<Page>
As filed with the Securities and Exchange Commission on November 5, 2001
Registration No. 333-68256
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------
AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
DIGIRAD CORPORATION
(Exact Name of Registrant as Specified in its Charter)
<Table>
Delaware 3845 33-0145723
(State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer
Incorporation or Organization) Classification Code Number) Identification Number)
</Table>
--------------------------
9350 TRADE PLACE
SAN DIEGO, CALIFORNIA 92126-6334
(858) 578-5300
(Address, Including Zip Code, and Telephone Number, Including Area Code, 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,
of Agent for Service)
--------------------------
Copies to:
<Table>
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, NEW YORK 10016
(858) 720-2500 (212) 210-9511
</Table>
--------------------------
Approximate date of commencement of proposed sale to the public:
As soon as practicable after the effective date of this Registration Statement.
--------------------------
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. / /
If 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. / /
If 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. / /
If 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. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434, check
the following box. / /
--------------------------
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.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<Page>
THE INFORMATION IN THIS PROSPECTUS 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.
<Page>
PRELIMINARY PROSPECTUS SUBJECT TO COMPLETION NOVEMBER 5, 2001
--------------------------------------------------------------------------------
Shares
[LOGO]
DIGIRAD CORPORATION
Common Stock
----------------------------------------------------------------------
This is our initial public offering of shares of our common stock. No public
market currently exists for our common stock.
We currently anticipate the initial public offering price to be between $ and
$ per share. We have applied to have our common stock approved for quotation
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.
<Table>
<Caption>
Per share Total
-------------------------------------------------------------------------------------
Public offering price $ $
-------------------------------------------------------------------------------------
Underwriting discounts and commissions $ $
-------------------------------------------------------------------------------------
Proceeds, before expenses, to us $ $
-------------------------------------------------------------------------------------
</Table>
The underwriters may also purchase up to 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. If the underwriters exercise
the option in full, the total underwriting discounts and commissions will be
$ , and our total proceeds before expenses will be $ .
The underwriters are offering the common shares as set forth under
"Underwriting." Delivery of the shares will be made on or about , 2001.
UBS Warburg
CIBC World Markets
Wachovia Securities
--------------------------------------------------------------------------------
The date of this prospectus is , 2001.
<Page>
Middle top:
The words "Charting the Future of Nuclear Medicine."
<Table>
Top left: Top right:
Graphic: Photo of technician working at a Graphic: Photo of a DIGIRAD-TM- mobile nuclear
wire-bonding machine. imaging services unit with technician standing
between a Digirad SPECTour(SM) Chair and a
Digirad Imaging acquisition and processing
system in front 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.
</Table>
Bottom middle:
Digirad logo.
<Page>
--------------------------------------------------------------------------------
You should rely only on the information contained in this prospectus. We have
not authorized anyone to provide you with any other information. We are offering
to sell, and seeking offers to buy, our common shares only in jurisdictions
where these offers and sales are permitted. The information in this prospectus
is accurate only as of the date of this prospectus, regardless of the time of
the delivery of this prospectus or of any sale of our common stock.
TABLE OF CONTENTS
--------------------------------------------------------------------------------
<Table>
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-1
</Table>
Through 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.
<Page>
Prospectus summary
This summary highlights information contained elsewhere in this prospectus. You
should read the entire prospectus carefully, especially the risks of investing
in shares of our common stock, which we discuss under the heading "Risk factors"
beginning on page 6, and the financial 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. A gamma camera is the preferred technology
used in nuclear imaging. Nuclear imaging offers the ability to non-invasively
measure physiological activity, including blood flow and organ function. We
believe that our technology 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, increased mobility, increased 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 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 mobile imaging
services 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 size
of a gamma camera and a significant improvement in spatial resolution, which is
a measurement of the quality of the image produced. 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 quality 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 camera and related products to
physician offices, imaging centers, hospitals and research 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 turnkey
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 enables
physicians to capture the revenue that would have otherwise been lost
because the patient was referred elsewhere. 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 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. We established our mobile nuclear cardiac imaging services 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,
1
<Page>
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.
INDUSTRY OVERVIEW
Nuclear Imaging
Nuclear medicine is used primarily in cardiovascular, oncology and neurological
applications. 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. 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 market consists of two primary technologies, gamma
cameras and dedicated positron emission tomography, or PET, machines. Frost &
Sullivan states that gamma 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 volume is
expected to grow by approximately 25% annually over the next 5 years.
Increasingly, a nuclear cardiac imaging procedure is the first 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 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. Although a number of cardiology practices with more
than five cardiologists have incorporated nuclear medicine into their practice
setting, most nuclear cardiology procedures are currently referred to hospitals
and imaging centers, where the cardiologist 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
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.
2
<Page>
- 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:
- 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 System
Our proprietary technology has enabled us to develop a gamma camera with many
unique features. Some of the features of the DIGIRAD-TM- solid-state camera 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; and
- 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 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:
- Leveraging 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 proprietary manufacturing processes to reduce costs and
improve performance;
- Expanding acceptance of additional clinical applications; and
- Continuing technological development.
Our principal executive offices are located at 9350 Trade Place, San Diego, CA
92126-6334. Our telephone number is (858) 578-5300. We maintain a web site on
the Internet at www.digirad.com. Our web site, and the information contained
therein, is not a part of this prospectus.
------------------------
3
<Page>
The offering
<Table>
Common stock we are offering................. shares
Common stock to be outstanding after this
offering................................... shares
Proposed Nasdaq National Market symbol....... DRAD
Use 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."
</Table>
The total number of outstanding shares of our common stock includes:
- 4,526,474 shares of our common stock outstanding as of August 23, 2001; and
- 29,748,030 shares of common stock issuable upon the automatic conversion of
all shares of preferred stock outstanding 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 5,952,426 shares of common stock upon the exercise 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 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 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 3,333 shares of common stock at fair market value for each
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:
- no exercise of the 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
- a one-for- reverse stock split of our outstanding shares of common
stock to be effected in connection with this offering.
4
<Page>
Summary financial and operating data
The following table summarizes our financial data and provides selected
operating data. The summary financial data for the years 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. You should read this data
together with our financial statements and related notes included elsewhere in
this prospectus and the information under "Selected historical financial and
operating data" and "Management's discussion and analysis of financial condition
and results of operations."
<Table>
<Caption>
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 -- 3,619
Stock-based compensation................................. -- -- 65 -- 197
------- -------- -------- ------- -------
Total cost of revenues................................. 388 265 10,738 3,602 10,254
------- -------- -------- ------- -------
Gross profit (loss)........................................ 1,533 19 (3,663) (2,146) 3,765
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 2,674
Amortization of intangible assets........................ -- -- 194 3 286
Stock-based compensation................................. -- -- 246 -- 895
------- -------- -------- ------- -------
Total operating expenses............................... 8,582 13,485 9,276 3,449 9,210
------- -------- -------- ------- -------
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):
Historical............................................... $ (1.87) $ (3.90) $ (3.61) $ (1.65) $ (1.35)
======= ======== ======== ======= =======
Pro forma................................................ $ (0.53) $ (0.19)
======== =======
Shares used to compute basic and diluted net loss per
share(1):
Historical............................................... 3,306 3,381 3,745 3,455 4,366
======= ======== ======== ======= =======
Pro forma................................................ 25,474 30,436
======== =======
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
</Table>
<Table>
<Caption>
As of June 30, 2001
--------------------------------------------
Pro forma as
Balance sheet data: Actual Pro forma(2) adjusted(3)
----------------------------------------------------------------------------------------------------------
Cash and cash equivalents................................... $ 3,510 $11,920
Working capital............................................. $ 4,504 $12,914
Total assets................................................ $ 28,428 $36,838
Long-term debt.............................................. $ 5,811 $ 5,811
Redeemable convertible preferred stock...................... $ 58,109 $ --
Total stockholders' equity (deficit)........................ $(48,240) $18,279
</Table>
------------
(1) Please see Note 1 to our 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) The pro forma balance sheet data give effect to the sale of 2,618,462 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 with this offering.
(3) The pro forma as adjusted balance sheet data give effect to the sale of
shares of our common stock in this offering at an assumed
initial public offering price of $ per share and the
application of the net proceeds to repay a portion of our outstanding
indebtedness.
* Not available because the methodology for tracking the number of procedures
performed in 2000 under acquired customer contracts was not consistent with
our current methodology.
5
<Page>
--------------------------------------------------------------------------------
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.
Our solid-state, digital gamma camera technologies represent a new approach in
the nuclear imaging market, and we have sold our products only in limited
quantities. Our success in this market depends on whether potential customers
view our new technology as effective and economically beneficial. We do not know
the rate at which physicians or other healthcare providers will adopt our
products or imaging services, if at all, or the rate at which they will purchase
them in the future, if at all. There can be no assurances that we can attract
future customers on acceptable terms that will enable us to develop a
sustainable, profitable business. If third-party payors do not accept our
products or imaging services or deny adequate payment to physicians and other
healthcare providers using our products and services, this may adversely affect
acceptance of our products. Acceptance of our products and imaging services by
physicians, including physicians who do not currently use cardiac imaging
products, is essential to our success and may require us to overcome resistance
to a new technology for cardiac imaging services. Our failure to do any of these
things may prevent us from selling sufficient quantities of our products and
imaging services to be profitable.
We have recently introduced our product into the marketplace and may not succeed
or become profitable.
We have not been profitable since our inception. We have incurred substantial
costs to develop, introduce and enhance our solid-state, digital gamma camera.
As of June 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 manufacturing operations and expansion in the
nuclear imaging services market will result in significant expenses over the
next several years that may not be offset by significant revenues. We expect
that a majority of our revenues for the near term and our ability to achieve
profitability will depend upon our ability to successfully market our
solid-state, digital gamma camera and our successful expansion into the nuclear
imaging 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, may not be successful and we may not be profitable in
any future period. Even if we do become profitable, we cannot ensure investors
that we can sustain or
--------------------------------------------------------------------------------
6
<Page>
Risk factors
--------------------------------------------------------------------------------
increase profitability on a quarterly or annual basis in the future. If our
revenues grow more slowly than anticipated, or if our operating expenses exceed
our expectations, our business will be adversely affected. You should consider
our business 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 both product sales and mobile imaging services could
cause significant volatility in our overall results. Competitive pressure may
make it difficult for us to acquire and retain customers and may require us to
reduce the price of our products and imaging services. 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, digital gamma camera technologies have only recently been
introduced into the marketplace. As these technologies are increasingly used by
more customers, significant defects may emerge. In addition, if our cameras are
perceived as being difficult to use or causing discomfort to patients, our
public image may be impaired. Public perception may also be impaired if we fail
to deliver our products in a timely manner due to difficulties with our
suppliers and vendors or due 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 business.
We may experience significant fluctuations in our quarterly results.
Our future operating results will depend on numerous factors, many of which we
do not control. Changes in any or all of these factors could cause our operating
results to fluctuate and increase the volatility of the market price of our
common stock. Some of these factors include:
- demand for our products and our ability to meet such demand;
- product and price competition;
- changes in the costs of components;
--------------------------------------------------------------------------------
7
<Page>
Risk factors
--------------------------------------------------------------------------------
- success of our sales and distribution channels;
- successful development and commercialization of new and enhanced products on
a timely basis;
- timing of significant orders and shipments;
- timing of and possible delay in our receiving approval for necessary
regulatory licenses;
- timing of new product introductions and product enhancements by us or our
competitors; and
- timing and magnitude of our expenditures.
Accordingly, 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 or that 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. 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. If this happens, the price of our common stock may decline.
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. As of June 30, 2001, we had
received orders for 117 cameras, 58 of which have not yet been delivered and
paid for, and we had signed contracts with 101 customers to use 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 customer could harm our business, financial condition and results of
operations.
The sales cycle for our products is typically lengthy, causing significant
fluctuations in our revenue.
Our sales efforts for our cameras are dependent on the capital expenditures
budgets of 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 funds and management effort long before we actually sell
our products and with no assurance that we will 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 could have
an immediate and significant adverse effect on our stock price.
--------------------------------------------------------------------------------
8
<Page>
Risk 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 established a direct sales team, an independent distributor network in
the United States and Canada, and a corporate partner in Japan to sell our
products and imaging services both domestically and internationally. Our future
revenue growth will depend in large part on our success in maintaining and
expanding these sales and distribution channels, which may be an expensive and
time-consuming process. We are highly dependent upon the efforts of talented
sales employees in increasing our revenue. We face intense competition for
qualified sales employees and may be unable to attract and retain such
personnel, which would adversely affect our ability to expand and maintain our
distribution network. If we are unable to expand and maintain our direct sales
team or distribution network, we may be unable to sell enough of our products
and imaging services for our business to be profitable.
We may be harmed by higher energy costs and interrupted power supplies resulting
from the electrical power shortages currently affecting California.
Our corporate headquarters and manufacturing facilities are located in San
Diego, California. Electrical power is vital to our operations and we rely on a
continuous power supply to conduct our operations. California is in the midst of
a power crisis and has recently experienced significant power shortages. In the
event of an acute power shortage, the California system operator has on some
occasions implemented, and may in the future continue to implement, 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 need to hire, train and retain 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 services and business
practices. International revenues are subject to inherent risks, including:
- costs of localizing product and service 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;
--------------------------------------------------------------------------------
9
<Page>
Risk factors
--------------------------------------------------------------------------------
- burdens of complying with a wide variety of foreign laws and labor
practices; and
- conforming our business model 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 applications may be
challenged or circumvented by our competitors. Despite our efforts to protect
our intellectual property rights, unauthorized parties may attempt to obtain and
use information or technologies, which we regard as proprietary. Policing
unauthorized use of our intellectual property will be difficult and we cannot be
certain that we will be able to prevent misappropriation of our technology,
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, or may 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 a license agreement with Segami Corporation for the
imaging acquisition and processing software for our digital gamma camera, and
the loss of the license could result in delivery delays, loss of customers and
loss of revenues.
Segami Corporation has developed an image acquisition and processing software
system for our digital gamma camera under a license agreement which we have the
option to renew on an annual basis. In the event that Segami attempted to
terminate the license agreement prior to the expiration of its annual term or
refused to extend the term of the license, we would have to find an alternative
software system to use in our gamma camera. To our knowledge, there are a
limited number of companies who would be able to develop and implement a
software system similar to what we use in our gamma camera. As a result, in the
event that we were unable to continue to use the software under the license from
--------------------------------------------------------------------------------
10
<Page>
Risk factors
--------------------------------------------------------------------------------
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 software system 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.
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 assurance that we will be able to
continue to attract and retain the personnel necessary to develop our business.
Failure to attract 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 any of our 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 sale and support of our products entails the risk of product liability or
warranty claims, such as those based on claims that the failure of one of our
products resulted in a misdiagnosis, among other issues. The medical instrument
industry in general has been subject to significant products liability
litigation. We may incur significant liability in the event of such litigation.
Although we maintain product liability insurance, we cannot be sure that this
coverage 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 of
operations.
--------------------------------------------------------------------------------
11
<Page>
Risk factors
--------------------------------------------------------------------------------
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 decide 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 upon our ability to manage
those operations and to 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 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.
We use hazardous and radioactive materials in our research, development and
manufacturing processes and the provision of our imaging services and must be
licensed to handle such materials. We are currently licensed in all states in
which we operate, and there can be no assurances that we will be able to retain
these licenses indefinitely. In addition, we must become licensed in all states
in which we plan to expand. Obtaining these additional licenses is an expensive
and time consuming process, and in some cases we may not be able to obtain these
licenses at all. We are subject to federal, state and local regulation governing
the use, handling, storage and disposal of hazardous materials. We cannot
completely eliminate the risk of contamination or injury resulting from
hazardous materials and we may incur liability as a result of any contamination
or injury. We have 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 increase materially in the future.
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
--------------------------------------------------------------------------------
12
<Page>
Risk factors
--------------------------------------------------------------------------------
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.
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 for 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 the FDA, 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 and record keeping 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
of third-party medical device manufacturers who supply components to us, are
subject to this regulation. We and such third-party manufacturers are or will be
required to:
- undergo rigorous inspections by domestic and international agencies;
- obtain the prior approval of these agencies before we can market and sell
our products; and
- satisfy content requirements for all of our sales and promotional materials.
Compliance with the regulations of these agencies may delay or prevent us from
introducing new or improved products, which could in turn affect our ability to
achieve or maintain a profitable level of sales. 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 regulations pertaining 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
--------------------------------------------------------------------------------
13
<Page>
Risk factors
--------------------------------------------------------------------------------
similar approvals could prevent us from successfully marketing our technology
and could harm our operating results. Furthermore, changes in the applicable
governmental regulations could prevent further commercialization of our
technologies and 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 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.
We are directly or indirectly through our clients subject to extensive
regulation by both the federal government and the states 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:
- the federal Medicare and Medicaid Anti-Kickback Law, which prohibits persons
from 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;
- 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;
- the federal Health Insurance Portability and Accountability Act of 1996,
which prohibits executing a scheme to defraud any healthcare benefit
program, including private payors;
- 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;
- 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 Medicaid patients 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 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 sale,
manufacture, administration and prescribing of 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.
If our operations are found to be in violation of any of the laws described
above or the other governmental regulations to which we or our clients 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. Any
--------------------------------------------------------------------------------
14
<Page>
Risk factors
--------------------------------------------------------------------------------
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 of interpretations.
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 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 see "Business--Government Regulation."
Healthcare reform legislation could limit the prices we can charge for our
imaging services, which would reduce our revenues and harm our operating
results.
In addition to extensive existing government healthcare regulation, there are
numerous initiatives at the federal and state levels for comprehensive reforms
affecting the payment for and availability of healthcare services, including a
number of proposals that would significantly limit reimbursement under the
Medicare and Medicaid 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 in the Medicare and Medicaid programs and containment of healthcare
costs on an interim basis by means that could include a short-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 enacted federal laws could have a negative impact on
camera sales to hospitals desiring to use the camera in out-patient facilities.
In order for institutional healthcare providers, such as hospitals, to be
eligible for cost-based Medicare reimbursement for their out-patient facilities,
these facilities must meet specific requirements. If these requirements are met,
a facility will be classified as "provider-based" and therefore eligible for
cost-based Medicare reimbursement, which is potentially more favorable than
other types of Medicare reimbursement. However, recently promulgated federal
regulations affect the ability of a Medicare provider to include a facility as
provider-based for purposes of Medicare reimbursement. While recent federal
legislation offers some relief for facilities previously recognized as
provider-based, some of our hospital customers may have difficulty qualifying
their out-patient facilities for provider-based status. If a hospital customer
cannot obtain provider-based status for their out-patient nuclear imaging
facility and therefore may not be eligible for cost-based Medicare
reimbursement, then the provider may not purchase a camera from us.
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.
--------------------------------------------------------------------------------
15
<Page>
Risk factors
--------------------------------------------------------------------------------
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 camera 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", as an independent diagnostic
testing facility, or IDTF, in five (5) states and are seeking such enrollment by
Medicare contractors in additional states. Enrollment is essential for us to
receive payment for healthcare services directly from Medicare. There can be no
assurances we will be able to maintain such enrollment or that we will be able
to gain such enrollment 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 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 completion of this offering, our executive officers, directors and
beneficial owners of 5% or more of our common stock and their affiliates will,
in aggregate, beneficially own approximately % of our outstanding common
stock or % if the underwriters' over-allotment option is exercised in full. As
a result, these persons, acting together, may have the ability to determine the
outcome of matters submitted to our stockholders for approval, including the
election and removal of directors and any merger, consolidation or sale of all
or substantially all of our assets. In addition, such persons, acting together,
may have the ability to control the management and affairs of our company.
Accordingly, this concentration of ownership may harm the market price of our
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
attempting to obtain control of our company.
Please see "Principal stockholders" for additional information on concentration
of ownership of our common stock.
--------------------------------------------------------------------------------
16
<Page>
Risk factors
--------------------------------------------------------------------------------
There may not be an active, liquid trading market for our common stock.
We cannot assure you that there will be an active trading market for our common
stock following this offering. You may not be able to sell your shares quickly
or at the market price if trading in our stock is not active. The initial public
offering price was determined by negotiations between us and the representatives
of the underwriters based upon a number of factors. The initial public offering
price may not be indicative of prices that will prevail in the trading market.
Please see "Underwriting" for more information regarding our arrangement with
the underwriters and the factors considered in setting the initial public
offering price.
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.
The trading price of our common stock is likely to be highly volatile and could
be subject to wide fluctuations in price in response to various factors, many of
which are beyond our control, including:
- actual or anticipated variations in quarterly operating results;
- announcements of technological innovations by us or our competitors;
- new products or services introduced or announced by us or our competitors;
- changes in financial estimates by securities analysts;
- conditions or trends in the medical device industry and the imaging service
industry;
- changes in the market valuations of 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;
- additions or departures of key personnel; and
- sales of our common stock.
In addition, the stock market in general, and the Nasdaq National Market in
particular, have experienced extreme price and volume fluctuations that have
often been unrelated or disproportionate to the operating performance of listed
companies. Further, there has been particular volatility in the market prices of
securities of medical device companies and imaging services companies. These
broad market and industry factors may seriously 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 company's securities, securities
class-action litigation has often been instituted against that company. Such
litigation, if instituted against us, could result in substantial costs and a
diversion of management's attention and resources, which could seriously harm
our business, 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.
Sales of substantial amounts of our common stock in the public market after this
offering could seriously 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. Based upon the number of
--------------------------------------------------------------------------------
17
<Page>
Risk factors
--------------------------------------------------------------------------------
shares outstanding at August 23, 2001, upon the closing of this offering, we
will have outstanding shares of common stock, assuming no 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 offering will be freely tradeable without
restriction or further registration under the Securities Act of 1933, unless
these shares are purchased by "affiliates" as that term is defined in Rule 144
of the Securities Act of 1933. The remaining shares of our common
stock were issued and sold by us in reliance on exemptions from the registration
requirements of the Securities Act of 1933. These shares may be sold in the
public market only if they are registered or if they qualify for an exemption,
such as Rule 144 or 701 under the Securities Act of 1933.
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.
Investors in this offering will experience immediate and substantial dilution.
The initial public offering price will be substantially higher than the pro
forma book value per share of our common stock. Purchasers of common stock in
this offering will experience immediate and substantial dilution in the pro
forma net tangible book value of their stock of $ per share, assuming
an initial public offering price for our common stock of $ per share.
This dilution is due in large part to the fact that prior investors paid an
average price of $ per share when they purchased their shares of common
stock, which is substantially less than the assumed initial public offering
price of $ per share.
We have not paid dividends and do not anticipate paying dividends on our common
stock in the foreseeable future.
We currently anticipate that we will retain all future earnings, if any, to
finance the growth and development of our business and do not anticipate paying
cash dividends on our common stock in the foreseeable future. Any payment 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 distributions to our stockholders.
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
<Page>
--------------------------------------------------------------------------------
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
<Page>
--------------------------------------------------------------------------------
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 offering
will be invested 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 be at the discretion of our
board of directors and will be dependent on our financial condition, operating
results, capital requirements and other factors that our board deems relevant.
--------------------------------------------------------------------------------
20
<Page>
--------------------------------------------------------------------------------
Capitalization
The following table sets forth our capitalization as of June 30, 2001:
- on an actual basis;
- on a pro forma basis to give effect to the issuance of 2,618,462 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 with this offering; and
- on a pro forma as adjusted basis to give effect to the sale of
shares of our common stock in this offering at an assumed initial public
offering price of $ per share and the application of
the net proceeds to repay a portion of our outstanding indebtedness.
You should read this table together with "Use of proceeds," "Management's
discussion and analysis of financial condition and results of operations" and
the consolidated financial statements and related notes included elsewhere in
this prospectus.
<Table>
<Caption>
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, 150,000,000 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................................ 4,578 71,068
Deferred compensation..................................... (1,713) (1,713)
Notes receivable from stockholders........................ (112) (112)
Accumulated deficit....................................... (50,998) (50,998)
-------- --------
Total stockholders' equity (deficit)...................... (48,240) 18,279
-------- --------
Total capitalization...................................... $ 21,294 $ 29,704
======== ========
</Table>
The table above does not include:
- the issuance of up to 5,952,426 shares of common stock upon the exercise 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
--------------------------------------------------------------------------------
21
<Page>
Capitalization
--------------------------------------------------------------------------------
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 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 3,333 shares of common stock at fair market value for each
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
<Page>
--------------------------------------------------------------------------------
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 share of our
common stock and the pro forma net tangible book value per share of our common
stock after this offering.
Pro forma net tangible book value per share represents the amount of total
tangible assets less total liabilities, divided by the pro forma number of
shares of common stock then outstanding. Our pro forma net tangible book value
at June 30, 2001, would have been $15.9 million, or $ per share of common
stock, after giving effect to the issuance of 2,618,462 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 with this offering. After giving further effect to
the sale of shares of common stock in this offering at an assumed initial
public offering price of $ per share, and after deducting estimated
underwriting discounts and commissions and estimated offering expenses, our pro
forma net tangible book value at June 30, 2001, would have been $ million,
or $ per share. This represents an immediate increase in pro forma net
tangible book value of $ per share to existing stockholders and an
immediate dilution of $ per share to new investors purchasing common stock
in this offering. The following table illustrates this per share dilution:
<Table>
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......................... $
======
</Table>
The following table summarizes as of June 30, 2001, on the pro forma basis
described above, 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 at an assumed initial public offering price of $
per share and before deducting underwriting discounts and commissions and
estimated offering expenses:
<Table>
<Caption>
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.............................. % $ % $
========== ===== =========== ===== =====
</Table>
If the underwriters exercise their over-allotment option in full, the following
will occur:
- our pro forma net tangible book value after the offering will increase
$ per share to existing stockholders and our pro forma net tangible
book value after the offering will be diluted $ per share to
new investors;
- the percentage of shares of our common stock held by existing stockholders
will decrease to approximately % of the total number of shares of our
common stock outstanding after this offering; and
- the number of shares of our common stock held by new investors will increase
to , or approximately % of the total number of shares of our
common stock outstanding after this offering.
--------------------------------------------------------------------------------
23
<Page>
Dilution
--------------------------------------------------------------------------------
The tables and calculations above assume no issuance of the following shares
described below:
- the issuance of up to 5,952,426 shares of common stock upon the exercise 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 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 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 3,333 shares of common stock at fair market value for each
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.
If we assume the exercise of all stock options and warrants outstanding as of
August 23, 2001, our pro forma net tangible book value after the offering will
increase $ per share to existing stockholders and our pro forma net
tangible book value after the offering will be diluted $ per share to
new investors.
To the extent that any of the other shares of common stock described above are
issued, there will be further dilution to new investors. See "Capitalization,"
"Management--Benefit Plans," and the notes to our consolidated financial
statements included elsewhere in this prospectus for further information.
--------------------------------------------------------------------------------
24
<Page>
--------------------------------------------------------------------------------
Selected historical financial and operating data
Our selected statement of operations data for the years ended December 31, 1996
and 1997, and our selected balance sheet data as of December 31, 1996, 1997 and
1998, are derived from our 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 for the years ended December 31, 1998,
1999 and 2000 and our selected balance sheet data as of December 31, 1999 and
2000, are derived from our audited financial statements for such years and as of
such dates, which are included elsewhere in this prospectus. Our selected
statement of operations data for the six-month periods ended June 30, 2000 and
2001, and our selected balance sheet data as of June 30, 2001, are derived from
our unaudited financial statements for such years and as of such date, which are
included elsewhere in this prospectus. The unaudited financial statements
include all adjustments, consisting of normal recurring accruals, which we
consider necessary for a fair representation of the financial position and the
results of operations for these periods.
Operating results for the six months ended June 30, 2001 are not necessarily
indicative of the results that may be expected for the entire year ending
December 31, 2001. You should read the data set forth below in conjunction with
"Management's discussion and analysis of financial condition and results of
operations" and our consolidated financial statements and related notes included
elsewhere in this prospectus.
<Table>
<Caption>
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 -- 3,619
Stock-based compensation.......................... -- -- -- -- 65 -- 197
------- ------- ------- -------- -------- ------- -------
Total cost of revenues.......................... 687 417 388 265 10,738 3,602 10,254
------- ------- ------- -------- -------- ------- -------
Gross profit (loss)................................. (99) 2 1,533 19 (3,663) (2,146) 3,765
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 2,674
Amortization of intangible assets................. -- -- -- -- 194 3 286
Stock-based compensation.......................... -- -- -- -- 246 -- 895
------- ------- ------- -------- -------- ------- -------
Total operating expenses........................ 2,332 5,828 8,582 13,485 9,276 3,449 9,210
------- ------- ------- -------- -------- ------- -------
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):
Historical........................................ $ (0.77) $ (1.95) $ (1.87) $ (3.90) $ (3.61) $ (1.65) $ (1.35)
======= ======= ======= ======== ======== ======= =======
Pro forma......................................... $ (0.53) $ (0.19)
======== =======
Shares used to compute basic and diluted net loss
per share(1):
Historical........................................ 3,256 3,273 3,306 3,381 3,745 3,455 4,366
======= ======= ======= ======== ======== ======= =======
Pro forma......................................... 25,474 30,436
======== =======
</Table>
--------------------------------------------------------------------------------
25
<Page>
Selected historical financial and operating data
--------------------------------------------------------------------------------
<Table>
<Caption>
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)
--------------------------------------------------------------------------------------------------------------------------------
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
</Table>
------------
(1) Please see Note 1 to our 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.
* Not available because the methodology for tracking the number of procedures
performed in 2000 under acquired customer contracts was not consistent with
our current methodology.
<Table>
<Caption>
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 $ 23,050 $ 28,428
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) $(43,479) $(48,240)
</Table>
--------------------------------------------------------------------------------
26
<Page>
--------------------------------------------------------------------------------
Management's discussion and analysis of financial condition and results of
operations
YOU 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.
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 sell our
solid-state, digital gamma cameras and related equipment to physician practices,
imaging centers, hospitals and research laboratories in the United States,
Canada and Japan. We also use our proprietary technology to provide mobile
nuclear imaging services to physician offices and imaging centers through our
Digirad Imaging Solutions business unit, or DIS.
We incorporated as San Diego Semiconductor in 1985. In 1994, we changed our name
to Digirad Corporation and began development of a solid-state gamma camera for
nuclear 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. We expect that 38 units in our backlog will be shipped by December 31,
2001 with the remainder expected to be shipped in 2002.
In the second half of 2000, we formed DIS to provide turnkey nuclear cardiac
imaging services to physician offices. We entered the service business via the
strategic acquisition of certain assets of two operators that provide us with
both critical mass and platforms for growth of our imaging services 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
--------------------------------------------------------------------------------
27
<Page>
Management's discussion and analysis of financial condition and results of
operations
--------------------------------------------------------------------------------
products. Our product revenue consists of sales of solid-state gamma cameras,
custom designed chairs and accessories such as printers and collimators. We
generated approximately 30% of our revenues for the six months ended June 30,
2001 from our imaging services business. We derive 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 turnkey basis utilizing our proprietary DIGIRAD(TM)
2020TC Imager(TM) gamma camera and the SPECTour(TM) chair. We offer this imaging
service on a contract basis, with the typical contract length being one to three
years and comprised of one day of service per week. As we continue to grow, we
expect our imaging services revenue to account for a majority of total revenues.
We sell our products to customers in North America and Japan. A relatively small
number of customers account for a significant percentage of our revenues. For
the year ended December 31, 2000, three product customers-Performance Medical
Group, Inc., Radiology Regional Center and CMS Imaging, Inc.-accounted for
15.9%, 11.6% and 10.1% of our consolidated revenues, respectively. However, for
the six months ended June 30, 2001, no product customers accounted for 10% or
more of consolidated revenues. No imaging services customer accounted for 10% or
more of our consolidated revenues for the year ended December 31, 2000 or the
six months ended June 30, 2001.
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 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--Total revenues increased to $14.0 million for the six months
ended June 30, 2001 from $1.5 million for the comparable period in 2000.
Products--Our product revenue increased to $9.8 million for the six months ended
June 30, 2001 from $1.5 million for the comparable period in 2000. This increase
was due to increased sales of our gamma 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. Product revenue accounted for 70% of
total revenues for the first six months of 2001 versus 100% for the first six
months of 2000.
Imaging Services--Our imaging services revenue was $4.2 million for the six
months ended June 30, 2001. We did not have any imaging services revenue during
the six months ended June 30, 2000, as we did not start this business until the
second half of 2000. We performed approximately 6,900 procedures for the six
months ended June 30, 2001, and were operating 18 mobile routes as of June 30,
2001. Imaging services revenue accounted for 30% of total revenues for the first
six months of 2001.
--------------------------------------------------------------------------------
28
<Page>
Management's discussion and analysis of financial condition and results of
operations
--------------------------------------------------------------------------------
Cost of Revenues
Total Cost of Revenues--Total cost of revenues increased to $10.3 million for
the six months ended June 30, 2001 from $3.6 million for the same period in
2000.
Products--Cost of product revenue consists primarily of materials, labor and
other costs associated with the products we sell. Our cost of product revenue
increased to $6.6 million for the six months ended June 30, 2001 from
$3.6 million for the comparable period in 2000. The increase in the cost of
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 67% in the first six months of
2001.
Imaging Services--Cost of imaging services revenue consists primarily of labor,
radiopharmaceuticals, equipment depreciation and other costs associated with
provision of services. Our cost of imaging services revenue was $3.7 million for
the six months ended June 30, 2001. There was no cost of imaging services
revenue for the comparable period in 2000. As a percentage of imaging services
revenue, cost of services revenue was 87% in the first six months of 2001.
Gross profit
Total gross profit--Total gross profit increased to $3.8 million for the six
months ended June 30, 2001 from a loss of $2.1 million for the comparable period
in 2000.
Products--Our product gross profit increased to $3.2 million for the six months
ended June 30, 2001 from a loss of $2.1 million for the comparable period in
2000. This increase was primarily due to reductions in our cost per unit from
volume discounts, design modifications, and better utilization of our
manufacturing capacity. Although we expect continued gross profit improvements
with increased sales as we better utilize our existing manufacturing capacity
and benefit from economies of scale, we expect such improvements, if any, to
occur at a slower rate than those experienced between 2000 and 2001.
Imaging services--Our imaging services gross profit was $0.6 million for the six
months ended June 30, 2001. There was no comparable gross profit from imaging
services for the six months ended June 30, 2000 because at that date we had not
yet entered the imaging services business.
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. Research and
development expenses increased to $1.3 million for the six months ended
June 30, 2001 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 for the increase in research and
development expenses for the first six months of 2001. For the first six months
of 2001, research and development expenses amounted to 9% of total revenue.
Sales and Marketing--Sales and marketing expenses consist primarily of salaries,
commissions, bonuses, recruiting costs, travel, marketing materials and trade
shows. Sales and marketing expenses increased to $4.0 million for the six months
ended June 30, 2001 from $1.3 million in the comparable period in 2000. Our
continued development of our sales and marketing functions to support the sales
of our gamma camera and the growth of our mobile nuclear imaging services
business accounted primarily for the increase in sales and marketing expenses.
For the first six months of 2001, sales and marketing expenses amounted to 29%
of total revenue.
--------------------------------------------------------------------------------
29
<Page>
Management's discussion and analysis of financial condition and results of
operations
--------------------------------------------------------------------------------
General and Administrative--General and administrative expenses consist
primarily of salaries and other related costs for finance, human resources and
other personnel, as well as accounting, legal and other professional fees.
General and administrative expenses increased to $2.7 million for the six months
ended June 30, 2001 from $1.1 million in the comparable period in 2000.
Increased headcount and related costs account primarily for the increase in
general and administrative expenses. For the first six months of 2001, general
and administrative expenses amounted to 19% of total revenue.
Amortization of Intangible Assets--Intangible assets primarily represent
acquired customer contracts and the capitalized costs related to our patent and
trademark portfolio. Amortization of intangibles increased to $286,000 for the
six months ended June 30, 2001 from $3,000 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 accounted for
the increase in amortization of intangible assets.
Stock-Based Compensation Charges--Stock-based compensation represents the
amortization of deferred compensation and the fair value of stock awards to
non-employees. In connection with the grant of stock options to employees and
directors, we recorded deferred compensation of $2.0 million for the six months
ended June 30, 2001. We recorded this amount as a component of stockholders'
equity and will amortize the amount as a charge to 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 ended
June 30, 2001. The compensation charges relate to cost of revenues, research and
development, sales and marketing, and general and administrative expenses in the
amount of $197,000, $61,000, $450,000 and $384,000, respectively, for the six
months 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.
--------------------------------------------------------------------------------
30
<Page>
Management's discussion and analysis of financial condition and results of
operations
--------------------------------------------------------------------------------
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 $9.9 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 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
$194,000 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.
Stock-Based Compensation Charges--In connection with the grant of stock options
to employees and directors, we recorded deferred compensation of $0.8 million
for 2000. We recorded this amount as a component of stockholders' equity and
will amortize the amount as a charge to operations over the vesting period of
the options. We recorded amortization of deferred compensation and other
non-cash stock compensation charges of $0.3 million during 2000. The
compensation charges relate to cost of revenues, research and development, sales
and marketing, and general and administrative expenses in the amount of $64,000,
$6,000, $51,000, and $189,000, respectively, during 2000.
--------------------------------------------------------------------------------
31
<Page>
Management's discussion and analysis of financial condition and results of
operations
--------------------------------------------------------------------------------
Interest Expense
Interest expense increased 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 for the increase in interest expense.
Interest Income
Interest income 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 for the decrease in interest income.
Net Loss
Net loss increased to $13.5 million in 2000 from $13.2 million in 1999 and
$6.2 million in 1998 as a result of the factors described above.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations principally through private equity financings
supplemented with long-term debt and equipment financing arrangements. The
equity investments were in the form of six series of preferred stock offerings
between March 1995 and August 2001, which yielded aggregate net proceeds
totaling approximately $66 million. At June 30, 2001, our outstanding borrowings
totaled $11.4 million.
As of June 30, 2001, cash and cash equivalents totaled $3.5 million compared to
$6.6 million at December 31, 2000. We currently invest our cash reserves in
United States investment grade corporate-debt securities with maturities not
exceeding 12 months and money market funds.
Net cash used in operating activities amounted to approximately $15.0 million,
$12.1 million, $5.5 million and $9.1 million for the years ended December 31,
2000, 1999, 1998 and for 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 receivable and inventories
resulting from the growth in our business.
Net cash used in investing activities amounted to approximately $7.2 million,
$0.9 million, $1.7 million and $2.5 million for the years ended December 31,
2000, 1999, 1998 and the six months ended June 30, 2001, respectively. Investing
activities consist primarily of capital expenditures and asset acquisitions.
Net cash provided by financing activities amounted to approximately
$26.2 million, $2.0 million, $1.5 million and $8.6 million for the years ended
December 31, 2000, 1999, 1998 and the six months ended June 30, 2001,
respectively. Private placement of preferred stock and proceeds from bank
borrowings and lease financings were primarily responsible for the net cash
provided by financing activities. We raised $17.9 million in 2000 and
$5.8 million in the first six months of 2001 through the private placement of
Series E preferred stock. In addition, we raised $8.4 million in August 2001
through the private placement of Series F preferred stock.
In July 2001, we entered into an agreement with a bank for a $4.3 million
revolving line of credit to provide working capital for the product business.
Borrowings under the line of credit accrue interest at the bank's floating prime
rate plus 2% 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 in
July 2002 with any unpaid balance
--------------------------------------------------------------------------------
32
<Page>
Management's discussion and analysis of financial condition and results of
operations
--------------------------------------------------------------------------------
due upon expiration. At June 30, 2001, the outstanding balance under this
facility was $2.4 million. We intend to repay this loan in full with proceeds
from this offering.
In January 2001, we entered into a loan and security agreement for a revolving
line of credit to provide working capital for our imaging 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.
We have notes payable to stockholders totaling $0.7 million, which bear interest
at 6.35% per year. The notes mature on December 31 of the year immediately
following the first year in which the Company generates cash from operations,
which is expected to be after 2001.
As of June 30, 2001, we had capital lease obligations totaling $5.5 million.
These obligations are secured by the specific equipment financed under each
lease and will be repaid monthly over the lease terms, which range from 36 to
63 months.
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% limitation in the
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 RISK
Our exposure to market risk for 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 pay with respect to our various outstanding debt
--------------------------------------------------------------------------------
33
<Page>
Management's discussion and analysis of financial condition and results of
operations
--------------------------------------------------------------------------------
instruments. Our risk associated with fluctuating interest rates is limited,
however, to certain of our long-term debt and capital lease obligations, the
interest rates under which 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. We attempt to ensure 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.
INFLATION
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, we adopted Statement of Financial Accounting Standards, or
SFAS, No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES.
This statement establishes accounting and reporting standards requiring that
every derivative instrument, including certain derivative instruments imbedded
in other contracts, be recorded in the balance sheet as either an asset or
liability measured at its fair value. The statement also requires that changes
in the derivative's fair value be recognized in earnings unless specific hedge
accounting criteria are met. We believe the adoption of SFAS No. 133 will not
have an effect on our financial statements because we do not engage in
derivative or hedging 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 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.
--------------------------------------------------------------------------------
34
<Page>
--------------------------------------------------------------------------------
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, increased
mobility, increased 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
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 mobile imaging services 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 size
of a gamma camera and a significant improvement in spatial resolution which is a
measurement of the quality of the image produced. 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 quality 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 camera and related products to
physician offices, imaging centers, hospitals and research 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 enables
physicians to capture the revenue that would have otherwise been lost
because the patient was referred elsewhere. 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- 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. We expect that 38 units in our backlog will be shipped by
December 31, 2001 with the remainder expected to be shipped in 2002. In addition
to numerous 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, 111 were
ordered by customers in the United States and six were purchased by customers in
Japan. For the fiscal year ended December 31, 2000, three of our product
customers -Performance
--------------------------------------------------------------------------------
35
<Page>
Business
--------------------------------------------------------------------------------
Medical Group, Inc., Radiology Regional Center and CMS Imaging, Inc.-each
accounted for over ten percent of our consolidated revenues. None of these
product customers currently accounts for more than ten percent of our
consolidated revenues.
We established our mobile nuclear cardiac imaging services operations in the
third quarter 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,
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. No
one physician office has accounted for more than ten percent of our consolidated
revenues.
We intend to continue expanding our imaging services business throughout the
United States, and we have completed license applications to expand into another
12 states.
INDUSTRY OVERVIEW
Diagnostic imaging
Diagnostic imaging technology generates representations of the internal anatomy
or physiology, primarily through non-invasive means. Diagnostic imaging
facilitates the early diagnosis of diseases and disorders, often minimizing the
cost and amount of care required and reducing the need for more costly and
invasive procedures. Currently, there are five major types of non-invasive
diagnostic imaging technologies available: x-ray; magnetic resonance imaging, or
MRI; computerized tomography, or CT; 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 measure varying degrees of physiological activity, including
blood flow, organ function, metabolic activity, biochemical activity, and other
functional activity within the body. This functional information allows for the
earlier diagnosis of certain diseases than the information provided by
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 of two primary
technologies, gamma cameras and dedicated positron emission tomography, or PET,
machines. Frost & Sullivan states that gamma 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.
In a typical nuclear imaging procedure, the patient is injected with a small
amount of radioactive drug, or radiopharmaceutical, which is quickly broken down
by the body. Depending on the composition of the radiopharmaceutical, the
functionality of the tissue and the procedure being used, the
radiopharmaceutical localizes differently in normal versus abnormal tissues. The
physician uses images taken from a gamma camera and related clinical information
to evaluate the physiological performance of the organ being examined.
--------------------------------------------------------------------------------
36
<Page>
Business
--------------------------------------------------------------------------------
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 done in the U.S. in 2000, 7.9 million, or 51%, were
cardiology related procedures. Nuclear imaging of the heart provides healthcare
professionals valuable information related to blood flow, to, through, and from
the heart as well as information on the heart muscle. Radiopharmaceuticals are
unique in their ability to remain in the heart muscle, enabling visualization
during a nuclear cardiac imaging procedure.
Increasingly, a nuclear cardiac imaging procedure is the first non-invasive,
diagnostic imaging procedure performed on patients with suspected heart disease.
Following a nuclear study, patients with suspected heart disease will often be
referred to more invasive diagnostic or therapeutic treatments. These treatments
may include: angiography, an x-ray procedure by which catheters are inserted
into an artery or vein to take pictures of blood vessels; angioplasty, a
procedure by which catheters with balloon tips are used to widen narrowed
arteries; or cardiac surgery. 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.
The number of nuclear cardiac imaging procedures grew approximately 23% from
1999 to 2000, and is 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 referred to hospitals and imaging centers, where the
cardiologist 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
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 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 of procedures
performed in hospital, outpatient facilities, diagnostic imaging centers,
physician offices and the following:
--------------------------------------------------------------------------------
37
<Page>
Business
--------------------------------------------------------------------------------
- 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.
--------------------------------------------------------------------------------
38
<Page>
Business
--------------------------------------------------------------------------------
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:
<Table>
<Caption>
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 floors
be used 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.
</Table>
--------------------------------------------------------------------------------
39
<Page>
Business
--------------------------------------------------------------------------------
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 currently referred to hospitals or imaging centers,
creating additional income, and improving the service they provide to their
patients;
- Expand our Integrated, Direct Sales Force--We use a direct sales force,
supplemented by distributors internationally and in selected domestic
geographies. This improves our ability to control 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 direct
sales organization allows us to build a distribution asset that can be of
great value over time as we look to grow the business 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 cost of our selling efforts, better meet the demands of
our customers, and truly offer our customers a solution tailored to their
needs;
- Leverage our Proprietary Manufacturing Processes--We believe our
manufacturing process gives us a key competitive advantage by enabling us to
manufacture products that use our proprietary technology in a cost efficient
manner. Our manufacturing strategy combines our internal design expertise
and proprietary process technology with the advanced manufacturing
capabilities and capacity of our strategic manufacturing 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
working with clinicians to understand the ways in which they use our camera
to validate the use of
--------------------------------------------------------------------------------
40
<Page>
Business
--------------------------------------------------------------------------------
our camera for these new clinical applications. In addition, we believe that
these new applications of our camera do not constitute new procedures for
which we would have to obtain further regulatory approval. 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, which generates
three-dimensional images of the body's internal organs. We also plan to
develop 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. The imaging area of most
conventional vacuum tube cameras is approximately fifteen inches by twenty
inches. In addition, 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. The DIGIRAD 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 because 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
--------------------------------------------------------------------------------
41
<Page>
Business
--------------------------------------------------------------------------------
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.
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 capacities of third
parties. We believe our manufacturing processes give us a key competitive
advantage by enabling us to manufacture products that use 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 in our
facilities. As is done with the modules, the key components of the camera's
mechanical and electrical systems are designed by us, and either outsourced or
built internally. These key components include a personal computer, power
supplies, cooling system, liquid crystal display, controller boards, data
acquisition and communication system, and the mechanical structure of the
camera. We perform sub-assembly tests and final system performance tests in our
facilities.
All components used in the product are available from multiple sources with the
exception of the Segami image acquisition and processing software. All suppliers
of critical materials, components and subassemblies undergo ongoing quality
certification by us, with the objective of maintaining strong relationships with
the best suppliers. We utilize enterprise resource planning software and
collaborative web-based software to ensure efficient and secure handling of
inventory and material. The enterprise resource planning software helps us to
manage our inventory and materials by centralizing our purchasing procedures,
monitoring our inventory supplies and streamlining our billing methods. The
collaborative web-based software is a secure electronic network that enables our
employees to access our documents from anywhere in the world via the Internet.
We successfully completed a certification audit performed by the state of
California's Food and Drug Branch in the first quarter of 2000. As part of this
audit, the California Food and Drug Branch recognized our compliance with 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 from the FDA, enabling us to market
our 2020TC Imager camera and SPECTour 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. In
addition, the Canadian government requires approval of a gamma camera model by
the Canadian Standards Association before the model can be sold in Canada, and
we expect to receive such approval in the third quarter of 2001. 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. Underwriters Laboratories Inc. is an independent,
not-for-profit product safety testing and certification organization, and some
gamma camera customers in the United States require that the model of the
--------------------------------------------------------------------------------
42
<Page>
Business
--------------------------------------------------------------------------------
camera they purchase pass a test developed for medical products by this
organization. In early 2002, we plan to initiate the drive for ISO-9000 quality
certification with the expectation of receiving certification in late 2002.
ISO-9000 is a compilation of quality standards promulgated by the International
Organization for Standardization, and a manufacturer that has been certified to
use a quality program that meets ISO-9000 does not have to independently test
each product that it sells in the European Community.
Imaging services
Our imaging services business is operated by our Digirad Imaging Solutions
business unit. We established our imaging services operations in the third 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 van 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.
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, 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 professional component, such
as the interpretation of the test. Under our second option, we lease cameras,
related equipment and technical personnel to physicians on a turnkey 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,
equipment used to handle and measure the radiopharmaceuticals used in the
procedure, 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, equipment used to handle and measure the radiopharmaceuticals
used in the procedure, 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.
--------------------------------------------------------------------------------
43
<Page>
Business
--------------------------------------------------------------------------------
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 both gamma cameras
and imaging services. We utilize a team selling approach with Territory
Managers, and Sales Representatives. Our Territory Managers typically have over
10 years of experience selling sophisticated capital equipment in the medical
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 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 supplement to the one year
warranty
--------------------------------------------------------------------------------
44
<Page>
Business
--------------------------------------------------------------------------------
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;
- 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, joint development efforts, 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 crystal sheet 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.
--------------------------------------------------------------------------------
45
<Page>
Business
--------------------------------------------------------------------------------
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 as their photo-detectors. The typical
photomultiplier tube 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 photomultiplier tubes are packed together in an array
of anywhere from nine to 100 tubes. Optical photons striking anywhere on the
surfaces of the photomultiplier tubes 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 photomultiplier tubes, to spatially resolve the point at which a gamma ray
strikes the surface of the camera. This method, called the Anger method, can
only estimate where the gamma ray strikes. It does so by combining the output
signals of all of the photomultiplier tubes and computing a position as a
function of the weighted average of the individual photomultiplier tube signals.
Because there can be considerable discrepancies between where the gamma ray is
reported to have struck the detector versus where it actually struck the
detector, Anger style gamma cameras can produce blurred images, 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-photomultiplier tube 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
photomultiplier tube. 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, and numerous other
factors, Anger style photomultiplier tubes 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 use of silicon photodiodes as photodetectors has, in turn,
enabled the use of a more efficient scintillation crystal 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
--------------------------------------------------------------------------------
46
<Page>
Business
--------------------------------------------------------------------------------
emits blue wavelengths of light during scintillation. Silicon photodiodes,
however, are most sensitive to the 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 rays as does 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. Our
detector 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 purpose is to
only allow gamma rays that are perpendicular to the camera surface to be
detected, thereby helping prevent blurred images. Below is a view of the 2020TC
Imager camera detector head assembly and illustrates the arrangement of the
modules, collimator and lead-shielded head case.
[Picture of detection head.]
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 photomultiplier tubes, 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.
--------------------------------------------------------------------------------
47
<Page>
Business
--------------------------------------------------------------------------------
[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 photomultiplier tubes than those striking in the
middle of the crystal. Because the Anger camera requires input from multiple
photomultiplier tubes 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. Conventional Anger style gamma cameras
must be powered continuously in order to temperature stabilize their vacuum
photomultiplier tubes, 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 photomultiplier tubes.
The shock of crossing a curb cut or a door threshold will not change the
performance characteristics of our solid-state detector as it can with a
--------------------------------------------------------------------------------
48
<Page>
Business
--------------------------------------------------------------------------------
photomultiplier tube. 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 in and out of buildings and
vehicles.
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
addition to our broad solid-state detector and photodiode technology patents, 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 of medical imagers 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 major manufacturers of nuclear medicine cameras, all of whose
cameras are based on the conventional vacuum tube technology, include Philips
Medical Systems through its subsidiary ADAC Laboratories, General Electric
Medical Systems, Siemens Medical Systems, Marconi 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, magnetic resonance imaging, computed
tomography, ultrasound and nuclear medicine. The possibility exists that one or
more of these companies could decide to develop its own solid-state, digital
gamma camera. However, we believe it would be difficult to develop an
economically viable competitive camera without infringing our patents.
--------------------------------------------------------------------------------
49
<Page>
Business
--------------------------------------------------------------------------------
Imaging Services--Competition in the mobile nuclear imaging services business is
limited. Competitors tend to be small, undercapitalized businesses employing
conventional vacuum tube cameras that must be transported in large trucks and
cannot be moved in and out of physician offices. We expect to have a distinct
competitive advantage by controlling the enabling technology that provides the
convenience, quality and high level of service physicians will expect. As a
result, we believe that our imaging services business will have a proprietary
technological position. Additionally, we do not expect competition in the mobile
imaging service business from traditional nuclear imaging manufacturers because
their focus is on camera sales to hospitals.
GOVERNMENT REGULATION
Our business is subject to extensive federal and state government regulation.
Some of these laws have not been fully 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 laws
The healthcare industry is subject to extensive federal, state and local
regulation relating to licensure, conduct of operations, ownership of
facilities, addition of facilities and services and payment for services.
In particular, the federal Anti-Kickback Law 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 or arranging for a good or service, for which payment
may be made under a federal healthcare program such as the Medicare and Medicaid
programs. The definition of "remuneration" has been broadly interpreted to
include gifts, discounts, the furnishing of supplies or equipment, credit
arrangements, payments of cash and waivers of payments. The statute itself has
been broadly interpreted to mean that if any ONE purpose of an arrangement
involving remuneration is to induce referrals of federal healthcare covered
business, the statute has been violated. The penalties for violating the
Anti-Kickback Law can be severe. These sanctions include criminal penalties and
civil sanctions, including fines, imprisonment and possible exclusion from
Medicare, Medicaid and other federal healthcare Programs.
The Anti-Kickback Law is broad, and it prohibits many arrangements and practices
that are lawful in businesses outside of the healthcare industry. Recognizing
that the Anti-Kickback law is broad and may technically prohibit many innocuous
or beneficial arrangements within the healthcare industry, the United States
Department of Health and Human Services has issued a series of regulations,
known as the "safe harbors," beginning in July of 1991. These regulations set
forth certain safe harbors which, if all applicable requirements are met, will
assure healthcare providers and other parties that they will not be prosecuted
under the Anti-Kickback Law. 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,
the failure of a transaction or arrangement to fit within one or more safe
harbors does not necessarily mean that the transaction or arrangement is illegal
or that prosecution under the Anti-Kickback Law will 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 the Office of the Inspector General of the United States Department of
Health and Human Services, or OIG. 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
--------------------------------------------------------------------------------
50
<Page>
Business
--------------------------------------------------------------------------------
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. Some of these
state prohibitions apply to referral of patients for healthcare services
reimbursed by any source, not only the Medicare and Medicaid programs. Some of
these state prohibitions may be more restrictive than the Anti-Kickback Law in
material respects, and the federal safe harbors may not apply.
Our nuclear imaging services model includes providing services and supplies to
physicians, for which the physicians pay us, for the use in treating their
privately insured patients. These physicians also refer Medicare patients to us,
for which we bill the Medicare program directly. This type of arrangement, if
not properly structured, may violate the Anti-Kickback Law and also raises
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 have attempted to structure such
arrangements and our other business activities to comply with the Anti-Kickback
Law 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.
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, 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
--------------------------------------------------------------------------------
51
<Page>
Business
--------------------------------------------------------------------------------
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 the Centers for Medicare & Medicaid
Services interpret 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 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.
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" 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, the government must decide whether to intervene in the lawsuit and to
become the primary prosecutor. If the government declines to join the lawsuit,
then 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 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, the number of suits brought against healthcare providers by private
individuals has increased dramatically, many of which are still under seal from
the public. In addition, various states are considering or have 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.
When a person is determined to have violated the federal False Claims Act, it
must pay three times the actual damages sustained by the government, plus
mandatory civil penalties of between $5,500 to
--------------------------------------------------------------------------------
52
<Page>
Business
--------------------------------------------------------------------------------
$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 splitting
The marketing and operation of our diagnostic imaging systems are subject to
state laws prohibiting the practice of medicine by non-physicians, or the
employment or excessive control of the medical judgment of physicians by
non-physicians (often referred to as the corporate practice of medicine). We
have attempted to structure our operations so that they do not involve the
practice of medicine, or violate corporate practice of medicine statutes. For
example, all professional medical services relating to our operations, including
the interpretation of scans 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 structure our operations 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
We derive a substantial percentage of our revenues from government programs,
such as Medicare, or 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. 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 diagnosis related
groups, 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, the Centers for Medicare and Medicaid Services 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. Each
ambulatory payment classification 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.
--------------------------------------------------------------------------------
53
<Page>
Business
--------------------------------------------------------------------------------
Medicare billing and enrollment
We can bill Medicare directly for services only to the extent we are enrolled as
an independent diagnostic testing facility. Medicare has delegated the function
of enrollment 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 regulations and program
memoranda from the Centers for Medicare and Medicaid Services set forth uniform
rules governing independent diagnostic testing facility billing and enrollment,
each carrier is free to interpret these rules to a certain extent. For example,
an independent diagnostic testing 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 add
considerable expense to or limit the types of business models we may be able to
utilize successfully in the carrier's jurisdiction.
Part of our business involves the leasing of equipment and personnel to
physicians, who then bill Medicare and other third party payors directly for
nuclear imaging services. Medicare rules permit physicians to bill for certain
diagnostic tests performed using leased equipment and personnel, and to receive
payment based on the applicable Medicare fee schedule, if certain conditions are
satisfied. We have attempted to structure our equipment and personnel leases so
that physicians are able to bill in this manner if they comply with the terms of
the leases, but there can be no assurance to that effect. If any of our leasing
physicians are deemed not to meet these conditions, payment to the affected
physicians could be 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 or penalties. 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 limitations
Non-governmental third party payors, such as commercial health maintenance
organizations, or HMOs, preferred provider organizations, or PPOs, and other
insurers, may impose varying requirements and limitations on our ability to
receive payment directly for services we provide. For instance, some payors will
not reimburse us separately for the nuclear imaging tests we perform, and
instead require that reimbursement be paid only on a "global" basis to the
physician who provides the professional interpretation of the nuclear imaging
test. Such payor requirements and limitations restrict the types of business
models we can successfully utilize for patients covered by these payors.
Pharmaceutical laws
Our services involve radiopharmaceuticals and other substances regulated as
drugs by state and federal agencies, including the federal Food and Drug
Administration and state pharmacy boards. These agencies administer laws
governing the manufacturing, distribution, use, administration and prescribing
of drugs. These laws include the federal Food, Drug and Cosmetic Act, state food
and drug laws and state pharmacy acts. Some of our activities may be deemed to
require additional permits or licensure under laws which impose substantial
restrictions on who can qualify for such permits or licensure. If any of these
agencies deemed our activities to require additional 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 controlled storage, use and disposal of
material containing radioactive isotopes. While this material has a short
half-life, meaning it quickly breaks down into inert, or non-radioactive
substances, using such materials presents the risk of accidental environmental
--------------------------------------------------------------------------------
54
<Page>
Business
--------------------------------------------------------------------------------
contamination and physical injury. We are subject to federal, state and local
regulations governing the use, storage, handling and disposal of 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
contamination or injury from those hazardous materials. In the event of an
accident, we could be held liable for any damages that result, and any 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 order to
comply with current or future environmental laws and regulations. We have not
had material expenses related to environmental, health and safety laws or
regulations to date and we have no inspection for which a plan of correction has
not been accepted.
U.S. Food and Drug Administration, or FDA, and state or foreign approvals
The manufacture and sale of medical devices intended for commercial distribution
are subject to extensive governmental regulation in the United States. Medical
devices are regulated in the United States primarily by the FDA and also by
certain similar state agencies, such as the California Food and Drug Branch. The
FDA requires that medical devices be manufactured in registered establishments.
California's Food and Drug Branch requires medical device manufacturers to
obtain a Medical Device Manufacturing License.
As part of the regulatory framework, medical devices require pre-market
clearance (demonstrating substantial equivalence to a legally marketed device)
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 devices in the United States and the
export of unapproved 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 way a new device can be introduced into the market in the United States is
for the manufacturer or distributor to obtain FDA clearance by a 510(k)
notification that such device is substantially equivalent to a prior approved
device. The FDA requires a rigorous demonstration of substantial equivalence. A
medical device manufacturer must obtain a new 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 the device or a new indication for use of
the device. When any change or modification is made to a device or its intended
use, the manufacturer is expected to make the initial determination as to
whether the change or modification is of a kind that would necessitate the
filing of a new 510(k). We have received 510(k) clearance to market our 2020TC
Imager camera and SPECTour chair, and may require similar FDA clearances for
additional products or improvements to our current products.
Any products manufactured or distributed by us are subject to continuing
regulation by the FDA and the State of California, which includes record keeping
requirements, reporting of adverse experience with the use of the device, Good
Manufacturing Practices requirements and post-market surveillance. It may also
include post-market registry and other actions deemed necessary by the FDA.
--------------------------------------------------------------------------------
55
<Page>
Business
--------------------------------------------------------------------------------
Sales of medical device products outside the United States are subject to
foreign regulatory requirements that vary from country to country. The time
required to obtain approvals required by foreign countries may be longer or
shorter than that required for FDA clearance, and requirements for licensing may
differ from FDA requirements.
We will spend considerable time and effort to comply with the FDA, state, and
foreign regulatory requirements described above. Any failure to obtain and
maintain compliance with such requirements could have a material adverse effect
on our business and subject us to sanction.
FACILITIES
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, we had 257 employees, including 18 in our research and
development department, 43 in our sales and marketing department, 105 in our
manufacturing department, 25 in general and administrative functions and 66 in
mobile imaging services operations. We believe that our relations with our
employees are good.
LEGAL PROCEEDINGS
In July 2001, we were served 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 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. We believe we have meritorious defenses against this complaint
and that its ultimate resolution will not have a material adverse impact on us.
--------------------------------------------------------------------------------
56
<Page>
--------------------------------------------------------------------------------
Management
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
The following table sets forth certain information regarding our executive
officers, key employees and directors as of August 23, 2001:
<Table>
<Caption>
Name Age Position(s)
-----------------------------------------------------------------------------------------------------------------------
Executive Officers and Key Employees:
R. Scott Huennekens................................ 37 President, Chief Executive Officer and
Director
Gary J.G. Atkinson................................. 49 Vice President of Finance and Chief
Financial Officer
Richard L. Conwell................................. 50 Vice President of Marketing
Robert E. Johnson.................................. 44 Vice President of Sales and Service
John F. Sheridan................................... 46 Vice President of Operations
David M. Sheehan................................... 38 President, Digirad Imaging Solutions, Inc.
Directors:
Timothy J. Wollaeger(1)............................ 57 Chairman of the Board of Directors
R. King Nelson(2).................................. 44 Director
Brad Nutter........................................ 49 Director
Kenneth E. Olson(1)(2)............................. 64 Director
Douglas Reed, M.D.(2).............................. 47 Director
</Table>
---------
(1) Members of Compensation Committee
(2) Members of Audit Committee
R. SCOTT HUENNEKENS has been our President and a member of our board of
directors since May 1999 and our Chief Executive Officer since June 1999. Prior
to being appointed as our 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
--------------------------------------------------------------------------------
57
<Page>
Management
--------------------------------------------------------------------------------
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 the President of Digirad Imaging Solutions, Inc., our
wholly owned subsidiary, since September 2000. Prior to joining us, from
May 1999 to September 2000, Mr. Sheehan served as the President and Chief
Executive Officer of Rapidcare.com, an e-health company that connects physicians
with families and children who suffer from chronic disease. Prior to that, from
May 1997 to May 1999, Mr. Sheehan served as Vice President of Sales & Marketing
for a division of Baxter Healthcare Corporation which provided cardiopulmonary
services to hospitals. Prior to that, from July 1991 to May 1997, Mr. Sheehan
worked at Haemonetics Corporation, a supplier of blood processing services and
equipment, in various sales, marketing, and business development positions.
Mr. Sheehan received a B.S. in mechanical engineering from Worcester Polytechnic
Institute and an M.B.A. from the Tuck School of Business at Dartmouth College.
TIMOTHY J. WOLLAEGER has been a member of our board of directors since
June 1994, and our Chairman since January 1996. In addition, Mr. Wollaeger
served as our Chief Executive Officer in May 1999. Mr. Wollaeger is the general
partner of Kingsbury Associates, L. P., a venture capital firm he founded in
December 1993 which focuses on investments in the healthcare industry. From
May 1990 until 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. Wollaeger is chairman of the board of directors of Biosite
Incorporated. Mr. Wollaeger received a B.A. in economics from Yale University
and an M.B.A. from Stanford University.
R. KING NELSON has been a member of our board of directors since May 2000. Since
May 1999, Mr. Nelson has served as the Chief Executive Officer of VenPro
Corporation, a medical device company which develops bioprosthetic implants for
venous vascular and cardiovascular medicine. Prior to that, from January 1996 to
December 1998, Mr. Nelson served as President of the perfusion service business
of Baxter Healthcare Corporation. Prior to that, from January 1980 to
December 1995, Mr. Nelson held various positions at Baxter Healthcare
Corporation. Mr. Nelson received a B.S. from Texas Tech University and an M.B.A.
in international business from the University of Miami.
BRAD NUTTER has been a member of our board of directors since August 2001. From
February 2000 to October 2000, Mr. Nutter served as Executive 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
--------------------------------------------------------------------------------
58
<Page>
Management
--------------------------------------------------------------------------------
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 been a member of our board of directors since March 1996.
From December 1990 to February 1996 and from March 1997 to June 1998, Mr. Olson
served as Chief Executive Officer at Proxima Corporation, a supplier of display
projection systems for professional desktop computers. Mr. Olson also serves on
the board of directors for Avanir Pharmaceuticals and WD-40 Company. Mr. Olson
received a B.S. in electrical engineering from the University of California at
Los Angeles and an M.B.A. from Pepperdine University.
DOUGLAS REED, M.D. has been a member of our board of directors since
September 2000. He is a managing director of Vector Fund Management, a venture
capital firm which focuses on investments in the life sciences and healthcare
industry. Prior to that, from October 1998 to July 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 served as Vice President of Business Development at NPS
Pharmaceuticals, Inc., a company which develops small molecule drugs and
recombinant peptides. From June 1988 to April 1996, 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. Reed received 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. Reed is board
certified as a neuro-radiologist 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 completion of this offering, our amended
and restated certificate of incorporation will provide for a classified board of
directors consisting of three classes of directors, each serving a staggered
three-year term. As a result, a portion of our board of directors will be
elected each year. To implement the classified structure, two of the nominees to
the board of directors will be elected to a one-year term, two will be elected
to a two-year term and two will be elected to a three-year term. After the
offering, directors will be elected for three-year terms. Dr. Reed and
Mr. Nutter will be designated Class I Directors, whose terms expire at the 2002
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 the board of directors may delay or prevent 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.
--------------------------------------------------------------------------------
59
<Page>
Management
--------------------------------------------------------------------------------
- Compensation Committee--The compensation committee of the board of directors
recommends, reviews and oversees the salaries, benefits and stock option
plans for our executive officers, employees, consultants, directors and
other individuals compensated by us. The compensation committee also
administers our compensation 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 the board of directors or committees. We will also be granting
options to our outside directors as compensation, as described below under the
heading "Benefit plans--Automatic Option Grant Program."
From time to time during the fiscal year ended December 31, 2000, some of our
directors were granted options to purchase shares of our common stock under our
1998 Stock Option/Stock Issuance Plan. For information concerning these grants,
please 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. Prior to the formation of the compensation committee, the board of
directors as a whole made decisions relating to compensation of our executive
officers. Upon completion of this 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.
--------------------------------------------------------------------------------
60
<Page>
Management
--------------------------------------------------------------------------------
Executive compensation table
--------------------------------------------------------------------------------
<Table>
<Caption>
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
</Table>
----------
(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 concerning stock options granted to
our named executive officers during the fiscal year ended December 31, 2000:
Option Grants in Last Fiscal Year
--------------------------------------------------------------------------------
<Table>
<Caption>
Potential Potential
Individual grants realizable value at realizable value at
----------------------------------------------------- assumed annual assumed annual
Number of Percentage of rates of stock rates of stock
securities total options Exercise price appreciation price appreciation
underlying granted to price for option term(1) for option term(2)
options employees in per Expiration --------------------- ---------------------
Name granted fiscal year share date 5% 10% 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
</Table>
----------
(1) Potential realizable value is based upon fair market value of our common
stock on the grant date of the options as determined by our board of
directors.
(2) Potential realizable value is based upon the initial public offering price
of our common stock of $ .
--------------------------------------------------------------------------------
61
<Page>
Management
--------------------------------------------------------------------------------
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 estimate or projection of our future common stock prices. These amounts
represent assumed rates of appreciation in the value of our common stock from
the fair market value on the date of grant. Actual gains, if any, on stock
option exercises are dependent on the future performance of our common stock and
overall stock market conditions. The actual value realized may be greater or
less than the potential realizable value set forth in the table.
We have never granted any stock appreciation rights.
OPTIONS EXERCISED AND YEAR-END VALUES
The following table sets forth information concerning the number and value of
options exercised by each of the named executive officers as of December 31,
2000 and the number and value of unexercised options held by each of the named
executive officers as of December 31, 2000. Options shown as exercisable in the
table below are immediately exercisable; however, we have the right to purchase
the shares of 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 stock as of December 31, 2000. Accordingly, the value of unexercised
in-the-money options at December 31, 2000 represents an amount equal to the
difference between the assumed fair market value of $0.50 of the common stock as
determined by our board of directors and the applicable exercise price per
share, multiplied by the number of unexercised 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
--------------------------------------------------------------------------------
<Table>
<Caption>
Number of securities
underlying unexercised Value of unexercised
Shares options at in-the-money options at
acquired December 31, 2000 December 31, 2000(2)
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 -- -- --
<Caption>
Value of unexercised
in-the-money options at
December 31, 2000(3)
---------------------------
Name Exercisable Unexercisable
---------------------- ---------------------------
R. Scott Huennekens... --
Robert E. Johnson..... --
John F. Sheridan...... --
Richard L. Conwell.... --
David M. Sheehan...... --
</Table>
------------
(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.
--------------------------------------------------------------------------------
62
<Page>
Management
--------------------------------------------------------------------------------
(3) Amount based on the difference between the initial public offering price of
our common stock and the exercise price of the option.
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 million shares of common stock have been authorized for
issuance under our 2001 incentive plan. Such share reserve consists of the
number of shares 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 of shares of
common stock reserved for issuance under our 2001 incentive plan will
automatically increase on the first trading day in January each calendar year,
beginning in calendar year 2002, by an amount equal to 2% of the total number of
shares of common stock outstanding 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, under which eligible individuals in
our employ or service may be granted options to purchase shares of common
stock at an exercise price not less than 100% of the fair market value of
those shares on the grant date;
- the stock issuance program, under which such individuals may be issued
shares of common stock directly, through the purchase of such 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
members to purchase shares of common stock at an exercise price equal to
100% of the fair market value of those shares on the grant date; and
- the director fee option grant program, under which our non-employee board
members may be given the opportunity to apply a portion of the annual
retainer fee otherwise payable to them in cash each year to the acquisition
of special below-market option grants.
Eligibility--The individuals eligible to participate in our 2001 incentive plan
include our officers and other employees, our non-employee board members and any
consultants we hire.
--------------------------------------------------------------------------------
63
<Page>
Management
--------------------------------------------------------------------------------
Administration--The discretionary option grant program and the stock issuance
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 option grants or
stock issuances are to be made, the number of shares subject to each such grant
or issuance, the status of any granted option as either an incentive stock
option or a non-statutory stock option under the federal 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 at fair market value on the exercise date. The option
may also be exercised through a same-day sale program without any cash
outlay by the optionee. In addition, the plan administrator may provide
financial assistance to one or more optionees in the exercise of their
outstanding options or the purchase of their unvested shares by allowing
such individuals to deliver a full-recourse, interest-bearing promissory
note in payment of the exercise price and any associated withholding taxes
incurred in connection with such exercise or purchase;
- the compensation committee will have the authority to cancel outstanding
options under the discretionary option grant program, including options
transferred from the predecessor plans, in return for the grant of new
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 election to surrender their outstanding options for an appreciation
distribution from us equal to the 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;
--------------------------------------------------------------------------------
64
<Page>
Management
--------------------------------------------------------------------------------
- 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 tender offer for more than
50% of our outstanding voting stock or a change in the majority of our board
through one or more contested elections for board membership. Such
accelerated vesting may occur either at the time of such 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 months following an 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 to the closing of this offering, provided 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 to purchase a number of shares of common
stock to be determined prior to the closing of this offering, provided such
individual has served on our board for at least six months.
Each automatic grant will have an exercise price per share equal to the fair
market value per share of our common stock on the grant date and will have a
term of 10 years, subject to earlier termination following the optionee's
cessation of board service. The option will be immediately exercisable for all
of the option shares; however, we may repurchase, at the 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.
--------------------------------------------------------------------------------
65
<Page>
Management
--------------------------------------------------------------------------------
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.
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 have an
exercise price per share equal to one-third of the fair market value of the
option shares on the grant date, and the number of shares subject to the option
will be determined by dividing the amount of the retainer fee applied to the
program by two-thirds of the fair market value per share of our common stock 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 portion of the retainer fee
applied to that option. The option will become exercisable in a 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% of our
outstanding 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.
--------------------------------------------------------------------------------
66
<Page>
Management
--------------------------------------------------------------------------------
LIMITATIONS ON DIRECTORS' LIABILITY AND INDEMNIFICATION
Our certificate of incorporation limits the liability of directors to the
maximum extent permitted by Delaware law. Delaware law provides that directors
of a corporation will not be personally liable for monetary damages for breach
of their fiduciary duties as directors, except liability for:
- any breach of their duty of loyalty to the corporation or its stockholders;
- acts or omissions not in good faith or that involve intentional misconduct
or a knowing violation of law;
- unlawful payments of dividends or unlawful stock repurchases or redemptions;
and
- any transaction from which the director derived an improper personal
benefit.
The limitation of liability does not apply to liabilities arising under the
federal securities laws and does not affect the availability of equitable
remedies such as injunctive relief or rescission. Our certificate of
incorporation and bylaws provide that we will indemnify our directors and
officers and may indemnify our employees and other agents to the fullest extent
permitted by law. We believe that indemnification under our bylaws covers at
least negligence on the part of indemnified parties. Our 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.
We have entered into agreements to indemnify our directors and executive
officers, in addition to the indemnification provided for in our bylaws. These
agreements, among other things, provide for indemnification for judgments,
fines, settlement amounts and expenses, including attorneys' fees incurred by
the director, or executive officer in any action or proceeding, including any
action by or in our right, arising out of the person's services as a director or
executive officer, any of our subsidiaries or any other company or enterprise to
which the 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.
At present, there is no pending litigation or proceeding involving any of our
directors, officers or employees in which indemnification is sought, nor are we
aware of any threatened litigation that may result in claims for
indemnification.
--------------------------------------------------------------------------------
67
<Page>
--------------------------------------------------------------------------------
Certain relationships and related transactions
SALES OF SECURITIES
Series E Preferred Stock Financing--From June 1998 to June 2000, we issued and
sold 4,004,965 shares of Series E preferred stock to 17 accredited investors at
a price of $3.036 per share. The shares of Series E preferred stock will
automatically convert into 4,004,965 shares of common stock in connection with
this offering. Investors owning 5% or more of our capital stock who participated
in this transaction include:
<Table>
<Caption>
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............. 329,379 329,379
</Table>
Mr. Wollaeger, one of our directors, is a general partner of Kingsbury
Associates, L.P., which is a general partner 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 to
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 affiliated with Kingsbury Associates.
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 entities affiliated with Sorrento Associates.
Dr. Reed, one of our directors, is a managing director of Vector Fund
Management, L.L.C., which is a general partner of Vector Later-Stage Equity
Fund, L.P., and is a managing director of Vector Fund Management, II, L.L.C.,
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., 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.
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
--------------------------------------------------------------------------------
68
<Page>
Certain relationships and related transactions
--------------------------------------------------------------------------------
offering if not previously exercised. Investors owning 5% or more of our capital
stock who participated in this transaction include:
<Table>
<Caption>
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 16,468 181,157
</Table>
Additional 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:
<Table>
<Caption>
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 24,703
</Table>
In 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, is a member of Palavacinni Partners, LLC.
Series F Preferred Stock Financing--In August 2001, we issued and sold 2,618,462
shares of Series 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
--------------------------------------------------------------------------------
69
<Page>
Certain relationships and related transactions
--------------------------------------------------------------------------------
this offering. Investors owning 5% or more of our capital stock and directors
who participated in this transaction include:
<Table>
<Caption>
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
</Table>
Mr. Olson, one of our directors, is the trustee of the Kenneth E. Olson Trust
dated March 16, 1989.
Dr. Reed, one of our directors, is a member of Palavacinni Partners, LLC.
Registration Rights--In connection with the preferred stock financings
referenced above, we entered into agreements with the investors providing for
registration rights with respect to their shares. For a more complete
description of the rights we granted to these stockholders, please see
"Description of capital stock--Registration Rights."
For additional information regarding the sale of securities to executive
officers, directors and holders of more than 5% of our outstanding common stock,
please see "Principal stockholders."
OPTION AGREEMENTS WITH DIRECTORS
Since January 1, 1998, we have granted options to purchase shares of our common
stock to our directors in the following transactions:
<Table>
<Caption>
Name of Director Date of Grant Number of Shares Exercise Price
--------------------------------------------------------------------------------------------------------
Kenneth E. Olson ................................. April 1998 3,000 $0.21
April 1998 3,000 $0.25
December 1998 5,000 $0.35
May 1999 3,000 $0.35
March 2000 5,000 $0.35
May 2000 30,000 $0.50
March 2001 5,000 $1.00
R. Scott Huennekens .............................. December 1998 225,000 $0.35
May 1999 220,000 $0.35
March 2000 575,000 $0.35
January 2001 120,000 $1.00
R. King Nelson ................................... May 2000 50,000 $0.50
March 2001 5,000 $1.00
Timothy J. Wollaeger.............................. November 2000 30,000 $0.50
Brad Nutter....................................... August 2001 50,000 $1.50
</Table>
--------------------------------------------------------------------------------
70
<Page>
--------------------------------------------------------------------------------
Principal stockholders
The following table sets forth information with respect to the beneficial
ownership of our common stock as of August 23, 2001, as adjusted to reflect the
sale of the shares of common stock in this offering by:
- each person or group of affiliated persons who we know beneficially owns 5%
or more of our common stock;
- each 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 the executive officers and directors as a group.
Beneficial ownership is calculated according to the rules of the Securities and
Exchange Commission. Except as indicated in the footnotes to this table, the
persons named in the table have sole voting and investment power with respect to
all shares of common stock shown as beneficially owned by them, subject to
community property laws where applicable. The number of shares beneficially
owned by a person includes the number of shares underlying options and warrants
that are exercisable within 60 days from August 23, 2001. These shares are also
deemed outstanding for 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 ownership is based upon 34,274,504 shares of common stock outstanding
at August 23, 2001, assuming the conversion of all outstanding shares of
preferred stock into common stock. Unless otherwise indicated, the address for
each of the following stockholders is: c/o Digirad Corporation, 9350 Trade
Place, San Diego, California 92126-6334.
<Table>
<Caption>
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%
</Table>
* Less than one percent.
--------------------------------------------------------------------------------
71
<Page>
Principal stockholders
--------------------------------------------------------------------------------
(1) In this prospectus, we refer to 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 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 pecuniary interest,
if any.
(2) In this prospectus, we refer to 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., collectively, as entities affiliated with Vector Fund
Management. Douglas Reed, M.D., a member of our board of directors, is a
managing director of the general 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 6,615,721 shares held by entities affiliated with Kingsbury
Associates and 30,000 shares of common stock held by Mr. Wollaeger.
(6) Includes 130,770 shares held by the Kenneth E. Olson Trust dated March 16,
1989 and options to purchase 166,000 shares of common 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
<Page>
--------------------------------------------------------------------------------
Description of capital stock
Upon the closing of this offering, our authorized capital stock will consist of
150,000,000 shares of common stock, $0.001 par value per share, and 10,000,000
shares of undesignated preferred stock, $0.001 par value per share.
The following description of our capital stock does not purport to be complete
and is subject to and qualified by our certificate of incorporation and bylaws,
which are included as exhibits to the registration statement of which this
prospectus forms a part, and by the provisions of applicable Delaware law.
COMMON STOCK
As of August 23, 2001, there were 4,526,474 shares of common stock outstanding.
There will be shares of common stock outstanding upon the closing
of this offering, which gives effect to the shares of common stock
offered by us in this offering and the conversion of shares 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 of holders of our common stock:
- the 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 is entitled to one vote per share on
all matters to be voted on by stockholders generally, including the election
of directors;
- there are no cumulative voting rights; and
- upon our liquidation, dissolution or winding up, the holders of shares of
common stock will be entitled to share ratably in the distribution of all of
our assets remaining available for distribution after satisfaction of all
our liabilities and the payment of the liquidation preference of any
outstanding preferred stock.
PREFERRED STOCK
As of August 23, 2001, there were 29,748,030 shares of redeemable convertible
preferred stock outstanding. We have secured consents from the requisite number
of stockholders to the automatic conversion of all outstanding shares of
redeemable convertible preferred stock in connection with this offering. As a
result, all outstanding shares of redeemable convertible preferred stock will be
converted into 29,748,030 shares of 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, if the final price per
share of shares in this offering is less then $ per share, a small number of
additional shares of common stock will be issued upon conversion of the
Series F preferred stock.
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;
--------------------------------------------------------------------------------
73
<Page>
Description 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 preferred stock.
WARRANTS
As of August 23, 2001, we had outstanding warrants to purchase 603,578 shares of
common stock, at a weighted average exercise price of $2.59 per share. Of the
outstanding warrants, warrants to purchase 65,875 shares will terminate upon the
closing of this offering and warrants to purchase 60,000 shares will expire if a
consulting agreement is terminated before July 31, 2002.
In addition, we have entered into a consulting agreement under which we will
issue additional warrants to purchase 3,333 shares of common stock at fair
market value for each digital cameras sold by the consultant, up to a maximum of
40,000 shares, and thereafter issue warrants to purchase 1,500 shares of common
stock at fair market value for each of our digital cameras sold by the
consultant.
OPTIONS
As of August 23, 2001, options to purchase an aggregate total of 5,952,426
shares of common stock were outstanding under our 1995 Stock Option Plan, our
1997 Stock Option/Stock Issuance Plan and our 1998 Stock Option/Stock Issuance
Plan. Options to purchase a total of 4,725,883 shares of common stock remain
available for grant under our option plans. Please see "Management--Benefit
Plans" and "Shares eligible for future sale" for a detailed description of the
stock option plans.
REGISTRATION RIGHTS
The holders of the shares of common stock which will be issued upon conversion
of the preferred stock in connection with this offering, which holders are
referred to below as our preferred investors, have the right to cause us to
register their shares under the Securities Act of 1933 as follows:
- Demand Registration Rights: Preferred investors holding at least 30% of the
shares of common stock issued upon conversion of the preferred stock have
the right to demand that we register their shares, subject to limitations,
commencing one year after the effective date of the registration
--------------------------------------------------------------------------------
74
<Page>
Description of capital stock
--------------------------------------------------------------------------------
statement for this offering. We are not required to effect more than two
registrations pursuant to such demand registration rights;
- Piggyback Registration Rights: In the event we propose 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 to file a
registration statement on Form S-3, our preferred investors may require us
to file up to two registration statements on Form S-3 during any twelve
month period with respect to their shares of common stock, subject to
limitations.
These registration rights are subject to conditions and limitations, among them
the right of the underwriters of an offering to limit the number of shares of
common stock held by our preferred investors to be included in a registration.
We are generally required to bear all of the expenses of all such registrations,
including the reasonable fees of a single counsel acting on behalf of all
selling holders, but excluding underwriting discounts and selling commissions.
Registration of any of the shares of common stock held by our preferred
investors would result in such shares becoming freely tradable without
restriction under the Securities Act of 1933 immediately upon effectiveness of
such registration.
POSSIBLE ANTI-TAKEOVER MATTERS
General--Provisions of Delaware law, as well as our certificate of incorporation
and bylaws, 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 of Delaware 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--We are subject to the "business combination"
provisions of Section 203 of the Delaware General Corporation Law. Subject to
certain exceptions, Section 203 prohibits a publicly-held Delaware corporation
from engaging in a "business combination" with an "interested stockholder" for a
period of three years after the date of the transaction in which the person
became an interested stockholder, unless:
- the transaction is approved by the board of directors prior to the date the
interested stockholder obtained interested stockholder status;
- upon consummation of the transaction that resulted in the stockholders
becoming an interested stockholder, the interested stockholder owned at
least 85% of our voting stock outstanding at the time the transaction
commenced, excluding for purposes of determining the number of shares
outstanding those shares owned by (a) persons who are directors and also
officers and (b) 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 or subsequent to the date the person became an interested stockholder,
the business combination is approved by the board of directors and
authorized at an annual or special meeting of stockholders by the
affirmative vote of at least two-thirds of the outstanding voting stock that
is not owned by the interested stockholder.
--------------------------------------------------------------------------------
75
<Page>
Description of capital stock
--------------------------------------------------------------------------------
A "business combination" includes mergers, asset sales and other transactions
resulting in a financial benefit to the interested stockholder. Subject to
certain exceptions, an "interested stockholder" is a person who, together with
affiliates and associates, owns, or within three years did own, 15% or more of
the corporation's voting stock. This statute could prohibit or delay the
accomplishment of mergers or other takeover or change in control attempts with
respect to us and, accordingly, may discourage attempts to acquire us.
Charter and Bylaw Provisions--In addition, certain provisions of our certificate
of incorporation and bylaws summarized in the following paragraphs may be deemed
to have an anti-takeover effect and may delay, defer or prevent a tender offer
or takeover attempt that a stockholder might consider in its best interest,
including those attempts that might result in a premium over the then market
price for the shares held by stockholders.
- Classified Board of Directors; Removal; Filling Vacancies and Amendment: Our
certificate of incorporation and bylaws provide that the board will be
divided into three classes of directors serving staggered, three-year terms.
The classification of the board has the effect of requiring at least two
annual stockholder meetings, instead of one, to replace a majority 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 at duly called annual or special meetings
of stockholders. The certificate of incorporation further provides that
special meetings of our stockholders may be called by the chairman of the
board of directors, the chief executive officer or a majority of the board
of directors. 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 by the board of directors with respect to unsolicited takeover bids.
In addition, the limited ability of the stockholders to call a special
meeting of stockholders may make it more difficult to change the existing
board and management.
- Advance Notice Requirements for Stockholder Proposals and Director
Nomination: The bylaws provide that stockholders seeking to bring business
before an annual meeting of stockholders, or to nominate candidates for
election as directors at an annual meeting of stockholders, must provide
timely notice thereof in writing. To be timely, a stockholder's notice must
be delivered to or mailed and received at our principal executive offices
not less than 120 days prior to the date of our annual meeting. The bylaws
also specify certain requirements as to the form and content of a
stockholder's notice. These provisions may preclude 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 unissued shares of common
stock and preferred stock are available for future issuance without
stockholder approval. These additional shares may be utilized for a variety
of corporate purposes, including future public offerings to raise additional
capital, corporate acquisitions, employee benefit plans and "poison pill"
rights plans.
--------------------------------------------------------------------------------
76
<Page>
Description of capital stock
--------------------------------------------------------------------------------
The existence of authorized but unissued shares of common stock and preferred
stock could render more difficult or discourage an attempt to obtain control
of us by means of a proxy contest, tender offer, merger or otherwise.
NASDAQ NATIONAL MARKET
We have applied to list our common stock on the Nasdaq National Market under the
trading symbol "DRAD."
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is .
--------------------------------------------------------------------------------
77
<Page>
--------------------------------------------------------------------------------
Shares eligible for future sale
Prior 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 price of our common stock prevailing
from time to time. The market price of our common stock could decline as a
result of sales of a large number of shares of our common stock in the market
after this offering, or the perception that such sales could occur. Such sales
also might make it more difficult for us to sell equity securities in the future
at a time and price that we deem appropriate. Based upon the number of shares
outstanding at August 23, 2001, upon the closing of this offering, we will have
shares of common stock outstanding, assuming no 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 offering will be freely tradable without restriction or
further registration under the Securities Act of 1933, unless these shares are
purchased by "affiliates" as that term is defined in Rule 144 under the
Securities Act of 1933. The remaining shares of our common stock
were issued and sold by us in reliance on exemptions from the registration
requirements of the Securities Act of 1933. These shares may be sold in the
public market only if they are registered or if they qualify for an exemption
from registration, such as Rule 144 or 701 under the Securities Act of 1933,
which are summarized below. The remaining shares are eligible for sale in the
public market as follows:
ELIGIBILITY OF RESTRICTED SHARES FOR SALE IN THE PUBLIC MARKET
<Table>
<Caption>
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)..............................................
</Table>
Rule 144
In general, under Rule 144 of the Securities Act of 1933 as currently in effect,
beginning 90 days after the date of this offering, a person who has beneficially
owned shares of our common stock for at least one year is entitled to sell,
within any three month period, a number of shares of our common stock that does
not exceed the greater of:
- 1% of the number of shares of common stock then outstanding; or
- the average weekly trading volume in our common stock during the four
calendar weeks preceding the date on which notice of such sale is filed with
the Securities and Exchange Commission.
Sales made under Rule 144 must also comply with manner of sale and notice
requirements and are subject to the availability of current public information
about us.
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 our affiliate at any time during the 90 days
preceding a sale, and who has beneficially
--------------------------------------------------------------------------------
78
<Page>
Shares eligible for future sale
--------------------------------------------------------------------------------
owned the shares proposed to be sold for at least two years, would be entitled
to sell such shares under Rule 144(k) without regard to the volume limitations
or the manner of sale, notice or public information requirements of Rule 144.
Rule 701
Under Rule 701 of the Securities Act of 1933 as currently in effect, any of our
employees, consultants, directors or advisors who have purchased shares from us
under a stock option plan or other written agreement can resell those shares
90 days after the effective date of this offering in reliance on Rule 144 but
without complying with some of its restrictions, including the holding period.
The sale of such shares may still remain subject, however, to contractual
restrictions contained in lock-up agreements, described below.
LOCK-UP AGREEMENTS
Each of our stockholders and holders of options and warrants to purchase shares
of our common stock who individually own more than 1% of our common stock
(assuming the exercise of such options or warrants), as well as each of our
directors and officers, have entered into lock-up agreements pursuant to which
they have agreed that they will not offer, sell, contract to sell, pledge or
otherwise dispose of, directly or indirectly, any shares of our common stock or
any securities convertible into, or exercisable or exchangeable for, our common
stock without the prior written consent of UBS Warburg for a period of 180 days
from the date of this offering. Collectively, over 90% of our issued or issuable
shares prior to this offering are subject to this lock-up agreement. Upon
expiration of the lock-up agreements, shares will become eligible for sale
in the public market, subject to volume and holding requirements of Rule 144 or
701 of the Securities Act of 1933.
STOCK PLANS
Following 90 days after the date of this prospectus, shares issued upon the
exercise of options that we granted prior to the date of this offering will also
be eligible for sale in the public market under Rule 701 of the Securities Act
of 1933, as described above. As of August 23, 2001, options to purchase a total
of 5,952,426 shares of common stock were outstanding. Each option grant is
subject to a market stand-off provision, which allows us 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 expiration of the market stand-off provisions referred to above.
--------------------------------------------------------------------------------
79
<Page>
--------------------------------------------------------------------------------
Material United States federal tax consequences to non-United States holders of
common stock
The following is a general discussion of the material 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 discussion does not address all aspects of United
States federal income and estate taxation or any aspects of state, local, or
non-U.S. taxation, nor does it consider any specific facts or circumstances 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 of dividends paid to a
foreign partnership, the certification requirement would
--------------------------------------------------------------------------------
80
<Page>
Material United States federal tax consequences to non-United States holders of
common stock
--------------------------------------------------------------------------------
generally be applied to the partners of the partnership, unless the partnership
agrees to become 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 not be subject to United States federal income tax on any gain realized
upon the sale 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, in which 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
--------------------------------------------------------------------------------
81
<Page>
Material 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
individual's gross estate for United States federal estate tax purposes, unless
an applicable estate tax treaty provides otherwise.
--------------------------------------------------------------------------------
82
<Page>
--------------------------------------------------------------------------------
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 the following table. UBS Warburg LLC, CIBC World Markets
Corp. and First Union Securities, Inc. are the representatives of the
underwriters.
<Table>
<Caption>
Number of
Underwriter shares
-------------------------------------------------------------------------
UBS Warburg LLC.............................................
CIBC World Markets Corp.....................................
First Union Securities, Inc.................................
---------
Total.......................................................
=========
</Table>
If the underwriters sell more shares than the total number set forth in the
table above, the underwriters have a 30-day option to buy from us up to an
additional shares at the initial public offering price less the
underwriting discounts and commissions to cover these sales. If any shares are
purchased 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
will pay to the underwriters. These amounts are shown assuming both no exercise
and full exercise of the underwriters' option to purchase up to an additional
shares.
<Table>
<Caption>
No exercise Full exercise
--------------------------------------------------------------------------------------
Per share................................................ $ $
Total.................................................... $ $
</Table>
We estimate that the total expenses of the offering payable by us, excluding
underwriting discounts and commissions, will be approximately $ .
Shares sold by the underwriters to the public will initially be offered at the
initial public offering price set forth on the cover of this prospectus. Any
shares sold by the underwriters to securities 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 and our stockholders and
optionholders owning 1% or more of our common stock (assuming the exercise of
such options) 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 statement under the Securities Act of 1933 relating to, any
shares of our common stock or securities convertible into or exchangeable for
shares of common stock during the period from the date 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
<Page>
--------------------------------------------------------------------------------
program. The number of shares available for sale to the general public in the
offering will be reduced to the extent these persons purchase reserved shares.
Any reserved shares not so purchased will be offered by the underwriters to the
general public on the same terms as the other shares.
Prior to this offering, there has been no public market for our common stock.
The initial 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, the underwriters may purchase and sell shares
of our common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters 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'
option to 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 shares or purchasing shares in the open market. In
determining the source of shares to close out the covered short position, the
underwriters will consider, among other things, the price of shares available
for purchase in the open market as compared to the price at which they may
purchase shares through the overallotment option. "Naked" short sales are any
sales in excess of the overallotment option. 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 the
offering.
Stabilizing transactions consist of bids or purchases made for the purpose of
preventing or retarding a decline in the market price of our common stock while
the offering is in progress. The underwriters also may impose a penalty bid.
This occurs when a particular underwriter repays to the underwriters a portion
of the underwriting discount received by it because the representatives have
repurchased shares sold by or for 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 price of our common stock may be higher than the price that
otherwise might exist in the open market. If these activities are commenced,
they may be discontinued by the underwriters at any time. These transactions may
be effected on the Nasdaq National Market, in the over-the-counter market or
otherwise.
We have agreed to indemnify the several underwriters against liabilities,
including liabilities under the Securities Act of 1933, and to contribute to
payments that the underwriters may be required to make in respect thereof.
First Union Securities, Inc., one of the underwriters, is an indirect,
wholly-owned subsidiary of Wachovia Corporation. Wachovia Corporation conducts
its investment banking, institutional, and capital markets businesses through
its various bank, broker-dealer and nonbank subsidiaries (including First Union
Securities, Inc.) under the trade name of Wachovia Securities. Any references to
Wachovia Securities in this prospectus, however, do not include Wachovia
Securities, Inc., member NASD/SIPC and a separate broker-dealer subsidiary of
Wachovia Corporation and an affiliate of First Union Securities, Inc., which may
or may not be participating as a selling dealer in the distribution of the
securities offered by this prospectus.
--------------------------------------------------------------------------------
84
<Page>
--------------------------------------------------------------------------------
Legal matters
The validity of the shares of common stock offered in this prospectus will be
passed upon for us by Brobeck, Phleger & Harrison LLP, San Diego, California.
Certain legal matters in connection with the offering will be passed upon for
the underwriters by Alston & Bird LLP, New York, New York.
Experts
The consolidated financial statements as of December 31, 1999 and 2000, and for
each of the three years in the period ended December 31, 2000, included in this
prospectus and registration statement have been audited by Ernst & Young, LLP,
independent auditors, as stated in their report appearing in this prospectus and
registration statement, and are included in reliance upon the report of that
firm given upon their authority as experts in accounting and auditing.
Where you can find more information
We have filed with the SEC a registration statement on Form S-1 (including the
exhibits, schedules and amendments to the registration statement) under the
Securities Act of 1933 with respect to the shares of common stock to be sold in
this offering. This prospectus does not contain all the information set forth in
the registration statement. For further information with respect to our company
and the shares of common stock to be sold in this offering, reference is made to
the registration statement. Statements contained in this prospectus as to the
contents of any contract, agreement or other document referred to are not
necessarily complete, and in each instance reference is made to the copy of such
contract, agreement or other document filed as an exhibit to the registration
statement, each such statement being qualified in all respects by such
reference.
Our SEC filings, including the registration statement, are also available to you
on the Commission's website (http://www.sec.gov). You may read and copy all or
any portion of the registration statement or any other information we file at
the SEC's public reference room at 450 Fifth Street, N.W., Washington, D.C.
20549. You can request copies of these documents, upon payment of a duplicating
fee, by writing to the SEC. Please call the SEC at 1-800-SEC-0330 for further
information on the operation of the public reference rooms.
As a result of this offering, we will become subject to the information and
reporting requirements of the Securities Exchange Act of 1934, and in accordance
with those requirements, we will file periodic reports, proxy statements and
other information with the SEC.
--------------------------------------------------------------------------------
85
<Page>
--------------------------------------------------------------------------------
Index To Consolidated Financial Statements
<Table>
<Caption>
Page
----------------------------------------------------------------------
Report of Ernst & Young LLP, Independent Auditors........... F-2
Consolidated Balance Sheets as of December 31, 1999 and 2000
and June 30, 2001 (unaudited)............................. F-3
Consolidated Statements of Operations for the years ended
December 31, 1998, 1999 and 2000 and the six months ended
June 30, 2000 and 2001 (unaudited)........................ F-4
Consolidated Statements of Stockholders' Equity (Deficit)
for the years ended December 31, 1998, 1999 and 2000 and
the six months ended June 30, 2001 (unaudited)............ F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1999 and 2000 and the six months ended
June 30, 2000 and 2001 (unaudited)........................ F-6
Notes to Consolidated Financial Statements.................. F-7
</Table>
--------------------------------------------------------------------------------
F-1
<Page>
--------------------------------------------------------------------------------
Report of Ernst & Young LLP, Independent Auditors
The Board of Directors and Stockholders
Digirad Corporation
We have audited the accompanying consolidated balance sheets of Digirad
Corporation as of December 31, 1999 and 2000, and the related statements of
operations, stockholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 2000. 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, 1999 and 2000, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States.
/s/ ERNST & YOUNG LLP
San Diego, California
June 5, 2001, except for Note 4 and Note 11,
as to which the date is August 23, 2001.
--------------------------------------------------------------------------------
F-2
<Page>
DIGIRAD CORPORATION
--------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
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 2,665,868 2,428,620
Deferred offering costs and other
assets................................ -- -- 836,880
------------ ------------ ------------
Total assets............................ $ 5,699,304 $ 23,049,742 $ 28,428,313
============ ============ ============
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 2,235,369 4,578,536 62,660,543
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) (43,479,435) (48,240,096) $ 9,869,040
------------ ------------ ------------ ============
Total liabilities and stockholders'
equity (deficit)...................... $ 5,699,304 $ 23,049,742 $ 28,428,313
============ ============ ============
</Table>
See accompanying notes.
--------------------------------------------------------------------------------
F-3
<Page>
DIGIRAD CORPORATION
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
<Table>
<Caption>
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 6,437,768
Imaging services............... -- -- 839,296 -- 3,618,812
Stock-based compensation....... -- -- 64,392 -- 196,809
----------- ------------ ------------ ----------- -----------
Total cost of revenues........... 388,172 264,545 10,738,039 3,601,803 10,253,389
----------- ------------ ------------ ----------- -----------
Gross profit (loss).............. 1,532,797 19,344 (3,662,617) (2,145,323) 3,765,551
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 4,027,935
General and administrative..... 2,533,452 1,967,050 2,878,199 1,071,668 2,674,383
Amortization of intangible
assets....................... -- -- 194,291 3,347 285,864
Stock-based compensation....... -- -- 246,128 -- 894,902
----------- ------------ ------------ ----------- -----------
Total operating expenses......... 8,582,011 13,485,299 9,276,463 3,448,883 9,210,401
----------- ------------ ------------ ----------- -----------
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 product revenue...... $ 53,959 $ 138,675
Cost of imaging services
revenue.................... 10,433 58,134
Research and development..... 5,954 61,116
Sales and marketing.......... 51,283 449,932
General and administrative... 188,891 383,854
------------ -----------
$ 310,520 $ 1,091,711
============ ===========
</Table>
See accompanying notes.
--------------------------------------------------------------------------------
F-4
<Page>
DIGIRAD CORPORATION
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Years ended December 31, 1998, 1999 and 2000 and the six months ended June 30,
2001(unaudited)
<Table>
<Caption>
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
Issuance of
warrants in
conjunction with
debt............. -- -- 259,106 -- -- -- 259,106
Issuance of
options, warrants
and other equity
instruments to
non-employees.... -- -- 46,605 -- -- -- 46,605
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 2,235,369 (536,820) (85,919) (45,096,429) (43,479,435)
Exercise of common
stock options
(unaudited)...... 214,128 214 76,637 -- (26,000) -- 50,851
Repurchase of
unvested
restricted stock
(unaudited)...... (3,565) (3) (1,348) -- -- -- (1,351)
Issuance of
options, warrants
and other equity
instruments to
non-employees.... -- -- 271,695 -- -- -- 271,695
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 $4,578,536 $(1,712,989) $(111,919) $(50,998,299) $(48,240,096)
========= ====== ========== =========== ========= ============ ============
</Table>
See accompanying notes.
--------------------------------------------------------------------------------
F-5
<Page>
DIGIRAD CORPORATION
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
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.............. -- -- 194,291 3,347 285,864
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
Options, warrants and other equity
instruments issued to non-employees.... -- -- 46,605 2,640 271,695
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) (361,854) (202,442) (1,235,968)
Inventories............................ -- -- (3,587,173) (3,448,369) (3,889,449)
Accounts payable....................... 621,590 300,109 1,332,197 166,684 934,664
Accrued compensation................... (7,833) 169,122 577,658 130,593 372,758
Accrued warranty and other accrued
liabilities.......................... (267,700) 89,682 1,830,370 860,592 166,590
----------- ------------ ------------ ----------- -----------
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 $ -- $ --
=========== ============ ============ =========== ===========
</Table>
See accompanying notes.
--------------------------------------------------------------------------------
F-6
<Page>
DIGIRAD 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)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company
Digirad Corporation (the "Company"), a Delaware corporation, designs, develops,
manufactures and markets 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 formed two Delaware corporations, Digirad Imaging
Solutions, Inc. and its subsidiary Digirad Imaging Systems, Inc., together
"DIS", to provide turnkey nuclear cardiology imaging to physicians in their
offices on a national basis. DIS is a wholly owned subsidiary of Digirad and was
capitalized by contributing certain acquired assets (see Note 2). The
accompanying consolidated financial statements include the operations of DIS.
Intercompany accounts have been eliminated in consolidation.
Interim Financial Data
The accompanying consolidated financial statements for the six months ended
June 30, 2000 and 2001 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 of only normal
recurring adjustments, necessary to state fairly the financial information set
forth therein, in accordance with accounting principles generally accepted in
the United States.
The results of operations for the interim period ended June 30, 2001 are not
necessarily indicative of the results which may be reported for any other
interim period or for the year ending December 31, 2001.
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. 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-7
<Page>
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)
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 market value.
Deferred Offering Costs and Other Assets
Deferred offering costs and other assets primarily consist 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
results of operations.
Concentration of Credit Risk
The Company sells its products to customers in the United States and Japan. A
relatively small number of customers account for a significant percentage of the
Company's revenues. For the year ended December 31, 2000, three product
customers accounted for 15.9%, 11.6% and 10.1% of our consolidated revenues.
However, for the six months ended June 30, 2001, no product customers accounted
for 10% or more of consolidated revenues. No imaging services customers
accounted for 10% or more of our consolidated revenues for the year ended
December 31, 2000 or the six months ended June 30, 2001. 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 significant percentage of the Company's net imaging services revenue in 2000
and 2001 is derived from governmental agencies, such as Medicare. 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 and contractual
allowances, which historically have been within management's estimates.
Inventories
Inventories are stated at the lower of cost or market, cost being determined on
a first-in, first-out basis.
Property and Equipment
Depreciation and amortization of property and equipment, including assets
recorded under capital leases, is provided using the straight-line method over
the shorter of the estimated useful lives of the related assets, which is
generally 3 to 10 years, or the lease term if applicable.
Intangibles
Intangibles include acquired customer contracts and patents and trademarks and
are recorded at cost. Intangibles, except for patents, are amortized over their
estimated useful lives, which are generally five years. Patents are amortized
over the lesser of their estimated useful or legal lives (up to 20 years).
--------------------------------------------------------------------------------
F-8
<Page>
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)
Impairment of Long-Lived Assets
The Company follows Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 121, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF,
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, the impairment to
be recognized is measured by the amount by which the carrying amount of the
assets exceeds the projected discounted future net cash flows arising from the
assets. SFAS 121 also addresses the accounting for long-lived assets that are
expected to be disposed of. To date, no such impairments have been identified.
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 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
and customer acceptance.
The Company has two primary sources of revenue which are product sales and
imaging services. Product revenues consist of revenues from the sales of gamma
cameras and revenues are recognized generally upon shipment 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. The Company also
provides installation and training for camera sales. The installation is
outsourced to a national service company and training is provided by Company
representatives. Neither service is essential to the functionality of the
product. Both services are performed shortly after delivery and represent an
insignificant cost to the Company. The Company accrues these costs at the time
of shipment.
Imaging services revenue is derived from the Company's mobile nuclear imaging
services. Revenue related to mobile imaging services is recognized at the time
services are performed and collection is reasonably assured. Imaging services
revenue is billed on a per procedure or per day basis. The Company is reimbursed
for mobile imaging services provided to patients under certain programs
administered by governmental agencies and private insurance companies. Laws and
regulations governing the Medicare and Medicaid programs are complex 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 exclusion from the 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 Compensation
The Company has elected to follow Accounting Principles Board ("APB") Opinion
No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEEs, and related Interpretations in
accounting for its employee stock
--------------------------------------------------------------------------------
F-9
<Page>
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)
options. Under APB 25, if the exercise price of the Company's employee stock
options is not less than the fair market value of the underlying stock on the
date of grant, no compensation expense is recognized. In conjunction with the
Company's initial public offering contemplated by this prospectus and other
events that occurred in 2000, the Company reviewed its exercise prices and
arrived at a revised fair value for certain stock options granted subsequent to
June 30, 2000. With respect to the options granted between June 30, 2000 and
December 31, 2000 and for the six months ended June 30, 2001, the Company has
recorded deferred stock compensation of $800,735 and $1,996,183, respectively,
for the difference between the original exercise price per share determined by
the Board of Directors and the revised estimate of fair value per share at the
respective grant date. The approximate weighted average exercise price and
approximate weighted average revised fair value per share for the 798,250
options granted between June 30, 2000 and December 31, 2000 was $0.50 and $1.50,
respectively. The approximate weighted average exercise price and approximate
weighted average revised fair value per share for the 1,169,200 options granted
during the six months ended June 30, 2001 was $1.13 and $2.84, respectively.
Deferred stock compensation is recognized and amortized on an accelerated basis
in accordance with Financial Accounting Standards Board Interpretation ("FIN")
No. 28, 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, and Emerging Issues Task Force ("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. The
fair value of the unvested options, warrants, and other equity instruments is
periodically remeasured and the related amortization is adjusted as necessary.
Compensation expense related to stock options, warrants, and other equity
instruments to acquire common stock issued to non-employees was $46,605 for the
year ended December 31, 2000 and $271,695 for the six months ended June 30,
2001.
Warranty Costs
The Company provides a warranty on certain of its products, generally for
periods of up to 12 months and accrues the estimated cost at the time revenue is
recorded.
Research and Development
Research and development costs are expensed as incurred.
Advertising Costs
Advertising costs are expensed as incurred. Total advertising costs for the
years ended December 31, 1998, 1999 and 2000 and for the six months ended
June 30, 2000 and 2001, were $63,183, $205,500, $133,987, $117,787 and $174,883,
respectively.
Comprehensive Income
SFAS No. 130, 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 on
--------------------------------------------------------------------------------
F-10
<Page>
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)
investments 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
The Company calculated net loss per share in accordance with SFAS 128, 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, 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, 30,412,668 and
33,466,687 for the years ended December 31, 1998, 1999 and 2000 and the six
months ended June 30, 2001, respectively, were excluded from historical basic
and diluted earnings per share because of their anti-dilutive effect.
--------------------------------------------------------------------------------
F-11
<Page>
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)
The unaudited pro forma basic and diluted net loss per share calculations assume
the conversion of all outstanding shares of preferred stock into common shares
using the as-if converted method as of January 1, 2000 or the date of issuance,
if later.
<Table>
<Caption>
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
============ ===========
</Table>
--------------------------------------------------------------------------------
F-12
<Page>
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)
Recent Accounting Pronouncements
In June 1999, the FASB issued SFAS No. 137, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES--DEFERRAL OF EFFECTIVE DATE OF FASB STATEMENT
NO. 133. SFAS No. 137 defers for one year the effective date of 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
quarters of all fiscal years 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. The ineffective 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 the adoption 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 this 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-13
<Page>
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)
$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") in excess of certain thresholds 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
non-competition and 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. The consulting agreement
also contained non-competition provisions. 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 will
be recorded as stock-based compensation expense over the three-year period of
the agreement. The fair value of the stock is periodically remeasured and the
related amortization is adjusted as necessary.
3. FINANCIAL STATEMENT DETAILS
The composition of certain balance sheet accounts is as follows:
Accounts Receivable
<Table>
<Caption>
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
========== ========== ==========
</Table>
--------------------------------------------------------------------------------
F-14
<Page>
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)
Inventories
<Table>
<Caption>
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
======== ========== ==========
</Table>
Property and Equipment
<Table>
<Caption>
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
=========== =========== ===========
</Table>
During 2000 and 2001, the Company entered into a series of financing
transactions structured as capital leases. The equipment, consisting of vans
equipped with the Company's portable gamma cameras, is used by DIS to provide
mobile nuclear imaging services. The terms of these leases generally range from
36 to 63 months. The cost of the equipment was $2,973,636 ($106,899 of
accumulated depreciation) at December 31, 2000 and $4,112,650 ($396,939 of
accumulated depreciation) at June 30, 2001.
Intangibles
<Table>
<Caption>
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
-------- ---------- ----------
421,458 2,789,335 2,837,949
Less accumulated amortization............................... (9,301) (123,467) (409,329)
-------- ---------- ----------
$412,157 $2,665,868 $2,428,620
======== ========== ==========
</Table>
--------------------------------------------------------------------------------
F-15
<Page>
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)
Other Accrued Liabilities
<Table>
<Caption>
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
======== ======== ==========
</Table>
4. DEBT
The composition of the Company's debt balance is as follows:
<Table>
<Caption>
December 31,
------------------------- June 30,
1999 2000 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
========== =========== ===========
</Table>
Notes Payable to Financial Institutions
In April 2000, the Company entered into a line of credit with 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 credit
accrues interest at the bank's floating prime rate plus 2%. The Company is
required to make monthly interest payments. The revolving line of credit expires
July 31, 2002 with any unpaid balance due upon expiration.
In July 2001, in conjunction with the amended line of credit the Company issued
the lender a warrant to purchase 42,490 shares of Series E preferred stock at a
price of $3.036 and valued the warrants at $84,130. The warrant is exercisable
immediately. The value of the warrant is recorded as debt discount and is
amortized to interest expense on a straight-line basis over the term of the
debt. The fair value of the warrant was determined using the Black-Scholes
option pricing model with the following assumptions: dividend yield of 0%;
expected volatility of 75%; risk-free interest rate of 3%; and a term of 3
years.
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.
--------------------------------------------------------------------------------
F-16
<Page>
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)
During 1999 and 2000, in conjunction with the loan and security agreement (as
amended), the Company issued the lender warrants to purchase 294,713 shares of
Series E preferred stock at a price of $3.036 per share and valued the warrants
at $280,600. The warrants are exercisable immediately. The value of the warrant
is recorded as debt discount and is amortized to interest expense on a
straight-line basis over the term of the debt. The fair value of the warrants
was determined using the Black-Scholes option pricing model with the following
assumptions: dividend yield of 0%; expected volatility of 75%; risk-free
interest rate of 6%; and a term of three years.
In January 2001, the Company entered into a 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. The
borrowings under the line of credit are limited to 85% of Qualified Account (as
defined) and accrue interest at the higher of prime plus 1.25% or 10.25%. The
revolving credit line expires in January 2004.
Notes Payable to Stockholders
The Company has notes payable to stockholders totaling $735,000 that bear
interest at 6.35% per year. The notes mature 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 classified as long-term.
Principal maturities on long-term debt, excluding capital lease obligations (see
Note 5), and notes payable to stockholders are as follows at December 31, 2000:
<Table>
2001....................... $1,536,023
2002....................... 1,605,937
----------
$3,141,960
==========
</Table>
The Company's borrowings are generally subject to financial and other
restrictive covenants. Substantially all of the Company's assets have been
pledged as collateral.
5. LEASE COMMITMENTS
The Company leases its facilities under non-cancelable operating leases which
expire through 2002. Rent expense was $303,475, $390,919, $418,470, $199,549,
and $346,188 for the years ended December 31, 1998, 1999 and 2000 and the six
months ended June 30, 2000 and 2001, respectively.
--------------------------------------------------------------------------------
F-17
<Page>
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)
Annual future minimum lease payments as of December 31, 2000 are as follows:
<Table>
<Caption>
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
===========
</Table>
6. REDEEMABLE CONVERTIBLE PREFERRED STOCK
<Table>
<Caption>
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
=========== ===========
</Table>
Deferred issuance costs through December 31, 2000 and June 30, 2001 for all
series of preferred stock totaled $385,758 and $473,652, respectively, and are
being accreted up to the redemption value through July 31, 2004 (the earliest
redemption date).
The preferred stock is redeemable on or after July 31, 2004, upon the request of
at least 66 2/3% of the holders of preferred stock. The Company shall redeem all
outstanding shares of preferred stock by paying in cash its liquidation value
plus declared but unpaid dividends. No dividends have been declared through
June 30, 2001.
--------------------------------------------------------------------------------
F-18
<Page>
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)
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 at a price equal to or exceeding
$7.50 per share of common stock, or with the approval of holders of at least 75%
of the outstanding shares of preferred stock and the approval of 60% of the
holders of Series D. Each share of the Series A, B, C, D, and E preferred stock
is convertible, at the option of the holder, into one share of the Company's
common stock, which has been reserved for issuance upon conversion of the
preferred stock, subject to certain antidilution adjustments. As of June 30,
2001, the requisite number of preferred stockholders had consented to the
automatic conversion of their shares in connection with the public offering.
Holders of the Series A, B, C, D, and E preferred stock are entitled to receive
dividends, if and when declared by the Board of Directors, at a rate of $0.10,
$0.11, $0.125, $0.231, and $0.304 per share per annum, respectively. 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 a majority of the then outstanding
preferred shares regarding certain changes in the rights and interests of the
preferred shares. The shareholders also have certain antidilutive rights.
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.
During the six months ended June 30, 2001, in conjunction with various sales and
marketing arrangements, the Company issued warrants to purchase 90,000 shares of
the Company's common stock at prices ranging from $1.50 to $3.04 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, in conjunction with convertible bridge note financing the
Company issued warrants to purchase up to 65,875 shares of Series E preferred
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.
--------------------------------------------------------------------------------
F-19
<Page>
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)
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 per share. The fair value of the warrants issued was $126,164 in
1999 and $154,365 in 2000.
All of the warrants above 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 of 6%; and a term of three years.
Stock Options
In December 1998, the Company's 1997 Stock Option/Stock Issuance Plan was
replaced with the 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 of 8,154,860 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.
The following table summarizes option activity under the stock option plans:
<Table>
<Caption>
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
==========
</Table>
As of December 31, 2000 and June 30, 2001, 1,202,190 and 1,540,264 shares,
respectively, were available for future grant.
--------------------------------------------------------------------------------
F-20
<Page>
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)
Following is a further breakdown of the options outstanding as of December 31,
2000:
<Table>
<Caption>
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
============ ============ ============= ========= =============
</Table>
The weighted average fair values of options granted in 1998, 1999, and 2000 were
$0.08, $0.07, and $0.59, respectively.
Adjusted pro forma information regarding net loss is required by SFAS 123, and
has been determined as if the Company had accounted for 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 1998, 1999 and 2000: a
risk-free interest rates of 5%, 5% and 6%, respectively; a dividend yield of 0%;
and a life of the option of five, five and six years, respectively.
For purposes of pro forma disclosures, the estimated fair value of the options
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:
<Table>
<Caption>
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)
</Table>
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 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. 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.
--------------------------------------------------------------------------------
F-21
<Page>
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)
Common Shares Reserved for Issuance
The following table summarizes common shares reserved for future issuance:
<Table>
<Caption>
December 31, June 30,
2000 2001
-----------------------------------------------------------------------------------------
Redeemable convertible preferred stock...................... 25,190,857 27,129,568
Convertible preferred stock warrants........................ 360,588 360,588
Common stock warrants....................................... 10,500 100,500
Common stock options........................................ 5,833,743 7,130,181
Commitment to issue common stock (Note 2)................... 150,000 150,000
------------- -----------
Total common shares reserved for issuance................... 31,545,688 34,870,837
============= ===========
</Table>
8. INCOME TAXES
As of December 31, 2000, the Company had federal and California income tax net
operating loss carryforwards of approximately $39,896,000 and $27,920,000,
respectively. The difference between the federal and California tax loss
carryforwards is primarily attributable to the 50% limitation in the utilization
of California net operating loss carryforwards. The federal tax loss
carryforwards will begin expiring in 2006 unless previously utilized. The
California tax loss carryforwards will begin to expire in 2002 unless previously
utilized. The Company also has federal and California research and development
and other credit carryforwards of approximately $1,570,000 and $1,250,000,
respectively. The federal research and development and other credit
carryforwards begin to expire in 2005 unless previously utilized.
The Company's net operating loss and credit carryforwards are subject to an
annual limitation on their use as a result of changes in ownership during 1995
and 1997, pursuant to Internal Revenue Code Sections 382 and 383. However, these
annual limitations are not expected to have a material affect on the Company's
ability to utilize its carryforwards.
--------------------------------------------------------------------------------
F-22
<Page>
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)
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 assets is uncertain.
<Table>
<Caption>
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..................................... $ -- $ --
============ ============
</Table>
9. SEGMENTS
During 2000, the Company commenced commercial operations and realigned its
operating structure into two reportable segments, products and imaging services.
The Company's new reporting 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 performance and allocates
certain costs based on the percentage of sales 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-23
<Page>
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)
reportable segments in fiscal 2000 and thereafter. As a result, prior years have
been presented as "Other" in the information shown below.
<Table>
<Caption>
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............................... $ -- $ -- $ (4,072,836) $(2,145,323) $ 3,225,922
Imaging services....................... -- -- 410,219 -- 539,629
Other.................................. 1,532,797 19,344 -- -- --
----------- ------------ ------------ ----------- -----------
Consolidated gross profit (loss)..... $ 1,532,797 $ 19,344 $ (3,662,617) $(2,145,323) $ 3,765,551
=========== ============ ============ =========== ===========
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....................... -- -- 243,487 -- 610,131
Other.................................. 573,030 733,947 -- -- --
----------- ------------ ------------ ----------- -----------
Consolidated depreciation and
amortization....................... $ 573,030 $ 733,947 $ 1,134,250 $ 371,141 $ 1,152,380
=========== ============ ============ =========== ===========
Identifiable assets by segment:
Products............................... $ -- $ -- $ 16,001,066 $12,489,000 $23,654,270
Imaging services....................... -- -- 7,048,676 -- 4,774,043
Other.................................. 16,365,039 5,699,304 -- -- --
----------- ------------ ------------ ----------- -----------
Consolidated assets.................. $16,365,039 $ 5,699,304 $ 23,049,742 $12,489,000 $28,428,313
=========== ============ ============ =========== ===========
</Table>
Sales to a distributor in Japan represented 8.5% and 5.0% 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 foreign sales for the years ended
December 31, 1998 and 1999.
--------------------------------------------------------------------------------
F-24
<Page>
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)
10. EMPLOYEE RETIREMENT PLAN
The Company has a 401(k) retirement plan (the "Plan"), under which all full-time
employees may contribute up to 15% of their annual salary, within limits. The
Company may elect to make discretionary contributions upon the approval of the
Board of Directors. Through June 30, 2001, the Company had not contributed to
the Plan.
11. SUBSEQUENT EVENTS
On August 23, 2001, 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 of the
Series F preferred stock are entitled to similar rights and privileges as
described in Note 6, except that the price-based antidilution provisions of the
Series F preferred stock were modified.
In July 2001, the Company was served 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 material impact on the financial statements.
--------------------------------------------------------------------------------
F-25
<Page>
[LOGO]
<Page>
--------------------------------------------------------------------------------
Part II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
The expenses to be paid by the Registrant are as follows. All amounts other than
the SEC registration fee, the NASD filing fees and the Nasdaq National Market
listing fee are estimates.
<Table>
<Caption>
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................................................... $
==========
</Table>
Item 14. Indemnification of Directors and Officers
Section 145 of the Delaware General Corporation Law permits a corporation to
include in its charter documents, and in agreements between the corporation and
its directors and officers, provisions expanding the scope of indemnification
beyond that specifically provided by the current law.
Article IV of the Registrant's amended and restated certificate of incorporation
allows for the indemnification of directors and officers 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 has entered into indemnification agreements with our directors
and executive officers, in addition to indemnification provided for in our
bylaws, and intends to enter into indemnification agreements with any new
directors and executive officers in the future. The indemnification agreements
may require the Registrant, among other things, to indemnify our directors and
officers against certain liabilities that may arise by reason of their status or
service as directors and officers (other than liabilities arising from willful
misconduct of a culpable nature), to advance their expenses incurred as a result
of any proceeding against them as to which they could be indemnified, and to
obtain directors' and officers' insurance, if 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 litigation that may result in
claims for indemnification.
Reference is also made to Section of the Underwriting Agreement, which
provides for the indemnification of officers, directors and controlling persons
of the Registrant against certain liabilities. The indemnification provision in
the Registrant's amended and restated certificate of incorporation, bylaws and
the indemnification agreements entered into between the Registrant and each of
its
--------------------------------------------------------------------------------
II-1
<Page>
Part II
--------------------------------------------------------------------------------
directors and executive officers may be sufficiently broad to permit
indemnification of the Registrant's directors and executive officers for
liabilities arising under the Securities Act of 1933.
The Registrant applied for liability insurance for our officers and directors.
Reference is made to the following documents filed as exhibits to this
Registration Statement regarding relevant indemnification provisions described
above and elsewhere in this prospectus:
<Table>
<Caption>
Exhibit
Document Number
----------------------------------------------------------------------
Form of Underwriting Agreement.............................. 1.1
Form of Amended and Restated Certificate of Incorporation to
be in effect immediately prior to the closing of this
offering.................................................. 3.2
Form of Amended and Restated Bylaws to be in effect
immediately prior to the closing of this offering......... 3.4
Form of Indemnification Agreement........................... 10.28
</Table>
Item 15. Recent Sales of Unregistered Securities
(1) On June 23, 1998, the Registrant issued 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 $3.036
per share to 2 purchasers in connection with a Loan 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) On April 6, 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-2
<Page>
Part 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 Registrant issued and sold to 5 purchasers
convertible promissory notes in the aggregate principal amount of $2,000,000
that were convertible into shares of the Registrant's Series E Preferred Stock.
In consideration for entering into the promissory notes, the Registrant also
issued the purchasers warrants to purchase up to 65,875 shares of the
Registrant's Series E Preferred Stock at an exercise price of $3.036 per share.
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;
(8) On August 14, 2000, the Registrant issued warrants to purchase up to
65,877 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
$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 Registrant issued and sold 3,005,595 shares of
its Series E Preferred Stock to 10 purchasers for an aggregate purchase price of
$9,124,987, which amount reflected the conversion of $2,000,000 of the
Registrant's convertible promissory notes into shares of Series 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 with an exercise price of $1.50 per share to
Cardiovascular 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 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
500 shares of its Common Stock with an exercise price of $3.04 per share to
Robert McKenzie 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
--------------------------------------------------------------------------------
II-3
<Page>
Part II
--------------------------------------------------------------------------------
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;
(12) On December 8, 2000, the Registrant issued and sold 181,157 shares of
its Series E Preferred Stock to 6 purchasers for an aggregate purchase price 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 exercise price of $2.00 per share to
Oklahoma Cardiovascular Associates 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 access to all 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 issued warrants to purchase up to
10,000 shares of its Common Stock with an exercise price of $3.04 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;
(18) On March 9, 2001, the Registrant issued and sold 150,362 shares of its
Series E Preferred Stock to 3 purchasers for an aggregate purchase price of
$456,499. The Registrant relied on the exemption provided by Section 4(2) and/or
Regulation D promulgated under the Securities Act of
--------------------------------------------------------------------------------
II-4
<Page>
Part 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 March 16, 2001, the Registrant issued and sold 296,050 shares of its
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 with an exercise price of $3.04 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;
(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 issued warrants to purchase up to
20,000 shares of its Common Stock with an exercise price of $3.04 per share to 3
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;
(23) On July 31, 2001, the Registrant issued a warrant to purchase up to
42,490 shares of its Series E Preferred Stock to Silicon Valley Bank 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 access to all
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 warrants to purchase up to an
aggregate of 100,000 shares of its Common Stock to two principals of McAdams and
Whitman Consulting, LLC in connection with a Consulting Agreement. 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;
(25) On August 23, 2001, the Registrant issued and sold 2,618,462 shares of
its Series F Preferred Stock to 25 purchasers for an aggregate purchase 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-5
<Page>
Part 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 January 1, 1998, the Registrant granted options to purchase
shares of its Common Stock to various directors, employees and consultants
pursuant to its 1995 Stock Option Plan. 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 its 1997 Stock Option/Stock Issuance Plan. 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
(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 has granted
options to purchase shares of its Common Stock to various directors, employees
and consultants pursuant to its 1998 Stock Option/Stock Issuance Plan. 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
(a) Section 4(2) as transactions not involving a public offering, 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.
The recipients of the above-described securities represented their intention to
acquire the securities for investment only and not with a view to distribution
thereof. Appropriate legends were affixed to the stock certificates issued in
such transactions. All recipients had adequate access, through employment or
other relationships, to information about the Registrant. No underwriters were
involved in the distribution of the above-described securities.
--------------------------------------------------------------------------------
II-6
<Page>
Part II
--------------------------------------------------------------------------------
Item 16. Exhibits and Financial Statement Schedules
(a) Exhibits
<Table>
<Caption>
Number Description
------------------------------------------------------------------------------------
1.1* Form of Underwriting Agreement.
3.1** Amended and Restated Certificate of Incorporation.
3.2* Form of Amended and Restated Certificate of Incorporation to
be in effect immediately prior to the closing of the initial
public offering.
3.3** Bylaws.
3.4* Form of Amended and Restated Bylaws to be in effect
immediately prior to the closing of the initial public
offering.
4.1* Form of Specimen Common Stock Certificate.
5.1* Opinion of Brobeck, Phleger & Harrison LLP.
10.1+** License Agreement by and between Registrant and the Regents
of the University of California, dated May 19, 1999, as
amended.
10.2+** Software License Agreement by and between Registrant and
Segami Corporation, dated June 16, 1999.
10.3+** 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 Registrant and
Silicon Valley Bank, dated April 1, 2000, as amended.
10.8* Loan and Security Agreement by and between Orion Imaging
Systems, Inc., Digirad Imaging Systems, Inc. and Heller
Healthcare Finance, Inc., dated January 9, 2001.
10.9* Master Lease Agreement by and between Registrant and GE
Healthcare Financial Services, dated September 26, 2000.
10.10** Equipment Lease Agreement by and between Registrant and
MarCap Corporation, dated October 1, 2000.
10.11** 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.
10.12** Asset Purchase Agreement by and among Digirad Imaging
Systems, Inc., Nuclear Imaging Systems, Inc. and
Cardiovascular Concepts, P.C., dated September 29, 2000.
10.13* 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.
10.14** Convertible Promissory Note and Warrant Purchase Agreement
by and among Registrant and the investors listed on Exhibit
A, dated September 29, 2000.
10.15** Form of Warrant to purchase shares of Series E Preferred
Stock by and between Registrant and the investors listed on
the attached schedule.
10.16** Form of Warrant to purchase shares of Common Stock by and
between Registrant and the investors listed on the attached
schedule.
10.17+** Fourth Additional Series E Preferred Stock Purchase
Agreement by and among Registrant and the investors listed
on Schedule 1 thereto, dated November 10, 2000, as amended.
</Table>
--------------------------------------------------------------------------------
II-7
<Page>
Part II
--------------------------------------------------------------------------------
<Table>
<Caption>
Number Description
------------------------------------------------------------------------------------
10.18+** Series F Preferred Stock Purchase Agreement by and among
Registrant and the investors listed on Schedule 1 thereto,
dated August 23, 2001.
10.19** Amended and Restated Investors' Rights Agreement by and
among Registrant and the investors listed on Schedule A
thereto, dated August 23, 2001.
10.20** Amended and Restated Co-Sale Agreement by and among
Registrant and the investors listed on Schedule A thereto,
dated November 10, 2000.
10.21** Amended and Restated Series E Voting Agreement by and among
Registrant and the investors listed therein, dated November
10, 2000.
10.22** 1998 Stock Option/Stock Issuance Plan, as amended.
10.23** 1998 Stock Option/Stock Issuance Plan, Form of Notice of
Grant.
10.24** 1998 Stock Option/Stock Issuance Plan, Form of Stock Option
Agreement.
10.25** 1998 Stock Option/Stock Issuance Plan, Form of Stock
Purchase Agreement.
10.26* 2001 Stock Incentive Plan.
10.27* Form of Indemnification Agreement.
10.28+** Consulting Agreement dated July 31, 2001.
10.29+** Service Agreement by and between Registrant and Universal
Servicetrends, Inc., dated August 25, 2000.
10.30** Master Equipment Lease Agreement by and between Registrant
and DVI Financial Services, Inc., dated May 24, 2001.
10.31** Loan Agreement by and between Registrant and Gerald G. Loehr
Trust, dated September 1, 1993, as amended.
10.32** Loan Agreement by and between Registrant and Clinton L.
Lingren, dated September 1, 1993, as amended.
10.33** Loan Agreement by and between Registrant and Jack F. Butler,
dated September 1, 1993, as amended.
10.34* Form of Warrant to purchase shares of Series E Preferred
Stock by and between Registrant and the investors listed on
the attached schedule.
10.35** Warrant to purchase shares of Series E Preferred Stock by
and between Registrant and Silicon Valley Bank, dated
July 31, 2001.
10.36+* Warrant Issuance Agreement, dated July 31, 2001.
10.37+* Warrant to purchase shares of Common Stock, dated July 31,
2001.
21.1** Subsidiaries of Registrant.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2* Consent of Brobeck, Phleger & Harrison LLP (included in
Exhibit 5.1).
24.1** Powers of Attorney (included in the Signature Page).
</Table>
---------
* To be filed by amendment.
** Previously filed as an exhibit to the Registration Statement.
+ Certain portions of this Exhibit for which confidential treatment has been
requested have been redacted and filed separately with the Securities and
Exchange Commission.
(b) Financial Statement Schedules.
SCHEDULE II--Valuation and Qualifying Accounts and Reserves
All other schedules are omitted because they are not applicable or not required
or because the required information is shown in the Consolidated Financial
Statements of Digirad Corporation or the notes thereto.
--------------------------------------------------------------------------------
II-8
<Page>
Part II
--------------------------------------------------------------------------------
Item 17. Undertakings
The undersigned Registrant hereby undertakes to provide to the Underwriter at
the closing specified in the Underwriting Agreement, certificates in such
denominations and registered in such names as required by the Underwriter to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act of
1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the SEC such indemnification is against
public policy as expressed in the Act, and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a director, officer or
controlling person of the Registrant 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 registered, the Registrant will, unless
in the opinion of counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of
1933 the information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424 (b)(1) or (4), or 497(h)
under the Securities Act of 1933 shall 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
1933 each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
--------------------------------------------------------------------------------
II-9
<Page>
--------------------------------------------------------------------------------
Signatures
Pursuant to the requirements of the Securities Act of 1933, the Registrant has
duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized in San Diego, California, on this 5th day
of November 2001.
<Table>
DIGIRAD CORPORATION
By: /s/ GARY J. G. ATKINSON
-----------------------------------------
Name: Gary J. G. Atkinson
Title: CHIEF FINANCIAL OFFICER
</Table>
Pursuant to the requirements of the Securities Act of 1933 this Registration
Statement has been signed by the following persons in the capacities indicated
on November 5, 2001:
<Table>
<Caption>
Signature Title Date
----------------------------------------------------------------------------------------------------
*
--------------------------------- President, Chief Executive Officer November 5, 2001
R. Scott Huennekens and Director
/s/ GARY J. G. ATKINSON
--------------------------------- Chief Financial Officer (principal November 5, 2001
Gary J. G. Atkinson financial and accounting officer)
--------------------------------- Chairman of the Board of Directors November 5, 2001
Timothy J. Wollaeger
--------------------------------- Director November 5, 2001
R. King Nelson
--------------------------------- Director November 5, 2001
Brad Nutter
--------------------------------- Director November 5, 2001
Kenneth E. Olson
--------------------------------- Director November 5, 2001
Douglas Reed, M.D.
</Table>
<Table>
*By: /s/ GARY J. G. ATKINSON
----------------------------
Gary J. G. Atkinson
ATTORNEY IN FACT
</Table>
--------------------------------------------------------------------------------
II-10
<Page>
Schedule II
--------------------------------------------------------------------------------
DIGIRAD CORPORATION
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
<Table>
<Caption>
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
======= ======== ===========
</Table>
--------------------------------------------------------------------------------
S-1
<Page>
--------------------------------------------------------------------------------
Index to exhibits
<Table>
<Caption>
Number Description
------------------------------------------------------------------------------------
1.1* Form of Underwriting Agreement.
3.1** Amended and Restated Certificate of Incorporation.
3.2* Form of Amended and Restated Certificate of Incorporation to
be in effect immediately prior to the closing of the initial
public offering.
3.3** Bylaws.
3.4* Form of Amended and Restated Bylaws to be in effect
immediately prior to the closing of the initial public
offering.
4.1* Form of Specimen Common Stock Certificate.
5.1* Opinion of Brobeck, Phleger & Harrison LLP.
10.1+** License Agreement by and between Registrant and the Regents
of the University of California, dated May 19, 1999, as
amended.
10.2+** Software License Agreement by and between Registrant and
Segami Corporation, dated June 16, 1999.
10.3+** 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 Registrant and
Silicon Valley Bank, dated April 1, 2000, as amended.
10.8* Loan and Security Agreement by and between Orion Imaging
Systems, Inc., Digirad Imaging Systems, Inc. and Heller
Healthcare Finance, Inc., dated January 9, 2001.
10.9* Master Lease Agreement by and between Registrant and GE
Healthcare Financial Services, dated September 26, 2000.
10.10** Equipment Lease Agreement by and between Registrant and
MarCap Corporation, dated October 1, 2000.
10.11** 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.
10.12** Asset Purchase Agreement by and among Digirad Imaging
Systems, Inc., Nuclear Imaging Systems, Inc. and
Cardiovascular Concepts, P.C., dated September 29, 2000.
10.13* 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.
10.14** Convertible Promissory Note and Warrant Purchase Agreement
by and among Registrant and the investors listed on Exhibit
A, dated September 29, 2000.
10.15** Form of Warrant to purchase shares of Series E Preferred
Stock by and between Registrant and the investors listed on
the attached schedule.
10.16** Form of Warrant to purchase shares of Common Stock by and
between Registrant and the investors listed on the attached
schedule.
10.17+** Fourth Additional Series E Preferred Stock Purchase
Agreement by and among Registrant and the investors listed
on Schedule 1 thereto, dated November 10, 2000, as amended.
10.18+** Series F Preferred Stock Purchase Agreement by and among
Registrant and the investors listed on Schedule 1 thereto,
dated August 23, 2001.
</Table>
<Page>
Index to exhibits
--------------------------------------------------------------------------------
<Table>
<Caption>
Number Description
------------------------------------------------------------------------------------
10.19** Amended and Restated Investors' Rights Agreement by and
among Registrant and the investors listed on Schedule A
thereto, dated August 23, 2001.
10.20** Amended and Restated Co-Sale Agreement by and among
Registrant and the investors listed on Schedule A thereto,
dated November 10, 2000.
10.21** Amended and Restated Series E Voting Agreement by and among
Registrant and the investors listed therein, dated November
10, 2000.
10.22** 1998 Stock Option/Stock Issuance Plan, as amended.
10.23** 1998 Stock Option/Stock Issuance Plan, Form of Notice of
Grant.
10.24** 1998 Stock Option/Stock Issuance Plan, Form of Stock Option
Agreement.
10.25** 1998 Stock Option/Stock Issuance Plan, Form of Stock
Purchase Agreement.
10.26* 2001 Stock Incentive Plan.
10.27* Form of Indemnification Agreement.
10.28+** Consulting Agreement dated July 31, 2001.
10.29+** Service Agreement by and between Registrant and Universal
Servicetrends, Inc., dated August 25, 2000.
10.30** Master Equipment Lease Agreement by and between Registrant
and DVI Financial Services, Inc., dated May 24, 2001.
10.31** Loan Agreement by and between Registrant and Gerald G. Loehr
Trust, dated September 1, 1993, as amended.
10.32** Loan Agreement by and between Registrant and Clinton L.
Lingren, dated September 1, 1993, as amended.
10.33** Loan Agreement by and between Registrant and Jack F. Butler,
dated September 1, 1993, as amended.
10.34* Form of Warrant to purchase shares of Series E Preferred
Stock by and between Registrant and the investors listed on
the attached schedule.
10.35** Warrant to purchase shares of Series E Preferred Stock by
and between Registrant and Silicon Valley Bank, dated
July 31, 2001.
10.36+* Warrant Issuance Agreement, dated July 31, 2001.
10.37+* Warrant to purchase shares of Common Stock, dated July 31,
2001.
21.1** Subsidiaries of Registrant.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2* Consent of Brobeck, Phleger & Harrison LLP (included in
Exhibit 5.1).
24.1** Powers of Attorney (included in the Signature Page).
</Table>
---------
* To be filed by amendment.
** Previously filed as an exhibit to the Registration Statement.
+ Certain portions of this Exhibit for which confidential treatment has been
requested have been redacted and filed separately with the Securities and
Exchange Commission.