualification for reimbursement;
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- technical leadership and superiority;
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- effective marketing and distribution; and
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- speed to market.
Intellectual Property
We rely on a combination of patent, trademark, copyright, trade secret and other intellectual property laws, nondisclosure agreements and other measures to protect our intellectual property. We believe that in order to have a
distinctcompetitive advantage, we must develop and maintain the proprietary aspects of our technologies. We require our employees, consultants and advisors to execute confidentiality agreements in connection with their employment, consulting or advisory relationships with us. We also require our employees, consultants and advisors who we expect to work on our products to agree to disclose and assign to us all inventions conceived during the work day, using our property, or which relate to our business. Despite any measures taken to protect our intellectual property, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary.Patents
We have developed a patent portfolio that covers our overall products, components and processes. As of March 31, 2004, we had 21 issued U.S. patents and 31 pending patent applications, including ten U.S.
applications, three international Patent Cooperation Treaty, or PCT, applications and 18 foreign applications seeking protection for selected patents in Japan, Canada and Russia. The issued and pending patents cover, among other things, aspects of solid-state radiation detectors including our photodiodes, signal processing, and system configuration. Our issued patents expire between December 23, 2014 and April 20, 2021. We have multiple patents covering unique aspects and improvements for many of our products. We have entered into a royalty-bearing license for one U.S. patent with a third party for exclusive use (subject to certain reservation of rights by
controllingtheenabling technology that provides the convenience, quality and high level of service physicians will expect. As a result, weU.S. Government) in nuclear imaging. We do not believe that our current products implement the licensed patent and we are currently negotiating with the third-party licensor to amend the patent license.In addition to our solid-state detector and photodiode technology patents, we hold specific patents for an alternative solid-state method using Cadmium Zinc Telluride, that we previously pursued for use in gamma cameras. While each of our patents applies to nuclear medicine, many also apply to the construction of area detectors for other types of medical imagers and imaging
servicesmethods.The medical device industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. Patent litigation can involve complex factual and legal questions and its outcome is uncertain. Any claim relating to infringement of patents that is successfully asserted against us may require us to pay substantial damages. Even if we were to prevail, any litigation could be costly and time consuming and would divert the attention of our management and key personnel from our business operations. Our success will
havealso depend in part on our not infringing patents issued to others, including our competitors and potential competitors. If our products are found to infringe the patents of others, our development, manufacture and sale of such potential products could be severely restricted or prohibited. In addition, our competitors may independently develop similar technologies. Because of the importance of our patent portfolio to our business, we may lose market share to our competitors if we fail to protect our intellectual property rights.As the number of entrants into our market increases, the possibility of a
proprietary technological position. Additionally,patent infringement claim against us grows. While we make an effort to ensure that our products do notexpectinfringe other parties' patents and proprietary rights, our products and methods may be covered by U.S. patents held by our competitors. In addition, our competitors may assert that future products we may market infringe their patents.Further, a patent infringement suit brought against us may force us to
see competitionstop or delay developing, manufacturing or selling potential products that are claimed to infringe a third party's intellectual property, unless that party grants us rights to use its intellectual property. In such cases, we may be required to obtain licenses to patents or proprietary rights of others in order to continue to commercialize our products. However, we may not be able to obtain any licenses required under any patents or proprietary rights of third parties on acceptable terms, or at all. Even if we were able to obtain rights to the third party's intellectual property, these rights may be non-exclusive, thereby giving our competitors access to the same intellectual property. Ultimately, we may be unable to commercialize some of our potential products or may have to cease some of our business operations as a result of patent infringement claims, which could severely harm our business.Trademarks
We have trademark registrations in the
mobile imaging service business from traditional nuclear imaging manufacturers because their focus is on camera sales to hospitals. GOVERNMENT REGULATION OurUnited States for the following marks: 2020tc Imager®, CardiusSST®, Digirad®, Digirad Logo®, Digirad Imaging Solutions®, FlexImaging®, and SPECTour®. We have trademark applications pending in the United States for the following marks: CardiusSM, DigiServSM, DigiSpectSM, DigiTechSM, and SolidiumSM. We have obtained and sought trademark protection for some of these listed marks in the European Community and Japan.Government Regulations
The healthcare industry, and thus our business, is subject to extensive federal, state, local and
state governmentforeign regulation. Some ofthesethe pertinent laws have not beenfullydefinitively interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. In addition, these laws and their interpretations are subject to change.FRAUD AND ABUSE LAWSBoth federal and state governmental agencies are continuing heightened civil and criminal enforcement efforts in the healthcare industry. As indicated by work plans and reports issued by these agencies, the federal government will continue to scrutinize, among other things, the billing practices of healthcare providers. The federal government also has increased funding in recent years to fight healthcare fraud, and various agencies, such as the United States Department of Justice, the Office of Inspector General of the Department of Health and Human Services, or OIG, and state Medicaid fraud control units, are coordinating their enforcement efforts.
Compliance Program
The healthcare
industry islaws applicable to our business are complex and, as noted above, subject toextensive federal, statevariable interpretations. We implemented a compliance program in 2002 to help ensure that we remain in compliance with these laws. As part of that program, we have established a compliance committee consisting of senior management andlocal regulation relatinglegal counsel that meets regularly, established a compliance hotline that permits our personnel tolicensure,report anonymously any compliance issues that may arise and instituted other safeguards intended to help prevent any violations of the Fraud and Abuse Laws discussed below and other applicable healthcare laws, and to remediate any situations that could give rise to violations. We also review our transactions and agreements, both past and present, to help assure they are compliant.Like most companies with active and effective compliance programs, we occasionally discover compliance concerns. For example, we have discovered certain isolated arrangements that we entered into in good faith but that, upon review by our compliance personnel, raised some compliance concerns under these laws. In accordance with our compliance program, we took immediate remedial steps. We cannot assure you that these remedial steps will insulate us from liability associated with these isolated arrangements.
Through our compliance efforts, we constantly strive to structure our business operations and relationships with our customers to comply with all applicable legal requirements. However, it is possible that governmental entities or other third parties could interpret these laws differently and assert non-compliance with respect to these business operations and relationships including these isolated arrangements. While there have been no claims asserted against us, if a claim were asserted and we were not to prevail, possible sanctions could have a material effect on our financial statements or our ability to conduct
of operations, ownership of facilities, addition of facilitiesour operations. We discuss below the statutes andservicesregulations that are most relevant to our business andpayment for services. In particular, themost frequently cited in enforcement actions.Fraud and Abuse Laws
Anti-Kickback Statute
The federal Anti-Kickback
LawStatute prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or furnishing,orarranging for or recommending a good or service, for which payment may be made in whole or part under a federal healthcare program such as the Medicare and MedicaidPrograms.programs. The definition of "remuneration" has been broadly interpreted to include anything of value, including for example gifts, discounts, the furnishing of supplies or equipment, credit arrangements, payments of cash and waivers of payments.The statute itself has been broadlySeveral courts have interpreted the statute's intent requirement to mean that if anyONEone purpose of an arrangement involving remuneration is to induce referralsofor otherwise generate business involving goods or services reimbursed in whole or in part under federal healthcarecovered business,programs, the statute has been violated.The penaltiesPenalties forviolating the Anti-Kickback Law can be severe. These sanctionsviolations include criminal penalties andcivil sanctions
includingsuch as fines, imprisonment and possible exclusion from Medicare, Medicaid and other federal healthcarePrograms.programs. In addition, some kickback allegations have been claimed to violate the Federal False Claims Act, discussed in more detail below.The Anti-Kickback
LawStatute is broad anditprohibits many arrangements and practices that are lawful in businesses outside of the healthcare industry. Recognizing that the Anti-KickbacklawStatute is broad and may technically prohibit many innocuous or beneficial arrangements,withinthehealthcare industry, the United States Department of Health and Human ServicesOIG has issued a series of regulations, known as the "safe harbors," beginning in July of 1991. Theseregulationssafe harbors set forthcertain safe harbors which,provisions that, if all their applicable requirements are met, will assure healthcare providers and other parties that they will not be prosecuted under the Anti-KickbackLaw. Additional provisions providing similar protections have been published intermittently since 1991. Although full compliance with all applicable safe harbors ensures against prosecution under the Anti-Kickback Law, theStatute. The failure of a transaction or arrangement to fit precisely within one or more safe harbors does not necessarily mean thatthe transaction or arrangementit is illegal or that prosecutionunder the Anti-Kickback Lawwill be pursued. However, conduct and business arrangements that do not fully satisfy each applicable safe harbor may result in increased scrutiny by government enforcement authorities such as theOffice of the Inspector General of the United States Department of Health and Human Services, orOIG.To provide specific guidance on the application of the Anti-Kickback Law, Congress required the OIG to implement an advisory opinion process. In an advisory opinion, the OIG may determine that it will not sanction the advisory opinion's requestor even if the arrangement or practice in question technically violates the - -------------------------------------------------------------------------------- 49BUSINESS - -------------------------------------------------------------------------------- Anti-Kickback Law. Although these advisory opinions are binding on the OIG and the parties requesting the opinions, no third-party may legally rely on them.Many states have adopted laws similar to the Anti-Kickback
Law.Statute. Some of these state prohibitions apply to referral of patients for healthcare items or services reimbursed by any source, not only the Medicare and MedicaidPrograms. Someprograms.Government officials have focused their enforcement efforts on marketing of
these state prohibitions may be more restrictive thanhealthcare services, among other activities, and recently have brought cases against sales personnel who allegedly offered unlawful inducements to potential or existing customers in an attempt to procure their business. As part of our compliance program, we review our marketing materials and train our sales personnel to help assure compliance with the Anti-KickbackLawStatute.In DIS, we offer lease agreements under which physicians lease our equipment and personnel, typically for one or two days a week, for a term of a year. Under this option, which comprises 93% of our DIS customers, our customers pay us the same fixed amount for each lease day regardless of the number of patients they see or the reimbursement they obtain. They also pay us for radiopharmaceuticals and pharmacological stress agents (collectively, "supplies") used in
material respects,performing the tests.Under a second contracting option, the "mixed bill" model, used by approximately 7% of our customers, we provide and
the federal safe harbors may not apply. Our nuclear imaging services model includes providingare paid for services and supplies provided to physicians forwhich the physicians pay us, for thetheir use in treating their privately insured patients. These physicians also refer Medicare patients to us, forwhichwhom we perform the technical component of nuclear imaging procedures and on whose behalf we bill the Medicare program directly. This type of arrangement, if not properly structured,maycould be construed to violate the Anti-KickbackLawStatute and alsoraisesto raise issues under another Medicare statute, 42 U.S.C. Section 1320a-7(b)(6). That statute prohibits providers from charging Medicare substantially in excess of the provider's usual and customary charges unless the Secretary of Health and Human Services finds good cause.We believe that we have
attempted to structure such arrangementsstructured our lease and "mixed bill" models, as well as ourother servicesmarketing program, to comply with the Anti-KickbackLawStatute and similar state laws, as well as with 42 U.S.C. Section 1320a-7(b)(6). However,there can be no assurances to this effect. We have attempted to structure our business arrangements forwe cannot rule out theprovision of single photon emission imagingpossibility that the government or other third parties could interpret these laws differently andother services comply with the Anti-Kickbackassert otherwise.Stark Law
and similar state laws, but there can be no assurances to this effect. In addition, theThe Ethics in Patient Referral Act of 1989, commonly referred to as the federal physician self-referral
prohibitionlaw or Stark Law, prohibits physician referrals of Medicare patients to an entity for certaindesignated healthcare services"designated health services" if the physician or an immediate family member has anownership interest in,indirect orcompensation arrangementdirect financial relationship with the entity and no statutory or regulatory exception applies. Financial relationships include an ownership interest in, or compensation arrangement with, the entity. It also prohibits an entity receiving a prohibited referral from billing and collecting for services rendered pursuant to such referral.Initially, the"Designated health services" under StarkLaw applied only to clinical laboratoryinclude inpatient and outpatient hospital services,and regulations applicable to clinical laboratory services were issued in 1995. Earlier that same year, the Stark Law's self-referral prohibition expanded to additional goods and services, includingradiology services, magnetic resonance imaging, computerized axialtomographtomography scans, ultrasound services andultrasound services. In 1998, the Healthcareoutpatient prescription drugs. The Health Care Financing Administration, now known as the Centers forMedicare and Medicaid Services, or CMS,
published proposed rules for the remaining designated healthcare services, that would have included nuclear imaging within the meaning of "radiology services." However,indicated inJanuary of 2001, CMS publisheda final rulewhich it characterized as the first phase of what will be a two-phase final rule, which reversed this position and indicatedissued in 2001 that nuclear medicinewouldis notbecovered as a designated healthcare servicecoveredunder the Stark Law. CMS has also indicated thatother supplies provided by usradiopharmaceuticals and pharmacological stress agents used in nuclear imaging procedures do not constitute designated healthcare services. However, it is possible that CMSwill again reversemay change its interpretation in the future to include nuclear imagingas a Stark covered service,and/orthat suchone or both of these suppliescould be interpreted in the future to constituteas designated healthcare services under the Stark Law. Should that occur, we believe the financial relationships we have with our physician customers fall within one or more exceptions to the prohibition on referrals. Therefore, we do not believe the physicians would be prohibited from referring Medicare patients to us. However, we cannot rule out the possibility that the government or other third parties could interpret these laws differently and assert otherwise.A person who engages in a scheme to circumvent the Stark Law's prohibitions may be fined up to $100,000 for each such arrangement or scheme. In addition, anyone who presents or causes to be presented a claim to the Medicare
Programprogram in violation of the Stark Law is subject to monetary penalties of up to $15,000 perservice,claim submitted, an assessment of several times the amount claimed, and possible exclusion from participation in federal healthcare programs.ClaimsIn addition, claims submitted in violation of the Stark Law mayalsobe alleged to be subject to liability under the federal False Claims Act and its whistleblower provisions (as discussed below).Several states in which we operate have enacted
or are consideringlegislation that prohibits physician self-referral arrangements and/or requires physicians to disclose any financial interest they may have- -------------------------------------------------------------------------------- 50BUSINESS - --------------------------------------------------------------------------------with a healthcare provider to their patients when referring patients to that provider. Some of these statutes cover all patients and are not limited to Medicare beneficiaries. Possible sanctions for violating state physician self-referral laws vary, but may include loss of license and civil and criminal sanctions. State laws vary from jurisdiction to jurisdiction and,at leastincertaina few states, are more restrictive than the federal StarkLaw in a number of material respects. In certain states, these restrictions may add considerable expense to or limit altogether the types of business models we may successfully utilize.Law. Some states have indicated they will interpret their own self-referral statutes the same way that CMS interprets the Stark Law, but it is possible the states will interpret their own laws differently in the future. We believe that we haveattempted to structurestructured our operations to comply with thesefederal andstate physician self-referral prohibition lawsbut there can be no assurancesin the jurisdictions in which we operate. However, we cannot rule out the possibility that the government or other third parties could interpret these statutes differently and assert otherwise. In certain states in which we do not yet operate, these laws may add considerable expense tothis effect.or limit altogether the types of business models we may successfully utilize.HIPAA
The Health Insurance Portability and Accountability Act of 1996, or HIPAA, created two new federal crimes: healthcare fraud and false statements relating to healthcare matters. The healthcare fraud statute prohibits knowingly and willfully executing a scheme to defraud any healthcare benefit program, including private payors. A violation of this statute is a felony and may result in fines, imprisonment or exclusion from government sponsored programs. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services. A violation of this statute is a felony and may result in fines or imprisonment.
The Health Insurance PortabilityIn addition to creating the two new federal healthcare crimes, HIPAA also establishes uniform standards governing the conduct of certain electronic healthcare transactions and
Accountability Act of 1996 also will require us to follow federal privacy,protecting the security andtransaction standards for the transmission, storage and useprivacy of individually identifiable health information maintained or transmitted by healthcare providers, health plans and healthcare clearinghouses. Two standards have been promulgated under HIPAA with whichmay add significant costswe currently are required to comply. We must comply with the Standards for Privacy of Individually Identifiable Health Information, which restrict our use andpotential burdendisclosure of certain individually identifiable health information. We have been required toour operations. A violation of these privacycomply with the Privacy Standards since April 14, 2003. We must also comply with the Standards for Electronic Transactions, which establish standardsmay result in criminal and civil penalties. Both federal and state government agencies are continuing heightened and coordinated civil and criminal enforcement efforts. As part of announced enforcement agency work plans, the federal government will continue to scrutinize, among other things, the billing practices of hospitals and other providers offor common healthcareservices. The federal government also has increased funding to fight healthcare fraud, and it is coordinating its enforcement efforts among various agencies,transactions, such as claims information, plan eligibility, payment information and theUnited States Departmentuse ofJustice, the OIG, and state Medicaid fraud control units.electronic signatures. We have been required to comply with these Standardssince October 16, 2003. We believe that we are in compliance with these standards. Two other standards relevant to our use of medical information have been promulgated under HIPAA, although our compliance with these standards is not yet required. The Security Standards will require us to implement certain security measures to safeguard certain electronic health information by April 21, 2005. In addition, CMS recently published a final rule, which will require us to adopt Unique Health Identifiers for use in filing and processing healthcare claims and other transactions by May 23, 2007. While the government intended this legislation to reduce administrative expenses and burdens for the healthcare industry,
will continueour compliance with this law may entail significant and costly changes for us. If we fail to comply with these standards, we could be subject toincreasing government scrutinycriminal penalties andinvestigations. FEDERAL FALSE CLAIMS ACTcivil sanctions.In addition to federal regulations issued under HIPAA, some states have enacted privacy and security statutes or regulations that, in some cases, are more stringent than those issued under HIPAA. In those cases, it may be necessary to modify our operations and procedures to comply with the more stringent state laws, which may entail significant and costly changes for us. We believe that we are in compliance with such state laws and regulations. However, if we fail to comply with applicable state laws and regulations, we could be subject to additional sanctions.
Federal False Claims Act
Another trend affecting the healthcare industry is the increased use of the federal False Claims Act and, in particular, actions under the False Claims Act's "whistleblower" or "qui tam" provisions. Those provisions allow a private individual to bring actions on behalf of the government alleging that the defendant has defrauded the federal government.
After the individual has initiated the lawsuit, theThe government must decide whether to intervene in the lawsuit and to become the primary prosecutor. Ifthe governmentit declines tojoin the lawsuit, thendo so, the individual may choose to pursue the case alone,in which case the individual's counsel will have primary control over the prosecution,although the government must be kept apprised of the progress of the lawsuit. Whether or not the federal government intervenes in the case, it will receive the majority of any recovery. If the individual's litigation is successful, the individual is entitled to no less than 15%, but no more than 30%, of whatever amount the government recovers.The percentage of the individual's recovery varies, depending on whether the government intervened in the case and other factors. Recently,In recent years, the number of suits brought against healthcare providers by private individuals has increaseddramatically, many of which are still under seal from the public.dramatically. In addition, various statesare considering orhave enacted laws modeled after the federal False Claims Act.We are unable to predict whether we will be subject to future actions or the impact of any future actions. - -------------------------------------------------------------------------------- 51BUSINESS - --------------------------------------------------------------------------------When
a personan entity is determined to have violated the federal False Claims Act, itmustmay be required to pay up to three times the actual damages sustained by the government, plusmandatorycivil penalties of between $5,500 to $11,000 for each separate false claim. There are many potential bases for liability under the federal False Claims Act. Liability arises, primarily, when an entity knowingly submits, or causes another to submit, a false claim for reimbursement to the federal government. Although simple negligence should not give rise to liability, submitting a claim with reckless disregard or deliberate ignorance of its truth or falsity could result in substantial civil liability.UNLAWFUL PRACTICE OF MEDICINE AND FEE SPLITTINGThemarketingFalse Claims Act has been used to assert liability on the basis of inadequate care, improper referrals, andoperationimproper use ofour diagnostic imaging systemsMedicare numbers when detailing the provider of services, in addition to the more predictable allegations as to misrepresentations with respect to the services rendered. We are unable to predict whether we could be subject tostate laws prohibitingactions under thepractice of medicine by non-physicians,False Claims Act, or theemployment or excessive controlimpact of such actions. However, the costs of defending claims under the False Claims Act, as well as sanctions imposed under the Act, could significantly affect our financial performance.Billing and Reimbursement
DIS
Reimbursement to physicians for nuclear imaging tests consists of both a "technical component" (i.e., the actual performance of the
medical judgmenttest) and a "professional component" (i.e., the interpretation ofphysicians by non-physicians (oftenthe test, sometimes referred to as a "read" of thecorporate practicetest). Physicians may bill for the professional component if they perform and document a bona fide interpretation. Medicare and certain other payors permit providers who perform both the technical and professional components to either bill "globally" for both components ofmedicine). We have attemptedthe tests, if applicable requirements are met, or tostructurebill for the technical component and professional component separately. In ouroperations so thatlease model, our physician customers bill globally for both the technical andprofessional components of the tests. Assuming they
domeet certain requirements, including but notinvolvelimited to adequate supervision of thepracticenon-physician personnel performing the tests, they may bill and be paid by Medicare according to the Medicare Physician Fee Schedule.Under our "mixed bill" model, we provide the technical component of
medicine,nuclear imaging services and bill either the physician (who, in turn, bills the patient orviolate corporate practice of medicine statutes.third-party payor) or, if the patient is a Medicare patient, the Medicare program. Forexample,those services we bill directly, our Medicare payment is based on the Medicare Physician Fee Schedule and we bill the patient for any co-payment. The physician performs and bills the payor for the professional component for allprofessional medical services relating to our operations,patients, including the interpretation ofscans and related diagnoses, are separately provided by licensed physicians not employed by us. Some states also have laws that prohibit any fee-splitting arrangement between a physician and a non-physician. We have also attempted to structurethe test. In ouroperations so that they do not violate these state laws with respect to fee splitting. However, there can be no such assurance to that effect with respect to these two sets of laws. CERTIFICATE OF NEED LAWS Some states require a certificate of need, or similar regulatory approval, prior to the acquisition of high-cost capital items or services, including diagnostic imaging systems or provision of diagnostic imaging services by us or our clients. Certificate of need regulations may limit or preclude us or our clients from providing diagnostic imaging services or systems. REIMBURSEMENT Welease agreement model, we derivea substantial percentage ofour revenues directly and only fromgovernment programs, suchcustomer physicians. In our "mixed bill" model, we derive revenues from Medicare, asMedicare, orwell as direct billings to physicians.We derive a smaller percentage of our revenues from direct billings to other third-party payors. Services for which we submit direct billings for Medicare patients typically are reimbursed by Medicare on a fee schedule basis. As a result of federal cost-containment legislation that has been in effect for many years, Medicare generally pays for inpatient services under a prospective payment system based upon a fixed amount for each Medicare patient discharge. Each discharge is classified into one of many diagnosis related groups, or DRGs. A pre-determined payment amount covers all inpatient operating costs, regardless of the services actually provided or the length of the patient's stay. Because Medicare reimburses most hospitals for all services rendered to a Medicare inpatient on the basis of a pre-determined amount based on the DRG, most hospitals, and all free-standing facilities, cannot be separately reimbursed by Medicare for a single photon emission imaging scan or other procedure performed on hospital inpatients. Many state Medicaid Programs have adopted comparable payment policies. On August 1, 2000, CMS implemented a Medicare outpatient prospective payment system under which services and items furnished in hospital outpatient departments are reimbursed using a pre-determined amount for each ambulatory payment classification, or APC. Each APC is based on the specific procedures performed and items furnished during a patient visit. Certain items and services are paid on a fee schedule, and hospitals are reimbursed additional amounts for certain drugs, biologics and new technologies. We cannot predict what impact the new Medicare outpatient reimbursement system will have on the demand for our cameras and services from hospitals. - -------------------------------------------------------------------------------- 52BUSINESS - -------------------------------------------------------------------------------- In addition, the Ethics in Patient Referral Act of 1989, commonly referred to as the federal physician self-referral prohibition or Stark Law, prohibits physician referrals of Medicare patients to an entity for certain designated healthcare services if the physician or an immediate family member has an ownership interest in, or compensation arrangement with, the entity and no statutory or regulatory exception applies. It also prohibits an entity receiving a prohibited referral from billing and collecting for services rendered pursuant to such referral. Initially, the Stark Law applied only to clinical laboratory services and regulations applicable to clinical laboratory services were issued in 1995. Earlier that same year, the Stark Law's self-referral prohibition expanded to additional goods and services, including radiology services, magnetic resonance imaging, computerized axial tomograph scans, and ultrasound services. In 1998, the Healthcare Financing Administration, now known as the Centers for Medicare and Medicaid Services, or CMS, published proposed rules for the remaining designated healthcare services, that would have included nuclear imaging within the meaning of "radiology services." However, in January of 2001, CMS published a final rule which it characterized as the first phase of what will be a two-phase final rule, which reversed this position and indicated that nuclear medicine would not be a service covered under the Stark Law. CMS has also indicated that other supplies provided by us do not constitute designated healthcare services. However, it is possible that CMS will again reverse its interpretation in the future to include nuclear imaging as a Stark covered service, and/or that such supplies could be interpreted in the future to constitute designated healthcare services under the Stark Law. A person who engages in a scheme to circumvent the Stark Law's prohibitions may be fined up to $100,000 for each such arrangement or scheme. In addition, anyone who presents or causes to be presented a claim to the Medicare Program in violation of Stark is subject to monetary penalties of up to $15,000 per service, an assessment of several times the amount claimed, and possible exclusion from participation in federal healthcare programs. Claims submitted in violation of Stark may also be subject to liability under the federal False Claims Act and its whistleblower provisions (as discussed below). Several states in which we operate have enacted or are considering legislation that prohibits physician self-referral arrangements and/or requires physicians to disclose any financial interest they may have with a healthcare provider to their patients when referring patients to that provider. Possible sanctions for violating state physician self-referral laws vary, but may include loss of license and civil and criminal sanctions. State laws vary from jurisdiction to jurisdiction and, at least in certain states, are more restrictive than the federal Stark Law in a number of material respects. In certain states, these restrictions may add considerable expense to or limit altogether the types of business models we may successfully utilize. Some states have indicated they will interpret their own self-referral statutes the same way that CMS interprets the Stark Law, but it is possible the states will interpret their own laws differently in the future. We have attempted to structure our operations to comply with these federal and state physician self-referral prohibition laws, but there can be no assurances to this effect. The Health Insurance Portability and Accountability Act of 1996 created two new federal crimes: healthcare fraud and false statements relating to healthcare matters. The healthcare fraud statute prohibits knowingly and willfully executing a scheme to defraud any healthcare benefit program, including private payors. A violation of this statute is a felony and may result in fines, imprisonment or exclusion from government sponsored programs. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services. A violation of this statute is a felony and may result in fines or imprisonment. The Health Insurance Portability and Accountability Act of 1996 also will require us to follow federal privacy, security and transaction standards for the transmission, storage and use of individually - -------------------------------------------------------------------------------- 53BUSINESS - -------------------------------------------------------------------------------- identifiable health information, which may add significant costs and potential burden to our operations. A violation of these privacy standards may result in criminal and civil penalties. Both federal and state government agencies are continuing heightened and coordinated civil and criminal enforcement efforts. As part of announced enforcement agency work plans, the federal government will continue to scrutinize, among other things, the billing practices of hospitals and other providers of healthcare services. The federal government also has increased funding to fight healthcare fraud, and it is coordinating its enforcement efforts among various agencies, such as the United States Department of Justice, the OIG, and state Medicaid fraud control units. We believe that the healthcare industry will continue to be subject to increasing government scrutiny and investigations. MEDICARE BILLING AND ENROLLMENT We can bill Medicare directly for services only to the extent we are enrolled as an IDTF.Medicare has delegated the
functionfunctions of enrollment and payment to contractors known as the Medicare carriers, each of whose jurisdiction varies, as some carriers govern several states, some just one state and some just a portion of a state. Although federal regulationsand CMS program memorandaset forth uniform rules governingIDTFindependent testing diagnostic facility, billing and enrollment, each carrier is free to interpret these rules to a certain extent. For example, anIDTFindependent testing diagnostic facility is required to have one or more supervising physicians, each of whom meets certain proficiency requirements; these precise proficiency requirements vary from carrier to carrier. The nature of a particular carrier's proficiency and other requirements may addconsiderableexpense to or limit the types of business models we may be able to utilize successfully in the carrier's jurisdiction.PartAt present, we are licensed as independent testing facilities in nine states and perform independent testing diagnostic facility services in five states.Services for which we and our customer physicians bill Medicare typically are reimbursed according to the Medicare Physician Fee Schedule that assigns a specified value to each procedure or supply, which are identified according to numeric codes. Medicare revises this Physician Fee Schedule on an annual basis. Under the Medicare Modernization Act, the Physician Fee Schedule payment rates for 2004 were increased, instead of reduced as expected prior to the legislation. The payment methodology to physician practices for drugs were changed, and some payment rates decreased. If the amounts payable under the Physician Fee Schedule or payments for supplies decreases under prescribed payment methodologies, we may receive less revenue from Medicare under our
business involvesmixed bill model. Similarly, our physician customers may receive less revenue for theleasing of equipment and personnel totests they perform under our lease model, which may adversely affect the amount we can charge physicians whothen billenter into new lease agreements or renew existing agreements.We also lease our cameras to hospitals. The payment policies implemented by state and federal reimbursement programs for hospitals affect demand for our leasing services business by hospitals. Medicare,
and other third party payors directlythe single largest third-party payor in the United States, which pays certain hospitals fornuclearimaging services using our products, generally pays for inpatient services under a prospective payment system, or PPS. Under PPS, hospitals receive a fixed amount for each Medicare patient discharge for inpatient services.Medicare rules permit physiciansEach discharge is classified into one of many diagnosis related groups corresponding tobillthe patient's condition. The payment amount assigned to each diagnosis related group reimburses the hospital for inpatient operating costs, regardless of the services actually provided or the length of the patient's stay. Hospital capital-related costs, including investments in depreciable equipment also is paid under a PPS methodology. Although there may be opportunities to obtain additional amounts for certaindiagnostic testshigh-cost new technologies in the inpatient setting, under this PPS payment methodology, Medicare does not separately reimburse hospitals for services performed usingleased equipmentour cameras, since payment for this service is included in the diagnosis related group payment amount. Many state Medicaid programs andpersonnel,private payors have adopted comparable payment policies.Medicare pays for hospital outpatient services under the outpatient prospective payment system. Under this system, services and items furnished in hospital outpatient departments are reimbursed using a pre-determined amount for each ambulatory payment classification. Each ambulatory payment classification groups together similar services comparable both clinically and with respect to
receive paymentthe use of resources. Certain items and services are paid based onthe applicable Medicarea fee schedule, and hospitals are reimbursedadditional amounts for certain drugs, biologics and new technologies. Under the Medicare Modernization Act, revisions were made to the payment methodology for radiopharmaceuticals and drugs used with our cameras, which resulted in the increase of some and decrease of other payment rates to hospitals for these supplies. We cannot predict the extent to which the payment methodology changes will have an impact on our revenue or business, if
certain conditions are satisfied.any.We believe we have
attempted to structurestructured ourequipment and personnel leasesDIS contracts so that physicians and hospitals are able to bill in this manner if they comply with the terms of theleases, but there can be no assurance to that effect. Ifcontracts and the requirements of applicable radioactive materials laws are met. However, if any of ourleasingcustomer physicians are deemed not to meet these conditions, payment to the affected physicians could be reduced, denied or recouped. If the failure to comply is deemed to be "knowing" and/or "willful," as defined in federal statutes, the government could seek to impose fines orpenalties.penalties under the False Claims Act and other statutes. This may require us to restructure our agreements with these physicians and/or respond to any resultant claims by physicians or the government.NON-GOVERNMENTAL THIRD PARTY PAYOR LIMITATIONSCamera Sales
We currently sell cameras to physicians, physician groups or medical groups. Physicians who perform or supervise nuclear imaging procedures in their offices are reimbursed by Medicare under the Physician Fee Schedule, assuming applicable requirements are met. Physicians are also reimbursed for the supplies they use in performing these procedures. The payment policies implemented by state and federal reimbursement programs for physicians affect demand for our cameras. We also sell cameras to hospitals. The payment policies implemented by state and federal reimbursement programs for hospitals affect demand for our cameras. The same rules and regulations concerning reimbursement for inpatient and outpatient services that apply to our hospital leases also apply to our sales of cameras to hospitals.
Non-Governmental Third-Party Payor Limitations
Non-governmental
third partymanaged-care payors, such ascommercialhealth maintenance organizations,or HMOs,preferred provider organizations,or PPOs,and certain other insurers,mayoften impose varying requirements and limitations on the ability of diagnostic test providers such as ourabilitylease services division to receive payment directly for the serviceswethey provide. Forinstance,example, some payors will not reimburseus separatelya provider of nuclear imaging services for thenuclear imagingtestswe perform,it performs unless the provider has a contract with the payor, andinstead require thatin many instances such payors will not enter into such contracts. On the other hand, most of these payors currently will provide reimbursementbe paid onlyon a "global" basis tothea physician who has a contract with the payor and who supervises or performs the test and provides the professionalinterpretation of the nuclear imaging test.interpretation. Such payor requirements and limitations restrict the types of business models we can successfully utilize for patients covered by thesepayors. PHARMACEUTICAL LAWSpayors, but currently do not preclude us from successfully implementing our lease and mixed bill models. However, we cannot rule out the possibility that some of these payors will impose new requirements or limitations in the future that could adversely affect these models and require us to develop new models.Pharmaceutical Laws
Our lease services business involve administering and furnishing radiopharmaceuticals and
other substancespharmacological stress agents, which are regulated as drugs by state and federal agencies, including thefederal Food and Drug AdministrationFDA and state pharmacy boards. These agencies administer laws governing the manufacturing, sale, distribution, use, administration and prescribing ofdrugs. These laws includedrugs, including the federal Food, Drug and Cosmetic Act, state food and drug laws and state pharmacy acts. Some of our activities may be deemed by relevant agencies to requireadditionalpermits or licensure- -------------------------------------------------------------------------------- 54BUSINESS - --------------------------------------------------------------------------------under these lawswhich impose substantial restrictions on who can qualify for such permits or licensure.that we currently do not possess. If any of these agencies deemed our activities to requireadditionalsuch permits or licensure, we would be required to either obtain such permits or licensure, if possible, or modify the types of business models we can utilize in the affected jurisdiction(s).ENVIRONMENTAL, HEALTH AND SAFETY LAWS Our imaging services involve the controlledIn either case, we would incur substantial expense and could encounter substantial operational burdens.Radioactive Materials Laws
The procurement, use, transfer and storage
use and disposalofmaterial containingradioactiveisotopes. While this material has a short half-life, meaning it quickly breaks down into inert, or non-radioactive substances, using suchmaterialspresents the risk of accidental environmental contamination and physical injury. We areis subject tofederal,comprehensive regulation under state andlocal regulations governingfederal laws. In some states, the federal Nuclear Regulatory Commission, or NRC, directly regulates such use (NRC States). In other states, a state regulatory agency performs such regulation under an agreement with the federal government (Agreement States). In both Agreement and NRC States, the usestorage, handlingof radioactive materials requires licensure anddisposalcompliance with comprehensive rules governing such licensure.Because our DIS business entails the use of radiopharmaceuticals in performing nuclear medicine tests, we are required to obtain and maintain licensure under radioactive materials
and waste products. Although we believe that our safety procedures for handling and disposing of these hazardous materials comply with the standards prescribed by law and regulation, we cannot completely eliminate the risk of accidental contaminationlaws, orinjury from those hazardous materials. In the event of an accident, we could be held liable for any damages that result,RAM laws, andany liability could exceed the limits or fall outside the coverage of our insurance. We may not be able to maintain insurance on acceptable terms, or at all. We could incur significant costs and the diversion of our management's attention in orderto comply withcurrentsuch laws. The RAM laws require, among other things, that such materials be used by, orfuture environmentalthat their use be supervised by, individuals with specified training, expertise and credentials in the type of use in question. Such individuals are known as "authorized users."The RAM laws include specific provisions applicable to the medical use of radioactive materials. For a business such as ours, the authorized user must be a physician with training and
regulations.expertise in the use of radioactive materials for diagnostic purposes. We have entered into contracts with qualified physicians in each of our regions to serve as authorized users.In some states, the authorized user is required to participate in or oversee the selection of patients and the ordering of procedures and/or supplies. Some states also required that an authorized user perform an interpretation of the nuclear medicine tests. The authorized user need not
had material expenses relatedbe present at the customer physician's site toenvironmental, healthperform such functions.Under the RAM laws, physicians who are not licensed authorized users, but who are supervised by an authorized user on behalf of a licensed entity, are permitted to use radioactive materials under the authority of such licensure, if certain conditions are met. Because our physician customers in our lease services business are not licensees and
safetyin most cases are not qualified to serve as authorized users, they perform nuclear medicine procedures as "supervised persons." To the extent required by applicable RAM laws, the authorized users perform some of the functions described above. For example, in states where an authorized user must perform an interpretation to satisfy RAM licensing laws, an authorized user does so. The physician customer reimburses the authorized user for doing so and also performs his orregulations to date andher own interpretation.We believe that we have
no inspection forstructured our operations so that they comply with applicable RAM laws in the jurisdictions in whicha plan of correction has not been accepted. U.S. FOOD AND DRUG ADMINISTRATION, OR FDA, AND STATE OR FOREIGN APPROVALS The manufacturewe operate, andsale ofthat the manner in which we comply with these laws is also consistent with applicable Medicare requirements. However, we cannot rule out the possibility that the government or other third parties could interpret these laws differently and assert otherwise.Medical Device Regulation
Our products are medical devices
intended for commercial distribution aresubject to extensivegovernmentalregulationinby theUnited States. Medical devices are regulatedFDA and other regulatory bodies. FDA regulations govern, among other things, the following activities that we or our partners perform and will continue to perform:
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- product design and development;
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- product testing;
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- product manufacturing;
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- product labeling;
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- product storage;
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- recordkeeping;
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- premarket clearance or approval;
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- advertising and promotion; and
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- product sales and distribution.
Unless an exemption applies, each medical device we wish to commercially distribute in the United States
primarilywill require either prior 510(k) clearance or prior premarket approval, or PMA, from the FDA. The FDA classifies medical devices into one of three classes, depending on the degree of risk associated with each medical device and the extent of control needed to ensure safety and effectiveness. Devices deemed to pose lower risk are placed in either class I or II, which requires the manufacturer to submit to the FDA a premarket notification requesting permission for commercial distribution. This process is known as 510(k) clearance. Some low-risk devices are exempted from this requirement. Devices deemed by the FDAand also by certain similar state agencies,to pose the greatest risk, such asthe California Food and Drug Branch. The FDA requires that medicallife-sustaining, life-supporting or implantable devices,be manufactured in registered establishments. California's Food and Drug Branch requires medicalor a devicemanufacturers to obtain a Medical Device Manufacturing License. As part of the regulatory framework, medical devices require pre-market clearance (demonstrating substantial equivalencedeemed not substantially equivalent to alegallypreviously cleared 510(k) device, are placed in class III. In general, a class III device cannot be marketeddevice) or pre-market approval (indicating the device is safe and effective for intended use) prior to commercial distribution. In addition, certain material changes or modifications to, and changes in intended use of, medical devices also are subject to FDA review and clearance or approval. The FDA regulates the research, testing, manufacture, safety, effectiveness, labeling, storage, record keeping, promotion and distribution of medical devicesin the United Statesandunless theexportapproves the device after submission ofunapproved medical devices from the United States to other countries. Noncompliance with applicable requirements can result in failure of the government to grant pre-market clearance or approval for devices, withdrawal or suspension of approval, total or partial suspension of production, fines, injunctions, civil penalties, refunds, recall or seizure of products and criminal prosecution. The State of California imposes similar state requirements and may impose similar sanctions on us. One wayanew device can be introduced into the market in the United States is for the manufacturer or distributorPMA.510(k) Clearance Pathway
When we are required to obtain
FDA clearance bya 510(k) clearance for a device which we wish to market, we must submit a premarket notification to FDA demonstrating thatsuchthe device is substantially equivalent to aprior approved device. The FDA requires a rigorous demonstration of substantial equivalence. A medical device manufacturer must obtain a newpreviously cleared 510(k)each time it makes a change or modification to a legally marketed device that could significantly affect the safety or effectiveness of the device, or where there is a major change or modification in the intended use of thedevice or anew indicationdevice that was in commercial distribution before May 28, 1976 forusewhich the FDA has not yet called for the submission of PMA applications. By regulation, the FDA is required to respond to a 510(k) premarket notification within 90 days of submission of thedevice. When any change or modification is made tonotification. As a practical matter, clearance can take significantly longer. If FDA determines that the device, or its intended use, is not substantially equivalent to a previously-cleared device or use, themanufacturer is expected to makeFDA will place theinitial determination as to whetherdevice, or thechangeparticular use of the device, into class III.After a device receives 510(k) clearance, any modification that could significantly affect its safety or
- -------------------------------------------------------------------------------- 55BUSINESS - -------------------------------------------------------------------------------- modification is of a kindeffectiveness, or that wouldnecessitate the filing ofconstitute a major change in its intended use, design or manufacture, will require a new 510(k).clearance or could require a PMA. The FDA requires each manufacturer to make this determination initially, but the FDA can review any such decision and can disagree with a manufacturer's determination. If the FDA disagrees with a manufacturer's determination that a new clearance or approval is not required for a particular modification, the FDA can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or PMA is obtained. If the FDA requires us to seek 510(k) clearance or PMA for any modifications to a previously cleared product, we may be required to cease marketing or recall the modified device until we obtain this clearance or approval. Also, in these circumstances, we may be subject to significant regulatory fines or penalties. We havereceivedmade and plan to continue to make additional product enhancements to our gamma cameras that we believe do not require new 510(k)clearanceclearances.Premarket Approval Pathway
A PMA application must be submitted if the device cannot be cleared through the 510(k) process. The PMA process is much more demanding than the 510(k) premarket notification process. A PMA application must be supported by extensive data including, but not limited to,
market our 2020TC Imager cameratechnical, preclinical, clinical trials, manufacturing andSPECTour chair,labeling to demonstrate to the FDA's satisfaction the safety and effectiveness of the device.After a PMA application is complete, the FDA begins an in-depth review of the submitted information. The FDA, by statute and regulation, has 180 days to review an accepted PMA application, although the review generally occurs over a significantly longer period of time, and can take up to several years. During this review period, the FDA may request additional information or clarification of information already provided. Also during the review period, an advisory panel of experts from outside the FDA may be convened to review and evaluate the application and provide recommendations to the FDA as to the approvability of the device. In addition, the FDA will conduct a preapproval inspection of the manufacturing facility to ensure compliance with the Quality System Regulation. New PMA applications or PMA application supplements are required for significant modifications to the manufacturing process, labeling and design of a device that is approved through the PMA process. PMA supplements often
require submission of the same type of information as a PMA application, except that the supplement is limited to information needed to support any changes from the device covered by the original PMA application, and may not require
similaras extensive clinical data or the convening of an advisory panel.Clinical Trials
A clinical trial is almost always required to support a PMA application and is sometimes required for a 510(k) premarket notification. These trials generally require submission of an application for an investigational device exemption to the FDA. The investigational device exemption application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. The investigational device exemption application must be approved in advance by the FDA
clearancesforadditional products or improvements to our current products. Any products manufactured or distributed by us are subject to continuing regulationa specified number of patients, unless the product is deemed a non-significant risk device and eligible for more abbreviated investigational device exemption requirements. Clinical trials for a significant risk device may begin once the investigational device exemption application is approved by the FDA and theStateappropriate institutional review boards at the clinical trial sites. Our clinical trials must be conducted in accordance with FDA regulations. The results ofCalifornia, which includes record keeping requirements, reporting of adverse experience with the useclinical testing may not be sufficient to obtain approval of the product.Pervasive and Continuing FDA Regulation
After a device
Good Manufacturing Practicesis placed on the market, numerous regulatory requirementsand post-market surveillance. It may also include post-market registryapply. These include:
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- Quality System Regulation, which requires manufacturers to follow design, testing, control, documentation and other
actions deemed necessaryquality assurance procedures during the manufacturing process;- •
- labeling regulations, which prohibit the promotion of products for unapproved or "off-label" uses and impose other restrictions on labeling; and
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- medical device reporting, regulations, which require that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to recur.
Failure to comply with applicable regulatory requirements can result in enforcement action by the
FDA. SalesFDA, which may include any of the following sanctions:
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- fines, injunctions, and civil penalties;
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- recall or seizure of our products;
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- operating restrictions, partial suspension or total shutdown of production;
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- refusing our request for 510(k) clearance or PMA of new products;
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- withdrawing 510(k) clearance or PMAs that are already granted; and
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- criminal prosecution.
We are subject to unannounced inspections by the FDA and the Food and Drug Branch of the California Department of Health Services, and these inspections may include the manufacturing facilities of our subcontractors.
International
International sales of medical
device products outside the United Statesdevices are subject to foreignregulatory requirements thatgovernment regulations, which vary substantially from country to country. The time required to obtainapprovals requiredapproval by a foreigncountriescountry may be longer or shorter than that required for FDAclearance,approval, and the requirements may differ.The primary regulatory environment in Europe is that of the European Union, which consists of 15 countries encompassing most of the major countries in Europe. Other countries, such as Switzerland, have voluntarily adopted laws and regulations that mirror those of the European Union with respect to medical devices. The European Union has adopted numerous directives and standards regulating the design,
manufacture, clinical trials, labeling, and adverse event reporting for
licensing may differ from FDA requirements. We will spend considerable time and effort tomedical devices. Devices that comply with the requirements of a relevant directive will be entitled to bear CE conformity marking, indicating that the device conforms with the essential requirements of the applicable directives and, accordingly, can be commercially distributed throughout Europe. CE is an abbreviation for European Compliance. The method of assessing conformity varies depending on the class of the product, but normally involves a combination of self-assessment by the manufacturer and a third-party assessment by a "Notified Body." This third-party assessment may consist of an audit of the manufacturer's quality system and specific testing of the manufacturer's product. An assessment by a Notified Body in one country within the European Union is required in order for a manufacturer to commercially distribute the product throughout the European Union. In 2001, we were certified by TUV Product Service, a Notified Body, under the European Union Medical Device Directive allowing the CE conformity marking to be applied.Our current products are approved for market release by the FDA. We also received regulatory approval from the Japanese Ministry of Health in October 2000, which is similar to our FDA
state,Establishment Registration. In March 2003, we received GOST certification, the quality andforeign regulatory requirements described above. Any failuresafety certification system administered by the Russian committee, Gosstandart, toobtain and maintain compliance with such requirements could have a material adverse effect on our business and subject us to sanction. FACILITIESdistribute the 2020tc/SPECTour chair in Russia.Employees
As of
June 30, 2001, we lease in aggregate approximately 48,000 square feet in San Diego, California. These facilities serve as our executive headquarters and as the base for our marketing and product support operations, research and development and manufacturing activities. These leased facilities also include approximately 7,000 square feet of clean room space. In addition, Digirad Imaging Solutions, our wholly-owned subsidiary, leases office space in eight locations in Indiana, Maryland, New Jersey, North Carolina, Ohio, Pennsylvania and Florida which together represent approximately 18,000 combined square feet of office space These leased facilities serve as a base for the marketing and imaging services operations of Digirad Imaging Solutions. EMPLOYEES As of June 30, 2001,March 31, 2004, we had257a total of 316 employees,including 18of which 150 were employed inour researchclinical anddevelopment department, 43regulatory, 75 inour sales and marketing department, 105 in our manufacturing department, 25operations, 40 in general and administrative,functions34 in sales and66marketing and 17 inmobile imaging services operations.research and development. We had a total of 180 employees in our DIS subsidiary. None of our employees is represented by a labor union. We have not experienced any work stoppages and consider our employee relations to be good. We are, however, aware of a claim by one former employee and three current employees that they are due unpaid overtime because of an alleged misclassification of their positions as exempt rather than non-exempt employees. For a further discussion, see "Risk Factors—Risks Related to Our Intellectual Property and Potential Litigation—We may be subject to lawsuits and actions brought by our employees."Facilities
Our operations are headquartered in an approximately 70,000 square foot facility in Poway, California that is leased to us until February 2010. We believe that our
relations withexisting facility is adequate for ouremployeescurrent needs.Legal Proceedings
We are
good. LEGAL PROCEEDINGS In July 2001, we were served with notice thatcurrently not acomplaint had been filed by Medical Management Concepts, Inc. in the United States District Court for the Eastern District of Pennsylvania. The complaint alleges, among other things, breach of the terms of a Services Agreementparty to any material legal proceedings.Executive Officers, Key Employees and
an Employee Lease Agreement, each dated September 2000 and entered into by and between our wholly owned subsidiary, Digirad Imaging Systems, Inc., and Medical Management Concepts as part of our acquisition of some of the customer contracts and select assets relating to the mobile nuclear imaging services of Nuclear Imaging Systems, Inc. and Cardiovascular Concepts, P.C. This complaint seeks recovery of damages for approximately $81,000 plus 12.5% of the adjusted estimated net revenue generated from gross sums billed to our mobile nuclear imaging customers from May 1, 2001 to October 31, 2003. We intend to vigorously defend against this complaint. - -------------------------------------------------------------------------------- 56- -------------------------------------------------------------------------------- Management EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEESDirectorsThe following table sets forth certain information regarding our executive officers, key employees and
directors as of August 23, 2001:directors:
NAME AGE POSITION(S) - -----------------------------------------------------------------------------------------------------------------------EXECUTIVE OFFICERS AND KEY EMPLOYEES: R. Scott Huennekens................................ 37Name Age Position(s) David M. Sheehan 41 President, Chief Executive Officer and Director Gary J.G. Atkinson................................. 49 Vice President of Finance andTodd P. Clyde 35 Chief Financial Officer Richard L. Conwell................................. 50Vera P. Pardee 47 Vice President, General Counsel and Secretary Diana M. Bowden 42 Vice President of Marketing Robert E. Johnson.................................. 44Herbert J. Bellucci 54 Senior Vice President of Operations Paul J. Early 68 Vice President and Corporate Radiation Safety Officer Richard L. Conwell 53 Vice President, Advanced Research and Development and Business Development Martin B. Shirley 41 Regional Vice President of Sales, and Service John F. Sheridan................................... 46EastStephen L. Bollinger 45 Regional Vice President of Operations David M. Sheehan................................... 38 President, Digirad Imaging Solutions, Inc. DIRECTORS:Sales, WestTimothy J. Wollaeger(1) ............................ 57(3)60 Chairman of the Board of Directors Raymond V. Dittamore(2)(3) 61 Director Robert M. Jaffe 52 Director R. King Nelson(2).................................. 44Nelson(1)(2)47 Director Brad Nutter........................................ 49 DirectorKenneth E. Olson(1)(2)............................. 64Olson(2)(3)67 Director Douglas Reed, M.D. (2).............................. 4750 Director - ---------
- (1)
Members- Member of
Compensation Committeethe compensation committee- (2)
Members- Member of
Audit Committee R. SCOTT HUENNEKENSaudit committee- (3)
- Member of the corporate governance committee
David M. Sheehan has
beenserved as our President and Chief Executive Officer since March 2002 and as a member of our board of directors sinceMay 1999 and our Chief Executive Officer since June 1999. Prior to being appointedJuly 2002. Mr. Sheehan joined us in September 2000 asour President and Chief Executive Officer, from March 1997 to April 1999, Mr. Huennekens served as our Chief Financial Officer and Vice President of Sales and Marketing. Prior to joining us, from July 1993 to March 1997, Mr. Huennekens held various positions at Baxter Healthcare Corporation, a medical products and services company, including Vice President of Sales & Marketing for the Novacor division and its sales of left ventricular assist devices, and Business Unit Manager/Director of Marketing for the Bentley division and its sales of cardiopulmonary products. Mr. Huennekens is a Certified Public Accountant and received a B.S. in business administration from the University of Southern California and an M.B.A. from the Harvard Business School. GARY J.G. ATKINSON has been our Vice President of Finance and Chief Financial Officer since May 2001. Prior to joining us, from April 2000 to February 2001, Mr. Atkinson served as Chief Financial Officer at Situs Corporation, a company which develops drugs and drug delivery devices for intravesical applications. Prior to that, from November 1992 to April 2000, Mr. Atkinson served as Vice President of Finance at Isis Pharmaceuticals, a publicly held pharmaceutical research and development company. Mr. Atkinson is a Certified Public Accountant and received a B.S. from Brigham Young University. RICHARD L. CONWELL has been our Vice President of Marketing since January 2001. From January 1998 to January 2001, Mr. Conwell served as our Vice President of Research and Development. From June 1995 to January 1998, Mr. Conwell served as our Vice President of Operations. Prior to joining us, Mr. Conwell served as Vice President of Thermo Gamma-Metrics, a company which develops and markets on-line, high-speed process-optimization systems for raw-materials analysis, where he was - -------------------------------------------------------------------------------- 57MANAGEMENT - -------------------------------------------------------------------------------- responsible for the company's bulk material analyzer business. Mr. Conwell received a B.S. in physics and computer science from Ball State University. ROBERT E. JOHNSON has been our Vice President of Sales and Service since April 1999. Prior to joining us, from February 1993 to March 1999, Mr. Johnson served as Region Vice President and Vice President of United States Sales for ADAC Laboratories, a provider of nuclear medicine and radiation therapy planning systems. Prior to that, Mr. Johnson held various sales management and sales positions with Siemens Medical Systems, a company that develops and manufactures medical equipment. Mr. Johnson received a B.A. in marketing from the University of South Florida. JOHN F. SHERIDAN has been our Vice President of Operations since March 1998 and leads the development and manufacturing efforts for our scintillator/photodiode detector system. Prior to joining us, from October 1983 to March 1998, Mr. Sheridan held various positions, including Director of Operations, at Analog Devices, Inc., a semiconductor company that develops, manufacturers and markets high performance integrated circuits used in signal-processing applications. Mr. Sheridan received a B.S. in chemistry from the University of West Florida and an M.B.A. from Boston University. DAVID M. SHEEHAN has been thePresident of Digirad Imaging Solutions, Inc., our wholly ownedsubsidiary, since September 2000. Prior to joining us, fromsubsidiary. From May 1999 to September 2000, Mr. Sheehan served as the President and Chief Executive Officer of Rapidcare.com, an e-healthcompany that connects physicians with families and children who suffer from chronic disease. Prior to that, fromcompany. From May 1997 to May 1999,Mr. Sheehanhe served as Vice President of Sales,&Marketing,forand Business Development of a divisionofat BaxterHealthcare Corporation whichInternational, Inc. that provided cardiopulmonary products and services to hospitals. Prior tothat, from July 1991 to May 1997, Mr. Sheehan workedthis, he held operations, sales and marketing positions at Haemonetics Corporation, a supplier of blood processingservicesequipment andequipment, in various sales, marketing, and business development positions.services. Mr. Sheehan receivedahis B.S. in mechanical engineering from Worcester Polytechnic Institute andanhis M.B.A. from the Tuck School of Business at Dartmouth College.TIMOTHYTodd P. Clyde has served as our Chief Financial Officer since November 2002. From January 2002 to November 2002, Mr. Clyde was Chief Financial Officer at Del Mar Database, Inc., a software company developing products for the mortgage lending industry. From March 2000 to October 2001, Mr. Clyde was Vice President and Controller at Verance Corporation, a digital information tracking and security company. From October 1997 to March 2000, Mr. Clyde was Vice President and Division Controller at I-Bus/Phoenix, a division of Maxwell Technologies, Inc. which is a manufacturer of customized industrial computing. Prior to this, he was a senior auditor at Ernst & Young, LLP, an international public accounting firm. Mr. Clyde received his B.S. in accounting and his Masters of Accountancy from Brigham Young University. Mr. Clyde is a Certified Public Accountant.
Vera P. Pardee has served as our Vice President, General Counsel and Secretary since April 2003. From July 2000 to February 2002, Ms. Pardee served as Vice President, General Counsel and Secretary of Nanogen, Inc., a biotechnology company developing molecular diagnostic tests for the clinical research and
diagnostics markets. From January 1988 to June 2001, Ms. Pardee was in private practice as a partner and associate at Seltzer Caplan Vitek McMahon and from 1983 to 1987 as an associate at O'Melveny & Myers, LLP. Ms. Pardee received her J.D. from Southwestern University School of Law.
Diana M. Bowden has served as our Vice President of Marketing since September 2002. From June 2001 to August 2002, Ms. Bowden served as Director of Marketing with our wholly-owned subsidiary, Digirad Imaging Solutions. From August 2000 to June 2001, Ms. Bowden served as Director of Marketing at Keylime Software, Inc., a web analytics company. From May 1998 to May 2000, she served as Director of Sales and Marketing at Ultra Acquisition Corporation, an e-commerce and manufacturing company. From June 1994 to May 1998, Ms. Bowden served as Vice President, Sales and Marketing at RadNet, a radiology service provider. Prior to this she served in various product management and sales management positions at Quest Diagnostics Incorporated, a large medical reference laboratory, and in sales and marketing positions at Iolab, a former Johnson & Johnson pharmaceutical company. She received her B.A. in biological sciences from U.C. Santa Barbara and her M.B.A. in marketing from the Peter Drucker Graduate School of Management of the Claremont Graduate University.
Herbert J.
WOLLAEGERBellucci hasbeenserved as our Senior Vice President, Operations since May 2003. From April 1994 to April 2003, Mr. Bellucci was Vice President of Manufacturing at Omnicell, a company that manufactures electromechanical dispensing systems for drugs and hospital supplies. Prior to this, he was Senior Vice President of Operations at Laserscope, a manufacturer of minimally invasive surgical devices, Vice President of Operations at Vidamed, a medical device company, and Manufacturing Manager at Spectra-Physics, a division of Thermo Electric Corporation which is a supplier of laser technology. Mr. Bellucci received his B.S. in engineering from Brown University and his M.B.A. from Stanford University.Paul J. Early has served as our Vice President and Corporate Radiation Safety Officer since March 2001. Prior to joining us, Mr. Early was the President of Associates at Medical Physics, the scientific journal of the American Association of Physicists in Medicine. Mr. Early is the author of multiple books, including the nuclear medicine textbook "Textbook of Nuclear Medicine Technology." Mr. Early is a Diplomat of the American Board of Medical Physics, the American Board of Science in Nuclear Medicine and the American Board of Radiology. Mr. Early received his B.S. from St. Ambrose University and completed two years of post-graduate studies at Creighton University.
Richard L. Conwell has served as our Vice President of Advanced Research and Development and Business Development since August 2001. Prior to that, he served as our Vice President of Marketing from January 2001 to August 2001, as Vice President of Research and Development and Marketing from March 2000 to January 2001, and as Vice President of Research and Development from June 1996 to March 2000. Prior to joining us, Mr. Conwell was Vice President of Thermo Gamma Metrics, a company which develops and markets on-line, high-speed process optimization systems for raw-materials analysis, where he was responsible for the company's bulk material analyzer business. Mr. Conwell received his B.S. in physics and computer science from Ball State University.
Martin B. Shirley has served as our Regional Vice President of Sales, East since July 2002. Prior to that, Mr. Shirley served as a Regional Sales Director for us from January 2001 to January 2002, and as a Territory Manager for us from January 2000 to January 2001. From March 1999 to December 1999, he was a principal of IsoPoint, Inc., a software company, where he was responsible for sales and contracting. Prior to this, Mr. Shirley was Regional Sales Manager at SMV America, Inc., a manufacturer of gamma cameras that was purchased by General Electric, and a Territory Manager for Dupont in their radiopharmaceutical business. Prior to this, Mr. Shirley spent five years as a Certified Nuclear Technologist. Mr. Shirley received his A.S. in nuclear medicine technology from Hillsborough Community College and his A.A. in liberal arts from Santa Fe Community College.
Stephen L. Bollinger has served as our Regional Vice President of Sales, West since July 2002. From February 2002 to July 2002, Mr. Bollinger served as our Western Regional Sales Director. From
October 2000 to February 2002 Mr. Bollinger worked at Data Return Corporation, a company that provides managed website hosting services, as Western Regional Sales Manager. From June 1986 to September 2000, Mr. Bollinger was a West Coast Regional Sales Manager for Kodak's medical imaging products division. Mr. Bollinger received his B.S. from University of Phoenix and his M.B.A. from University of Colorado.
Timothy J. Wollaeger has served as a member of our board of directors since
JuneApril 1994 and as our Chairman since January 1996.In addition,Mr. Wollaegerserved as our Chief Executive Officer in May 1999. Mr. Wollaegerhas been the Managing Director for the San Diego office of Sanderling Biomedical Venture Capital since April 2002. He isthealso a general partner of Kingsbury Associates,L. P.L.P., a venture capital firm he founded inDecember 1993January 1994, which focuses on investments in the healthcare industry. From May 1990untilto December 1993, Mr. Wollaeger served as Senior Vice President and a director of Columbia Hospital Corporation, a hospital management company now known as HCA Healthcare Corporation. From October 1986 until July 1993, Mr. Wollaeger was a general partner of Biovest Partners, a seed venture capital firm.Mr. WollaegerHe ischairmanChairman of the board of directors of BiositeDiagnostics, Inc.Incorporated and a founder and director of several privately held medical products companies. Mr. Wollaeger receivedahis B.A. in economics from Yale University andanhis M.B.A. from the StanfordUniversity. R. KING NELSONUniversity Graduate School of Business.Raymond V. Dittamore has
beenserved as a member of our board of directors sinceMay 2000. Since May 1999,March 2004. Mr.NelsonDittamore is a retired audit partner of Ernst & Young, LLP, an international public accounting firm. Mr. Dittamore retired after 35 years of service, including 14 years as the managing partner of the firm's San Diego office. Mr. Dittamore is a director of Qualcomm Incorporated, Invitrogen Corporation and Gen-Probe Incorporated. Mr. Dittamore received his B.S. from San Diego State University.Robert M. Jaffe has served as a member of our board of directors since June 2002. He is a founder and investment officer of Sorrento Associates. Prior to founding Sorrento Associates in 1985, he was an investment banker at Merrill Lynch Capital Markets. Prior to this, he was an investment banker at Salomon Brothers, Inc. and Goldman, Sachs & Co. He was also a member of the technical staff at Hughes Aircraft Company and a consultant at McKinsey & Co. Mr. Jaffe received his M.B.A. from the Harvard Business School where he was a Baker Scholar and the recipient of The Loeb Rhoades Fellowship. He received his M.S. in electrical engineering from the California Institute of Technology, and his B.S. in electrical engineering and computer science from the University of California at Berkeley.
R. King Nelson has served as a member of our board of directors since March 2004 and previously served as a director from May 2000 to April 2002. From May 1999 to December 2003, Mr. Nelson served as the President and Chief Executive Officer of VenPro Corporation, a medical device company
whichthat develops bioprosthetic implants for venous vascular and cardiovascular medicine.Prior to that, fromFrom January19961980 to December 1998, Mr. Nelsonservedheld various executive positions at Baxter Healthcare Corporation, most recently as President of the perfusion servicebusiness of Baxter Healthcare Corporation. Prior to that, from January 1980 to December 1995, Mr. Nelson held various positions at Baxter Healthcare Corporation.business. Mr. Nelson receivedahis B.S. from Texas Tech University andanhis M.B.A. in international business from the University of Miami.BRAD NUTTERKenneth E. Olson has
been a member of our board of directors since August 2001. From February 2000 to October 2000, Mr. Nutterserved asExecutive Vice President of Gambro AB, an international medical technology and healthcare company, and President and Chief Executive Officer of Gambro Healthcare, a division of Gambro AB which provides dialysis services to out-patient centers. Prior to that, from - -------------------------------------------------------------------------------- 58MANAGEMENT - -------------------------------------------------------------------------------- June 1997 to January 2000, Mr. Nutter served as Executive Vice President and Chief Operating Officer of Syncor International Corporation, an international provider of radiopharmaceuticals and medical imaging services. From May 1996 to June 1997, Mr. Nutter served as a partner at The Align Group, a privately-held international healthcare marketing organization, which Mr. Nutter founded. Prior to that, from January 1995 to April 1996, Mr. Nutter held various positions, including Senior Vice President of Corporate Marketing, at Sunrise Medial, Inc., an international healthcare manufacturer of homecare and institutional products. Mr. Nutter received a B.A. in business administration from Texas Christian University. KENNETH E. OLSON has beena member of our board of directors since March 1996. From June 1984 to June 1998, he served as Chairman, and from December 1990 to February 1996 and from March 1997 to June 1998,Mr. Olsonhe served as Chief Executive Officer, at Proxima Corporation, a supplier ofdisplay projection systems for professional desktop computers.digital imaging systems. From 1971 to 1987, he was Chairman and Chief Executive Officer of Topaz, Inc., a designer and manufacturer of computer peripherals. Mr. Olson also serves on the board of directors for Avanir Pharmaceuticals and WD-40 Company.Mr. Olson received a B.S. inHe studied electrical engineeringfrom the University of CaliforniaatLos AngelesUCLA andanreceived his M.B.A. from Pepperdine University.DOUGLAS REED,Douglas Reed, M.D. has
beenserved as a member of our board of directors sinceSeptemberAugust 2000. Heishas been amanaging directorManaging Director of Vector Fund Management, a venture capital firm which focuses on investments in the life sciences and healthcareindustry. Prior to that, fromindustry since June 2000. From October 1998 toJulyJanuary 2000, Dr. Reed served as Vice President of Business Development for GelTex Pharmaceuticals, Inc., a company that develops and markets non-absorbed polymer drugs. From April 1996 to September 1998, Dr. Reed servedas Vice President of Business Development at NPS Pharmaceuticals, Inc., a company which develops small molecule drugs and recombinant peptides.
From June 1988Prior toApril 1996,this, Dr. Reed served as Vice President at S.R. One, Limited, a venture capital fund focused on investments in biopharmaceuticals and the life sciences. Dr. Reedreceived a B.A. in biology and an M.D., each from the University of Missouri--Kansas City, and an M.B.A. from the Wharton School at the University of Pennsylvania. Dr. Reedis board certified as aneuro-radiologistneuroradiologist and has held faculty positions at the University of Washington and Yale University in the department of radiology.COMPOSITION OF OUR BOARD OF DIRECTORS We currently have six directors. Upon completionDr. Reed received his B.A. in biology and M.D. from the University ofthis offering, our amendedMissouri—Kansas City, andrestated certificatehis M.B.A. from the Wharton School at the University ofincorporation will provide for a classifiedPennsylvania.Board Composition
Our board of directors
consistingcurrently consists ofthree classes ofseven directors, eachservingof whom has been elected to serve astaggered three-yearone year term.AsOur directors hold office until their successors have been elected and qualified or until their earlier death, resignation, disqualification or removal for cause by the affirmative vote of the holders of aresult,majority of the outstanding stock entitled to vote on election of directors. Mr. Jaffe, who currently serves as aportionmember of our board of directors, has submitted his resignation which will become effective immediately prior to the effectiveness of this offering. Upon his resignation, one of our authorized board seats will beelectedvacant.Board Committees
Our board of directors has an audit committee, a compensation committee and a corporate governance committee.
Audit Committee
Our audit committee oversees our corporate accounting and financial reporting process. The audit committee consists of Mr. Dittamore, Mr. Nelson and Mr. Olson, each
year. To implementof whom is an independent member of our board of directors as defined by applicable Securities and Exchange Commission, or SEC, rules and theclassified structure, twoNasdaq National Market listing standards. The functions of this committee include, among other things:
- •
- meeting with our management periodically to consider the adequacy of our internal controls and the objectivity of our financial reporting;
- •
- meeting with our independent auditors and with internal financial personnel regarding these matters;
- •
- recommending to our board of directors the engagement of our independent auditors;
- •
- reviewing our audited financial statements and reports and discussing the statements and reports with our management, including any significant adjustments, management judgments and estimates, new accounting policies and disagreements with management; and
- •
- reviewing our financial plans and reporting recommendations to our full board for approval and to authorize action.
Both our independent auditors and internal financial personnel regularly meet privately with our audit committee and have unrestricted access to this committee.
Compensation Committee
Our compensation committee consists of Mr. Nelson and Mr. Wollaeger, each of whom is a non-management member of our board of directors. The functions of this committee include, among other things:
- •
- reviewing and, as it deems appropriate, recommending to our board of directors, policies, practices and procedures relating to the compensation of our directors, officers and other managerial employees and the establishment and administration of our employee benefit plans;
- •
- exercising authority under our employee benefit plans; and
- •
- advising and consulting with our officers regarding managerial personnel and development.
Corporate Governance Committee
Our corporate governance committee currently consists of Mr. Dittamore, Mr. Olson and Mr. Wollaeger, each of whom is a non-management member of our board of directors. The functions of this committee include, among other things:
- •
- reviewing and recommending nominees for election as directors;
- •
- assessing the performance of the
nomineesboard of directors;- •
- developing guidelines for board composition; and
- •
- reviewing and administering our corporate governance guidelines and considering other issues relating to corporate governance.
We currently pay our directors $4,000 for attending in-person board meetings and $500 for attending board meetings telephonically. In addition, we also currently pay our directors $1,000 for attending in-person committee meetings and $500 for attending telephonic committee meetings. In addition, directors are reimbursed for reasonable out-of-pocket expenses in connection with attending meetings of our board of directors and committees of the board of directors. In 2003, none of our non-employee directors were granted options to purchase our common stock.
Effective upon the completion of this offering, we will adopt our 2004 Non-Employee Directors' Stock Option Program to provide for the automatic grant of options to purchase 10,000 shares of common stock to non-employee directors who join the board of directors
will be electedafter the completion of this offering, and annual grants of 5,000 shares of our common stock to each of our non-employee directors. In addition, all of our directors are eligible to participate in our 2004 Stock Incentive Plan. For aone-year term, two will be electedmore detailed description of these plans, see "Benefit Plans."Compensation Committee Interlocks And Insider Participation
Except for Mr. Wollaeger's unpaid service to
a two-year term and two will be elected to a three-year term. Afterus as Chief Executive Officer during part of May 1999, no member of our compensation committee has ever been an officer or employee of ours. None of our executive officers currently serve, or has served during theoffering, directors will be elected for three-year terms. Dr. Reed and Mr. Nutter will be designated Class I Directors, whose terms expire atlast completed fiscal year, on the2002 annual meeting of stockholders. Messrs. Olson and Wollaeger will be designated Class II Directors, whose terms expire at the 2003 annual meeting of stockholders. Messrs. Huennekens and Nelson will be designated the Class III Directors, whose terms expire at the 2004 annual meeting of the stockholders. This classification of thecompensation committee or board of directorsmay delayof any other entity that has one orprevent a change in control of our company or in our management. See "Description of capital stock--Possible Anti-Takeover Matters." BOARD COMMITTEES - - AUDIT COMMITTEE--The audit committee of the board of directors reviews, acts on and reports to the board of directors with respect to various auditing and accounting matters, including the recommendation of our auditors, the scope of the annual audits, fees to be paid to the auditors, the performance of our independent auditors and our accounting practices. As of the closing of this offering, the members of the audit committee will be Messrs. Nelson and Olson and Dr. Reed. - -------------------------------------------------------------------------------- 59Management - -------------------------------------------------------------------------------- - - COMPENSATION COMMITTEE--The compensation committee of the board of directors recommends, reviews and oversees the salaries, benefits and stock option plans for ourmore executive officersemployees, consultants, directors and other individuals compensated by us. The compensation committee also administersserving as a member of ourcompensation plans. As of the closing of this offering, the members of the compensation committee will be Messrs. Olson and Wollaeger. DIRECTOR COMPENSATION All directors are reimbursed for the reasonable expenses of attending the meetings of theboard of directors orcommittees. We will also be granting options to our outside directors ascompensationas described below undercommittee.Executive Compensation
The following table provides information regarding the
heading "Benefit plans--Automatic Option Grant Program." From time to timecompensation earned during the fiscal year ended December 31,2000, some2003 by our Chief Executive Officer and our other four most highly compensated executive officers. We refer to our Chief Executive Officer and these other executive officers as our "named executive officers" in this prospectus.Summary Compensation Table
Long-Term
CompensationAnnual Compensation Name and Principal Position Securities
Underlying
Options(#)Other
Compensation(2)Salary Bonus(1) David M. Sheehan
President, Chief Executive Officer and Director$ 216,538 $ 37,500 — — Todd P. Clyde
Chief Financial Officer170,000 22,000 — — Diana M. Bowden
Vice President of Marketing134,251 12,000 — — Martin B. Shirley
Regional Vice President of Sales, East203,867 — — — Stephen L. Bollinger
Regional Vice President of Sales, West184,287 — — —
- (1)
- These amounts represent bonuses earned during the fiscal year ended December 31, 2003. Annual bonuses earned during a fiscal year are paid in the first quarter of
our directors werethe subsequent fiscal year.- (2)
- In accordance with the rules of the Securities and Exchange Commission, the other annual compensation described in this table does not include various perquisites and other personal benefits received by a named executive officer that do not exceed the lesser of $50,000 or 10% of such officer's salary and bonus disclosed in this table.
Stock Option Grants in Last Fiscal Year
During the fiscal year ended December 31, 2003, we granted stock options to purchase 285,589 shares of our common stock under our 1998 Stock Option/Stock Issuance
Plan. For information concerning thesePlan, including grantsplease see the description under the heading "Certain relationships and related transactions--Option Agreements with Directors." COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Our compensation committee consists of Messrs. Olson and Wollaeger. Neither member of the compensation committee is currently an officer or employee of ours. Mr. Wollaeger served as our Chief Executive Officer for the month of May 1999. Priortothe formation of the compensation committee, the board of directors as a whole made decisions relating to compensation of ourexecutive officers.Upon completionNo grants ofthis offering, the compensation committee will make all compensation decisions regarding our executive officers. EXECUTIVE COMPENSATION The following table sets forth the compensation received during the fiscal year ended December 31, 2000 by our Chief Executive Officer, the three other most highly compensated executive officers who were serving at the end of the fiscal year ended December 31, 2000 whose annual salaries and bonuses exceeded $100,000 and to David M. Sheehan, the President of Digirad Imaging Solutions. We refer to these officers as our named executive officers in other parts of this prospectus. - -------------------------------------------------------------------------------- 60MANAGEMENT - -------------------------------------------------------------------------------- EXECUTIVE COMPENSATION TABLE - --------------------------------------------------------------------------------
LONG-TERM COMPENSATION AWARDS -------------- NUMBER OF ANNUAL COMPENSATION SECURITIES ------------------------------- UNDERLYING NAME AND PRINCIPAL POSITION(S) SALARY BONUS OTHER OPTIONS - ------------------------------------------------------------------------------------------------------------R. Scott Huennekens ...................................... $213,462 $70,000 -- 575,000 President and Chief Executive Officer Robert E. Johnson ........................................ $155,423 -- $85,000(1) 200,000 Vice President of Sales and Service John F. Sheridan ......................................... $171,904 $35,000 $19,800(2) 150,000 Vice President of Operations Richard L. Conwell ....................................... $152,557 $15,000 -- 50,000 Vice President of Marketing David M. Sheehan(3) ...................................... $ 47,308 $ 9,500 -- 400,000 President, Digirad Imaging Solutions- ---------- (1) Consists of commissions paid to Mr. Johnson for the fiscal year ended December 31, 2000. (2) Consists of $15,000 paid to Mr. Sheridan for relocation expenses and $4,800 in benefits received under our health and benefit plans. (3) Mr. Sheehan commenced his employment as President of Digirad Imaging Solutions, Inc. in September 2000 with an annual base salary of $175,000. OPTION GRANTS The following table sets forth information concerningstock optionsgrantedwere made toourany of the named executive officers during 2003. All options were granted at thefiscal year ended December 31, 2000: OPTION GRANTS IN LAST FISCAL YEAR
POTENTIAL REALIZABLE INDIVIDUAL GRANTS VALUE AT ASSUMED ----------------------------------------------------- ANNUAL RATES OF NUMBER OF PERCENTAGE OF STOCK PRICE SECURITIES TOTAL OPTIONS EXERCISE APPRECIATION FOR UNDERLYING GRANTED TO PRICE OPTION TERM(1) OPTIONS EMPLOYEES IN PER EXPIRATION --------------------- NAME GRANTED FISCAL YEAR SHARE DATE 5% 10% - -------------------------------------------------------------------------------------------------------------R. Scott Huennekens........... 575,000 22.3% $0.35 03/09/10 $126,565 $320,741 Robert E. Johnson............. 200,000 7.8% $0.35 03/09/10 $ 44,023 $111,562 John F. Sheridan.............. 150,000 5.8% $0.35 03/09/10 $ 33,017 $ 83,671 Richard L. Conwell............ 50,000 1.9% $0.35 03/09/10 $ 11,006 $ 27,890 David M. Sheehan.............. 400,000 15.5% $0.50 12/29/10 $125,779 $318,748- ---------- (1) Potential realizable value is based uponfair market value of our common stockon the grant date of the optionsas determined by our board of directorswhich is substantially less than the initial public offering price. If the potential realizable value were calculated over the ten-year term of the options, based on the initial public offering price, the resulting stock price at the end of the term would be significantly higher. - -------------------------------------------------------------------------------- 61MANAGEMENT - -------------------------------------------------------------------------------- The figures above represent options to purchase shares of our common stock granted under our 1998 Stock Option/Stock Issuance Plan. We granted options to purchase an aggregate of 2,574,964 shares of our common stock in 2000. The options granted to our employees typically vest in a 25% increment on the first annual anniversary of the date of grant and thereafter vest on a daily basis over a three-year period. The options granted to the named executive officers listed in the table above began to vest on a daily basis over a four-year period beginning on each of their respective dates of grant. Options granted to the persons listed above expire 10 years from the dates of grant. The potential realizable value at assumed annual rates of stock price appreciation for the option term represents hypothetical gains that could be achieved for the respective options if exercised at the end of the option term. The 5% and 10% assumed annual rates of compounded stock price appreciation are required by rules of the Securities and Exchange Commission and do not represent our estimateorprojection of our future common stock prices. These amounts represent assumed rates of appreciation in the value of our common stock from the fair market valuecompensation committee, as applicable, on the date of grant.Actual gains, if any, on stock option exercises are dependent onGenerally, 25% of thefuture performanceshares subject to options vest one year from the date ofour common stockhire andoverall stock market conditions. The actual value realized may be greater or less thanthepotential realizable value set forthremainder of the shares vest in equal daily installments over thetable. We have never granted any stock appreciation rights. OPTIONS EXERCISED AND YEAR-END VALUESthree years thereafter. Options expire ten years from the date of grant.Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option Values
The following table sets forth
information concerningthe number of shares of common stock subject to exercisable andvalueunexercisable stock options held as ofoptions exercisedDecember 31, 2003 by each of the named executiveofficers as of December 31, 2000 and the number andofficers. The value of unexercised in-the-money optionsheld by eachat December 31, 2003 is calculated based on an assumed initial public offering price of $13.00 per share of our common stock, which is the midpoint of thenamed executive officers asrange listed on the cover ofDecember 31, 2000.this prospectus, less the per share exercise price, multiplied by the number of shares issued upon exercise of the options, without taking into account any taxes that may be payable in connection with the option exercise. Options shown as exercisable in the table below are immediatelyexercisable; however,exercisable, but wehave the right to purchase the shares of unvested common stock underlying some of these options upon termination of the holder's employment with us.
There was no public trading price for the common
Number of Securities
Underlying
Unexercised Options at
December 31, 2003Value of Unexercised
In-the-Money Options at
December 31, 2003Name Shares
Acquired on
ExerciseValue
RealizedExercisable Unexercisable Exercisable Unexercisable David M. Sheehan — — 416,190 — $ 5,199,569 $ — Todd M. Clyde — — 92,857 — 1,161,641 — Diana M. Bowden — — 20,727 — 258,932 — Martin B. Shirley — — 34,691 — 432,796 — Stephen L. Bollinger — — 23,698 — 295,924 — Benefit Plans
1991 Stock Option Program
Beginning in 1991, we began issuing stock
as of December 31, 2000. Accordingly, the value of unexercised in-the-moneyoptionsat December 31, 2000 represents an amount equaltothe difference between the assumed fair market value of $0.50 of the common stock as determined by ourdirectors, officers, employees and consultants. Our board of directorsand the applicable exercise price per share, multiplied by the numbercreated a pool ofunexercised in-the-money options. An option is in-the-money if the fair market value of the underlying shares exceeds the exercise price of the options.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES - --------------------------------------------------------------------------------------------------------------------- NUMBER OF SECURITIES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT SHARES DECEMBER 31, 2000 DECEMBER 31, 2000(2) ACQUIRED ON VALUE ----------------------------- ---------------------------- NAME EXERCISE REALIZED(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---------------------------------------------------------------------------------------------------------------------R. Scott Huennekens....... 28,572 $4,286 1,221,428 -- $216,214 -- Robert E. Johnson......... 28,572 $4,286 421,428 -- $ 63,214 -- John F. Sheridan.......... 28,572 $4,286 496,428 -- $ 94,464 -- Richard L. Conwell........ 28,572 $4,286 346,428 -- $ 76,964 -- David M. Sheehan.......... -- -- 400,000 -- -- --- ---------- (1) Amount based on the difference between the fair market value of our common stock on the date of exercise as determined by our board of directors, and the exercise price of the option. (2) Amount based on the difference between the fair market value of our common stock on December 31, 2000 of $0.50, as determined by our board of directors, and the exercise price of the option. - -------------------------------------------------------------------------------- 62MANAGEMENT - -------------------------------------------------------------------------------- BENEFIT PLANS 2001 STOCK INCENTIVE PLAN INTRODUCTION--Our 2001 Stock Incentive Plan is intended to serve as the successor equity incentive program to our 1995 Stock Option Plan, 1997 Stock Option/Stock Issuance Plan and 1998 Stock Option/Stock Issuance Plan, which we collectively refer to as our predecessor plans. Our 2001 incentive plan is to be adopted by our board of directors, and we intend to seek the approval of our stockholders, prior to the closing of this offering. Our 2001 incentive plan will become effective on the date the underwriting agreement for this offering is signed. At that time, all outstanding options under the predecessor plans will be transferred to our 2001 incentive plan, and no further option grants will be made under those predecessor plans. The transferred options will continue to be governed by their existing terms, unless our compensation committee elects to extend one or more features of our 2001 incentive plan to those options. Except as otherwise noted below, the transferred options will have substantially the same terms as in effect for grants made under the discretionary option grant program of our 2001 incentive plan. SHARE RESERVE--Twelve millionreserved shares of common stockhave been authorizedfor issuanceunderto these individuals and granted options using individual stock option agreements that followed a general form. We refer to this process as our2001 incentive plan. Such share reserve consists1991 Stock Option Program, or 1991 Program. As ofthe numberMarch 31, 2004, there were a total ofshares we estimate will be carried over from our predecessor plans, including the shares subject to outstanding options thereunder, plus an additional increase of approximately 3,500,000 shares. The number of2,721 shares of common stock reserved for issuance under our2001 incentive plan1991 Program, subject to adjustment for any future stock split, or any future stock dividend or other similar change in our common stock or our capital structure. Under our 1991 Program, as of March 31, 2004, options to purchase 560 shares of our common stock had been exercised, options to purchase 653 shares of our common stock were outstanding and 1,509 shares of our common stock remained available for grant. As of March 31, 2004, the outstanding options were exercisable at a weighted average exercise price of approximately $394.18 per share. The foregoing share numbers reflect a 1-for-200 reverse split of our capital stock effected in October 2002 and a 1-for-3.5 reverse split of our common stock which was approved by our stockholders on April 30, 2004. We have not granted any options under our 1991 Program since August 1997, and following the consummation of this offering, no additional options willautomatically increase onbe granted under our 1991 Program.Under our 1991 Program, only nonstatutory stock options may be granted and such options may only be granted to directors, officers, employees and consultants. Our board of directors administers our 1991 Program, including selecting the
first trading dayaward recipients and determining the number of shares to be subject to each option, the exercise price of each option, the term of each option and the vesting and exercise periods of each option. Under our 1991 Program, options may not be assigned or transferred inJanuary each calendar year, beginning in calendar year 2002,any manner other than byan amount equal to 2%will or by the laws of descent or distribution and may be exercised during the lifetime of the participant only by the participant. Upon exercise of options issued under the 1991 Program, optionees enter into a stock purchase agreement with us that, among other things, provides us (i) a repurchase right with respect to a portion of the purchased shares, exercisable within 60 days of the termination of the services provided by the optionee and (ii) a right of first refusal, exercisable in connection with any proposed transfer of the purchased shares by the optionee.If an optionee's status as an employee, director or consultant terminates for any reason other than death or disability, the optionee may exercise their vested options within the 60 day period following the termination. In the event the optionee dies while the optionee is an employee, director or consultant of our company, the options vested as of the date of death may be exercised prior to the earlier of their expiration date or 12 months from the date of the optionee's death. In the event the optionee becomes disabled while the optionee is an employee, director or consultant of our company, the options vested as of the date of disability may be exercised prior to the earlier of their expiration date or 12 months from the date of the optionee's disability.
Our board of directors has discretion to provide for acceleration of vesting in connection with a corporate transaction.
1997 Stock Option/Stock Issuance Plan
Our 1997 Stock Option/Stock Issuance Plan, or the 1997 Plan, was approved by our board of directors in September 1997 and by our stockholders in October 1997. As of March 31, 2004, there were a total
numberof 1,185 shares of common stockoutstanding on the last trading day in December of the preceding calendar year. EQUITY INCENTIVE PROGRAMS--Our 2001 incentive plan is divided into five separate components: - - the discretionary option grant program,reserved for issuance underwhich eligible individualsour 1997 Plan, subject to adjustment for a stock split, or any future stock dividend or other similar change in ouremploycommon stock orservice may be grantedour capital structure. As of March 31, 2004, options to purchase 191 shares of common stock had been exercised, options to purchase 118 shares of common stock were outstanding and 876 shares of common stock remained available for grant. As of March 31, 2004, the outstanding options were exercisable atana weighted average exercise pricenotof approximately $175.83 per share. All capital stock and option share numbers reflect a 1-for-200 reverse split of our capital stock effected in October 2002 and a 1-for-3.5 reverse split of our common stock to be effected prior to completion of the offering. After the consummation of this offering, no additional options will be granted under our 1997 Plan.Awards under our 1997 Plan may consist of incentive stock options, which are stock options that qualify under Section 422 of the Internal Revenue Code, nonstatutory stock options and direct issuances of common stock.
Under our 1997 Plan, our board may grant incentive stock options to employees, including officers and employee directors. Nonstatutory stock options and stock issuances may be granted to employees, directors, and consultants. The board of directors or a committee designated by the board, referred to as the plan administrator, administers our 1997 Plan, including selecting the award recipients, determining the number of shares to be subject to each award, determining the exercise or purchase price of each award and determining the vesting and exercise periods of each award. The exercise price of all incentive stock options granted under our 1997 Plan must be at least equal to the fair market value of the common stock on the date of grant. The exercise price of all nonstatutory stock options granted under our 1997 Plan must be determined by the plan administrator, but in no event may be less than
100%85% of the fair market value on the date ofthose sharesgrant. With respect to any participant who owns stock possessing more than 10% of the voting power of all our classes of stock or the stock of any parent or subsidiary of us, the exercise price of any incentive stock option must equal at least 110% of the fair market value on the grantdate; - -date. The maximum term of an incentive stock option or nonstatutory stock option must not exceed ten years, provided, however, that the maximum term of any incentive stock option granted to participant who owns stock possessing more than 10% of the voting power of all our classes of stock or the stockissuance program, under which such individualsof any parent or subsidiary of us must not exceed five years. The purchase price per share for direct stock issuances must be not less than 85% of the fair market value on the date of issuance.Under our 1997 Plan, options may not be assigned or transferred in any manner other than by will or by the laws of descent or distribution and may be exercised during the lifetime of the participant only by the participant.
If an optionee's status as an employee, director or consultant terminates for any reason other than death or disability, the optionee may exercise their vested options within the three-month period following
the termination. In the event the optionee dies while the optionee is an employee, director or consultant of our company, the options vested as of the date of death may be exercised prior to the earlier of their expiration date or 12 months from the date of the optionee's death. In the event the optionee becomes disabled while the optionee is an employee, director or consultant of our company, the options vested as of the date of disability may be exercised prior to the earlier of their expiration date or 12 months from the date of the optionee's disability.
In the event of a corporate transaction where the acquiror does not assume or replace options granted under our 1997 Plan, such outstanding options will become fully vested and exercisable immediately prior to the consummation of the corporate transaction. In the event of a corporate transaction in which the acquiror assumes or replaces options granted under our 1997 Plan, options issued under our 1997 Plan will not be subject to accelerated vesting. However, assumed or replaced options will automatically become fully vested and exercisable if the optionee's service is terminated by reason of an involuntary termination within 24 months of the occurrence of a corporate transaction.
Under our 1997 Plan, a corporate transaction is generally defined as:
- •
- a merger or consolidation in which securities possessing more than 50% of the total combined voting power of the company's outstanding securities are transferred to a person or persons different from the persons holding those securities immediately prior to such transaction; or
- •
- the sale, transfer or other disposition of all or substantially all of the assets of the company.
Our 1997 Plan will terminate automatically in 2007 unless terminated earlier by our board of directors. The board of directors also has the authority to amend our 1997 Plan. However, no action may be taken which will adversely affect any option previously granted under our 1997 Plan, without the optionee's consent. To the extent necessary to comply with applicable provisions of federal securities laws, state corporate and securities laws, the Internal Revenue Code, the rules of any applicable stock exchange or national market system, and the rules of any non-U.S. jurisdiction applicable to awards granted to residents therein, we shall obtain stockholder approval of any such amendment to our 1997 Plan in such a manner and to such a degree as required.
1998 Stock Option/Stock Issuance Plan
Our 1998 Stock Option/Stock Issuance Plan, or the 1998 Plan, was approved by our board of directors in December 1998 and by our stockholders in November 1999. As of March 31, 2004, there were a total of 1,678,901 shares of common stock
directly, throughreserved for issuance under thepurchase1998 Plan, subject to adjustment for any future stock split, or any future stock dividend or other similar change in our common stock or our capital structure. As ofsuch shares at a price not less than 100% of their fair market value at the time of issuance or as a bonus tied to the attainment of performance milestones or the completion of a specified period of service; - - the salary investment option grant program, under which our executive officers and other highly compensated employees may be given the opportunity to apply a portion of their base salary to the acquisition of special below-market stock option grants; - - the automatic option grant program, under which option grants will automatically be made at periodic intervals to our non-employee board membersMarch 31, 2004, options to purchase 41,756 shares of common stock had been exercised, options to purchase 1,580,748 shares of common stock were outstanding and 56,519 shares of common stock remained available for grant. As of March 31, 2004, the outstanding options were exercisable atana weighted average exercise price of approximately $2.23 per share. All capital stock and option share numbers reflect a 1-for-200 reverse split of our capital stock effected in October 2002 and a 1-for-3.5 reverse split of our common stock to be effected prior to completion of the offering.After the completion of this offering, no additional options will be granted under our 1998 Plan and all options granted under our 1998 Plan that expire without having been exercised or are cancelled will become available for grant under our 2004 Stock Incentive Plan.
Awards under our 1998 Plan may consist of incentive stock options, which are stock options that qualify under Section 422 of the Internal Revenue Code, nonstatutory stock options and direct issuances of common stock.
Under the 1998 Plan, our board may grant incentive stock options to employees, including officers and employee directors. Nonstatutory stock options and stock issuances may be granted to employees,
directors, and consultants. Our board of directors or a committee designated by the board, referred to as the plan administrator, administers our 1998 Plan, including selecting the award recipients, determining the number of shares to be subject to each award, determining the exercise or purchase price of each award and determining the vesting and exercise periods of each award. The exercise price of all incentive stock options granted under our 1998 Plan must be at least equal to the fair market value of the common stock on the date of grant. The exercise price of all nonstatutory stock options granted under our 1998 Plan must be determined by the plan administrator, but in no event may be less than 85% of the fair market value on the date of grant. With respect to any participant who owns stock possessing more than 10% of the voting power of all our classes of stock or the stock of any parent or subsidiary of us, the exercise price of any incentive stock option must equal at least 110% of the fair market value on the grant date. The maximum term of an incentive stock option or nonstatutory stock option must not exceed ten years, provided, however, that the maximum term of any incentive stock option granted to participant who owns stock possessing more than 10% of the voting power of all our classes of stock or the stock of any parent or subsidiary of us must not exceed five years. The purchase price per share for direct stock issuances must be not less than 85% of the fair market value on the date of issuance.
Under our 1998 Plan, options may not be assigned or transferred in any manner other than by will or by the laws of descent or distribution and may be exercised during the lifetime of the participant only by the participant.
If an optionee's status as an employee, director or consultant terminates for any reason other than death or disability, the optionee may exercise their vested options within the three-month period following the termination. In the event the optionee dies while the optionee is an employee, director or consultant of our company, the options vested as of the date of death may be exercised prior to the earlier of their expiration date or 12 months from the date of the optionee's death. In the event the optionee becomes disabled while the optionee is an employee, director or consultant of our company, the options vested as of the date of disability may be exercised prior to the earlier of their expiration date or 12 months from the date of the optionee's disability.
In the event of a corporate transaction where the acquiror does not assume or replace options granted under our 1998 Plan, such outstanding options will become fully vested and exercisable immediately prior to the consummation of the corporate transaction. In the event of a corporate transaction in which the acquiror assumes or replaces options granted under our 1998 Plan, options issued under our 1998 Plan will not be subject to accelerated vesting. However, assumed or replaced options will automatically become fully vested and exercisable if the optionee's service is terminated by reason of an involuntary termination within 24 months of the occurrence of a corporate transaction.
Under our 1998 Plan, a corporate transaction is generally defined as:
- •
- a merger or consolidation in which securities possessing more than 50% of the total combined voting power of the company's outstanding securities are transferred to a person or persons different from the persons holding those securities immediately prior to such transaction; or
- •
- the sale, transfer or other disposition of all or substantially all of the assets of the company.
Our 1998 Plan will terminate automatically in 2008 unless terminated earlier by our board of directors. Our board of directors also has the authority to amend our 1998 Plan. However, no action may be taken which will adversely affect any option previously granted under our 1998 Plan, without the optionee's consent. To the extent necessary to comply with applicable provisions of federal securities laws, state corporate and securities laws, the Internal Revenue Code, the rules of any applicable stock exchange or national market system, and the rules of any non-U.S. jurisdiction applicable to awards granted to residents therein, we will obtain stockholder approval of any such amendment to our 1998 Plan in such a manner and to such a degree as required.
2004 Stock Incentive Plan
Our board of directors and our stockholders approved our 2004 Stock Incentive Plan in April 2004. We have reserved 1,400,000 shares of our common stock for issuance under our 2004 Stock Incentive Plan, subject to adjustment for a stock split, or any future stock dividend or other similar change in our common stock or our capital structure. The number of shares initially reserved under the 2004 Stock Incentive Plan will be increased by any shares, up to a maximum of 1,500,000 shares, represented by awards under the 1998 Stock Option/Stock Issuance Plan that are forfeited, expire or are cancelled on or after the effective date of the registration statement relating to this offering. No awards have yet been granted under our 2004 Stock Incentive Plan and therefore 1,400,000 shares of common stock remain available for grant.
Our 2004 Stock Incentive Plan provides for the grant of stock options, restricted stock, restricted stock units, stock appreciation rights and dividend equivalent rights, collectively referred to as "awards." Stock options granted under the 2004 Stock Incentive Plan may be either incentive stock options under the provisions of Section 422 of the Internal Revenue Code, or non-qualified stock options. Incentive stock options may be granted only to employees. Awards other than incentive stock options may be granted to employees, directors and consultants.
Our board of directors or a committee designated by our board of directors, referred to as the "plan administrator," will administer our 2004 Stock Incentive Plan, including selecting the optionees, determining the number of shares to be subject to each award, determining the exercise or purchase price of each award and determining the vesting and exercise periods of each award.
The exercise price of all incentive stock options granted under our 2004 Stock Incentive Plan must be at least equal to 100% of the fair market value of
those sharesthe common stock on thegrant date; and - - the director fee option grant program, under which our non-employee board members may be given the opportunitydate of grant. If, however, incentive stock options are granted toapply a portionan employee who owns stock possessing more than 10% of theannual retainer fee otherwise payable to them in cash each year to the acquisitionvoting power ofspecial below-market option grants. ELIGIBILITY--The individuals eligible to participate inall classes of our2001 incentive plan include our officers and other employees, our non-employee board members and any consultants we hire. ADMINISTRATION--The discretionary option grant program andstock or the stockissuance program will be administered by the compensation committee. This committee will determine which eligible individuals are to receive option grants or stock issuances under those programs, the time or times when such - -------------------------------------------------------------------------------- 63MANAGEMENT - -------------------------------------------------------------------------------- option grants or stock issuances are to be made, the number of shares subject to each such grant or issuance, the statusof anygranted option as either anparent or subsidiary of us, the exercise price of any incentive stock optionor a non-statutory stock option undergranted must equal at least 110% of thefederal tax laws, the vesting schedule to be in effect for the option grant or stock issuance and the maximum term for which any granted option is to remain outstanding. The compensation committee will also have the exclusive authority to select the executive officers and other highly compensated employees who may participate in the salary investment option grant program in the event that program is activated for one or more calendar years. PLAN FEATURES--Our 2001 incentive plan will include the following features: - - the exercise price for the shares of common stock subject to option grants made under our 2001 incentive plan may be paid in cash or in shares of common stock valued atfair market value on the grant date and the maximum term of these incentive stock options must not exceed five years from the date of grant. The maximum term of an incentive stock option granted to any other participant must not exceed ten years from the date of grant. The plan administrator will determine the term and exercisedate. The optionor purchase price of all other awards granted under our 2004 Stock Incentive Plan.Under our 2004 Stock Incentive Plan, incentive stock options may
alsonot be sold, pledged, assigned, hypothecated, transferred or disposed of in any manner other than by will or by the laws of descent or distribution and may be exercisedthrough a same-day sale program without any cash outlayduring the lifetime of the participant only by theoptionee.participant. Other awards will be transferable by will or by the laws of descent or distribution and to the extent provided in the award agreement. Our 2004 Stock Incentive Plan permits the designation of beneficiaries by holders of awards, including incentive stock options.In
addition,the event a participant in our 2004 Stock Incentive Plan terminates service or is terminated by us without cause, any options which have become exercisable prior to the time of termination will remain exercisable for three months from the date of termination, unless a shorter or longer period of time is determined by the plan administrator. In the event a participant in our 2004 Stock Incentive Plan is terminated by us for cause, the plan administrator has the discretion to determine whether any options which have become exercisable prior to the time of termination will immediately terminate. If termination was caused by death or disability, any options which have become exercisable prior to the time of termination will remain exercisable for 12 months from the date of termination, unless a shorter or longer period of time is determined by the plan administrator. In no event mayprovide financial assistancea participant exercise the option after the expiration date of the option.In the event of a corporate transaction where the acquiror assumes or replaces awards granted under our 2004 Stock Incentive Plan, none of these awards will be subject to
oneaccelerated vesting. However, assumed or replaced awards will automatically become fully vested if the grantee is terminated by theacquiror without cause within 12 months after the occurrence of a corporate transaction. In the event of a corporate transaction where the acquiror does not assume or replace awards granted under our 2004 Stock Incentive Plan, all of these awards become fully vested immediately prior to the consummation of the corporate transaction. Under our 2004 Stock Incentive Plan, a corporate transaction is generally defined as:
- •
- an acquisition of 40% or more
optionees in the exerciseoftheir outstanding optionsour stock by any individual orthe purchaseentity including by tender offer or a reverse merger;- •
- a sale, transfer or other disposition of
their unvested shares by allowing such individuals to deliver a full-recourse, interest-bearing promissory note in paymentall or substantially all of theexercise price and any associated withholding taxes incurredassets of our company;- •
- a merger or consolidation in
connection with such exercisewhich our company is not the surviving entity; orpurchase; - - the compensation committee- •
- a complete liquidation or dissolution.
Unless terminated sooner, our 2004 Stock Incentive Plan will
haveautomatically terminate in 2014. Our board of directors has the authority tocancel outstanding optionsamend or terminate our 2004 Stock Incentive Plan. No amendment or termination of our 2004 Stock Incentive Plan will adversely affect any rights under awards already granted to a participant unless agreed to by thediscretionaryaffected participant. To the extent necessary to comply with applicable provisions of federal securities laws, state corporate and securities laws, the Internal Revenue Code, the rules of any applicable stock exchange or national market system, and the rules of any non-U.S. jurisdiction applicable to awards granted to residents therein, we will obtain stockholder approval of any such amendment to our 2004 Stock Incentive Plan in such a manner and to such a degree as required.2004 Non-Employee Director Stock Option Program
Our 2004 Non-Employee Director Stock Option Program will be adopted as part of our 2004 Stock Incentive Plan and will be subject to the terms and conditions of our 2004 Stock Incentive Plan. Our 2004 Non-Employee Director Stock Option Program was approved by our board of directors in April 2004. Our 2004 Non-Employee Director Stock Option Program will become effective as of the effective date of this prospectus, and no awards will be made under this program until that time.
The purpose of our 2004 Non-Employee Director Stock Option Program is to promote the success of our business by enhancing our ability to attract and retain the best available non-employee directors and to provide them additional incentives.
Our 2004 Non-Employee Director Stock Option Program will establish an automatic option grant program
including options transferred from the predecessor plans, in returnfor the grant ofnew options for the same or a different number of option shares with an exercise price per share based upon the fair market value of our common stock on the new grant date; and - - stock appreciation rights are authorized for issuance under the discretionary option grant program. Such rights will provide the holders with the electionawards tosurrender their outstanding options for an appreciation distribution from us equalnon-employee directors. Under this program, each non-employee director first elected tothe fair market value of the vested shares of common stock subject to the surrendered option, less the aggregate exercise price payable for those shares. Such appreciation distribution may be made in cash or in shares of common stock. None of the outstanding options under our predecessor plans contain any stock appreciation rights. The 2001 incentive plan will include the following change in control provisions which may result in the accelerated vesting of outstanding option grants and stock issuances: - - in the event that we are acquired by merger or asset sale, each outstanding option under the discretionary option grant program which is not to be assumed by the successor corporation will automatically accelerate in full, and all unvested shares under the discretionary option grant and stock issuance programs will immediately vest, except to the extent our repurchase rights with respect to those shares are to be assigned to the successor corporation; - - the compensation committee will have complete discretion to structure one or more options under the discretionary option grant program so those options will vest as to all the option shares in the event those options are assumed in the acquisition but the optionee's service with us or the acquiring entity is subsequently terminated. The vesting of outstanding shares under the stock issuance program may be accelerated upon similar terms and conditions; - - the compensation committee will also have the authority to grant options which will immediately vest in the event we are acquired, whether or not those options are assumed by the successor corporation; - - the compensation committee may grant options and structure repurchase rights so that the shares subject to those options or repurchase rights will immediately vest in connection with a successful - -------------------------------------------------------------------------------- 64MANAGEMENT - -------------------------------------------------------------------------------- tender offer for more than 50% of our outstanding voting stock or a change in the majority ofour boardthrough one or more contested elections for board membership. Such accelerated vesting may occur either at the timeofsuch transaction or upon the subsequent termination of the individual's service; and - - the options currently outstanding under our predecessor plans will immediately vest in the event we are acquired by merger or sale of substantially all our assets, unless those options are assumed by the acquiring entity or our repurchase rights with respect to any unvested shares subject to those options are assigned to such entity. However, a number of those options may also contain a special acceleration provision pursuant to which the shares subject to those options will immediately vest upon an involuntary termination of the optionee's employment within 18 monthsdirectors followingan acquisition in which the repurchase rights with respect to those shares are assigned to the acquiring entity. SALARY INVESTMENT OPTION GRANT PROGRAM--In the event the compensation committee elects to activate the salary investment option grant program for one or more calendar years, each of our executive officers and other highly compensated employees selected for participation may elect, prior to the start of the calendar year, to reduce his or her base salary for that calendar year by a specified dollar amount not less than $10,000 nor more than $50,000. Each selected individual who files such a timely election will automatically be granted, on the first trading day in January of the calendar year for which his or her salary reduction is to be in effect, an option to purchase that number of shares of common stock determined by dividing the salary reduction amount by two-thirds of the fair market value per share of our common stock on the grant date. The option will be exercisable at a price per share equal to one-third of the fair market value of the option shares on the grant date. As a result, the option will be structured so that the fair market value of the option shares on the grant date less the exercise price payable for those shares will be equal to the amount by which the optionee's salary is reduced under the program. The option will become exercisable in a series of 12 equal monthly installments over the calendar year for which the salary reduction is to be in effect. AUTOMATIC OPTION GRANT PROGRAM--Under the automatic option grant program, each individual who first becomes a non-employee board member at any time after the completion of this offering will automatically receive on the date such individual joins the board an option grant for a number of shares of common stock to be determined prior tothe closing of this offeringprovided such individual has not been in our prior employ. In addition, on the date of each annual stockholders meeting held after the completion of this offering, each non-employee board member who is to continue to serve as a non-employee board member, including each of our current non-employee board members,will automatically be granted an option topurchase a number ofacquire 10,000 shares of our common stockto be determined prior to the closing of this offering, provided such individual has served on our board foratleast six months. Each automatic grant will havean exercise price per share equal to the fair market valueper shareof our common stock at the date of grant. These options will be fully vested and exercisable on the grant date. Upon the dateand will haveof each annual stockholders' meeting, each non-employee director who has been atermmember of10 years, subjectour board of directors for at least six months prior toearlier termination followingtheoptionee's cessation of board service. The option will be immediately exercisable for alldate of theoption shares; however, we may repurchase,stockholders' meeting will receive an automatic grant of options to acquire 5,000 shares of our common stock atthe exercise price paid per share, any shares purchased under the option which are not vested at the time of the optionee's cessation of board service. The shares subject to each initial automatic option grant will vest in a series of 3 successive annual installments upon the optionee's completion of each year of board service over the 3-year period measured from the grant date. The shares subject to each annual automatic option grant will vest upon the optionee's completion of one year of board service measured from the grant date. However, the shares will immediately vest in full upon certain changes in control or ownership or upon the optionee's death or disability while a board member. - -------------------------------------------------------------------------------- 65MANAGEMENT - -------------------------------------------------------------------------------- DIRECTOR FEE OPTION GRANT PROGRAM--Should the director fee option grant program be activated in the future, each non-employee board member will have the opportunity to apply all or a portion of any cash retainer fee for the year to the acquisition of a below-market option grant. The option grant will automatically be made on the first trading day in January in the year for which the retainer fee would otherwise be payable in cash. The option will havean exercise priceper shareequal toone-third ofthe fair market value of our common stock at theoption sharesdate of grant. These options will be fully vested and exercisable on the grantdate,date. The term of each automatic option grant and thenumberextent to which it will be transferable will be provided in the agreement evidencing the option.Our 2004 Non-Employee Director Stock Option Program will be administered by the board or a committee designated by our board made up of
sharestwo or more non-employee directors so that such awards would be exempt from Section 16(b) of the Exchange Act, referred to as the "program administrator." The program administrator will determine the terms and conditions of awards, and construe and interpret the terms of the program and awards granted under the program. Non-employee directors may also be granted additional awards under the 2004 Stock Incentive Plan, subject to the discretion of the board or the committee.Unless terminated sooner, our 2004 Non-Employee Director Stock Option Program will terminate automatically in 2014 when our 2004 Stock Incentive Plan terminates. Our board of directors has the authority to amend, suspend or terminate our 2004 Non-Employee Director Stock Option Program. No amendment or termination of our 2004 Non-Employee Director Stock Option Program will adversely affect any rights under options already granted to a non-employee director unless agreed to by the affected non-employee director. Our 2004 Non-Employee Director Stock Option Program was adopted by the board pursuant to its discretionary authority under our 2004 Stock Incentive Plan to make option
will be determined by dividinggrants to non-employee directors. Accordingly, stockholder approval is not required for the adoption or any amendment of our 2004 Non-Employee Director Stock Option Program.Employment Arrangements and Change of Control Arrangements
We have not entered into employment agreements with any of our executive officers.
In June 2002, we entered into a letter agreement with David M. Sheehan, our President, Chief Executive Officer and director, whereby we agreed to pay him cash bonuses in the amount of $25,000 on each of June 2002, October 2002 and January 2003 in connection with his service to us as an employee. We also agreed to pay Mr. Sheehan a further cash bonus dependent upon our receipt of certain revenues and cashflow for the
retainer fee appliedfiscal year ending December 31, 2002. In addition, we agreed that in the event that at any time on or before June 2004 we were acquired or substantially all of our assets were sold, Mr. Sheehan and other members of senior management would be entitled tothe programreceive an aggregate bonus in an amount not less than $400,000 and not greater than 10% of any proceeds received bytwo-thirdsus in connection with such acquisition or sale in excess ofthe fair market value per share$30,000,000. We also agreed to make a further grant of options to Mr. Sheehan to purchase shares of our common stockon thepursuant to our 1998 Plan.We routinely grant
date. Asour executive officers stock options under our stock incentive plans. For aresult, the option will be structured so that the fair market valuedescription of theoption shares on the grant date less the exercise price payable for those shares will be equalchange of control provisions applicable tothe portionsuch stock options, see "Management—Benefit Plans."Limitation of Liability and Indemnification of Officers and Directors
As permitted by Section 102 of the
retainer fee applied to that option. The option will become exercisableDelaware General Corporation Law, we have adopted provisions ina series of 12 equal monthly installments over the calendar year for which the election is to be in effect. However, the option will become immediately exercisable for all the option shares upon the optionee's death or disability while serving as a board member. Our 2001 incentive plan will also have the following features: - - outstanding options under the salary investment and director fee option grant programs will immediately vest if we are acquired by a merger or asset sale or if there is a successful tender offer for more than 50% ofouroutstanding voting stock or a change in the majority of our board through one or more contested elections; - - limited stock appreciation rights will automatically be included as part of each grant made under the salary investment option grant program and the automatic and director fee option grant programs, and these rights may also be granted to one or more officers as part of their option grants under the discretionary option grant program. Options with this feature may be surrendered to us upon the successful completion of a hostile tender offer for more than 50% of our outstanding voting stock. In return for the surrendered option, the optionee will be entitled to a cash distribution from us in an amount per surrendered option share based upon the highest price per share of our common stock paid in that tender offer; and - - the board may amend or modify the 2001 incentive plan at any time, subject to any required stockholder approval. The 2001 incentive plan will terminate no later than ten years after the completion of this offering. EMPLOYMENT ARRANGEMENTS None of our employees are employed for a specified term, and each employee's employment with us is subject to termination at any time by either party for any reason, with or without cause. All of our current employees have entered into agreements with us which contain restrictions and covenants relating to the protection of our confidential information. LIMITATIONS ON DIRECTORS' LIABILITY AND INDEMNIFICATION Ourrestated certificate of incorporationlimitsand restated bylaws that limit or eliminate the personal liability of our directors for a breach of their fiduciary duty of care as a director. The duty of care generally requires that, when acting on behalf of the corporation, directors exercise an informed business judgment based on all material information reasonably available tothe maximum extent permitted by Delaware law. Delaware law provides that directors ofthem. Consequently, acorporationdirector will not be personally liable to us or our stockholders for monetary damagesforor breach oftheirfiduciarydutiesduty asdirectors,a director, except for liability for:- -
- •
- any breach of
theirthe director's duty of loyalty tothe corporationus oritsour stockholders;- -------------------------------------------------------------------------------- 66MANAGEMENT - -------------------------------------------------------------------------------- - - acts- •
- any act or
omissionsomission not in good faith or thatinvolveinvolves intentional misconduct or a knowing violation of law;- - unlawful payments of dividends or- •
- any act related to unlawful stock repurchases, redemptions or
redemptions; and - -other distributions or payment of dividends; or- •
- any transaction from which the director derived an improper personal benefit.
The limitationThese limitations of liability
does not apply to liabilities arising under the federal securities laws and doesdo not affect the availability of equitable remedies such as injunctive relief or rescission. Our restated certificate of incorporationand bylaws provide that we willalso authorizes us to indemnify ourdirectors andofficers,and may indemnify our employeesdirectors and other agents to the fullest extent permitted under Delaware law.As permitted by
law. We believe that indemnification underSection 145 of the Delaware General Corporation Law, our restated bylawscovers at least negligence onprovide that:
- •
- we may indemnify our directors, officers, and employees to the
part of indemnified parties. Ourfullest extent permitted by the Delaware General Corporation Law, subject to limited exceptions;- •
- we may advance expenses to our directors, officers and employees in connection with a legal proceeding to the fullest extent permitted by the Delaware General Corporation Law, subject to limited exceptions; and
- •
- the rights provided in our restated bylaws
also permit us to secure insurance on behalf of any officer, director, employee or other agent for any liability arising out of his or her actions in their capacity as an officer, director, employee or other agent, regardless of whether the bylaws would permit indemnification.are not exclusive.We have entered, and intend to continue to enter, into separate indemnification agreements with each of our directors and officers which may be broader than the specific indemnification provisions contained in the Delaware General Corporation Law. These indemnification agreements require us, among other things, to indemnify our officers and directors
and executiveagainst liabilities that may arise by reason of their status or service as directors or officers,in additionother than liabilities arising from willful misconduct. These indemnification agreements also require us tothe indemnification provided for in our bylaws. These agreements, among other things, provide for indemnification for judgments, fines, settlement amounts andadvance any expensesincluding attorneys' feesincurred by thedirector,directors orexecutive officer in any action or proceeding, including any action by or in our right, arising out of the person's servicesofficers as adirector or executive officer,result of anyof our subsidiaries or any other company or enterpriseproceeding against them as to whichthe person provides services at our request. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers.they could be indemnified.At present,
there is nowe are not aware of any pending or threatened litigation or proceeding involvingany of our directors, officersa director, officer, employee oremployeesagent in which indemnificationis sought, norwould be required or permitted. We arewenot aware of any threatened litigation or proceeding thatmaymight result inclaimsa claim for such indemnification.- -------------------------------------------------------------------------------- 67- -------------------------------------------------------------------------------- Certain relationshipsWe have purchased a policy of directors' and
related transactions SALES OF SECURITIES SERIES E PREFERRED STOCK FINANCING--From June 1998officers' liability insurance that insures our directors and officers against the cost of defense, settlement or payment of a judgment in some circumstances.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSAll share and per share amounts have been adjusted to
June 2000,give effect to a 1-for-200 reverse split of our capital stock effected in October 2002 and a 1-for-3.5 reverse split of our common stock which was approved by our stockholders on April 30, 2004.Issuances of Options
From January 2001 to March 31, 2004, we granted options to purchase an aggregate of 1,008,495 shares of our common stock to our current directors and executive officers, including each of our executive officers named in the Summary Compensation Table, at an average weighted exercise price of $1.36.
Issuance of Common Stock
In January 2002, David M. Sheehan, our President, Chief Executive Officer and a director, exercised an option to purchase 29 shares at an aggregate exercise price of $10,000.
Issuances of Preferred Stock
As previously indicated, all of the share numbers in this prospectus, including those appearing in the following discussion, have been revised to reflect a 1-for-200 reverse split of our capital stock effected in October 2002 and a 1-for-3.5 reverse split of our common stock which was approved by our stockholders on April 30, 2004.
In January, March and April 2001, we issued and sold
4,004,965to investors 9,694 shares of our Series E preferred stock, at a purchase price of $607.20 per share, for an aggregate purchase price of approximately $5.9 million. In April, May and June 2002, we issued and sold shares of our Series H preferred stock. As part of that offering, we permitted any existing preferred stockholders that purchased their pro rata share of the Series H preferred stock to exchange their shares of Series A, Series B, Series C, Series D, Series E or Series F preferred stock for shares of our Series G preferred stock. The exchange ratio was equal to the liquidation value of such series divided by the Series G purchase price. In connection with the Series H offering, an aggregate of 9,611 shares of our Series E preferred stock with an aggregate liquidation value of approximately $5.8 million were exchanged for shares of our Series G preferred stock at a price of $2.00 per share. As a result, each share of Series E preferred stock was exchanged for approximately 304 shares of Series G preferred stock.Upon completion of this offering, the 5,447 shares of our Series E preferred stock outstanding as of March 31, 2004, all of which are held by stockholders who did not exchange such shares for Series G preferred stock, will convert into 1,554 shares of our common stock.
In August 2001, we issued and sold 13,092 shares of our Series F preferred stock, at a purchase price of $650.00 per share, for an aggregate purchase price of approximately $8.5 million. In connection with the Series H offering, in April, May and June 2002, an aggregate of 12,322 of these shares of our Series F preferred stock with an aggregate liquidation value of approximately $8.0 million were exchanged for shares of our Series G preferred stock at a price of $2.00 per share. As a result each share of Series F preferred stock was exchanged for 325 shares of Series G preferred stock.
Upon completion of this offering, the 770 shares of our Series F preferred stock outstanding as of March 31, 2004, all of which are held by stockholders who did not exchange such shares for Series G preferred stock, will convert into 235 shares of our common stock.
In April, May and June 2002, we issued and sold 31,008,401 shares of our Series G preferred stock, at a purchase price of $2.00 per share, in exchange for the conversion of outstanding shares of our Series A, Series B, Series C, Series D, Series E and Series F preferred stock having an aggregate liquidation value of approximately $62.0 million. Concurrently with such exchange, we issued and sold 12,561,706 shares of our Series H preferred stock, at a purchase price of $1.39 per share, for an aggregate purchase price of
approximately $17.5 million. Following the issuance of our Series G preferred stock, holders of 24,191 shares of our Series G preferred stock elected to convert such shares into 6,905 shares of our common stock. Upon completion of this offering, the 30,984,210 shares of our Series G preferred stock outstanding as of March 31, 2004 will convert into 8,852,664 shares of our common stock, and the 12,561,706 shares of our Series H preferred stock outstanding as of March 31, 2004 will convert into 3,588,952 shares of our common stock.
The purchasers of our Series E preferred stock, Series F preferred stock, Series G preferred stock and Series H preferred stock include, among others, the following directors and holders of more than 5% of our outstanding stock:
Shares of Preferred Stock Name Series E(1) Series F(2) Series G(3) Series H(4) Entities affiliated with Kingsbury Associates(5) 625 923 4,788,417 980,348 Entities affiliated with Sorrento Associates(6) — 385 3,870,246 1,220,217 Entities affiliated with Vector Fund Management(7) — 769 6,117,483 1,284,533 Palivacinni Partners, LLC(8) 124 100 70,000 35,221 Entities affiliated with Merrill Lynch Ventures(9) 4,044 538 3,398,635 2,443,201 Kenneth E. Olson Trust dated March 16, 1989(10) — 154 65,127 84,268 Linda K. Olson (11) — — 30,001 4,498 GE Capital Equity Investments, Inc.(12) — 4,615 1,498,159 1,435,545 Health Care Indemnity, Inc. 1,647 — 2,000,000 299,791 Entities affiliated with Sanderling Ventures(13) — — — 2,158,702
- (1)
- Each share of Series E preferred stock was exchanged into approximately 304 shares of our Series G preferred stock.
- (2)
- Each share of Series F preferred stock was exchanged into approximately 325 shares of our Series G preferred stock.
- (3)
- Each share of Series G preferred stock is convertible into approximately 0.29 shares of our common stock.
- (4)
- Each share of Series H preferred stock is convertible into approximately 0.29 shares of our common stock.
- (5)
- Includes (a) 320 shares of Series E preferred stock, 1,749,552 shares of Series G preferred stock (2,151 shares of which have been converted to
17 accredited investors at a price614 shares of$3.036 per share. Thecommon stock) and 18,628 shares of Series H preferred stock held by Kingsbury Capital Partners, L.P.; (b) 305 shares of Series E preferred stockwill automatically convert into 4,004,965and 1,740,460 shares of Series G preferred stock (2,140 shares of which have been converted to 611 shares of common stock) held by Kingsbury Capital Partners, L.P., II; (c) 277 shares of Series F preferred stock,in connection with this offering. Investors owning 5% or more739,092 shares of Series G preferred stock (909 shares of which have been converted to 259 shares of common stock) and 332,533 shares of Series H preferred stock held by Kingsbury Capital Partners, L.P., III; and (d) 646 shares of Series F preferred stock, 559,313 shares of Series G preferred stock (688 shares of which have been converted to 196 shares of common stock) and 629,187 shares of Series H preferred stock held by Kingsbury Capital Partners, L.P., IV. Timothy J. Wollaeger, a member of ourcapital stock who participated in this transaction include:
NUMBER OF SHARES OF COMMON STOCK NUMBER OF ISSUABLE UPON SHARES OF SERIES E CONVERSION OF SERIES E INVESTORS PREFERRED STOCK PREFERRED STOCK - ---------------------------------------------------------------------------------------------------------Entities affiliated with Kingsbury Associates............... 329,380 329,380 Entities affiliated with Sorrento Associates................ 329,380 329,380 Entities affiliated with Vector Fund Management............. 329,379 329,379Mr. Wollaeger, oneboard ofourdirectors, isathe general partner of Kingsbury Associates, L.P., which isathe general partner of each of Kingsbury Capital Partners, L.P.,I,Kingsbury Capital Partners, L.P., II, Kingsbury Capital Partners, L.P., III and Kingsbury Capital Partners, L.P., IV.In this prospectus, we refer toMr. Wollaeger disclaims beneficial ownership of the shares held by Kingsbury Capital Partners, L.P.,I,Kingsbury Capital Partners, L.P., II, Kingsbury Capital Partners, L.P., III and Kingsbury Capital Partners, L.P., IV,collectively, as entities affiliatedexcept to the extent of his pecuniary interests in the named fund. As general partner, Mr. Wollaeger has voting and investment power with respect to the shares held by KingsburyAssociates. In this prospectus, we referCapital Partners, L.P.,
Kingsbury Capital Partners, L.P., II, Kingsbury Capital Partners, L.P., III and Kingsbury Capital Partners, L.P., IV.
- (6)
- Includes (a) 1,298,864 shares of Series G preferred stock (1,597 shares of which have been converted to 456 shares of common stock) held by Sorrento Growth Partners I, L.P.; (b) 533,416 shares of Series G preferred stock (656 shares of which have been converted to 187 shares of common stock) and 162,581 shares of Series H preferred stock held by Sorrento Ventures II, L.P.; (c) 320 shares of Series F preferred stock, 1,692,933 shares of Series G preferred stock (2,082 shares of which have been converted to 594 shares of common stock) and 862,067 shares of Series H preferred stock held by Sorrento Ventures III, L.P.; and (d) 65 shares of Series F preferred stock, 345,033 shares of Series G preferred stock (425 shares of which have been converted to 121 shares of common stock) and 195,569 shares of Series H preferred stock held by Sorrento Ventures CE, L.P. Robert M. Jaffe, a member of our board of directors, is president of (a) Sorrento Growth, Inc., which is the general partner of Sorrento Equity Growth Partners I, L.P., which is the general partner of Sorrento Growth Partners I, L.P.; and (b) Sorrento Associates, Inc., which is the general partner of (i) Sorrento Equity Partners, L.P., the general partner of Sorrento Ventures II, L.P., and (ii) Sorrento Equity Partners III, L.P., the general partner of Sorrento Ventures III, L.P. and Sorrento Ventures CE, L.P. Mr. Jaffe disclaims beneficial ownership of the shares held by Sorrento Growth Partners I, L.P., Sorrento Ventures II, L.P., Sorrento Ventures III, L.P. and Sorrento Ventures CE, L.P.,
collectively, as entities affiliatedexcept to the extent of his pecuniary interests in the named fund. As president of Sorrento Growth, Inc. and Sorrento Associates, Inc., Mr. Jaffe may be deemed to have voting and investment power with respect to the shares held by SorrentoAssociates. Dr.Growth Partners I, L.P., Sorrento Ventures II, L.P., Sorrento Ventures III, L.P. and Sorrento Growth Partners CE, L.P. Mr. Jaffe has submitted his resignation from our board of directors which will become effective immediately prior to the effectiveness of this offering.- (7)
- Includes (a) 2,740,530 shares of Series G preferred stock (3,370 shares of which have been converted to 962 shares of common stock) and 508,697 shares of Series H preferred stock held by Vector Later-Stage Equity Fund, L.P.; (b) 192 shares of Series F preferred stock, 844,239 shares of Series G preferred stock (1,038 shares of which have been converted to 296 shares of common stock) and 193,960 shares of Series H preferred stock held by Vector Later-Stage Equity Fund II, L.P.; and (c) 577 shares of Series F preferred stock, 2,532,714 shares of Series G preferred stock (3,114 shares of which have been converted to 889 shares of common stock) and 581,876 shares of Series H preferred stock held by Vector Later-Stage Equity Fund II (Q.P.), L.P. Douglas Reed,
onea member of our board of directors, is a managing director of Vector Fund Management,L.L.C.L.P., which isathe general partner of Vector Later-Stage Equity Fund, L.P., and Vector Fund Management II, LLC, which is the general partner of each of Vector Later-Stage Equity Fund II, L.P. and Vector Later-Stage Equity Fund II (Q.P.), L.P. Dr. Reed disclaims beneficial ownership of the shares held by Vector Later-Stage Equity Fund, L.P., Vector Later-Stage Equity Fund II, L.P. and Vector Later-Stage Equity Fund II (Q.P.), L.P., except to the extent of his pecuniary interests in the named fund. Dr. Reed may be deemed to share voting and investment power with respect to the shares held by Vector Later-Stage Equity Fund, L.P., Vector Later-Stage Equity Fund II, L.P. and Vector Later-Stage Equity Fund II (Q.P.), L.P. with the other managing director and members of the investment committee of Vector Fund Management, L.P. and Vector Fund Management II, LLC.- (8)
- Douglas Reed, a member of our board of directors, is a managing member of Palivacinni Partners, LLC. Dr. Reed disclaims beneficial ownership of the shares held by Palivacinni Partners, LLC, except to the extent of his pecuniary interest and may be deemed to share investment and voting power over the shares with the other managing members.
- (9)
- Includes (a) 4,044 shares of Series F preferred stock held by Merrill Lynch Ventures, LLC (and subsequently transferred to Merrill Lynch Ventures L.P., 2001) and (b) 538 shares of Series F preferred stock, 3,398,635 shares of Series G preferred stock and 2,443,201 shares of Series H preferred stock held by Merrill Lynch Ventures, L.P. 2001.
- (10)
- Kenneth E. Olson, a member of our board of directors, is the trustee of the Kenneth E. Olson Trust dated March 16, 1989.
- (11)
- Linda K. Olson is the spouse of Kenneth E. Olson, a member of our board of directors.
- (12)
- 1,842 shares of Series G preferred stock held by GE Capital Equity Investments, Inc. have been converted into 526 shares of common stock.
- (13)
- Includes (a) 1,492,158 shares of Series H preferred stock held by Sanderling Venture Partners V, L.P.; (b) 365,501 shares of Series H preferred stock held by Sanderling V Biomedical, L.P.; (c) 147,876 shares of Series H preferred stock held by Sanderling V Limited Partnership; (d) 131,580 shares of Series H preferred stock held by Sanderling V Beteiligungs GMBH & Co. KG; and (e) 21,587 shares of Series H preferred stock held by Sanderling V Ventures Management. Timothy J. Wollaeger, a member of our board of directors, is a managing director of Middleton, McNeil & Mills Associates V, LLC, the general partner of Sanderling Venture Partners V, L.P., Sanderling V Biomedical, L.P., Sanderling V Limited Partnership and Sanderling V Beteiligungs GMBH & Co. KG. Mr. Wollaeger is an owner of Sanderling V Ventures Management. Mr. Wollaeger disclaims beneficial ownership of the shares held by Sanderling Venture Partners V, L.P., Sanderling V Biomedical, L.P., Sanderling V Limited Partnership, Sanderling V Beteiligungs GMBH & Co. KG and Sanderling V Ventures Management, except to the extent of his pecuniary interests in the named fund. Mr. Wollaeger may be deemed to share voting and investment power with respect to the shares held by Sanderling Venture Partners V, L.P., Sanderling V Biomedical, L.P., Sanderling V Limited Partnership and Sanderling V Beteiligungs GMBH & Co. KG with the other managing directors of Middleton, McNeil & Mills Associates V, LLC. Mr. Wollaeger may be deemed to share voting and investment power with respect to the shares held by Sanderling V Ventures Management with the other owners.
Sales of Promissory Notes and Warrants
In January 2002, we borrowed an aggregate of approximately $1.9 million from existing stockholders and a new investor. We issued each lending party a convertible promissory note in January 2002 bearing interest at 12% per annum. In addition, we issued and sold to these parties warrants to purchase 227 shares of our common stock at an initial purchase price of $0.70 per underlying share of common stock, which amount was paid to us through a retention of the interest that accrued on each investor's note. Aside and apart from this $0.70 per share purchase price, each warrant has an exercise price of $1,050.00 per share.
In April 2002, each of the convertible promissory notes issued in January 2002 was satisfied in full by converting each note into shares of our Series H preferred stock at a purchase price of $1.39.
The purchasers of our convertible promissory notes and warrants to purchase our common stock include, among others, the following directors and holders of more than 5% of our outstanding stock:
Name Principal Amount
of Promissory NoteShares of Series H
Preferred Stock
Issued Upon
Conversion of
Notes(1)Shares of
Common Stock
Underlying
WarrantsEntities affiliated with Kingsbury Associates(2) $ 1,025,000 737,410 120 Entities affiliated with Vector Fund Management(3) $ 200,000 143,884 24 Merrill Lynch Ventures L.P., 2001 $ 100,000 71,942 12 Kenneth E. Olson Trust dated March 16, 1989(4) $ 100,000 71,942 12
- (1)
- Each share of Series H preferred stock is convertible into 0.29 shares of our common stock.
- (2)
- Includes (a) $25,000 in principal amount of loan and 13 shares of common stock underlying warrants issued to Kingsbury Capital Partners, L.P.; (b) $300,000 in principal amount of loan and 35 shares of common stock underlying warrants issued to Kingsbury Capital Partners, L.P., III; and (c) $700,000 in
principal amount of loan and 82 shares of common stock underlying warrants issued to Kingsbury Capital Partners, L.P., IV. Timothy J. Wollaeger, a member of our board of directors, is the general partner of Kingsbury Associates, L.P., which is a general partner of each of Kingsbury Capital Partners, L.P., Kingsbury Capital Partners, L.P., III and Kingsbury Capital Partners, L.P., IV. Mr. Wollaeger disclaims beneficial ownership of the shares held by Kingsbury Capital Partners, L.P., Kingsbury Capital Partners, L.P., III and Kingsbury Capital Partners, L.P., IV, except to the extent of his pecuniary interests in the named fund. Mr. Wollaeger has voting and investment power with respect to the shares held by Kingsbury Capital Partners, L.P., Kingsbury Capital Partners, L.P., III and Kingsbury Capital Partners, L.P., IV.
- (3)
- Includes (a) $50,000 in principal amount of loan and 6 shares of common stock underlying warrants issued to Vector Later-Stage Equity Fund II, L.P.; and (b) $150,000 in principal amount of loan and 18 shares of common stock underlying warrants issued to Vector Later-Stage Equity Fund II (Q.P.), L.P. Douglas Reed, a member of our board of directors, is managing director of Vector Fund Management II,
L.L.C.,LLC, which is a general partner of Vector Later-Stage Equity Fund II, L.P. and Vector Later-Stage Equity Fund II (Q.P.), L.P.In this prospectus, we refer to Vector Later-Stage Equity Fund, L.P.,Dr. Reed disclaims beneficial ownership of the shares held by Vector Later-Stage Equity Fund II, L.P.,and Vector Later-Stage Equity Fund II (Q.P.), L.P.,collectively, as entities affiliatedexcept to the extent of his pecuniary interests in the named fund. Dr. Reed may be deemed to share voting and investment power with respect to the shares held by Vector Later-Stage Equity Fund II, L.P. and Vector Later-Stage Equity Fund II (Q.P.), L.P. with the other managing director and members of the investment committee of Vector FundManagement. BRIDGE LOAN FINANCING AND ADDITIONAL SERIES E PREFERRED STOCK FINANCING--In September 2000, we issued and sold an aggregate of $2,000,000 of convertible promissory notes to 5 accredited investors. In November 2000, the convertible promissory notes automatically converted into 658,759 shares of Series E preferred stock at a price of $3.036 per share. In addition, in consideration for the bridge loans, we issued to the investors warrants to purchase up to 65,875 shares of our Series E preferred stock at an exercise price of $3.036 per share. These warrants will terminate in connection with this - -------------------------------------------------------------------------------- 68CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------------------------------------------------------------------------------- offering if not previously exercised. Investors owning 5% or more of our capital stock who participated in this transaction include:
NUMBER OF AGGREGATE NUMBER OF SHARES OF SERIES E NUMBER OF SHARES OF COMMON AGGREGATE PREFERRED STOCK WARRANTS TO STOCK ISSUABLE UPON PRINCIPAL ISSUED UPON PURCHASE CONVERSION OF SERIES E AMOUNT OF CONVERSION OF SHARES OF SERIES E PREFERRED STOCK AND INVESTORS PROMISSORY NOTE PROMISSORY NOTES PREFERRED STOCK WARRANTS - ------------------------------------------------------------------------------------------------------------------Entities affiliated with Kingsbury Associates........... $1,000,000 329,380 32,938 362,318 Entities affiliated with Vector Fund Management........... $ 500,000 164,689 16,468 181,157ADDITIONAL SERIES E PREFERRED STOCK FINANCING--From November 2000 to April 2001, we issued and sold 5,125,463 shares of Series E preferred stock to 34 accredited investors at a price of $3.036 per share. The shares of Series E preferred stock will automatically convert into 5,125,463 shares of common stock in connection with this offering. Investors owning 5% or more of our capital stock who participated in this transaction include:
NUMBER OF SHARES OF COMMON STOCK NUMBER OF ISSUABLE UPON SHARES OF SERIES E CONVERSION OF SERIES E INVESTORS PREFERRED STOCK PREFERRED STOCK - ---------------------------------------------------------------------------------------------------------Entities affiliated with Merrill Lynch Ventures............. 658,761 658,761 Entities affiliated with Kingsbury Associates............... 454,380 454,380 Entities affiliated with Vector Fund Management............. 164,689 164,689 Palavacinni Partners, LLC................................... 24,703 24,703In this prospectus, we refer to Merrill Lynch Ventures, LLC and Merrill Lynch Ventures, L.P. 2001, collectively, as entities affiliated with Merrill Lynch Ventures. Dr. Reed, one of our directors, isManagement II, LLC.- (4)
- Kenneth E. Olson, a member of
Palavacinni Partners, LLC. SERIES F PREFERRED STOCK FINANCING--In August 2001, we issued and sold 2,618,462 sharesour board ofSeries F preferred stock to 25 accredited investors at a price of $3.25 per share. The shares of Series F preferred stock will automatically convert into 2,618,462 shares of common stock in connection with this offering. Investors owning 5% or more of our capital stock and directors who participated in this transaction include:
NUMBER OF SHARES OF COMMON STOCK NUMBER OF ISSUABLE UPON SHARES OF SERIES F CONVERSION OF SERIES F INVESTORS PREFERRED STOCK PREFERRED STOCK - ---------------------------------------------------------------------------------------------------------Entities affiliated with Kingsbury Associates............... 184,616 184,616 Entities affiliated with Vector Fund Management............. 153,847 153,847 Entities affiliated with Merrill Lynch Ventures............. 107,692 107,692 Entities affiliated with Sorrento Associates................ 76,923 76,923 Kenneth E. Olson Trust dated March 16, 1989................. 30,769 30,769 Palavacinni Partners, LLC................................... 20,000 20,000- -------------------------------------------------------------------------------- 69CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------------------------------------------------------------------------------- Mr. Olson, one of ourdirectors, is the trustee of the Kenneth E. Olson Trust dated March 16, 1989.Dr. Reed, one ofBonus Arrangements
In June 2002, we entered into a letter agreement with David M. Sheehan, our
directors, isPresident, Chief Executive Officer and amember of Palavacinni Partners, LLC. REGISTRATION RIGHTS--Indirector, whereby we agreed to pay him cash bonuses in connection with his service to us as an employee and in thepreferred stock financings referenced above, weevent that our business was acquired or our assets sold. For a description of this letter agreement, see "Management—Employment Arrangements and Change of Control Arrangements."Other Transactions
We have entered into agreements with
the investors providing forall holders of our preferred stock, including entities affiliated with some of our directors and holders of 5% or more of our common stock, whereby we granted them registration rights with respect to theirshares.shares of common stock issuable upon conversion of their preferred stock. Foramorecomplete description of theinformation regarding registration rights,we granted to these stockholders,please see "Description ofcapital stock--Registration Rights.Capital Stock."For additional information regarding the saleWe have entered into indemnification agreements with each of
securities toour executive officers and directors. The indemnification agreements require us to indemnify these individuals to the fullest extent permitted by Delaware law and may be broader than the specific indemnification provisions contained in the Delaware General Corporation Law. In addition, we have purchased a policy of directors' and officers' liability insurance that insures our directors andholdersofficers against the cost ofmore than 5%defense, settlement or payment ofour outstanding common stock, please see "Principal stockholders." OPTION AGREEMENTS WITH DIRECTORS In April 1998, we granted Kenneth E. Olsonastock option under our 1997 Stock Option Plan to purchase 3,000 shares of our common stock at an exercise price of $0.21 per share. In April 1998, we granted Mr. Olson a stock option under our 1997 Stock Option/Stock Issuance Plan to purchase 3,000 shares of our common stock at an exercise price of $0.25 per share. In December 1998, we granted Mr. Olson a stock option under our 1998 Stock Option/Stock Issuance Plan to purchase 5,000 shares of our common stock at an exercise price of $0.35 per share. In May 1999, we granted Mr. Olson an additional stock option under our 1998 Stock Option/Stock Issuance Plan to purchase 3,000 shares of our common stock at an exercise price of $0.35 per share. In March 2000, we granted Mr. Olson an additional stock option under our 1998 Stock Option/Stock Issuance Plan to purchase 5,000 shares of our common stock at an exercise price of $0.35 per share. In May 2000, we granted Mr. Olson an additional stock option under our 1998 Stock Option/Stock Issuance Plan to purchase 30,000 shares of our common stock at an exercise price of $0.50 per share. In March 2001, we granted Mr. Olson an additional stock option under our 1998 Stock Option/Stock Issuance Plan to purchase 5,000 shares of our common stock at an exercise price of $1.00 per share. In December 1998, we granted R. Scott Huennekens a stock option under our 1998 Stock Option/ Stock Issuance Plan to purchase 225,000 shares of our common stock at an exercise price of $0.35 per share. In May 1999, we granted Mr. Huennekens an additional stock option under our 1998 Stock Option/Stock Issuance Plan to purchase 200,000 shares of our common stock at an exercise price of $0.35 per share. In March 2000, we granted Mr. Huennekens an additional stock option under our 1998 Stock Option/Stock Issuance Plan to purchase 575,000 shares of our common stock at an exercise price of $0.35 per share. In January 2001, we granted Mr. Huennekens an additional stock option under our 1998 Stock Option/Stock Issuance Plan to purchase 120,000 shares of our common stock at an exercise price of $1.00 per share. In May 2000, we granted R. King Nelson a stock option under our 1998 Stock Option/Stock Issuance Plan to purchase 50,000 shares of our common stock at an exercise price of $0.50 per share. In March 2001, we granted Mr. Nelson an additional stock option under our 1998 Stock Option/Stock Issuance Plan to purchase 5,000 shares of our common stock at an exercise price of $1.00 per share. In November 2000, we granted Timothy J. Wollaeger a stock option under our 1998 Stock Option/ Stock Issuance Plan to purchase 30,000 shares of our common stock at an exercise price of $0.50 per share. In August 2001, we granted Brad Nutter a stock option under our 1998 Stock Option/Stock Issuance Plan to purchase 50,000 shares of our common stock at an exercise price of $1.50 per share. - -------------------------------------------------------------------------------- 70- -------------------------------------------------------------------------------- Principal stockholdersjudgment in some circumstances.The following table sets forth information
with respect toregarding the beneficial ownership of our common stock as ofAugust 23, 2001, as adjusted to reflectApril 28, 2004, for:
- •
- each executive officer named in the
saleSummary Compensation Table;- •
- each of
the shares of common stock in this offering by: - -our directors;- •
- each person
or group of affiliated persons who we knowknown by us to beneficiallyownsown more than 5%or moreof our common stock;- - eachand- •
- all of our
named executive officers listed in "Executive Compensation" above and our current Vice President and Chief Financial Officer; - - each of our current directors; and - - all of theexecutive officers and directors as a group.Information with respect to beneficial ownership has been furnished by each director, officer or beneficial owner of more than 5% of our common stock. Beneficial ownership is
calculated according todetermined in accordance with the rules of the Securities and ExchangeCommission.Commission and includes voting and investment power with respect to the securities. Except as indicatedin the footnotesby footnote, and subject tothis table,applicable community property laws, the persons named in the table have sole voting and investment power with respect to all shares of common stock shown as beneficially owned bythem, subject to community property laws where applicable.them. The number of sharesbeneficially owned by aof common stock used to calculate the percentage ownership of each listed person includes thenumbershares ofsharescommon stock underlying optionsandor warrants held by such persons that are exercisable within 60 daysfrom August 23, 2001. These shares are also deemed outstanding forof April 28, 2004, if any.Percentage of beneficial ownership before the
purpose of computing the percentage of outstanding shares owned by the person. The shares are not deemed outstanding, however, for the purpose of computing the percentage ownership of any other person. Percentage ownershipoffering is basedupon 34,274,504on 12,502,409 shares, consisting of 58,115 shares of common stock outstandingat August 23, 2001, assumingas of April 28, 2004, and 12,444,294 shares issuable upon the conversion ofall outstandingthe preferred stock. Percentage of beneficial ownership after the offering is based on 18,002,409 shares,of preferred stock into common stock.including 5,500,000 shares offered by this prospectus. Unless otherwise indicated, the address foreach ofthe following stockholdersis:is c/o Digirad Corporation,9350 Trade Place, San Diego,13950 Stowe Drive, Poway, California92126-6334.92064.
PERCENTAGE OF SHARES BENEFICIALLY NUMBER OF NUMBER OF SHARES OWNED SHARES UNDERLYING OPTIONS ---------------------- BENEFICIALLY AND WARRANTS BEFORE AFTER NAME AND ADDRESS OF BENEFICIAL OWNER OWNED BENEFICIALLY OWNED OFFERING OFFERING - -----------------------------------------------------------------------------------------------------------Entities affiliated with Kingsbury Associates(1)................................ 6,615,721 132,938 19.2% 3655 Nobel Drive, Suite 490 San Diego, CA 92122 Entities affiliated with Vector Fund Management(2)................................ 5,106,807 16,468 14.9% 1751 Lake Cook Road, Suite 350 Deerfield, IL 60015 Entities affiliated with Sorrento Associates(3)................................ 4,506,524 -- 13.1% 4370 La Jolla Village Drive, Suite 1040 San Diego, CA 92122 Entities affiliated with Merrill Lynch Ventures(4).................................. 2,234,051 -- 6.5% 2 World Financial Center, 31st Floor New York, NY 10281 R. Scott Huennekens............................ 1,370,000 1,341,428 3.8% Robert E. Johnson.............................. 550,000 521,428 1.6% John F. Sheridan............................... 575,000 546,428 1.7% Richard L. Conwell............................. 400,000 371,428 1.2% Gary J.G. Atkinson............................. 250,000 250,000 * David M. Sheehan............................... 410,000 410,000 1.2% Timothy J. Wollaeger(5)........................ 6,645,721 132,938 19.3% R. King Nelson................................. 55,000 55,000 * Brad Nutter.................................... 50,000 50,000 * Kenneth E. Olson(6)............................ 296,770 166,000 * Douglas Reed, M.D.(7).......................... 5,151,510 16,468 15.0% All Executive Officers and Directors as a Group (11 persons)................................. 15,754,001 3,811,712 41.3%
Percentage of Shares
Beneficially OwnedNumber of
Shares
Beneficially
OwnedName and Address of Beneficial Owner Before Offering After Offering Executive Officers and Directors: David M. Sheehan(1) 416,219 3.2 % 2.3 % Todd P. Clyde(2) 112,857 * * Diana M. Bowden(3) 35,013 * * Martin B. Shirley(4) 40,405 * * Stephen L. Bollinger(5) 29,412 * * Timothy J. Wollaeger(6) 2,268,553 18.1 12.6 Raymond V. Dittamore(7) 11,429 * * Robert M. Jaffe(8) 1,455,772 11.6 8.1 R. King Nelson(9) 11,507 * * Kenneth E. Olson(10) 103,445 * * Douglas Reed, M.D.(11) 2,147,116 17.2 11.9 5% Stockholders: Entities affiliated with Vector Fund Management(12)
1751 Lake Cook Road, Suite 350
Deerfield, IL 600152,117,054 16.9 11.8 Merrill Lynch Ventures, LLC(13)
4 World Financial Center, 23rd Floor
New York, NY 100801,670,301 13.4 9.3 Entities affiliated with Kingsbury Associates(14)
3655 Nobel Drive, Suite 490
San Diego, CA 921221,650,203 13.2 9.2
Entities affiliated with Sorrento Associates(8)
4370 La Jolla Village Drive, Suite 1040
San Diego, CA 921221,455,772 11.6 8.1 GE Capital Equity Investments, Inc.
120 Long Ridge Road
Stamford, CT 06927838,727 6.7 4.7 Health Care Indemnity, Inc.
One Park Plaza
Nashville, TN 37069657,082 5.3 3.6 All directors and executive officers as a group (15 persons) 6,923,766 51.3 36.4
- *
Less- Indicates beneficial ownership of less than
one percent. - --------------------------------------------------------------------------------1% of the total outstanding common stock.- (1)
- Includes 416,190 shares subject to options exercisable within 60 days of April 28, 2004.
- (2)
- Includes 112,857 shares subject to options exercisable within 60 days of April 28, 2004.
- (3)
- Includes 35,013 shares subject to options exercisable within 60 days of April 28, 2004.
- (4)
- Includes 40,405 shares subject to options exercisable within 60 days of April 28, 2004.
- (5)
- Includes 29,412 shares subject to options exercisable within 60 days of April 28, 2004.
- (6)
- Includes (a) 74 shares subject to options and warrants exercisable within 60 days of April 28, 2004 and 505,807 shares held by Kingsbury Capital Partners, L.P.; (b) 71
PRINCIPAL STOCKHOLDERS - -------------------------------------------------------------------------------- (1) In this prospectus, we refershares subject to options exercisable within 60 days of April 28, 2004 and 497,885 shares held by Kingsbury Capital Partners, L.P., II; (c) 49 shares subject to warrants exercisable within 60 days of April 28, 2004 and 306,436 shares held by Kingsbury Capital Partners, L.P., III; (d) 115 shares subject to warrants exercisable within 60 days of April 28, 2004 and 339,766 shares held by Kingsbury Capital Partners, L.P., IV; (e) 426,330 shares held by Sanderling Venture Partners V, L.P.; (f) 104,428 shares held by Sanderling V Biomedical, L.P.; (g) 42,250 shares held by Sanderling V Limited Partnership; (h) 37,594 shares held by Sanderling V Beteiligungs GMBH & Co. KG; and (i) 6,167 shares held by Sanderling V Ventures Management. Timothy J. Wollaeger, a member of our board of directors, is the general partner of Kingsbury Associates, L.P., which is a general partner of each of Kingsbury Capital Partners, L.P., Kingsbury Capital Partners, L.P., II, Kingsbury Capital Partners, L.P., III and Kingsbury Capital Partners, L.P., IV. Mr. Wollaeger is also a managing director of Middleton, McNeil & Mills Associates V, LLC, the general partner of Sanderling Venture Partners V, L.P., Sanderling V Biomedical, L.P., Sanderling V Limited Partnership and Sanderling V Beteiligungs GMBH & Co. KG, and is an owner of Sanderling V Ventures Management. Mr. Wollaeger disclaims beneficial ownership of the shares held by Kingsbury Capital Partners, L.P., Kingsbury Capital Partners, L.P., II, Kingsbury Capital Partners, L.P., III, Kingsbury Capital Partners, L.P., IV, Sanderling Venture Partners V, L.P., Sanderling V Biomedical, L.P., Sanderling V Limited Partnership, Sanderling V Beteiligungs GMBH & Co. KG and Sanderling V Ventures Management, except to the extent of his pecuniary interests in the named fund. As general partner, Mr. Wollaeger has voting and investment power with respect to the shares held by Kingsbury Capital Partners, L.P., Kingsbury Capital Partners, L.P., II, Kingsbury Capital Partners, L.P., III and Kingsbury Capital Partners, L.P., IV. Mr. Wollaeger shares voting and investment power with respect to the shares held by Sanderling Venture Partners V, L.P., Sanderling V Biomedical, L.P., Sanderling V Limited Partnership and Sanderling V Beteiligungs GMBH & Co. KG with the other managing directors of Middleton, McNeil & Mills Associates V, LLC. Mr. Wollaeger may be deemed to share voting and investment power with respect to the shares held by Sanderling V Ventures Management with the other owners.
- (7)
- Includes 11,429 shares subject to options exercisable within 60 days of April 28, 2004.
- (8)
- Includes (a) 371,559 shares held by Sorrento Growth Partners I, L.P.; (b) 199,042 shares held by Sorrento Ventures II, L.P.; (c) 730,593 shares held by Sorrento Ventures III, L.P.; and (d) 154,578 shares held by Sorrento Ventures CE, L.P. Robert M. Jaffe, a member of our board of directors, is president of (a) Sorrento Growth, Inc., which is the general partner of Sorrento Equity Growth Partners I, L.P., which is the general partner of Sorrento Growth Partners I, L.P.; and (b) Sorrento Associates, Inc., which is the general partner of (i) Sorrento Equity Partners, L.P., the general partner of Sorrento Ventures II, L.P., and (ii) Sorrento Equity Partners III, L.P., the general partner of Sorrento Ventures III, L.P. and Sorrento Ventures CE, L.P. Mr. Jaffe disclaims beneficial ownership of the shares held by Sorrento Growth Partners I, L.P., Sorrento Ventures II, L.P., Sorrento Ventures III, L.P. and Sorrento Ventures CE, L.P., except to the extent of his pecuniary interests in the named fund. As president of Sorrento Growth, Inc. and Sorrento Associates, Inc., Mr. Jaffe may be deemed to have voting and investment power with respect to the shares held by Sorrento Growth Partners I, L.P., Sorrento Ventures II, L.P., Sorrento Ventures III, L.P. and Sorrento Growth Partners CE, L.P. Mr. Jaffe, who currently serves as a member of our board of directors, has submitted his resignation which will become effective immediately prior to the effectiveness of this offering.
- (9)
- Includes 11,507 shares subject to options exercisable within 60 days of April 28, 2004.
- (10)
- Includes (a) 60,750 shares subject to options exercisable within 60 days of April 28, 2004; (b) 12 shares subject to warrants exercisable within 60 days of April 28, 2004 held by the Kenneth E. Olson Trust dated March 16, 1989; and (c) 42,683 shares held by the Kenneth E. Olson Trust dated March 16, 1989. Kenneth E. Olson, a member of our board of directors, is the trustee of the Kenneth E. Olson Trust dated March 16, 1989.
- (11)
- Includes (a) 929,312 shares held by Vector Later-Stage Equity Fund, L.P.; (b) 12 shares subject to warrants exercisable within 60 days of April 28, 2004 and 296,923 shares held by Vector Later-Stage Equity Fund II, L.P.; (c) 36 shares subject to warrants exercisable within 60 days of April 28, 2004 and 890,771 shares held by Vector Later-Stage Equity Fund II (Q.P.), L.P.; and (d) 30,062 shares held by Palivacinni Partners, LLC. Douglas Reed, a member of our board of directors, is a managing director of Vector Fund Management, L.P., which is the general partner of Vector Later-Stage Equity Fund, L.P., and Vector Fund Management II, LLC, which is the general partner of each of Vector Later-Stage Equity Fund II, L.P. and Vector Later-Stage Equity Fund II (Q.P.), L.P. and is a managing member of Palivacinni Partners, LLC. Dr. Reed disclaims beneficial ownership of the shares held by Vector Later-Stage Equity Fund, L.P., Vector Later-Stage Equity Fund II, L.P. and Vector Later-Stage Equity Fund II (Q.P.), L.P., except to the extent of his pecuniary interests in the named fund. Dr. Reed may be deemed to share voting and investment power with respect to the shares held by Vector Later-Stage Equity Fund, L.P., Vector Later-Stage Equity Fund II, L.P. and Vector Later-Stage Equity Fund II (Q.P.), L.P. with the other managing director and members of the investment committee of Vector Fund Management, L.P. and Vector Fund Management II, LLC. Dr. Reed disclaims beneficial ownership of the shares held by Palivacinni Partners, LLC, except to the extent of his pecuniary interests in the entity. Dr. Reed may be deemed to have voting and investment power with respect to the shares held by Palivacinni Partners, LLC with the other managing members.
- (12)
- Includes (a) 929,312 shares held by Vector Later-Stage Equity Fund, L.P.; (b) 12 shares subject to warrants exercisable within 60 days of April 28, 2004 and 296,923 shares held by Vector Later-Stage Equity Fund II, L.P.; and (c) 36 shares subject to warrants exercisable within 60 days of April 28, 2004 and 890,771 shares held by Vector Later-Stage Equity Fund II (Q.P.), L.P. Douglas Reed, a member of our board of directors, and Barclay A Phillips are the managing directors of each of Vector Fund Management, L.P., which is the general partner of Vector Later-Stage Equity Fund, L.P., and Vector Fund Management II, LLC, which is the general partner of each of Vector Later-Stage Equity Fund II, L.P. and Vector Later-Stage Equity Fund II (Q.P.), L.P. Dr. Reed and Mr. Phillips, together with
D. Theodore Berghorst, Peter Drake and James Foght who are also members of the investment committee of Vector Fund Management, L.P. and Vector Fund Management II, LLC, may be deemed to have voting and investment power with respect to the shares held by Vector Later-Stage Equity Fund, L.P., Vector Later-Stage Equity Fund II, L.P. and Vector Later-Stage Equity Fund II (Q.P.), L.P. Dr. Reed, Mr. Phillips, Mr. Berghorst, Dr. Drake and Dr. Foght each disclaim beneficial ownership of the shares held by Vector Later-Stage Equity Fund, L.P., Vector Later-Stage Equity Fund II, L.P. and Vector Later-Stage Equity Fund II (Q.P.), L.P., except to the extent of his pecuniary interests in the named fund.
- (13)
- Includes 12 shares subject to warrants exercisable within 60 days of April 28, 2004 held by Merrill Lynch Ventures, L.P. 2001. Merrill Lynch Ventures, LLC is the general partner of Merrill Lynch Ventures, L.P. 2001 and is managed by a board of directors which may be deemed to exercise voting and investment power with respect to such shares. The members of the board of directors are Nathan Thorne, Mandy Puri, George Bitar, Mac Gardner and Jerry Kennedy, each of whom disclaims beneficial ownership of the shares held by Merrill Lynch Ventures, L.P. 2001 except to the extent of his or her pecuniary interest therein.
- (14)
- Includes (a) 74 shares subject to options and warrants exercisable within 60 days of April 28, 2004 and 505,807 shares held by Kingsbury Capital Partners, L.P.; (b) 71 shares subject to options exercisable within 60 days of April 28, 2004 and 497,885 shares held by Kingsbury Capital Partners, L.P., II; (c) 49 shares subject to warrants exercisable within 60 days of April 28, 2004 and 306,436 shares held by Kingsbury Capital Partners, L.P., III; and (d) 115 shares subject to warrants exercisable within 60 days of April 28, 2004 and 339,766 shares held by Kingsbury Capital Partners, L.P., IV. Timothy J. Wollaeger, a member of our board of directors, is the general partner of Kingsbury Associates, L.P., which is a general partner of each of Kingsbury Capital Partners, L.P., Kingsbury Capital Partners, L.P., II, Kingsbury Capital Partners, L.P., III and Kingsbury Capital Partners, L.P., IV. Mr. Wollaeger disclaims beneficial ownership of the shares held by Kingsbury Capital Partners, L.P., Kingsbury Capital Partners, L.P., II, Kingsbury Capital Partners, L.P., III and Kingsbury Capital Partners, L.P., IV,
collectively, as entities affiliated with Kingsbury Capital Partners. Timothy J. Wollaeger, a member of our board of directors, is a general partner of Kingsbury Associates, L.P., which is a general partner of each of the previously-mentioned investment funds, and Mr. Wollaeger shares investment and voting power over these shares with the other general partners of Kingsbury Associates, L.P. Mr. Wollaeger disclaims beneficial ownership of such shares,except to the extent of his pecuniaryinterest, if any. (2) In this prospectus, we referinterests in the named fund. Mr. Wollaeger has voting and investment power with respect toVector Later-Stage Equity Fund, L.P., Vector Later-Stage Equity Fund II, L.P., and Vector Later-Stage Equity Fund II (Q.P.), L.P., collectively, as entities affiliated with Vector Fund Management. Douglas Reed, M.D., a member of our board of directors, is a managing director ofthegeneral partner of each of the previously-mentioned investment funds, and Dr. Reed shares investment and voting power over these shares with the other managing directors of each of the general partners of these funds. Dr. Reed disclaims beneficial ownership of all such shares, except to the extent of his pecuniary interest, if any. (3) In this prospectus, we refer to Sorrento Growth Partners I, L.P., Sorrento Ventures II, L.P., Sorrento Ventures III, L.P., and Sorrento Ventures CE, L.P., collectively, as entitles affiliated with Sorrento Associates. (4) In this prospectus, we refer to Merrill Lynch Ventures, LLC and Merrill Lynch Ventures, L.P. 2001, collectively, as entitles affiliated with Merril Lynch Ventures. (5) Includes 6,615,721shares held byentities affiliated withKingsburyAssociatesCapital Partners, L.P., Kingsbury Capital Partners, L.P., II, Kingsbury Capital Partners, L.P., III and30,000Kingsbury Capital Partners, L.P., IV.The following descriptions of our capital stock give effect to the following events:
- •
- a 1-for-200 reverse split of our capital stock effected in October 2002;
- •
- a 1-for-3.5 reverse split of our common stock to be effected prior to completion of this offering;
- •
- the restatement of our certificate of incorporation and bylaws upon completion of this offering; and
- •
- the conversion of our preferred stock into 12,444,294 shares of common stock,
held by Mr. Wollaeger. (6) Includes 130,770 shares held bywhich will occur upon theKenneth E. Olson Trust dated March 16, 1989 and options to purchase 166,000 sharescompletion ofcommon stock held by Mr. Olson. (7) Includes 5,106,807 shares held by entities affiliated with Vector Fund Management and 44,703 shares held by Palivacinni Partners, LLC. Dr. Reed is a member of Palivacinni Partners, LLC and shares investment and voting power over these shares with the other members. Dr. Reed disclaims beneficial ownerhip of such shares except to the extent of his pecuniary interest, if any. - -------------------------------------------------------------------------------- 72- -------------------------------------------------------------------------------- Description of capital stockthis offering.Upon
the closingcompletion of this offering, our authorized capital stock will consist of250,000,000150,000,000 shares of common stock,$0.001$0.0001 par value per share, and 10,000,000 shares of undesignated preferred stock,$0.001$0.0001 par value per share.The following
descriptionsummary of the rights of our capital stockdoesis notpurport to becomplete and issubjectqualified in its entirety by reference toand qualified byour restated certificate of incorporation and restated bylaws to be in effect upon the completion of this offering, copies of which areincludedfiled as exhibits to the registration statement of which this prospectusformsis a part, and by the provisions of applicable Delaware law.COMMON STOCK As of August 23, 2001, there were 4,526,474Common Stock
Outstanding Shares
Based on 58,115 shares of common stock
outstanding. Thereoutstanding as of April 28, 2004, the issuance of 5,500,000 shares of common stock in this offering, the issuance of 12,444,294 shares of common stock upon conversion of all outstanding shares of our preferred stock, and no exercise of outstanding options or warrants, there will be 18,002,409 shares of common stock outstanding upon the closing of thisoffering, which gives effectoffering. As of the same date, there were 1,636,385 shares subject to outstanding options under our 1991 Stock Option Program, our 1997 Stock Option/Stock Issuance Plan and our 1998 Stock Option/Stock Issuance Plan. In addition, as of the same date, there were warrants outstanding to purchase 45,550 shares of our commonstock offered by us in this offering and the conversionstock. As ofshares of preferred stock as discussed below. The outstanding shares of common stock are, and the shares offered by us in this offering will be, when issued in consideration for payment thereof, fully paid and nonassessable. The following summarizes the rights ofApril 28, 2004, we had approximately 310 holders of our commonstock: - - the holdersstock.Voting Rights
Holders of our common stock are
entitled to dividends and other distributions as may be declared from time to time by the board of directors out of funds legally available for that purpose, if any; - - the holders of common stock have no preemptive or other subscription rights to purchase shares of our stock, nor are they entitled to the benefits of any redemption or sinking fund provisions; - - each holder of shares of common stock isentitled to one vote per share on all matters to be votedonupon bystockholders generally, includingthe stockholders. The holders of common stock are not entitled to cumulate voting rights with respect to the election ofdirectors; - - theredirectors, which means that the holders of a majority of the shares voted can elect all of the directors then standing for election.Dividends
Subject to limitations under Delaware law and preferences that may apply to any outstanding shares of preferred stock, holders of our common stock are
no cumulative voting rights; and - - uponentitled to receive ratably such dividends or other distribution, if any, as may be declared by our board of directors out of funds legally available therefor.Liquidation
In the event of our liquidation, dissolution or winding up, holders of our common stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to the liquidation preference of any of our outstanding preferred stock.
Rights and Preferences
Our common stock has no preemptive, conversion or other rights to subscribe for additional securities. There are no redemption or sinking fund provisions applicable to our common stock. The rights, preferences and privileges of holders of our common stock are subject to, and may be adversely affected by, the rights of the holders of shares of any series of our preferred stock that we may designate and issue in the future.
Fully Paid and Nonassessable
All outstanding shares of our common stock are, and all shares our common stock to be outstanding upon completion of this offering will be,
entitledvalidly issued, fully paid and nonassessable.Preferred Stock
As of April 28, 2004, there were 43,555,313 shares of convertible preferred stock outstanding. We have secured consents from the requisite number of stockholders to
share ratably inthedistributionautomatic conversion of allof our assets remaining available for distribution after satisfaction of all our liabilities and the payment of the liquidation preference of anyoutstandingpreferred stock. PREFERRED STOCK As of August 23, 2001, there were 29,748,030shares of redeemable convertible preferred stockoutstanding. Allin connection with this offering. As a result, all outstanding shares of redeemable convertible preferred stock will be converted into29,748,03012,444,294 shares of our common stock in connection with this offering and such shares of redeemable convertible preferred stock will no longer be authorized, issued or outstanding.In addition,
ifas of thefinal price per share of shares in this offering is less then $ per share, a small number of additionalsame date, there were warrants to purchase 1,939 shares ofcommonour preferred stock, of which warrants to purchase 249 shares willbe issued upon conversionexpire if not exercised prior to the completion of theSeries F preferred stock.offering.Upon the closing of this offering, our board of directors will be authorized, without further stockholder approval, to issue from time to time one or more series of preferred stock and to fix or alter the designations, powers, preferences, rights and any qualifications, limitations or restrictions of the shares of such series, including:
- -
- •
- the number of shares constituting the series and the distinctive designation of the series;
- -------------------------------------------------------------------------------- 73DESCRIPTION OF CAPITAL STOCK - -------------------------------------------------------------------------------- - -- •
- the dividend rate on the share of the series, whether dividends will be cumulative, and if so, from which date or dates, and the relative rights of priority, if any, of payment of dividends on shares of the series;
- -- •
- whether the series will have conversion privileges and, if so, the terms and conditions of conversion;
- -- •
- whether the series will have a sinking fund for the redemption or purchase of shares of that series, and, if so, the terms and amount of the sinking fund;
- -- •
- whether or not the shares of the series will be redeemable or exchangeable, and, if so, the dates, terms and conditions of redemption or exchange, as the case may be;
- -- •
- whether the series will have voting rights in addition to the voting rights provided by law, and if so, the terms of the voting rights; and
- -- •
- the rights of the shares of the series in the event of our voluntary or involuntary liquidation, dissolution or winding up and the relative rights or priority, if any, of payment of shares of the series.
The board of directors may authorize the issuance of preferred stock with terms and conditions which could discourage a takeover or other transaction that holders of some or a majority of common stock might believe to be in their best interests or in which holders of common stock might receive a premium for their shares over the then market price.
We have no present plans to issue any shares of our preferred
stock. WARRANTSstock after completion of this offering.Warrants
As of
August 23, 2001, we hadApril 28, 2004, there were warrants outstandingwarrantsto purchase603,578the following shares ofcommon stock, at a weighted average exercise price of $2.59 per share. Of the outstanding warrants, warrantsour capital stock:
Description Number of Shares Before This Offering Weighted Average
Exercise Price
Before
This OfferingNumber of Shares After This Offering Weighted Average
Exercise Price After
This OfferingSeries E Preferred Stock 1,939 $ 607.20 1,690 $ 607.20 Common Stock 44,996 $ 13.14 44,996 $ 13.14 Warrants to purchase
65,8751,477 shares of our Series E preferred stock will terminate five years after the date of this offering. Warrants to purchase 249 shares of our Series E preferred stock will terminate uponthe closingcompletion of this offering and warrants to purchase60,000213 shares of our Series E preferred stock willexpire if a consulting agreement is terminated beforeterminate on July 31,2002. In addition, we have entered into a consulting agreement under which we2006. Warrants to purchase 7,452 shares of our common stock willissue additionalterminate on certain dates from November 14, 2005 through April 22, 2009. Additionally, warrants to purchase10,00037,544 shares of our common stockatwill terminate on November 13, 2007.Each of these warrants has a net exercise provision under which its holder may, in lieu of payment of the exercise price in cash, surrender the warrant and receive a net amount of shares based on the fair market value of the underlying security at the time of exercise of the warrant after deduction of the aggregate exercise price. Each of these warrants also contains provisions for
every three digital cameras sold bytheconsultant, upadjustment of the exercise price and the aggregate number of shares issuable upon the exercise of the warrant in the event of stock dividends, stock splits, reorganizations and reclassifications and consolidations.On May 7, 2004, we agreed to
a maximum of 40,000 shares, and thereafterissuewarrantstopurchase 1,500 shares of common stock at fair market value for eachtwo of ourdigital cameras sold by the consultant. OPTIONS As of August 23, 2001, optionsstockholders warrants to purchase an aggregatetotalof5,952,42647,618 shares of our common stockwere outstanding underwithin five business days of the completion of this offering. Such warrants will have a term of four years from the closing of this offering and a per share exercise price equal to the final price at which we sell shares of our1995 Stock Option Plan,common stock in this offering. In addition, the holders of these warrants received registration rights and became party to our1997 Stock Option/Stock Issuance Planamended andour 1998 Stock Option/Stock Issuance Plan. Optionsrestated investors' rights agreement, as discussed more fully below. We may also enter into a similar agreement with an additional stockholder whereby we would issue such stockholder warrants to purchasea total of 4,725,883up to 23,809 shares of our common stockremain available for grant underon substantially the same terms outlined above.We have granted registration rights pursuant to the terms of our
option plans. Please see "Management--Benefit Plans"amended and"Shares eligible for future sale" forrestated investors' rights agreement, as discussed more fully below, to adetailed descriptionholder of warrants to purchase an aggregate of 213 shares of our Series E preferred stock.Registration Rights
Under an amended and restated investors' rights agreement, the
stock option plans. REGISTRATION RIGHTS Theholders of a majority of the shares of our common stockwhich will beissued upon the conversion oftheour Series A preferred stock,in connection with this offering, which holders are referred to below as ourSeries B preferredinvestors,stock, Series C preferred stock, Series D preferred stock, Series E preferred stock, Series F preferred stock, Series G preferred stock and Series H preferred stock have the right tocauserequire us to register their sharesunderwith the SecuritiesActand Exchange Commission following the completion of1933this offering, so that those shares may be publicly resold, or to include their shares in any registration statement we file as follows:- - DEMAND REGISTRATION RIGHTS: Preferred investors holdingDemand Registration Rights
At any time beginning one year after the completion of this offering, holders of at least
30%25% of the shares of our common stock issued upon the conversion oftheour Series A preferred stock, Series B preferred stock, Series C preferred stock, Series D preferred stock, Series E preferred stock, Series F preferred stock, Series G preferred stock and Series H preferred stock have the right to demand that weregisterfile up to two registration statements, so long as at least 20% of their- -------------------------------------------------------------------------------- 74DESCRIPTION OF CAPITAL STOCK - -------------------------------------------------------------------------------- shares,registrable securities will be registered and/orthe proposed aggregate offering price of the securities registered, net of underwriting discounts and commissions, is at least $25,000,000, subject to
limitations, commencing one year after the effective date of thespecified exceptions.Form S-3 Registration Rights
If we are eligible to file a "short-form" registration statement
for this offering. We are not requiredon Securities and Exchange Commission Form S-3, stockholders with registration rights have the right toeffect more than two registrations pursuant to suchdemandregistration rights; - - PIGGYBACK REGISTRATION RIGHTS: In the eventthat wepropose to register any shares of common stock either for our account or for the account of other security holders, our preferred investors are entitled to receive notice of such registration and to have their shares included in any such registration, subject to limitations; and - - S-3 REGISTRATION RIGHTS: At any time after we become eligible tofile a registration statement on Form S-3our preferred investors may require usso long as the aggregate offering price of the securities tofile up to twobe sold under the registrationstatementsstatement on Form S-3,duringnet of underwriting discounts and commissions, is at least $1,000,000, subject to specified exceptions."Piggyback" Registration Rights
If we register any
twelve month periodsecurities for public sale solely for cash, stockholders withrespectregistration rights will have the right to include their shares in the registration statement. The underwriters ofcommon stock, subject to limitations. These registration rights are subject to conditions and limitations, among themany underwritten offering will have the rightof the underwriters of an offeringto limit the number of such sharesof common stock held by our preferred investorsto be included ina registration. We are generally requiredthe registration statement. In this offering the underwriters have excluded any sales by existing investors.Expenses of Registration
Other than underwriting discounts and commissions, we will pay all expenses relating to
bearpiggyback registrations and all expenses relating to demand registrations and Form S-3 registrations so long as the aggregate amount of securities to be sold under each such registration statement exceeds the threshold amounts discussed above. However, we will not pay for the expenses of any demand or Form S-3 registration if the request is subsequently withdrawn by the stockholders initiating these registration rights, subject to specified exceptions.Expiration of Registration Rights
The registration rights described above will expire seven years after this offering is completed. The registration rights will terminate earlier for a particular stockholder at such time as that holder, following completion of this offering, can resell all
such registrations, including the reasonable feesof its securities in asingle counsel acting on behalf of all selling holders, but excluding underwriting discounts and selling commissions. Registration of any90-day period under Rule 144 of theshares of common stock held by our preferred investors would result in such shares becoming freely tradable without restriction under theSecuritiesAct of 1933 immediately upon effectiveness of such registration. POSSIBLE ANTI-TAKEOVER MATTERS GENERAL--ProvisionsAct.Anti-takeover Effects of Delaware
law, as well as our certificateLaw and Provisions ofincorporationOur Certificate of Incorporation andbylaws, could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from acquiring, control of us. Such provisions could limit the price that some investors might be willing to pay in the future for our common stock. These provisions ofBylawsDelaware
law and our certificate of incorporation and bylaws may also have the effect of discouraging or preventing certain types of transactions involving an actual or threatened change of control of us, including unsolicited takeover attempts, even though such a transaction may offer our stockholders the opportunity to sell their stock at a price above the prevailing market price. DELAWARE TAKEOVER STATUTE--WeTakeover StatuteWe are subject to
the "business combination" provisions ofSection 203 of the Delaware General Corporation Law.Subject to certain exceptions, Section 203This statute regulating corporate takeovers prohibits apublicly-heldDelaware corporation from engaging ina "business combination"any business combination withan "interested stockholder"any interested stockholder fora period ofthree yearsafterfollowing the date that the stockholder became an interested stockholder, unless:
- •
- prior to the date of the transaction,
in which the person became an interested stockholder, unless: - - the transaction is approved bythe board of directorsprior to the date the interested stockholder obtained interested stockholder status; - - upon consummationof the corporation approved either the business combination or the transactionthatwhich resulted in thestockholdersstockholder becoming an interestedstockholder,stockholder;- •
- the interested stockholder owned at least 85% of
ourthe voting stock of the corporation outstanding at the time the transaction commenced, excluding for purposes of determining the number of shares outstandingthose(a) shares owned by(a)persons who are directors and also officers and (b) shares owned by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or- - at
- •
- on or subsequent to the date of the
person became an interested stockholder,transaction, the business combination is approved by the boardof directorsand authorized at an annual or special meeting of- -------------------------------------------------------------------------------- 75DESCRIPTION OF CAPITAL STOCK - --------------------------------------------------------------------------------stockholders, and not by written consent, by the affirmative vote of at leasttwo-thirds662/3% of the outstanding voting stockthatwhich is not owned by the interested stockholder.A "business combination" includes mergers, asset salesSection 203 defines a business combination to include:
- •
- any merger or consolidation involving the corporation and the interested stockholder;
- •
- any sale, transfer, pledge or other
transactions resultingdisposition involving the interested stockholder of 10% or more of the assets of the corporation;- •
- subject to exceptions, any transaction that results in
a financial benefitthe issuance or transfer by the corporation of any stock of the corporation to the interestedstockholder. Subject to certain exceptions,stockholder; or- •
- the receipt by the interested stockholder of the benefit of any loans, advances, guarantees, pledges or other financial benefits provided by or through the corporation.
In general, Section 203 defines an
"interested stockholder" is ainterested stockholder as any entity or personwho, together with affiliates and associates, owns, or within three years did own,beneficially owning 15% or more of thecorporation'soutstanding votingstock. This statute could prohibitstock of the corporation and any entity ordelayperson affiliated with or controlling or controlled by theaccomplishmententity or person.Certificate of
mergers or other takeover or change in control attempts with respect to usIncorporation andaccordingly, may discourage attempts to acquire us. CHARTER AND BYLAW PROVISIONS--In addition, certain provisionsBylaw ProvisionsProvisions of our restated certificate of incorporation and restated bylaws,
summarized inwhich will become effective upon thefollowing paragraphsclosing of this offering, maybe deemedhave the effect of making it more difficult for a third party tohave an anti-takeover effect and may delay, deferacquire, orpreventdiscourage a third party from attempting to acquire, control of our company by means of a tender offer, a proxy contest or otherwise. These provisions may also make the removal of incumbent officers and directors more difficult. These provisions are intended to discourage certain types of coercive takeoverattemptpractices and inadequate takeover bids and to encourage persons seeking to acquire control of our company to first negotiate with us. These provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock. These provisions may make it more difficult for stockholders to take specific corporate actions and could have the effect of delaying or preventing astockholder might considerchange inits best interest, including those attempts that might result in a premium over the then market price for the shares heldour control. The amendment of any of these anti-takeover provisions would require approval bystockholders. - - CLASSIFIED BOARD OF DIRECTORS; REMOVAL; FILLING VACANCIES AND AMENDMENT: Ourholders of at least 662/3% of our outstanding common stock entitled to vote.In particular, our restated certificate of incorporation and restated bylaws provide
thatfor theboard willfollowing:No Written Consent of Stockholders
Any action to be
divided into three classes of directors serving staggered, three-year terms. The classification of the board has the effect of requiringtaken by our stockholders must be effected atleast two annual stockholder meetings, instead of one, to replaceamajority of members of the board. Subject to the rights of the holders of any outstanding series of preferred stock, the certificate of incorporation authorizes only the board to fill vacancies, including newly created directorships. Accordingly, this provision could prevent a stockholder from obtaining majority representation on the board by enlarging the board of directors and filling the new directorships with its own nominees. The certificate of incorporation also provides that directors may be removed by stockholders only for cause and only by the affirmative vote of holders of two-thirds of the outstanding shares of voting stock. - - STOCKHOLDER ACTION; SPECIAL MEETING OF STOCKHOLDERS: The certificate of incorporation provides that stockholders may not take action by written consent, but may only take action atduly called annual or specialmeetingsmeeting and may not be effected by written consent.Special Meetings of
stockholders. The certificate of incorporation further provides that specialStockholdersSpecial meetings of our stockholders may be called only by the president, chief executive officer, chairman of the board of directors,
the chief executive officer ora majority of theboardmembers ofdirectors. This limitation on the right of stockholders to call a special meeting could make it more difficult for stockholders to initiate actions that are opposed by the board of directors. These actions could include the removal of an incumbent director or the election of a stockholder nominee as a director. They could also include the implementation of a rule requiring stockholders' ratification of specific defensive strategies that have been adopted bythe board of directorswith respect to unsolicited takeover bids. In addition, the limited abilityor stockholders holding not less than 20% of thestockholderstotal number of votes tocallbe cast at such aspecial meeting of stockholders may make it more difficultmeeting.Advance Notice Requirement
Stockholder proposals to
change the existing board and management. - - ADVANCE NOTICE REQUIREMENTS FOR STOCKHOLDER PROPOSALS AND DIRECTOR NOMINATION: The bylaws provide that stockholders seeking to bring businessbe brought before an annual meeting of our stockholdersormust comply with advance notice procedures. These advance notice procedures require timely notice and apply in several situations, including stockholder proposals relating tonominate candidatesthe nominations of persons for electionas directors at an annual meetingto the board ofstockholders, must providedirectors. Generally, to be timely, noticethereof in writing. To be timely, a stockholder's noticemust bedelivered to or mailed andreceived at our principal executive offices not less than90 days or more than 120 days prior to the first anniversary date of the annual meeting for the preceding year.
Amendment of Bylaws and Certificate of Incorporation
The approval of not less that 662/3% of the outstanding shares of our
annual meeting. Thecapital stock entitled to vote is required to amend the provisions of our restated bylawsalso specify certain requirements asby stockholder action, or to amend theformprovisions of our restated certificate of incorporation that are described in this section or that are described under "Management—Limitation of Liability andcontentIndemnification ofa stockholder's notice.Officers and Directors" above. These provisionsmay precludewill make it more difficult to circumvent the anti-takeover provisions of our restated certificate of incorporation and our restated bylaws.Issuance of Undesignated Preferred Stock
Our board of directors is authorized to issue, without further action by the stockholders,
from bringing matters before an annual meeting of stockholders or from making nominations for directors at an annual meeting of stockholders. - - AUTHORIZED BUT UNISSUED SHARES: The authorized but unissuedup to 10,000,000 shares ofcommon stock andundesignated preferred stockare available for future issuance without stockholder approval. These additional - -------------------------------------------------------------------------------- 76DESCRIPTION OF CAPITAL STOCK - -------------------------------------------------------------------------------- shares may be utilized for a varietywith rights and preferences, including voting rights, designated from time to time by the board ofcorporate purposes, including future public offerings to raise additional capital, corporate acquisitions, employee benefit plans and "poison pill" rights plans.directors. The existence of authorized but unissued shares ofcommon stock andpreferred stockcouldenables our board of directors to render more difficult or to discourage an attempt to obtain control of us by means of a merger, tender offer, proxy contesttender offer, mergeror otherwise.NASDAQ NATIONAL MARKETTransfer Agent and Registrar
The transfer agent and registrar for our common stock is American Stock Transfer & Trust Company.
Nasdaq National Market Listing
We have applied
to listfor approval for trading and quotation of our common stock on the Nasdaq National Market under thetradingsymbol "DRAD."TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the common stock is . - -------------------------------------------------------------------------------- 77- -------------------------------------------------------------------------------- Shares eligible for future sale
SHARES ELIGIBLE FOR FUTURE SALEPrior to this offering, there has been no public market for our common stock.
We cannot predict what effect, if any, market sales of shares or the availability of shares for sale will have on the market priceIf our stockholders sell substantial amounts of our common stock in the public market following this offering, the prevailingfrom time to time. Themarket price of our common stock coulddeclinedecline. Furthermore, because we do not expect many shares will be available for sale for 180 days after this offering as a result of certain contractual and legal restrictions on resale described below, sales ofa large number of sharessubstantial amounts of our common stock in the public market afterthis offering, orthese restrictions lapse could adversely affect theperception that such sales could occur. Such sales also mightprevailing market price and make itmoredifficult or impossible for us to sell equity or equity-related securities in the future at a time and pricethatwe deem appropriate.Based upon the number of shares outstanding at August 23, 2001, upon the closingUpon completion of this offering, we will have 17,998,646 shares of common stock outstanding, assuming no exercise of currently outstanding options or warrants. Of these shares, the 5,500,000 shares sold in this offering, plus any additional shares sold upon exercise of the underwriters' over-allotment option,
and no exercise of options or warrants to purchase shares of our common stock. Of these shares, the shares being sold in this offeringwill be freelytradabletransferable without restrictionor further registrationunder the Securities Act,of 1933,unlessthese sharesthey arepurchasedheld by our "affiliates" as that term isdefined in Rule 144used under the Securities Actof 1933.and the rules and regulations promulgated thereunder. The remaining 12,498,646 shares ofourcommon stockwere issued and soldheld byus in reliance on exemptions from the registration requirements of the Securities Act of 1933. Theseexisting stockholders are restricted shares. Restricted shares may be sold in the public market only ifthey areregistered or if they qualify for an exemption from registrationsuch as Ruleunder Rules 144 or 701 promulgated under the Securities Act,of 1933,which rules are summarized below.The remainingTaking into account the lock-up agreements described below and the provisions of Rules 144 and 701, based upon our shares
are eligibleoutstanding as of March 31, 2004, additional shares will be available for sale in the public market, subject to certain volume and other restrictions, as follows:ELIGIBILITY OF RESTRICTED SHARES FOR SALE IN THE PUBLIC MARKET
NUMBER DATE OF SHARES - ------------------------------------------------------------------------------After the date of this prospectus (subject, in some cases, to volume limitations).................................... At various times after 90 days from the date of this prospectus (subject, in some cases, to volume limitations).............................................. At various times after 180 days from the date of this prospectus (subject, in some cases, to volume limitations)..............................................RULE
- •
- 243,845 restricted shares will be eligible for immediate sale on the effective date of this offering;
- •
- 68,322 restricted shares will be eligible for sale 90 days after the date of this prospectus; and
- •
- 12,186,479 restricted shares will be eligible for sale upon expiration of the lock-up agreements, which will occur 180 days after the date of this prospectus.
Lock-up Agreements
All of our directors and officers and substantially all of our stockholders and optionholders have signed lock-up agreements with respect to shares of our common stock or any securities convertible into or exercisable or exchangeable for shares of our common stock for 180 days after the date of this prospectus. See "Underwriting" for more description of the lock-up agreements.
Rule 144
In general, under Rule 144
of the Securities Act of 1933as currently in effect, beginning 90 days after the date of thisoffering,prospectus, a person who has beneficially owned shares of our common stock for at least one year, including the holding period of certain prior owners other than affiliates, is entitled to sell within anythree monththree-month period a number of shares that does not exceed the greater of 1% of the number of shares of our common stockthat does not exceedthen outstanding, which will equal approximately 179,986 shares immediately after thegreater of: - - 1% of the number of shares of common stock then outstanding;offering, or- -the average weekly trading volumeinof our common stock on the Nasdaq National Market during the four calendar weeks preceding thedatefiling of a notice onwhich notice of such sale is filedForm 144 withthe Securities and Exchange Commission.respect to that sale. Salesmadeunder Rule 144mustare alsocomply with manner of sale andsubject to certain manner-of-sale provisions, notice requirements andare subject tothe availability of current public information about us.RULE 144(K)Additionally, substantially all Rule 144 shares are subject to the 180-day lock-up arrangement described above.Rule 144(k)
Under Rule 144(k)
of the Securities Act of 1933 as currently in effect,, a person who is not deemed to have been one of ouraffiliateaffiliates at any time during the90 daysthree months preceding a sale and who has beneficially- -------------------------------------------------------------------------------- 78SHARES ELIGIBLE FOR FUTURE SALE - --------------------------------------------------------------------------------ownedthesharesproposed to be soldfor at least two years,would beincluding the holding period of certain prior owners other than affiliates, is entitled to sellsuchthose sharesunder Rule 144(k)withoutregard tocomplying with the volume limitations,or the manner of sale,manner-of-sale provisions, noticeorrequirements and public informationrequirementsprovisions of Rule 144.RULETherefore, unless restricted under the 180-day lock-up arrangement or otherwise, Rule 144(k) shares may be sold immediately upon the closing of this offering.Rule 701
UnderIn general, under Rule 701 of the Securities Act
of 1933as currently in effect,anyeach of our directors, officers, employees, consultantsdirectorsor advisors whohavepurchased shares from usunderbefore the date of this prospectus in connection with a compensatory stockoptionplan or other written compensatory agreementcanis eligible to resellthosesuch shares 90 days after the effective date of this offering in reliance on Rule 144, but withoutcomplyingcompliance withsome of itscertain restrictions, including the holdingperiod.period, contained in Rule 144. However, substantially all Rule 701 shares are subject to the 180-day lock-up arrangement described above.Registration Rights
As described above in "Description of Capital Stock—Registration Rights," upon completion of this offering, the holders of 12,498,878 shares of our common stock, including shares issued upon conversion of our preferred stock and shares issued upon the exercise of certain of our warrants, will be entitled to rights with respect to the registration of their shares under the Securities Act, subject to the 180 day lock-up arrangement described above. Registration of these shares under the Securities Act would result in the shares becoming freely tradable without restriction under the Securities Act, except for shares purchased by affiliates. Any sales of securities by these stockholders could have a material adverse effect on the trading price of our common stock.
Employee Benefit Plans
We intend to file with the Securities and Exchange Commission a registration statement on Form S-8 under the Securities Act covering the shares of common stock reserved for issuance under our 1991 Stock Option Program, 1997 Stock Option/Stock Issuance Plan, 1998 Stock Option/Stock Issuance Plan, 2004 Stock Incentive Plan and 2004 Non-Employee Director Stock Option Program. The registration statement is expected to be filed and become effective as soon as practicable after the completion of this offering. Accordingly, shares registered under the registration statement will be available for sale in the open market, subject to Rule 144 volume limitations applicable to affiliates, and subject to any vesting restrictions and lock-up agreements applicable to these shares.
Under the terms and subject to the conditions contained in a purchase agreement dated the date of this prospectus, the underwriters named below, for whom Merrill Lynch, Pierce, Fenner & Smith Incorporated, J.P. Morgan Securities Inc., Banc of America Securities LLC and William Blair & Company, L.L.C. are acting as representatives, have severally agreed to purchase, and we have agreed to sell to them, severally, the number of shares indicated below:
Underwriters Number
of SharesMerrill Lynch, Pierce, Fenner & Smith
IncorporatedJ.P. Morgan Securities Inc. Banc of America Securities LLC William Blair & Company, L.L.C. Total 5,500,000 The underwriters are offering the shares of common stock subject to their acceptance of the shares from us and subject to prior sale. The purchase agreement provides that the obligations of the several underwriters to pay for and accept delivery of the shares of common stock offered by this prospectus are subject to the approval of specified legal matters by their counsel and to other conditions. The underwriters are obligated to take and pay for all of the shares of common stock offered by this prospectus if any such shares
may still remain subject, however,are taken. However, the underwriters are not required tocontractual restrictions contained in lock-up agreements,take or pay for the shares covered by the underwriters' over-allotment option described below.LOCK-UP AGREEMENTS A majorityThe underwriters initially propose to offer part of
our stockholders,the shares of common stock directly to the public at the public offering price listed on the cover page of this prospectus and part to certain dealers at a price that represents a concession not in excess of $ per share under the public offering price. Any underwriter may allow, and such dealers may reallow, a concession not in excess of $ per share to other underwriters or to certain dealers. After the initial offering of the shares of common stock, the offering price and other selling terms may from time to time be varied by the representatives.We have granted to the underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase up to an aggregate of 825,000 additional shares of common stock at the public offering price listed on the cover page of this prospectus, less underwriting discounts and commissions. The underwriters may exercise this option solely for the purpose of covering over-allotments, if any, made in connection with the offering of the shares of common stock offered by this prospectus. To the extent the option is exercised, each underwriter will become obligated, subject to certain conditions, to purchase about the same percentage of the additional shares of common stock as
wellthe number listed next to the underwriter's name in the preceding table bears to the total number of shares of common stock listed next to the names of all underwriters in the preceding table. If the underwriters' option is exercised in full, the total price to the public would be $ , the total underwriters' discounts and commissions would be $ and the total proceeds to us would be $ .On behalf of the underwriting syndicate, Merrill Lynch, Pierce, Fenner & Smith Incorporated and J.P. Morgan Securities Inc. will be responsible for recording a list of potential investors that have expressed an interest in purchasing shares of common stock as part of this offering.
The underwriters have informed us that they do not intend sales to discretionary accounts to exceed five percent of the total number of shares of common stock offered by them.
We, each of our directors and officers and holders of
options and warrants to purchase sharessubstantially all of ourcommonoutstanding stockhave entered into lock-up agreements pursuant to which theyhave agreed that, without the prior written consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated andJ.P. Morgan Securities Inc., we and they will not, during the period ending 180 days after the date of this prospectus:
- •
- offer, pledge, sell, contract to sell,
pledgesell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, lend or otherwise transfer or dispose of directly or indirectly, any shares ofourcommon stock or any securities convertible into or exercisable or exchangeable forourcommon stock; or- •
- enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the common stock,
withoutwhether any transaction described above is to be settled by delivery of common stock or such other securities, in cash or otherwise. These restrictions do not apply to:
- •
- the
prior written consentsale ofUBS Warburg forshares to the underwriters in connection with this offering;- •
- the issuance by us of shares of common stock upon the exercise of an option or a
periodwarrant or the conversion of180 days from the date of this offering. STOCK PLANS Following 90 days aftera security outstanding on the date of this prospectus that is described in this prospectus;- •
- transfers by any person other than us of shares
issued uponor other securities acquired in open market transactions after theexercisecompletion ofoptionsthe offering, provided thatwe granted prior tono filing by thedate of this offering will also be eligible for sale in the public markettransferor under Rule701144 of the Securities Act or Section 16 of1933, as described above. Asthe Securities and Exchange Act is required or will be voluntarily made in connection with such transfer;- •
- the issuance by us of
August 23, 2001,shares or options to purchasea total of 5,952,426shares of common stockwere outstanding. Each option grant is subjectpursuant toa market stand-off provision, which allows usour existing employee benefits plans described in this prospectus;- •
- transfers to
restrict the sale of shares obtained through the exercise of options for up to 180 days from the date of this offering. Of these shares, shares may be eligible for sale in the public market beginning 180 days from the date of this prospectus. We also intend to file a registration statement to register for resale an additional shares of common stock for issuance under our stock option plans. This registration statement will become effective immediately upon filing. Shares of common stock registered under this registration statement will be available for sale in the public market from time to time subject to vesting and the expirationlimited partners or stockholders of themarket stand-off provisions referred to above. - -------------------------------------------------------------------------------- 79- -------------------------------------------------------------------------------- Material United States federal tax consequences to non-United States holders of common stock The following is a general discussion oftransferor, provided that thematerial United States federal income and estate tax considerations with respect to the ownership and disposition of our common stock applicable to non-U.S. holders. In general, a "Non-U.S. Holder" is any holder of our common stock other than: - - a citizen or individual resident of the United States, - - a corporation or other entity created or organized in the United States or under the laws of the United States or of any state or political subdivision of the United States, - - an estate, the income of which is included in gross income for United States federal income tax purposes regardless of its source, or - - a trust whose administration is subject to the primary supervision of a United States court and which has one or more United States persons who have the authority to control all substantial decisions of the trust. This discussion is based on current provisions of the Internal Revenue Code, Treasury Regulations promulgated under the Internal Revenue Code, judicial opinions, published positions of the Internal Revenue Service, and all other applicable authorities, all of which are subject to change, possibly with retroactive effect. This discussiontransfer does notaddress all aspects of United States federal income and estate taxationinvolve a disposition for value; or- •
- transfers by any
aspects of state, local,person other than us by gift, will ornon-U.S. taxation, nor does it consider any specific factsintestacy, orcircumstancesto immediate family members;provided further that
may apply to particular Non-U.S. Holders that may be subject to special treatment under the United States federal income tax laws, such as insurance companies, tax-exempt organizations, financial institutions, brokers, dealers in securities, and United States expatriates. PROSPECTIVE INVESTORS ARE URGED TO CONSULT THEIR TAX ADVISORS REGARDING THE UNITED STATES FEDERAL, STATE, LOCAL AND NON-U.S. INCOME AND OTHER TAX CONSIDERATIONS OF ACQUIRING, HOLDING AND DISPOSING OF SHARES OF COMMON STOCK. DIVIDENDS--In general, dividends paid to a Non-U.S. Holder will be subject to United States withholding tax at a 30% rate of the gross amount, or a lower rate prescribed by an applicable income tax treaty, unless the dividends are effectively connected with a trade or business carried on by the Non-U.S. Holder within the United States. Dividends that are effectively connected with such a United States trade or business generally will not be subject to United States withholding tax if the Non-U.S. Holder files the required forms, including IRS Form W-8ECI, or any successor form, with the payor of the dividend, and generally will be subject to United States federal income tax on a net income basis, in the same manner as if the Non-U.S. Holder were a resident of the United States. A corporate Non-U.S. Holder that receives effectively connected dividends may be subject to an additional branch profits tax at a rate of 30%, or at a lower rate as may be specified by an applicable income tax treaty, on the repatriation from the United States of its "effectively connected earnings and profits," subject to adjustments. Under Treasury Regulations generally effective for payments made after December 31, 2000, referred to in this prospectus as the "Final Regulations," a Non-U.S. Holder will be required to satisfy certification requirements, directly or through an intermediary, in order to claim a reduced rate of withholding under an applicable income tax treaty. A Non-U.S. Holder generally certifies entitlement to benefits under a treaty by providing an IRS Form W-8BEN. In addition, under the Final Regulations,in the case ofdividends paid to a foreign partnership, the certification requirement would - -------------------------------------------------------------------------------- 80MATERIAL UNITED STATES FEDERAL TAX CONSEQUENCES TO NON-UNITED STATES HOLDERS OF COMMON STOCK - -------------------------------------------------------------------------------- generally be applied to the partnerseach of thepartnership, unlesslast three transactions described above, thepartnershiprecipient of the shares agrees tobecome a "withholding foreign partnership," and the partnership would be required to provide various information, including a United States taxpayer identification number. The Final Regulations also provide "look-through" rules for tiered partnerships. A Non-U.S. Holder of our common stock that is eligible for a reduced rate of United States federal income tax withholding under a tax treaty may obtain a refund of any excess amounts withheld by filing an appropriate claim for refund with the IRS. GAIN ON SALE OR OTHER DISPOSITION OF COMMON STOCK--In general, a Non-U.S. Holder will notbe subject toUnited States federal income tax on any gain realized uponthesale or other taxable disposition of the holders shares of common stock unless: - - the gain is effectively connected with a trade or business carried on by the Non-U.S. Holder within the United States,restrictions described inwhich case the branch profits tax discussed above may also apply if the Non-U.S. Holder is a corporation, - - the Non-U.S. Holder is an individual who holds shares of common stock as a capital asset and is present in the United States for 183 days or more in the taxable year of disposition and various other conditions are met, - - the Non-U.S. Holder is subject to tax under the provisions of the Internal Revenue Code regarding the taxation of United States expatriates, or - - we are or have been a "U.S. real property holding corporation" within the meaning of Section 897(c)(2) of the Internal Revenue Code at any time within the shorter of the five-year period preceding such disposition or such holders holding period. We do not believe that we are, and do not anticipate becoming, a United States real property holding corporation. BACKUP WITHHOLDING AND INFORMATION REPORTING--Generally, we must report annually to the IRS the amount of dividends paid, the name and address of the recipient, and the amount, if any, of tax withheld. A similar report is sent to the recipient. These information reporting requirements apply even if withholding was not required because the dividends were effectively connected dividends or withholding was reduced by an applicable income tax treaty. Under tax treaties or other agreements, the IRS may make its reports available to tax authorities in the recipients country of residence. Payments made to a Non-U.S. Holder that is not an exempt recipient generally will be subject to backup withholding at a rate of 31%, rather than withholding at a 30% rate or lower treaty rate discussed above, unless a Non-U.S. Holder certifies as to its foreign status, which certification may be made on IRS Form W-8 BEN. Proceeds from the disposition of common stock by a Non-U.S. Holder effected by or through a United States office of a broker will be subject to information reporting and to backup withholding at a rate of 31% of the gross proceeds unless the Non-U.S. Holder certifies to the payor under penalties of perjury as to, among other things, its address and status as a Non-U.S. Holder or otherwise establishes an exemption. Generally, United States information reporting and backup withholding will not apply to a payment of disposition proceeds if the transaction is effected outside the United States by or through a non-United States office of a broker. However, if the broker is, for United States federal income tax purposes, a United States person, a controlled foreign corporation, a foreign person who derives 50% or more of its gross income for specified periods from the conduct of a United States trade or business, specified United States branches of foreign banks or insurance companies, or, a - -------------------------------------------------------------------------------- 81MATERIAL UNITED STATES FEDERAL TAX CONSEQUENCES TO NON-UNITED STATES HOLDERS OF COMMON STOCK - -------------------------------------------------------------------------------- foreign partnership with various connections to the United States, information reporting but not backup withholding will apply unless: - - the broker has documentary evidence in its files that the holder is a Non-U.S. Holder and other conditions are met; or - - the holder otherwise establishes an exemption. Backup withholding is not an additional tax. Rather, the United States federal income tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. If backup withholding results in an overpayment of United States federal income taxes, a refund may be obtained, provided the required documents are filed with the IRS. ESTATE TAX--Our common stock owned or treated as owned by an individual who is not a citizen or resident, as defined for United States federal estate tax purposes, of the United States at the time of death will be included in the individuals gross estate for United States federal estate tax purposes, unless an applicable estate tax treaty provides otherwise. - -------------------------------------------------------------------------------- 82- -------------------------------------------------------------------------------- Underwriting We and the underwriters for the offering named below have entered into an underwriting agreement concerning the shares being offered. Subject to conditions, each underwriter has severally agreed to purchase the number of shares indicated in thethis paragraph.The following
table. UBS Warburg LLC and First Union Securities, Inc. are the representatives of the underwriters.
NUMBER OF UNDERWRITER SHARES - -------------------------------------------------------------------------UBS Warburg LLC............................................. First Union Securities, Inc................................. --------- Total....................................................... =========If the underwriters sell more shares than the total number set forth in thetableabove, the underwriters have a 30-day option to buy from us up to an additional shares at the initial public offering price lessshows the underwriting discounts and commissionsto cover these sales. If any sharesthat we arepurchased under this option, the underwriters will severally purchase shares in approximately the same proportion as set forth in the table above. The following table shows the per share and total underwriting discounts and commissions we willto pay to theunderwriters.underwriters in connection with this offering. These amounts are shown assuming both no exercise and full exercise of the underwriters' option to purchaseup to anadditionalshares.shares of our common stock.
NO EXERCISE FULL EXERCISE - --------------------------------------------------------------------------------------Paid by Us No Exercise Full Exercise Per share................................................share$ $ Total....................................................Total $ $ WeIn addition, we estimate that the
totaloffering expensesof the offeringpayable by us,excludingin addition to the underwriting discounts andcommissions,commission, will be approximately $ .Shares sold byIn order to facilitate the offering of the common stock, the underwriters
tomay engage in transactions that stabilize, maintain or otherwise affect thepublic will initially be offered atprice of theinitial public offering price set forth on the cover of this prospectus. Any shares sold bycommon stock. Specifically, the underwriters may sell more shares than they are obligated tosecurities dealers may be sold at a discount of up to $ per share from the initial public offering price. Any of these securities dealers may resell any shares purchased from the underwriters to other brokers or dealers at a discount of up to $ per share from the initial public offering price. If all the shares are not sold at the initial public offering price, the representatives may change the offering price and the selling terms. The underwriters have informed us that they do not expect discretionary sales to exceed % of the shares of common stock to be offered. Our company and each of, our directors, officers, stockholders and optionholders have agreed with the underwriters not to offer, sell, contract to sell, hedge or otherwise dispose of, directly or indirectly, or file with the SEC a registration statementpurchase under theSecurities Act of 1933 relating to, any shares of our common stock or securities convertible into or exchangeable for shares of common stock duringpurchase agreement, creating a short position. A short sale is covered if theperiod fromshort position is no greater than thedate of this prospectus continuing through the date 180 days after the date of this prospectus, without the prior written consent of UBS Warburg LLC. The underwriters have reserved for sale, at the initial public offering price, shares of our common stock being offered for sale to our customers and business partners. At the discretion of our management, other parties, including our employees, may participate in the reserved shares - -------------------------------------------------------------------------------- 83- -------------------------------------------------------------------------------- program. Thenumber of shares available forsale to the general public in the offering will be reduced to the extent these personspurchasereserved shares. Any reserved shares not so purchased will be offeredby the underwriterstounder thegeneral public on the same terms as the other shares. Prior to this offering, there has been no public market for our common stock.over-allotment option. Theinitial public offering price was negotiated by us and the representatives. The principal factors to be considered in determining the initial public offering price included: - - the information set forth in this prospectus and otherwise available to the representatives; - - the history and the prospects for the industry in which we compete; - - the ability of our management; - - our prospects for future earnings, the present state of our development and our current financial position; - - the general condition of the securities markets at the time of this offering; and - - recent market prices of, and demand for, publicly traded common stock of comparable companies. In connection with the offering, theunderwritersmay purchase and sell shares of our common stock in the open market. These transactions may includecan close out a covered shortsales, stabilizing transactions and purchases to cover positions created by short sales. Short sales involve thesale by exercising theunderwriters of a greater number of shares than they are required to purchase in the offering. "Covered" short sales are sales made in an amount not greater than the underwriters'over-allotment optionto purchase additional shares from us in the offering. The underwriters may close out any covered short position by either exercising their option to purchase additional sharesor purchasing shares in the open market. In determining the source of shares to close outthea covered shortposition,sale, the underwriters will consider, among other things, the open market price of sharesavailable for purchase in the open market ascompared to the priceat which theyavailable under the over-allotment option. The underwriters maypurchasealso sell sharesthrough the overallotment option. "Naked" short sales are any salesin excess of theoverallotment option.over-allotment option, creating a naked short position.The underwriters must close out any naked short position by purchasing shares in the open market. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the common stock in the open market after pricing that could adversely affect investors who purchase in this offering. In addition, to stabilize the
offering. Stabilizingprice of the common stock, the underwriters may bid for, and purchase, shares of common stock in the open market. Finally, the underwriting syndicate may reclaim selling concessions allowed to an underwriter or a dealer for distributing the common stock in this offering, if the syndicate repurchases previously distributed common stock in transactionsconsistto cover syndicate short positions or to stabilize the price ofbidsthe common stock. Any of these activities may stabilize orpurchases made for the purpose of preventing or retarding a decline inmaintain the market price ofourthe common stockwhile the offering is in progress.above independent market levels. The underwritersalsoare not required to engage in these activities, and mayimpose a penalty bid. This occurs when a particular underwriter repays toend any of these activities at any time.Merrill Lynch Ventures, L.P. 2001, which is an affiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated, one of the underwriters,
a portion ofbeneficially owns in theunderwriting discount received by it because the representatives have repurchasedaggregate 1,670,301 shares,sold byorfor the account of that underwriter in stabilizing or short covering transactions. These activities by the underwriters may stabilize, maintain or otherwise affect the market price of our common stock. As a result, the price13.4%, of our common stock, assuming conversion of all of our outstanding convertible preferred stock.Because we may be deemed to have a conflict of interest with Merrill Lynch, Pierce, Fenner & Smith Incorporated, the offering will be conducted in accordance with Conduct Rule 2720 of the National Association of Securities Dealers, Inc. This rule requires that the public offering price of any equity security be no higher than the price
that otherwise might existrecommended by a qualified independent underwriter which has participated in theopen market. If these activities are commenced, they maypreparation of the registration statement and performed its usual standard of due diligence with respect to that registration statement. J.P. Morgan Securities Inc. has agreed to act as qualified independent underwriter for this offering. The price of the shares will bediscontinuedno higher than that recommended bythe underwriters atJ.P. Morgan Securities Inc. J.P. Morgan Securities Inc. will not receive anytime. These transactions may be effectedadditional compensation for acting as qualified independent underwriter for this offering.We have applied for quotation of our common stock on the Nasdaq National Market
inunder theover-the-counter market or otherwise.symbol "DRAD."We and the underwriters have agreed to indemnify
the several underwriterseach other against certain liabilities, including liabilities under the SecuritiesAct of 1933, and to contribute to payments thatAct.At our request, the underwriters have reserved for sale, at the initial public offering price, up to shares offered in this prospectus for sale to some of our directors, officers, employees, business associates and other persons with whom we have a relationship. The number of shares of common stock available for sale to the general public will be reduced to the extent these persons purchase reserved shares. Any reserved shares which are not orally confirmed for purchase within one day of pricing of this offering will be offered by the underwriters to the general public on the same basis as the other shares offered by this prospectus.
Prior to this offering, there has been no public market for our common stock. The initial public offering price will be determined by negotiations between us and the representatives. Among the factors to be considered in determining the initial public offering price will be our future prospects and those of our industry in general, our revenues, earnings and other financial operating information in recent periods, and the price-earnings ratios, price-sales ratios, market prices of securities and financial and operating information of companies engaged in activities similar to ours. The estimated initial public offering price range set forth on the cover page of this preliminary prospectus is subject to change as a result of market conditions and other factors. Any active trading market for the shares may
be required to makenot develop. It is also possible that after the offering the shares will not trade inrespect thereof. - -------------------------------------------------------------------------------- 84- -------------------------------------------------------------------------------- Legal mattersthe market above the initial offering price.The validity of the shares of common stock offered in this prospectus will be passed upon for us by
Brobeck, PhlegerMorrison &HarrisonFoerster LLP, San Diego, California. Certain legal matters in connection with the offering will be passed upon for the underwriters byAlstonLatham &BirdWatkins LLP,New York, New York. Experts TheSan Diego, California.Ernst & Young LLP, independent auditors, have audited our consolidated financial statements
as ofat December 31,19992002 and2000,2003, and for each of the three years in the period ended December 31,2000,2003, as set forth in their report. We have included our financial statements and schedule inthisthe prospectus and elsewhere in the registration statementhave been audited byin reliance on Ernst & YoungLLP, independent auditors, as stated in their report appearing in this prospectus and registration statement, and are included in reliance upon the report of that firmLLP's reports, givenuponon their authority as experts in accounting and auditing.Where you can find more information
WHERE YOU CAN FIND MORE INFORMATIONWe have filed with the
SECSecurities and Exchange Commission a registration statement on Form S-1(including the exhibits, schedules and amendments to the registration statement)under the Securities Actof 1933with respect to the shares of common stockto be sold inbeing offered by thisoffering.prospectus. This prospectus does not contain all of the informationset forthin the registrationstatement.statement and its exhibits. For further informationwith respect to our companyabout us and theshares ofcommon stockto be sold inoffered by thisoffering, reference is madeprospectus, we refer you to the registrationstatement.statement and its exhibits. Statements contained in this prospectus as to the contents of any contractagreementor any other document referred to are not necessarily complete, and in each instance,reference is madewe refer you to the copy ofsuchthe contractagreementor other document filed as an exhibit to the registrationstatement, each such statement beingstatement. Each of these statements is qualified in all respects bysuchthis reference.Our SECYou can read our Securities and Exchange Commission filings, including the registration statement
are also available to you onof which this prospectus is a part, over the Internet at the Securities and Exchange Commission's website(http://www.sec.gov)atwww.sec.gov. You may also read and copyall oranyportion of the registration statement or any other informationdocument we file with the Securities and Exchange Commission atthe SEC'sits public referenceroomfacilities at 450 Fifth Street, N.W., Washington, D.C. 20549. Youcan requestmay also obtain copies ofthese documents, upon payment of a duplicating fee,the document at prescribed rates by writing to theSEC.Public Reference Section of the Securities and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call theSECSecurities and Exchange Commission at 1-800-SEC-0330 for further information on the operation of the public referencerooms. As a resultfacilities.Upon completion of this offering, we will
becomebe subject to the informationandreporting requirements of theSecuritiesExchange Actof 1934,andin accordance with those requirements,we will fileperiodicreports, proxy statements and other information with theSEC.Securities and Exchange Commission. We also intend to furnish our stockholders with annual reports containing our financial statements audited by an independent public accounting firm and quarterly reports containing our unaudited financial information. We maintain a website atwww.digirad.com. Uponapprovalcompletion of this offering, you may access our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of thecommon stock for quotation onExchange Act with theNasdaq National Market,Securities and Exchange Commission free of charge at our website as soon as reasonably practicable after suchreports, proxymaterial is electronically filed with, or furnished to, the Securities and Exchange Commission. The reference to our web address does not constitute incorporation by reference of the informationstatements and other information may also be inspectedcontained atthe offices of Nasdaq Operations, 1735 K Street, N.W., Washington, D.C. 20006. - -------------------------------------------------------------------------------- 85- --------------------------------------------------------------------------------this site.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE - ----------------------------------------------------------------------Report of Ernst & Young LLP, Independent Auditors...........AuditorsF-2
Consolidated Financial StatementsConsolidated Balance Sheets as of December 31, 19992002 and20002003 andJune 30, 2001March 31, 2004 (unaudited).............................F-3 Consolidated Statements of Operations for the years ended December 31, 1998, 19992001, 2002 and20002003 and thesixthree months endedJune 30, 2000March 31, 2003 and20012004 (unaudited)........................F-4 Consolidated Statements of Changes in Stockholders' Equity (Deficit) for the years ended December 31, 1998, 19992001, 2002 and20002003 and thesixthree months endedJune 30, 2001March 31, 2004 (unaudited)............F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 19992001, 2002 and20002003 and thesixthree months endedJune 30, 2000March 31, 2003 and20012004 (unaudited)........................F-6 Notes to Consolidated Financial Statements..................StatementsF-7 - -------------------------------------------------------------------------------- F-1- -------------------------------------------------------------------------------- REPORT OF ERNST
Report of Ernst &YOUNGYoung LLP,INDEPENDENT AUDITORSIndependent AuditorsThe Board of Directors and Stockholders
Digirad CorporationWe have audited the accompanying consolidated balance sheets of Digirad Corporation as of December 31,
19992002 and2000,2003, and the related statements of operations, changes in stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 31,2000.2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.We conducted our audits in accordance with auditing standards generally accepted in the 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 consolidated financial position of Digirad Corporation at December 31,
19992002 and2000,2003, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31,2000,2003, in conformity with accounting principles generally accepted in the United States./s/
/s/ ERNST & YOUNG LLP San Diego, California
June 5, 2001,
March 12, 2004
except forthe first paragraph ofNote4 and Note 11,9 "Changes in Capitalization,"
as to which the date isAugust 23, 2001. - -------------------------------------------------------------------------------- F-2DIGIRAD CORPORATION - -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETSApril 30, 2004
PRO FORMA DECEMBER 31, STOCKHOLDERS' --------------------------- EQUITY 1999 2000 JUNE 30, 2001 JUNE 30, 2001 (unaudited) (unaudited) - --------------------------------------------------------------------------------------------------------ASSETS Current assets: Cash and cash equivalents............. $ 2,625,713 $ 6,555,281 $ 3,510,477 Accounts receivable, net.............. -- 3,054,021 4,987,020 Inventories, net...................... 288,788 3,875,961 7,765,410 Other current assets.................. 221,162 590,644 989,732 ------------ ------------ ------------ Total current assets.................... 3,135,663 14,075,907 17,252,639 Property and equipment, net............. 2,151,484 6,307,967 7,910,174 Intangibles, net........................ 412,157 2,823,535 2,557,619 Other assets............................ -- -- 836,880 ------------ ------------ ------------ Total assets............................ $ 5,699,304 $ 23,207,409 $ 28,557,312 ============ ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable...................... $ 1,290,581 $ 2,622,778 $ 3,557,442 Accrued compensation.................. 500,859 1,078,517 1,451,275 Accrued warranty...................... 22,523 1,034,000 832,759 Other accrued liabilities............. 106,245 925,138 1,292,969 Current portion of debt............... 414,672 2,934,580 5,613,945 ------------ ------------ ------------ Total current liabilities............... 2,334,880 8,595,013 12,748,390 Long-term debt, net of current portion............................... 1,420,758 4,944,422 5,075,883 Notes payable to stockholders........... 735,000 735,000 735,000 Commitments and contingencies Redeemable convertible preferred stock-- $.001 par value; 18,690,839, 27,129,568 and 27,582,646 shares authorized at December 31, 1999, 2000 and June 30, 2001 (unaudited), respectively; 18,493,211, 25,190,857 and 27,129,568 shares issued and outstanding at December 31, 1999, 2000 and June 30, 2001, respectively; liquidation value--$52,593,153 and $58,479,080 at December 31, 2000 and June 30, 2001 (unaudited), respectively. None outstanding pro forma (unaudited)..................... 32,259,100 52,254,742 58,109,136 $ -- Stockholders' equity (deficit): Common stock--$.001 par value; 27,000,000, 36,438,729 and 38,091,807 shares authorized at December 31, 1999, 2000 and June 30, 2001 (unaudited), respectively; 3,401,034, 4,364,040 and 4,574,603 shares issued and outstanding at December 31, 1999, 2000 and June 30, 2001 (unaudited), respectively, 31,704,170 shares outstanding pro forma (unaudited)... 3,401 4,364 4,575 31,704 Additional paid-in capital............ 523,055 2,393,036 4,707,535 62,789,542 Deferred compensation................. -- (536,820) (1,712,989) (1,712,989) Notes receivable from stockholders.... (4,180) (85,919) (111,919) (111,919) Accumulated deficit................... (31,572,710) (45,096,429) (50,998,299) (50,998,299) ------------ ------------ ------------ ------------ Total stockholders' equity (deficit).... (31,050,434) (43,321,768) (48,111,097) $ 9,998,039 ------------ ------------ ------------ ============ Total liabilities and stockholders' equity (deficit)...................... $ 5,699,304 $ 23,207,409 $ 28,557,312 ============ ============ ============
Digirad Corporation
Consolidated Balance Sheets
Pro forma
redeemable
convertible
preferred stock and
stockholders' equity at
March 31, 2004December 31, March 31,
20042002 2003 (unaudited) (unaudited) Assets Current assets: Cash and cash equivalents $ 6,987,666 $ 7,681,407 $ 8,901,690 Accounts receivable, net 7,868,234 12,195,031 12,647,441 Inventories, net 5,752,123 3,709,321 3,746,618 Other current assets 502,805 854,170 677,211 Total current assets 21,110,828 24,439,929 25,972,960
Property and equipment, net
11,113,884
10,087,030
10,579,988
Intangibles, net 894,528 511,832 518,345 Other assets — — 820,609 Restricted cash — 120,000 120,000 Total assets $ 33,119,240 $ 35,158,791 $ 38,011,902 Liabilities and stockholders' equity (deficit) Current liabilities: Accounts payable $ 2,150,724 $ 3,036,209 $ 4,550,211 Accrued compensation 1,721,107 1,893,336 2,413,444 Accrued warranty 857,830 1,051,242 1,176,537 Other accrued liabilities 3,102,109 2,647,741 3,762,414 Deferred revenue 1,331,462 1,514,488 1,610,563 Current portion of notes payable to stockholders — 245,000 245,000 Current portion of debt 8,166,421 11,473,619 11,386,143 Total current liabilities 17,329,653 21,861,635 25,144,312 Notes payable to stockholders, net of current portion 735,000 490,000 490,000 Long-term debt, net of current portion 5,030,327 4,232,071 3,720,021
Commitments and contingencies
Redeemable convertible preferred stock, $0.000001 par value: 46,023,000 shares authorized at December 31, 2002, 2003 and March 31, 2004 (unaudited); 43,555,313 shares issued and outstanding at December 31, 2002, 2003 and March 31, 2004 (unaudited), none pro forma; liquidation value—$119,512,154 at December 31, 2002, 2003 and March 31, 2004 (unaudited), none pro forma (unaudited) 83,952,228 84,277,992 84,366,530 $ —
Stockholders' equity (deficit):
Common stock, $0.001 par value: 213,692, 53,000,000 and 53,000,000 shares authorized at December 31, 2002, 2003 and March 31, 2004 (unaudited), respectively; 13,535, 23,540 and 54,352 shares issued and outstanding at December 31, 2002, 2003 and March 31, 2004 (unaudited), respectively, 12,498,646 outstanding pro forma (unaudited) 14 24 54 12,499 Additional paid-in capital 4,246,375 5,031,869 6,315,266 90,669,351 Deferred compensation — (554,375 ) (1,489,767 ) (1,489,767 ) Accumulated deficit (78,174,357 ) (80,180,425 ) (80,534,514 ) (80,534,514 ) Total stockholders' equity (deficit) (73,927,968 ) (75,702,907 ) (75,708,961 ) $ 8,657,569 Total liabilities and stockholders' equity (deficit) $ 33,119,240 $ 35,158,791 $ 38,011,902 See accompanying notes.
- -------------------------------------------------------------------------------- F-3DIGIRAD CORPORATION - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS
SIX MONTHS ENDED YEARS ENDED DECEMBER 31, JUNE 30, ----------------------------------------- ------------------------- 1998 1999 2000 2000 2001 (unaudited) (unaudited) - --------------------------------------------------------------------------------------------------------REVENUES: Products....................... $ 339,802 $ 283,889 $ 5,815,474 $1,456,480 $ 9,802,365 Imaging services............... -- -- 1,259,948 -- 4,216,575 Licensing and other............ 1,581,167 -- -- -- -- ----------- ------------ ------------ ----------- ----------- Total revenues................... 1,920,969 283,889 7,075,422 1,456,480 14,018,940 COST OF REVENUES: Products....................... 388,172 264,545 9,834,351 3,601,803 6,437,769 Imaging services............... -- -- 839,296 -- 3,394,363 ----------- ------------ ------------ ----------- ----------- Total cost of revenues........... 388,172 264,545 10,673,647 3,601,803 9,832,132 ----------- ------------ ------------ ----------- ----------- Gross profit (loss).............. 1,532,797 19,344 (3,598,225) (2,145,323) 4,186,808 OPERATING EXPENSES: Research and development....... 5,425,678 10,062,957 2,372,412 1,082,770 1,327,317 Sales and marketing............ 622,881 1,455,292 3,585,433 1,291,098 4,027,934 General and administrative..... 2,533,452 1,967,050 2,878,199 1,071,668 2,898,832 Amortization of intangible assets....................... -- -- 208,624 3,347 314,532 Stock-based compensation....... -- -- 296,187 -- 1,063,043 ----------- ------------ ------------ ----------- ----------- Total operating expenses......... 8,582,011 13,485,299 9,340,855 3,448,883 9,631,658 ----------- ------------ ------------ ----------- ----------- Loss from operations............. (7,049,214) (13,465,955) (12,939,080) (5,594,206) (5,444,850) Interest income.................. 903,294 360,476 242,831 123,736 144,732 Interest expense................. (46,041) (86,942) (780,123) (220,704) (545,391) ----------- ------------ ------------ ----------- ----------- Net loss......................... (6,191,961) (13,192,421) (13,476,372) (5,691,174) (5,845,509) Accretion of deferred issuance costs on preferred stock....... -- -- (47,347) -- (56,361) ----------- ------------ ------------ ----------- ----------- Net loss applicable to common stockholders................... $(6,191,961) $(13,192,421) $(13,523,719) $(5,691,174) $(5,901,870) =========== ============ ============ =========== =========== Basic and diluted net loss per share.......................... $ (1.87) $ (3.90) $ (3.61) $ (1.65) $ (1.35) =========== ============ ============ =========== =========== Shares used to compute basic and diluted net loss per share..... 3,305,804 3,380,530 3,745,049 3,454,822 4,366,429 =========== ============ ============ =========== =========== - ---------- The composition of stock-based compensation is as follows: Cost of revenues............... $ 64,392 $ 196,809 Research and development....... 5,954 61,116 Sales and marketing............ 36,950 421,264 General and administrative..... 188,891 383,854 ------------ ----------- $ 296,187 $ 1,063,043 ============ ===========
Digirad Corporation
Consolidated Statements of Operations
Years ended December 31, Three months ended
March 31,2001 2002 2003 2003 2004 (unaudited) Revenues: DIS $ 10,239,256 $ 23,005,004 $ 34,848,641 $ 7,502,926 $ 10,406,978 Product 18,065,131 18,526,651 21,387,729 5,476,291 5,460,886 Total revenues 28,304,387 41,531,655 56,236,370 12,979,217 15,867,864
Cost of revenues:
DIS 8,344,742 16,599,230 24,463,028 5,641,904 7,264,566 Product 13,192,140 13,632,437 15,091,721 3,840,943 3,639,340 Stock-based compensation 297,933 123,588 113,568 1,317 115,496 Total cost of revenues 21,834,815 30,355,255 39,668,317 9,484,164 11,019,402 Gross profit 6,469,572 11,176,400 16,568,053 3,495,053 4,848,462
Operating expenses:
Research and development 3,008,651 2,967,055 2,190,570 579,274 640,151 Sales and marketing 9,974,027 8,065,497 6,007,858 1,546,531 1,780,405 General and administrative 8,160,558 9,496,794 8,097,349 1,851,327 2,145,470 Amortization and impairment of intangible assets 991,229 1,011,371 443,784 119,249 16,076 Stock-based compensation 1,280,733 482,581 112,659 708 187,292 Total operating expenses 23,415,198 22,023,298 16,852,220 4,097,089 4,769,394 Income (loss) from operations (16,945,626 ) (10,846,898 ) (284,167 ) (602,036 ) 79,068
Other income (expense):
Interest income 118,174 65,078 35,412 10,943 7,907 Interest expense (1,438,787 ) (1,989,907 ) (1,431,549 ) (335,731 ) (322,584 ) Other expense (1,644,542 ) — — — (29,942 ) Total other income (expense) (2,965,155 ) (1,924,829 ) (1,396,137 ) (324,788 ) (344,619 ) Net loss (19,910,781 ) (12,771,727 ) (1,680,304 ) (926,824 ) (265,551 ) Accretion of deferred issuance costs on preferred stock (130,274 ) (265,146 ) (325,764 ) (85,350 ) (88,538 ) Net loss applicable to common stockholders $ (20,041,055 ) $ (13,036,873 ) $ (2,006,068 ) $ (1,012,174 ) $ (354,089 ) Basic and diluted net loss per share $ (3,146.16 ) $ (1,432.31 ) $ (127.62 ) $ (74.63 ) $ (10.88 ) Shares used in computing basic and diluted net loss per share 6,370 9,102 15,719 13,563 32,558 Pro forma basic and diluted net loss per share $ (0.13 ) $ (0.02 ) Pro forma shares used to compute basic and diluted net loss per share 12,460,013 12,476,852 The composition of stock-based compensation is as follows: Cost of product revenue $ 200,365 $ 72,000 $ 82,529 $ 35 $ 55,066 Cost of DIS revenue 97,568 51,588 31,039 1,282 60,430 Research and development 96,335 60,622 8,200 153 27,499 Sales and marketing 540,402 228,057 18,211 317 44,699 General and administrative 643,996 193,902 86,248 238 115,094 $ 1,578,666 $ 606,169 $ 226,227 $ 2,025 $ 302,788 See accompanying notes.
- -------------------------------------------------------------------------------- F-4DIGIRAD CORPORATION - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) YEARS ENDED DECEMBER 31, 1998, 1999 AND 2000 AND THE SIX MONTHS ENDED JUNE 30, 2001(UNAUDITED)
NOTES COMMON STOCK ADDITIONAL RECEIVABLE TOTAL -------------------- PAID-IN DEFERRED FROM ACCUMULATED STOCKHOLDERS' SHARES AMOUNT CAPITAL COMPENSATION STOCKHOLDERS DEFICIT EQUITY (DEFICIT) - ----------------------------------------------------------------------------------------------------------------------------Balance at December 31, 1997............... 3,284,423 $3,284 $ 351,509 $ -- $ -- $(12,188,328) $(11,833,535) Exercise of common stock options.... 80,886 81 35,058 -- -- -- 35,139 Net loss........... -- -- -- -- -- (6,191,961) (6,191,961) --------- ------ ---------- ----------- --------- ------------ ------------ Balance at December 31, 1998............... 3,365,309 3,365 386,567 -- -- (18,380,289) (17,990,357) Exercise of common stock options.... 35,725 36 10,324 -- (4,180) -- 6,180 Issuance of warrants in conjunction with debt............. -- -- 126,164 -- -- -- 126,164 Net loss........... -- -- -- -- -- (13,192,421) (13,192,421) --------- ------ ---------- ----------- --------- ------------ ------------ Balance at December 31, 1999............... 3,401,034 3,401 523,055 -- (4,180) (31,572,710) (31,050,434) Repayment of note receivable from stockholder...... -- -- -- -- 4,180 -- 4,180 Exercise common stock options.... 663,006 663 195,168 -- (85,919) -- 109,912 Issuance of common stock in asset acquisitions (Note 2)......... 300,000 300 410,700 -- -- -- 411,000 Commitment to issue common stock (Note 2)......... -- -- 172,000 -- -- -- 172,000 Issuance of warrants in conjunction with debt............. -- -- 259,106 -- -- -- 259,106 Issuance of options and warrants to consultants...... -- -- 32,272 -- -- -- 32,272 Deferred compensation..... -- -- 800,735 (800,735) -- -- -- Amortization of deferred compensation..... -- -- -- 263,915 -- -- 263,915 Net loss........... -- -- -- -- -- (13,476,372) (13,476,372) Accretion of deferred issuance costs on preferred stock............ -- -- -- -- -- (47,347) (47,347) --------- ------ ---------- ----------- --------- ------------ ------------ Balance at December 31, 2000............... 4,364,040 4,364 2,393,036 (536,820) (85,919) (45,096,429) (43,321,768) Exercise of common stock options (unaudited)...... 214,128 214 76,637 -- (26,000) -- 50,851 Repurchase of unvested restricted stock (unaudited)...... (3,565) (3) (1,350) -- -- -- (1,353) Issuance of options and warrants to consultants (unaudited)...... -- -- 243,029 -- -- -- 243,029 Deferred compensation (unaudited)...... -- -- 1,996,183 (1,996,183) -- -- -- Amortization of deferred compensation (unaudited)...... -- -- -- 820,014 -- -- 820,014 Net loss (unaudited)...... -- -- -- -- -- (5,845,509) (5,845,509) Accretion of deferred issuance costs on preferred stock (unaudited)...... -- -- -- -- -- (56,361) (56,361) --------- ------ ---------- ----------- --------- ------------ ------------ Balance at June 30, 2001(unaudited).... 4,574,603 $4,575 $4,707,535 $(1,712,989) $(111,919) $(50,998,299) $(48,111,097) ========= ====== ========== =========== ========= ============ ============
Digirad Corporation
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
Common stock Notes
receivable
from
stockholdersAdditional
paid-in
capitalDeferred
compensationAccumulated
deficitTotal
stockholders'
equity (deficit)Shares Amount Balance at December 31, 2000 6,235 $ 6 $ 2,239,727 $ (536,820 ) $ (85,919 ) $ (45,096,429 ) $ (43,479,435 ) Repayment of note receivable from stockholder — — — — 14,312 — 14,312 Exercise of common stock options 319 1 97,793 — (5,312 ) — 92,482 Issuance of options, warrants and other equity instruments to non-employees — — 192,652 — — — 192,652 Deferred compensation — — 1,715,521 (1,715,521 ) — — — Amortization of deferred compensation — — — 1,386,014 — — 1,386,014 Net loss — — — — — (19,910,781 ) (19,910,781 ) Accretion of deferred issuance costs on preferred stock — — — — — (130,274 ) (130,274 ) Balance at December 31, 2001 6,554 7 4,245,693 (866,327 ) (76,919 ) (65,137,484 ) (61,835,030 ) Conversion of preferred stock to common stock 6,905 7 48,375 — — — 48,382 Exercise of common stock options 67 — 46,332 — — — 46,332 Issuance of common stock for fractional shares following 1-to- 200 stock split 9 — — — — — — Issuance of warrants to non-employees — — 16,921 — — — 16,921 Issuance of warrants in connection with bridge financing — — 243,052 — — — 243,052 Reversal of deferred compensation resulting from forfeitures — — (353,998 ) 353,998 — — — Amortization of deferred compensation — — — 512,329 — — 512,329 Forfeiture/reserve of notes receivable from shareholders — — — — 76,919 — 76,919 Net loss — — — — — (12,771,727 ) (12,771,727 ) Accretion of deferred issuance costs on preferred stock — — — — — (265,146 ) (265,146 ) Balance at December 31, 2002 13,535 14 4,246,375 — — (78,174,357 ) (73,927,968 ) Exercise of common stock options 10,005 10 4,892 — — — 4,902 Deferred compensation — — 780,602 (780,602 ) — — — Amortization of deferred compensation — — — 226,227 — — 226,227 Net loss — — — — — (1,680,304 ) (1,680,304 ) Accretion of deferred issuance costs on preferred stock — — — — — (325,764 ) (325,764 ) Balance at December 31, 2003 23,540 24 5,031,869 (554,375 ) — (80,180,425 ) (75,702,907 ) Exercise of common stock options (unaudited) 30,812 30 15,067 — — — 15,097 Deferred compensation (unaudited) — — 1,228,130 (1,228,130 ) — — — Amortization of deferred compensation (unaudited) — — — 292,738 — — 292,738 Issuance of warrants to consultants (unaudited) — — 40,200 — — — 40,200 Net loss (unaudited) — — — — — (265,551 ) (265,551 ) Accretion of deferred issuance costs on preferred stock (unaudited) — — — — — (88,538 ) (88,538 ) Balance at March 31, 2004 (unaudited) 54,352 $ 54 $ 6,315,266 $ (1,489,767 ) $ — $ (80,534,514 ) $ (75,708,961 ) See accompanying notes.
- -------------------------------------------------------------------------------- F-5DIGIRAD CORPORATION - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED YEARS ENDED DECEMBER 31, JUNE 30, ------------------------------------------ --------------------------- 1998 1999 2000 2000 2001 (unaudited) (unaudited) - -----------------------------------------------------------------------------------------------------------------------OPERATING ACTIVITIES Net loss................................... $(6,191,961) $(13,192,421) $(13,476,372) $(5,691,174) $(5,845,509) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation and amortization............ 573,030 733,947 939,959 367,794 866,516 Amortization of intangibles.............. -- -- 208,624 3,347 314,530 Amortization of deferred compensation.... -- -- 263,915 -- 820,014 Amortization of debt discount related to warrants issued in conjunction with debt................................... -- 6,942 174,949 20,957 55,482 Stock options and warrants issued to consultants............................ -- -- 32,272 2,640 243,029 Changes in operating assets and liabilities: Accounts receivable.................... (83,977) 113,296 (2,952,106) (1,298,786) (1,932,999) Other assets........................... (106,223) (306,711) (361,853) (202,442) (1,235,968) Inventories............................ -- -- (3,587,173) (3,448,369) (3,889,449) Accounts payable....................... 621,590 300,109 1,373,532 166,684 934,664 Accrued compensation................... (7,833) 169,122 577,657 130,593 372,758 Accrued warranty and other accrued liabilities.......................... (267,700) 89,682 1,789,035 860,592 166,590 ----------- ------------ ------------ ----------- ----------- Net cash used by operating activities........ (5,463,074) (12,086,034) (15,017,561) (9,088,164) (9,130,342) INVESTING ACTIVITIES Asset acquisitions......................... -- -- (2,172,000) -- -- Purchases of property and equipment........ (1,559,695) (916,649) (5,040,938) (894,265) (2,468,723) Patents and other assets................... (103,859) (12,664) (30,050) 2,530 (48,614) ----------- ------------ ------------ ----------- ----------- Net cash used by investing activities........ (1,663,554) (929,313) (7,242,988) (891,735) (2,517,337) FINANCING ACTIVITIES Net issuances of common stock.............. 35,139 6,180 109,912 15,888 49,498 Net borrowings under line of credit........ -- -- 788,348 -- 2,168,675 Proceeds from issuance of notes payable.... -- 2,000,000 4,000,000 1,000,000 -- Repayment of obligation under notes payable.................................. -- (45,349) (812,691) (353,805) (741,646) Net proceeds from sale of preferred stock.................................... 1,500,000 -- 17,948,295 10,637,321 5,798,033 Proceeds from lease financing.............. -- -- 4,239,075 -- 1,596,708 Repayment of obligations under capital leases................................... (21,341) -- (87,002) -- (268,393) Repayment of note receivable from stockholder.............................. -- -- 4,180 -- -- ----------- ------------ ------------ ----------- ----------- Net cash provided by financing activities.... 1,513,798 1,960,831 26,190,117 11,299,404 8,602,875 ----------- ------------ ------------ ----------- ----------- Net increase (decrease) in cash and cash equivalents................................ (5,612,830) (11,054,516) 3,929,568 1,319,505 (3,044,804) Cash and cash equivalents at beginning of period..................................... 19,293,059 13,680,229 2,625,713 2,625,713 6,555,281 ----------- ------------ ------------ ----------- ----------- Cash and cash equivalents at end of period... $13,680,229 $ 2,625,713 $ 6,555,281 $ 3,945,218 $ 3,510,477 =========== ============ ============ =========== =========== SUPPLEMENTAL INFORMATION: Cash paid during the period for interest..... $ 59,283 $ 89,526 $ 480,576 $ 208,222 $ 553,102 =========== ============ ============ =========== =========== Issuance of warrants in conjunction with debt....................................... $ -- $ 126,164 $ 259,106 $ 49,621 $ -- =========== ============ ============ =========== =========== Conversion of bridge notes into Series E preferred stock............................ $ -- $ -- $ 2,000,000 $ -- $ -- =========== ============ ============ =========== =========== Stock issued for asset acquisitions.......... $ -- $ -- $ 411,000 $ -- $ -- =========== ============ ============ =========== ===========
Digirad Corporation
Consolidated Statements of Cash Flows
Years ended December 31, Three months ended
March 31,2001 2002 2003 2003 2004 (unaudited) Operating activities Net loss $ (19,910,781 ) $ (12,771,727 ) $ (1,680,304 ) $ (926,824 ) $ (265,551 ) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation 1,941,637 2,648,410 2,811,204 685,756 719,805 Loss on disposal of assets — — 8,020 — 29,942 Amortization and impairment of intangibles 991,229 966,765 443,784 119,249 16,077 Stock-based compensation 1,386,014 589,248 226,227 2,025 292,738 Amortization of debt discount related to warrants issued in conjunction with debt 110,954 335,477 — — — Options, warrants and other equity instruments issued to non-employees 192,652 16,921 — — 10,050 Changes in operating assets and liabilities: Accounts receivable (1,748,827 ) (3,065,386 ) (4,326,797 ) (661,154 ) (452,410 ) Inventories (4,749,603 ) 2,873,441 2,042,802 844,819 (37,297 ) Other assets (79,243 ) 167,082 (346,384 ) 88,501 (613,500 ) Accounts payable 1,840,790 (2,312,844 ) 885,485 214,151 1,514,002 Accrued compensation 1,026,763 (384,173 ) 172,229 59,469 520,108 Accrued warranty and other accrued liabilities 1,899,894 100,907 (260,956 ) (596,900 ) 1,239,968 Deferred revenue 329,959 1,001,503 183,026 118,430 96,075 Net cash provided by (used in) operating activities (16,768,562 ) (9,834,376 ) 158,336 (52,478 ) 3,070,007
Investing activities
Purchases of property and equipment (7,742,297 ) (1,653,667 ) (1,797,351 ) (323,754 ) (1,242,705 ) Patents and other assets (73,878 ) (112,776 ) (181,088 ) (9,064 ) (22,590 ) Net cash used in investing activities (7,816,175 ) (1,766,443 ) (1,978,439 ) (332,818 ) (1,265,295 )
Financing activities
Net issuances of common stock 92,482 46,332 4,902 — 15,097 Net borrowings under lines of credit 2,731,490 2,697,739 3,139,151 (101,873 ) (174,290 ) Proceeds from issuance of notes payable — 2,154,656 — — — Repayment of obligation under notes payable (1,536,024 ) (2,105,936 ) — — — Net proceeds from sale of preferred stock 14,145,810 15,549,982 — — — Proceeds from capital lease financing 5,363,920 — 1,531,028 — 104,737 Repayment of obligations under capital leases (815,567 ) (1,721,255 ) (2,161,237 ) (491,481 ) (529,973 ) Repayment of notes receivable from stockholders 14,312 — — — — Net cash provided by (used in) financing activities 19,996,423 16,621,518 2,513,844 (593,354 ) (584,429 ) Net increase (decrease) in cash and cash equivalents (4,588,314 ) 5,020,699 693,741 (978,650 ) 1,220,283 Cash and cash equivalents at beginning of period 6,555,281 1,966,967 6,987,666 6,987,666 7,681,407 Cash and cash equivalents at end of period $ 1,966,967 $ 6,987,666 $ 7,681,407 $ 6,009,016 $ 8,901,690 Supplemental information: Cash paid during the period for interest $ 1,485,467 $ 1,503,546 $ 1,326,173 $ 364,663 $ 318,925 Conversion of bridge notes into preferred stock $ — $ 1,575,000 $ — $ — $ — Conversion of preferred stock to common stock $ — $ 48,382 $ — $ — $ — See accompanying notes.
- -------------------------------------------------------------------------------- F-6DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)
Digirad Corporation
Notes to Consolidated Financial Statements(Information as of March 31, 2004 and for the
three months ended March 31, 2003 and 2004 is unaudited)1.
THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES THE COMPANYThe Company and Summary of Significant Accounting Policies
The Company
Digirad Corporation (the "Company"), a Delaware corporation, designs, develops, manufactures, markets, and
marketsservices solid-state digital gamma cameras for use in nuclear medicine and provides,mobile nuclear medicine imaging services. Nuclear medicine imaging provides unique information about organ function and physiology and can be used for the early detection of many forms of cancer and cardiovascular disease. The Company's portable gamma cameras, which incorporate its proprietary semiconductor detector technology, provide improved images, solid-state reliability, and can be formatted into unique lightweight sizes and shapes. In addition to conventional nuclear medicine applications, the Company's solid-state cameras offer the medical profession imagers that can be used in a variety of new clinical diagnostic imaging applications, which include cost saving applications in the surgical centers, emergency rooms, intensive care units, critical care units and other shared facilities. BASIS OF PRESENTATION In 2000, the Company formedthrough twoDelaware corporations,subsidiaries, Digirad Imaging Solutions, Inc. andits subsidiaryDigirad Imaging Systems, Inc.,together "DIS",collectively "DIS," in-office services for physicians, offering experienced licensed personnel and equipment that travel toprovide turn-key nuclear cardiology imaging to physicians in their officesthe physician's office on anationalper day, contractual basis.DIS is a wholly owned subsidiary
Basis of
Digirad and was capitalized by contributing certain acquired assets (see Note 2).PresentationThe accompanying consolidated financial statements include the operations of DIS. Intercompany accounts have been eliminated in consolidation.
INTERIM FINANCIAL DATA
Interim Financial Information
The
accompanying consolidatedfinancial statements as of and for thesixthree months endedJune 30, 2000March 31, 2003 and20012004 are unaudited. The unaudited financial statements have been prepared on the same basis as the audited financial statements and, in the opinion of management, include all adjustments, consisting only ofonlynormal recurring adjustments, necessary to state fairly the financial informationset forth therein, in accordance with generally accepted accounting principles.therein. The results of operations for theinterim periodthree months endedJune 30, 2001March 31, 2004 are not necessarily indicative of the resultswhichthat may be reported forany other interim period or forthe yearendingended December 31,2001. USE OF ESTIMATES2004.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and disclosures made in the accompanying notes to the consolidated financial statements. The Company's significant estimates include the reserve for doubtful accounts, contractual allowances and revenue adjustments, the reserves for excess and obsolete inventories, the reserve for warranty costs and the valuation allowance for deferred tax assets. Actual results could differ from those estimates.
PRO FORMA STOCKHOLDERS' EQUITY If an initial public offering contemplated by this Prospectus is consummated under the terms presently anticipated, all shares of redeemable convertible preferred stock outstanding at June 30, 2001 will automatically convert into 27,129,568 common shares. Unaudited pro forma stockholders' equity at June 30, 2001, as adjusted for the conversion of the redeemable convertible preferred stock is disclosed in the accompanying balance sheet. - -------------------------------------------------------------------------------- F-7DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED) CASH AND CASH EQUIVALENTS
Cash and Cash Equivalents
The Company considers all investments with an original maturity of three months or less when purchased to be cash equivalents. Cash equivalents primarily represent funds invested in money market funds whose cost equals fair market value.
OTHER ASSETS Other assets primarily consist
Concentration of
legal, accounting and other costs incurred in connection with a proposed public offering of common stock in the Company. These deferred offering costs total $626,572 and will be charged against the proceeds received in connection with the offering. In the event the offering is unsuccessful, these costs will be charged against the operations of the Company. CONCENTRATION OF CREDIT RISKCredit RiskThe Company
sellshas primarily sold its products to customers in the United States andJapan. A relatively small number ofits possessions. Limited sales have also been made to customersaccount for a significant percentage of the Company's revenues.in Canada, Japan and Russia. For theyearyears ended December 31,2000, three customers accounted for 15.9%, 11.6%2001, 2002 and10.1% of consolidated revenues and for the six months ended June 30, 2001,2003, nocustomersproduct or DIS customer accounted for 10% or more of consolidated revenues.Revenues in 1998 and 1999 were for sales of various pre-commercialization components of the Company's products, licensing and contract research and were not representative of the Company's current products. A significantThe percentage of the Company's net
imaging servicesDIS revenuein 2000 and 2001 isderived from governmental agencies, such asMedicare.Medicare, has continued to decline each year since services were initiated in 2000 to less than 5% ofconsolidated revenue in the year ended December 31, 2003 and the three months ended March 31, 2004. Management believes that there are minimal credit risks associated with transactions and balances with these governmental agencies. However, there is a potential risk that reimbursement rates can be reduced in the future.
The Company maintains reserves for potential credit losses, billing adjustments and contractual allowances, which historically have been within management's estimates.
INVENTORIES
Inventories
Inventories are stated at the lower of cost or market, cost being determined on a first-in, first-out basis.
PROPERTY AND EQUIPMENT
Property and Equipment
Depreciation and amortization of property and equipment, including assets recorded under capital leases,
isare provided using the straight-line method over the shorter of the estimated useful lives of the related assets, which isgenerally 3three to10seven years, or the lease term, if applicable.INTANGIBLES
Intangibles
Intangibles include patents, trademarks and acquired customer contracts
a covenant not-to-compete, patents and trademarksand are recorded at cost.Intangibles, except for patents, are amortized over their estimated useful lives, which range from three to five years.Patents are amortized over the lesser of their estimated useful or legal lives (up to 20 years).IMPAIRMENT OF LONG-LIVED ASSETSTrademarks are amortized over 10 years. Acquired customer contracts are amortized over their estimated useful lives, which is generally five years.
Impairment of Long-Lived Assets
The Company follows Financial Accounting Standards Board ("FASB")
issuedStatement of Financial Accounting Standards ("SFAS") No.121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR - -------------------------------------------------------------------------------- F-8Accounting for the Impairment or Disposal of Long-Lived Assets. The scope of SFAS No. 144 includes long-lived assets, or groups of assets, to be held and used as well as those which are to be disposed of by sale or by other method, but excludes a number of long-lived assets such as goodwill and intangible assets not being amortized under the application of SFAS No. 142,Goodwill and Other Intangible Assets. SFAS No. 144 requires impairment losses to be recorded 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 assets' carrying amount. DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED) LONG-LIVED ASSETS TO BE DISPOSED OF,144,SFAS 121 also addresses the accounting for long-livedIf such assetsthatareexpectedconsidered to bedisposed of. To date, no such impairments have been identified. REVENUE RECOGNITIONimpaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets.During 2002 and 2003, the Company recorded $566,057 and $228,117, respectively, for impairment on customer contracts acquired for DIS. The Company regularly reviews the performance of these contracts, assessing each contract's profitability and ability to generate cash flow. If profitability is marginal based on volumes and/or pricing, the Company attempts to negotiate a new contract or mutually agrees with the physician to terminate the contract. If the contract is terminated, the remaining unamortized balance of the contract is written-off and recognized as an impairment loss in the period the Company determines the contract will be terminated.
Shipping and Handling Fees and Costs
The Company records all shipping and handling billings to a customer in a sales transaction as revenue earned for the goods provided in accordance with the Emerging Issues Task Force ("EITF") Issue 00-10,Accounting for Shipping and Handling Fees and Costs. The Company's revenues related to shipping and handling for all periods presented are immaterial. Shipping and handling costs are included in cost of revenues and were $300,133, $229,462, $251,536, $42,061 and $94,174 for 2001, 2002, 2003 and the three months ended March 31, 2003 and 2004, respectively.
Revenue Recognition
The Company recognizes revenue when all four of the following criteria are met: (i) persuasive evidence that an arrangement exists; (ii) delivery of the products and/or services has occurred; (iii) the selling price is fixed or determinable; and (iv) collectibility is reasonably assured. In addition, the Company complies with SEC Staff Accounting Bulletin No. 101,
REVENUE RECOGNITION IN FINANCIAL STATEMENTSRevenue Recognition in Financial Statements ("SAB 101"), which became effective in the fourth quarter of 2000.. SAB 101 sets forth guidelines on the timing of revenue recognition based upon factors such as passage of title, installation, payment terms and customer acceptance.The Company has two primary sources of
revenue which arerevenue: 1) product sales, which includes the associated sale of maintenance services and 2) mobile in-office nuclear imaging services. Product revenues consist of revenues from the sales of gamma cameras andrevenues are recognized generallyaccessories and the Company recognizes revenue uponshipment and passage of title. Revenue for products that have not previously satisfied customer acceptance requirements or from sales where customer payments are based solely on customer acceptance are recognized upon customer acceptance.delivery to customers. The Company also provides installation and training for camerasales. The installation is outsourced to a national service companysales in the United States. Installation and training for sales outside of the United States isprovided by Company representatives.the responsibility of the distributors. Neither service is essential to the functionality of the product. Both services are performed shortly after delivery and represent an insignificant cost,towhich theCompany. TheCompany accruesthese costsat the time revenue is recognized. The Company also sells or provides maintenance services beyond the first year following the purchase by the customer. Revenue from these contracts is deferred and recognized ratably over the period ofshipment. Imaging servicesthe obligation and is included in product sales in the accompanying consolidated statements of operations.DIS revenue is derived from the Company's mobile in-office nuclear imaging services. Revenue related to mobile imaging services is recognized at the time services are performed and disposables are provided and collection is reasonably assured.
ImagingNo product sales are included in DIS revenue. DIS servicesrevenue isare generally billed on aper procedureper-day basis under annual contracts which specify the number of days of service to be provided. If a physician fails to complete a minimum number of lease days in a given annual period, the Company has the right to bill the physician for the shortfall and only recognizes the revenue upon collection. No material amounts have been billed orper day basis.recognized as revenue since inception for customers who do not schedule the minimal number of lease days. The Company isreimbursedcompensated for mobile imaging services provided to patients directly from the physicians under contract or, on a smaller scale, from certain programs administered by governmental agencies and private insurance companies.Laws
Unaudited Pro Forma Stockholders' Equity Presentation
The unaudited pro forma stockholders' equity information in the accompanying consolidated balance sheet assumes the conversion of the outstanding shares of redeemable convertible preferred stock into 12,444,294 shares of common stock as though the completion of the initial public offering had occurred on
March 31, 2004. Common shares issued in such initial public offering and
regulations governing the Medicare and Medicaid programsany related estimated net proceeds arecomplex and subject to interpretation. The Company believes that they are in compliance with all applicable laws and regulations and they are not aware of any pending or threatened investigations involving allegations of potential wrongdoing. Non-compliance can result in significant regulatory action including fines, penalties and exclusionexcluded fromthe Medicare and Medicaid programs. In 1998, in addition to certain grant revenues, the Company also received $1,250,000 from a collaboration agreement that was terminated in 1999. STOCK-BASED COMPENSATIONsuch pro forma information.
Stock-Based Compensation
The Company has elected to follow Accounting Principles Board ("APB") Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEEs,Accounting for Stock Issued to Employees, and related Interpretations in accounting for its employee stockoptions.options as permitted by SFAS No. 123,Accounting for Stock-Based Compensation. Under APB 25, if the exercise price of the Company's employee stock options is not less than the fairmarketvalue of the underlying stock on the date of grant, no compensation expense is recognized. Inconjunctiondetermining the fair value of the common stock, the Board of Directors considered, among other factors, (i) the advancement of the Company's technology, (ii) the Company's financial position and (iii) the fair value of the Company's common stock or preferred stock as determined in arm's-length transactions. During 2001 the Company filed a registration statement with theCompany'sSecurities and Exchange Commission in an attempt to complete an initial public offeringcontemplated by this prospectus and other events that occurred in 2000,for the sale of its common stock. Based on discussions with its investment bankers regarding potential market value, the Company reviewed its historical exercise prices and arrived at arevisedfair value for certain stock options grantedsubsequent to June 30, 2000. With respect to the - -------------------------------------------------------------------------------- F-9DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30,in 2001AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED) options granted between June 30, 2000andDecember 31, 2000 and for the six months ended June 30, 2001, the Company hasrecorded deferred stock compensation of$800,735 and $1,996,183, respectively,$1,715,521, for the difference between the original exercise price per share determined by the Board of Directors and therevisedestimate of fair value per share at the respective grant date. Based on market conditions and the Company's financial performance, the initial public offering was effectively terminated during the third quarter of 2001 and the Company had to complete a private round of financing to fund its ongoing operations (see Note 3). In conjunction with the Company's initial public offering contemplated by this prospectus, the Company reviewed its exercise prices and arrived at a fair value for certain stock options granted during the year ended December 31, 2003 and the three months ended March 31, 2004. The Company recorded deferred stock compensation of $780,602 and $1,228,130, respectively, for the year ended December 31, 2003 and three months ended March 31, 2004, for the difference between the original exercise price per share determined by the Board of Directors and the estimate of fair value per share at the respective grant date.The approximate weighted average exercise price and approximate weighted average
revisedfair value per share for the798,2502,369 options grantedbetween June 30, 2000 andduring the year ended December 31,20002001 was$0.50$889.00 and$1.50,$1,050.00, respectively. The approximate weighted average exercise price and approximate weighted averagerevisedfair value per share for the1,169,200285,589 options granted during thesix monthsyear endedJune 30, 2001December 31, 2003 was$1.13$0.49 and$2.84,$3.26, respectively. Deferred stock compensation is recognized and amortized on an accelerated basis in accordance withFinancial Accounting Standards BoardFASB Interpretation ("FIN") No. 28,ACCOUNTING FOR STOCK APPRECIATION RIGHTS AND OTHER VARIABLE STOCK OPTION OR AWARD PLANs,Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, over the vesting period of the related options, generally four years. Deferred compensation for stock options and warrants granted to non-employees is recorded at fair value as determined in accordance with SFAS No. 123,ACCOUNTING FOR STOCK-BASED COMPENSATIOn,andEmerging Issues Task Force ("EITF")EITF No. 96-18,ACCOUNTING FOR EQUITY INSTRUMENTS THAT ARE ISSUED TO OTHER THAN EMPLOYEES FOR ACQUIRING OR IN CONJUNCTION WITH SELLING GOODS OR SERVICES.Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods or Services. The fair value of the unvested options, warrants, andwarrantsother equity instruments is periodically remeasured and the related amortization is adjusted as necessary. Compensation expense related to stock options, warrants, andwarrantsother equity instruments topurchaseacquire common stock issued to non-employees was$32,272$192,652 and $138,447 for theyearyears ended December 31,20002001 and$243,0292002, respectively. No material amounts of non-employee stock-based compensation were recorded in 2003.The expected future amortization expense for deferred compensation as of March 31, 2004 is $703,784 in 2004, $485,355 in 2005, $230,910 in 2006, and $69,718 in 2007 for a total of $1,489,767.
Pro forma information regarding net loss is required by SFAS No.123, and has been determined as if the Company had accounted for all of its employee stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using the Minimum Value pricing model with the following weighted average assumptions for 2001, 2002, and 2003: risk-free interest rates of 4%, 3.8% and 3% respectively; a dividend yield of 0%; and a life of the options of six,
months ended June 30, 2001. WARRANTY COSTSfive and five years, respectively.For purposes of disclosures required by SFAS No. 123, the estimated fair value of the options is amortized on an accelerated basis in accordance with FIN No. 28 over the vesting period. The
Company providesCompany's adjusted net loss information is as follows:
Years ended December 31, Three months ended
March 31,2001 2002 2003 2003 2004 Net loss applicable to common stockholders, as reported $ (20,041,055 ) $ (13,036,873 ) $ (2,006,068 ) $ (1,012,174 ) $ (354,089 ) Add: total stock-based employee compensation included in reported net loss 1,386,014 512,329 226,227 2,025 292,738 Less: total stock-based employee compensation determined under the fair value method for all awards (1,671,812 ) (1,288,485 ) (270,581 ) (15,442 ) (330,100 ) Adjusted net loss $ (20,326,853 ) $ (13,813,029 ) $ (2,050,422 ) $ (1,025,591 ) $ (391,451 ) Basic and diluted net loss per share, as reported $ (3,146.16 ) $ (1,432.31 ) $ (127.62 ) $ (74.63 ) $ (10.88 ) Adjusted basic and diluted net loss per share $ (3,191.03 ) $ (1,517.58 ) $ (130.44 ) $ (75.62 ) $ (12.02 ) The above results are not likely to be representative of the effects of applying SFAS No.123 on reported net income or loss for future years.
Warranty
We provide a warranty on certain of
itsour productsgenerally for periods of up to 12 monthsandaccruesaccrue the estimated cost at the time revenue is recorded.RESEARCH AND DEVELOPMENTWarranty expense is charged to product cost of goods sold. Initially, the warranty periods were generally 12 months but have ranged up to 24 months. Since July 2002, substantially all of the warranty periods have been 12 months before customer-sponsored maintenance begins. Warranty reserves are established based on historical experience with failure rates and repair costs and the number of units at customers covered by warranty and are depleted as gamma cameras are repaired. The costs consist principally of materials, personnel, overhead and transportation. We review warranty reserves monthly and, if necessary, make adjustments. Historically, the Company has recorded adjustments for changes inestimates and, solely at management's discretion, to retrofit cameras with new components to improve camera reliability. The activities in our warranty reserve during 2001, 2002 and 2003 are as follows:
Balance at December 31, 2000 $ 1,034,000 Provision charged to cost of revenues 1,753,488 Reductions for actual charges incurred, net (1,598,129 ) Balance at December 31, 2001 1,189,359 Provision charged to cost of revenues 1,635,577 Reductions for actual charges incurred, net (1,967,106 ) Balance at December 31, 2002 857,830 Provision charged to cost of revenues 1,960,974 Reductions for actual charges incurred, net (1,767,562 ) Balance at December 31, 2003 1,051,242 Provision charged to cost of revenues 524,000 Reductions for actual charges incurred, net (398,705 ) Balance at March 31, 2004 $ 1,176,537 Included in the above provision charged to cost of revenues are amounts for changes in estimates of historical failure rates and repair costs related to preexisting warranties and amounts for retrofit and/or minor component changes management, at its sole discretion, implemented to improve overall product reliability. These changes did not affect safety, efficacy, labeling or intended use as defined in the product specifications. These charges for the years ended December 31, 2001, 2002, and 2003 and for the quarter ended March 31, 2004, were $520,000, $550,000, $275,000 and zero, respectively.
Research and Development
Research and development costs are expensed as incurred.
ADVERTISING COSTS
Advertising Costs
Advertising costs are expensed as incurred. Total advertising costs for the years ended December 31,
1998, 19992001, 2002 and20002003 andforthesixthree months endedJune 30, 2000March 31, 2003 and 2004, were $411,940, $240,646, $231,617, $68,119 and $116,411, respectively.
Other Expense
In 2001,
were $63,183, $205,500, $133,987, $117,787 and $174,883, respectively. COMPREHENSIVE INCOMEthe Company recorded expense of $1,644,542 related to costs incurred in connection with a proposed public offering of common stock which was not completed.
Comprehensive Income
SFAS No. 130,
REPORTING COMPREHENSIVE INCOME,Reporting Comprehensive Income, requires that all components of comprehensive income, including net income, be reported in the financial statements in the period in which they are recognized. Comprehensive income is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources, including unrealized gains and losses oninvestments and foreign currency translation adjustments. The Company's comprehensive loss is the same as the reported net loss for all periods.
NET LOSS PER SHARE
Net Loss Per Share
The Company calculated net loss per share in accordance with SFAS No. 128,
EARNINGS PER SHARE,Earnings Per Share, and SAB No. 98. Basic earnings per share ("EPS") is calculated by dividing the net income or loss available to common stockholders by the weighted average number of common shares outstanding for the period,- -------------------------------------------------------------------------------- F-10DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)without consideration for common stock equivalents. Diluted EPS is computed by dividing the net income available to common stockholders by the weighted average number of common shares outstanding for the period and the weighted average number of dilutive common stock equivalents outstanding for the period determined using the treasury-stock method. For purposes of this calculation, common stock subject to repurchase by the Company, convertible preferred stock, options, and warrants are considered to be common stock equivalents and are only included in the calculation of diluted earnings per share when their effect is dilutive. Under the provisions of SAB No. 98, common shares issued for nominal consideration (as defined), if any, would be included in the per share calculations as if they were outstanding for all periods presented. No common shares have been issued for nominal consideration.Potentially dilutive securities totaling
21,973,776, 21,752,688, 30,412,66851,933, 13,866,966, 13,883,385 and33,466,687 for the years ended14,089,881 as of December 31,1998, 19992001, 2002, 2003 and2000 and the six months ended June 30, 2001,March 31, 2004 respectively, were excluded from historical basic and diluted earnings per share because of their anti-dilutive effect.The unaudited pro forma basic and diluted net loss per common share
calculations assumeand pro forma basic and diluted weighted average common shares outstanding give effect to the conversion of all outstandingshares of redeemable convertible preferred stock
into common shares usingupon theas-if converted methodcompletion of the Company's proposed initial public offering (using the as if-converted method).
Years ended December 31, Three months ended
March 31,2001 2002 2003 2003 2004 Historical: Numerator: Net loss $ (19,910,781 ) $ (12,771,727 ) $ (1,680,304 ) $ (926,824 ) $ (265,551 ) Accretion of deferred issuance costs on preferred stock (130,274 ) (265,146 ) (325,764 ) (85,350 ) (88,538 ) Net loss applicable to common stockholders $ (20,041,055 ) $ (13,036,873 ) $ (2,006,068 ) $ (1,012,174 ) $ (354,089 ) Denominator: Weighted average common shares 6,493 9,102 15,719 13,563 32,558 Weighted average unvested common shares subject to repurchase (123 ) — — — — Denominator for basic and diluted earnings per share 6,370 9,102 15,719 13,563 32,558 Basic and diluted net loss per share $ (3,146.16 ) $ (1,432.31 ) $ (127.62 ) $ (74.63 ) $ (10.88 ) Pro forma: Net loss $ (1,680,304 ) $ (265,551 ) Pro forma basic and diluted net loss per share (unaudited) $ (0.13 ) $ (0.02 ) Shares used above 15,719 32,558 Pro forma adjustments to reflect weighted average effect of assumed conversion of preferred stock (unaudited) 12,444,294 12,444,294 Pro forma shares used to compute basic and diluted net loss per share (unaudited) 12,460,013 12,476,852
Recently Issued Accounting Standards
In November 2002, the FASB issued FIN No. 45,Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. This interpretation elaborates on the disclosures required in financial statements concerning obligations under certain guarantees. The recognition provisions of the interpretation are effective in 2003 and are applicable only to guarantees issued or modified after December 31, 2002. The Company has not issued or modified any such guarantees and accordingly the interpretation did not have a material impact on our financial position, results of operations or cash flows for the fiscal year ended December 31, 2003.
In January
1, 20002003, the FASB issued FIN No. 46,Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN No. 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. In December 2003, the FASB issued FIN No. 46R, a revision to FIN No. 46. FIN No. 46R provides a broad deferral of the latest date by which all public entities must apply FIN No. 46 to certain variable interest entities to the first reporting period ending after March 15, 2004. We do not expect the adoption ofissuance, if later.
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30, ----------------------------------------- ---------------------------- 1998 1999 2000 2000 2001 - --------------------------------------------------------------------------------------------------------------Numerator: Net loss.......................... $(6,191,961) $(13,192,421) $(13,476,372) $(5,691,174) $(5,845,509) Accretion of deferred issuance costs on preferred stock........ -- -- (47,347) -- (56,361) ----------- ------------ ------------ ----------- ----------- Net loss applicable to common stockholders...................... $(6,191,961) $(13,192,421) $(13,523,719) $(5,691,174) $(5,901,870) =========== ============ ============ =========== =========== Denominator: Weighted average common shares.... 3,305,804 3,384,212 3,809,507 3,483,857 4,536,135 Weighted average unvested common shares subject to repurchase.... -- (3,682) (64,458) (29,035) (169,706) ----------- ------------ ------------ ----------- ----------- Denominator for basic and diluted earnings per share................ 3,305,804 3,380,530 3,745,049 3,454,822 4,366,429 =========== ============ ============ =========== =========== Basic and diluted net loss per share............................. $ (1.87) $ (3.90) $ (3.61) $ (1.65) $ (1.35) =========== ============ ============ =========== =========== Pro forma basic and diluted net loss per share......................... $ (0.53) $ (0.19) ============ =========== Shares used above................... 3,745,049 4,366,429 Pro forma adjustment to reflect assumed weighted average effect of conversion of preferred stock..... 21,729,208 26,069,875 ------------ ----------- Pro forma shares used to compute basic and diluted net loss per share............................. 25,474,257 30,436,304 ============ ===========- -------------------------------------------------------------------------------- F-11DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED) RECENT ACCOUNTING PRONOUNCEMENTSFIN No. 46 or FIN No. 46R to have a material impact upon our financial position, cash flows or results of operations.In
June 1999,May 2003, the FASB issued SFAS No.137, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES--DEFERRAL OF EFFECTIVE DATE OF FASB STATEMENT NO. 133.150,Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No.137 defers150 establishes standards forone year the effective datehow an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No.133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which was originally issued in June 1998. SFAS No. 133 now will apply to all fiscal quarters150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning ofall fiscal yearsthe first interim period beginning after June 15,2000. SFAS No. 133 requires the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings.2003. Theineffective portion of a derivative's change in fair value will be immediately recognized in earnings. As of December 31, 2000, the Company did not hold any derivative instruments, or conduct any hedging activities. Therefore there is no anticipated impact to the consolidated financial statements for theadoption of SFAS No.133. In June 2001, the FASB issued SFAS No. 141, BUSINESS COMBINATIONS, and SFAS No. 142, GOODWILL AND INTANGIBLE ASSETS. SFAS No. 141 is effective for all business combinations completed after June 30, 2001. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001; however, certain provisions of this150 did not have a material effect on our consolidated financial statements.2. Financial Statement
apply to goodwill and other intangible assets acquired between July 1, 2001 and the effective date of SFAS No. 142. Major provisions of these Statements and their effective dates for the Company are as follows: (i) all business combinations initiated after June 30, 2001 must use the purchase method of accounting. The pooling of interest method of accounting is prohibited except for transactions initiated before July 1, 2001; (ii) Intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability; (iii) Goodwill and intangible assets with indefinite lives acquired after June 30, 2001, will not be amortized. Effective January 1, 2002, all previously recognized goodwill and intangible assets with indefinite lives will no longer be subject to amortization; (iv) Effective January 1, 2002, goodwill and intangible assets with indefinite lives will be tested for impairment annually and whenever there is an impairment indicator; and (v) all acquired goodwill must be assigned to reporting units for purpose of impairment testing and segment reporting. The Company is currently evaluating the impact that SFAS Nos. 141 and 142 will have on its financial reporting requirements. 2. ASSET ACQUISITIONS On August 31, 2000, the Company entered into an Asset Purchase Agreement with Florida Cardiology and Nuclear Medicine Group ("FC"), a provider of fixed site and mobile nuclear imaging services that operates in Florida. The Company paid $1,648,000 (including 300,000 shares of common stock valued at $411,000) to acquire the accounts receivables, customer contracts of the mobile nuclear imaging services of FC and a covenant not-to-compete from the seller. The Company utilizes its technology, products, processes and procedures to provide services to the customers acquired. The Company allocated the purchase price to the assets acquired as follows: $101,000 to accounts receivable and - -------------------------------------------------------------------------------- F-12DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED) $1,547,000 to customer contracts. The cost of the customer contracts is being amortized over five years. As additional consideration for the purchase of the assets, the Company shall pay to FC a payment based on earnings before interest, income taxes, depreciation and amortization ("EBITDA") during the six months ending August 31, 2001. The payout is payable 50% in cash and 50% in common stock to be issued at the fair value at the date of issuance. In addition, if the Company meets certain revenue collection thresholds during the nine-month period ending one year from the closing of the purchase, the Company will issue 100,000 shares of common stock to FC. As part of the agreement with FC, the Company entered into a service agreement with FC, whereby FC provided medical billing and collection services. In 2001, the Company replaced FC with another third-party billing and collections service provider. In November 2000, the Company completed an Asset Purchase Agreement with Nuclear Imaging Systems, Inc. and Cardiovascular Concepts, P.C. (together, "NIS"), a provider of fixed site and mobile nuclear imaging services, which operated in several Mid-Atlantic states. The Company paid $935,000 primarily to acquire NIS's customer contracts. The Company utilizes its technology, products, processes and procedures to provide imaging services to the customers acquired. The Company allocated the purchase price to the assets acquired as follows: $56,000 to fixed assets, $7,000 to deposits and $872,000 to customer contracts. The cost of the customer contracts is being amortized over five years. As part of the Asset Purchase Agreement, the Company entered into a medical billing and collection service agreement with Medical Management Concepts, Inc. ("MMC"), a subsidiary of NIS. In 2001 the agreement with MMC was terminated and the Company replaced MMC with another third-party billing and collections service provider. In addition to the Asset Purchase Agreement, the Company entered into a consulting agreement with the principal shareholder of NIS, whereby the consultant agreed to provide consulting services (as defined) for a period of three years ending on September 29, 2003. As compensation, the consultant could receive up to 150,000 shares of the Company's common stock, based on achieving certain revenue targets; however, as long as the consultant does not breach the non-competition conditions, he will receive a minimum of 100,000 shares of common stock. The fair value of the minimum 100,000 shares of common stock is $172,000 and has been recorded as a covenant not-to-compete on the accompanying balance sheet and amortized over three years. 3. FINANCIAL STATEMENT DETAILSDetailsThe composition of certain balance sheet accounts is as follows:
ACCOUNTS RECEIVABLE
DECEMBER 31, ------------------------- JUNE 30, 1999 2000 2001 - -----------------------------------------------------------------------------------------------------Accounts receivable......................................... $ -- $3,093,142 $5,221,011 Less allowance for doubtful accounts........................ -- (39,121) (233,991) ---------- ---------- ---------- $ -- $3,054,021 $4,987,020 ========== ========== ==========- -------------------------------------------------------------------------------- F-13DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED) INVENTORIES
DECEMBER 31, ----------------------- JUNE 30, 1999 2000 2001 - ---------------------------------------------------------------------------------------------------Raw materials............................................... $266,574 $1,620,999 $2,074,876 Work-in-progress............................................ 22,214 2,110,857 4,909,053 Finished goods.............................................. -- 144,105 781,481 -------- ---------- ---------- $288,788 $3,875,961 $7,765,410 ======== ========== ==========PROPERTY AND EQUIPMENT
DECEMBER 31, ------------------------- JUNE 30, 1999 2000 2001 - ------------------------------------------------------------------------------------------------------Machinery and equipment..................................... $ 2,155,228 $ 6,074,846 $ 8,176,057 Furniture and fixtures...................................... 212,932 239,505 227,495 Computers and software...................................... 1,121,685 1,313,903 1,531,845 Leasehold improvements...................................... 773,167 891,757 919,711 Construction in process..................................... 140,451 365,279 425,546 ----------- ----------- ----------- 4,403,463 8,885,290 11,280,654 Less accumulated depreciation and amortization.............. (2,251,979) (2,577,323) (3,370,480) ----------- ----------- ----------- $ 2,151,484 $ 6,307,967 $ 7,910,174 =========== =========== ===========
Accounts Receivable
December 31, March 31,
20042002 2003 Accounts receivable $ 8,538,972 $ 12,828,618 $ 13,397,375 Less reserves and allowance for doubtful accounts (670,738 ) (633,587 ) (749,934 ) $ 7,868,234 $ 12,195,031 $ 12,647,441
Inventories
December 31, March 31,
20042002 2003 Raw materials $ 1,655,874 $ 1,402,187 $ 1,358,383 Work-in-progress 3,691,639 2,203,700 2,425,510 Finished goods 643,729 439,739 321,523 5,991,242 4,045,626 4,105,416 Less reserves for excess and obsolete inventories (239,119 ) (336,305 ) (358,798 ) $ 5,752,123 $ 3,709,321 $ 3,746,618
Property and Equipment
December 31, 2002 2003 March 31, 2004 Machinery and equipment $ 14,885,708 $ 16,063,473 $ 16,870,169 Furniture and fixtures 261,875 241,989 241,989 Computers and software 2,006,555 2,326,609 2,372,499 Leasehold improvements 939,585 940,085 18,438 Construction in process 52,482 135,680 525,801 18,146,205 19,707,836 20,028,896 Less accumulated depreciation and amortization (7,032,321 ) (9,620,806 ) (9,448,908 ) $ 11,113,884 $ 10,087,030 $ 10,579,988 During 2000, 2001, 2003 and
2001,the three months ended March 31, 2004, the Company entered into a series of financing transactions structured as capital leases. The equipment, consisting of vans equipped with the Company'sportablemobile gamma cameras, is used by DIS to provide mobile nuclear imaging services. The initial terms of these leasesgenerallyrange from 36 to 63 months. The cost of the equipment financed was$2,973,636$6,082,148 ($106,8991,816,149 of accumulated depreciation) at December 31,20002002 and$4,112,650$6,484,719 ($396,9392,582,288 of accumulated depreciation) atJune 30, 2001. INTANGIBLES
DECEMBER 31, ----------------------- JUNE 30, 1999 2000 2001 - ---------------------------------------------------------------------------------------------------Acquired customer contracts................................. $ -- $2,419,000 $2,419,000 Patents and trademarks...................................... 421,458 370,335 418,949 Covenant not-to-compete..................................... -- 172,000 172,000 -------- ---------- ---------- 421,458 2,961,335 3,009,949 Less accumulated amortization............................... (9,301) (137,800) (452,330) -------- ---------- ---------- $412,157 $2,823,535 $2,557,619 ======== ========== ==========- -------------------------------------------------------------------------------- F-14DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED) OTHER ACCRUED LIABILITIES
DECEMBER 31, --------------------- JUNE 30, 1999 2000 2001 - -------------------------------------------------------------------------------------------------Accrued interest............................................ $ 29,817 $154,415 $ 91,217 Customer deposits........................................... -- 125,200 11,200 Sales tax payable........................................... 9,675 118,255 183,435 Accrued royalties........................................... -- 96,000 125,500 Accrued offering costs...................................... -- -- 337,814 Other accrued liabilities................................... 66,753 431,268 543,803 -------- -------- ---------- $106,245 $925,138 $1,292,969 ======== ======== ==========4. DEBTDecember 31, 2003 and $6,629,310 ($2,840,794 of accumulated depreciation) at March 31, 2004.
Intangibles
December 31, March 31, 2004 2002 2003 Acquired customer contracts $ 842,447 $ 244,921 $ 244,921 Patents and trademarks 503,027 482,900 505,490 1,345,474 727,821 750,411 Less accumulated amortization (450,946 ) (215,989 ) (232,066 ) $ 894,528 $ 511,832 $ 518,345
Other Accrued Liabilities
December 31, March 31, 2004 2002 2003 Sales tax payable $ 657,353 $ 511,794 $ 456,515 Radiopharmaceuticals and consumable medical supplies — 606,176 666,231 License fees 115,066 263,603 292,712 Customer deposits 832,676 294,550 346,327 Interest 122,122 109,272 92,481 Legal costs 797,954 121,000 122,618 Public offering costs — — 727,089 Other accrued liabilities 576,938 741,346 1,058,441 $ 3,102,109 $ 2,647,741 $ 3,762,414 3. Debt
The composition of the Company's debt balance is as follows:
DECEMBER 31, ------------------------- JUNE 30, 1999 2000
December 31, 2002 2003 March 31, 2004 Lines of credit $ 6,217,576 $ 9,356,727 $ 9,182,436 Capital lease obligations (Note 4) 6,979,172 6,348,963 5,923,728 13,196,748 15,705,690 15,106,164 Current portion of debt (8,166,421 ) (11,473,619 ) (11,386,143 ) Long-term debt, less current portion $ 5,030,327 $ 4,232,071 $ 3,720,021
Lines of Credit
Since December 2001,
- ------------------------------------------------------------------------------------------------------Lines of credit............................................. $ -- $ 788,348 $ 2,957,023 Loan and security agreement................................. 1,954,650 3,141,960 2,400,314 Capital lease obligations (Note 5).......................... -- 4,152,074 5,480,389 Debt discount............................................... (119,220) (203,380) (147,898) ---------- ----------- ----------- 1,835,430 7,879,002 10,689,828 Current portion of debt..................................... (414,672) (2,934,580) (5,613,945) ---------- ----------- ----------- Long-term debt, less current portion........................ $1,420,758 $ 4,944,422 $ 5,075,883 ========== =========== ===========NOTES PAYABLE TO FINANCIAL INSTITUTIONS In April 2000,the Companyentered intohas had a $5,000,000 line of creditwith a bank for a $2,500,000 revolving line of credit. Borrowings under the line of credit accrue interest at the bank's floating prime rate plus 1% (9.75% at December 31, 2000) and are limited to the available borrowing base (as defined). In July 2001, the line of credit was increased to $4,300,000 and the amended line of creditwhich accrues interest at the bank's floating prime rate plus2%1.75% (5.75% at December 31, 2003). The Company is required to make monthly interest payments. The revolving line of credit expiresJuly 31, 2002October 15, 2004 with any unpaid balance due upon expiration. $4,825,000 and $4,729,274 was outstanding as of December 31, 2003 and March 31, 2004, respectively.In
November 1999, the Company entered into a loan and security agreement to borrow up to $3,000,000. In August 2000, the Company modified its November 1999 loan agreement to borrow an additional $1,000,000. Borrowings under this agreement accrue interest at rates between 13.53% and 14.40%. The Company is required to make monthly payments of $156,273 on principal and interest through November 2002. During 1999 and 2000,2001, in conjunction with theloan and security agreement (as amended),amended line of credit, the Company issued the lenderwarrantsa warrant to purchase294,713213 shares of Series E preferred stock at a price of$3.036 per share and valued the warrants at $280,529.$607.20. Thewarrants are exercisable immediately. The value of thewarrant isrecorded as debt discountexercisable immediately andis amortized to interest expense on a straight-line basis overexpires five years from thetermdate ofthe debt.issuance. The fair value of thewarrantswarrant was determined to be insignificant as calculated using the Black-Scholes option pricing model with the following assumptions: dividend yield of 0%; expected volatility of 75%; risk-free interest rate of6%3%; and atermlife of three years.- -------------------------------------------------------------------------------- F-15DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)In January 2001, the Company entered into a three year loan and security agreement related to DIS for a revolving line of credit. The Company can draw up to
$2,500,000 and an additional $2,500,000 upon approval by the lender's credit committee.$5,000,000. The borrowings under the line of credit are limited to 85% of QualifiedAccountAccounts (as defined) and accrue interest at the higher of prime plus 1.25% or10.25%8.25%. The revolving credit line expiresin JanuaryDecember 31, 2004.NOTES PAYABLE TO STOCKHOLDERS$4,531,727 and $4,453,162 was outstanding as of December 31, 2003 and March 31, 2004, respectively. In March 2004, the borrowings under the line of credit were revised to accrue interest at the higher of prime plus 1.25% or 6%.
Notes Payable to Stockholders
The Company has notes payable to stockholders totaling $735,000 that bear interest at 6.35% per year. The notes
matureare due in twelve equal quarterly installments starting on March 31,of the year immediately following the first year in which the Company generates cash from operations. Since the Company does not expect to generate cash from operations in the year ended December 31, 2001, these notes have been classified2004. Accordingly, $245,000 is included aslong-term. Principal maturities on long-term debt, excluding capital lease obligations (see Note 5), andcurrent portion of notes payable to stockholdersare as followsat December 31,2000:2003 in the accompanying balance sheet.
2001....................... $1,536,023 2002....................... 1,605,937 ---------- $3,141,960 ==========In January 2002, the Company issued and sold convertible promissory notes in the aggregate principal amount of $1,925,000 bearing an annual interest rate of 12%. On May 7, 2002, holders of $1,425,000 of the convertible promissory notes elected to convert the principal balance and outstanding interest on the notes into Series H preferred stock. The remaining convertible promissory note balance of $500,000, plus accrued interest was repaid in June 2002. In consideration for the bridge loans, the Company issued to the noteholders warrants to purchase 227 shares of the Company's common stock at an exercise price of $1,050.00 per share (See Note 5).
In March 2002, the Company borrowed $150,000 from one of its stockholders under the terms of a secured loan bearing interest at 8% per annum. The loan plus accrued interest was converted into Series H preferred stock in June 2002.
The Company's borrowings are generally subject to financial and other restrictive covenants. The Company is in compliance with all covenants at December 31, 2003. Substantially all of the Company's assets have been pledged as collateral.
5. LEASE COMMITMENTS4. Commitments and Contingencies
Leases
The Company leases its facilities under non-cancelable operating leases
whichthat expire through2002.2010. Rent expense was$303,475, $390,919, $418,470, $199,549,$726,237, $887,340 and$346,188$1,028,895 (including common area charges) for the years ended December 31,1998, 19992001, 2002 and2000 and the six months ended June 30, 2000 and 2001,2003, respectively. Annual future minimum lease payments as of December 31,20002003 are as follows:
OPERATING CAPITAL LEASES LEASES - --------------------------------------------------------------------------------------2001........................................................ $351,872 $ 1,240,640 2002........................................................ 158,122 1,305,916 2003........................................................ 69,375 1,199,575 2004........................................................ 28,125 880,552 2005........................................................ 24,375 880,552 Thereafter.................................................. 4,063 -- -------- ----------- Total minimum lease payments................................ $635,932 5,507,235 ======== Less amount representing interest........................... (1,355,161) ----------- Present value of future minimum capital lease obligations... 4,152,074 Less amounts due in one year................................ (721,163) ----------- Long-term portion of capital lease obligations.............. $ 3,430,911 ===========- -------------------------------------------------------------------------------- F-16DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30,
Operating
LeasesCapital
Leases2004 $ 695,584 $ 2,741,210 2005 708,433 2,662,690 2006 668,063 1,533,943 2007 614,907 421,305 2008 554,412 145,523 Thereafter 619,400 — Total minimum lease payments $ 3,860,799 7,504,671 Less amount representing interest (1,155,708 ) Present value of future minimum capital lease obligations 6,348,963 Less amounts due in one year (2,116,892 ) Long-term portion of capital lease obligations $ 4,232,071
Litigation
In 2001,
AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED) 6. REDEEMABLE CONVERTIBLE PREFERRED STOCKa complaint was filed in the United States District Court for the Eastern District of Pennsylvania. The complaint alleged, among other things, breach of the terms of certain agreements. The Company settled the claim for $500,000, which was recorded in 2002 as a general and administrative expense in the statement of operations.
DECEMBER 31, 2000 JUNE 30, 2001 -------------------------- -------------------------- REDEMPTION REDEMPTION AND AND PRICE PER NUMBER LIQUIDATION NUMBER LIQUIDATION DATE ISSUED SERIES SHARE OF SHARES VALUE OF SHARES VALUE - ----------------------------------------------------------------------------------------------------------------------March 1995............................ A $ 1.00 2,250,000 $ 2,250,000 2,250,000 $ 2,250,000 December 1995......................... B $ 1.10 2,281,000 2,509,100 2,281,000 2,509,100 August 1997........................... C $ 1.25 4,800,000 6,000,000 4,800,000 6,000,000 August 1997........................... D $2.3073 8,668,140 20,000,000 8,668,140 20,000,000 June 1998............................. E $ 3.036 494,071 1,500,000 494,071 1,500,000 March, April, June, November and December 2000....................... E $ 3.036 6,697,646 20,334,053 6,697,646 20,334,053 January, March and April 2001......... E $ 3.036 -- -- 1,938,711 5,885,927 ---------- ----------- ---------- ----------- 25,190,857 52,593,153 27,129,568 58,479,080 ========== ========== Less: Unamortized deferred issuance costs (338,411) (369,944) ----------- ----------- $52,254,742 $58,109,136 =========== ===========The Company is currently not involved in any litigation. In the future, however, the Company may from time to time become involved in litigation relating to claims arising in the normal course of business, such as claims related to employment practices, product liability or patent infringement.
Compliance with Laws and Regulations
The Company is directly or indirectly through its clients, subject to extensive regulation by both the federal government and the states and foreign countries in which it conducts its business. The healthcare laws applicable to the Company are complex and are subject to variable interpretations. The Company has established a compliance program to help ensure that it will remain in compliance with the applicable healthcare laws and has instituted other safeguards intended to help prevent any violations of the laws and to remediate any situations that could give rise to violations.
In 2004, the Company discovered certain isolated arrangements entered into in good faith but that, upon review by its compliance personnel, raised some compliance concerns under these laws. In accordance with its compliance program, the Company took immediate remedial steps. While there have been no claims asserted against the Company, it cannot be assured that those remedial steps will insulate the Company from liability associated with these isolated arrangements. Although uncertain, if a claim
were asserted and the Company were not to prevail, possible sanctions could have a material effect on the Company's financial statements or the Company's ability to conduct its operations.
5. Redeemable Convertible Preferred Stock and Stockholders' Equity
Reverse Stock Split
In October 2002, the Board of Directors and stockholders approved a 1:200 reverse split of the Company's common stock and preferred stock. All share and per share information in the accompanying consolidated financial statements and notes thereto have been restated to reflect the stock split.
Redeemable Convertible Preferred Stock
At December 31, 2003, the various series of preferred stock outstanding are as follows:
Liquidation value Date issued Series Issuance
price per shareNumber of
sharesDecember 31,
2003March 31,
2004March 1995 A $ 200.00 250 $ 50,000 $ 50,000 December 1995 B $ 220.00 — — — August 1997 C $ 250.00 800 200,000 200,000 August 1997 D $ 461.46 2,130 982,910 982,910 June 1998 through April 2001 E $ 607.20 5,447 3,307,418 3,307,418 August 2001 F $ 650.00 770 500,500 500,500 April, May, and June 2002 G $ 2.00 30,984,210 61,968,420 61,968,420 April, May, and June 2002 H $ 1.39 12,561,706 52,502,906 52,502,906 43,555,313 $ 119,512,154 $ 119,512,154 On April 23, 2002, the stockholders agreed to recapitalize the Company and entered into a Stock Purchase and Exchange Agreement under which the Company sold Series H preferred stock and exchanged shares of Series A, B, C, D, E and F preferred stock for Series G preferred stock for those Existing Stockholders (as defined) that purchased their pro-rata amount of Series H preferred stock. The Company received $15,846,149 in cash and $1,654,656 from the conversion of bridge notes and related accrued interest as consideration. The Company incurred $346,168 of offering costs related to the financing. The Company issued 12,561,706 Series H preferred shares and on conversion of 139,343 Series A, B, C, D, E, and F preferred shares, the Company issued 30,984,210 Series G preferred shares.
Deferred issuance costs through December 31,
20002002, 2003 andJune 30, 2001the three months ended March 31, 2004 for all series of preferred stock totaled$385,758 and $473,652, respectively,$982,043 and are being accreted up to the redemption value through July 31, 2004 (the earliest redemption date). Unamortized deferred issuance costs are $213,512 and $124,974 at December 31, 2003 and March 31, 2004.The preferred stock is redeemable on or after July 31, 2004, upon the request of at least
66 2/3%half in number of theholders of preferred stock.Major Investors (as defined). The Company shall redeem all outstanding shares of preferred stock by paying in cash itsliquidationredemption value plus declared but unpaid dividends. No dividendshave been declared through
June 30, 2001.March 31, 2004. The redemption value for each series of preferred stock is equal to its issuance price, except for Series H, which is equal to $4.1796 per share or $52,502,906 in total.If the funds of the Company legally available for redemption are insufficient to redeem the total number of preferred shares to be redeemed, those funds which are legally available will be used to redeem the maximum possible ratably over the various series of preferred stock. If the offering contemplated by this prospectus is not completed, and the redeemable preferred shares remain outstanding, the Company does not anticipate having legally available funds to redeem any portion of these preferred shares in 2004 or in the forseeable future beyond 2004. For the same reason the Company has not accreted up the $35 million difference between the issuance value and the redemption value.
The preferred stock will automatically be converted into shares of common stock upon the closing of a sale of the Company's common stock in a public offering registered under the Securities Act of 1933 which results in aggregate gross proceeds equal to or exceeding
$15,000,000$25,000,000 at a price equal to or exceeding$7.50$4.1796 per share of common stock, or with the approval of at least half in number of Major Investors (as defined) and holders ofat least 75%a majority in interest of the then outstandingshares of preferred stock and the approval of 60%voting power of theholders ofSeriesD.H preferred stock. Each share ofthe Series A, B, C, D, and Epreferred stock is convertible, at the option of the holder, into one share ofthe Company'scommon stock, except for Series F whichhas been reserved for issuance upon conversionis convertible into 1.07 shares ofthe preferredcommon stock, subject to certain antidilutionadjustments.adjustments for certain equity issuances after April 23, 2002.Holders of the Series A, B, C, D, E, F, G, and
EH preferred stock are entitled to receive non-cumulative dividends, if and when declared by the Board of Directors, at a rate of$0.10, $0.11, $0.125, $0.231,$20.00, $22.00, $25.00, $46.146, $60.72, $65.00, $0.20, and$0.304$0.13932 per share per annum, respectively. The holder of Series G and H preferred stock are entitled to receive dividends prior and in preference to any declaration or payment of dividends (payable other than in common stock) on series A, B, C, D, E, or F preferred stock, with series H preferred stock having prior preference to Series G preferred stock. The holder of each share of preferred stock is entitled to the number of votes equal to the number of shares of common stock into which the preferred stock could be converted. The Company is subject to certain covenants under the agreements that require the vote or written consent by both (a) half in number of the Major Investors and (b) the holders of a majority of the then outstandingpreferred shares regarding certain changes in the rights and interestsvoting power of the Series H preferredshares.stock. Theshareholdersstockholders also have certain antidilutive rights.- -------------------------------------------------------------------------------- F-17DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)The Series H preferred stockholders, voting as a separate class, are entitled to elect three members of the board of directors; Series G preferred stock holders, voting as a separate class, are entitled to elect two members of the board of directors; and any additional member of the board of directors shall be elected by the holders of Series A, B, C, D, E, and F and common stockholders, voting as a separate class.
In the event of any liquidation, dissolution or winding up of the Company, the holders of preferred stock are entitled to receive their liquidation value prior and in preference to any distribution of the assets or surplus funds of the Company to the holders of common stock. If, upon the occurrence of such event, the assets and funds distributed among the holders of preferred stock are insufficient to permit full payment, the entire assets and funds of the Company would be distributed among the preferred shareholders in proportion to the product of the liquidation preference of each such share and the number of such shares owned by each such holder.
7. STOCKHOLDERS' EQUITY (DEFICIT) WARRANTS During 2000, in conjunction with two consulting agreements, the Company issued two warrants to purchase 10,000 and 500 shares of the Company's common stock at $1.50 and $3.04 per share, respectively. The warrants are exercisable immediately and expire in November 2005. The fair value of the warrants was $5,670.
Warrants
During the
six monthsyear endedJune 30,December 31, 2001, in conjunction with various sales and marketing arrangements, the Company issued warrants to purchase90,000300 shares of the Company's common stock at prices ranging from$1.50$700.00 to$3.04$2,128.00 per share. Warrants for 216 shares of common stock are exercisable immediately and expire five years from the date of issuance. The remaining 84 warrants vest 29 warrants per year beginning July 2002 and expire in July 2006. The fair value of the warrants was $144,100.During the year ended December 31, 2002, in conjunction with sales and marketing arrangements, the Company issued warrants to purchase 57,144 shares of the Company's common stock at $4.90 per share. In conjunction with consulting agreements, the Company issued warrants to purchase 16 shares of the Company's common stock at $2,100.00 per share.
The warrants are exercisable immediately, and expire five years from the date of issuance. The fair value of the warrants was $16,921.
During the year ended December 31, 2003, in conjunction with sales and marketing arrangements, the Company issued warrants to purchase 429 shares of the Company's common stock at $0.49 per share. The warrants are exercisable immediately and expire five years from the date of issuance. The fair value of the warrants
was $138,300. In September 2000,is not material.During the three months ended March 31, 2004, in conjunction with
convertible bridge note financingvarious consulting arrangements, the Company issued warrants to purchaseup to 65,8755,715 shares ofSeries E preferredthe Company's common stock at$3.036 per share. The warrants are exercisable immediately and expire the earlier of (i) September 2005 or (ii) the closing of an initial public offering. The fair value of the warrants was $104,741 and was recognized as interest expense in December 2000 due to the conversion of the bridge notes. During 1999 and 2000, in connection with the Company's loan security agreements, the Company issued 294,713 warrants to purchase Series E preferred stock at a price of $3.036$5.50 per share. The fair value of the warrantsissuedwas$126,164 in 1999 and $154,365 in 2000. The$40,200.All of the warrants were valued using the Black-Scholes option pricing model with the following assumptions: dividend yield of 0%; expected volatility of 75%; risk-free interest
rate ofrates ranging from 3% to 6%; and a term of three years.STOCK OPTIONS In December 1998,
Stock Options
Under the Company's 1991 Stock Option Program, 1997 Stock Option/Stock Issuance Plan
was replaced with theand 1998 Stock Option/Stock Issuance Plan,("1998 Plan") under which 1,000,000 shares of common stock were reserved for issuance upon exercise of options granted by the Company. Under all stock option plans,the Company is authorized to issue an aggregate of6,654,8601,682,807 shares of common stock. Terms of the stock option agreements, including vesting requirements (which is generally four years), are determined by the Board of Directors. Upon grant, the options are exercisable immediately; however any exercised but unvested shares are subject to repurchase by the Company at the original exercise price. Options granted have a term of up to ten years.- -------------------------------------------------------------------------------- F-18DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)The following table summarizes option activity under the stock option plans:
WEIGHTED AVERAGE EXERCISE SHARES PRICE - ------------------------------------------------------------------------------------Outstanding at December 31, 1997............................ 2,506,360 $ 0.31 Granted................................................... 1,248,170 $ 0.33 Cancelled................................................. (193,079) $ 0.42 Exercised................................................. (80,886) $ 0.43 ---------- Outstanding at December 31, 1998............................ 3,480,565 $ 0.31 Granted................................................... 773,500 $ 0.35 Cancelled................................................. (1,164,991) $ 0.26 Exercised................................................. (35,725) $ 0.29 ---------- Outstanding at December 31, 1999............................ 3,053,349 $ 0.34 Granted................................................... 2,574,964 $ 0.48 Cancelled................................................. (333,754) $ 0.36 Exercised................................................. (663,006) $ 0.30 ---------- Outstanding at December 31, 2000............................ 4,631,553 $ 0.42 Granted................................................... 1,230,700 $ 1.14 Cancelled................................................. (58,209) $ 0.68 Exercised................................................. (214,127) $ 0.37 ---------- Outstanding at June 30, 2001................................ 5,589,917 $ 0.58 ==========
Shares Weighted average
exercise priceOutstanding at December 31, 2000 6,594 $ 294.57 Granted 3,008 $ 910.04 Cancelled (798 ) $ 741.83 Exercised (410 ) $ 292.38 Outstanding at December 31, 2001 8,394 $ 471.80 Granted 1,462,293 $ 0.68 Cancelled (106,273 ) $ 16.64 Exercised (99 ) $ 625.76 Outstanding at December 31, 2002 1,364,315 $ 2.29 Granted 285,589 $ 0.49 Cancelled (259,602 ) $ 2.84 Exercised (10,005 ) $ 0.49 Outstanding at December 31, 2003 1,380,297 $ 1.83 Granted 244,579 $ 5.50 Cancelled (12,545 ) $ 2.80 Exercised (30,812 ) $ 0.49 Outstanding at March 31, 2004 1,581,519 $ 2.42 As of December 31,
20002001, 2002, 2003 andJune 30, 2001, 1,202,190March 31, 2004, 350,501, 316,894, 290,899 and40,26458,904 shares, respectively, were available for futuregrant.grants.Following is a further breakdown of the options outstanding as
of December 31, 2000:of:
WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE PRICE EXERCISE PRICE OPTIONS CONTRACTUAL OF OPTIONS VESTED OF VESTED EXERCISE PRICE OUTSTANDING LIFE IN YEARS OUTSTANDING OPTIONS OPTIONS - --------------------------------------------------------------------------------------------------$ 0.21 606,995 5.0 $ 0.21 579,584 $ 0.21 $ 0.25 360,527 7.1 $ 0.25 265,919 $ 0.25 $ 0.35 2,155,174 8.6 $ 0.35 646,971 $ 0.35 $ 0.50 1,158,057 9.6 $ 0.50 98,984 $ 0.50 $ 0.75 300,000 5.2 $ 0.75 285,000 $ 0.75 $ 3.04 - $3.50 50,800 9.4 $ 3.41 50,800 $ 3.41 ------------ ------------ ------------- --------- ------------- 4,631,553 8.1 $ 0.42 1,927,258 $ 0.44 ============ ============ ============= ========= =============
December 31, 2003 Exercise
priceOptions
outstandingWeighted
average
contractual
life in yearsWeighted
average exercise
price of options
outstandingVested
optionsWeighted
average exercise
price of vested
options$0.49 1,377,199 8.6 $ 0.49 848,067 $ 0.49 $147 - $245 623 3.8 $ 196.35 623 $ 196.35 $350 - $525 1,381 5.0 $ 404.11 1,381 $ 404.11 $700 309 5.9 $ 700.00 309 $ 700.00 $1,050 667 7.0 $ 1,050.00 667 $ 1,050.00 $1,400 21 7.6 $ 1,400.00 21 $ 1,400.00 $2,100 - $2,128 39 7.1 $ 2,120.10 39 $ 2,120.10 $2,450 58 6.4 $ 2,450.00 58 $ 2,450.00 1,380,297 8.6 $ 1.83 851,165 $ 2.66
March 31, 2004 Exercise
PriceOptions outstanding Weighted average contractual life in years Weighted average exercise price of options outstanding Vested options Weighted average exercise price of vested options $0.49 1,333,872 8.6 $ 0.49 886,243 $ 0.49 $5.50 244,579 9.9 $ 5.50 929 $ 5.50 $147 - $245 623 3.5 $ 196.35 623 $ 196.35 $350 - $525 1,381 4.8 $ 404.11 1,381 $ 404.11 $700 302 5.8 $ 700.00 302 $ 700.00 $1,050 644 7.0 $ 1,050.00 644 $ 1,050.00 $1,400 21 7.3 $ 1,400.00 21 $ 1,400.00 $2,100 - $2,128 39 6.8 $ 2,120.10 39 $ 2,120.10 $2,450 58 6.1 $ 2,450.00 58 $ 2,450.00 1,581,519 8.8 $ 2.42 890,240 $ 2.54 The weighted average fair values of options granted in
1998, 1999,2001, 2002 and20002003 were$0.08,$1,394.65, $0.07 and$0.59,$2.92, respectively.Adjusted pro forma information regarding net loss is required by SFAS 123, and has been determined as if
Bridge Notes
On January 25, 2002, the Company
had accountedexecuted bridge loans in the form of Convertible Promissory Notes and associated Warrant Purchase Agreements with various investors forits employeetotal gross proceeds of $1,925,000. The notes bore interest at 12% per annum and ultimately were converted into Series H Preferred Stock. The warrants allowed the investors to purchase 227 shares of the Company's common stockoptions underover the next five years at $1,050.00 per share. The proceeds from the financing were allocated to the carrying values of the notes and the warrants on the basis of their relative fairvalue method of that - -------------------------------------------------------------------------------- F-19DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED) Statement. The fair value for these options was estimatedvalues at the date ofgrantissuance and which also created a beneficial conversion feature equal to the fair value of the warrants. The separate fair value of the notes was equal to their face values on the basis of their terms. The separate fair value ofthe warrants and the separate value of the beneficial conversion feature was each determined to be $121,526 using the
Minimum ValueBlack-Scholes option pricing model with the followingweighted- average assumptions for 1998, 1999 and 2000: a risk-free interest rates of 5%, 5% and 6%, respectively; aassumptions: expected dividend yield of 0%;, expected volatility of 75%, risk-free interest rate of 3.8% andaexpected life of three years. The resulting discount on theoptionnotes offive, five$243,052 was amortized to interest expense over the period the notes were outstanding. With the exception of $500,000 that was repaid in cash, the notes andsix years, respectively. For purposes of pro forma disclosures,accrued interest were converted into Series H preferred stock over theestimated fair valuethree closing dates of theoptions is amortized on an accelerated basis in accordance with FIN 28 over the vesting period. The Company's pro forma net loss information is as follows:
YEARS ENDED DECEMBER 31, ----------------------------------------- 1998 1999 2000 - -------------------------------------------------------------------------------------------------------Pro forma net loss.......................................... $(6,244,166) $(13,307,042) $(13,632,212) Pro forma net loss per share-basic and diluted.............. $ (1.89) $ (3.94) $ (3.64)The pro forma results above are not likely to be representative of the effects of applying SFAS 123 on reported net income or loss for future years. NOTES RECEIVABLE FROM STOCKHOLDERSSeries H preferred stock between April 23, 2002 and June 17, 2002.
Notes Receivable from Stockholders
At December 31,
1999 and 2000 and June 30,2001, the Company had notes receivable from employee stockholders of$4,180, $85,919 and $111,919, respectively.$76,919. The notes relate to the exercise of common stock options, are full recourse and bear interest at 6% per year. The notes are due on the earlier of (i) the date on which the employee ceases to be employed by the Company, (ii) 90 days after an initial public offering of the Company's common stock; or (iii) May 15, 2010.COMMON SHARES RESERVED FOR ISSUANCEDuring 2002, in conjunction with a recapitalization, the Company wrote-off the value of the notes receivable since the underlying shares had little or no value and collection of the notes was unlikely. In the future, if the Company provides financing for employees to purchase stock options, the Company will account for options under variable plan accounting in accordance with EITF Issue No. 95-16,Accounting for Stock Compensation Arrangements with Employer Loan Features Under APB Opinion No. 25.
Common Shares Reserved for Issuance
The following table summarizes common shares reserved for future
issuance:issuance at March 31, 2004:
DECEMBER 31, JUNE 30, 2000 2001 - -----------------------------------------------------------------------------------------Redeemable convertible preferred stock...................... 25,190,857 27,129,568 Convertiblestock12,444,294 Redeemable convertible preferred stock warrants........................ 360,588 360,588warrants554 Common stock warrants....................................... 10,500 100,500warrants63,417 Common stock options........................................ 5,833,743 5,630,181 Commitment to issue common stock (Note 2)................... 150,000 150,000 ------------- -----------options1,640,423 Total common shares reserved for issuance................... 31,545,688 33,370,837 ============= ===========issuance14,148,688 8. INCOME TAXES6. Income Taxes
As of December 31,
2000,2003, the Company had federal and California income tax net operating loss carryforwards of approximately$39,896,000$71,600,000 and$27,920,000,$38,300,000, respectively. The difference between the federal and California tax loss carryforwards is primarily attributable to the50%limitation in the utilization of California net operating losscarryforwards.carryforwards, which ranges from 50% to 60% during the period from 1996 to 2003. The federal tax loss carryforwards will begin expiring in 2006 unless previously utilized. The California tax loss carryforwards will begin to expire in20022004 unless previously utilized. The Company also has federal and California research and development and other credit carryforwards of approximately$1,570,000$1,900,000 and$1,250,000,$1,300,000, respectively. The federal research and development and other credit carryforwards begin to expire in 2005 unless previously utilized.- -------------------------------------------------------------------------------- F-20DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED) ThePursuant to Internal Revenue Code Sections 382 and 383, use of the Company's net operating loss and credit carryforwards
are subject to an annual limitation on their use asmay be limited because of aresult of changescumulative change in ownershipduring 1995 and 1997, pursuant to Internal Revenue Code Sections 382 and 383. However, these annual limitations are not expected toof more than 50%, which may havea material affect on the Company's ability to utilize its carryforwards.occurred.Significant components of the Company's deferred tax assets are shown below. A valuation allowance
of which $5,402,000 relates to 2000,has been recognized to offset the deferred tax assets, as realization of such assetsis uncertain.
DECEMBER 31, --------------------------- 1999 2000 - -----------------------------------------------------------------------------------------Deferred tax assets: Capitalized research expense.............................. $ 1,517,000 $ 1,011,000 Net operating loss carryforwards.......................... 10,535,000 15,569,000 Research and development and other credits................ 1,332,000 2,193,000 Other, net................................................ 536,000 963,000 ------------ ------------ Total deferred tax assets................................... 13,920,000 19,736,000 Deferred tax liabilities--expensed patents.................. (53,000) (467,000) ------------ ------------ Total net deferred tax assets............................... 13,867,000 19,269,000 Valuation allowance for deferred tax assets................. (13,867,000) (19,269,000) ------------ ------------ Net deferred tax assets..................................... $ -- $ -- ============ ============9. SEGMENTS During 2000,has not met theCompany commenced commercial operations and realigned its operating structure into two reportable segments, products and imaging services."more likely than not" threshold required under SFAS No. 109.
December 31, 2002 2003 Deferred tax assets: Net operating loss carryforwards $ 26,832,000 $ 27,254,000 Research and development and other credits 3,187,000 3,037,000 Reserves 741,000 856,000 Capitalized research expense 279,000 181,000 Capitalized inventory costs 238,000 117,000 Other, net 1,179,000 1,164,000 Total deferred tax assets 32,456,000 32,609,000 Deferred tax liabilities—depreciation and amortization (949,000 ) (1,567,000 ) Valuation allowance for deferred tax assets (31,507,000 ) (31,042,000 ) Net deferred tax assets $ — $ — 7. Segments
The Company's
newreporting segments have been determined based on the nature of the products and/or services offered to customers or the nature of their function in the organization. The Company evaluates performanceand allocates certain costsbased on thepercentage of salesoperating income contributed by each segment. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies.In prior years, the Company operated in one reportable segment, which is not comparable to the two - -------------------------------------------------------------------------------- F-21DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED) reportable segments in fiscal 2000 and thereafter. As a result, prior years have been presented as "Other" in the information shown below.
SIX MONTHS ENDED YEARS ENDED DECEMBER 31, JUNE 30, ------------------------------------------ --------------------------- 1998 1999 2000 2000 2001 - -----------------------------------------------------------------------------------------------------------------REVENUES BY SEGMENT: Products............................... $ -- $ -- $ 5,815,474 $ 1,456,480 $ 9,802,365 Imaging services....................... -- -- 1,259,948 -- 4,216,575 Other.................................. 1,920,969 283,889 -- -- -- ----------- ------------ ------------ ----------- ----------- Consolidated revenues................ $ 1,920,969 $ 283,889 $ 7,075,422 $ 1,456,480 $14,018,940 =========== ============ ============ =========== =========== GROSS PROFIT (LOSS) BY SEGMENT: Products............................... $ -- $ -- $ (4,018,877) $(2,145,323) $ 3,364,596 Imaging services....................... -- -- 420,652 -- 822,212 Other.................................. 1,532,797 19,344 -- -- -- ----------- ------------ ------------ ----------- ----------- Consolidated gross profit (loss)..... $ 1,532,797 $ 19,344 $ (3,598,225) $(2,145,323) $ 4,186,808 =========== ============ ============ =========== =========== NET LOSS BY SEGMENT: LOSS FROM OPERATIONS Products............................... $ -- $ -- $(12,324,646) $(5,594,206) $(3,041,840) Imaging services....................... -- -- (614,434) -- (2,403,010) Other.................................. (7,049,214) (13,465,955) -- -- -- ----------- ------------ ------------ ----------- ----------- Consolidated loss from operations.... (7,049,214) (13,465,955) (12,939,080) (5,594,206) (5,444,850) RECONCILING ITEMS Interest income........................ 903,294 360,476 242,831 123,736 144,732 Interest expense....................... (46,041) (86,942) (780,123) (220,704) (545,391) ----------- ------------ ------------ ----------- ----------- Consolidated net loss................ $(6,191,961) $(13,192,421) $(13,476,372) $(5,691,174) $(5,845,509) =========== ============ ============ =========== =========== DEPRECIATION AND AMORTIZATION BY SEGMENT: Products............................... $ -- $ -- $ 890,763 $ 371,141 $ 542,249 Imaging services....................... -- -- 257,820 -- 638,797 Other.................................. 573,030 733,947 -- -- -- ----------- ------------ ------------ ----------- ----------- Consolidated depreciation and amortization....................... $ 573,030 $ 733,947 $ 1,148,583 $ 371,141 $ 1,181,046 =========== ============ ============ =========== =========== IDENTIFIABLE ASSETS BY SEGMENT: Products............................... $ -- $ -- $ 16,001,066 $12,489,000 $23,654,270 Imaging services....................... -- -- 7,206,343 -- 4,903,042 Other.................................. 16,365,039 5,699,304 -- -- -- ----------- ------------ ------------ ----------- ----------- Consolidated assets.................. $16,365,039 $ 5,699,304 $ 23,207,409 $12,489,000 $28,557,312 =========== ============ ============ =========== ===========
Years ended December 31, Three months ended
March 31,2001 2002 2003 2003 2004 Revenues by segment: DIS $ 10,239,256 $ 23,005,004 $ 34,848,641 $ 7,502,926 $ 10,406,978 Product 18,065,131 18,526,651 21,387,729 5,476,291 5,460,886 Consolidated revenues $ 28,304,387 $ 41,531,655 $ 56,236,370 $ 12,979,217 $ 15,867,864
Gross profit by segment:
DIS $ 1,796,946 $ 6,354,186 $ 10,354,574 $ 1,859,740 $ 3,081,982 Product 4,672,626 4,822,214 6,213,479 1,635,313 1,766,480 Consolidated gross profit $ 6,469,572 $ 11,176,400 $ 16,568,053 $ 3,495,053 $ 4,848,462
Net loss by segment:
Loss from operations DIS $ (6,046,596 ) $ (5,420,551 ) $ 1,648,768 $ (257,390 ) $ 510,698 Product (10,899,030 ) (5,426,347 ) (1,932,935 ) (344,646 ) (431,630 ) Consolidated income (loss) from operations (16,945,626 ) (10,846,898 ) (284,167 ) (602,036 ) 79,068 Reconciling items Interest income 118,174 65,078 35,412 10,943 7,907 Interest expense (1,438,787 ) (1,989,907 ) (1,431,549 ) (335,731 ) (322,584 ) Other income (expense) (1,644,542 ) — — — (29,942 ) Consolidated net loss $ (19,910,781 ) $ (12,771,727 ) $ (1,680,304 ) $ (926,824 ) $ (265,551 )
Depreciation, amortization and impairment of intangible assets by segment:
DIS $ 1,767,170 $ 2,451,557 $ 2,151,731 $ 533,583 $ 500,541 Product 1,165,696 1,163,618 1,103,257 271,422 235,341 Consolidated depreciation and amortization $ 2,932,866 $ 3,615,175 $ 3,254,988 $ 805,005 $ 735,882
Identifiable assets by segment:
DIS $ 13,586,502 $ 14,710,088 $ 16,016,201 $ 15,263,960 $ 17,329,671 Product 16,335,908 18,409,152 19,142,590 16,132,277 20,682,231 Consolidated assets $ 29,922,410 $ 33,119,240 $ 35,158,791 $ 31,396,237 $ 38,011,902 Sales to a distributor in Japan represented
8.5% and 5.0%2.2% of total revenues for the year ended December 31,2000 and the six months ended June 30,2001,respectively. The Company did not have any foreignsales to a customer in Puerto Rico represented less than 1% of total revenues for the years ended December 31,19982002 and1999. - -------------------------------------------------------------------------------- F-22DIGIRAD CORPORATION - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED) 10. EMPLOYEE RETIREMENT PLAN2003 and sales to a customer in Russia represented less than 3% of total revenues for the year ended December 31, 2003. Sales to a customer in Canada represented less than 2% of total revenues for the three months ended March 31, 2004.8. Employee Retirement Plan
The Company has a 401(k) retirement plan (the "Plan"), under which all full-time employees may contribute up to
15%20% of their annual salary, within limits. The Company may elect to make discretionary contributions upon the approval of the Board of Directors. ThroughJune 30, 2001,March 31, 2004, the Company had not contributed to the Plan.11. SUBSEQUENT EVENTS9. Subsequent Events
Changes in Capitalization
On
August 23, 2001,April 27, 2004, the Company's board of directors approved the following:
- •
- Upon the effectiveness of the initial public offering contemplated by this prospectus, to reserve 1,400,000 shares of common stock for issuance pursuant to the 2004 Stock Incentive Plan;
- •
- Upon the effectiveness of the initial public offering contemplated by this prospectus, the filing of an amended and restated certificate of incorporation to provide for 150,000,000 shares of authorized common stock and 10,000,000 shares of undesignated preferred stock; and
- •
- The 1-for-3.5 reverse split of the outstanding common stock to be effected prior to completion of this offering.
The 1-for-3.5 reverse stock split was approved by the Company's stockholders on April 30, 2004. The accompanying financial statements give retroactive effect to the reverse stock split for all periods presented.
Settlement Agreement
On April 29, 2004, the Company
issued 2,618,462 shares of Series F preferred stock at $3.25 per share for total proceeds of $8,510,002. These holders ofand certain outside consultants agreed to terminate theSeries F preferred stock are entitled to similar rightsexisting consulting agreements between them andprivilegesasdescribed in Note 6, except that the price-based antidilution provisions of the Series F preferred stocka result, 20,281 outstanding warrants weremodified. In July 2001, the Companycancelled. There wasserved with notice that a complaint had been filed by Medical Management Concepts, Inc. in the United States District Court for the Eastern District of Pennsylvania. The complaint alleges, among other things, breach of the terms of a Services Agreement and an Employee Lease Agreement, each dated September 2000 and entered into by and between DIS and MMC. This complaint seeks recovery of damages for approximately $81,000 plus 12.5% of the adjusted estimated net revenue generated from gross sums billed to our mobile nuclear imaging customers from May 1, 2001 to October 31, 2003. The Company believes it has meritorious defenses against this complaint and that its ultimate resolution will not have a materialno impact on the financialstatements. - -------------------------------------------------------------------------------- F-23[LOGO]- -------------------------------------------------------------------------------- Part IIstatements for the termination of the agreements or cancellation of the warrants.
Loan Modification and Warrant Issuance
On May 7, 2004, the Company agreed to accelerate payments due under certain notes payable and issue warrants to two of its stockholders following the consummation of the initial public offering contemplated by this prospectus. The warrants to purchase 47,618 shares of common stock will be valued using the Black-Scholes option pricing model. The fair value of these warrants is estimated to be approximately $355,000.
5,500,000 Shares
Common Stock
P R O S P E C T U SMerrill Lynch & Co.
JPMorgan
Banc of America Securities LLC
William Blair & Company
, 2004
Through and including , 2004 (the 25th day after commencement of this offering), federal securities law may require all dealers selling our common stock, whether or not participating in this offering, to deliver a prospectus. This delivery requirement is in addition to the obligation of dealers to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions.
PART II—INFORMATION NOT REQUIRED IN PROSPECTUSITEMItem 13.
OTHER EXPENSES OF ISSUANCE AND DISTRIBUTIONOther Expenses of Issuance and DistributionThe
expenses to be paid byfollowing table sets forth theRegistrant are as follows. All amountscosts and expenses, other than theSECunderwriting discount, payable by the registrant in connection with the sale of common stock being registered. All amounts are estimates except the Securities and Exchange Commission registration feethe NASD filing feesand theNasdaqNationalMarket listing fee are estimates.
AMOUNT TO BE PAID ----------SEC registration fee........................................ $ NASD filing fee............................................. Nasdaq National Market listing fee.......................... Legal fees and expenses..................................... Accounting fees and expenses................................ Printing and engraving...................................... Blue sky fees and expenses (including legal fees)........... Transfer agent fees......................................... Miscellaneous............................................... Total................................................... $ ==========ITEMAssociation of Securities Dealers Inc. filing fee.
SEC registration fee $ 11,220 NASD filing fee 9,355 Nasdaq National Market application fee 5,000 Nasdaq National Market entry fee �� 95,000 Nasdaq National Market annual fee (prorated for 2004) 14,811 Accounting fees and expenses 500,000 Legal fees and expenses 800,000 Printing and engraving expenses 200,000 Blue sky fees and expenses 5,000 Transfer agent and registrar fees and expenses 20,000 Miscellaneous 34,614
Total
$
1,695,000
Item 14.INDEMNIFICATION OF DIRECTORS AND OFFICERSIndemnification of Directors and OfficersAs permitted by Section 102 of the Delaware General Corporation Law, we have adopted provisions in our restated certificate of incorporation and restated bylaws, which will become effective following the completion of this offering, that limit or eliminate the personal liability of our directors for a breach of their fiduciary duty of care as a director. The duty of care generally requires that, when acting on behalf of the corporation, directors exercise an informed business judgment based on all material information reasonably available to them. Consequently, a director will not be personally liable to us or our stockholders for monetary damages or breach of fiduciary duty as a director, except for liability for:
- •
- any breach of the director's duty of loyalty to us or our stockholders;
- •
- any act or omission not in good faith or that involves intentional misconduct or a knowing violation of law;
- •
- any act related to unlawful stock repurchases, redemptions or other distributions or payment of dividends; or
- •
- any transaction from which the director derived an improper personal benefit.
These limitations of liability do not affect the availability of equitable remedies such as injunctive relief or rescission. Our restated certificate of incorporation also authorizes us to indemnify our officers, directors and other agents to the fullest extent permitted under Delaware law.
As permitted by Section 145 of the Delaware General Corporation Law,
permits a corporationour restated bylaws provide that:
- •
- we may indemnify our directors, officers, and employees to
include in its charter documents, and in agreements betweenthecorporation and its directors and officers, provisions expanding the scope of indemnification beyond that specifically providedfullest extent permitted by thecurrent law. Article IV ofDelaware General Corporation Law, subject to limited exceptions;- •
- we may advance expenses to our directors, officers and employees in connection with a legal proceeding to the
Registrant's amendedfullest extent permitted by the Delaware General Corporation Law, subject to limited exceptions; andII-1
- •
- the rights provided in our restated bylaws are not exclusive.
Our restated certificate of incorporation,
allowsattached as Exhibit 3.1 hereto, and our restated bylaws, attached as Exhibit 3.2 hereto, provide for the indemnificationof directorsprovisions described above andofficers to the fullest extent permissible under Delaware law. Article VI of the Registrant's bylaws provides for the indemnification of officers, directors and third parties acting on behalf of us if such person acted in good faith and in a manner reasonably believed to be in and not opposed to our best interest, and, with respect to any criminal action or proceeding, the indemnified party had no reason to believe his or her conduct was unlawful. The Registrant haselsewhere herein. In addition, we have entered into separate indemnification agreements, a form of which is attached as Exhibit 10.20 hereto, with our directors andexecutiveofficers which may be broader than the specific indemnification provisions contained inaddition to indemnification provided for in our bylaws, and intends to enter intothe Delaware General Corporation Law. These indemnification agreementswith any new directors and executive officers in the future. The indemnification agreements mayrequirethe Registrant,us, among other things, to indemnify our officers and directorsand officersagainstcertainliabilities that may arise by reason of their status or service as directorsandor officers,(otherother than liabilities arising from willfulmisconduct of a culpable nature),misconduct. These indemnification agreements also require us to advancetheirany expenses incurred by the directors or officers as a result of any proceeding against them as to which they could beindemnified, and to obtainindemnified. In addition, we have purchased a policy of directors' and officers' liability insuranceif available on reasonable terms. At present, there is no litigation or proceeding pending involving a director, officer or employee of the Registrant regarding which indemnification is sought, nor is the Registrant aware of any threatened litigationthatmay result in claims for indemnification. Reference is also made to Section of the Underwriting Agreement, which provides for the indemnification of officers,insures our directors andcontrolling personsofficers against the cost ofthe Registrant against certain liabilities. Thedefense, settlement or payment of a judgment in some circumstances. These indemnificationprovision in the Registrant's amended and restated certificate of incorporation, bylawsprovisions and the indemnification agreementsentered into between the Registrant and each of its - -------------------------------------------------------------------------------- II-1PART II - -------------------------------------------------------------------------------- directors and executive officersmay be sufficiently broad to permit indemnification ofthe Registrant'sour officers and directorsand executive officersfor liabilities, including reimbursement of expenses incurred, arising under the SecuritiesAct of 1933. The Registrant applied for liability insurance for our officers and directors.Act.Reference is made to the following documents filed as exhibits to this
Registration Statementregistration statement regarding relevant indemnification provisions described above and elsewhere in this prospectus:
EXHIBIT DOCUMENT NUMBER - ----------------------------------------------------------------------Document Exhibit
NumberForm of Underwriting Agreement..............................Agreement1.1 Form of Amended andRestated Certificate of Incorporation to be in effectimmediately prior toupon the closing of thisoffering.................................................. 3.2offering3.1 Form of Amended andRestated Bylaws to be in effectimmediately prior toupon the closing of thisoffering......... 3.4offering3.2 Form of Indemnification Agreement........................... 10.28Agreement10.20 ITEM
Item 15.RECENT SALES OF UNREGISTERED SECURITIES (1) On June 23, 1998, the Registrant issuedRecent Sales of Unregistered SecuritiesThe following list sets forth information regarding all securities we have sold since January 2001. All share amounts and
sold 494,071 shares of its Series E Preferred Stock to Johnson & Johnson Development Corporation for an aggregate purchase price of $1,500,000. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuance was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (2) On October 27, 1999, the Registrant issued warrants to purchase up to 197,628 shares of its Series E Preferred Stock with an exercise price of $3.036per share prices reflect a 1-for-200 reverse stock split that was effected in October 2002 and a 1-for-3.5 reverse stock split of our common stock to2 purchasers in connection with a Loanbe effected prior to completion of this offering.
- (1)
- In January, March and
Security Agreement under which the purchasers agreed to loan the Registrant up to $2,000,000. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (3) On March 15, 2000, the Registrant issued and sold 2,194,797 shares of its Series E Preferred Stock to 10 purchasers for an aggregate purchase price of $6,663,415. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (4) OnApril6, 2000, the Registrant issued and sold 1,151,407 shares of its Series E Preferred Stock to 6 purchasers for an aggregate purchase price of $3,495,676. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (5) On May 9, 2000, the Registrant issued warrants to purchase up to 31,208 shares of its Series E Preferred Stock with an exercise price of $3.036 per share to 2 purchasers in connection with a Loan and Security Agreement between the parties in which the purchasers agreed to loan the Registrant up to $2,000,000. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general - -------------------------------------------------------------------------------- II-2PART II - -------------------------------------------------------------------------------- solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (6) On June 9, 2000, the Registrant issued and sold 164,690 shares of its Series E Preferred Stock to Ocean Avenue Investors, LLC--Anacapa Fund I for an aggregate purchase price of $500,000. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuance was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (7) On September 29, 2000, the Registrant2001, we issued and sold to5 purchasers convertible promissory notes in the aggregate principal amount of $2,000,000 that were convertible intoinvestors 9,694 shares ofthe Registrant'sour Series EPreferred Stock.preferred stock, at a purchase price of $607.20 per share, for aggregate consideration of approximately $5.9 million.- (2)
- In January, March, May, July and December 2001, we issued to certain consultants, in connection with and in partial consideration for
entering into the promissory notes, the Registrant also issued the purchasersservices rendered to us, warrants to purchaseup to 65,875an aggregate of 386 shares ofthe Registrant's Series E Preferred Stockour common stock at exercise prices ranging from $700.00 to $2,128.00 per share. Upon completion of this offering, these warrants will remain exercisable for an aggregate of 386 shares of our common stock at exercise prices ranging from $700.00 to $2,128.00 per share.- (3)
- In January and December 2001, we issued to a consulting firm, in connection with and in partial consideration for services rendered to us, warrants to purchase 29 and 7 shares of our common stock, respectively, at an exercise price of
$3.036$1,400.00 and $2,100.00 pershare. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Actshare, respectively. Upon completion of1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investmentthis offering, these warrants will remain exercisable for 29 andrepresented to the Registrant that the securities were being acquired for investment; (8) On August 14, 2000, the Registrant issued warrants to purchase up to 65,8777 shares ofits Series E Preferred Stock withour common stock, respectively, at an exercise price of$3.036$1,400.00 and $2,100.00 per share, respectively.- (4)
- In July 2001, we issued to
2 purchasersa commercial lender, in connection with and in partial consideration for a loan we received, a warrant to purchase 213 shares of our Series E preferred stock at an exercise price of $607.20 per share. Upon completion of this offering, this warrant will be immediately exercisable for 61 shares of our common stock at an exercise price of $2,125.20 per share.II-2
- (5)
- In August 2001, we issued and sold to investors 13,092 shares of our Series F preferred stock, at a purchase price of $650.00 per share, for aggregate consideration of approximately $8.5 million.
- (6)
- In January 2002, we issued to certain existing investors and a new investor convertible promissory notes bearing 12% interest per annum in connection with a
Loanborrowing of an aggregate of approximately $2.0 million from those stockholders andSecurity Agreement betweenthat investor.- (7)
- In January 2002, and in connection with the
partiesconvertible promissory note issuance described inwhich the purchasers agreed to loan the Registrant up to $1,000,000. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (9) On November 10, 2000, the Registrantparagraph (3), we issued and sold3,005,595the parties referred to in paragraph (3) warrants to purchase an aggregate of 227 shares ofits Series E Preferred Stock to 10 purchasersour common stock for $0.70 per underlying share. Upon the completion of this offering, these warrants will remain exercisable for an aggregatepurchase priceof$9,124,987, which amount reflected the conversion of $2,000,000 of the Registrant's convertible promissory notes into227 shares ofSeries E Preferred Stock. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (10) On November 14, 2000, the Registrant issued a warrant to purchase up to 10,000 shares of its Common Stock withour common stock at an exercise price of$1.50$1,050.00 pershare to Cardiovascular Consultantsshare.- (8)
- In April 2002, each of the convertible promissory notes described in
connection with a consulting relationship. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuanceparagraph (6) wasmade without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (11) On November 14, 2000, the Registrant issued a warrant to purchase up to 500converted into shares ofits Common Stock with an exercise priceour Series H preferred stock.- (9)
- In April, May and June 2002, we issued shares of
$3.04 per shareour Series G preferred stock toRobert McKenzie in connection with a consulting relationship. The Registrant relied onexisting investors upon their exchange of 9,611 shares of our Series E preferred stock, for no additional consideration to us. Upon theexemption provided by Section 4(2) and/or Regulation D promulgated undercompletion of this offering, theSecurities Act5,447 shares of1933. The issuance was made without general - -------------------------------------------------------------------------------- II-3PART II - -------------------------------------------------------------------------------- solicitation or advertising. The purchaser was a sophisticated investor with accessour Series E preferred stock outstanding as of December 31, 2003 will convert into 1,554 shares of our common stock.- (10)
- In April, May and June 2002, we issued shares of our Series G preferred stock to
all relevant information necessaryexisting investors upon their exchange of 12,322 shares of our Series F preferred stock, for no additional consideration toevaluateus. Upon theinvestmentcompletion of this offering, the 770 shares of our Series F preferred stock outstanding as of December 31, 2003 will convert into approximately 235 shares of our common stock.- (11)
- In April, May and
represented to the Registrant that the securities were being acquired for investment; (12) On December 8, 2000, the RegistrantJune 2002, we issued and sold181,15731,008,401 shares ofitsour SeriesE Preferred StockG preferred stock to6 purchasers for an aggregateexisting investors, at a purchaseprice of $549,993. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (13) On December 14, 2000, the Registrant issued 300,000 shares of its Common Stock to Dr. John F. Kilgore in connection with Dr. Kilgore's entering into a Non-Competition and Non-Disclosure Agreement. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuance was made without general solicitation or advertising. Dr. Kilgore was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (14) On January 4, 2001, the Registrant issued warrants to purchase up to 20,000 shares of its Common Stock with an exercise price of $1.50 per share to 2 purchasers in connection with consulting relationships. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (15) On January 19, 2001, the Registrant issued and sold 683,463 shares of its Series E Preferred Stock to 4 purchasers for an aggregate purchase price of $2,074,994. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (16) On January 26, 2001, the Registrant issued a warrant to purchase up to 20,000 shares of its Common Stock with an exerciseprice of $2.00 per share, in exchange for the conversion of outstanding shares of our Series A, Series B, Series C, Series D, Series E and Series F preferred stock having an aggregate liquidation value of approximately $62.0 million.- (12)
- Following the issuances of our Series G preferred stock referred to
Oklahoma Cardiovascular Associatesin paragraphs (9), (10) and (11), we issued shares of our common stock to existing investors upon their election to convert 24,191 shares of Series G preferred stock. Upon the completion of this offering, the 30,984,210 shares of Series G preferred stock outstanding as of December 31, 2004 will convert into 8,852,664 shares of our common stock.- (13)
- In April, May and June 2002, and concurrently with the conversion of the outstanding shares of our Series A, Series B, Series C, Series D, Series E and Series F preferred stock described in paragraph (11), we issued and sold to investors 12,561,706 shares of our Series H preferred stock, at a purchase price of $1.39 per share, for aggregate consideration of approximately $17.5 million. Upon the completion of this offering, the 12,561,706 shares of our Series H preferred stock outstanding as of December 31, 2003 will convert into 3,588,952 shares of our common stock.
- (14)
- In March 2002, we issued to two of our consultants, in connection with
a consulting relationship. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuance was made without general solicitation or advertising. The purchaser was a sophisticated investor with accessservices rendered toall relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (17) On March 1, 2001, the Registrant issuedus, warrants to purchaseup to 10,000an aggregate of 16 shares ofits Common Stock withour common stock at an exercise price of$3.04$2,100.00 pershare to 2 purchasers in connection with consulting relationships. The Registrant relied onshare. Upon theexemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Actcompletion of1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (18) On March 9, 2001, the Registrant issued and sold 150,362 shares of its Series E Preferred Stock to 3 purchasersthis offering, these warrants will remain exercisable for an aggregatepurchase priceof$456,499. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of - -------------------------------------------------------------------------------- II-4PART II - -------------------------------------------------------------------------------- 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (19) On March162001, the Registrant issued and sold 296,050shares ofits Series E Preferred Stock to 11 purchasers for an aggregate purchase price of $898,808. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (20) On March 28, 2001, the Registrant issued warrants to purchase up to 20,000 shares of its Common Stock withour common stock at an exercise price of$3.04$2,100.00 pershareshare.- (15)
- In November 2002, we issued to
2 purchasersa third party consulting firm, in connection withconsulting relationships. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with accessservices rendered toall relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (21) On April 9, 2001, the Registrant issued and sold 808,836 shares of its Series E Preferred Stock to Merrill Lynch Ventures, LLC for an aggregate purchase price of $2,455,626. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuance was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (22) On May 15, 2001, the Registrant issuedus, warrants to purchaseup to 20,000an aggregate of 28,572 shares ofits Common Stock withour common stock at an exercise price of$3.04$4.90 pershareshare. Upon the completion of this offering, these warrants will remain exercisable for an aggregate of 28,572 shares of our common stock at an exercise price of $4.90 per share.II-3
- (16)
- In November 2002, we issued to
3 purchasersthe two principals of the third party consulting firm described in paragraph (15), in connection withconsulting relationships. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with accessservices rendered toall relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (23) On July 31, 2001, the Registrant issued a warrantus, warrants to purchaseup to 42,490an aggregate of 28,572 shares ofits Series E Preferred Stockour common stock at an exercise price of $4.90 per share, warrants toSilicon Valley Bankpurchase 19,600 shares of which were subsequently terminated. Upon the completion of this offering, the remaining warrants will remain exercisable for an aggregate of 8,972 shares of our common stock at an exercise price of $4.90 per share.- (17)
- In July 2003, we issued to two of our consultants, in connection with
a Loan and Security Agreement. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuance was made without general solicitation or advertising. The purchaser was a sophisticated investor with accessservices rendered toall relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (24) On July 31, 2001, the Registrant issued a warrantus, warrants to purchaseup to 100,000an aggregate of 429 shares ofits Common Stockour common stock at an exercise price of $4.90 per share.- (18)
- In February 2004, we issued to
McAdams and Whitman Consultingtwo of our consultants, in connection witha Consulting Agreement. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Actservices rendered to us, warrants to purchase an aggregate of1933. The issuance was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (25) On August 23, 2001, the Registrant issued and sold 2,618,4625,715 shares ofits Series F Preferred Stock to 25 purchasers forour common stock at anaggregate purchaseexercise price of$8,510,002. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a - -------------------------------------------------------------------------------- II-5PART II - -------------------------------------------------------------------------------- sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment; (26) Prior to$5.50 per share.- (19)
- From January
1, 1998, the Registrant2001 through April 28, 2004, we granted options to purchase 2,058,282 shares ofits Common Stockour common stock tovariousemployees, directorsemployeesand consultantspursuant to its 1995under our 1991 Stock OptionPlan. With respect to all grants of options, each of the issuances were exempt from the registration requirements of the Securities Act of 1933 either by virtue of either (a) Section 4(2) as transactions not involving a public offering, or (b) Rule 701; (27) From time to time since January 1, 1998, the Registrant has granted options to purchase shares of its Common Stock to various directors, employees and consultants pursuant to itsProgram, 1997 Stock Option/Stock IssuancePlan. With respectPlan and 1998 Stock Option/Stock Issuance Plan at exercise prices ranging from $0.49 per share toall grants of$2,128.00 per share. Of the optionseach of the issuances were exempt from the registration requirements of the Securities Act of 1933 either by virtue of (a) Section 4(2) as transactions not involving a public offering, or (b) Rule 701; (28) From time to time since January 1, 1998, the Registrant hasgranted,options to purchase1,634,826 remain outstanding, 44,690 shares ofits Common Stock to various directors, employees and consultantscommon stock have been purchased pursuant toitsexercises of stock options and 378,766 shares have been repurchased or terminated and returned to the stock option pool available under our 1991 Stock Option Program, 1997 Stock Option/Stock Issuance Plan and 1998 Stock Option/Stock Issuance Plan.With respect to all grants of options, eachThe offers, sales, and issuances of the
issuancessecurities described in paragraphs (1), (3) - (13) and (15) were deemed to be exempt from registration under theregistration requirementsSecurities Act in reliance on Section 4(2) of the Securities Act because the issuance of1933 either by virtue of (a) Section 4(2) as transactionssecurities to the recipients did notinvolvinginvolve a publicoffering, or (b) Rule 701; (29) As of August 23, 2001, the Registrant has issued and sold, in the aggregate, 393,774 shares of its Common Stock at a per share exercise price of $0.21 to $0.75 to directors, employees and consultants pursuant to their exercise of options to purchase Common Stock issued pursuant under the Registrant's 1995 Stock Option Plan; (30) As of August 23, 2001, the Registrant has issued and sold, in the aggregate, 127,161 shares of its Common Stock at a per share exercise price of $0.21 to $0.35 to employees and consultants pursuant to their exercise of options to purchase Common Stock issued pursuant under the Registrant's 1997 Stock Option/Stock Issuance Plan; and (31) As of August 23, 2001, the Registrant has issued and sold, in the aggregate, 518,789 shares of its Common Stock for per share exercise prices ranging from $0.35 to $1.50 to directors, employees and consultants pursuant to their exercise of options to purchase Common Stock issued pursuant under the Registrant's 1998 Stock Option/Stock Issuance Plan.offering. The recipients ofthe above-describedsecurities in each such transaction represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distributionthereof.thereof and appropriate legends were affixed to the share certificates and warrants issued in such transactions. Each of the recipients of securities in the transactions described in paragraphs (1), (3) - (13) and (15) were accredited or sophisticated persons and had adequate access, through employment, business or other relationships, to information about us.The offers, sales and issuances of the options and common stock described in paragraphs (2), (14) and (16) - (19) were deemed to be exempt from registration under the Securities Act in reliance on Rule 701 because the transactions were under compensatory benefit plans and contracts relating to compensation as provided under Rule 701. The recipients of such options and common stock were our employees, directors or bona fide consultants and received the securities under our compensatory benefit plans or a contract relating to compensation. Appropriate legends were affixed to the
stockshare certificates issued in such transactions.AllEach of these recipients had adequate access, through employment or other relationships, to information aboutthe Registrant. Nous.There were no underwriters
were involvedemployed inthe distributionconnection with any of theabove-described securities. - -------------------------------------------------------------------------------- II-6PART II - -------------------------------------------------------------------------------- ITEMtransactions set forth in this Item 15.II-4
Item 16.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a)Exhibits and Financial Statement Schedules
- (a)
- The following exhibits are filed herewith:
NUMBER DESCRIPTION - ------------------------------------------------------------------------------------Exhibit
NumbersExhibit Description 1.1** Form of Underwriting Agreement. 3.1* Amended and Restated Certificate of Incorporation. 3.2**Form of Amended andRestated Certificate of Incorporation to be in effectimmediately prior toupon the closing ofthe initial publicthis offering.3.3* Amended and Restated Bylaws. 3.4*3.2** Form of Amended andRestated Bylaws to be in effectimmediately prior toupon the closing ofthe initial publicthis offering.4.1** Form of Specimen CommonStock Certificate.4.2 Amended and Restated Investors' Rights Agreement by and among Digirad Corporation and the investors listed on the schedule attached thereto, dated April 23, 2002, as amended. 5.1** Opinion of Brobeck, PhlegerMorrison &HarrisonFoerster LLP.10.1*+10.1† License Agreement by and between RegistrantDigirad Corporation and the Regents of the University of California, dated May 19, 1999, as amended.10.2*+10.2† Software License Agreement by and between RegistrantDigirad Corporation and Segami Corporation, dated June 16,1999. 10.3*1999, as amended.10.3† License Agreement by and between Digirad Corporation and Cedars-Sinai Health System, dated May 22, 2001. 10.4† License Agreement by and between Digirad Corporation and Cedars-Sinai Health System, dated April 1, 2003. 10.5† Development and Supply Agreement by and between Digirad Corporation and QuickSil Inc., dated June 18, 1999 10.6 Loan and Security Agreement by and between Registrant and MMC/GATX Partnership No. I, dated October 27, 1999, as amended. 10.4* Promissory Note Agreement by and between Registrant and MMC/GATX Partnership No. I, dated November 1, 1999. 10.5* Promissory Note Agreement by and between Registrant and MMC/GATX Partnership No. I, dated May 12, 2000, as amended. 10.6* Promissory Note Agreement by and between Registrant and MMC/GATX Partnership No. I, dated August 15, 2000, as amended. 10.7* Loan and Security Agreement by and between RegistrantDigirad Corporation and Silicon Valley Bank, datedas of April 1, 2000,July 31, 2001, as amended.10.7** Irrevocable Standby Letter of Credit executed by Silicon Valley Bank in favor of Digirad Corporation, dated November 5, 2003. 10.8** Loan and SecurityAgreement by and betweenRegistrantDigirad Corporation andSilicon Valley Bank,Gerald G. Loehr Trust, dated September 1, 1993, as amended.10.9** Loan Agreement by and between Digirad Corporation and Clinton L. Lingren, dated September 1, 1993, as amended. 10.10** Loan Agreement by and between Digirad Corporation and Jack F. Butler, dated September 1, 1993, as amended. 10.11** Equipment Lease Agreement by and between Orion Imaging Systems, Inc. and MarCap Corporation, dated October 1, 2000. 10.12** Equipment Lease Agreement by and between Digirad Imaging Solutions, Inc. and MarCap Corporation, dated June 13, 2003. 10.13** Master Equipment Lease Agreement by and between Digirad Imaging Solutions, Inc. and DVI Financial Services, Inc., dated May 24, 2001. 10.14** Sublease Agreement by and between Digirad Corporation as sublessee and REMEC, Inc. as sublessor, dated November 3, 2003. 10.15**# 1991 Stock Option Program Stock Option Agreement. 10.16**# 1997 Stock Option/Stock Issuance Plan, as amended. 10.17**# 1998 Stock Option/Stock Issuance Plan, as amended. 10.18**# 2004 Stock Incentive Plan. 10.19**# 2004 Non-Employee Director Option Program. 10.20**# Form of July 31, 2001. 10.9*Indemnification Agreement.II-5
10.21# Letter Agreement by and between Digirad Corporation and David M. Sheehan, dated June 11, 2002. 10.22** Loan and Security Agreement by and between Orion Imaging Systems, Inc., Digirad Imaging Systems, Inc. and Heller Healthcare Finance, Inc., dated January 9, 2001. 10.10*2001, as amended.10.23** Master Lease Agreement by and between RegistrantDigirad Corporation and GE Healthcare Financial Services, dated September 26, 2000.10.11* Equipment Lease10.25† Agreement for Services by and between Registrant and MarCap Corporation, dated October 1, 2000. 10.12* Lease Agreement by and between Registrant and Judd/King No. 1, a California general partnership, dated January 27, 1998, as amended, for the property located at 9350 Trade Place, San Diego, California. 10.13* Asset Purchase Agreement by and amongDigirad ImagingSystems,Solutions, Inc. and MBR Associates, Inc.,Nuclear Imaging Systems, Inc. and Cardiovascular Concepts, P.C.,datedSeptember 29, 2000. 10.14* Asset Purchase Agreement by and among Registrant, Orion Imaging Systems, Inc., Florida Cardiology and Nuclear Medicine Group, P.A. and Dr. John Kilgore, dated August 31, 2000, as amended. 10.15* Convertible Promissory Note and Warrant Purchase Agreement by and among Registrant and the investors listed on Exhibit A, dated September 29, 2000. 10.16*April 1, 2002.10.26** Form of Warrant to purchase shares of Series E Preferred Stock by and between Registrantamong Digirad Corporation and the investors listed on the schedule attachedschedule. 10.17*thereto.10.27** Form of Warrant to purchase shares of Series FE Preferred Stock by andbetween Registrantamong Digirad Corporation and the investors listed on the schedule attachedschedule.- -------------------------------------------------------------------------------- II-7PART II - --------------------------------------------------------------------------------
NUMBER DESCRIPTION - ------------------------------------------------------------------------------------10.18* Fourth Additional Series E Preferredthereto.10.28 Form of Warrant to purchase shares of Common Stock Purchase Agreementby and amongRegistrantDigirad Corporation and the investors listed onSchedule 1 thereto, dated November 10, 2000, as amended. 10.19*the schedule attached thereto.10.29** Warrant to purchase shares of Series FE Preferred StockPurchase Agreementby and between Digirad Corporation and Silicon Valley Bank, dated July 31, 2001.10.31** Form of Warrant to purchase shares of Common Stock by and among RegistrantDigirad Corporation and the investors listed onSchedule 1 thereto, dated August 23, 2001. 10.20* Amended and Restated Investors' Rights Agreementthe schedule attached thereto.10.32 Form of Warrant to purchase shares of Common Stock by and among RegistrantDigirad Corporation and the investors listed onSchedule A thereto, dated August 23, 2001. 10.21* Amended and Restated Co-Sale Agreementthe schedule attached thereto.10.33 Form of Warrant to purchase shares of Common Stock by and among RegistrantDigirad Corporation and the investors listed onSchedule A thereto, dated November 10, 2000. 10.22* Amended and Restated Series E Voting Agreement by and among Registrant andtheinvestors listed therein, dated November 10, 2000. 10.23* 1998 Stock Option/Stock Issuance Plan, as amended. 10.24* 1998 Stock Option/Stock Issuance Plan, Form of Notice of Grant. 10.25* 1998 Stock Option/Stock Issuance Plan, Form of Stock Option Agreement. 10.26* 1998 Stock Option/Stock Issuance Plan, Form of Stock Purchase Agreement. 10.27* 2001 Stock Incentive Plan. 10.28* Form of Indemnification Agreement.schedule attached thereto.21.1** Subsidiaries of Registrant.Digirad Corporation.23.1 Consent of Ernst & Young LLP, Independent Auditors. 23.2** Consent of Brobeck, PhlegerMorrison &HarrisonFoerster LLP (included in Exhibit 5.1).24.1 Powers24.1** Power of Attorney (included inon signature page).
* To be included by amendment.
**
Previously filed.
#
Indicates management contract or compensatory plan.
†
Application has been made to theSignature Page).Securities and Exchange Commission to seek confidential treatment of certain provisions. Omitted material for which confidential treatment has been requested has been filed separately with the Securities and Exchange Commission.- --------- * To be filed by amendment. + Certain portions of this Exhibit for which confidential treatment has been requested have been redacted and filed separately with the Securities and Exchange Commission.II-6
- (b)
- Financial
Statement Schedules.statement schedules.SCHEDULE
II--VALUATIONII—VALUATION AND QUALIFYING ACCOUNTSAND RESERVES All
Reserves for
bad debt(1)Reserves for billing adjustments and contractual
allowances(2)Excess and
Obsolete
Inventory(3)Balance at December 31, 2000 $ 39,121 $ 480,220 $ 135,000 Provision 676,476 2,564,911 56,808 Write-offs and recoveries, net (229,678 ) (2,694,633 ) — Balance at December 31, 2001 485,919 350,098 191,808 Provision 719,335 938,223 234,731 Write-offs and recoveries, net (735,337 ) (1,087,500 ) (187,420 ) Balance at December 31, 2002 469,917 200,821 239,119 Provision 299,273 512,919 177,360 Write-offs and recoveries, net (394,021 ) (455,322 ) (80,174 ) Balance at December 31, 2003 $ 375,169 $ 258,418 $ 336,305
- (1)
- The provision was charged against other general and administrative expenses.
- (2)
- The provision was charged against revenue.
- (3)
- The provision was charged against cost of revenues.
No other financial statement schedules are
omittedprovided becausethey are not applicable orthe information called for is not required orbecause the required informationis shown either in theConsolidated Financial Statements of Digirad Corporationconsolidated financial statements or the notes thereto.ITEM
Item 17.UNDERTAKINGSUndertakings.The undersigned
Registranthereby undertakes to provide to theUnderwriterunderwriters at the closing specified in theUnderwriting Agreement,underwriting agreement certificates in such denominations and registered in such names as required by theUnderwriterunderwriters to permit prompt delivery to each purchaser.Insofar as indemnification for liabilities arising under the Securities Act
of 1933may be permitted to our directors, officers and controlling personsof the Registrantpursuant to theforegoing provisions,DGCL, our restated certificate of incorporation or our restated bylaws, the underwriting agreement or otherwise,the Registrant haswe have been advised that in the opinion of theSECSecurities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment bythe Registrantus of expenses incurred or paid bya director, officerone of our directors, officers, or controllingperson of the Registrantpersons in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registeredthe Registranthereunder, we will, unless in the opinion of our counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the- -------------------------------------------------------------------------------- II-8PART II - --------------------------------------------------------------------------------question of whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue.The undersigned RegistrantWe hereby
undertakesundertake that:
(1) For purposes of determining any liability under the Securities Act,
of 1933the information omitted from the form of prospectus filed as part of thisRegistration Statementregistration statement in reliance upon Rule 430A and contained in a form of prospectus filed bythe registrantus pursuant to Rule424 (b)424(b)(1) or (4),or 497(h) underII-7
the Securities Act
of 1933shall be deemed to be part of this Registration Statement as of the time it was declared effective; and(2) For the purpose of determining any liability under the Securities Act,
of 1933each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, andthethis offering of such securities at that time shall be deemed to be the initialbona fide offering thereof.- -------------------------------------------------------------------------------- II-9- -------------------------------------------------------------------------------- SignaturesII-8
Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Amendment No. 4 to Registration Statement (No. 333-113760) to be signed on its behalf by the undersigned, thereunto duly authorized in San Diego, California, on this
24th4th day ofAugust 2001.June, 2004.
DIGIRAD CORPORATION
By:/s/ R. SCOTT HUENNEKENS -----------------------------------------
/s/ DAVID M. SHEEHANName: R. Scott HuennekensDavid M. Sheehan Title: PRESIDENT AND CHIEF EXECUTIVE OFFICERPresident and Chief Executive Officer POWER OF ATTORNEY We, the undersigned directors and/or officers of Digirad Corporation (the "Company"), hereby severally constitute and appoint R. Scott Huennekens, President and Chief Executive Officer, and Gary J.G. Atkinson, Chief Financial Officer, and each of them individually, with full powers of substitution and resubstitution, our true and lawful attorneys, with full powers to them and each of them to sign for us, in our names and in the capacities indicated below, the registration statement on Form S-1 filed with the SEC, and any and all amendments to said registration statement (including post-effective amendments), and any registration statement filed pursuant to Rule 462(b) under the Securities Act of 1933 in connection with the registration under the Securities Act of 1933 of our equity securities, and to file or cause to be filed the same, with all exhibits thereto and other documents in connection therewith, with the SEC, granting unto said attorneys, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as each of them might or could do in person, and hereby ratifying and confirming all that said attorneys, and each of them, or their substitute or substitutes, shall do or cause to be done by virtue of this Power of Attorney.Pursuant to the requirements of the Securities Act of 1933, as amended, this Amendment No. 4 to Registration Statement (No. 333-113760) has been signed by the following persons in the capacities
indicatedand onAugust 24, 2001:the dates indicated:
SIGNATURE TITLE DATE - ----------------------------------------------------------------------------------------------------/s/ R. SCOTT HUENNEKENS - ---------------------------------Name Title Date /s/ DAVID M. SHEEHAN
David M. SheehanPresident, Chief Executive Officer August 24, 2001 R. Scott Huennekensand Director/s/ GARY J.G. ATKINSON - ---------------------------------(Principal Executive Officer)June 4, 2004
/s/ TODD P. CLYDE
Todd P. Clyde
Chief Financial Officer(principal August 24, 2001 Gary J.G. Atkinson financial(Principal Financial andaccounting officer) /s/ TIMOTHYAccounting Officer)
June 4, 2004
*
Timothy J.WOLLAEGER - ---------------------------------Wollaeger
Chairman of the Board of DirectorsAugust 24, 2001 Timothy J. Wollaeger /s/ R. KING NELSON - ---------------------------------
June 4, 2004
*
Raymond V. Dittamore
DirectorAugust 24, 2001
June 4, 2004
*
Robert M. Jaffe
Director
June 4, 2004
*
R. King Nelson/s/ BRAD NUTTER - ---------------------------------
DirectorAugust 24, 2001 Brad Nutter- -------------------------------------------------------------------------------- II-10
SIGNATURE TITLE DATE - ----------------------------------------------------------------------------------------------------/s/ KENNETH E. OLSON - --------------------------------- Director August 24, 2001
June 4, 2004
*
Kenneth E. Olson/s/ DOUGLAS REED, M.D. - ---------------------------------
DirectorAugust 24, 2001
June 4, 2004
*
Douglas Reed, M.D.
Director
June 4, 2004- -------------------------------------------------------------------------------- II-11SCHEDULE II - -------------------------------------------------------------------------------- DIGIRAD CORPORATION VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
RESERVES FOR EXCESS AND RESERVES FOR RESERVES FOR OBSOLETE PRODUCT BAD DEBT INVENTORY WARRANTY - --------------------------------------------------------------------------------------------------------Balance at December 31, 1997................................ $ -- $ -- $ -- Provision................................................. -- -- -- Write-offs and recoveries, net............................ -- -- -- ------- -------- ----------- Balance at December 31, 1998................................ -- -- -- Provision................................................. -- -- 22,523 Write-offs and recoveries, net............................ -- -- -- ------- -------- ----------- Balance at December 31, 1999................................ -- -- 22,523 Provision................................................. 39,121 135,000 2,062,427 Write-offs and recoveries, net............................ -- -- (1,050,950) ------- -------- ----------- Balance at December 31, 2000................................ $39,121 $135,000 $ 1,034,000 ======= ======== ===========
*By:
/s/ DAVID M. SHEEHAN
David M. Sheehan
Attorney-in-fact- -------------------------------------------------------------------------------- S-1- --------------------------------------------------------------------------------II-9
NUMBER DESCRIPTION - ------------------------------------------------------------------------------------Exhibit
NumbersExhibit Description 1.1** Form of Underwriting Agreement. 3.1* Amended and Restated Certificate of Incorporation. 3.2**Form of Amended andRestated Certificate of Incorporation to be in effectimmediately prior toupon the closing ofthe initial publicthis offering.3.3* Amended and Restated Bylaws. 3.4*3.2** Form of Amended andRestated Bylaws to be in effectimmediately prior toupon the closing ofthe initial publicthis offering.4.1** Form of Specimen CommonStock Certificate.4.2 Amended and Restated Investors' Rights Agreement by and among Digirad Corporation and the investors listed on the schedule attached thereto, dated April 23, 2002, as amended. 5.1** Opinion of Brobeck, PhlegerMorrison &HarrisonFoerster LLP.10.1*+10.1† License Agreement by and between RegistrantDigirad Corporation and the Regents of the University of California, dated May 19, 1999, as amended.10.2*+10.2† Software License Agreement by and between RegistrantDigirad Corporation and Segami Corporation, dated June 16,1999. 10.3*1999, as amended.10.3† License Agreement by and between Digirad Corporation and Cedars-Sinai Health System, dated May 22, 2001. 10.4† License Agreement by and between Digirad Corporation and Cedars-Sinai Health System, dated April 1, 2003. 10.5† Development and Supply Agreement by and between Digirad Corporation and QuickSil Inc., dated June 18, 1999 10.6 Loan and Security Agreement by and between Registrant and MMC/GATX Partnership No. I, dated October 27, 1999, as amended. 10.4* Promissory Note Agreement by and between Registrant and MMC/GATX Partnership No. I, dated November 1, 1999. 10.5* Promissory Note Agreement by and between Registrant and MMC/GATX Partnership No. I, dated May 12, 2000, as amended. 10.6* Promissory Note Agreement by and between Registrant and MMC/GATX Partnership No. I, dated August 15, 2000, as amended. 10.7* Loan and Security Agreement by and between RegistrantDigirad Corporation and Silicon Valley Bank, datedas of April 1, 2000,July 31, 2001, as amended.10.7** Irrevocable Standby Letter of Credit executed by Silicon Valley Bank in favor of Digirad Corporation, dated November 5, 2003. 10.8** Loan and SecurityAgreement by and betweenRegistrantDigirad Corporation andSilicon Valley Bank,Gerald G. Loehr Trust, dated September 1, 1993, as amended.10.9** Loan Agreement by and between Digirad Corporation and Clinton L. Lingren, dated September 1, 1993, as amended. 10.10** Loan Agreement by and between Digirad Corporation and Jack F. Butler, dated September 1, 1993, as amended. 10.11** Equipment Lease Agreement by and between Orion Imaging Systems, Inc. and MarCap Corporation, dated October 1, 2000. 10.12** Equipment Lease Agreement by and between Digirad Imaging Solutions, Inc. and MarCap Corporation, dated June 13, 2003. 10.13** Master Equipment Lease Agreement by and between Digirad Imaging Solutions, Inc. and DVI Financial Services, Inc., dated May 24, 2001. 10.14** Sublease Agreement by and between Digirad Corporation as sublessee and REMEC, Inc. as sublessor, dated November 3, 2003. 10.15**# 1991 Stock Option Program Stock Option Agreement. 10.16**# 1997 Stock Option/Stock Issuance Plan, as amended. 10.17**# 1998 Stock Option/Stock Issuance Plan, as amended. 10.18**# 2004 Stock Incentive Plan. 10.19**# 2004 Non-Employee Director Option Program. 10.20**# Form of July 31, 2001. 10.9*Indemnification Agreement.10.21# Letter Agreement by and between Digirad Corporation and David M. Sheehan, dated June 11, 2002. 10.22** Loan and Security Agreement by and between Orion Imaging Systems, Inc., Digirad Imaging Systems, Inc. and Heller Healthcare Finance, Inc., dated January 9, 2001. 10.10*2001, as amended.
10.23** Master Lease Agreement by and between RegistrantDigirad Corporation and GE Healthcare Financial Services, dated September 26, 2000.10.11* Equipment Lease10.25† Agreement for Services by and between Registrant and MarCap Corporation, dated October 1, 2000. 10.12* Lease Agreement by and between Registrant and Judd/King No. 1, a California general partnership, dated January 27, 1998, as amended, for the property located at 9350 Trade Place, San Diego, California. 10.13* Asset Purchase Agreement by and amongDigirad ImagingSystems,Solutions, Inc. and MBR Associates, Inc.,Nuclear Imaging Systems, Inc. and Cardiovascular Concepts, P.C.,datedSeptember 29, 2000. 10.14* Asset Purchase Agreement by and among Registrant, Orion Imaging Systems, Inc., Florida Cardiology and Nuclear Medicine Group, P.A. and Dr. John Kilgore, dated August 31, 2000, as amended. 10.15* Convertible Promissory Note and Warrant Purchase Agreement by and among Registrant and the investors listed on Exhibit A, dated September 29, 2000. 10.16*April 1, 2002.10.26** Form of Warrant to purchase shares of Series E Preferred Stock by and between Registrantamong Digirad Corporation and the investors listed on the schedule attachedschedule. 10.17*thereto.10.27** Form of Warrant to purchase shares of Series FE Preferred Stock by andbetween Registrantamong Digirad Corporation and the investors listed on the schedule attachedschedule. 10.18* Fourth Additional Series E Preferredthereto.10.28 Form of Warrant to purchase shares of Common Stock Purchase Agreementby and amongRegistrantDigirad Corporation and the investors listed onSchedule 1 thereto, dated November 10, 2000, as amended. 10.19*the schedule attached thereto.10.29** Warrant to purchase shares of Series FE Preferred StockPurchase Agreementby and between Digirad Corporation and Silicon Valley Bank, dated July 31, 2001.10.31** Form of Warrant to purchase shares of Common Stock by and among RegistrantDigirad Corporation and the investors listed onSchedule 1 thereto, dated August 23, 2001.INDEX TO EXHIBITS - --------------------------------------------------------------------------------
NUMBER DESCRIPTION - ------------------------------------------------------------------------------------10.20* Amended and Restated Investors' Rights Agreementthe schedule attached thereto.10.32 Form of Warrant to purchase shares of Common Stock by and among RegistrantDigirad Corporation and the investors listed onSchedule A thereto, dated August 23, 2001. 10.21* Amended and Restated Co-Sale Agreementthe schedule attached thereto.10.33 Form of Warrant to purchase shares of Common Stock by and among RegistrantDigirad Corporation and the investors listed onSchedule A thereto, dated November 10, 2000. 10.22* Amended and Restated Series E Voting Agreement by and among Registrant andtheinvestors listed therein, dated November 10, 2000. 10.23* 1998 Stock Option/Stock Issuance Plan, as amended. 10.24* 1998 Stock Option/Stock Issuance Plan, Form of Notice of Grant. 10.25* 1998 Stock Option/Stock Issuance Plan, Form of Stock Option Agreement. 10.26* 1998 Stock Option/Stock Issuance Plan, Form of Stock Purchase Agreement. 10.27* 2001 Stock Incentive Plan. 10.28* Form of Indemnification Agreement.schedule attached thereto.21.1** Subsidiaries of Registrant.Digirad Corporation.23.1 Consent of Ernst & Young LLP, Independent Auditors. 23.2** Consent of Brobeck, PhlegerMorrison &HarrisonFoerster LLP (included in Exhibit 5.1).24.1 Powers24.1** Power of Attorney (included inon signature page).
* To be included by amendment.
**
Previously filed.
#
Indicates management contract or compensatory plan.
†
Application has been made to theSignature Page).Securities and Exchange Commission to seek confidential treatment of certain provisions. Omitted material for which confidential treatment has been requested has been filed separately with the Securities and Exchange Commission.- --------- * To be filed by amendment. + Certain portions
TABLE OF CONTENTS
PROSPECTUS SUMMARY
Digirad Corporation
THE OFFERING
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
RISK FACTORS
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
USE OF PROCEEDS
DIVIDEND POLICY
CAPITALIZATION
DILUTION
SELECTED CONSOLIDATED FINANCIAL DATA
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS
MANAGEMENT
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
PRINCIPAL STOCKHOLDERS
DESCRIPTION OF CAPITAL STOCK
SHARES ELIGIBLE FOR FUTURE SALE
UNDERWRITING
LEGAL MATTERS
EXPERTS
WHERE YOU CAN FIND MORE INFORMATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report ofthis Exhibit for which confidential treatment has been requested have been redactedErnst & Young LLP, Independent Auditors
Digirad Corporation Consolidated Balance Sheets
Digirad Corporation Consolidated Statements of Operations
Digirad Corporation Consolidated Statements of Changes in Stockholders' Equity (Deficit)
Digirad Corporation Consolidated Statements of Cash Flows
Digirad Corporation Notes to Consolidated Financial Statements
PART II—INFORMATION NOT REQUIRED IN PROSPECTUSItem 13. Other Expenses of Issuance and
filed separately with theDistribution
Item 14. Indemnification of Directors and Officers
Item 15. Recent Sales of Unregistered Securities
Item 16. Exhibits andExchange Commission.