-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, OZlHzSCvBsngXAr3DUNQVO5Io1nNPEA2tgnxahswSdBoSvnjYkINXZqURQwuqQPi GbxXwkLGSrLZylH9KNXpHw== 0000891554-02-001605.txt : 20020415 0000891554-02-001605.hdr.sgml : 20020415 ACCESSION NUMBER: 0000891554-02-001605 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020328 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HOWTEK INC CENTRAL INDEX KEY: 0000749660 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER PERIPHERAL EQUIPMENT, NEC [3577] IRS NUMBER: 020377419 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-09341 FILM NUMBER: 02589960 BUSINESS ADDRESS: STREET 1: 21 PARK AVE CITY: HUDSON STATE: NH ZIP: 03051 BUSINESS PHONE: 6038825200 10-K 1 d50184_10-k.txt ANNUAL REPORT SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____ ____ ____ to ____ ____ ____ Commission file number 1-9341 HOWTEK, INC. (Exact name of registrant as specified in its charter) Delaware 02-0377419 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 21 Park Avenue, Hudson, New Hampshire 03051 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (603) 882-5200 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12 (g) of the Act: Title of Class Common Stock, $.01 par value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant as required to file such reports), and (2) has been subject to such filing requirement for the past 90 days. YES X NO . --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [x] The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing price for the registrant's Common Stock on March 1, 2002 was $33,544,562. As of March 1, 2002, the registrant had 15,297,661 shares of Common Stock outstanding. 2 "Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995: Certain information included in this report on Form 10-K that are not historical facts contain forward looking statements that involve a number of known and unknown risks, uncertainties and other factors that could cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievement expressed or implied by such forward looking statements. These risks and uncertainties include, but are not limited to, uncertainty of future sales levels, protection of patents and other proprietary rights, the impact of supply and manufacturing constraints or difficulties, possible technological obsolescence of products, competition, and other risks detailed in Howtek's Securities and Exchange Commission filings. The words "believe", "expect", "anticipate" and "seek" and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. PART I Item 1. Business. General Howtek, Incorporated, ("Howtek" or the "Company"), located in Hudson, New Hampshire, was founded in 1984. Howtek develops, manufactures, and markets digitizing systems, or "scanners", which convert printed, photographic and other "hard copy" images to digital form for use in the medical, photo finishing, and graphic arts industries. The Company introduced the first "desktop" scanner in 1986, smaller, easier to use and less costly than alternative scanners at that time, helping to make possible the shift to decentralized corporate electronic publishing. Howtek followed with a series of award winning, industry leading products, continuing to improve the quality of digital imaging, and reducing the price and complexity of scanning systems. Facing diminishing returns in its traditional graphic arts business, Howtek, in the last several years, has heavily invested in technology and product development in the fields of medical and photographic imaging and digitization. After two years of work supporting development-stage OEM customers in the new field of Computer Assisted Detection (CAD) of breast cancer, Food & Drug Administration (FDA) approvals for sales in the United States of CAD systems incorporating Howtek digitizers were received by two key Howtek OEM customers during the first quarter of 2002. The Company believes such FDA approvals, coupled with newly implemented medical cost reimbursement coverage for procedures utilizing such CAD systems, may contribute to sales growth in this area. The Company's FotoFunnel(TM) photographic scanner solution was introduced by one key OEM customer in 2000, as part of an Internet-driven photo finishing solution. During 2001, as a result of a general reassessment of the role of the Internet in photo finishing, large retail accounts, in general, elected not to purchase such systems. In response, the Company has repositioned its FotoFunnel product line, offering its photographic products to retail photo finishers as an inexpensive way to offer photo images on compact disk (CD) to retail photo customers. Sales of FotoFunnel are expected to increase during 2002 from 2001 levels. 3 In support of its shift in focus to medical and photo processing markets, the Company has in recent years (1) updated product lines, introducing industry-leading products in medical and photo processing/Internet markets, (2) migrated from in-house manufacturer to outsourcing to more effectively utilize outside engineering, development, and manufacturing resources, (3) substantially reduced personnel and overhead, and (4) implemented an OEM and large scale systems integrator marketing and sales strategy for primary digitizer markets. See Note 7 of Notes to Financial Statements for certain revenue information by product line and information regarding export sales. Medical Business Howtek MultiRAD(TM) digitizers are used in medical imaging to convert radiographic films to digital records for computer analysis, diagnosis, transmission or storage. Market It has been over a hundred years since the X-ray was invented. In 1999, 270 million X-ray exams were performed in the United States, making X-ray the most prevalent diagnostic tool in medicine.(1) Medical imaging technologies and applications now extend beyond radiology, and play a role in all branches of medicine. The overall healthcare market is growing at a rapid pace. According to Imaging Economics the medical imaging market is growing even more quickly.(2) United States healthcare expenditures are expected to increase from $1.2 trillion in 1999 to $2.2 trillion in 2008. Approximately six percent of the total healthcare budget in 1999 was spent on diagnostic imaging, with that percentage expected to increase to 15% by 2008. While medical imaging grows in significance, a shortage of physicians that can read diagnostic images has already started and the shortage is expected to grow through 2020. Howtek's MultiRAD X-ray and radiographic film digitizers play a significant role in three distinct medical applications: computer-assisted detection of breast cancer, Teleradiology/Picture Archiving & Communication (PACS), and patient record duplication and management. Computer Assisted Detection is used to provide physicians with support in detecting breast cancer at an early stage. There is a tremendous need for devices that facilitate the early detection of breast cancer and other forms of cancer. For most cancers, the earlier treatment is rendered, the greater the likelihood of successfully managing the cancer. Some studies show that if breast cancer is detected while still localized and before metastasis spread, the five-year survival rate is 96.8% or better. If the cancer spreads regionally before treatment, the survival rate drops to around 75.9%. If there is distant metastasis, the survival rate drops to around 20.6%. 1 Diagnostic Imaging, July 2000 2 Imaging Economics, "The Big Picture" Lightfoote, November/December 2000 4 A primary method of detecting breast cancer is through mammography screening. Mammography is a radiographic examination of a breast. The American Cancer Society recommends that women undergo annual mammogram examinations beginning at age 40. Approximately 5 million additional women in the United States will be entering the mammography testing 40-and-over age category within the next 5 years. A problem in this process, that the Company's OEM customers seek to address, is that in routine screening of mammography films an estimated 10% of identifiable breast cancers are missed as a result of radiologist oversight. In the United States, reimbursement for a secondary reading of mammography films using CAD systems began in January 2002, effectively creating the domestic market in which the Company's OEM CAD customers compete. There are approximately 20,000 mammography centers located throughout the world. Approximately 10,000 of these centers are located in the United States. The Company believes that economic, marketing and legal factors will drive mammography centers to adopt CAD technology, and that newly implemented reimbursement programs will help to support acquisitions of such systems. The Company believes that the potential market for digitizers employed in computer aided detection of breast cancer is significant. Teleradiology is the practice of transmitting images for analysis, consultation or diagnostic interpretation to another location. The Company's digitizers are used in this process to convert radiographic film to digital form, for transmission, communication or storage. Use of teleradiology is increasingly influenced by the economics of managed care, which mandates ever-growing sensitivity to costs and has strongly encouraged the decentralization of patient care, with specialized services available in fewer locations, on a consultative, remote basis. In the past, radiologists were located in a medical facility close to the patient where they performed examinations and interacted face-to-face with the local clinician and the patient. As reimbursement for radiological interpretations have declined and utilization has increased, radiologists are under pressure to increase the number of interpretations and compete for business over much larger geographic areas. The evolution toward managed regional healthcare systems, coupled with increasing radiologist specialization has resulted in a growing demand for equipment and systems capable of acquiring medical images remotely, at increasingly distributed points of primary patient contact, and transmitting those images for review and analysis centrally. Using teleradiology, information on a patient can be brought to the radiologist faster and at significantly lower cost than the method of transporting the patient from the point-of-care facility to the diagnostic facility. In addition, the digitization and transmission of medical images has enabled the formation of large-scale image storage and management networks known as Picture Archiving and Communication Systems, or PACS. PACS combine teleradiology, local area networks (LAN) and medical information systems to facilitate management and storage of medical images and integration of those images into patient management and hospital information systems. These systems also enable virtually instantaneous recall and viewing of medical images, and permit the viewing of several images simultaneously. PACS can significantly reduce the cost of providing efficient radiology services, in part by reducing the incidence of lost and misplaced medical films. In a manual system, it is estimated that approximately 10% of all medical films are lost 5 and an additional 10% to 15% are misplaced or misfiled, creating the need to take expensive duplicate images, delaying the delivery of quality medical care and resulting in increased medical costs and liability exposure. According to the Technology Marketing Group (TMG of Des Plaines, IL) hospitals spent nearly $600 million on PACS in 1999. PACS are typically located within the campus of the healthcare facility and are connected by the LAN. Growth in the PACS market is expected to increase 7 to 10 percent per year for the next five years.(3) Patient Record Duplication and Management is an increasing concern. All medical institutions are inundated with medical images, most of them on film, and the storage problem is increasing. In 1999, 270 million radiological studies were performed with an average of 4 films per study, creating an estimated 1.08 billion films. Of these films, none are thrown away. Not even institutions with digital PACS are spared; the PAC only stores information on active patients. Even in these so-called "filmless" hospitals, long-term storage is provided through the film library, which manually stores films. This can create a major problem and cost when images need to be duplicated or distributed for medical review by multiple practitioners or when copies of images are required for a variety of other purposes, including personal copies of patient records and litigation. The typical method of making images available for physician review has been to duplicate films for distribution, upon request, with the patient charged as much as $8 for each film in the radiological study to create a duplicate of that study. Typically, to duplicate a radiological study, the patient record is pulled from the film library. Duplicates are made individually by hand tying up a technologist for 4-6 minutes per film. Alternatively, films are sent out to a third party service bureau for duplication. The duplicates are placed in a new film jacket and the originals returned to the film library. The $8 fee barely covers the cost of handling and manually duplicating each individual film. A duplicated film has a higher contrast, similar to duplicate copies made on a plain paper photocopier. The duplicate is created photographically from an X-ray, losing gray content. Duplicate films tend to look black and white; shades of gray are often lost. The American College of Radiology and the FDA do not allow the use of duplicate films for primary reading of mammograms. Therefore, in order to read an image consulting physicians will often be required to make an appointment with the film library to review a particular set of films. The Company believes that degradation in image quality of duplicated X-rays often acts as an impediment to receipt of second opinions from healthcare providers. Historically, the specialized format of medical image files has created an obstacle to digitally duplicating a film or file for distribution on CD or DVD media. Radiological images are typically stored and viewed in what is called a "DICOM" format, a specialized file structure including patient and image information in addition to full image data. DICOM has been adopted and is well accepted within the radiology field, but is not generally supported outside 3 Medical Imaging, September 2000 6 this specialty. Use of DICOM images is often limited by the fact that many general physicians, surgeons, therapists, and others in the medical community do not have the specialized DICOM viewing stations that can cost from $30,000 to $120,000 or more. Therefore, the Company believes that use of the DICOM format can create a serious impediment to interconnectivity throughout the healthcare enterprise. In order to address the needs of the medical community that cannot afford a conventional DICOM station, Howtek introduced a new line of ImageFunnel(TM) products, which incorporate the Company's digitizers, to assist in providing an alternative, cost-effective method for duplication, distribution and storage of DICOM medical images. The Company's ImageFunnel products are currently under consideration by a variety of potential purchasers. The United States market for such solutions, if adopted, could include up to 6,000 hospitals and an additional 7,000 clinics and large medical practices. No assurance can be given that the Company will be able to successfully market its line of ImageFunnel products. MultiRAD(TM) Technology and Products Historically, radiographic film digitizers that utilize a laser light source to illuminate a film, and a photo multiplier tube to sense and measure the amount of light penetrating different regions of the film, captured the highest quality digital images. While these "first-generation" laser digitizers offer excellent image quality, they are expensive to acquire, comparatively delicate, and in many cases expensive to maintain. A "second-generation" of digitizers, using a fluorescent light source for image illumination and a charge-coupled device (CCD) sensor for image capture, offers reduced cost at the expense of reduced image quality. MultiRAD(TM) Individually Calibrated Red LED Illumination Technology Howtek believes that its competitive advantage in the medical digitizer market is based on its introduction of a "third generation" film digitizer that utilizes high energy, narrow-band red light, generated by an array of individually controlled, solid state, light emitting diodes (LEDs), to improve illumination of films and increase resulting image quality. This individually calibrated Red LED illumination technology avoids problems and disadvantages associated with use of common fluorescent light for film illumination, without the acquisition and maintenance costs commonly associated with film digitizers using laser illumination technology. As a result, the Company believes its MultiRADscanners are less expensive than existing competitive products with comparable capabilities, and are superior in performance to scanners previously available at comparable prices. In Howtek's proprietary radiological film digitization system, 56 individual, high-output LEDs transmit light through the radiological film, using a very high quality lens and imaging system to focus transmitted light on a sensitive 8000 element CCD detector. Generated light is nearly monochromatic at a wavelength of approximately 670 nanometers (nm). This red wavelength is matched to the peak sensitivity of the CCD camera, contributing to high signal strength, which results in improved dynamic range and image quality. This patent-pending solid state Red LED illumination system is thought by the Company to offer the following advantages over fluorescent illumination methods used by Howtek's competitors, contributing to improved image quality and to operator productivity: 7 o Near-Monochromatic Illumination o Higher and Flatter Illumination Profile o Adjustment to Lens Shape o Temporal Stability o Warm-up Characteristics o Adjustable Illumination Width MultiRAD(TM) Radiographic Film Digitizer Products. The MultiRAD product line, used to digitize radiographic film in Telemedicine, image archiving and Computer Assisted Diagnosis applications, among others, currently includes: o The MultiRAD 860, a high-resolution film digitizer that the Company believes is uniquely positioned to serve an increasing market for computer-assisted mammography. The MultiRAD 860 list price is $19,995. o The MultiRAD 460, with a list price of $16,995, offers lower resolution image capture applicable in Teleradiology and archiving applications. ImageFunnel(TM) Products. Howtek's ImageFunnel products, which in most cases include a MultiRAD digitizer, are used to retrieve a patient's image-based medical records from a variety of sources, including film, and write them to a patent-pending compact disk (CD) which includes a portable DICOM format file viewer. ImageFunnel solutions can be used to duplicate, distribute and store patient image records by medical film libraries and service bureaus, offering an alternative to lower-quality hard copies of image records. Howtek offers ImageFunnel solutions complete including compact workstations, applications software and CD burner. DVD support is anticipated. ImageFunnel Systems are offered in the following configurations, at the prices listed: Product Description List Price -------------------- ------------------------------------ ---------------- ImageFunnel Writes all images both analog and $46,999 digital to CD -------------------- ------------------------------------ ---------------- DicomFunnel Writes digital images to CD $19,999 -------------------- ------------------------------------ ---------------- FilmFunnel Writes analog images to CD $29,999 -------------------- ------------------------------------ ---------------- Sales & Marketing The Company reaches the Computer Assisted Detection market through OEMs. Current OEM customers include CADx Medical Systems, Inc., Integrated Software Solutions, Inc. (ISSI), Scanis, Inc., and Medizeus, Inc. After more than two years of support by Howtek, CADx Medical Systems, Inc., and ISSI received FDA approval in the first quarter of 2002 to market their products, incorporating Howtek's digitizers, in the United States. In its other medical markets, Howtek is a leading supplier of digitizers for medical film images with an established distribution channel including OEM's, value added resellers and distributors. 8 Competition MultiRAD(TM). Howtek's competition for high quality medical digitizing market includes the "first generation" LumiScan(TM) digitizer from Lumisys Corporation, now owned by Kodak. Since 1990, Lumisys digitizers, using a monochromatic laser illumination source, have been considered the quality standard in medical image digitizers. In the computer-assisted detection and teleradiology/PACS markets, Lumisys digitizers enjoyed an overwhelming market share. As described more fully below, the Company believes that the technology employed by the Lumisys devices has several inherent weaknesses. Because Lumisys' laser technology requires manufacturing costs greater than those of Howtek's newer generation technology products, Lumisys products are expensive to acquire compared to the Howtek digitizer. Lumisys' technology is also comparatively delicate, and expensive to maintain. As a result, Lumisys is believed by the Company to have lost market share to other competitors, including Howtek. Vidar Corporation, a privately held subsidiary of a Swedish firm, has the greatest overall market share in medical digitizers, as a result of Vidar's dominance in the lower quality and most price sensitive segments of the market. Vidar digitizers might be considered a second generation of medical film digitizers (with Lumisys laser illuminated digitizers as the first generation). Vidar devices use a fluorescent light source to illuminate an image, capturing image information with a charge-coupled device (CCD). Offering a lower cost alternative to laser illuminated digitizers, (comparable or lower in price than Howtek's products) the Vidar products offer lower image quality than the Lumisys or the Howtek products. Vidar's Sierra Film Digitizer, priced under $10,000 reinforces Vidar's position in the low end market entry niche. Although it is slower and less productive than Vidar's own high end or comparable Lumisys or Howtek product, the Sierra is expected to attract sales that are based purely on price. In general, Howtek uses its proprietary solid state, red-light illumination system and superior image quality to compete with Lumisys and Vidar. The Company competes with Lumisys on the basis of comparable (or superior) image quality and significantly lower price. With Vidar, the Company competes on the basis of superior image quality. A key comparative measure of a digitizer's ability to acquire high quality images is the "dynamic range" of the device. Dynamic range measures the range, from pure white to pure black, within which a digitizer is able to detect differences in lightness or darkness (density). The ability to distinguish shades within a primarily dark, or dense area of a radiological film is particularly significant in many diagnostic and medical imaging applications. Howtek digitizers have a greater dynamic range and therefore a significantly greater ability to distinguish meaningful information within seemingly dark areas of the radiological films, than Vidar devices. This is an increasingly understood competitive advantage, which Howtek emphasizes. ImageFunnel(TM). Howtek's ImageFunnel solution competes on the basis of price and image quality with systems from several other vendors. Agfa Corporation offers a digital copy solution that takes digital images and stores to CD for a list price of $65,000. TDK, Inc. has a similar solution price at $60,000. MedWeb, Inc. has a non-DICOM solution priced at $15,000. In all cases the medical images are either compressed or the format is changed so that the images cannot be returned to a DICOM network as active patients. The CD products offered in these 9 systems may contain viewers, but are in most cases not fully compliant DICOM viewers. Unlike Howtek's ImageFunnel, these products do not create a portable, totally standard, fully diagnostic DICOM format image distribution and management system. Because of the nature of the ImageFunnel solution, full diagnostic quality patient images can be made portable without sacrificing the subsequent ability to reintroduce the images at any point in the medical enterprise's digital workflow. FotoFunnel(TM) Business Howtek's FotoFunnel solutions permit photo finishers and other retailers to offer consumer photographic images on CD, in digital form for uploading to the Internet, or as reprints or photo- products. FotoFunnel solutions represent an inexpensive approach to offering photographic customers digital products and services. Howtek's FotoFunnel scanner, which digitizes new and old photo prints on-site and within fast photo processing workflows, was initially offered on an exclusive, OEM basis through a reseller that promoted the product for use in Internet and e-commerce applications for photo processing. As a result of a general reassessment of the role of the Internet in photo-finishing, however, Howtek repositioned the product as an on-site CD and reprint production system, offering, in Howtek's opinion, an immediate benefit to retailers and consumers. In July 2001, Howtek added the capability to accept digital camera memory to its FotoFunnel solutions, allowing retailers that use FotoFunnel the ability to extend their business to digital camera owners and users. Market The Company believes that digital and web-based photo services will fundamentally change the way consumer photographs are processed, enhanced, distributed and used. The Company also believes that the promise of a digital photographic solution that offers users features not available in traditional photography, drives not just digital camera manufacturers and users, it may also expand the demands and expectations of users of traditional cameras and films. Traditional photos are processed at over 35,000 photo lab and photofinisher locations worldwide. The principal market for Howtek's FotoFunnel system and scanner are an estimated 18,000 - 25,000 "fast" (same day) or "one-hour" photo finishers, most of them mass retailers, typically located in high traffic retail locations. In deciding whether to provide digital photo finishing services, these retailers must often balance the potential return from digital services against the costs of acquiring more expensive digital minilabs or upgrading their traditional photo finishing equipment to digital capabilities. Howtek's FotoFunnel system allows them to offer CDs and other digital products and service by scanning old, shoeboxes of valued photos, or scanning prints just produced from new rolls of film. Today, many retailers can accept files generated by the FotoFunnel system and Howtek's new FlashFunnel(TM) product to produce photo enlargements and other reprints on their existing minilabs. Howtek believes that by treating the minilab as a computer peripheral, such retailers are able to increase minilab utilization and returns on the minilab capital investment. 10 Current growth in digital cameras and digital photography has created an opportunity for Howtek. The number of digital cameras purchased has doubled in each of the past two years. Worldwide, the number of digital cameras accounts for about 25% of all new purchases. Currently, about 100 billion pictures are exposed each year on film, and 16 billion with digital camera; the annual growth rates are 5% for photos on film and 45% for photos using digital camera. During the third quarter of 2001, Howtek introduced its FlashFunnel(TM) system, offering photo retailers a flexible and comparatively inexpensive means to unload digital camera memory and produce CDs, reprints and other photo-products. Products FotoFunnel(TM) Scanner. The FotoFunnelis a compact, automatic batch-feeding scanner designed to quickly digitize photographic prints. FotoFunnel can be used for both newly developed prints and for older, existing prints. FotoFunnel is offered at a suggested retail price of $5,495. Standard discounts to resellers and OEMs range from 20-40%, with higher discounts available for high volume committed orders. The scanner will accommodate up to 70 prints in the feed tray and feed most size prints from 2 inches by 2 inches up to a 5 inch by 7 inch. FotoFunnel employs CCD technology and cold cathode tube illumination. A simple feed system is used to guide the prints through a short, straight paper path, eliminating scratches or other damage to the print. Photo prints are put in an input tray and the scan process is started. From this point the system takes over, scanning the photographs at a resolution of up to 600 dpi and with a color depth of up to 36 bits. The system recognizes and skips duplicates. The software calibrates for the optimum quality (for example lighting) of the photograph automatically. A unique feature of the FotoFunnel is that photos pass the CCD sensor without mirrors or the usual glass panel separation. This precludes any possible reflection or distortion of the picture through dust particles that might adhere to the glass panel, which (in the worst case) may cause lines on the final product. Also, by eliminating glass panels, picture sharpness and contrast are enhanced. The FotoFunnel incorporates a standard SCSI 2-Interface, so that it can be connected to any PC with SCSI adapter and running Microsoft Windows 95/98/NT/2000/XP. Once the photos have been scanned, they appear as thumbnail previews on the computer monitor, and can be manipulated to, among other things, select the photographs and switch the horizontal/vertical orientation of the image. The system then automatically compresses the data so that, regardless of the size of the original photo, up to 80 photographs can be stored on a diskette and many more can be stored on a CD or can be transmitted over the Internet. The high speed of scanning, up to four photos per minute, allows the entire process from development of photos from film, scanning and production of CD or diskette to be completed within the one-hour processing requirements of many small photo labs. FotoFunnel(TM) Software Options. Customers using FotoFunnel have several software options. The FotoFunnel scanner is available with a TWAIN software interface, which permits use of the 11 scanner with common and specialty software applications supporting the TWAIN protocol. This is of particular benefit where an OEM or systems integrator has developed its own software for imaging or photo systems, and seeks to add the FotoFunnel as a principal or additional source of image capture. Howtek has also developed a proprietary software application, called FunnelScan(TM), which permits users to operate the scanner, review and align images, and save the images to floppy disk, CD or defined Internet sites. The FunnelScan application automatically de-skews, crops and color corrects images as they are scanned. The FunnelScan software also permits the user to download pictures from digital camera memory, and other media and sources, including flatbed and film scanners. FlashFunnel(TM) Solutions. Howtek's FlashFunnel product is available in software or workstation configuration to provide photofinishers and other retailers with the ability to offer fast, on-site compact disk (CD), digital image file and reprint production from digital camera memory and from conventional flatbed and slide scanners. The system can also be upgraded with Howtek's FotoFunnel production print scanner. The FlashFunnel is available as a very compact turnkey solution, including a digital camera memory reader and flat panel display, for under $3,000. It is also available in a software only version, at less than $1,000. The software powering the FlashFunnel system is Howtek's FunnelScan software, which operates across Howtek's Professional Photo Processing family of products. Using Howtek's software as a "digital hub", a retailer imports images from digital camera memory, adds scanned images from prints or slides, and assembles all those images on a simple, easy to use computer desktop. Scanned images are automatically cropped and straightened as they are imported. On the desktop, images can be rotated, named or renamed, and then saved to CD or file. The process is quick, very easy, and requires no specialized training or skills. CDs can then be created, including copies of every image in high, medium and low file sizes, allowing higher quality prints and reprints from larger image files, containing more image data, while offering smaller "thumbnail" files for easy email and internet use. Each CD also includes two PC based picture viewers, one that operates from the CD itself and is completely portable, and a second, more sophisticated viewer and organizer that permits image editing, e-mailing, creation of computer-based slide shows using images from the CD, and creation of photo screen savers that can be used or shared. CDs created using Howtek's software can be configured to show and promote the retailer's brand, provide links to the retailer's web site, and generally contribute to consumer relationship management by the photo (or digital photo) retailer. Howtek is working with current customers to define and create web links to offer specials and promotions to consumers, and even to provide and update advertisements and coupons directly to consumer's computers and homes. A retailer can now add such services within existing one-hour or same day photo processing workflows, without adding staff or space. By keeping CD and reprint production on site, the 12 photo retailer can increase utilization of these services, without giving up profit margins on digital services or underlying roll film development to third party, overnight film photo finishing services. Sales & Marketing The Company's primary FotoFunnel resellers are photo finishing equipment manufacturers already relied on by photo retailers to provide and support photo finishing equipment and systems. In particular, the FotoFunnel solution has been selected for resale by Noritsu America Corporation, which offers the FotoFunnel scanner as a component of its new "Digital Print Station", which can serve as a digital front end for certain of Noritsu's minilabs and is offered by Noritsu, domestically and internationally, with new equipment and as an upgrade to existing installations. Complementing the equipment manufacturer channel, Howtek maintains a limited dealer and distributor network primarily to promote FotoFunnel solutions to smaller scale individual and independent photo retailers. Internationally, the Company works through certain of Noritsu Koki Co.'s international subsidiaries and distributors, and through independent distributors in Holland, Israel, Finland and Australia. Competition FotoFunnel(TM) Scanning Equipment. Competition exists from products that digitize the strip of photo negatives created when processing new rolls of film, and from products using generic, flatbed scanners manufactured for general office use. Today, there are several companies offering negative film scanning systems including Canon Corporation, Eastman Kodak, Pixel Magic, Inc., and Pakon, Inc. (Pakon was acquired by Eastman Kodak during 2001). These systems are fast (they can digitize a roll of film in about 4 minutes), however, they are more expensive than the Howtek scanner. They also require some operator training to ensure image quality and proper operation. Management and correction of colors in the conversion from a photo negative to a positive digital and printed image can be complicated and is subject to errors. Finally, these systems are unable to work with existing prints and cannot serve the "shoebox" market of customers seeking to digitize pictures that were developed previously, where negatives may not be available. Howtek competes with these systems on the basis of price and convenience. Comparatively inexpensive office flatbed scanners, available from a wide range of manufacturers, can also be used to digitize existing photo prints. Kodak has offered a flatbed scanner integrated into a retail kiosk to permit one-at-a-time digitizing and editing of particularly important images with some success. This service is expensive to the consumer (approximately $8 per image), and the Company believes that the labor requirements involved in using a standard flatbed scanner in a conventional photo lab's workflow often makes this an impractical method. In an effort to address this issue Kodak offers a Fujitsu office scanner, incorporating an automatic document feed mechanism. Howtek believes that initial reaction to this Kodak product has been mixed. The longevity and durability of an office scanner in the rigorous commercial photo lab environment have yet to be proven. The FotoFunnel competes with such products on the basis of price, greater image quality, reduced space requirement and gentle, reliable print feed design. 13 Graphic Arts and Prepress Business Howtek has reduced its attention to declining prepress graphic arts markets to concentrate on what it believes are greater business opportunities in its medical and photographic imaging and digitization markets. This change in focus has permitted the Company to make significant reductions in those parts of Howtek's overhead and expense structure previously related to the traditional, comparatively low margin, graphic arts business. As a means of providing the Company with a source of continuing, incremental revenue and gross margin, Howtek continues to offer a limited variety of graphic arts products through a long standing OEM customer, and through direct web-based marketing. Recent Development The Company recently announced that it has entered into a definitive agreement with Intelligent Systems Software Inc. ("ISSI"), a privately held company based in Boca Raton, Florida, pursuant to which ISSI would merge with and into a subsidiary of Howtek. If the merger is consummated, a total of 8,400,000 shares of Howtek common stock will be issued in the merger in exchange for all of the issued and outstanding capital stock of ISSI. In January 2002, ISSI received approval from the U.S. Food and Drug Administration (FDA) to market and sell ISSI's new MammoReader(TM) Computer Aided Detection CAD system in the United States. Subsequent to completion of the contemplated merger, Howtek's existing film and photo digitizer operations, including engineering, manufacturing management, marketing and support, will be conducted through a wholly owned subsidiary corporation, based at the Company's current headquarters in Hudson, NH. The Company's objective is to continue to grow its medical business, providing industry-leading digitizers to ISSI and to other respected customers. The completion of the merger is subject to the registration of the shares of Howtek common stock to be issued in the merger under the Securities Act of 1933, as amended, and other customary conditions, including approval of the merger by stockholders of both Howtek and ISSI. It is currently expected that the merger will be consummated by June 30, 2002. Risk Factors There are enormous uncertainties and risks associated with the Company's business strategy. Howtek's future operating results will depend, among other factors, on its ability to continue to increase sales significantly, on retaining current key employees and on attracting additional qualified personnel. Risk factors include, but are not limited to, the Company's history of significant operating losses, intense competition in all of its product lines, risk associated with foreign sales, need to obtain additional financing, technical obsolescence of existing products, 14 ability to protect proprietary information, the timely availability of sufficient quantities of parts, materials and components which are in some cases available from sole sources or a limited number of suppliers, and uncertainty regarding the proposed merger with ISSI. Government Regulation Current products in the Company's medical digitizer product line are subject to regulation by the Food and Drug Administration ("FDA"). The Company has received FDA 510(k) pre-market clearance, which is required for the sale of its medical products. Sources and Availability of Materials The electronics industry is subject to periodic fluctuations in the production capacity of integrated circuit manufacturers and other key suppliers. Currently, the Company believes that there are adequate sources and availability of the components necessary to manufacture its products. Patents The Company has several patents covering its scanner and prepress technology in the United States and certain foreign countries, which is the basis of its current business. These patents help the Company maintain a proprietary position in the scanner market, but because of the pace of innovation in that market it is difficult to determine the overall importance of these patents to the Company. The Company has current patent applications pending, has filed foreign patent applications based on some of its United States patents and plans to file additional domestic and foreign applications when it believes such protection will benefit the Company. There is no assurance that additional patents will be obtained either in the United States or in foreign countries or that existing or future patents or copyrights will provide substantial protection or commercial benefit to the Company. There is rapid technological development in the Company's markets with concurrent extensive patent filings and a rapid rate of issuance of new patents. Although the Company believes that its technologies have been independently developed and do not infringe the patents or intellectual property rights of others, certain components of the Company's products could infringe patents, either existing or which may be issued in the future, in which event the Company may be required to modify its designs or obtain a license. No assurance can be given that the Company will be able to do so in a timely manner or upon acceptable terms and conditions; and the failure to do either of the foregoing could have a material adverse effect upon the Company's business. 15 In addition to protecting its technology and products by seeking patent protection when deemed appropriate, the Company also relies on trade secrets, proprietary know how and continuing technological innovation to develop and maintain its competitive position. The Company requires all of its employees to execute confidentiality agreements. Insofar as the Company relies on confidentiality agreements, there is no assurance that others will not independently develop similar technology or that the Company's confidentiality agreements will not be breached. All key officers and employees have agreed to assign to the Company certain technical and other information and patent rights, if any, acquired by them during their employment with the Company and after any termination of their employment with the Company (if such information or rights arose out of information obtained by them during their employment). Manufacturing The Company operates an ISO 9001 and FDA-certified manufacturing facility in Hudson, NH. Currently, the Company's FotoFunnel, medical and drum scanner products are manufactured by third party contract manufacturing organizations. The software applications that are sold with the Company's products are either developed in-house or licensed from third parties. Research and Development The Company spent $751,467, $709,595 and $799,960 on research and development activities during the years ended December, 2001, 2000 and 1999, respectively. The research and development expenses are primarily attributed to the development of the Company's FotoFunnel and medical imaging products. Employees On March 1, 2002 the Company had 24 full time employees and 1 part time employee. None of the Company's employees are represented by labor organizations and the Company is not aware of any activities seeking such organization. The Company considers its relations with employees to be good. Backlog The dollar amount of the Company's backlog, and orders believed to be firm, as of December 31, 2001 was approximately $157,000 as compared to approximately $108,000 on the corresponding date in 2000. 16 Environmental Protection Compliance with federal, state and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had a material effect upon the capital expenditures, earnings (losses) and competitive position of the Company. Item 2. Properties The Company's principal executive offices and research and development laboratory are located at 21 Park Avenue, Hudson, New Hampshire. The facility consists of approximately 21,000 square feet of manufacturing, research and development and office space and is leased by the Company from Mr. Robert Howard, Chairman of the Board of Directors of the Company, pursuant to a lease which expires September 30, 2002 at an annual rent of $78,500. Additionally, the Company is required to pay real estate taxes, provide insurance and maintain the premises. If the Company is required to seek additional or replacement facilities, it believes there are adequate facilities available at commercially reasonable rates. Item 3. Legal Proceedings. Not applicable Item 4. Submission of Matters to a Vote of Security-Holders Not applicable 17 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. The Company's Common Stock is traded on the Nasdaq SmallCap Market under the symbol "HOWT". The following table sets forth the range of high and low sale prices for each quarterly period during 2001 and 2000. Fiscal year ended High Low ---- --- December 31, 2001 First Quarter $3.375 $2.500 Second Quarter 3.000 1.860 Third Quarter 2.150 .700 Fourth Quarter 1.900 .930 Fiscal year ended December 31, 2000 First Quarter $4.125 $1.875 Second Quarter 2.563 .625 Third Quarter 3.063 1.188 Fourth Quarter 4.281 1.750 As of March 1, 2002 there were 291 holders of record of the Company's Common Stock. The Company has not paid any cash dividends on its Common Stock to date, and the Company does not contemplate payment of cash dividends in the foreseeable future. Future dividend policy will depend on the Company's earnings, capital requirements, financial condition, and other factors considered relevant to the Company's Board of Directors. There are no non-statutory restrictions on the Company's present or future ability to pay dividends. The Company currently has two outstanding Series of Preferred Stock that has dividend rights that are senior to holders of Common Stock. 18 Item 6. Selected Financial Data
Year Ended December 31, ----------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 ----- ----- ----- ----- ----- Sales $ 4,835,297 $ 7,793,517 $ 6,663,230 $ 5,323,601 $ 7,874,813 Gross margin 898,891 1,900,027 1,594,124 1,223,135 1,663,317 Unusual charges -- -- -- -- (3,394,406) Total operating expenses (3,439,557) (3,595,661) (3,789,306) (4,096,944) (8,236,477) Loss from operations (2,540,666) (1,695,634) (2,195,182) (2,873,809) (6,573,160) Interest expense - net (80,105) (132,014) (1,801,646) (498,514) (258,912) Income from legal settlement -- -- -- -- 6,000,000 Net loss (2,620,771) (1,827,648) (3,996,828) (3,372,323) (832,072) Net loss available to common shareholders (2,775,821) (2,896,520) (3,996,828) (3,372,323) (832,072) Net loss per share (0.20) (0.22) (0.32) (0.33) (0.09)
Year Ended December 31, ----------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 ----- ----- ----- ----- ----- Total current assets $ 3,586,602 $ 5,082,016 $ 4,457,910 $ 4,798,576 $ 5,332,546 Total assets 4,161,125 5,945,928 5,696,609 6,351,421 7,071,294 Total current liabilities 2,003,807 2,143,873 2,019,340 2,198,995 1,540,222 Loans payable to related parties, including current portion 500,000 1,400,000 1,140,000 765,000 -- Note payable, including current portion 178,870 -- -- -- -- Convertible Subordinated Debentures, including current portion 10,000 117,000 117,000 1,881,000 2,181,000 Stockholders' equity 2,039,557 2,902,055 2,920,269 2,271,426 3,350,072
19 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Results of Operations Overview The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Many of the Company's estimates and assumptions used in the preparation of the financial statements relate to the Company's products, which are subject to rapid technological change. It is reasonably possible that changes may occur in the near term that would affect management's estimates with respect to inventories, equipment and software development costs. (See Notes to Financial Statements, Note 1 - Summary of Significant Accounting Policies.) Howtek, develops, manufactures, and markets digitizing systems, or "scanners", which convert printed, photographic and other "hard copy" images to digital form for use in the medical, photo finishing, and graphic arts industries. The Company introduced the first "desktop" scanner in 1986, smaller, easier to use and less costly than alternative scanners at that time, helping to make possible the shift to decentralized corporate electronic publishing. Howtek followed with a series of award winning, industry leading products, continuing to improve the quality of digital imaging, and reducing the price and complexity of scanning systems. Facing diminishing returns in its traditional graphic arts business, Howtek, in the last several years, has heavily invested in technology and product development in the fields of medical and photographic imaging and digitization. After two years of work supporting development-stage OEM customers in the new field of Computer Assisted Detection (CAD) of breast cancer, FDA approvals for sales in the United States of CAD systems incorporating Howtek digitizers were received by two key Howtek OEM customers during the first quarter of 2002. The Company believes such FDA approvals, coupled with newly implemented medical cost reimbursement coverage for procedures utilizing such CAD systems, may contribute to sales growth in this area. The Company's FotoFunnel photographic scanner solution was introduced by one key OEM in 2000, as part of an Internet-driven photo finishing solution. During 2001, as a result of a general reassessment of the role of the Internet in photo finishing, large retail accounts, in general, elected not to purchase such systems. In response, the Company repositioned its FotoFunnel product line, offering its photographic products to retail photo finishers as an inexpensive way to offer photo images on compact disk (CD) to retail photo customers. Sales of FotoFunnel are expected to increase during 2002. Howtek has reduced its attention to declining prepress graphic arts markets to concentrate on greater business opportunities in its medical and photographic imaging and digitization markets. 20 This process has permitted the Company to make significant reductions in those parts of Howtek's overhead and expense structure previously related to the traditional, comparatively low margin, graphic arts business. In support of its shift in focus to medical and photo processing markets, the Company has (1) updated product lines, introducing industry-leading products in medical and photo processing/Internet markets, (2) migrated from in-house manufacturer to outsourcing to more effectively utilize outside engineering, development, and manufacturing resources, (3) substantially reduced personnel and overhead, and (4) implemented an OEM and large scale systems integrator marketing and sales strategy for primary digitizer markets. Year Ended December 31, 2001 compared to Year Ended December 31, 2000 Sales. Sales for the year ended December 31, 2001 were $4,835,297, compared with sales of $7,793,517 for the year ended December 31, 2000. As expected, as a result of the Company's shift in the focus of its business, sales of the Company's prepress and graphic arts products, including related maintenance and repair services, decreased by $1,788,047, from $3,319,407 in 2000 to $1,531,360 in 2001. The Company continues to emphasize its medical and photographic business opportunities, while managing the decline in its traditional graphic arts business. Sales of the Company's medical imaging products increased from $2,256,312 (29% of sales) for the year ended December 31, 2000 to $2,315,738 (48% of sales) for the year ended December 31, 2001. Howtek's medical product sales are made primarily to the Company's respective "integration partners" or resellers, which add software and other components to Howtek's products to provide full medical imaging solutions to their customers. The Company believes that there has been a softening in the telemedicine and Picture Archiving and Communications Systems (PACS) segments of the medical market place, as customer purchases are being deferred or reconsidered as a result of what is perceived to be an overall softness in the economy. To address this softening the Company has increased the number of resellers offering the Howtek digitizers into the telemedicine and large-scale PACS markets. The increases in resellers are expected to contribute to increase sales of medical products in future periods. The Company has made a significant investment in time and resources in developing and supporting OEM customers using its digitizers in computer assisted diagnosis of breast cancer systems and applications. The FDA recently approved for sales in the United States, CAD systems incorporating Howtek digitizers offered by two of the Company's OEM customers. In 2001 the Company introduced its new FilmFunnel(TM) and ImageFunnel(TM) systems for commercial sale. These systems couple Howtek digitizers with image view and media-burning capabilities and includes Howtek's portable MyLivingRecord(TM) image viewing solutions. The Company expects that these systems will offer film libraries, radiology departments and individuals, a cost-effective approach to the duplication, distribution and personal retention of medical images. FilmFunnel and ImageFunnel systems are expected to contribute higher per 21 sales revenues and margins than current digitizer sales, while the MyLivingRecord media component creates the potential for recurring, consumables revenues. These markets, which are new to the Company, are expected by the Company to be comparatively resistant to an increasingly adverse economic environment. Sales of the Company's FotoFunnelphoto print scanning system decreased from $2,217,798 (28% of sales) for the year ended December 31, 2000 to $988,199 (20% of sales) for the year ended December 31, 2001. Almost all FotoFunnel sales in 2000 were made to one reseller, which purchased the scanners in connection with an Internet-driven business model that proved unsuccessful. The Company has since established alternative positioning and distribution channels for the FotoFunnel product line, including Noritsu America Corporation, which offers and promotes the FotoFunnel scanner as an accessory with certain of its minilab and photo-finishing products. The Company is now participating in FotoFunnel field evaluation and testing programs with a variety of retail and photo chains and mass merchants which precede purchase decisions by such buyers. Gross Margin. Gross margin for the year ended December 31, 2001 decreased to 19% from 24% in 2000. This decrease is due to the Company's decision to increase its inventory reserve by $300,000 associated with its prepress and graphic arts product lines. Before the increase in reserve gross margins improved to 25% in 2001 from 24% in 2000, as a result of reduced production overhead and indirect production expenses, associated with the Company's continuing overhead and expense control measures, increased sales of higher margin medical digitizers into the market for computer assisted diagnosis of breast cancer, and increased sales of FotoFunnel products through channels that have higher margins than the Company's original OEM channel. Engineering and Product Development. Engineering and product development costs for the year ended December 31, 2001 increased slightly from $709,595 in 2000 to $751,467 in 2001. The Company expects to continue its utilization of outside and contract engineering resources as appropriate. General and Administrative. General and administrative expenses decreased 4% from $1,165,392 in 2000 to $1,124,710 in 2001. This change results primarily from a decrease in expense associated with the redesign of the Company's Web site incurred in 2000. Marketing and Sales. Marketing and sales expenses for the year ended December 31, 2001 decreased 9% from $1,720,674 in 2000 to $1,563,380 in 2001. During the second and third quarter of 2001, the Company significantly reduced expenses related to its traditional graphic art business, while increasing medical and FotoFunnel sales expenses. Interest Expense. Net interest for the year ended December 31, 2001 decreased 39%, from $132,014 in 2000 to $80,105 in 2001. This decrease is due primarily to a decrease in loan balances and interest rates. 22 As a result of the foregoing, the Company recorded a net loss of $2,620,771 or $0.20 per share for the year ended December 31, 2001 on sales of $4,835,297 compared to a net loss of $1,827,648 or $0.22 per share in 2000 on sales of $7,793,517. Year Ended December 31, 2000 compared to Year Ended December 31, 1999 Sales. Sales for the year ended December 31, 2000 were $7,793,517, an increase of $1,130,287 or 17% from sales during the year ended December 31, 1999 of $6,663,230. Sales of the Company's medical imaging products increased 50% from $1,508,197 (23% of sales) for the year ended December 31, 1999 to $2,256,312 (29% of sales) for the year ended December 31, 2000. Sales through system integrators and resellers, including General Electric Medical Systems and Konica Medical Imaging, Inc., contributed to increased sales in 2000. The Company's medical product sales also benefited from demand by key OEM customers involved in computer-assisted detection of breast cancer. These customers marketed systems including Howtek digitizers outside the United States while seeking FDA approval to sell domestically. A key objective over the coming quarters was to add additional, qualified OEM and systems integration resellers. In 2000 the Company began commercial shipments of its FotoFunnel(TM) photographic print scanner line from its third party manufacturing supplier. FotoFunnel sales were $2,217,798 (28% of sales), with virtually all sales made to Telepix Imaging, Inc., a member of the Gretag Imaging Group. During the third quarter the Company reduced production of its FotoFunnel print scanner to implement new design features, and deliver enhanced scanner units. Several engineering design and manufacturing changes which offered increase scanning speed, improved customer workflow and generally enhanced scanner performance were achieved during the third quarter. Sales of the Company's prepress and graphic arts products, including related maintenance and repair services, decreased 36% from $5,155,033 (77% of sales) in 1999 to $3,319,407 (43% of sales) in 2000. This decline reflected increased competition in the market for the Company's graphic arts scanners, and a decision by the Company not to renew a distribution agreement under which it could redistribute flatbed scanners manufactured by Scanview, A/S. This reduction in sales was acute during the fourth calendar quarter of 2000, as the Company reduced and focused its prepress and graphic arts sales channels, eliminating a number of previous dealers and distributors. Gross Margin. Gross margin for the year ended December 31, 2000 remained steady from 1999, at 24% of sales, in spite of a decision by the Company to increase inventory reserves associated with its prepress and graphic arts product lines from $200,175 to $361,931. Engineering and Product Development. Engineering and product development costs for the year ended December 31, 2000 decreased 11% from $799,960 in 1999 to $709,595 in 2000. The overall decrease in engineering and product development costs resulted primarily from reductions in manpower. 23 General and Administrative. General and administrative expense decreased 9% from $1,286,895 in 1999 to $1,165,392 in 2000. During the first quarter of 1999 the Company established reserves of $186,662 to permit the Company to take back discontinued HiDemand(TM) 400 graphic arts scanner products to encourage resellers and customers to acquire its Scanview line of products and a non-recurring expense of $21,142 associated with the write off of tooling and inventories associated with the discontinued HiDemand 400 product. Giving effect to the HiDemand 400 reserve and write down for the year ended December 31, 1999, the general and administrative expenses increased 8%, from $1,079,091 in 1999 compared to $1,165,392 for the comparable period in 2000. The increase was due primarily to the expense incurred to redesign the Company's Web site. Marketing and Sales. Marketing and sales expenses for the year ended December 31, 2000 increased slightly from $1,702,451 in 1999 to $1,720,674 in 2000. The change resulted from decreases in advertising and promotional expenses in the graphic arts area, where there was an increasing reliance on direct mail and telemarketing to support its sales efforts, while medical sales expenses increased and new expenses were incurred relating to the FotoFunnel business. Interest Expense. Net interest expense for the year ended December 31, 2000 decreased to $132,014 from $1,801,646 in 1999. During the first quarter of 1999 the Company recorded interest expense of $1,671,158 relative to the conversion of Convertible Subordinated Debentures as required by Statement of Financial Accounting Standards No. 84, "Induced Conversions of Convertible Debt". This charge was wholly offset by a corresponding increase to additional paid-in capital by $1,671,158. The charge and corresponding benefit relate to the conversion to equity during the first quarter of 1999 of $1,764,000 of the Company's previously outstanding 9% Convertible Subordinated Debentures, due 2001 (the "9% Debenture"). In December 1998, the Company provided for a temporary reduction in the conversion price of the 9% Debenture to encourage conversion to common stock, and thereby reduce cash interest expenses, and sinking fund payments associated with the 9% Debenture. As a result of the foregoing, the Company recorded a net loss of $1,827,648 or $0.22 per share for the year ended December 31, 2000 on sales of $7,793,517 compared to a net loss of $3,996,828 or $0.32 per share for the same period in 1999 on sales of $6,663,230. During the year ended December 31, 2000 the Company issued 1,400 shares of 7% Series B Convertible Redeemable Preferred Stock with a conversion price below the Company's Common Stock quoted value and as a result accreted dividends of $996,283 were recorded and included in the net loss per share calculation. Liquidity and Capital Resources The Company's ability to generate cash adequate to meet its requirements depends primarily on operating cash flow and the availability of a $3,000,000 credit line under a Convertible Note and Revolving Loan and Security Agreement with its Chairman, Mr. Robert Howard, of which 24 $3,000,000 was available at December 31, 2001. The Company believes that these sources are sufficient to satisfy its cash requirements for the foreseeable future. (See Item 13 - "Certain Relationships and Related Transactions".) Working capital decreased $1,355,348 from $2,938,143 at December 31, 2000 to $1,582,795 at December 31, 2001. The ratio of current assets to current liabilities at December 31, 2001 and 2000 was 1.8 and 2.4, respectively. The Company has Secured Demand Notes and Security Agreements (the "Notes") owed to Mr. Robert Howard. Principal of these notes are due and payable in full, together with interest accrued and any penalties provided for, on demand. Under the terms of the Notes the Company agreed to pay interest at the lower rate of (a) 12% per annum, compounded monthly or (b) the maximum rate permitted by applicable law. The Notes currently bear interest at 12%. Payment of the Notes is secured by a security interest in certain assets of the Company. A total of $500,000 is outstanding pursuant to the Notes. During 1999 the Company borrowed $310,000 from Mr. Robert Howard, pursuant to Convertible Promissory Notes (the "Promissory Notes"). Under the terms of the Promissory Notes the Company agreed to pay interest at a fixed rate of 7% per annum. The Promissory Notes entitled the payee to convert outstanding principal due into shares of the Company's common stock at $1.00 per share, which was the market price of the Company's stock at the date the Promissory Notes were issued. In September 2001, Mr. Howard converted the outstanding balance, including interest, on the Promissory Notes into 361,474 shares of restricted common stock of the Company Proposed Merger with ISSI The Company recently announced that it has entered into a definitive agreement with ISSI, a privately held company based in Boca Raton, Florida, pursuant to which ISSI would merge with and into a subsidiary of Howtek. If the merger is consummated a total of 8,400,000 shares of Howtek common stock will be issued in the merger in exchange for all of the issued and outstanding capital stock of ISSI. In January 2002, ISSI received approval from the U.S. Food and Drug Administration (FDA) to market and sell ISSI's new MammoReader(TM) Computer Aided Detection CAD system in the United States. Subsequent to completion of the contemplated merger, Howtek's existing film and photo digitizer operations, including engineering, manufacturing management, marketing and support, will be conducted through a wholly owned subsidiary corporation, based at the Company's current headquarters in Hudson, NH. The Company's objective is to continue to grow its medical business, providing industry-leading digitizers to ISSI and to other respected customers. The completion of the merger is subject to the registration of the shares of Howtek common stock to be issued in the merger under the Securities Act of 1933, as amended, and other customary conditions, including approval of the merger by stockholders of both Howtek and ISSI. It is currently expected that the merger will be consummated by June 30, 2002. 25 Effect of New Accounting Pronouncements In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations" ("SFAS 141"), and No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 141 requires companies to use the purchase method of accounting for all business combinations initiated after June 30, 2001, and establishes specific criteria for the recognition of intangible assets separately from goodwill. SFAS 142 addresses the accounting for acquired goodwill and intangible assets. Goodwill and indefinite-lived intangible assets will no longer be amortized and will be tested for impairment at least annually. The provisions of SFAS 142 will be effective for the Company in fiscal year 2002. Goodwill and intangible assets acquired after June 30, 2001, will be subject immediately to the non-amortization and amortization provisions of this statement. Historically, the Company has not had goodwill or acquired other intangible assets. Accordingly, the Company does not expect adoption of these new standards to affect its financial statements as they relate to previous transactions. However, these new standards will affect the accounting for any business combinations initiated after June 30, 2001, including the proposed merger with ISSI. In October 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment of Disposal of Long-Lived Assets" ("SFAS144"), which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement supersedes SFAS 121 "Accounting for the Impairment of Long-Lived Assets to be Disposed Of" and APB Opinion No. 30 "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions for the Disposal of a Segment of a Business". SFAS 144 becomes effective for the fiscal years beginning after December 15, 2001. The Company expects to adopt SFAS 144 in the first quarter of fiscal 2002 and is currently reviewing the effects of adopting SFAS 144 on its financial position and results of operations. Item 7a. Quantitative and Qualitative Disclosures about Market Risk. Not applicable. Item 8. Financial Statements and Supplementary Data. See Financial Statements and Schedule attached hereto. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. Not applicable. 26 PART III Item 10. Directors and Executive Officers of the Registrant. Directors Director Name Age Position Since - ---- --- -------- ------ Robert Howard 78 Chairman of the Board, and Director 1984 W. Scott Parr 50 President, Chief Executive Officer and Director 1998 Ivan Gati 54 Director 1989 James Harlan 50 Director 2000 Kit Howard 58 Director 1999 Brett Smith 32 Director 2000 Harvey Teich 82 Director 1988 All persons listed above are currently serving a term of office as directors which continues until the next annual meeting of stockholders. Robert Howard, the founder and Chairman of the Board of Directors of the Company, was the inventor of the first impact dot matrix printer. Mr. Howard was Chief Executive Officer of the Company from its establishment in 1984 until December of 1993. He was the founder, and from 1969 to April 1980 he served as President and Chairman of the Board, of Centronics Data Computer Corp. ("Centronics"), a manufacturer of a variety of computer printers. He resigned from Centronics' Board of Directors in 1983. From April 1980 until 1983, Mr. Howard was principally engaged in the management of his investments. Commencing in mid-1982, Mr. Howard, doing business as R.H. Research, developed the ink jet technology upon which the Company was initially based. Mr. Howard contributed this technology, without compensation, to the Company. Mr. Howard was Chairman of the Board of Presstek, Inc. ("Presstek"), a public company which has developed proprietary imaging and consumables technologies for the printing and graphic arts industries from June 1988 to September 1998 and served as Chairman Emeritus of the Board from September 1998 to December 2000. In February 1994 Mr. Howard entered into a settlement agreement in the form of a consent decree with the Securities and Exchange Commission (the "Commission") in connection with the Commission's investigation covering trading in the Company's Common Stock by an acquaintance of Mr. Howard and a business associate of such acquaintance. Mr. Howard, without admitting or denying the Commission's allegations of securities laws violations, agreed to pay a fine and to the entry of a permanent injunction against future violations of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934. In addition, in December of 1997, in connection with the Commission's investigation into trading in the securities of Presstek, Mr. Howard, without admitting or denying the Commission's allegations of securities laws violations, agreed to pay a civil penalty of $2,700,000 and to the entry of a final judgement enjoining him future violations of Section 10(b) and 13(a) and Rules 10b-5, 12b-20, 13a-1 and 13a-20 of the Securities Exchange Act of 1934. 27 W. Scott Parr joined the Company in January 1998, as President and Chief Executive Officer. He was appointed to the Company's Board of Directors in February 1998. Prior to joining Howtek, Mr. Parr served as Divisional Director and a member of the Board of Directors of SABi International Ventures, Inc. in 1997, where he was responsible for restructuring and upgrading certain US companies owned by foreign and venture investors. From 1995 to 1997, Mr. Parr was Chief Executive Officer, General Counsel and Director of Allied Logic Corporation, a start-up venture specializing in proprietary molding and manufacturing technologies. From 1990 to 1995 Mr. Parr was General Counsel and a Director of LaserMaster Technologies, Inc. Ivan Gati is currently an executive business consultant. Mr. Gati served as Chairman of Turner Management, Inc., a vertically integrated real estate investment company from 1983 to 2000. Mr. Gati is also a member of the Board of Directors of Universal Automation Systems, Inc. James Harlan has been the Executive Vice President and Chief Financial Officer of HNG Storage Company, a natural gas storage and electric development company since 1998. From 1991 to 1997 Mr. Harlan served as General Manager and Chief Financial Officer of Pacific Resources Group and planning and finance development work with various Australian manufacturing and distribution businesses. He also served as operations research and planning analyst for the White House Office of Energy Policy and Planning from 1977 to 1978, the Department of Energy from 1978 to 1981, and U.S. Synthetic Fuels Corporation from 1981 to 1984. He has a PhD in applied economics with an operations research dissertation from Harvard University and a BS in Chemical Engineering from Washington University. Kit Howard holds a Bachelor of Science Degree from New York University. She worked in the financial community as a stockbroker from 1980 until 1986. Since then she has assisted Robert Howard, her husband and Chairman of the Company, in his various business enterprises. Brett Smith, the son of Mrs. Kit Howard, is currently the Chairman and CEO of ei3 Corporation, a provider of technology services to manufacturing companies utilizing advanced frame relay and internet technologies. Prior to ei3 Mr. Smith was a member of the restructuring team for Delta V Technologies, a subsidiary of Presstek, Inc., where he served as Director of Business Development from 1996 to 1999. From 1995 to 1996 Mr. Smith worked for the Asia Times newspaper start-up team in Hong Kong. He began his career as an analyst, from 1992 to 1994, at Susquehanna Investment Group. Mr. Smith received a BS from Emory University. Harvey Teich is a retired certified public accountant. On January 1, 1992, the accounting firm of Merman & Teich, where Mr. Teich had been a principal for the previous seventeen years, ceased to operate as a partnership. He is a member of the New York state Society for Certified Public Accountants. 28 Executive Officers and Key Employees Name Age Position - ---- --- -------- W. Scott Parr(1) 50 President, Chief Executive Officer, Director Richard F. Lehman(2) 64 Vice President, Engineering Annette L. Heroux(1) 45 Chief Financial Officer Joseph E. Manseau(2) 45 Vice President, Sales and Marketing Maurice R. Auger(2) 53 Vice President, Medical Sales - ------------------------------ 1. Officer appointed by the Board of Directors. 2. Key employees Richard F. Lehman joined the Company in July 1990, as Director of Scanner Engineering. In December 1993, he was named Vice President of Scanner Engineering and in October 1996, he was named Vice President of Engineering. Prior to joining the Company, Mr. Lehman was employed by Xerox Corporation for 23 years where he served in various engineering and managerial capacities. Annette L. Heroux joined the Company in October 1987 as Accounting Manager and was named Controller in October 1998 and Chief Financial Officer in July 1999. Prior to joining the Company, Ms. Heroux worked from 1980 to 1987 for Laurier, Inc., a small semiconductor equipment manufacturer, in various financial and managerial capacities. Joseph E. Manseau joined the Company in August 1998 as Regional Sales Manager and was named to Vice President Sales and Marketing on April 1, 1999. Prior to joining the Company Mr. Manseau worked from 1997 to 1998 for Escher-Grad Tech., Inc. where he was responsible for implementing the sales and marketing strategy for its large format image setters. From 1981 to 1997 he worked for AGFA and Compugraphic, currently divisions of Bayer Corporation, in various marketing and sales capacities. Maurice R. Auger joined the Company in October 2000 as Vice President of Medical Sales. Prior to joining the Company Mr. Auger worked from 1983 to 2000 for Cemax-Icon PACS (a Kodak Company) in various positions leading up to his promotion as North East Zone Technical Sales in 1997. 29 Item 11. Executive Compensation. The following table provides information on the compensation provided by the Company during fiscal years 2001, 2000 and 1999 to the persons serving as the Company's Chief Executive Officer during fiscal 2001, the Company's most highly compensated executive officers and certain key employees serving at the end of the 2001 fiscal year (named person). Included in this list are only those executive officers and key employees whose total annual salary and bonus exceeded $100,000 during the 2001 fiscal year. SUMMARY COMPENSATION TABLE Securities Underlying Name and Principal Position Year Salary($) Option(#) - --------------------------- ---- --------- --------- W. Scott Parr Chief Executive Officer ................... 2001 145,669 4,000 2000 138,357 -0- 1999 138,197 127,337 Richard F. Lehman Vice President, Engineering ............... 2001 114,135 4,000 2000 116,986 5,000 1999 112,735 5,000 Joseph E. Manseau Vice President, Prepress Sales & Marketing. 2001 111,424 4,000 2000 130,271 28,000 1999 126,529 18,410 Maurice R. Auger Vice President, Medical Sales ............. 2001 108,831 4,000 2000 29,153 90,457 OPTION GRANTS IN LAST FISCAL YEAR The following table sets forth certain information regarding stock options granted by the Company to the named person in 2001.
(4)Potential Individual Grants Realizable Value at Number of Percent of Assumed Annual Securities Total Options Rates of Stock underlying Granted to Exercise of Price Appreciation Options Employees Base Price Expiration for Option Term Name Granted in Fiscal Year ($/Sh) Date 5%($) 10%($) ---- ------- -------------- ------------ ---------- ----- ------ W. Scott Parr 4,000 2% .95 10/02/2011 2,390 6,056 Joseph E. Manseau 4,000 2% .95 10/02/2011 2,390 6,056 Richard F. Lehman 4,000 2% .95 10/02/2011 2,390 6,056 Maurice R. Auger 4,000 2% .95 10/02/2011 2,390 6,056
All options vested October 2, 2001. 4 The potential realizable value columns of the table illustrate values that might be realized upon exercise of the options immediately prior to their expiration, assuming the Company's Common Stock appreciates at the compounded rates specified over the term of the options. These numbers do not take into account provisions of options providing for termination of the option following termination of employment or non transferability of the options and do not make any provision for taxes associated with exercise. Because actual gains will depend upon, among other things, future performance of the Common Stock, there can be no assurance that the amounts reflected in this table will be achieved. 30 AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES The following table sets forth information regarding the exercise of stock options during the Company's last completed fiscal year by each of the named executive officers and key employees listed in the Summary Compensation Table and the fiscal year-end value of unexercised options.
Number of Securities Value of Underlying Unexercised Unexercised In-the Money Options at Options at Shares FY-End (#) FY-End($) (1) Acquired on Value Exercisable/ Exercisable/ Name Exercise (#) Realized Unexercisable Unexercisable - ---- ------------ -------- ------------- ------------- W. Scott Parr (2) 0 0 359,157/47,351 142,170/30,305 Joseph E. Manseau (2) 0 0 44,076/10,334 12,458/-0- Richard F. Lehman (2) 0 0 62,961/ 1,667 13,998/-0- Maurice R. Auger (2) 0 0 56,957/37,500 2,000/-0-
- -------------- (1) Based upon the closing price of the Common Stock on December 31, 2001, of $1.45 per share. (2) Options granted pursuant to the Company's 1993 Stock Option Plan, as amended. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION There is no Compensation Committee or other committee of the Company's Board of Directors performing similar functions. The person who performed the equivalent function in 2001 was Robert Howard, Chairman of the Board under the direction of the Board of Directors. W. Scott Parr, Chief Executive Officer and a director, participated in discussions with Mr. Howard during the past completed fiscal year in his capacity as an executive officer in connection with executive officer compensation. During 2001 none of the executive officers of the Company served on the Board of Directors or Compensation Committee of any other entity. 31 Item 12. Security Ownership of Certain Beneficial Owners and Management. - ------- -------------------------------------------------------------- The following table sets forth certain information regarding the Common Stock, Series A and Series B Convertible Preferred Stock of the Company owned on March 1, 2002, by (i) each person who is known to the Company to own beneficially more than 5% of the outstanding shares of the Company's Common Stock (ii) each executive officer and key employee named in the Summary Compensation Table, (iii) each director of the Company, and (iv) all current executive officers and directors as a group. The table also provides information regarding beneficial owners of more than 5% of the outstanding shares of the Company's Series A and Series B Convertible Preferred Stock.
Number of Shares Name and Address of Title Beneficially Percentage Beneficial Owner of Class Owned (1) (2) of Class ---------------- -------- -------------- -------- Robert Howard Common 3,019,346(3) 19.7% 145 East 57th Street New York, New York 10022 Donald Chapman Common 1,918,125(4) 11.9% 8650 South Ocean Drive Preferred Series A 4,600 64.3% Jenson Beach, FL 34957 Preferred Series B 680 48.6% W. Scott Parr Common 525,196(5) 3.3% 21 Park Avenue Preferred Series A 550 7.7% Hudson, NH 03051 Preferred Series B 50 3.6% Edgar Ball Preferred Series B 200 14.3% PO Box 560726 Rockledge, FL 32956 Dr. Lawrence Howard Preferred Series A 1,000 14.0% 660 Madison Avenue New York, NY 10021 John McCormick Preferred Series A 1,000 14.0% 11340 SW Aventine Circus Portland, OR 97219 Dr. Herschel Sklaroff Preferred Series B 100 7.1% 1185 Park Avenue New York, NY 10128 John Westerfield Preferred Series B 100 7.1% 4522 SW Bimini Circle N Palm City, FL 34990 Ivan Gati Common 65,000(6) * James Harlan Common 104,000(7) * Kit Howard Common 40,000(8) * Brett Smith Common 36,024(9) * Preferred Series B 20 1.4% Harvey Teich Common 75,000(10) * Richard Lehman Common 63,961(11) * Joseph Manseau Common 44,076(12) * All current executive officers and Common 3,907,883(3)& 24.3% directors as a group (8 persons) (5) through (10) Preferred Series A 550 7.7% Preferred Series B 70 5.0%
- ------------------------------------ * Less than one percent 32 1) A person is deemed to be the beneficial owner of securities that can be acquired by such person within 60 days from March 1, 2002, upon the exercise of options, warrants or rights; through the conversion of a security; pursuant to the power to revoke a trust, discretionary account or similar arrangement; or pursuant to the automatic termination of a trust, discretionary account or similar arrangement. Each beneficial owner's percentage ownership is determined by assuming that the options or other rights to acquire beneficial ownership as described above, that are held by such person (but not those held by any other person) and which are exercisable within 60 days from March 1, 2002, have been exercised. 2) Unless otherwise noted, the Company believes that the persons referred to in the table have sole voting and investment power with respect to all shares reflected as beneficially owned by them. 3) Includes options to purchase 10,000 shares of the Company's Common stock at $1.72 per share. Also, includes 40,000 shares beneficially owned by Mr. Howard's wife. 4) Includes 28,000 shares owned by Mr. Chapman's wife, 460,000 shares of Common Stock issuable upon conversion of 4,600 shares of Series A Convertible Preferred Stock and 340,000 shares of Common Stock issuable upon conversion of 680 shares of Series B Convertible Preferred Stock owned by Mr. Chapman. 5) Includes 11,000 shares owned by Mr. Parr's wife. Also includes options to purchase 275,268 shares of the Company's Common Stock at $1.13 per share, 77,649 shares at $0.81 per share, 2,250 shares at $1.00 per share, 4,000 shares at $0.95 per share and 25,000 shares at $1.75 per share, 55,000 shares of Common Stock issuable upon conversion of 550 shares of Series A Convertible Preferred Stock and 25,000 shares of Common Stock issuable upon conversion of 50 shares of Series B Convertible Preferred Stock owned by Mr. Parr. 6) Includes options to purchase 15,000 of the Company's Common Stock at $1.72 per share, 25,000 shares at $1.50 per share and 25,000 shares at $0.81 per share. 7) Includes options to purchase 25,000 shares of the Company's Common Stock at $1.75 per share. 8) Includes options to purchase 25,000 shares of the Company's Common Stock at $.81 per share. 9) Includes options to purchase 25,000 of the Company's Common Stock at $3.00 per share. Also, includes 10,000 shares of Common Stock issuable upon conversion of 20 shares of Series B Convertible Preferred Stock. 10) Includes 5,000 shares owned by Mr. Teich's wife in an irrevocable trust. Also includes options to purchase 20,000 of the Company's Common Stock at $1.72 per share, 25,000 shares at $1.50 per share and 25,000 shares at $0.81 per share. 33 11) Includes 1,000 shares owned by Mr. Lehman's wife. Also includes options to purchase 26,500 of the Company's Common Stock at $1.72 per share, 16,376 shares at $1.13 per share, 7,752 shares at $1.00 per share, 5,000 shares at $0.81 per share, 3,333 shares at $1.75 per share and 4,000 shares at $0.95 per share. 12) Includes options to purchase 3,000 shares of the Company's Common Stock at $1.00 per share, 10,000 shares at $.81 per share, 8,410 shares at $1.13 per share, 18,666 shares at $1.75 per share and 4,000 shares at $0.95 per share. 34 Item 13. Certain Relationships and Related Transactions. The Company has a Convertible Revolving Credit Promissory Note ("the Convertible Note") and Revolving Loan and Security Agreement (the "Loan Agreement") with Mr. Robert Howard, Chairman of the Board of Directors of the Company, under which Mr. Howard has agreed to advance funds, or to provide guarantees of advances made by third parties in an amount up to $3,000,000. The Loan Agreement expires January 4, 2003, subject to extension by the parties. Outstanding advances are collateralized by substantially all of the assets of the Company and bear interest at prime interest rate plus 2%. The Convertible Note entitles Mr. Howard to convert outstanding advances into shares of the Company's common stock at any time based on the outstanding closing market price of the Company's common stock at the time each advance is made. In 2001, Mr. Howard converted $1,244,219 principal and accrued interest on advances made under the Convertible Note into 1,071,436 shares of restricted common stock of the Company. As of December 31, 2001 no moneys were owed and the Company had $3,000,000 available for future borrowings under the Loan Agreement. The Company has Secured Demand Notes and Security Agreements (the "Notes") owed to Mr. Robert Howard. Principal of these notes are due and payable in full, together with interest accrued and any penalties provided for, on demand. Under the terms of the Notes the Company agreed to pay interest at the lower rate of (a) 12% per annum, compounded monthly or (b) the maximum rate permitted by applicable law. The Notes currently bear interest at 12%. Payment of the Notes is secured by a security interest in certain assets of the Company. A total of $500,000 is outstanding pursuant to the Notes. During 1999 the Company borrowed $310,000 from Mr. Robert Howard, pursuant to Convertible Promissory Notes (the "Promissory Notes"). Under the terms of the Promissory Notes the Company agreed to pay interest at a fixed rate of 7% per annum. The Promissory Notes entitled the payee to convert outstanding principal due into shares of the Company's common stock at $1.00 per share, which was the market price of the Company's stock at the date the Promissory Notes were issued. In September 2001, Mr. Howard converted the outstanding balance, including interest, on the Promissory Notes into 361,474 shares of restricted common stock of the Company. As of December 31, 2001, the Company had one lease obligation related to its facility. The lease obligation through September 30, 2002 is approximately $58,875. The Company's principal executive offices and research and development laboratory is leased by the Company from Mr. Robert Howard pursuant to a lease which expires September 30, 2002. Rental expense for the year ended December 31, 2001 was $78,500. 35 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. a) The following documents are filed as part of this Annual Report on Form 10-K: i. Financial Statements - See Index on page 40. ii. Financial Statement Schedule - See Index on page 40. All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are not applicable and, therefore, have been omitted. iii. Exhibits 2.1 Plan and Agreement of Merger dated February 15, 2002, by and among the Registrant, ISSI Acquisition Corp. and Intelligent Systems Software, Inc., Maha Sallam, Kevin Woods and W. Kip Speyer. 3. The following documents are filed as exhibits to this Annual Report on Form 10-K: 3(a) Certificate of Incorporation of the Registrant filed with the Secretary of State of the State of Delaware on February 24, 1984 [incorporated by reference to Exhibit 3.1 to the Registrant's Registration Statement on Form S-18 (Commission File No. 2-94097 NY), filed on October 31, 1984] 3(b) Certificate of Amendment of Certificate of Incorporation of the Registrant, filed with the Secretary of State of the State of Delaware on May 31, 1984 [incorporated by reference to Exhibit 3.1(a) to the Registrant's Registration Statement on Form S-18 (Commission File No. 2-94097-NY), filed on October 31, 1984] 3(c) Certificate of Amendment of Certificate of Incorporation of the Registrant filed with the Secretary of State of the State of Delaware on August 22, 1984 [incorporated by reference to Exhibit 3.1(b) to the Registrant's Registration Statement on Form S-18 (Commission File No. 2-94097-NY), filed on October 31, 1984]. 3(d) Certificate of Amendment of Certificate of Incorporation of the Registrant filed with the Secretary of State of the State of Delaware on October 22, 1987 [incorporated by reference to Exhibit 3(d) to 36 the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988]. 3(e) Certificate of Amendment of Certificate of Incorporation of the Registrant filed with the Secretary of State of the State of Delaware on September 28, 1999. 3(f) By-laws of Registrant [incorporated by reference to Exhibit 3.2 to the Registrant's Registration Statement on Form S-18 (Commission File No. 2-94097-NY), filed on October 31, 1984]. 10(a) Lease Agreement between the Registrant and its Chairman with respect to premises located at 21 Park Avenue, Hudson, New Hampshire, dated October 1, 1984, [incorporated by reference to Exhibit 10.2 to the Registrant's Registration Statement to Form S-18 (Commission File No. 2-94097-NY), filed on October 31, 1984]. 10(b) Form of Lease Renewal between the Registrant and its Chairman, Robert Howard, with respect to premises located at 21 Park Avenue, Hudson, New Hampshire. 10(c) Revolving Loan and Security Agreement, and Convertible Revolving Credit Promissory Note between Robert Howard and Registrant dated October 26, 1987 (the "Loan Agreement") [incorporated by reference to Exhibit 10 to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1987]. 10(d) Letter Agreement dated December 30, 1999, amending the Revolving Loan and Security Agreement, and Convertible Revolving Credit Promissory Note between Robert Howard and Registrant dated October 26, 1987. 10(e) Form of Secured Demand Notes between the Registrant and Mr. Robert Howard. [incorporated by reference to Exhibit 10(e) to the Registrant's Report on Form 10-K for the year ended December 31, 1998]. 10(f) Form of Security Agreements between the Registrant and Mr. Robert Howard [incorporated by reference to Exhibit 10(f) to the Registrant's Report on Form 10-K for the year ended December 31, 1998]. 10(i) Certificate of Designation of 7% Series A Convertible Preferred Stock dated December 22, 1999. [incorporated by reference to 37 Exhibit10(i) to the Registrant's Report on Form 10-K for the year ended December 31, 1999]. 10(j) Certificate of Designation of 7% Series B Convertible Preferred Stock dated October 16, 2000 [incorporated by reference to Exhibit 10(j) to the Registrant's Report on Form 10-K for the year ended December 31, 2000]. 23(a) Consent of BDO Seidman, LLP. (b) During the last quarter of the period covered by this Annual Report on Form 10-K the Company filed no reports on Form 8-K. (c) Exhibits - See (a) iii above. (d) Financial Statement Schedule - See (a) ii above. 38 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HOWTEK, INC. Date: March 28 , 2002 By: /s/ W. Scott Parr ------------------------- W. Scott Parr President, Chief Executive Officer, Director Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ---- /s/ Robert Howard Chairman of the - -------------------------- Board, Director March 28, 2002 Robert Howard /s/ W. Scott Parr President, Chief Executive - ------------------------- Officer, Director March 28, 2002 W. Scott Parr /s/ Annette Heroux Chief Financial Officer, Principal - ------------------------- Accounting Officer March 28, 2002 Annette Heroux /s/ Ivan Gati Director March 28, 2002 - ------------------------- Ivan Gati /s/ James Harlan Director March 28, 2002 - ------------------------- James Harlan /s/ Kit Howard Director March 28, 2002 - ------------------------- Kit Howard /s/ Brett Smith Director March 28, 2002 - ------------------------- Brett Smith /s/ Harvey Teich Director March 28, 2002 - ------------------------- Harvey Teich
39 INDEX TO FINANCIAL STATEMENTS AND SCHEDULE Page ---- Report of Independent Certified Public Accountants 41 Balance Sheets As of December 31, 2001 and 2000 42 Statements of Operations For the years ended December 31, 2001, 2000 and 1999 43 Statements of Stockholders' Equity For the years ended December 31, 2001, 2000 and 1999. 44 Statements of Cash Flows For the years ended December 31, 2001, 2000 and 1999. 45 Notes to Financial Statements 46-64 Schedule II - Valuation and Qualifying Accounts and Reserves 65 40 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors Howtek, Inc. Hudson, New Hampshire We have audited the accompanying balance sheets of Howtek, Inc. as of December 31, 2001 and 2000 and the related statements of operations, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. We have also audited the financial statement schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedule are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedule. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Howtek, Inc. at December 31, 2001 and 2000, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the schedule presents fairly, in all material respects, the information set forth therein. /s/ BDO SEIDMAN, LLP Boston, Massachussetts February 19, 2002 41 HOWTEK, INC. Balance Sheets
December 31, December 31, ------------ ------------ 2001 2000 ----- ----- Assets (note 2) Current assets: Cash and equivalents $ 495,360 $ 1,444,771 Trade accounts receivable net of allowance for doubtful accounts of $165,000 in 2001 and $256,000 in 2000 (note 7) 691,415 1,082,783 Inventory (note 1) 2,363,237 2,443,150 Prepaid and other 36,590 111,312 ------------ ------------ Total current assets 3,586,602 5,082,016 ------------ ------------ Property and equipment (note 1): Equipment 1,408,347 2,843,818 Leasehold improvements 41,721 36,821 Motor vehicles -- 6,050 ------------ ------------ 1,450,068 2,886,689 Less accumulated depreciation and amortization 1,118,685 2,398,553 ------------ ------------ Net property and equipment 331,383 488,136 ------------ ------------ Other assets (note 1): Software development costs, net 230,247 350,550 Debt issuance costs, net -- 16,965 Patents, net 12,893 8,261 ------------ ------------ Total other assets 243,140 375,776 ------------ ------------ Total assets $ 4,161,125 $ 5,945,928 ============ ============ Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 1,026,335 $ 1,096,174 Accrued interest 203,299 244,947 Accrued expenses 203,064 185,752 Loans payable to related party (note 2) 500,000 500,000 Convertible subordinated debentures (note 3) 10,000 117,000 Current maturities of note payable (note 4) 61,109 -- ------------ ------------ Total current liabilities 2,003,807 2,143,873 Loans payable to related party (note 2) -- 900,000 Note payable, less current maturities (note 4) 117,761 -- ------------ ------------ Total liabilities 2,121,568 3,043,873 ------------ ------------ Commitments and contingencies (notes 2 and 8) Stockholders' equity (notes 2, 3 and 5): Convertible preferred stock, $ .01 par value: authorized 1,000,000 shares; issued and outstanding 9,550 in 2001 and 2000, with the aggregate liquidation value of $2,215,000 plus 7% annual dividend 96 96 Common stock, $ .01 par value: authorized 25,000,000 shares; issued 15,241,833 in 2001 and 13,588,126 shares in 2000; outstanding 15,173,957 in 2001 and 13,520,250 shares in 2000 152,418 135,881 Additional paid-in capital 57,107,227 55,365,491 Accumulated deficit (54,269,920) (51,649,149) Treasury stock at cost (67,876 shares) (950,264) (950,264) ------------ ------------ Stockholders' equity 2,039,557 2,902,055 ------------ ------------ Total liabilities and stockholders' equity $ 4,161,125 $ 5,945,928 ============ ============
See accompanying notes to financial statements. 42 HOWTEK, INC. Statements of Operations
For the Years Ended December 31, --------------------------------------------------------- 2001 2000 1999 ----- ----- ----- Sales (notes 2 and 7) $ 4,835,297 $ 7,793,517 $ 6,663,230 Cost of sales 3,936,406 5,893,490 5,069,106 ------------ ------------ ------------ Gross margin 898,891 1,900,027 1,594,124 ------------ ------------ ------------ Operating expenses: Engineering and product development 751,467 709,595 799,960 General and administrative 1,124,710 1,165,392 1,286,895 Marketing and sales 1,563,380 1,720,674 1,702,451 ------------ ------------ ------------ Total operating expenses 3,439,557 3,595,661 3,789,306 ------------ ------------ ------------ Loss from operations (2,540,666) (1,695,634) (2,195,182) Interest expense - net (includes $114,952, $145,979 and $104,486, respectively, to related parties) (note 3) (80,105) (132,014) (1,801,646) ------------ ------------ ------------ Net loss (2,620,771) (1,827,648) (3,996,828) Preferred dividends 155,050 72,589 -- Accreted dividends -- 996,283 -- ------------ ------------ ------------ Net loss available to common shareholders $ (2,775,821) $ (2,896,520) $ (3,996,828) ============ ============ ============ Net loss per share (note 5) Basic and diluted $ (0.20) $ (0.22) $ (0.32) Weighted average number of shares used in computing earnings per share Basic and diluted 13,950,119 13,373,086 12,660,613
See accompanying notes to financial statements. 43 HOWTEK, INC. Statements of Stockholders' Equity
Preferred Stock Common Stock ------------------------------ ------------------------------- Additional Number of Number of Paid-in Shares Issued Par Value Shares Issued Par Value Capital -------------- ------------- --------------- -------------- ---------------- Balance at December 31, 1998 -- $ -- 11,128,082 $ 111,281 $ 47,938,799 Issuance of common stock relative to conversion of Convertible Subordinated Debentures (note 3) -- -- 1,764,000 17,639 3,417,519 Issuance of comon stock relative to conversion of loans payable to related parties (note 2 (b)) -- -- 200,326 2,003 223,363 Issuance of common stock in lieu of payment of accounts payable -- -- 195,090 1,951 187,233 Issuance of common stock pursuant to incentive stock option plan -- -- 27,166 272 39,988 Issuance of common stock for payment of interest to investors -- -- 15,878 159 38,544 Issuance of preferred stock relative to conversion of loans payable to investors (note 5 (a)) 6,900 69 -- -- 689,931 Issuance of stock subscription warrant for services (note 5 (d)) -- -- -- -- 27,000 Net loss -- -- -- -- -- ------------ ------------ ------------ ------------ ------------ Balance at December 31, 1999 6,900 69 13,330,542 133,305 52,562,377 Issuance of common stock pursuant to incentive stock option plan -- -- 131,822 1,318 143,619 Issuance of common stock for payment of dividends to investors (note 5 (a)) -- -- 25,762 258 72,010 Issuance of common stock relative to conversion of preferred stock (note 2) (1,000) (10) 100,000 1,000 (990) Issuance of preferred stock to investors (note 5 (a)) 3,650 37 -- -- 1,624,963 Issuance of stock subscription warrant for services (note 5 (d)) -- -- -- -- 39,818 Preferred stock dividends (note 5 (a)) -- -- -- -- (72,589) Accreted dividends (note 5 (a)) -- -- -- -- 996,283 Net loss -- -- -- -- -- ------------ ------------ ------------ ------------ ------------ Balance at December 31, 2000 9,550 96 13,588,126 135,881 55,365,491 Issuance of common stock pursuant to incentive stock option plan -- -- 118,832 1,188 151,071 Issuance of common stock relative to conversion of loan payable to related parties (note 2) -- -- 1,432,910 14,329 1,591,364 Issuance of common stock for payment of dividends to investors (note 5 (a)) -- -- 101,965 1,020 154,351 Preferred stock dividends (note 5 (a)) -- -- -- -- (155,050) Net loss -- -- -- -- -- ------------ ------------ ------------ ------------ ------------ Balance at December 31, 2001 9,550 $ 96 15,241,833 $ 152,418 $ 57,107,227 ============ ============ ============ ============ ============ See accompanying notes to financial statements. Accumulated Treasury Stockholders' Deficit Stock Equity ------------- ------------- ------------- Balance at December 31, 1998 $(44,828,390) $ (950,264) $ 2,271,426 Issuance of common stock relative to conversion of Convertible Subordinated Debentures (note 3) -- -- 3,435,158 Issuance of comon stock relative to conversion of loans payable to related parties (note 2 (b)) -- -- 225,366 Issuance of common stock in lieu of payment of accounts payable -- -- 189,184 Issuance of common stock pursuant to incentive stock option plan -- -- 40,260 Issuance of common stock for payment of interest to investors -- -- 38,703 Issuance of preferred stock relative to conversion of loans payable to investors (note 5 (a)) -- -- 690,000 Issuance of stock subscription warrant for services (note 5 (d)) -- -- 27,000 Net loss (3,996,828) -- (3,996,828) ------------ ------------ ------------ Balance at December 31, 1999 (48,825,218) (950,264) 2,920,269 Issuance of common stock pursuant to incentive stock option plan -- -- 144,937 Issuance of common stock for payment of dividends to investors (note 5 (a)) -- -- 72,268 Issuance of common stock relative to conversion of preferred stock (note 2) -- -- -- Issuance of preferred stock to investors (note 5 (a)) -- -- 1,625,000 Issuance of stock subscription warrant for services (note 5 (d)) -- -- 39,818 Preferred stock dividends (note 5 (a)) -- -- (72,589) Accreted dividends (note 5 (a)) (996,283) -- -- Net loss (1,827,648) -- (1,827,648) ------------ ------------ ------------ Balance at December 31, 2000 (51,649,149) (950,264) 2,902,055 Issuance of common stock pursuant to incentive stock option plan -- -- 152,259 Issuance of common stock relative to conversion of loan payable to related parties (note 2) -- -- 1,605,693 Issuance of common stock for payment of dividends to investors (note 5 (a)) -- -- 155,371 Preferred stock dividends (note 5 (a)) -- -- (155,050) Net loss (2,620,771) -- (2,620,771) ------------ ------------ ------------ Balance at December 31, 2001 $(54,269,920) $ (950,264) $ 2,039,557 ============ ============ ============
44 HOWTEK, INC. Statements of Cash Flows
For the Years Ended December 31, ---------------------------------------------------- 2001 2000 1999 ---- ---- ---- Cash flows from operating activities: Net loss $(2,620,771) $(1,827,648) $(3,996,828) ----------- ----------- ----------- Adjustments to reconcile net loss to net cash used by operating activities: Depreciation 242,335 339,818 341,290 Amortization 243,804 283,882 301,457 Interest relative to conversion of Convertible Subordinated Debentures (note 3) -- -- 1,671,158 Compensation expense relative to issue of Stock Subscription Warrants (note 5 (d)) -- 39,818 27,000 Changes in operating assets and liabilities: Accounts receivable 391,368 318,204 169,094 Inventory 79,913 206,310 277,622 Other current assets 74,722 33,078 (25,701) Accounts payable 80,161 (55,306) 77,873 Accrued interest 114,045 145,979 61,327 Accrued expenses 17,633 (58,461) 135,329 ----------- ----------- ----------- Total adjustments 1,243,981 1,253,322 3,036,449 ----------- ----------- ----------- Net cash used by operating activities (1,376,790) (574,326) (960,379) ----------- ----------- ----------- Cash flows from investing activities: Patents, software development and other (111,168) (137,140) (122,135) Additions to property and equipment (85,582) (111,773) (206,466) ----------- ----------- ----------- Net cash used by investing activities (196,750) (248,913) (328,601) ----------- ----------- ----------- Cash flows from financing activities: Issuance of common stock for cash 152,259 144,937 40,260 Issuance of preferred stock for cash -- 1,600,000 -- Proceeds of loans payable to related parties 480,000 260,000 632,163 Proceeds of loans payble to unrelated parties -- -- 696,906 Proceeds of note payable 193,492 -- -- Payment of loans payable to related parties (80,000) -- -- Payment of note payable (14,622) -- -- Payment of convertible subordinated debentures (107,000) -- -- ----------- ----------- ----------- Net cash provided by financing activities 624,129 2,004,937 1,369,329 ----------- ----------- ----------- Increase (decrease) in cash and equivalents (949,411) 1,181,698 80,349 Cash and equivalents, beginning of year 1,444,771 263,073 182,724 ----------- ----------- ----------- Cash and equivalents, end of year $ 495,360 $ 1,444,771 $ 263,073 =========== =========== =========== Supplemental disclosure of cash flow information: Interest paid $ 10,530 $ 10,530 $ 10,530 =========== =========== =========== Non-cash items from financing activities: Conversion of loans and accrued interest payable to related parties into Common Stock (note 2) $ 1,605,693 $ -- $ 225,366 =========== =========== =========== Conversion of accounts payable into related party loan payable $ 150,000 $ -- $ -- =========== =========== =========== Conversion of accounts payable into Common Stock $ -- $ 25,000 $ 189,184 =========== =========== =========== Conversion of accrued interest payable to investors into Common Stock $ -- $ -- $ 38,703 =========== =========== =========== Conversion of loans payable to investors into Preferred Stock (note 5 (a)) $ -- $ -- $ 690,000 =========== =========== =========== Issuance of common stock relative to conversion of Convertible Subordinated Debentures (note 3) $ -- $ -- $ 3,435,158 =========== =========== =========== Conversion of dividends payable into Common Stock $ 155,371 $ 72,268 $ -- =========== =========== ===========
See accompanying notes to financial statements. 45 HOWTEK, INC. Notes to Financial Statements (1) Summary of Significant Accounting Policies (a) Nature of Operations and Use of Estimates Howtek, Inc. (the "Company") designs, engineers, develops and manufactures digital image scanners, film digitizers and related software for applications in the medical imaging, prepress and photographic markets. The Company considers itself a single reportable business segment. The Company sells its products throughout the world through various distributors, resellers, systems integrators and OEMs. See Note 7 for geographical and major customer information. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Many of the Company's estimates and assumptions used in the preparation of the financial statements relate to the Company's products, which are subject to rapid technological change. It is reasonably possible that changes may occur in the near term that would affect management's estimates with respect to inventories, equipment and software development costs. (b) Inventory Inventory is valued at the lower of cost or market value, with cost determined by the first-in, first-out method. At December 31, inventory consisted of raw material and finished goods of approximately $1,330,000 and $1,033,000, respectively, for 2001 and raw material and finished goods of approximately $1,509,000 and $934,000, respectively, for 2000. (c) Property and Equipment Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the various classes of assets (ranging from 3 to 5 years). (d) Debt Issuance Costs Debt issuance costs, related to the outstanding Convertible Subordinated Debentures, was amortized over the 15-year term of the Debentures, ending December 2001, using the straight-line method. The debt issuance costs balances are presented net of accumulated amortization, which was $333,971 and $317,006 at December 31, 2001, and 2000, respectively. 46 HOWTEK, INC. Notes to Financial Statements (continued) (1) Summary of Significant Accounting Policies (continued) (e) Patents The costs for patents are being amortized over the estimated useful life of the respective assets using the straight-line method. The patents balances are presented net of accumulated amortization, which was $107,941 and $103,280 at December 31, 2001 and 2000, respectively. (f) Software Development Costs Software development costs for application software and application software enhancements are capitalized subsequent to the establishment of their technological feasibility (as defined in Statement of Financial Accounting Standards No. 86). The Company capitalized $101,875, $137,140 and $122,135 of internally developed and externally purchased software costs during fiscal 2001, 2000 and 1999, respectively. The capitalized software balances are presented net of accumulated amortization, which was $965,693 and $743,515 at December 31, 2001, and 2000, respectively. Capitalized software costs are amortized using the straight-line method over their estimated economic life, principally 3 years, commencing when each product is available for general release. (g) Revenue Recognition Revenues from product sales are recognized at the time the product is shipped. (h) Cost of Sales Cost of sales consists of the costs of products purchased for resale, any associated inbound and outbound freight and duty, any costs associated with manufacturing, warehousing, material movement and inspection, amortization of any license rights, and amortization of capitalized software. (i) Warranty Costs The Company's products are generally under warranty against defects in material and workmanship from a 90 day to 2year period, depending on the product. Warranty costs were not material in any period presented. 47 HOWTEK, INC. Notes to Financial Statements (continued) (1) Summary of Significant Accounting Policies (continued) (j) Engineering and Product Development These costs relate to research and development costs which are expensed as incurred, except for amounts related to software development costs incurred after the establishment of technological feasibility (see (f) above) which are capitalized. (k) Net Loss Per Common Share Net loss per common share has been computed in accordance with Statement of Financial Accounting Standards No. 128, "Earnings per Share". See Note 5 - Stockholders' Equity. (l) Cash Flow Information For purposes of reporting cash flows, the Company defines cash and equivalents as all bank transaction accounts, certificates of deposit, money market funds and deposits, and other money market instruments maturing in less than 90 days, which are unrestricted as to withdrawal. (m) Income Taxes The Company follows the liability method under Statement of Financial Accounting Standards No. 109 ("SFAS 109"). The primary objectives of accounting for taxes under SFAS 109 are to (a) recognize the amount of tax payable for the current year and (b) recognize the amount of deferred tax liability or asset for the future tax consequences of events that have been reflected in the Company's financial statements or tax returns. (n) Long Lived Assets Long-lived assets, such as property and equipment, are evaluated for impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through the estimated undiscounted future cash flows from the use of these assets. When any such impairment exists, the related assets are written down to fair value. This policy is in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets To Be Disposed Of". (o) Stock-Based Compensation The Company has not adopted the optional fair value based method for accounting for employee stock compensation plans, as permitted by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation". See Note 5 - Stockholders' Equity. 48 HOWTEK, INC. Notes to Financial Statements (continued) (1) Summary of Significant Accounting Policies (continued) (p) Advertising The Company expenses advertising costs as incurred. Advertising expense for the years ended December 31, 2001, 2000 and 1999 was $151,000, $134,000 and $143,000, respectively. (q) New Accounting Standards In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations" ("SFAS 141"), and No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 141 requires companies to use the purchase method of accounting for all business combinations initiated after June 30, 2001, and establishes specific criteria for the recognition of intangible assets separately from goodwill. SFAS 142 addresses the accounting for acquired goodwill and intangible assets. Goodwill and indefinite-lived intangible assets will no longer be amortized and will be tested for impairment at least annually. The provisions of SFAS 142 will be effective for the Company in fiscal year 2002. Goodwill and intangible assets acquired after June 30, 2001, will be subject immediately to the non-amortization and amortization provisions of this statement. Historically, the Company has not had goodwill or acquired other intangible assets. Accordingly, the Company does not expect adoption of these new standards to affect its financial statements as they relate to previous transactions. However these new standards will affect the accounting for any business combinations initiated after June 30, 2001. In October 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment of Disposal of Long-Lived Assets" ("SFAS 144"), which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement supersedes SFAS 121 "Accounting for the Impairment of Long-Lived Assets to be Disposed Of" and APB Opinion No. 30 "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions for the Disposal of a Segment of a Business". SFAS 144 becomes effective for the fiscal years beginning after December 15, 2001. The Company expects to adopt SFAS 144 in the first quarter of fiscal 2002 and is currently reviewing the effects of adopting SFAS 144 on its financial position and results of operations. (r) Financial Statements Certain balances in the 2000 financial statements have been reclassified to conform to the 2001 presentation. 49 HOWTEK, INC. Notes to Financial Statements (continued) (2) Related Party Transactions (a) Loan Payable to Principal Stockholder The Company has a Convertible Revolving Credit Promissory Note ("the Convertible Note") and Revolving Loan and Security Agreement (the "Loan Agreement") with Mr. Robert Howard, Chairman of the Board of Directors of the Company, under which Mr. Howard has agreed to advance funds, or to provide guarantees of advances made by third parties in an amount up to $3,000,000. The Loan Agreement expires January 4, 2003, subject to extension by the parties. Outstanding advances are collateralized by substantially all of the assets of the Company and bear interest at prime interest rate plus 2%. The Convertible Note entitles Mr. Howard to convert outstanding advances into shares of the Company's common stock at any time based on the outstanding closing market price of the Company's common stock at the time each advance is made. In 2001, Mr. Howard converted $1,244,219 principal and accrued interest of advances made under the Convertible Note into 1,071,436 shares of restricted common stock of the Company. As of December 31, 2001 no moneys were owed and the Company had $3,000,000 available for future borrowings under the Loan Agreement. The Company has Secured Demand Notes and Security Agreements (the "Notes") owed to Mr. Robert Howard. Principal of these notes are due and payable in full, together with interest accrued and any penalties provided for, on demand. Under the terms of the Notes the Company agreed to pay interest at the lower rate of (a) 12% per annum, compounded monthly or (b) the maximum rate permitted by applicable law. The Notes currently bear interest at 12%. Payment of the Notes is secured by a security interest in certain assets of the Company. A total of $500,000 is outstanding pursuant to the Notes. During 1999 the Company borrowed $310,000 from Mr. Robert Howard, pursuant to Convertible Promissory Notes (the "Promissory Notes"). Under the terms of the Promissory Notes the Company agreed to pay interest at a fixed rate of 7% per annum. The Promissory Notes entitled the payee to convert outstanding principal due into shares of the Company's common stock at $1.00 per share, which was the market price of the Company's stock at the date the Promissory Notes were issued. In September 2001, Mr. Howard converted the outstanding balance, including interest, on the Promissory Notes into 361,474 shares of restricted common stock of the Company. (b) Loan Payable to Related Party In 1998 the Company borrowed $200,000 from Dr. Lawrence Howard, son of the Company's Chairman, Robert Howard, pursuant to Secured Demand Notes and Security Agreements (the "Notes"). Principal of these notes were due and payable in full, together 50 HOWTEK, INC. Notes to Financial Statements (continued) (2) Related Party Transactions (continued) (b) Loan Payable to Related Party (continued) with interest accrued and any penalties provided for, on demand. Under the terms of the Notes the Company agreed to pay interest at the lower rate of (a) 12% per annum, compounded monthly or (b) the maximum rate permitted by applicable law. Payment of the Notes was secured by a security interest in certain assets of the Company. In the fourth quarter of 1999 the Company consummated an agreement with Dr. Lawrence Howard to convert the Notes and interest accrued into 200,326 shares of restricted common stock, par value $.01 per share of the Company (the "Common Stock"). The number of shares issued was determined using the market price of the Company's stock at the date of conversion. (c) Premises Lease and Other Expenses The Company conducts its operations in premises owned by Mr. Robert Howard, pursuant to a lease which expires September 30, 2002. As of December 31, 2001, future minimum lease payments under this lease are $58,875 for 2002. The Company is required to pay real estate taxes, provide insurance and maintain the premises. (d) Related Party Sales During the years ended December 31, 2000 and 1999, the Company sold engineering services totaling $24,456 and $93,045, respectively, to Presstek, Inc., which Mr. Howard was the Chairman Emeritus of the Board through December 2000. There were no sales to Presstek, Inc. in 2001. (e) Sales and Issues of Securities In February 1999, the Company borrowed $30,000 from Mr. W. Scott Parr, the Company's President, Chief Executive Officer, pursuant to a Convertible Promissory Note (the "Promissory Note"). Principal on the Promissory Note was payable in equal payments based on the borrowed amount at the end of each quarter starting March 31, 2003 through December 31, 2006. Under the terms of the Promissory Note the Company agreed to pay interest at a fixed rate of 7% per annum, beginning on December 31, 1999 and each succeeding year during the terms hereof. At the Company's option it may pay the interest in either cash or in restricted shares of the Company's common stock, or in 51 HOWTEK, INC. Notes to Financial Statements (continued) (2) Related Party Transactions (continued) (e) Sales and Issues of Securities (continued) any combination thereof. Interest paid in shares of the Company's common stock will be paid at the greater of $1.00 per share or the average per share closing market price at the time each interest payment is due. The Promissory Note entitled the payee to convert outstanding principal due into shares of the Company's common stock at $1.00 per share, which was the market price of the Company's stock at the date the Promissory Notes were issued. On December 31, 1999, the Company consummated an agreement with Mr. Parr to convert the Promissory Note into shares of 7.0% Series A convertible preferred stock, par value $.01 per share, of the Company (the "Preferred Stock") and converted the interest accrued into shares of its common stock, par value $.01 per share (the "Common Stock"). (See also Note 5.) (3) Convertible Subordinated Debentures The Company has 9% Convertible Subordinated Debentures (the "Debentures"), which became due December 1, 2001. Interest on the Debentures is payable semi-annually on June 1 and December 1. The Debentures were convertible into common stock of the Company at the conversion price of $19.00 per share, subject to adjustment in certain events. On December 31, 1998, the Company and the Trustee of the Debentures entered into a Second Supplemental Indenture (the "Agreement"). The purpose of the Agreement was to reduce the conversion price for the Debentures from $19.00 per share to $1.00 per share, subject to adjustment as set forth in the Indenture, during the period from December 31, 1998 through March 23, 1999. Under the Agreement, Debentures owned by related parties in the principal amount of $300,000 were converted into 300,000 shares of Common Stock, at the conversion price of $1.00 per share on December 31, 1998. Interest expense and corresponding credit to additional paid-in capital of $284,211 were recorded relative to the conversion of Convertible Subordinated Debentures as required in terms of Statement of Financial Accounting Standards No. 84, ("SFAS No. 84") "Induced Conversions of Convertible Debt". In the first quarter of 1999, Debentures in the principal amount of $1,764,000 were converted into 1,764,000 shares of Common Stock, at the conversion price of $1.00 per share. Interest expense and corresponding credit to additional paid-in capital of $1,671,158 was recorded relative to the conversion of Convertible Subordinated Debentures as required in terms of SFAS No. 84. As of December 31, 2000, the Company's outstanding balance on its Debentures was $117,000. In December 2001, $107,000 of its Debentures were presented for payment. As of December 31, 2001 the Company's outstanding balance on its Debentures was $10,000. 52 HOWTEK, INC. Notes to Financial Statements (continued) (4) Note Payable During 2001 the Company entered into a financing agreement with a supplier to purchase $193,492 of components, pursuant to a note payable (the "Note"). Principal on the Note is payable over 36 months starting October 1, 2001. Under the terms of the Note the Company agreed to pay interest at a fixed rate of 7% per annum. As of December 31, 2001, the Company owed $178,870 pursuant to the Note. Principal payments are due as follows: December 31, 2002 - $61,109, December 31, 2003 - $65,526, December 31, 2004 - $52,235. (5) Stockholders' Equity (a) Preferred Stock On December 22, 1999 the Company, pursuant to the authority of the Company's Board of Directors, adopted a resolution creating a series of preferred stock designated as 7.0% Series A Convertible Preferred Stock (the "Series A Preferred Stock"). The number of shares initially constituting the Series A Preferred Stock was 10,000, par value $.01 per share, which may be decreased (but not increased) by the Board of Directors without a vote of stockholders, provided, however, that such number may not be decreased below the number of then outstanding shares of Series A Preferred Stock. The holders of the shares of Series A Preferred Stock shall vote together with the Common Stock as a single class on all actions to be voted on by the stockholders of the Company. Each share of Series A Preferred Stock shall entitle the holder thereof to such number of votes per share on each such action as shall equal the number of whole shares of Common Stock into which each share of Series A Preferred Stock is then convertible. The holders shall be entitled to notice of any stockholder's meeting in accordance with the By-Laws of the Company. Each share of Series A Preferred Stock is convertible into that number of shares of Common Stock determined by dividing the aggregate liquidation preference of the number of shares of Series A Preferred Stock being converted by $1.00 (the "Conversion Rate"). The Conversion Rate shall be subject to appropriate adjustment by stock split, dividend or similar division of the Common Stock or reverse split or similar combinations of the Common Stock prior to conversion. The Company may at any time after the date of issuance, at the option of the Board of Directors, redeem in whole or in part the Series A Preferred Stock by paying cash equal to $100 per share together with any accrued and unpaid dividends (the "Redemption Price"). The Redemption Price shall be subject to appropriate adjustment by the Board of Directors of similar division of shares of Series A Preferred Stock or reverse split or similar combination of the Series A Preferred Stock. In the event the Company shall liquidate, dissolve or wind up, no distribution shall be made to the holders of shares of Common Stock unless, prior thereto the holders of shares of Series A Preferred Stock shall have received $100 per share (as adjusted for any stock dividends, combinations or splits) plus all declared or accumulated 53 HOWTEK, INC. Notes to Financial Statements (continued) (5) Stockholders' Equity (continued) (a) Preferred Stock (continued) but unpaid dividends. The holders of shares of Series A Preferred Stock, in preference to the holders of shares of Common Stock, shall be entitled to receive cumulative dividends of $7.00 per annum per share, payable annually, subject to appropriate adjustment by the Board of Directors of the Company in the event of any stock split, dividend or similar division of shares of Series A Preferred. Dividends are payable annually, in arrears, on the last day of December in each year. On December 31, 1999, the Company consummated an agreement with all the unrelated parties and Mr. W. Scott Parr to convert $690,000 pursuant to Convertible Promissory Notes into 6,900 shares of Series A Preferred Stock, par value $.01 per share, of the Company. On April 12, 2000, the Company sold, in private transactions, a total of 2,250 shares of its 7% Series A convertible Preferred Stock ($.01 per share par value), at $100 per share, consisting of 1,000 shares to an unrelated party, 1,000 shares to Dr. Lawrence Howard, son of the Company's Chairman, Mr. Robert Howard, and 250 shares to Mr. W. Scott Parr, the Company's President, Chief Executive Officer, for gross proceeds of $225,000. On October 19, 2000 the Company, pursuant to the authority of the Company's Board of Directors, adopted a resolution creating a series of preferred stock designated as 7.0% Series B Convertible Preferred Stock (the "Series B Preferred Stock"). The number of shares initially constituting the Series B Preferred Stock was 2,000, par value $.01 per share, which may be decreased (but not increased) by the Board of Directors without a vote of stockholders, provided, however, that such number may not be decreased below the number of then outstanding shares of Series B Preferred Stock. The holders of the shares of Series B Preferred Stock have no voting rights other than is required by law. Each share of Series B Preferred Stock, is convertible into that number of shares of Common Stock determined by dividing the aggregate liquidation preference of the number of shares of Series B Preferred Stock being converted by $2.00 (the "Conversion Rate"). The Conversion Rate shall be subject to appropriate adjustment by stock split, dividend or similar division of the Common Stock or reverse split or similar combinations of the Common Stock prior to conversion. The Company may at any time after the date of issuance, at the option of the Board of Directors, redeem in whole or in part the Series B Preferred Stock by paying cash equal to $1,000 per share together with any accrued and unpaid dividends (the "Redemption Price"). The Redemption Price shall be subject to appropriate adjustment by the Board of Directors of similar division of shares of Series B Preferred Stock or reverse split or similar combination of the Series B Preferred Stock. In 54 HOWTEK, INC. Notes to Financial Statements (continued) (5) Stockholders' Equity (continued) (a) Preferred Stock (continued) the event the Company shall liquidate, dissolve or wind up, no distribution shall be made to the holders of shares of Common Stock unless, prior thereto, the holders of shares of Series B Preferred Stock shall have received $1,000 per share (as adjusted for any stock dividends, combinations or splits) plus all declared or accumulated but unpaid dividends. The holders of shares of Series B Preferred Stock, in preference to the holders of shares of Common Stock, shall be entitled to receive cumulative dividends of $70.00 per annum per share, payable annually, subject to appropriate adjustment by the Board of Directors of the Company in the event of any stock split, dividend or similar division of shares of Series B Preferred. Dividends are payable annually, in arrears, on the last day of December in each year. In October 2000 the Company sold, in private transactions, a total of 1,400 shares of its 7% Series B Convertible Preferred Stock ($.01 per share par value), at $1,000 per share, consisting of 1,350 shares to unrelated parties, and 50 shares to Mr. W. Scott Parr, for gross proceeds of $1,400,000. The 1,400 shares of 7% Series B Convertible Redeemable Preferred Stock were issued with a conversion price below the Company's Common Stock quoted value and as a result accreted dividends of $996,283 were recorded and included in the net loss per share calculation for the year ended December 31, 2000. (b) Stock Options The Company has three stock option plans, which are described below. The Company applies APB Opinion 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for the plans. Under APB Opinion 25, when the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation cost is recognized. Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," ("SFAS No. 123") requires the Company to provide pro forma information regarding net income and earnings per share as if compensation cost for the Company's stock option plans had been determined in accordance with the fair value- based method prescribed in SFAS No. 123. The Company estimates the fair value of each granting of options at the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2001: no dividends paid; 55 HOWTEK, INC. Notes to Financial Statements (continued) (5) Stockholders' Equity (continued) (b) Stock Options (continued) expected volatility of 75.9%; risk-free interest rates of 4.78%, and 3.87%; and expected lives of 1 and 4 years. The weighted-average assumptions used for grants in 2000 were: no dividends paid; expected volatility of 76%; risk-free interest rates of 6.62% and 5.96%; and expected lives from 4 and 5 years. The weighted-average assumptions used for grants in 1999 were: no dividends paid; expected volatility of 45.8%; risk-free interest rates of 5.79%, 5.88% and 5.99%; and expected lives of 3 to 5 years. Under the accounting provisions of SFAS No. 123, the Company's net loss and loss per share would have been increased to the pro forma amounts indicated below: 2001 2000 1999 ---- ---- ---- Net loss available to common shareholders As reported $(2,775,821) $(2,896,520) $(3,996,828) Pro forma $(2,918,031) $(3,037,055) $(4,101,278) Basic and diluted loss per share As reported $ (.20) $ (.22) $ (.32) Pro forma $ (.21) $ (.23) $ (.32) The Howtek, Inc. 1993 Stock Option Plan, ("The 1993 Plan"). The 1993 Plan (the "Plan") was adopted in November 1993. On September 28, 1999, the Company held its Annual Meeting of Stockholders at which the Stockholders voted to amend the Company's 1993 Stock Option Plan to increase the number of shares of the Company's common stock issuable thereunder from 1,000,000 to 1,625,000 shares. The Plan provides for the granting of non-qualifying and incentive stock options to employees and other persons to purchase up to an aggregate of 1,625,000 shares of the Company's common stock. The purchase price of each share for which an option is granted shall be at the discretion of the Board of Directors or the Committee appointed by the Board of Directors provided that the purchase price of each share for which an incentive option is granted shall not be less than the fair market value of the Company's common stock on 56 HOWTEK, INC. Notes to Financial Statements (continued) (5) Stockholders' Equity (continued) (b) Stock Options (continued) the date of grant, except for options granted to 10% holders for whom the exercise price shall not be less than 110% of the market price. Incentive options granted under the Plan vest 100% over periods extending from six months to five years from the date of grant and expire ten years after the date of grant, except for 10% holders whose options shall expire five years after the date of grant. Non-qualifying options granted under the Plan are generally exercisable over a ten year period, vesting 1/3 each on the first, second, and third anniversaries of the date of grant. The Howtek, Inc. Director Incentive Plan The Company has a Director Incentive Plan (the "Director Plan"). The Company has reserved for issuance 250,000 shares under the Director Plan. The Director Plan provides for the award of (i) restricted and unrestricted stock, (ii) qualified stock options, and (iii) non-qualified stock options. The Director Plan is administered by a committee of at least one director or non-director appointed by the Board. The term of the Director Plan is ten years and the term of individual grants of stock options thereunder is ten years. Vesting periods for exercise of options and restrictions on the transferability of stock awards is determined by the committee administering the Director Plan. The Howtek, Inc. 2001 Stock Option Plan, ("The 2001 Plan"). The 2001 Plan was adopted in August 2001, at the Annual Meeting of Stockholders at which the Stockholders voted to replace the 1993 plan which had no further stock available for grant. The 2001 Plan provides for the granting of non-qualifying and incentive stock options to employees and other persons to purchase up to an aggregate of 1,200,000 shares of the Company's common stock. The purchase price of each share for which an option is granted shall be at the discretion of the Board of Directors or the Committee appointed by the Board of Directors provided that the purchase price of each share for which an incentive option is granted shall not be less than the fair market value of the Company's common stock on the date of grant, except for options granted to 10% holders for whom the exercise price shall not be less than 110% of the market price. Incentive options granted under the 2001 Plan vest 100% over periods extending from six months to five years from the date of grant and expire ten years after the date of grant, except for 10% holders whose options shall expire five years after the date of grant. Non-qualifying options granted under the 2001 Plan are generally exercisable over a ten year period, vesting 1/3 each on the first, second, and third anniversaries of the date of grant. 57 HOWTEK, INC Notes to Financial Statements (continued) (5) Stockholders' Equity (continued) (b) Stock Options (continued) A summary of stock option (incentive and non-qualifying) activity is as follows:
Option Price range Weighted Shares per share Average ---------------------------------------------------- Outstanding, January 1, 1999 1,007,116 $1.00-$1.81 $1.27 Granted 505,922 $ .81-$1.13 $ .94 Exercised (27,166) $ .81-$1.72 $1.48 Cancelled (202,298) $ .81-$1.81 $1.23 ---------------------------------------------------- Outstanding, December 31, 1999 1,283,574 $ .81-$1.81 $1.22 Granted 401,179 $1.37-$1.75 $1.74 Exercised (131,822) $ .81-$1.72 $1.10 Cancelled (127,442) $ .81-$1.81 $1.15 ---------------------------------------------------- Outstanding, December 31, 2000 1,425,489 $ .81-$1.81 $1.31 Granted 197,000 $ .95-$3.00 $1.21 Exercised (118,832) $ .81-$1.72 $1.28 Cancelled (27,068) $ .81-$1.75 $1.42 ---------------------------------------------------- Outstanding, December 31, 2001 1,476,589 $ .81-$3.00 $1.28 ==================================================== Exercisable at year-end 1999 642,772 $ .81-$1.81 $1.21 2000 678,417 $ .81-$1.81 $1.28 2001 1,078,641 $ .81-$3.00 $1.27 Available for future grants 2001 1,200,000
The weighted-average fair value of options granted during the year was $0.61 per option for 2001, $1.15 per option for 2000 and $0.42 per option for 1999. The weighted-average remaining contractual life of stock options outstanding for all plans at December 31, 2001 was 7.6 years. 58 HOWTEK, INC. Notes to Financial Statements (continued) (5) Stockholders' Equity (continued) (b) Stock Options (continued) The following table summarizes information about stock options outstanding at December 31, 2001:
$ .81 $ 1.00 $ 1.50 to to to Range of Exercise Prices: $ .95 $ 1.13 $ 3.00 ------------------------------------------------------ Outstanding options: Number outstanding at December 31, 2001 490,336 431,626 554,627 Weighted average remaining contractual life (years) 8.4 6.5 7.7 Weighted average exercise price $ .86 $ 1.12 $ 1.78 Exercisable options: Number outstanding at December 31, 2001 335,485 354,783 388,373 Weighted average remaining contractual life (years) 8.0 6.6 7.3 Weighted average exercise price $ .84 $ 1.12 $ 1.79
(c) Earnings per Share The Company follows Statement of Financial Accounting Standards No. 128, "Earnings per Share", which requires the presentation of both basic and diluted earning per share on the face of the Statements of Operations. Conversion of the subordinated debentures and other convertible debt and preferred stock and assumed exercise of options and warrants are not included in the calculation of diluted loss per share since the effect would be antidilutive. Accordingly, basic and diluted net loss per share do not differ for any period presented. The following table summarizes the common stock equivalent of securities that were outstanding as of December 31, 2001, 2000 and 1999, but not included in the calculation of diluted net loss per share because such shares are antidilutive:
2001 2000 1999 ---- ---- ---- Stock options 1,476,589 1,425,489 1,283,574 Stock warrants 57,000 57,000 50,000 Convertible Subordinated Debentures -- 6,158 6,158 Convertible Revolving Promissory Note -- 393,607 294,399 Convertible Promissory Note -- 310,000 310,000 Convertible Series A Preferred Stock 815,000 815,000 -- Convertible Series B Preferred Stock 700,000 700,000 --
59 HOWTEK, INC. Notes to Financial Statements (continued) (5) Stockholders' Equity (continued) (d) Stock Subscription Warrants In December, 1999 the Company issued a common stock purchase warrant (the "Warrant") to the company (the "Manufacturer") responsible for the assembly of the Company's MultiRAD(TM) medical film digitizer, as part of its manufacturing agreement. The Warrant entitles the Manufacturer to purchase from the Company up to 50,000 shares of the Company's common stock at $2.50 per share. The Manufacturer may exercise the Warrant at any time or from time to time on or prior to December 31, 2004. The Company estimated the fair value of the Warrant at the date of issue to be $54,000 using the Black-Scholes option-pricing model. Accordingly, the value of the Warrant was expensed over the two- year period of the agreement. During 2000 the Company issued a common stock purchase warrant (the "New Warrant") to the company (the "Supplier") responsible for software development of certain of the Company's software, as part of its development agreement entered into in 2000. The Warrant entitles the Supplier to purchase from the Company up to 7,000 shares of the Company's common stock at $3.00 per share. The Supplier may exercise the Warrant at any time or from time to time on or prior to February 28, 2005. The Company estimated the fair value of the Warrant at the date of issue to be $12,818 using the Black-Scholes option-pricing model. The value of the Warrant was expensed in 2000. (6) Income Taxes As a result of the 2001, 2000 and 1999 losses, no income tax expense was incurred for these years. Deferred income taxes reflect the impact of "temporary differences" between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. Deferred tax liabilities (assets) are comprised of the following at December 31:
2001 2000 ---- ---- Inventory (Section 263A) $ (155,000) $ (105,000) Inventory reserves (136,000) (123,000) Receivable reserves (56,000) (87,000) Other accruals (18,000) (18,000) Accumulated depreciation 1,000 (14,000) Tax credits (2,388,000) (2,317,000) NOL carry forward (14,222,000) (15,232,000) ------------ ------------ Gross deferred tax asset (16,974,000) (17,896,000) ------------ ------------ Deferred tax assets valuation allowance $ 16,974,000 $ 17,896,000 ------------ ------------ Net deferred tax assets $ -0 - $ -0- ============ ============
60 HOWTEK, INC. Notes to Financial Statements (continued) (6) Income Taxes (continued) As of December 31, 2001, the Company has net operating loss carryforwards totaling approximately $41,800,000. The amount of the net operating loss carryforwards, which may be utilized in any future period, may be subject to certain limitations based upon changes in the ownership of the Company's common stock. The following is a breakdown of the net operating loss expiration period: Expiration date Amount of remaining NOL 2002 8,900,000 2003 3,300,000 2004 4,200,000 2005 2,200,000 2006 2,200,000 2007 300,000 2008 600,000 2009 100,000 2010 4,000,000 2011 4,400,000 2012 2,300,000 2018 3,600,000 2019 2,200,000 2020 1,400,000 2021 2,100,000 In addition the Company has available tax credit carryforwards (adjusted to reflect provisions of the Tax Reform Act of 1986) of approximately $2,388,000, which are available to offset future taxable income and income tax liabilities, when earned or incurred. These amounts expire in various years through 2021. (7) Sales Information (a) Geographic Information The Company's sales are made to U.S. distributors, dealers and to foreign distributors of computer and related products. Total export sales, which includes sales made to a U.S. based international distributor of computer and related products, were $944,000 or 20% of total sales in 2001, $3,243,000 or 42% of total sales in 2000 and $740,000 or 11% of total sales in 1999. 61 HOWTEK, INC. Notes to Financial Statements (continued) (7) Sales Information (continued) (a) Geographic Information (continued) The Company's principal concentration of export sales was in Australia, which accounted for 35% of 2001 export sales. In 2000, with the addition of a large OEM customer, the Company's principal concentration of export sales was in Canada, which accounted for 71% of export sales. The Company's principal concentration of export sales had been in Europe with 41% of export sales in 1999. The balance of the export sales was into the Far East, Mexico and Central America. As of December 31, 2001 and 2000 the Company had outstanding receivables of $136,000 and $601,000, respectively, from distributors of its products who are located outside of the United States. (b) Major Customers During the years ended December 31, 2001 and 1999, the Company had no major customers. In 2000 the Company had one major customer that operated as an OEM, with sales of $2,062,955 (or 26% of sales) and an accounts receivable balance of $428,994 at December 31, 2000. (c) Product Information The Company's revenues by product line are as follows: For the year ended December 31, 2001 2000 1999 ---- ---- ---- Medical imaging $2,315,738 $2,256,312 $1,508,197 FotoFunnel 988,199 2,217,798 -- Graphic arts 1,531,360 3,319,407 5,155,033 ---------- ---------- ---------- Total $4,835,297 $7,793,517 $6,663,230 ========== ========== ========== (8) Commitments and Contingencies As of December 31, 2001, the Company had one lease obligation related to its facility. The lease obligation for 2002 is approximately $58,875. The Company's principal executive offices and research and development laboratory is leased by the Company from Mr. Robert Howard, Chairman of the Board of Directors pursuant to a lease which expires September 30, 2002. Rental expense for all leases for the years ended December 31, 2001, 2000 and 1999 was $78,500, $78,500 and $93,740, respectively. 62 HOWTEK, INC. Notes to Financial Statements (continued) (9) Financial instruments The carrying amounts of financial instruments, including cash and equivalents, accounts receivable, accounts payable, accrued expenses, demand notes payable to related parties and convertible debentures and other convertible debt approximated fair value as of December 31, 2001 and 2000, due to either short maturity or terms similar to those available to similar companies in the open market. (10) Quarterly Financial Data (unaudited) Net Gross Net Loss 2001 sales profit loss per share ---- ---------- ----------- ----------- --------- First quarter $1,513,604 $ 392,141 $ (639,591) $ (0.05) Second quarter $ 932,160 $ 146,627 $ (797,943) $ (0.06) Third quarter $1,139,025 $ 302,348 $ (548,205) $ (0.04) Fourth quarter $1,250,508 $ 57,775 $ (635,032) $ (0.05) 2000 ---- First quarter $1,517,518 $ 352,557 $ (564,464) $ (0.04) Second quarter $1,957,638 $ 597,126 $ (257,501) $ (0.02) Third quarter $2,760,773 $ 783,229 $ (175,627) $ (0.01) Fourth quarter $1,557,588 $ 167,115 $ (830,056) $ (0.14) (11) Subsequent Event The Company recently announced that it has entered into a definitive agreement with Intelligent Systems Software Inc. ("ISSI"), a privately held company based in Boca Raton, Florida, pursuant to which ISSI would merge with and into a subsidiary of Howtek. If the merger is consummated, a total of 8,400,000 shares of Howtek common stock will be issued in the merger in exchange for all of the issued and outstanding capital stock of ISSI. In January 2002, ISSI received approval from the U.S. Food and Drug Administration (FDA) to market and sell ISSI's new MammoReader(TM) Computer Aided Detection CAD system in the United States. Subsequent to completion of the contemplated merger, Howtek's existing film and photo digitizer operations, including engineering, manufacturing management, marketing and support, will be conducted through a wholly owned subsidiary corporation, based at the Company's current headquarters in Hudson, NH. The Company's objective is to continue to grow its medical business, providing industry-leading digitizers to ISSI and to other respected customers. 63 HOWTEK, INC. Notes to Financial Statements (continued) (11) Subsequent Event (continued) The completion of the merger is subject to the registration of the shares of Howtek common stock to be issued in the merger under the Securities Act of 1933, as amended, and other customary conditions, including approval of the merger by stockholders of both Howtek and ISSI. It is currently expected that the merger will be consummated by June 30, 2002. 64 HOWTEK, INC. Schedule II - Valuation and Qualifying Accounts and Reserves
Col. A Col. B Col. C Col. D Col. E - ----------------------------------------------------------------------------------------------- Balance at Charged to Balance Beginning Cost and at end Description of Year Expenses Deductions of Year - ----------------------------------------------------------------------------------------------- Year End December 31, 2001: Allowance for Doubtful Accounts $ 255,999 $ 50,845 $ 141,844 (1) $165,000 Inventory Reserve $ 361,931 $ 379,285 $ 41,216 (2) $700,000 Year End December 31, 2000: Allowance for Doubtful Accounts $ 150,500 $ 105,499 $ - (1) $255,999 Inventory Reserve $ 200,175 $ 289,370 $ 127,614 (2) $361,931 Year End December 31, 1999: Allowance for Doubtful Accounts $ 118,349 $ 281,312 $ 249,161 (1) $150,500 Inventory Reserve $ 101,553 $ 117,583 $ 18,961 (2) $200,175
(1) Represents the amount of accounts charged off. (2) Represents inventory written off and disposed of. 65 EX-2.1 3 d50184_exh2-1.txt PLAN AND AGREEMENT OF MERGER EXHIBIT 2.1 PLAN AND AGREEMENT OF MERGER THIS PLAN AND AGREEMENT OF MERGER (this "Agreement") is entered into as of the 15th day of February, 2002, by and among Howtek, Inc., a Delaware corporation ("Howtek"), ISSI Acquisition Corp., a Delaware corporation which is a wholly owned subsidiary of Howtek ("Merger Sub") (Howtek and Merger Sub collectively, the "Howtek Parties") and Intelligent Systems Software, Inc., a Florida corporation ("ISSI"), and Maha Sallam, Kevin Woods and W. Kip Speyer (the "Principal Stockholders"). RECITALS WHEREAS, the Board of Directors of each of Howtek, Merger Sub and ISSI has determined that it is in the best interests of their respective stockholders for Howtek to acquire ISSI upon the terms and subject to the conditions set forth herein; WHEREAS, the Howtek Parties and ISSI are desirous of effecting a merger, all upon the terms and conditions set forth herein; and WHEREAS, all capitalized terms not defined in this Agreement have the meanings ascribed to them in Annex 1 hereto. NOW, THEREFORE, the Howtek Parties and ISSI, intending to be legally bound, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, hereby represent, warrant, covenant, and agree as follows: SECTION 1 THE MERGER 1.1 Merger. Subject to the terms and conditions of this Agreement, ISSI shall be merged with and into Merger Sub in a transaction intended to qualify for non recognition treatment in accordance with Section 368(a)(1)(A) and (a)(2)(D) of the Code. SECTION 2 TERMS OF MERGER 1.2 Terms of Merger; Effective Time. The terms of merger (the "Merger") are: (a) ISSI shall be merged with and into Merger Sub in accordance with the statutory provisions of Delaware law. (b) Merger Sub shall be the surviving corporation (the "Surviving Corporation"), and the corporate identity, existence, purposes, powers, franchises, rights, and immunities of Merger Sub shall continue unaffected and unimpaired by the Merger. The corporate identity, existence, purposes, powers, franchises, rights, and immunities of ISSI shall 1 be merged into the Surviving Corporation, and the Surviving Corporation shall be fully vested therewith. (c) Immediately after the Closing, the Merger shall be effected by filing with each of the Secretary of State of Delaware ("Delaware SOS") and with the Secretary of State of the State of Florida ("Florida SOS") the Certificate of Merger and the Articles of Merger, respectively. The time at which the Certificate of Merger is filed with the Delaware SOS and the Articles of Merger is filed with the Florida SOS shall be the "Effective Time" of the Merger. Howtek shall cause the Certificate of Merger and Articles of Merger to be so filed and recorded within one (1) business day after the Closing Date. (d) Except insofar as specifically otherwise provided by law, shall cease at the Effective Time, whereupon the separate existence of ISSI and Merger Sub shall become a single corporation. (e) The certificate of incorporation and by-laws of Merger Sub shall remain in effect and unaltered as the certificate of incorporation and by-laws of the Surviving Corporation. (f) At the Effective Time, Howtek shall (i) amend its certificate of incorporation to (1) change its name to ISSI, Inc. (if available, or as otherwise mutually agreed by the parties hereto), (2) increase the number of its authorized shares of Howtek Common Stock from 25,000,000 to 50,000,000 and (3) provide for a classified Board of Directors in accordance with the provisions of subparagraph (r) below and (ii) change its trading symbol to ICAD (if available, or as otherwise mutually agreed by the parties hereto). (g) At the Effective Time, without any action by the holder thereof, all of the issued and outstanding shares of common stock, $.01 par value ("ISSI Common Stock"), of ISSI (excluding the RH Shares, if issued) shall be deemed cancelled, and converted into Eight Million Four Hundred Thousand (8,400,000) shares of common stock, $.01 par value (the "Howtek Common Stock"), of Howtek on a pro rata basis. The ratio between the number of shares of ISSI Common Stock outstanding as of the Effective Time (excluding the RH Shares, if issued) and 8,400,000 shall be the "Exchange Ratio." In the event the RH Shares are issued in accordance with the provisions of Section 5.16 hereof, at the Effective Time, without any action by the holder thereof, all of the RH Shares shall be deemed cancelled, and converted into such number of shares of Howtek Common Stock as equals the product of 1,600,000 multiplied by the Exchange Ratio. The 8,400,000 shares of Howtek Common Stock to be issued to the ISSI stockholders in accordance with the first sentence of this Section 2.1(g) and the shares of Howtek Common Stock to be issued to in accordance with the preceding sentence, if any, shall hereinafter be collectively referred to as the "Merger Consideration." No shares of ISSI Common Stock shall be deemed to be outstanding or have any rights, other than the right to receive Merger Consideration as set forth in this Section 2.1(g) or the right to receive cash in lieu of fractional shares as set forth in Section 2.1(h) below, after the Effective Time. (h) Fractional shares of Howtek Common Stock shall not be issued and each holder of ISSI Common Stock who would otherwise be entitled to receive any such fractional 2 shares (taking into account all share amounts to which such holder is otherwise entitled hereunder) shall receive cash (without interest) in lieu thereof in an amount equal to the fraction of the share of Howtek Common Stock to which such holder would otherwise be entitled multiplied by the closing market price of the Howtek Common Stock on the last trading day preceding the Effective Time. No Person entitled to receive a fractional share of Howtek Common Stock will be entitled to dividends, voting rights or any other rights of a stockholder of Howtek with respect to such fractional share. Promptly after the determination of the aggregate amount of cash to be paid to holders of fractional shares, the Exchange Agent (as hereinafter defined) shall send by mail, postage prepaid, to each such holder a check payable to such holder for the amount of cash payable in lieu of such holder's fractional interests. (i) On the Effective Time, Howtek shall make available to Continental Stock Transfer & Trust Company, as exchange agent (the "Exchange Agent"), for the benefit of the holders of shares of ISSI Common Stock for exchange in accordance with this Section 2, through the Exchange Agent, certificates evidencing such number of shares of Howtek Common Stock issuable to holders of ISSI Common Stock in the Merger pursuant to Section 2.1(g) (such certificates for shares of Howtek Common Stock, together with any dividends or distributions with respect thereto and cash, being hereinafter referred to as the "Exchange Fund"). The Exchange Agent shall, pursuant to irrevocable instructions, deliver the Howtek Common Stock contemplated to be issued pursuant to Section 2.1(g) and the cash in lieu of fractional shares of Howtek Common Stock to which such holders are entitled to pursuant to Section 2.1(h) hereof out of the Exchange Fund. (j) As promptly as practicable after the Effective Time, Howtek shall cause the Exchange Agent to mail to each holder of a certificate or certificates which immediately prior to the Effective Time represented outstanding shares of ISSI Common Stock (the "Certificates") (i) a letter of transmittal (which shall be in customary form and shall specify that delivery shall be effected, and risk of loss and title to the Certificates shall pass, only upon proper delivery of the Certificates to the Exchange Agent) and (ii) instructions for use in effecting the surrender of the Certificates in exchange for certificates evidencing shares of Howtek Common Stock, or cash in lieu of fractional shares of Howtek Common Stock to which such holder is entitled pursuant to Section 2.1(h) hereof. Howtek shall cause such letters of transmittal to be delivered to the Principal Stockholders at the Effective Time. (k) Upon surrender to the Exchange Agent of a Certificate for cancellation, together with such letter of transmittal, duly executed and completed in accordance with the instructions thereto, and such other documents as may be reasonably required pursuant to such instructions, the holder of such Certificate shall be entitled to receive in exchange therefor a certificate representing that number of whole shares of Howtek Common Stock which such holder's shares of ISSI Common Stock have been converted into pursuant to this Section 2 (and any cash in lieu of any fractional shares of Howtek Common Stock to which such holder is entitled pursuant to Section 2.1(h) and any dividends or other distributions to which such holder is entitled), and the Certificate so surrendered shall forthwith be cancelled. In the event of a transfer of ownership of shares of ISSI Common Stock which is not registered in the transfer records of ISSI, shares of Howtek Common Stock and cash in lieu of any fractional shares of 3 Howtek Common Stock to which such holder is entitled pursuant to Section 2.1(h) may be issued to a transferee if the Certificate representing such shares of ISSI Common Stock is presented to the Exchange Agent, accompanied by all documents required to evidence and effect such transfer and by evidence that any applicable stock transfer taxes have been paid. Until surrendered as contemplated by this Section 2.1(k), each Certificate shall be deemed at all times after the Effective Time to represent only the right to receive upon such surrender the number of whole shares of Howtek Common Stock into which the shares of ISSI Common Stock formerly represented thereby have been converted and cash in lieu of any fractional shares of Howtek Common Stock to which such holder is entitled pursuant to Section 2.1(g). (l) Any portion of the Exchange Fund (including any shares of Howtek Common Stock) which remains undistributed to the holders of ISSI Common Stock for six months after the Effective Time shall be delivered to Howtek, upon demand, and any holders of ISSI Common Stock who have not theretofore complied with this Section 2 shall thereafter look only to Howtek for the Merger Consideration and/or any cash in lieu of shares of Howtek Common Stock to which they are entitled. Any portion of the Exchange Fund remaining unclaimed by holders of shares of ISSI Common Stock as of a date which is immediately prior to such time as such amounts would otherwise escheat to or become property of any government entity shall, to the extent permitted by applicable law, become the property of Howtek free and clear of any claims or interest of any person previously entitled thereto. (m) None of the Exchange Agent, Howtek nor the Surviving Corporation shall be liable to any holder of shares of ISSI Common Stock for any such shares of Howtek Common Stock or cash delivered to a public official pursuant to any abandoned property, escheat or similar law. (n) If any Certificate shall have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the person claiming such Certificate to be lost, stolen or destroyed and, if required by Howtek, the posting by such person of a bond, in such reasonable amount as Howtek may direct, as indemnity against any claim that may be made against it with respect to such Certificate, Howtek will issue in exchange for such lost, stolen or destroyed Certificate the Merger Consideration, any cash in lieu of fractional shares of Howtek Common Stock to which the holders thereof are entitled pursuant to Section 2.1(g) and any dividends or other distributions to which the holders thereof are entitled pursuant to this Agreement. 4 (o) Each outstanding and unexpired option or warrant to purchase shares of ISSI Common Stock (each, an "Option" and, collectively, the "Options"), shall be assumed by Howtek and converted into an option to acquire, on the same terms and conditions, (including, without limitation, adjustments for any stock dividend, subdivision, reclassification, recapitalization, split, combination, exchange of shares or similar transaction), as were applicable under such stock option or other plan, if applicable, pursuant to which such Option was issued the number of shares of Howtek Common Stock equal to the number of Options multiplied by the Exchange Ratio. The exercise price per share issuable upon exercise of each such Option shall be equal to the quotient of (a) the exercise price of the option being converted divided by (b) the Exchange Ratio, which quotient shall then be rounded down to the nearest cent. (p) Notwithstanding anything in this Agreement to the contrary, shares of ISSI Common Stock which are issued and outstanding immediately prior to the Effective Time and which are held by ISSI stockholders who have exercised the right to dissent from the Merger provided under the Florida Business Corporation Act ("Florida Act") and, as of the Effective Time, have neither effectively withdrawn nor lost their rights to payment under the Florida Act, shall not be converted into or be exchangeable for the right to receive Merger Consideration, unless and until such holder shall have failed to exercise or shall have effectively withdrawn or lost such holder's right to dissent from the Merger provided under the Florida Act. If such holder shall have so failed to exercise or shall have effectively withdrawn or lost such right, such holder's shares of ISSI Common Stock shall thereupon be deemed to have been converted into and to have become exchangeable for, at the Effective Time, the right to receive the Merger Consideration provided for in this Agreement, without any interest thereon. (q) Prior to the Closing, ISSI shall give Howtek (i) notice of any written objections to the Merger made by any ISSI shareholder and any demand for the payment of the fair value of the shares owned by such shareholder pursuant to Section 607.1320 of the Florida Act, any withdrawals of such demands, and any other instruments served pursuant to such Section of the Florida Act and received by ISSI and (ii) the opportunity to participate in (and, from and after the Effective Time, direct) all negotiations and proceedings with respect to any such objections and demands for payment under the Florida Act. ISSI shall not, except with the prior written consent of Howtek or as otherwise required by applicable law, make any payment with respect to any such objections and demands for payment or agree to settle any such demands. 5 (r) At the Effective Time, the Board of Directors of the Surviving Corporation shall consist of nine (9) directors, subject to applicable Nasdaq governance rules, as follows: (a) three (3) directors whose terms expire at the first annual election of directors subsequent to Effective Time, which directors shall be Kevin Woods, Greg Stepic, and one designee of Howtek, who shall qualify as an outside director and whom ISSI shall approve; (b) three (3) directors whose terms expire at the second annual election of directors subsequent to Effective Time, which directors shall be Maha Sallam, Jim Harlan and one designee of Howtek, who shall qualify as an outside director and whom ISSI shall approve; and (c) three (3) directors whose terms expire at the third annual election of directors subsequent to the Effective Time, which directors shall include W. Kip Speyer, W. Scott Parr and Robert Howard. (s) At the Effective Time, the senior executive officers of the Surviving Corporation shall be as follows: W. Kip Speyer - Chairman of the Board and Chief Executive Officer; and W. Scott Parr - President and Chief Operating Officer. (t) The Convertible Promissory Notes of ISSI dated November 7, 2001 in the principal amounts of $45,045 and $11,110 issued to Michael T. Nelson and Jananne F. Nelson, respectively (each, a "Note"; collectively, the "Notes"), shall be assumed by Howtek and converted into convertible promissory notes convertible into, on the same terms and conditions (including, without limitation, adjustments for any stock dividend, subdivision, reclassification, recapitalization, split, combination, exchange of shares or similar transaction) as were applicable under the Notes, such number of shares of Howtek Common Stock equal to the number of shares of ISSI Common Stock that the holder of such Note would have been entitled to receive upon conversion of the Note multiplied by the Exchange Ratio. The conversion price per share issuable upon conversion of each such Note shall be equal to the quotient of (a) the conversion price of the Note being converted divided by (b) the Exchange Ratio, which quotient shall then be rounded down to the nearest cent. 2.2 Closing. The closing (the "Closing") of the transactions contemplated by this Agreement shall take place at 10:00 a.m. EST on the second business day following the satisfaction or waiver of all conditions to the obligations of the parties hereto to consummate the transactions contemplated by this Agreement (the "Closing Date"), at the offices of Blank Rome LLP, The Chrysler Building, 405 Lexington Avenue, New York, New York 10174, unless another time, date or place is agreed to in writing by the parties hereto. SECTION 3 REPRESENTATIONS AND WARRANTIES OF ISSI ISSI and, to the best of their knowledge, each of the Principal Stockholders, severally and not jointly, represents and warrants to the Howtek Parties as of the date hereof and as of the Closing Date (except for representations and warranties that speak as of a specific date or time, in which case, such representations and warranties shall be true and complete as of such date or time) as follows: 3.1 Organization of ISSI. ISSI is a corporation duly organized, validly existing, and in good standing under the laws of the State of Florida. ISSI has the requisite corporate power and 6 authority to own, lease, and operate its properties, to carry on its business where such properties are now owned, leased, or operated and such business is now conducted. ISSI is qualified to do business as a foreign corporation in the jurisdictions in which the failure to so qualify would have a Material Adverse Effect. Except as set forth on Schedule 3.1, ISSI is not a participant in any joint venture or partnership with any other Person with respect to any part of its operation of its business. 3.2 Authorization, Validity and Effect of Agreements. ISSI has the requisite corporate power and authority to execute and deliver this Agreement and all agreements and documents contemplated hereby. The consummation by ISSI of the transactions contemplated hereby has been duly authorized by all requisite corporate action except that approval by the stockholders of ISSI is required to consummate the Merger. This Agreement constitutes, and all agreements and documents contemplated hereby (when executed and duly delivered pursuant hereto) will constitute, the valid and legally binding obligations of ISSI, enforceable in accordance with their respective terms, subject to applicable bankruptcy, insolvency, moratorium or other similar laws relating to creditors' rights and general principles of equity. 3.3 Books and Records. The minute books, stock record books, and other records of ISSI all have been made available to Howtek, and have not been revoked, amended or otherwise modified. ISSI's stock record books are complete and correct in all respects. No minutes or resolutions of the Board of Directors and/or stockholders of ISSI relating to any actions which may have a Material Adverse Effect on ISSI have been omitted from the minute books and other records of ISSI. At the Closing, all of those books and records shall be in the possession of ISSI. 3.4 Absence of Conflicting Agreements. Except as set forth on Schedule 3.4, as to ISSI, the execution and delivery of this Agreement and the consummation of the transactions contemplated by this Agreement (with or without the giving of notice, the lapse of time, or both): (a) does not require the consent of any third party; (b) will not conflict with any provision of ISSI's Articles of Incorporation, By-Laws, or other organizational documents of ISSI; (c) will not conflict with, result in a breach of, or constitute a default under any applicable Order, Legal Requirement, or ruling of any court or Governmental Body to which ISSI is subject; (d) will not conflict with, constitute grounds for termination of, result in a breach of, constitute a default under, or accelerate or permit the acceleration of any performance required by the terms of, any agreement, instrument, license, or permit to which ISSI is a party or by which ISSI or its assets may be bound; and (e) will not create any claim, liability, mortgage, lien, pledge, condition, charge, or encumbrance of any nature whatsoever upon any of the assets of ISSI or any of ISSI Common Stock. Except for the filing of the Certificate of Merger and Articles of Merger, no filing or consent with any Governmental Body or any other third party is required of ISSI to consummate this Agreement or the transactions contemplated hereby. 3.5 Governmental Authorizations. Schedule 3.5 contains a complete and accurate list of each Governmental Authorization that is held by ISSI or that otherwise relates to the business of, or to any of the assets owned or used by, ISSI. ISSI has made available to Howtek true and complete copies of all such Governmental Authorizations. Each Governmental Authorization listed or required to be listed in Schedule 3.5 is valid and in full force and effect. No event has occurred or circumstance exists that may (with or without notice or lapse of time) (i) constitute or result 7 directly or indirectly in a violation of or a failure to comply with any term or requirement of any Governmental Authorization listed or required to be listed in Schedule 3.5, or (ii) result directly or indirectly in the revocation, withdrawal, suspension, cancellation, or termination of, or any modification to, any Governmental Authorization listed or required to be listed in Schedule 3.5. The Governmental Authorizations listed in Schedule 3.5 collectively constitute all of the Governmental Authorizations necessary to permit ISSI and its employees to lawfully conduct and operate ISSI's business in the manner it currently conducts and operates such business and to permit ISSI to own and use its assets in the manner in which it currently owns and uses such assets. 3.6 Real Property. Schedule 3.6 contains a complete description of all Real Property Interests (including street address, owner, and ISSI's use thereof). The Real Property Interests listed on Schedule 3.6 comprise all interests in real property necessary to conduct ISSI's business and operations as now conducted. Each leasehold or subleasehold interest on Schedule 3.6 is legal, valid, binding, enforceable, and in full force and effect. ISSI is not, and to ISSI's Knowledge, no other party thereto is, in default, violation, or breach under any lease or sublease, and no event has occurred and is continuing that constitutes (with notice or passage of time or both) a default, violation, or breach thereunder. Except as set forth on Schedule 3.6, ISSI has not received any notice of a default, offset, or counterclaim under any lease or sublease with respect to any of the Real Property Interests. As of the date hereof, ISSI enjoys peaceful and undisturbed possession of the leased Real Property Interests; and so long as ISSI fulfills its obligations under the lease(s) therefor, ISSI has enforceable rights to non-disturbance and quiet enjoyment against its lessor or sub-lessor; and, except as set forth in Schedule 3.6, no third party holds any interest in the leased premises with the right to foreclose upon ISSI's leasehold or subleasehold interest. ISSI has legal and practical access to all of the Leased Real Property. All Leased Real Property (including the improvements thereon): (a) is in good condition and repair consistent with its current use; (b) is available for immediate use in the conduct of ISSI's business and operations; and (c) complies in all respects with all applicable building or zoning codes and the regulations of any Governmental Body having jurisdiction, except to the extent that the current use by ISSI, while permitted, constitutes or would constitute a "nonconforming use" under current zoning or land use regulations. To ISSI's Knowledge, no eminent domain or condemnation proceedings are pending or threatened with respect to any Real Property Interests. 3.7 Tangible Personal Property. Except as described in Schedule 3.7, ISSI owns and has good title to each item of Tangible Personal Property necessary to conduct ISSI's business and operations as now conducted, and none of the Tangible Personal Property owned by ISSI is subject to any security interest, mortgage, pledge, conditional sales agreement, or other lien or encumbrance, except for Permitted Encumbrances. With allowance for normal repairs, maintenance, wear, and obsolescence, each item of Tangible Personal Property is in good operating condition and repair and is available for immediate use in ISSI's business and operations. 3.8 Contracts. Schedule 3.8 lists all material written Contracts and true and complete descriptions of all material oral Contracts (including any amendments and other modifications to such Contracts). All of the Contracts are in full force and effect and are valid, binding, and enforceable in accordance with their terms except as the enforceability of such Contracts may be affected by bankruptcy, insolvency, or similar laws affecting creditors' rights generally and by 8 judicial discretion in the enforcement of equitable remedies. ISSI is not, and, to ISSI's knowledge, no other party thereto is, in material default, violation, or breach in any respect under any Contract, and, no event has occurred and is continuing that constitutes (with notice or passage of time or both) a default, violation, or breach in any respect thereunder. Other than in the Ordinary Course of Business, to ISSI's Knowledge, no party to any Contract has any intention (a) to terminate such Contract or amend the terms thereof; (b) to refuse to renew the Contract upon expiration of its term; or (c) to renew the Contract upon expiration only on terms and conditions that are more onerous than those now existing. Except as set forth in Schedule 3.8 or as may occur in the Ordinary Course of Business: (a) ISSI has not assigned or otherwise transferred to any Person, or granted any option with respect to, any of its rights, obligations or liabilities under any Contract that relates to the business of, or any of the assets owned or used by ISSI; and (b) no officer, director, agent, employee, consultant, or contractor of ISSI is bound by any Contract that purports to limit the ability of such officer, director, agent, employee, consultant, or contractor to (i) engage in or continue any conduct, activity, or practice relating to the business of ISSI, or (ii) assign to ISSI or to any other Person any rights to any invention, improvement, or discovery. 3.9 Intangibles. Schedule 3.9 is a true and complete list of all Intangibles that are required to conduct ISSI's business and operations as now conducted, all of which are valid and in good standing and uncontested. ISSI has provided or made available to Howtek copies of all documents establishing or evidencing the Intangibles listed on Schedule 3.9. Each of Maha Sallam and Kevin Woods are familiar with those software technologies, patent applications and licenses in or related to the so called "Mammoreader" computer aided detection application (the "Technology") and with those applications for Letters Patent in the Unites States set forth in Schedule 3.9 and assigned to ISSI (the "Applications"). ISSI is the sole owner of, or has the exclusive license to (subject only to valid licenses disclosed on Schedule 3.9 and without payment of royalties, fees or otherwise) all right, title and interest in the Intangibles, including, without limitation, the Technology. The Applications are pending and awaiting action in the United State's Patent Office. The Intangibles, including, without limitation, the Technology, do not infringe upon any copyright, patent, patent applications know-how, methods processes or other intellectual property of any other Person. Except as set forth on Schedule 3.9, ISSI has not received any notice or demand alleging that ISSI is infringing upon or otherwise acting adversely to any trademarks, service marks, trade names, service names, copyrights, patents, patent applications, know-how, methods processes or other intellectual property of any other Person, and there is no claim, proceeding or action pending or threatened with respect thereto. To ISSI's Knowledge, no Person is infringing upon ISSI's rights or ownership interest in the Intangibles. ISSI is not improperly using any confidential information or trade secrets of any of its past or present employees. 3.10 Title to Properties. Except as disclosed in Schedule 3.6 or 3.7, ISSI has good and marketable title to its assets and properties, and its assets and properties are not subject to mortgages, pledges, liens, security interests, encumbrances, or other charges or rights of others of any kind or nature except for Permitted Encumbrances. 3.11 Financial Statements. ISSI has delivered to Howtek the following financial statements (the "Financial Statements") with respect to ISSI: (a) the financial statements, including the balance sheet, statement of income, changes in stockholder's equity and cash flow statements 9 from March 27, 1996 through the period ending December 31, 2000 as audited by Grant Thornton, independent public accountants, (b) the unaudited balance sheet, statement of income, changes in stockholders' equity and cash flow statements for the period ending December 31, 2001. Each of the foregoing Financial Statements (including, in all cases, the notes thereto, if any) (i) is accurate and complete in all respects, (ii) fairly presents in all respects the financial condition and results of operations of ISSI, and (iii) have been prepared in accordance with GAAP applied on a consistent basis throughout the period covered thereby. No financial statements of any Person other than ISSI are required by GAAP to be included in the financial statements of ISSI in order to present a true financial picture of ISSI, including, without limitation, off-balance sheet transactions. Except as set forth in Schedule 3.11, ISSI has no liabilities or obligations of any nature (whether known or unknown and whether absolute, accrued, contingent, or otherwise, including, without limitation, any capital commitments) except for liabilities or obligations reflected or reserved against in the Financial Statements and liabilities incurred in the Ordinary Course of Business since the dates thereof. 3.12 Tax Matters. (a) Except as set forth on Schedule 3.12(a) hereto: (i) All Tax Returns required to be filed by ISSI have been filed when due in a timely fashion and all such Tax Returns are true, correct and complete in all respects. (ii) ISSI has paid in full on a timely basis all Taxes owed by it that were payable on or prior to the date hereof, whether or not shown on any Tax Return. (iii) The amount of ISSI's liability for unpaid Taxes did not, as of December 31, 2001, exceed the amount of the current liability accruals for such Taxes (excluding reserves for deferred Taxes) reflected on the Financial Statements. (iv) ISSI has withheld and paid over to the proper Governmental Bodies all Taxes required to have been withheld and paid over (and complied in all respects with all information reporting and backup withholding requirements, including maintenance of required records with respect thereto) in connection with amounts paid to any employee, independent contractor, creditor, or other third party. (v) ISSI has received no notice of any Tax Proceeding currently pending with respect to it and ISSI has not received notice from any Tax Authority that it intends to commence a Tax Proceeding. (vi) No waiver or extension by ISSI of any statute of limitations is currently in effect with respect to the assessment, collection, or payment of Taxes of ISSI or for which ISSI is liable. 10 (vii) ISSI has not requested any extension of the time within which to file any Tax Return of ISSI that is currently in effect. (viii) There are no liens on the assets of ISSI relating or attributable to Taxes (except liens for Taxes not yet due). (ix) ISSI is not and has not been at any time during the preceding five years a "United States real property holding corporation" within the meaning of Section 897(c)(2) of the Code. (x) ISSI has not entered into an agreement or consent made under Section 341(f) of the Code. (xi) ISSI has not agreed to, nor is it required to, make any adjustments under Section 481(a) of the Code as a result of a change in accounting methods. (xii) ISSI is not and has not at any time been a party to a tax sharing, tax indemnity or tax allocation agreement, and ISSI has not assumed the Tax Liability of any other Person under any Contract. (xiii) ISSI is not and has not at any time been a member of an affiliated group filing a consolidated federal income tax return and does not have any liability for the Taxes of another entity or person under Section 1.1502-6 of the Treasury Regulations (or any similar provision of state, local or foreign law), as a transferee or successor, or otherwise. (xiv) ISSI is not a party to any joint venture, partnership or other arrangement that is treated as a partnership for U.S. federal income tax purposes. (xv) None of ISSI's assets are treated as "tax exempt use property" within the meaning of Section 168(h) of the Code. (xvi) ISSI has not made an election under Section 1362 of the Code to be treated as an "S" Corporation and is not currently treated as an "S" Corporation for federal income tax purposes. (b) ISSI has furnished or otherwise made available to Howtek correct and complete copies of (i) all income, franchise and other Tax Returns filed by ISSI since March 27, 1996; and (ii) all examination reports, statements of deficiencies and closing agreements received by ISSI relating to Taxes. (c) Schedule 3.12(c) contains complete and accurate statements of (i) ISSI's basis in its assets as of December 31, 2001, (ii) the amount of any net operating loss, net capital loss and any other Tax carryovers of ISSI (including losses and other carryovers subject to any limitations), and (iii) Tax elections made by ISSI as of December 31, 2001. Except as stated in Schedule 3.12(c), ISSI has no net operating losses or other Tax attributes presently subject to limitation under Code Sections 382, 383 or 384, or the federal consolidated return regulations. 11 3.13 Insurance. ISSI maintains insurance coverage with reputable insurers in such amounts and covering such risks as are in accordance with normal industry practice for companies engaged in businesses similar to that of ISSI (taking into account the cost and availability of such insurance). Schedule 3.13 sets forth a complete listing of all insurance maintained by ISSI (indicating form of coverage, name of carrier and broker, coverage limits and premium, whether occurrence or claims made, expiration dates, deductibles and all endorsements). 3.14 Personnel and Employee Benefits. (a) Employees and Compensation. Schedule 3.14 contains a true and complete list of all employees employed by ISSI as of the date hereof. Schedule 3.14 also contains a true and complete list of all employee benefit plans or arrangements covering the officers and employees employed by ISSI, including, with respect to the employees any: (i) "Employee welfare benefit plan," as defined in Section 3(1) of ERISA, that is maintained or administered by ISSI or to which ISSI contributes or is required to contribute (an "ISSI Welfare Plan"); (ii) "Multiemployer pension plan," as defined in Section 3(37) of ERISA, that is maintained or administered by ISSI or to which ISSI contributes or is required to contribute (an "ISSI Multiemployer Plan" and, together with the ISSI Welfare Plans, the "ISSI Benefit Plans"); (iii) "Employee pension benefit plan," as defined in Section 3(2) of ERISA (other than an ISSI Multiemployer Plan), to which ISSI contributes or is required to contribute (an "ISSI Pension Plan"); (iv) Employee plan that is maintained in connection with any trust described in Section 501(c)(9) of the Code; and (v) Employment, severance, or other similar contract, arrangement, or policy and each plan or arrangement (written or oral) providing for insurance coverage (including any self-insured arrangements), workers' compensation, disability benefits, supplemental unemployment benefits, vacation benefits, or retirement benefits or arrangement for deferred compensation, profit-sharing, bonuses, stock options, stock appreciation rights, stock purchases, or other forms of incentive compensation or post-retirement insurance, compensation, or benefits that (A) is not an ISSI Welfare Plan, ISSI Pension Plan, or ISSI Multiemployer Plan, and (B) is entered into, maintained, contributed to, or required to be contributed to by ISSI or under which ISSI has any liability relating to employees (collectively, "ISSI Benefit Arrangements"). 12 (b) Pension Plans. ISSI does not sponsor, maintain, or contribute to any ISSI Pension Plan other than any ISSI Pension Plan listed on Schedule 3.14. Each ISSI Pension Plan complies currently and has been maintained in substantial compliance with its terms and, both as to form and in operation, with all requirements prescribed by any and all statutes, orders, rules and regulations that are applicable to such plans, including ERISA and the Code. (c) Welfare Plans. Each ISSI Welfare Plan complies currently and has been maintained in substantial compliance with its terms and, both as to form and in operation, with all requirements prescribed by any and all statutes, orders, rules and regulations that are applicable to such plans, including ERISA and the Code. ISSI does not sponsor, maintain, or contribute to any ISSI Welfare Plan that provides health or death benefits to former employees of ISSI other than as required by Section 4980B of the Code or other applicable laws. (d) Benefit Arrangements. Each ISSI Benefit Arrangement has been maintained in substantial compliance with its terms and with the requirements prescribed by all statutes, orders, rules and regulations that are applicable to such ISSI Benefit Arrangement. ISSI has no written contract prohibiting the termination of any employee. (e) Multiemployer Plans. Except as disclosed in Schedule 3.14, ISSI has not at any time been a participant in any ISSI Multiemployer Plan. (f) Delivery of Copies of Relevant Documents and Other Information. ISSI has delivered or made available to Howtek true and complete copies of each of the following documents: (i) Each ISSI Welfare Plan and ISSI Pension Plan (and, if applicable, related trust agreements) and all amendments thereto, and written descriptions thereof that have been distributed to Employees, all annuity contracts or other funding instruments; and (ii) Each ISSI Benefit Arrangement and written descriptions thereof that have been distributed to Employees and complete descriptions of any ISSI Benefit Arrangement that is not in writing. 13 (g) Labor Relations. Except as set forth in Schedule 3.14(g), ISSI is not a party to or subject to any collective bargaining agreement or written or, to ISSI's Knowledge, oral employment agreement with any employee. Except as set forth in Schedule 3.14(g), with respect to the employees, ISSI has complied in all respects with all laws, rules and regulations relating to the employment of labor, including those related to wages, hours, collective bargaining, occupational safety, discrimination, and the payment of social security and other payroll related taxes, and has not received any notice alleging that ISSI has failed to comply with any such laws, rules, or regulations. No proceedings are pending or threatened between ISSI and any employee (singly or collectively). No labor union or other collective bargaining unit represents or claims to represent any of the employees. Except as set forth in Schedule 3.14, there is no union campaign being conducted to solicit cards from any employees to authorize a union to represent any of the employees of ISSI or to request a National Labor Relations Board certification election with respect to any employees. 3.15 Legal Actions and Orders. (a) There is no claim, legal action, counterclaim, suit, arbitration, or other legal or administrative proceeding, or Tax Proceeding pending threatened, against ISSI or relating to the assets or used by ISSI, or the business, or operations of ISSI, nor does ISSI know of any basis for the same. (b) Except as set forth in Schedule 3.15: (i) there is no Order to which ISSI or the assets owned or used by ISSI, or to which ISSI's business or operations, is subject; and (ii) no officer, director, agent, or employee of ISSI is subject to any Order that prohibits such officer, director, agent, or employee from engaging in or continuing any conduct, activity, or practice relating to the business of ISSI. (c) (i) ISSI is, and at all times has been, in compliance with all of the terms and requirements of each Order to which it, or any of the assets owned or used by it, or its business or operations, is or has been subject; (ii) no event has occurred or circumstance exists that may constitute or result in (with or without notice or lapse of time) a violation of or failure to comply with any term or requirement of any Order to which ISSI, or any of the assets owned or used by ISSI, or its business or operations, is subject; and (iii) ISSI has not received any notice or other communication (whether oral or written) from any Governmental Body or any other Person regarding any actual, alleged, possible, or potential violation of, or failure to comply with, any term or requirement of any Order to which ISSI, or any of the assets owned or used by ISSI, or its business or operations, is or has been subject. 14 3.16 Environmental Compliance. (a) Except as disclosed on Schedule 3.16: (i) none of the Tangible Personal Property, none of the Real Property and none of the Real Property Interests contain (x) any asbestos, polychlorinated biphenyls or any PCB contaminated oil; (y) any Contaminants; or (z) any underground storage tanks; (ii) no underground storage tank disclosed on Schedule 3.16 has leaked and has not been remediated or leaks and such tank is in substantial compliance with all applicable Environmental Laws; and (iii) to ISSI's Knowledge, all of the Leased Real Property Interests are in full compliance with all applicable Environmental Laws. (b) ISSI has obtained all Governmental Authorizations that are required under all Environmental Laws. 3.17 Compliance with Legal Requirements. Except as set forth in Schedule 3.17: (a) ISSI is, and at all times has been, in full compliance with each Legal Requirement that is or was applicable to it or to the conduct or operation of its business or the ownership or use of any of its assets; (b) No event has occurred or circumstance exists that (with or without notice or lapse of time) (A) may constitute or result in a violation by ISSI of, or a failure on the part of ISSI to comply with, any Legal Requirement, or (B) may give rise to any obligation on the part of ISSI to undertake, or to bear all or any portion of the cost of, any remedial action of any nature; and (c) ISSI has not received any notice or other communication (whether oral or written) from any Governmental Body or any other Person regarding (A) any actual, alleged, possible, or potential violation of, or failure to comply with, any Legal Requirement, or (B) any actual, alleged, possible, or potential obligation on the part of ISSI to undertake, or to bear all or any portion of the cost of, any remedial action of any nature. 3.18 Conduct of Business in Ordinary Course. Since December 31, 2001 and through the date hereof, there has not been any Material Adverse Effect involving ISSI. Without limiting the generality of the foregoing, since that date, ISSI has not: (a) made any material increase in compensation payable or to become payable to any of its employees outside the Ordinary Course of Business; (b) made any sale, assignment, lease, or other transfer of assets other than in the Ordinary Course of Business with suitable replacements being obtained therefor; (c) canceled any material debts owed to or claims held by ISSI outside the Ordinary Course of Business; (d) made any material changes in ISSI's accounting practices; 15 (e) suffered any material write-down of the value of any assets or any material write-off as uncollectable of any of its accounts receivable; (f) transferred or granted any right under, or entered into any settlement regarding the breach or infringement of, any license, patent, copyright, trademark, trade name, franchise, or similar right, or modified any existing right; (g) imposed any security interest upon any of its assets, tangible or intangible; (h) made any material capital expenditures; (i) made any material capital investment in or any material loan to any other Person outside the Ordinary Course of Business; (j) created, incurred, assumed, or guaranteed more than Ten Thousand Dollars ($10,000.00) in aggregate indebtedness for borrowed money in capitalized lease obligations; (k) made any or authorized any change to ISSI's Articles of Incorporation or Bylaws; (l) declared, set aside, or paid any dividend or made any distribution with respect to its capital stock (whether in cash or in kind) or redeemed, purchased, or otherwise acquired any of its capital stock; (m) experienced any material damage, destruction, or loss (whether or not covered by insurance) to its property; (n) made any loan to, or entered into any other transaction with, any of its directors, officers, and employees outside the Ordinary Course of Business; (o) granted any material increase in the base compensation of or made any other change of employment terms for any of its directors or officers; (p) granted any increase in the base compensation of or made any other change of employment terms for any of its employees outside the Ordinary Course of Business; (q) made or changed any material Tax election or taken any other action with respect to Taxes not in the Ordinary Course of Business and consistent with past practices; or (r) committed to do any of the foregoing. 3.19 Insolvency Proceedings. ISSI is not and its assets and properties are not the subject of any pending or threatened insolvency proceedings of any character, including, without limitation, bankruptcy, receivership, reorganization, or composition with creditors, voluntary or involuntary. ISSI has not made an assignment for the benefit of creditors or taken any action in contemplation of or which would constitute a valid basis for the institution of any such insolvency proceedings. 16 3.20 Capitalization. The authorized capital stock of ISSI consists of 100,000,000 shares of ISSI Common Stock. All of the issued and outstanding shares of ISSI Common Stock and their ownership are as described on Schedule 3.20. All of the outstanding shares of ISSI Common Stock have been validly issued and are fully paid and nonassessable and are held of record by the ISSI stockholders as set forth Schedule 3.20 hereto. Except as described on Schedule 3.20, (a) no shares of ISSI Common Stock are held in treasury; (b) there are no other issued or outstanding equity securities of ISSI or other securities of ISSI convertible or exchangeable at any time into equity securities of ISSI; (c) there are no outstanding stock appreciation rights, phantom stock rights, profit participation rights, or other similar rights with respect to any capital stock of ISSI; and (d) ISSI is not subject to any commitment or obligation that would require the issuance or sale of additional shares of capital stock of ISSI at any time under options, subscriptions, warrants, rights, or other obligations. Other than as set forth on Schedule 3.20, ISSI does not have any subsidiaries and does not have any equity interest in any corporation, partnership, limited liability company, joint venture, or other entity. 3.21 Relationships with Related Persons. No Related Person of ISSI has, or since the first day of the next to last completed fiscal year of ISSI has had, any interest in any property (whether real, personal, or mixed and whether tangible or intangible), used in or pertaining to ISSI's business. Except as set forth in Schedule 3.21, no Related Person of ISSI is, or since the first day of the next to last completed fiscal year of ISSI has owned (of record or as a beneficial owner) an equity interest or any other financial or profit interest in, a Person that has (i) had business dealings or a financial interest in any transaction with ISSI other than business dealings or transactions conducted in the Ordinary Course of Business with ISSI at substantially prevailing market prices and on substantially prevailing market terms, or (ii) engaged in competition with ISSI with respect to any line of the products or services of ISSI (an "ISSI Competing Business") in any market presently served by ISSI except for less than one percent of the outstanding capital stock of any ISSI Competing Business that is publicly traded on any recognized exchange or in the over-the-counter market. Except as set forth in Schedule 3.21, no Related Person of ISSI is a party to any Contract with, or has any claim or right against, ISSI. 3.22 Accounts; Lockboxes; Safe Deposit Boxes. Schedule 3.22 contains a true and complete list of (i) the names of each bank, savings and loan association, securities or commodities broker or other financial institution in which ISSI has an account, including cash contribution accounts, and the names of all persons authorized to draw thereon or have access thereto and (ii) the location of all lockboxes and safe deposit boxes of ISSI and the names of all persons authorized to draw thereon or have access thereto. At the Effective Time, ISSI shall not have any such account, lockbox or safe deposit box other than those listed in Schedule 3.22, nor shall any additional person have been authorized, from the date of this Agreement, to draw thereon or have access thereto. The stockholders of ISSI and their Affiliates have not commingled monies or accounts of ISSI with other monies or accounts of such stockholders and their Affiliates or relating to their other businesses nor have such stockholders or their Affiliates transferred monies or accounts of ISSI other than to an account of ISSI. At the Effective Time, all monies and accounts of ISSI shall be held by, and be accessible only to, ISSI. 17 3.23 Brokers or Finders. Neither ISSI, the Principal Stockholders nor any other ISSI stockholders, nor any director, officer, agent or employee thereof, has employed any broker or finder or has incurred or will incur any broker's, finder's or similar fees, commissions or expenses, in each case in connection with the transactions contemplated by this Agreement. 3.24 Disclosure. No representation or warranty of ISSI in this Agreement and no statement in the Schedules omit to state a material fact necessary to make the statements herein or therein, in light of the circumstances in which they were made, not misleading. 3.25 Due Diligence. Except as provided in Schedule 3.25, ISSI has provided to Howtek or Blank Rome LLP, counsel to Howtek, all Agreements, certificates, correspondence and other items, documents and information requested pursuant to the Corporate Review Memorandum dated January 25, 2002 of Blank Rome LLP. 3.26 FDA Qualification and Approvals: ISSI (i) is in compliance with the provisions of all laws relating to the regulation of ISSI's products, including the Federal Food, Drug, and Cosmetic Act (the "FDC Act") and all state laws comparable to the FDC Act, the rules and regulations promulgated thereunder and all rules and regulations promulgated by the Food and Drug Administration ("FDA") and all comparable state regulatory authorities; (ii) has all authorizations, approvals, consents, orders, registrations, licenses or permits of any court or the FDA and all comparable state and foreign regulatory authorities which are necessary or required for it to conduct its business as now conducted; and (iii) has had no material liabilities, debts, obligations or claims asserted against it, whether accrued, absolute, contingent or otherwise, and whether due or to become due, on account of such regulatory matters. All applications, submissions, information, claims and statistics and other data and conclusions derived therefrom, utilized as the basis for or submitted in connection with any and all requests for such authorizations, approvals, consents, orders, registrations, licenses or permits are accurate, complete, correct and true as of the date of submission and that any necessary or required updates, changes, corrections or modification to such applications, submissions, information and data have been submitted to the appropriate regulatory body. All experiments, human or otherwise, performed in connection with or as the basis for any regulatory approval required for ISSI's products have been performed in accordance with appropriate research and study design, and all required protocols and consents and any conclusions derived therefrom are scientifically supported. The claims approved by the FDA for ISSI's so called "MammoReader" product are valid and supported by proper research design, testing, analysis and disclosure." SECTION 4 REPRESENTATIONS AND WARRANTIES OF THE HOWTEK PARTIES The Howtek Parties, jointly and severally, represent and warrant to ISSI as of the date hereof and as of the Closing Date (except for representations and warranties that speak as of a 18 specific date or time, in which case, such representations and warranties shall be true and complete as of such date or time) as follows: 4.1 Organization of Howtek and Merger Sub. Each of Howtek and Merger Sub is a corporation duly organized, validly existing, and in good standing under the laws of the State of Delaware. Each of Howtek and Merger Sub has the requisite corporate power and authority to own, lease, and operate its properties, to carry on its business where such properties are now owned, leased, or operated and such business is now conducted. Each of Howtek and Merger Sub is qualified to do business as a foreign corporation in the jurisdictions in which the failure to so qualify would have a Material Adverse Effect. Neither Howtek nor Merger Sub is a participant in any joint venture or partnership with any other Person with respect to any part of its operations of its business. 4.2 Authorization, Validity and Effect of Agreements. Howtek and Merger Sub have the requisite corporate power and authority to execute and deliver this Agreement and all agreements and documents contemplated hereby. The consummation by Howtek and Merger Sub of the transactions contemplated hereby has been duly authorized by all requisite corporate action. This Agreement constitutes, and all agreements and documents contemplated hereby (when executed and duly delivered pursuant hereto) will constitute, the valid and legally binding obligations of Howtek and Merger Sub, enforceable in accordance with their respective terms, subject to applicable bankruptcy, insolvency, moratorium or other similar laws relating to creditors' rights and general principles of equity. 4.3 Absence of Conflicting Agreements. As to Howtek and Merger Sub, the execution and delivery of this Agreement and the consummation of the transactions contemplated by this Agreement (with or without the giving of notice, the lapse of time, or both): (a) do not require the consent of any third party; (b) will not conflict with any provision of the Certificate of Incorporation, By-Laws, or other organizational documents of Howtek or Merger Sub; (c) will not conflict with, result in a breach of, or constitute a default under any applicable Order, Legal Requirement, or ruling of any court or Governmental Body to which Howtek or Merger Sub is subject; (d) will not conflict with, constitute grounds for termination of, result in a breach of, constitute a default under, or accelerate or permit the acceleration of any performance required by the terms of, any material agreement, instrument, license, or permit to which Howtek is a party or by which Merger Sub or its assets may be bound; and (e) will not create any claim, liability, mortgage, lien, pledge, condition, charge, or encumbrance of any nature whatsoever upon any of the assets of Howtek or Merger Sub or any of the Howtek Common Stock. Except for the filing of the Certificate of Merger and Articles of Merger, no filing with any Governmental Body or any other third party is required to consummate this Agreement or the transactions contemplated hereby. 4.4 Capitalization. The authorized capital stock of Howtek consists of 1,000,000 shares of Preferred Stock, of which 9,550 shares are outstanding, and 25,000,000 shares of Howtek Common Stock, of which 15,173,957 shares were outstanding as December 31, 2001. All of the outstanding shares of such Preferred Stock and Howtek Common Stock have been 19 validly issued and are fully paid and nonassessable . All of the outstanding shares of Howtek Common Stock have been validly issued and are fully paid and nonassessable. Except as described on Schedule 4.4, (a) no shares of Howtek Common Stock are held in treasury; (b) there are no other issued or outstanding equity securities of Howtek or other securities of Howtek convertible or exchangeable at any time into equity securities of Howtek; (c) there are no outstanding stock appreciation rights, phantom stock rights, profit participation rights, or other similar rights with respect to any capital stock of Howtek; and (d) Howtek is not subject to any commitment or obligation that would require the issuance or sale of additional shares of capital stock of Howtek at any time under options, subscriptions, warrants, rights, or other obligations. Other than as set forth on Schedule 4.4, Howtek does not have any subsidiaries and does not have any equity interest in any corporation, partnership, limited liability company, joint venture, or other entity. 4.3 SEC Filings. (i) As of the date hereof, Howtek has filed all forms, reports and documents required to be filed by Howtek with the SEC (collectively, the "Howtek SEC Reports"). The Howtek SEC Reports (a) at the time filed, complied in all material respects with the applicable requirements of the Securities Act and the Securities Exchange Act of 1934, as amended, as the case may be, and (b) did not at the time they were filed (or if amended or superseded by a subsequent filing, then on the date of such filing), to Howtek's Knowledge, contain any untrue statement of a material fact or omit to state a material fact required to be stated in such Howtek SEC Reports or necessary in order to make the statements in such Howtek SEC Reports, in the light of the circumstances under which they were made, not misleading. To the Knowledge of the Howtek Parties, there is no material adverse information not contained in the Howtek SEC Reports with respect to Howtek which a reasonable investor would consider material in making an investment decision in a similar situation. (ii) Except as set forth on Schedule 4.5(ii), each of the consolidated financial statements (including, in each case, any related notes) contained in the Howtek SEC Reports during the last three fiscal years (the "Howtek Financial Statements"), complied as to form in all material respects with the applicable published rules and regulations of the SEC with respect thereto, was prepared in accordance with GAAP applied on a consistent basis throughout the periods involved (except as may be indicated in the notes to such financial statements or, in the case of unaudited statements, as permitted by Form 10-Q or 8-K promulgated by the SEC), and fairly presented the consolidated financial position of Howtek as at the respective dates and the consolidated results of its operations and cash flows for the periods indicated, except that the unaudited interim financial statements were or are subject to normal and recurring year-end adjustments which were not or are not expected to be material in amount. 4.6 Governmental Authorizations. Schedule 4.6 contains a complete and accurate list of each Governmental Authorization that is held by Howtek or that otherwise relates to the business of, or to any of the assets owned or used by, Howtek. Howtek has made available to Howtek true and complete copies of all such Governmental Authorizations. Each Governmental Authorization listed or required to be listed in Schedule 4.6 is valid and in full force and effect. No event has occurred or circumstance exists that may (with or without notice or lapse of time) (i) constitute or result directly or indirectly in a violation of or a failure to comply with any term or requirement of 20 any Governmental Authorization listed or required to be listed in Schedule 4.6, or (ii) result directly or indirectly in the revocation, withdrawal, suspension, cancellation, or termination of, or any modification to, any Governmental Authorization listed or required to be listed in Schedule 4.6. The Governmental Authorizations listed in Schedule 4.6 collectively constitute all of the Governmental Authorizations necessary to permit Howtek and its employees to lawfully conduct and operate Howtek's business in the manner it currently conducts and operates such business and to permit Howtek to own and use its assets in the manner in which it currently owns and uses such assets. 4.7 Tax Matters. (a) Except as set forth on Schedule 4.7 hereto: (i) All Tax Returns required to be filed by Howtek have been filed when due in a timely fashion and all such Tax Returns are true, correct and complete in all respects. (ii) Howtek has paid in full on a timely basis all Taxes owed by it that were payable on or prior to the date hereof, whether or not shown on any Tax Return. (iii) The amount of Howtek's liability for unpaid Taxes did not, as of December 31, 2001, exceed the amount of the current liability accruals for such Taxes (excluding reserves for deferred Taxes) reflected on the Financial Statements. (iv) Howtek has withheld and paid over to the proper Governmental Bodies all Taxes required to have been withheld and paid over (and complied in all respects with all information reporting and backup withholding requirements, including maintenance of required records with respect thereto) in connection with amounts paid to any employee, independent contractor, creditor, or other third party. (v) Howtek has received no notice of any Tax Proceeding currently pending with respect to it and Howtek has not received notice from any Tax Authority that it intends to commence a Tax Proceeding. (vi) No waiver or extension by Howtek of any statute of limitations is currently in effect with respect to the assessment, collection, or payment of Taxes of Howtek or for which Howtek is liable. (vii) Howtek has not requested any extension of the time within which to file any Tax Return of Howtek that is currently in effect. (viii) There are no liens on the assets of Howtek relating or attributable to Taxes (except liens for Taxes not yet due). 21 (ix) Howtek is not and has not been at any time during the preceding five years a "United States real property holding corporation" within the meaning of Section 897(c)(2) of the Code. (x) Howtek has not entered into an agreement or consent made under Section 341(f) of the Code. (xi) Howtek has not agreed to, nor is it required to, make any adjustments under Section 481(a) of the Code as a result of a change in accounting methods. (xii) Howtek is not and has not at any time been a party to a tax sharing, tax indemnity or tax allocation agreement, and ISSI has not assumed the Tax Liability of any other Person under any Contract. (xiii) Howtek is not and has not at any time been a member of an affiliated group filing a consolidated federal income tax return and does not have any liability for the Taxes of another entity or person under Section 1.1502-6 of the Treasury Regulations (or any similar provision of state, local or foreign law), as a transferee or successor, or otherwise. (xiv) Howtek is not a party to any joint venture, partnership or other arrangement that is treated as a partnership for U.S. federal income tax purposes. (xv) None of Howtek's assets are treated as "tax exempt use property" within the meaning of Section 168(h) of the Code. (xvi) Howtek has not made an election under Section 1362 of the Code to be treated as an "S" Corporation and is not currently treated as an "S" Corporation for federal income tax purposes. (b) Howtek has furnished or otherwise made available to ISSI correct and complete copies of (i) all income, franchise and other Tax Returns filed by Howtek during Howtek's last three fiscal years; and (ii) all examination reports, statements of deficiencies and closing agreements received by Howtek relating to Taxes. (c) Schedule 4.7(c) contains complete and accurate statements of (i) Howtek's basis in its assets as of December 31, 2001, (ii) the amount of any net operating loss, net capital loss and any other Tax carryovers of Howtek (including losses and other carryovers subject to any limitations), and (iii) Tax elections made by Howtek as of December 31, 2001. Except as stated in Schedule 4.7(c), Howtek has no net operating losses or other Tax attributes presently subject to limitation under Code Sections 382, 383 or 384, or the federal consolidated return regulations. 4.8 Insurance. Howtek maintains insurance coverage with reputable insurers in such amounts and covering such risks as are in accordance with normal industry practice for companies engaged in businesses similar to that of Howtek (taking into account the cost and availability of such insurance). Schedule 4.8 sets forth a complete listing of all insurance maintained by Howtek 22 (indicating form of coverage, name of carrier and broker, coverage limits and premium, whether occurrence or claims made, expiration dates, deductibles and all endorsements). 4.9 Conduct of Business in Ordinary Course. Since December 31, 2001 and through the date hereof, there has not been any Material Adverse Effect involving Howtek and its subsidiaries. Without limiting the generality of the foregoing, except as set forth on Schedule 4.9, since that date, Howtek has not: (a) made any material increase in compensation payable or to become payable to any of its employees outside the Ordinary Course of Business; (b) made any sale, assignment, lease, or other transfer of assets other than in the Ordinary Course of Business with suitable replacements being obtained therefor; (c) canceled any material debts owed to or claims held by Howtek outside the Ordinary Course of Business; (d) made any material changes in Howtek's accounting practices; (e) suffered any material write-down of the value of any assets or any material write-off as uncollectable of any of its accounts receivable; (f) transferred or granted any right under, or entered into any settlement regarding the breach or infringement of, any license, patent, copyright, trademark, trade name, franchise, or similar right, or modified any existing right; (g) imposed any security interest upon any of its assets, tangible or intangible; (h) made any material capital expenditures; (i) made any material capital investment in or any material loan to any other Person outside the Ordinary Course of Business; (j) created, incurred, assumed, or guaranteed more than Ten Thousand Dollars ($10,000.00) in aggregate indebtedness for borrowed money in capitalized lease obligations; (k) made any or authorized any change to Howtek's Certificate of Incorporation or Bylaws; (l) issued, sold, or otherwise disposed of any of its capital stock, or granted any options, warrants, or other rights to purchase or obtain (including upon conversion, exchange, or exercise) any of its capital stock; (m) declared, set aside, or paid any dividend or made any distribution with respect to its capital stock (whether in cash or in kind) or redeemed, purchased, or otherwise acquired any of its capital stock; 23 (n) experienced any material damage, destruction, or loss (whether or not covered by insurance) to its property; (o) made any loan to, or entered into any other transaction with, any of its directors, officers, and employees outside the Ordinary Course of Business; (p) granted any material increase in the base compensation of or made any other change of employment terms for any of its directors or officers; (q) granted any increase in the base compensation of or made any other change of employment terms for any of its employees outside the Ordinary Course of Business; (r) made or changed any material Tax election or taken any other action with respect to Taxes not in the Ordinary Course of Business and consistent with past practices; or (s) committed to do any of the foregoing. 4.10 Real Property. Except as set forth on Schedule 4.10, the Howtek SEC Reports contain a complete description of all Real Property Interests (including street address, owner, and Howtek's use thereof), which Real Property Interests comprise all interests in real property necessary to conduct Howtek's business and operations as now conducted. Each leasehold or subleasehold interest set forth in the Howtek SEC Reports or on Schedule 4.10 is legal, valid, binding, enforceable, and in full force and effect. ISSI is not, and to Howtek's Knowledge, no other party thereto is, in default, violation, or breach under any lease or sublease, and no event has occurred and is continuing that constitutes (with notice or passage of time or both) a default, violation, or breach thereunder. Except as set forth in the Howtek SEC Reports or on Schedule 4.10, Howtek has not received any notice of a default, offset, or counterclaim under any lease or sublease with respect to any of the Real Property Interests. As of the date hereof, Howtek enjoys peaceful and undisturbed possession of the leased Real Property Interests; and so long as Howtek fulfills its obligations under the lease(s) therefor, Howtek has enforceable rights to non-disturbance and quiet enjoyment against its lessor or sub-lessor; and, except as set forth in the Howtek SEC Reports or on Schedule 4.10, no third party holds any interest in the leased premises with the right to foreclose upon Howtek's leasehold or subleasehold interest. Howtek has legal and practical access to all of the Leased Real Property. All Leased Real Property (including the improvements thereon): (a) is in good condition and repair consistent with its current use; (b) is available for immediate use in the conduct of Howtek's business and operations; and (c) complies in all respects with all applicable building or zoning codes and the regulations of any Governmental Body having jurisdiction, except to the extent that the current use by Howtek, while permitted, constitutes or would constitute a "nonconforming use" under current zoning or land use regulations. To Howtek's Knowledge, no eminent domain or condemnation proceedings are pending or threatened with respect to any Real Property Interests. 4.11 Contracts. Except as set forth on Schedule 4.11, the Howtek SEC Reports list all material written Contracts and true and complete descriptions of all material oral Contracts (including any amendments and other modifications to such Contracts), and such Contracts are in 24 full force and effect and are valid, binding, and enforceable in accordance with their terms except as the enforceability of such Contracts may be affected by bankruptcy, insolvency, or similar laws affecting creditors' rights generally and by judicial discretion in the enforcement of equitable remedies. Howtek is not, and, to Howtek's Knowledge, no other party thereto is, in material default, violation, or breach in any respect under any Contract, and, no event has occurred and is continuing that constitutes (with notice or passage of time or both) a default, violation, or breach in any respect thereunder. Other than in the Ordinary Course of Business, to Howtek's Knowledge, no party to any Contract has any intention (a) to terminate such Contract or amend the terms thereof; (b) to refuse to renew the Contract upon expiration of its term; or (c) to renew the Contract upon expiration only on terms and conditions that are more onerous than those now existing. Except as set forth in the Howtek SEC Reports or on Schedule 4.11 or as may occur in the Ordinary Course of Business: (a) Howtek has not assigned or otherwise transferred to any Person, or granted any option with respect to, any of its rights, obligations or liabilities under any Contract that relates to the business of, or any of the assets owned or used by Howtek; and (b) no officer, director, agent, employee, consultant, or contractor of Howtek is bound by any Contract that purports to limit the ability of such officer, director, agent, employee, consultant, or contractor to (i) engage in or continue any conduct, activity, or practice relating to the business of Howtek, or (ii) assign to Howtek or to any other Person any rights to any invention, improvement, or discovery. 4.12 Intangibles. Schedule 4.12 is a true and complete list of all material Intangibles that are required to conduct Howtek's business and operations as now conducted, all of which are valid and in good standing and uncontested. Howtek has provided or made available to ISSI copies of all documents establishing or evidencing the Intangibles listed on Schedule 4.12. Howtek owns or has a valid license to use all of the Intangibles listed on Schedule 4.12. Except as set forth in the Howtek SEC Reports or on Schedule 4.12, Howtek has not received any notice or demand alleging that Howtek is infringing upon or otherwise acting adversely to any trademarks, service marks, trade names, service names, copyrights, patents, patent applications, know-how, methods processes or other intellectual property of any other Person, and there is no claim, proceeding or action pending or threatened with respect thereto. To Howtek's Knowledge, no Person is infringing upon Howtek's rights or ownership interest in the Intangibles. 4.13 Title to Properties. Except as disclosed in the Howtek SEC Reports, Schedule 4.10 or Schedule 4.13, Howtek has good and marketable title to its assets and properties, and its assets and properties are not subject to mortgages, pledges, liens, security interests, encumbrances, or other charges or rights of others of any kind or nature except for Permitted Encumbrances. 4.14 Personnel and Employee Benefits. (a) Employees and Compensation. Schedule 4.14 contains a true and complete list of all employees employed by Howtek as of the date hereof. Schedule 4.14 also contains a true and complete list of all employee benefit plans or arrangements covering the officers and employees employed by Howtek, including, with respect to the employees any: 25 (i) "Employee welfare benefit plan," as defined in Section 3(1) of ERISA, that is maintained or administered by Howtek or to which Howtek contributes or is required to contribute (a "Howtek Welfare Plan"); (ii) "Multiemployer pension plan," as defined in Section 3(37) of ERISA, that is maintained or administered by ISSI or to which ISSI contributes or is required to contribute (a "Howtek Multiemployer Plan" and, together with the Howtek Welfare Plans, the "Howtek Benefit Plans"); (iii) "Employee pension benefit plan," as defined in Section 3(2) of ERISA (other than a Howtek Multiemployer Plan), to which ISSI contributes or is required to contribute (a "Howtek Pension Plan"); (iv) Employee plan that is maintained in connection with any trust described in Section 501(c)(9) of the Code; and (v) Employment, severance, or other similar contract, arrangement, or policy and each plan or arrangement (written or oral) providing for insurance coverage (including any self-insured arrangements), workers' compensation, disability benefits, supplemental unemployment benefits, vacation benefits, or retirement benefits or arrangement for deferred compensation, profit-sharing, bonuses, stock options, stock appreciation rights, stock purchases, or other forms of incentive compensation or post-retirement insurance, compensation, or benefits that (A) is not a Howtek Welfare Plan, Howtek Pension Plan, or Howtek Multiemployer Plan, and (B) is entered into, maintained, contributed to, or required to be contributed to by Howtek or under which Howtek has any liability relating to employees (collectively, "Howtek Benefit Arrangements"). (b) Pension Plans. Howtek does not sponsor, maintain, or contribute to any Howtek Pension Plan other than any Howtek Pension Plan listed on Schedule 4.14. Each Howtek Pension Plan complies currently and has been maintained in substantial compliance with its terms and, both as to form and in operation, with all requirements prescribed by any and all statutes, orders, rules and regulations that are applicable to such plans, including ERISA and the Code. (c) Welfare Plans. Each Howtek Welfare Plan complies currently and has been maintained in substantial compliance with its terms and, both as to form and in operation, with all requirements prescribed by any and all statutes, orders, rules and regulations that are applicable to such plans, including ERISA and the Code. Howtek does not sponsor, maintain, or contribute to any Howtek Welfare Plan that provides health or death benefits to former employees of Howtek other than as required by Section 4980B of the Code or other applicable laws. (d) Benefit Arrangements. Each Howtek Benefit Arrangement has been maintained in substantial compliance with its terms and with the requirements prescribed by all statutes, 26 orders, rules and regulations that are applicable to such Howtek Benefit Arrangement. Howtek has no written contract prohibiting the termination of any employee. (e) Multiemployer Plans. Except as disclosed in the Howtek SEC Reports or in Schedule 4.14, Howtek has not at any time been a participant in any Howtek Multiemployer Plan. (f) Delivery of Copies of Relevant Documents and Other Information. Howtek has delivered or made available to ISSI true and complete copies of each of the following documents: (i) Each Howtek Welfare Plan and Howtek Pension Plan (and, if applicable, related trust agreements) and all amendments thereto, and written descriptions thereof that have been distributed to Employees, all annuity contracts or other funding instruments; and (ii) Each Howtek Benefit Arrangement and written descriptions thereof that have been distributed to Employees and complete descriptions of any Howtek Benefit Arrangement that is not in writing. (g) Labor Relations. Except as set forth in the Howtek SEC Reports or in Schedule 4.14(g), Howtek is not a party to or subject to any collective bargaining agreement or written or, to Howtek's Knowledge, oral employment agreement with any employee. Except as set forth in the Howtek SEC Reports or in Schedule 4.14(g), with respect to the employees, Howtek has complied in all respects with all laws, rules and regulations relating to the employment of labor, including those related to wages, hours, collective bargaining, occupational safety, discrimination, and the payment of social security and other payroll related taxes, and has not received any notice alleging that Howtek has failed to comply with any such laws, rules, or regulations. No proceedings are pending or threatened between ISSI and any employee (singly or collectively). No labor union or other collective bargaining unit represents or claims to represent any of the employees. Except as set forth in Schedule 4.14, there is no union campaign being conducted to solicit cards from any employees to authorize a union to represent any of the employees of Howtek or to request a National Labor Relations Board certification election with respect to any employees. 4.15 Legal Actions and Orders. (a) Except as set forth in the Howtek SEC Reports or on Schedule 4.15, there is no claim, legal action, counterclaim, suit, arbitration, or other legal or administrative proceeding, or Tax Proceeding pending, or to Howtek's Knowledge, threatened, against Howtek or relating to the assets or used by Howtek, or the business, or operations of Howtek, nor does Howtek know of any basis for the same. (b) Except as set forth in the Howtek SEC Reports or on Schedule 4.15: (i) there is no Order to which Howtek or the assets owned or used by Howtek, or to which Howtek's business or operations, is subject; 27 (ii) no officer, director, agent, or employee of Howtek is subject to any Order that prohibits such officer, director, agent, or employee from engaging in or continuing any conduct, activity, or practice relating to the business of Howtek; (iii) Howtek is, and at all times has been, in compliance with all of the terms and requirements of each Order to which it, or any of the assets owned or used by it, or its business or operations, is or has been subject; (iv) no event has occurred or circumstance exists that may constitute or result in (with or without notice or lapse of time) a violation of or failure to comply with any term or requirement of any Order to which Howtek, or any of the assets owned or used by Howtek, or its business or operations, is subject; and (v) Howtek has not received any notice or other communication (whether oral or written) from any Governmental Body or any other Person regarding any actual, alleged, possible, or potential violation of, or failure to comply with, any term or requirement of any Order to which Howtek, or any of the assets owned or used by Howtek, or its business or operations, is or has been subject. 4.16 Environmental Compliance. (a) Except as disclosed in the Howtek SEC Reports or on Schedule 4.16: (i) none of the Tangible Personal Property, none of the Real Property and none of the Real Property Interests contain (x) any asbestos, polychlorinated biphenyls or any PCB contaminated oil; (y) any Contaminants; or (z) any underground storage tanks; (ii) no underground storage tank disclosed on Schedule 4.16 has leaked and has not been remediated or leaks and such tank is in substantial compliance with all applicable Environmental Laws; and (iii) to Howtek's Knowledge, all of the Leased Real Property Interests are in full compliance with all applicable Environmental Laws. (b) Except as disclosed in the Howtek SEC Reports or on Schedule 4.16, Howtek has obtained all Governmental Authorizations that are required under all Environmental Laws. 4.17 Compliance with Legal Requirements. Except as set forth in the Howtek SEC Reports or on Schedule 3.17: (a) Howtek is, and at all times has been, in full compliance with each Legal Requirement that is or was applicable to it or to the conduct or operation of its business or the ownership or use of any of its assets; 28 (b) No event has occurred or circumstance exists that (with or without notice or lapse of time) (A) may constitute or result in a violation by Howtek of, or a failure on the part of Howtek to comply with, any Legal Requirement, or (B) may give rise to any obligation on the part of Howtek to undertake, or to bear all or any portion of the cost of, any remedial action of any nature; and (c) Howtek has not received any notice or other communication (whether oral or written) from any Governmental Body or any other Person regarding (A) any actual, alleged, possible, or potential violation of, or failure to comply with, any Legal Requirement, or (B) any actual, alleged, possible, or potential obligation on the part of Howtek to undertake, or to bear all or any portion of the cost of, any remedial action of any nature. 4.18 Relationships with Related Persons. Except as set forth in the Howtek SEC Reports or on Schedule 4.18, (i) no Related Person of Howtek has, or since the first day of the next to last completed fiscal year of Howtek has had, any interest in any property (whether real, personal, or mixed and whether tangible or intangible), used in or pertaining to Howtek's business; (ii) no Related Person of Howtek is, or since the first day of the next to last completed fiscal year of Howtek has owned (of record or as a beneficial owner) an equity interest or any other financial or profit interest in, a Person that has (1) had business dealings or a financial interest in any transaction with Howtek other than business dealings or transactions conducted in the Ordinary Course of Business with Howtek at substantially prevailing market prices and on substantially prevailing market terms, or (2) engaged in competition with Howtek with respect to any line of the products or services of Howtek (a "Howtek Competing Business") in any market presently served by Howtek except for less than one percent of the outstanding capital stock of any Howtek Competing Business that is publicly traded on any recognized exchange or in the over-the-counter market. Except as set forth in the Howtek SEC Reports or in Schedule 4.18, no Related Person of Howtek is a party to any Contract with, or has any claim or right against, Howtek. 4.19 Brokers or Finders. Neither Howtek nor Merger Sub, nor any director, officer, agent or employee thereof, has employed any broker or finder or has incurred or will incur any broker's, finder's or similar fees, commissions or expenses, in each case in connection with the transactions contemplated by this Agreement. 4.20 Disclosure. No representation or warranty of Howtek or Merger Sub in this Agreement and no statement in the Schedules omit to state a material fact necessary to make the statements herein or therein, in light of the circumstances in which they were made, not misleading. SECTION 5 COVENANTS 5.1 Conduct of Howtek's Business Prior to Closing. Except as otherwise contemplated by this Agreement or as disclosed in Schedule 5.1, from the date hereof through the earlier of the termination of this Agreement or the Effective Time, Howtek shall conduct its business in the Ordinary Course of Business. Without limiting the generality of the foregoing, except as set forth 29 in Schedule 5.1 or as contemplated by this Agreement or as consented to by Howtek, during the period set forth in the preceding sentence, Howtek shall act as follows: (i) Howtek shall not adopt any change in any method of accounting or accounting practice, except as contemplated or required by GAAP; (ii) Howtek shall not amend its Certificate of Incorporation or Bylaws; (iii) except for the disposition of obsolete equipment in the Ordinary Course of Business, Howtek shall not sell, mortgage, pledge, or otherwise dispose of any assets or properties owned, leased, or used in the operation of its business; (iv) Howtek shall not merge or consolidate with, or agree to merge or consolidate with, or purchase or agree to purchase all or substantially all of the assets of, or otherwise acquire, any other business entity; (v) Howtek shall not authorize for issuance, issue, or sell any additional shares of its capital stock or issue any securities or obligations convertible or exchangeable into shares of its capital stock or issue or grant any option, warrant, or other right to purchase any shares of its capital stock; provided, however, that Howtek may issue and sell up to such number of shares of Howtek Common Stock as equals five percent (5%) of the number of shares of Howtek Common Stock outstanding as of the date hereof. (vi) Howtek shall not incur, or agree to incur, any debt for borrowed money; (vii) Howtek shall not change its historic practices concerning the payment of accounts payable; (viii) except in the Ordinary Course of Business, Howtek shall not take any action, or fail to take action, to cause its liabilities to increase; (ix) Howtek shall not declare, issue, or otherwise approve the payment of dividends of any kind in respect of the capital stock of Howtek or redeem, purchase, or acquire any of its capital stock; (x) Howtek shall maintain the existing insurance policies on the assets of its business or other policies providing substantially similar coverages; (xi) except in the Ordinary Course of Business or except as otherwise contemplated by this Agreement, Howtek will not permit any increases in the compensation of any of its employees except as required by law or existing contract or agreement or enter into or amend any Howtek Benefit Plan or Howtek Benefit Arrangement; (xii) except in the Ordinary Course of Business, Howtek shall not enter into or renew, extend or terminate, or waive any Contract, or incur any obligation that will be binding on Howtek after Closing; 30 (xiii) Howtek shall not enter into any transactions with any Affiliate that will be binding upon Howtek following the Closing Date; (xiv) Howtek shall maintain its assets or replacements thereof in good operating condition and adequate repair, normal wear and tear excepted; (xv) Howtek shall not make or change any Tax election, amend any Tax Return, or take or omit to take any other action not in the Ordinary Course of Business that would have the effect of increasing any Taxes of Howtek; (xvi) Howtek shall file all Tax Returns when due; and (xvii) Howtek shall preserve its business and assets and keep available its present employees and preserve present relationships with its customers, employees, and others having business relations with it. 5.2 Conduct of ISSI's Business Prior to Closing. Except as otherwise contemplated by this Agreement, from the date hereof through the earlier of the termination of this Agreement or the Effective Time, ISSI shall conduct its business in the Ordinary Course of Business. Without limiting the generality of the foregoing, except as contemplated by this Agreement or as consented to by Howtek, during the period set forth in the preceding sentence, ISSI shall act as follows: (i) ISSI shall not adopt any change in any method of accounting or accounting practice, except as contemplated or required by GAAP; (ii) ISSI shall not amend its Articles of Incorporation or Bylaws; (iii) except for the disposition of obsolete equipment in the Ordinary Course of Business, ISSI shall not sell, mortgage, pledge, or otherwise dispose of any assets or properties owned, leased, or used in the operation of its business; (iv) ISSI shall not merge or consolidate with, or agree to merge or consolidate with, or purchase or agree to purchase all or substantially all of the assets of, or otherwise acquire, any other business entity; (v) ISSI shall not authorize for issuance, issue, or sell any additional shares of its capital stock or issue any securities or obligations convertible or exchangeable into shares of its capital stock or issue or grant any option, warrant, or other right to purchase any shares of its capital stock; provided, however, that ISSI may issue and sell up to such number of shares of ISSI Common Stock as equals five percent (5%) of the number of shares of ISSI Common Stock outstanding as of the date hereof. (vi) ISSI shall not incur, or agree to incur, any debt for borrowed money; (vii) ISSI shall not change its historic practices concerning the payment of accounts payable; 31 (viii) except in the Ordinary Course of Business, ISSI shall not take any action, or fail to take action, to cause its liabilities to increase; (ix) ISSI shall not declare, issue, or otherwise approve the payment of dividends of any kind in respect of the capital stock of ISSI or redeem, purchase, or acquire any of its capital stock; (x) ISSI shall maintain the existing insurance policies on the assets of its business or other policies providing substantially similar coverages; (xi) except in the Ordinary Course of Business or except as otherwise contemplated by this Agreement, ISSI will not permit any increases in the compensation of any of its employees except as required by law or existing contract or agreement or enter into or amend any ISSI Benefit Plan or ISSI Benefit Arrangement; (xii) except in the Ordinary Course of Business, ISSI shall not enter into or renew, extend or terminate, or waive any Contract, or incur any obligation that will be binding on ISSI after Closing, other than a new lease for office space in the Clearwater, Florida area; (xiii) ISSI shall not enter into any transactions with any Affiliate that will be binding upon ISSI following the Closing Date; (xiv) ISSI shall maintain its assets or replacements thereof in good operating condition and adequate repair, normal wear and tear excepted; (xv) ISSI shall not make or change any Tax election, amend any Tax Return, or take or omit to take any other action not in the Ordinary Course of Business that would have the effect of increasing any Taxes of ISSI; (xvi) ISSI shall file all Tax Returns when due; and (xvii) ISSI shall preserve its business and assets and keep available its present employees and preserve present relationships with its customers, employees, and others having business relations with it. 5.3 Access to ISSI Information. (a) Subject to the prior execution of an appropriate confidentiality agreement by Howtek, in a form reasonably acceptable to ISSI, from and after the date of this Agreement until the Closing Date, ISSI shall (a) give the Howtek Parties and the Howtek Parties' employees, accountants and counsel full and complete access upon reasonable notice during normal business hours, to all officers, employees, offices, properties, agreements, records and affairs of ISSI; (b) provide the Howtek Parties with all financial information of ISSI that is distributed to the officers and directors of ISSI, including, but not limited to, the monthly internal financial statements prepared by ISSI promptly upon distribution of such information to the officers and directors of ISSI (all of the foregoing financial information, collectively, the 32 "Additional ISSI Financials Statements"); and (c) provide copies of such information concerning ISSI as the Howtek Parties may reasonably request. (b) Subject to the prior execution of an appropriate confidentiality agreement by ISSI, in a form reasonably acceptable to Howtek, from and after the date of this Agreement until the Closing Date, Howtek shall (a) give ISSI and ISSI's employees, accountants and counsel full and complete access upon reasonable notice during normal business hours, to all officers, employees, offices, properties, agreements, records and affairs of Howtek; (b) provide ISSI with all financial information of Howtek that is distributed to the officers and directors of Howtek, including, but not limited to, the monthly internal financial statements prepared by Howtek promptly upon distribution of such information to the officers and directors of Howtek; and (c) provide copies of such information concerning Howtek as ISSI may reasonably request. 5.4 Directors and Officers Insurance. The Surviving Corporation shall obtain directors' and officers' insurance on or prior to the Closing Date with coverage reasonably satisfactory to the parties hereto. 5.5 Employment Agreements. Contemporaneously with the execution of this Agreement, Howtek shall enter into employment agreements with W. Kip Speyer and W. Scott Parr in the form of Exhibits 5.5 (a) and (b), respectively (collectively, the "Employment Agreements"). 5.6 Florida Business Corporation Act. ISSI shall take all action, to the extent necessary in accordance with applicable law, its Articles of Incorporation and By-laws, to (a) convene a special meeting of its stockholders, as soon as reasonably practicable in order that such stockholders may consider and vote on the adoption of this Agreement and the approval of the Merger in accordance with the Florida Act, or (b) cause a written consent to be executed by holders of a majority of the outstanding ISSI Common Stock to adopt this Agreement and approve the Merger in accordance with the Florida Act. 5.7 Delaware General Corporation Law. Howtek shall take all action, to the extent necessary in accordance with applicable law, its certificate of incorporation and by-laws, to convene a special meeting of the Howtek stockholders (the "Howtek Special Meeting"), as soon as reasonably practicable in order that the Howtek stockholders may consider and vote on the adoption of this Agreement and the approval of the Merger in accordance with the Delaware General Corporation Law ("Delaware Law"). 5.8 Securities Act. (a) With respect to the Merger Consideration to be issued in connection with the Merger, Howtek shall promptly prepare and file with the SEC a registration statement on Form S-4 (the "Registration Statement") under the Securities Act, which Registration Statement shall comply as to form in all material respects with the provisions of the Securities Act and the rules and regulations promulgated thereunder, and shall not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; 33 provided, however, that Howtek makes no and shall not make any representation, warranty or covenant with respect to any information furnished to it by ISSI, the Principal Stockholders or any of their accountants, counsel or authorized representatives specifically for inclusion in the Registration Statement. ISSI represents and covenants that it can deliver and it shall cause to be delivered to Parent at the earliest possible time any financial statements that may be required to be filed with the Registration Statement together with a letter from ISSI's independent certified public accountant that such financial statements comply with the requirements of Regulation S-X (17 CFR Part 210). ISSI and the Principal Stockholders, jointly and severally, hereby indemnify and hold harmless Howtek (and its directors, officers, employees, financial advisors, stockholders, agents and representatives) against any losses, claims, damages or liabilities to which any of such Persons may become subject based on any untrue statement of any material fact contained in the Registration Statement, or the omission or alleged omission therefrom of a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, but only to the extent that such untrue statement or alleged untrue statement or omission or alleged omission was made in the Registration Statement in reliance on and in conformity with information furnished to Howtek by ISSI, the Principal Stockholders or any of their accountants, counsel or authorized representatives specifically for use therein. (b) Within ninety (90) days after the Effective Time, Howtek shall prepare and file with the SEC a registration statement on Form S-8 to register the shares of Howtek Common Stock issuable upon exercise of the Options and the Executive Options. 5.9 Notice of Developments. Each Party shall give prompt written notice to the other Party of any material adverse development causing a breach of any of its own representations and warranties in Section 3, and Section 4 above. No disclosure by any Party pursuant to this Section 5.9, however, shall be deemed to amend or supplement the Disclosure Schedule or to prevent or cure any misrepresentation, breach of warranty or breach of covenant. 5.10 Exclusivity. (a) ISSI shall, and shall cause its subsidiaries and any of their respective Affiliates to, immediately cease and terminate any existing solicitation, initiation, encouragement, activity, discussion or negotiation with any Persons conducted heretofore by ISSI, its subsidiaries or any of their respective Affiliates, officers, directors, employees, financial advisors, stockholders, agents or representatives (each a "Representative") with respect to any proposed, potential or contemplated Acquisition Proposal. (b) Howtek shall, and shall cause its subsidiaries and any of their respective Affiliates to, immediately cease and terminate any existing solicitation, initiation, encouragement, activity, discussion or negotiation with any Persons conducted heretofore by Howtek, its subsidiaries or any of their respective Representatives with respect to any proposed, potential or contemplated Acquisition Proposal. 34 (c) From and after the date hereof, without the prior written consent of the other party hereto (Howtek, with respect to the Howtek Parties, and ISSI with respect to ISSI and the Principal Stockholders), neither ISSI nor the Howtek Parties shall authorize or permit any of its subsidiaries, and shall cause any and all of its Representatives not to, directly or indirectly, (A) solicit, initiate or encourage any inquiries or proposals that constitute, or could reasonably be expected to lead to, an Acquisition Proposal, or (B) engage in negotiations or discussions with any Third Party concerning, or provide any nonpublic information to any person or entity relating to, an Acquisition Proposal, or (C) enter into any letter of intent, agreement in principle or any acquisition agreement or other similar agreement with respect to any Acquisition Proposal. (d) Notwithstanding anything contained in this Agreement to the contrary, nothing contained in this Section 5.10 shall prevent (i) ISSI or Howtek (as the case may be, the "Target"), from furnishing non-public information to, or entering into discussions or negotiations with, any Third Party in connection with an unsolicited, bona fide written proposal for an Acquisition Proposal by such Third Party, if and only to the extent that (1) such Third Party has made a written proposal to the Board of Directors of the Target to consummate an Acquisition Proposal, (2) the Board of Directors of the Target determines in good faith, based on the advice of a financial advisor of nationally recognized reputation, that such Acquisition Proposal is reasonably capable of being completed on substantially the terms proposed, and would, if consummated, result in a transaction that would provide greater value to the Target's stockholders than the transaction contemplated by this Agreement, (3) the failure to take such action would, in the reasonable good faith judgment of the Board of Directors of the Target, based on a written opinion of Target's outside legal counsel, be a violation of its fiduciary duties to the Target's stockholders under applicable law, and (4) prior to furnishing such non-public information to, or entering into discussions or negotiations with, such Person, the Target receives from such Person an executed confidentiality agreement with material terms no less favorable to the Target than those contained in the confidentiality agreements entered into in accordance with the provisions of Section 5.3 hereof and provides prior notice to the other parties hereto of its decision to take such action or (ii) Howtek or its Representatives from entering into any discussions or negotiations, and/or consummating any transaction, with respect to the divestiture of Howtek's graphic arts and/or photographic business . (e) Neither ISSI nor the Howtek Parties shall release any Third Party from, or waive any provision of, any standstill agreement to which it is a party or any confidentiality agreement between it and another Person who has made, or who may reasonably be considered likely to make, an Acquisition Proposal. Without limiting the foregoing, it is understood that any violation of the restrictions set forth in the preceding sentence by (i) any Representative of ISSI or any of its subsidiaries shall be deemed to be a breach of this Section 5.10 by ISSI and (ii) any Representative of Howtek or any of its subsidiaries shall be deemed to be a breach of this Section 5.10 by Howtek. 5.11 Voting Agreement. Contemporaneously with the execution of this Agreement, Howtek and the Principal Stockholders shall enter into a voting agreement in the form of Exhibit 5.11 annexed hereto (the "Voting Agreement"). 35 5.12 Howtek Board of Directors. The Howtek Board of Directors shall use commercially reasonable efforts to secure the requisite vote of the Howtek stockholders to approve the Merger at the Howtek Special Meeting; provided, however, that the Howtek Board of Directors may withdraw its approval or recommendation of the Merger to the Howtek stockholders in the event that the Howtek Board of Directors, in its good faith judgment based on a written opinion of its outside counsel, determines that failure to withdraw its approval or recommendation of the Merger would be a violation of its fiduciary duties to its stockholders under applicable law. 5.13 Accrued Amounts under Employment Agreements. (a) Accrued amounts due to W. Kip Speyer as of the Closing Date under his employment agreement with ISSI, with respect to periods on and after October 1, 2001 through the Closing Date, shall be paid to Mr. Speyer at the Closing. (b) Accrued amounts earned by Maha Sallam, Kevin Woods and W. Kip Speyer, with respect to periods on or prior to September 30, 2001, which are currently being paid by ISSI over the twenty-four month period that commenced on October, 2001, shall continue to be paid as agreed by ISSI by the Surviving Corporation on the same terms and conditions. 36 5.14 Stock Options. On the Closing Date, Howtek shall grant non-qualified options to purchase an aggregate of 1,200,000 shares of Howtek Common Stock ("Executive Options") to ISSI executives, as set forth on Schedule 5.14, as an inducement to accepting employment with the Surviving Corporation. The foregoing options shall be exercisable at any time for a period of ten (10) years from the date of grant, an exercise price equal to $3.49 per share and shall vest as set forth on Schedule 5.14. 5.15 Shareholder Agreement. Contemporaneously with the execution of this Agreement, each of W. Kip Speyer, Maha Sallam, Kevin Woods, Greg Stepic, Robert Howard and W. Scott Parr shall enter into a stockholders agreement in the form of Exhibit 5.15 annexed hereto. 5.16 Working Capital. From and after the date hereof, ISSI and Howtek shall review and consider alternative financing approaches for the Surviving Corporation, consistent with the operating, business and financial plan of the Surviving Corporation. In the event ISSI and Howtek are unable to agree to an alternative plan of financing prior to the Closing Date, Robert Howard or his designee shall, at or immediately prior to Closing, purchase 1,600,000 shares of ISSI Common Stock (the "RH Shares") for an aggregate purchase price of $2,000,000. 5.17 ISSI Books and Records. Prior to the Closing Date, ISSI shall cause its minute books and other records to accurately reflect all actions approved by the Board of Directors and stockholders of ISSI and all committees of the Board of Directors of ISSI, as well as all objections by any stockholder or members of such Board of Directors or committees thereof to any such actions. SECTION 6 CONDITIONS TO OBLIGATIONS OF THE PARTIES 6.1 Conditions to Obligations of the Howtek Parties. All obligations of the Howtek Parties to consummate the Merger and the other transactions contemplated by this Agreement are subject, at the Howtek Parties' option, to the fulfillment prior to or at the Closing Date of each of the following conditions: (a) Representations and Warranties. All representations and warranties of ISSI contained in this Agreement shall be true and complete at and as of the Effective Time as though made at and as of that time (except for representations and warranties that speak as of a specific date or time which need only be true and complete as of such date or time). (b) Covenants and Conditions. ISSI shall have performed and complied with all covenants, agreements and conditions required by this Agreement to be performed or complied with by them prior to or on the Closing Date. 37 (c) No litigation. No action, suit or proceeding against ISSI relating to the consummation of any of the transactions contemplated by this Agreement or any governmental action seeking to delay or enjoin any such transactions shall be pending or threatened. (d) Material Adverse Change. From December 31, 2001 through the Effective Time, no Material Adverse Change with respect to ISSI shall have occurred. (e) Consents and Approvals. The required consents and approvals hereunder shall have been received, including, without limitation, the requisite stockholder approval as required under Delaware Law. (f) Opinion of Counsel. Receipt of an opinion of Morgan, Lewis & Bockius LLP, dated the Closing Date substantially in the form of Exhibit 6.1(f). (g) Fairness Opinion. Howtek and its stockholders shall have received a fairness opinion from an investment banking firm reasonably acceptable to Howtek with respect to the Merger not more than five (5) days prior to the Closing Date. (h) Listing. The shares of Howtek Common Stock to be issued in the Merger shall have been approved for listing on the Nasdaq Small Cap Market. (i) Registration Statement. The Registration Statement shall have become effective and no stop order suspending such effectiveness or qualification shall have been issued or proceedings for such purpose shall have been instituted or threatened. (j) Waiver of Acceleration Rights. Each ISSI employee subject to an employment agreement shall have waived all of his or her rights thereunder triggered by the Merger, including, without limitation, the right to accelerate certain bonuses. (k) Amendments to Employment Agreements. The employment agreements between ISSI and each of Maha Sallam, Kevin Woods and Greg Stepic shall be amended to provide that each such employee shall report to the Chief Executive Officer, President or Chief Operating Officer of the Surviving Corporation, as designated by the Chief Executive Officer of the Surviving Corporation. (l) Directors and Officers Insurance. The Surviving Corporation shall have obtained directors' and officers' insurance in accordance with the provisions of Section 5.4. (m) ISSI Books and Records. ISSI shall have delivered to Howtek complete and correct copies of all minutes and resolutions of the Board of Directors and/or stockholders of ISSI which accurately reflect all actions approved by the Board of Directors and/or stockholders of ISSI and all committees of the Board of Directors of ISSI, as well as all objections by any stockholder or member of such Board of Directors or committees thereof to any such actions. 38 6.2 Conditions to Obligations of ISSI. All obligations of ISSI to consummate the Merger and the other transactions contemplated by this Agreement, are subject, at ISSI's option, to the fulfillment prior to or at the Closing Date of each of the following conditions: (a) Representations and Warranties. All representations and warranties of the Howtek Parties contained in this Agreement shall be true and complete in all material respects at and as of the Closing Date as though made at and as of that time (except for representations and warranties that speak as of a specific date or time which need only be true and complete as of such date or time). (b) Covenants and Conditions. The Howtek Parties shall have performed and complied in all material respects with all covenants, agreements and conditions required by this Agreement to be performed or complied with by it prior to or on the Closing Date. (c) No litigation. No action, suit or proceeding against any of the Howtek Parties relating to the consummation of any of the transactions contemplated by this Agreement or any governmental action seeking to delay or enjoin any such transactions shall be pending or threatened. (d) Material Adverse Change. No Material Adverse Change with respect to Howtek has occurred. (e) Consents and Approvals. The required consents and approvals hereunder shall have been received, including, without limitation, the requisite stockholder approval as required under the Florida Act. (f) Opinion of Counsel. Receipt of an opinion of Blank Rome LLP dated the Closing Date substantially in the form of Exhibit 6.2(f). (g) Directors and Officers Insurance. The Howtek shall have obtained directors' and officers' insurance on or prior the Closing Date. (h) Listing. The shares of Howtek Common Stock to be issued in the Merger shall have been approved for listing on the Nasdaq Small Cap market. (i) Registration Statement. The Registration Statement shall have become effective and no stop order suspending such effectiveness or qualification shall have been issued or proceedings for such purpose shall have been instituted or threatened. 39 (j) Accrued Amounts under Employment Agreement. All accrued amounts due to W. Kip Speyer as of the Closing Date under his employment agreement with ISSI, with respect to periods on and after October 1, 2001 through the Closing Date, shall have been paid to Mr. Speyer in accordance with the provisions of Section 5.13(a). (k) Executive Options. Howtek shall have granted the Executive Options to ISSI executives in accordance with the provisions of Section 5.14. SECTION 7 CLOSING DELIVERIES 7.1 Deliveries by ISSI. On the Closing Date, ISSI shall deliver to the Howtek Parties the following, in form and substance reasonably satisfactory to the Howtek Parties and their counsel: (a) Exchange Agent Agreement. A duly executed exchange agent agreement if required by the Exchange Agent; (b) Certificate of Merger. A Certificate of Merger in the form attached hereto as Exhibit 7.1(b) dated the Closing Date and duly executed by the appropriate officers of ISSI (the "Certificate of Merger"); (c) Articles of Merger. Articles of Merger in the form attached hereto as Exhibit 7.1(c) dated the Closing Date and duly executed by the appropriate officers of ISSI (the "Articles of Merger"); (d) Certificate. A certificate, dated as of the Closing Date, executed by an appropriate officer of ISSI, certifying jointly and severally to Howtek: (i) that the representations and warranties of ISSI contained in this Agreement are true and complete as of the Closing Date as though made on and as of that date (except for representations and warranties that speak as of a specific date or time, which need only be true and complete as of such date or time), except to the extent that the failure of such representations and warranties shall not have had a Material Adverse Effect, and (ii) that ISSI has in all respects performed and complied with all of their respective obligations, covenants and agreements in this Agreement to be performed and complied with on or prior to the Closing Date, except to the extent that the failure to perform such covenants shall not have had a Material Adverse Effect; (e) Secretary's Certificate. A certificate, dated as of the Closing Date, executed by ISSI's Secretary (i) certifying that the resolutions, as attached to such certificate, were duly adopted by each of ISSI's Board of Directors and stockholders, authorizing and approving the execution of this Agreement and the consummation of the transaction contemplated hereby and that such resolutions remain in full force and effect, and (ii) providing, as attachments thereto, ISSI's Articles of Incorporation and Bylaws, with all amendments; 40 (f) Good Standing Certificates. Certificates as to the formation and/or good standing of ISSI issued by the Florida Secretary of State to be dated a date not more than a reasonable number of days prior to the Closing Date; (g) Other Documents. Such other documents listed herein or as are reasonably requested by the Howtek Parties or their counsel for complete implementation of this Agreement and consummation of the transaction contemplated hereby. 7.2 Deliveries by the Howtek Parties. Prior to or on the Closing Date, the Howtek Parties shall deliver the following, in form and substance reasonably satisfactory to the Exchange Agent, ISSI and its counsel: (a) Delivery of Merger Consideration. To the Exchange Agent, stock certificate(s) representing the Merger Consideration in the amounts contemplated by this Agreement, subject, however, to Section 2.1(g) hereof; (b) Certificate of Merger. To ISSI, the Certificate of Merger duly executed by the appropriate officers of Merger Sub; (c) Articles of Merger. To ISSI, the Articles of Merger duly executed by the appropriate officers of Merger Sub; (d) Officer's Certificate. A certificate, dated as of the Closing Date, executed on behalf of an officer of each of the Howtek Parties, certifying (i) that the representations and warranties of each of the Howtek Parties contained in this Agreement are true and complete in all material respects as of the Closing Date as though made on and as of that date, and (ii) that each of the Howtek Parties have in all material respects performed and complied with all of its obligations, covenants and agreements in this Agreement to be performed and complied with on or prior to the Closing Date; (e) Secretary's Certificate. To ISSI, a certificate, dated as of the Closing Date, executed by each of the Howtek Parties' Secretary: (i) certifying that the resolutions, as attached to such certificate, were duly adopted by each of the Howtek Parties' Board of Directors, authorizing and approving the execution of this Agreement and the consummation of the transaction contemplated hereby and that such resolutions remain in full force and effect; and (ii) providing, as an attachment thereto, each of the Howtek Parties' Certificates of Incorporation and Bylaws; (f) Good Standing Certificates. To ISSI, certificates as to the formation and/or good standing of the Howtek Parties issued by the Secretary of State of Delaware to be dated a date not more than a reasonable number of days prior to the Closing Date; 41 (g) Other Documents. To ISSI, such other documents listed herein or as are reasonably requested by ISSI or its counsel for complete implementation of this Agreement and consummation of the transactions contemplated hereby. SECTION 8 TERMINATION 8.1 Termination by Mutual Consent. This Agreement may be terminated at any time prior to Closing by the mutual consent of the parties. 8.2 Other Termination. This Agreement may be terminated by any party hereto and the Merger abandoned if any other party hereto (the Howtek Parties, on the one hand, and ISSI and the Principal Stockholders, on the other hand) shall have failed to satisfy any of its respective conditions precedent under Section 6 hereof (unless such failure results primarily from the terminating party's breach of any representation, warranty or covenant contained in this Agreement or under any other agreement contemplated hereunder) or the Closing shall not have occurred on or before June 30, 2002; which date may extended by the parties hereto to permit completion and approval of the Registration Statement and subsequent scheduling of the Howtek Special Meeting. 8.3 Termination by Howtek. Howtek may terminate this Agreement by giving written notice to ISSI at any time prior to the Closing in the event ISSI and/or the Principal Stockholders have breached any representation, warranty or covenant contained in this Agreement in any material respect, Howtek has notified ISSI of the breach and the breach has continued without cure for a period of 30 days after the notice of breach. 8.4 Termination by ISSI. ISSI may terminate this Agreement by giving written notice to Howtek at any time prior to the Closing in the event the Howtek Parties have breached any representation, warranty or covenant contained in this Agreement in any material respect, ISSI has notified Howtek of the breach and the breach has continued without cure for a period of 30 days after the notice of breach. 8.5 Specific Performance. The parties recognize that, if either party hereto breaches this Agreement and refuses to perform under the provisions of this Agreement, monetary damages alone would not be adequate to compensate the other party for its injury. Such party shall therefore be entitled, in addition to any other remedies that may be available, to obtain specific performance of the terms of this Agreement. If any action is brought by such party to enforce this Agreement, the breaching party shall waive the defense that there is an adequate remedy at law. 42 SECTION 9 SURVIVAL; INDEMNIFICATION; CERTAIN REMEDIES 9.1 Survival. All representations and warranties, covenants and agreements of the Howtek Parties, ISSI and the Principal Stockholders contained in or made pursuant to this Agreement or in any certificate furnished pursuant hereto shall survive the Effective Time for a period of two (2) years. 9.2 Indemnification by the Principal Stockholders. From and after the Closing, each of the Principal Stockholders shall indemnify and hold the Howtek Parties harmless against and with respect to, and shall promptly reimburse the Howtek Parties for any and all Losses arising out of or resulting from any breach of any representation or warranty, or any failure to perform any covenant or agreement, of such Principal Stockholder contained in this Agreement or in any exhibit hereto, including but not limited to any certificate, document, or instrument delivered to the Howtek Parties by such Principal Stockholder under or in connection with this Agreement. 9.3 Indemnification by Howtek. Howtek shall indemnify and hold harmless each ISSI stockholder who receives Merger Consideration from and against any and all loss, damage, liability, cost and expense to which such holder may become subject under the Securities Act or otherwise, insofar as such losses, damages, liabilities, costs or expenses are caused by any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement or in any amendments or supplements thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances in which they were made, not misleading; provided, however, that Howtek shall not be liable in any such case to the extent that any such loss, damage, liability, cost or expense arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission so made in conformity with written information furnished by such holder or any of his or her accountants, counsel or authorized representatives for use in the Registration Statement and/or in any amendments or supplements thereto. 9.4 Procedure for Indemnification. The procedure for indemnification shall be as follows: (a) The party claiming indemnification (the "Claimant") shall promptly give notice to the party from which indemnification is claimed (the "Indemnifying Party") of any claim, whether between the parties or brought by a third party, specifying in reasonable detail the factual basis for the claim. If the claim relates to an action, suit, or proceeding filed by a third party against Claimant, such notice shall be given by Claimant within five (5) business days after written notice of such action, suit, or proceeding was given to Claimant. (b) With respect to claims solely between the Howtek Parties and the Principal Stockholder(s), following receipt of notice from the Claimant of a claim, the Indemnifying Party shall have thirty (30) days to make such investigation of the claim as the Indemnifying Party deems necessary or desirable. For the purposes of such investigation, the Claimant agrees to make available to the Indemnifying Party and his authorized representatives the information relied upon by the Claimant to substantiate the claim. If the Claimant and the 43 Indemnifying Party agree at or prior to the expiration of the thirty (30) day period (or any mutually agreed upon extension thereof) to the validity and amount of such claim, the Indemnifying Party shall immediately pay to the Claimant the full amount of the claim. If the Claimant and the Indemnifying Party do not agree within the thirty (30) day period (or any mutually agreed upon extension thereof), the Claimant may seek appropriate remedy at law or equity. (c) With respect to any claim by a third party as to which the Claimant is entitled to indemnification under this Agreement, the Indemnifying Party shall have the right at his own expense, to participate in or assume control of the defense of such claim, and the Claimant shall cooperate fully with the Indemnifying Party, subject to reimbursement for actual out-of-pocket expenses incurred by the Claimant as the result of a request by the Indemnifying Party. If the Indemnifying Party elects to assume control of the defense of any third-party claim, the Claimant shall have the right to participate in the defense of such claim at its own expense. If the Indemnifying Party does not elect to assume control or otherwise participate in the defense of any third-party claim, he shall be bound by the results obtained in good faith by the Claimant with respect to such claim. (d) If a claim, whether between the parties or by a third party, requires immediate action, the parties will make every effort to reach a decision with respect thereto as expeditiously as possible. 44 9.5 Certain Limitations. (a) Anything contained in this Agreement to the contrary notwithstanding, each Principal Stockholder's total liability under this Section 9 for any Losses incurred by the Howtek Parties shall not exceed the lesser of (i) the sum of the aggregate market price of the Merger Consideration and the aggregate fair market value of the Options issued to such Principal Stockholder hereunder on the last trading day immediately prior to the Closing or (ii) the sum of the aggregate market price of the Merger Consideration and the aggregate fair market value of the Options issued to such Principal Stockholder hereunder on the last trading day immediately prior to the date that such Principal Stockholder receives a notice of a claim for indemnification in accordance with the provisions of Section 9.4 above, as the case may be (the "Cap"); provided, however, that the Cap shall be reduced by the amount of any capital gain tax paid or payable by such Principal Stockholder with respect to any shares of Merger Consideration sold by such Principal Stockholder prior to the date of a claim for indemnification hereunder in the event that the sum of (1) the aggregate market price of such Merger Consideration held by such Stockholder on the date of such claim, (2) the fair market value of such Options (and any shares of Howtek Common Stock issued upon exercise of such Options) held by such Principal Stockholder on the date of such claim and (3) the gross proceeds from the sale by such Principal Stockholder of any Merger Consideration or Options (including any shares of Howtek Common Stock issued upon exercise of such Options), less the amount of capital gains tax paid or payable by such Principal Stockholder with respect to such sale(s), is less than the Cap. Any such liability shall be satisfied, at such Principal Stockholder's sole discretion, by (i) the payment of cash to the Howtek Parties and/or (ii) the return to the Howtek Parties of an amount of Merger Consideration and/or Options having a fair market value equal to amount of such liability, subject to the limitations set forth in this subparagraph (a). (b) Anything contained herein to the contrary notwithstanding, the Principal Stockholders shall not be liable to the Howtek Parties for any Losses under this Section 9 unless and until the aggregate amount of all such Losses exceeds One Hundred Thousand Dollars ($100,000), at which time each Principal Stockholder shall be obligated to indemnify the Howtek Parties for the full amount of such Principal Stockholder's obligation to indemnify the Howtek Parties pursuant to this Section 9; provided, however, that no Claimant hereunder shall make a claim for indemnification against an Indemnifying Party under this Section 9 unless the aggregate amount of such claim exceeds Fifty Thousand Dollars ($50,000). 9.6 Attorney's Fees. In the event that any Party brings a claim for indemnification pursuant to this Section 9, to the extent not otherwise provided for in this Agreement, the prevailing Party shall be entitled to an award of all reasonable attorney's fees and expenses. SECTION 10 MISCELLANEOUS 10.1 Fees and Expenses. Except as otherwise provided in this Agreement, each party shall pay its own expenses incurred in connection with the authorization, preparation, execution and performance of this Agreement, including all fees and expenses of counsel, accountants, agents and 45 representatives, and each party shall be responsible for all fees or commissions payable to any finder, broker, advisor, or similar Person retained by or on behalf of such party. The provisions of this Section 10.1 shall survive the termination of this Agreement 10.2 Notices. All notices, requests, consents, payments, demands, and other communications required or contemplated under this Agreement shall be in writing and (a) personally delivered or sent via telecopy (receipt confirmed and followed promptly by delivery of the original), or (b) sent by Federal Express or other reputable overnight delivery service (for next business day delivery), shipping prepaid, as follows: If to the Howtek Parties to: Howtek, Inc. 21 Park Avenue Hudson, New Hampshire 03051 Attn: W. Scott Parr Telephone: (603) 882-5200 Fax: (603) 880-3843 With a copy to: Robert J. Mittman, Esquire Blank Rome LLP The Chrysler Building 405 Lexington Avenue New York, New York 10174 Telephone: (212) 885-5000 Fax: (212) 885-5001 If to ISSI or the Principal Stockholders: Intelligent Systems Software, Inc. 6405 Congress Avenue Boca Raton, FL 33487 Attn: W. Kip Speyer Telephone: (561) 994-4404 Fax: (561) 994-0881 With a copy to: John S. Fletcher, Esq. Morgan, Lewis & Bockius LLP 5300 First Union Financial Center Miami, Florida 33131 Telephone: 305-579-0432 Fax: 305-579-0321 46 or to such other Persons or addresses as any Person may request by notice given as aforesaid. Notices shall be deemed given and received at the time of personal delivery or completed telecopying, or, if sent by Federal Express or such other overnight delivery service one Business Day after such sending. 10.3 Binding Effect. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors, assigns, executors personal and legal representatives . 10.4 Further Assurances. The parties shall take any actions and execute any other documents that may be necessary or desirable (before or after the Closing) to the implementation and consummation of this Agreement. 10.5 GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED, CONSTRUED AND ENFORCED IN ACCORDANCE WITH THE LAWS OF THE STATE OF DELAWARE (WITHOUT REGARD TO THE CHOICE OF LAW PROVISIONS THEREOF). 10.6 Entire Agreement. Any confidentiality agreement entered into between or among the parties, this Agreement and the Annexes and the Schedules hereto, each of which Annexes and Schedules are hereby incorporated herein by reference, and all documents, certificates and other documents to be delivered by the parties pursuant hereto, collectively, represent the entire understanding and agreement between Howtek, Merger Sub and ISSI with respect to the subject matter of this Agreement. Except for the aforementioned confidentiality agreement, this Agreement supersedes all prior negotiations between the parties and cannot be amended, supplemented, or changed except by an agreement in writing duly executed by each of the parties hereto. 10.7 Waiver of Compliance; Consents. Except as otherwise provided in this Agreement, any failure of any of the parties to comply with any obligation, representation, warranty, covenant, agreement, or condition herein may be waived by the party entitled to the benefits thereof only by a written instrument signed by the party granting such waiver, but such waiver or failure to insist upon strict compliance with such obligation, representation, warranty, covenant, agreement, or condition shall not operate as a waiver of, or estoppel with respect to, any subsequent or other failure. Whenever this Agreement requires or permits consent by or on behalf of any party hereto, such consent shall be given in writing in a manner consistent with the requirements for a waiver of compliance as set forth in this Section 10.7. 10.8 Headings. The headings of the sections and subsections contained in this Agreement are inserted for convenience only and do not form a part or affect the meaning, construction or scope thereof. 10.9 Counterparts. This Agreement may be signed in two or more counterparts with the same effect as if the signature on each counterpart were upon the same instrument. 10.10 Cooperation. The parties hereto shall reasonably cooperate with each other and their respective counsel and accountants in connection with any actions required to be taken as part of 47 their respective obligations under this Agreement, and in connection with any litigation after the implementation and consummation of this Agreement, and otherwise use their commercially reasonable efforts to consummate the transaction contemplated hereby and to fulfill their obligations under this Agreement. 10.11 Public Announcements. The parties hereto shall consult with each other before issuing any press releases or otherwise making any public statements with respect to this Agreement or the transactions contemplated herein and shall not issue any such press release or make any such public statement without the prior written consent of the other party, which shall not be unreasonably withheld; provided, however, that a party may, without the prior written consent of the other party, issue such press release or make such public statement as may be required by law or any listing agreement with a national securities exchange to which the Howtek Parties are a party or Nasdaq if it has used all reasonable efforts to consult with the other party and to obtain such party's consent but has been unable to do so in a timely manner. This provisions of this Section 10.11 shall survive the termination of this Agreement. IN WITNESS WHEREOF, this Agreement has been executed by the duly authorized officers of ISSI and the Howtek Parties as of the date first written above. The Howtek Parties: ------------------ Howtek, Inc. By: /s/ W. Scott Parr ------------------------- Name: W. Scott Parr Title: President & CEO ISSI Acquisition Corp. By: /s/ W. Scott Parr ------------------------- Name: W. Scott Parr Title: President & CEO ISSI: ---- Intelligent Systems Software, Inc. By: /s/ W. Kip Speyer ------------------------- Name: W. Kip Speyer Title: Chairman, President & CEO 48 Principal Stockholders /s/ Maha Sallam ------------------------- Maha Sallam /s/ Kevin Woods ------------------------- Keven Woods /s/ W. Kip Speyer ------------------------- W. Kip Speyer 49 Annex 1 CERTAIN DEFINITIONS The following terms, as used in this Agreement, have the meanings set forth in this Annex 1 (terms defined in the singular to have the correlative meaning in the plural and vice versa): "Affiliate" means, with respect to any Person, (a) any other Person that directly or indirectly through one or more intermediaries controls, is controlled by, or is under common control with such Person, or (b) an officer or director of such Person or of an Affiliate of such Person within the meaning of clause (a) of this definition. For purposes of clause (a) of this definition, (i) a Person shall be deemed to control another Person if such Person (A) has sufficient power to enable such Person to elect a majority of the board of directors of such Person, or (B) owns a majority of the beneficial interests in income and capital of such Person; and (ii) a Person shall be deemed to control any partnership of which such Person is a general partner. "Acquisition Proposal" means any proposal or offer (including, without limitation, any proposal or offer to a Party's stockholders) with respect to a merger, acquisition, consolidation, recapitalization, reorganization, liquidation, tender offer or exchange offer or similar transaction involving, or any purchase of 15% or more of the consolidated assets of, or any equity interest representing 15% or more of the outstanding shares of capital stock in, such Party. "Closing" means the closing of the transactions contemplated by this Agreement on the Closing Date. "Closing Date" means the date on which the Closing occurs, as determined pursuant to Section 2.2. "Code" means the Internal Revenue Code of 1986, as amended. "Contaminant" shall mean and include any pollutant, contaminant, hazardous material (as defined in any of the Environmental Laws), toxic substances (as defined in any of the Environmental Laws), asbestos or asbestos containing material, urea formaldehyde, polychlorinated biphenyls, regulated substances and wastes, radioactive materials, and petroleum or petroleum by-products, including crude oil or any fraction thereof. "Contracts" means all contracts, consulting agreements, leases, non-governmental licenses and other agreements (including leases for personal or real property and employment agreements), written or oral (including any amendments and other modifications thereto) that relate to or affect a party's assets, properties, or its business or operations, the performance of which involves annual consideration in excess of $50,000 and that either (a) are in effect on the date of this Agreement, or (b) are entered into by any Party between the date of this Agreement and the Closing Date. 50 "Environmental Laws" shall mean and include, but not be limited to, any applicable federal, state or local law, statute, charter, ordinance, rule or regulation or any Governmental Body interpretation, policy or guidance, including, without limitation, applicable safety/environmental/health laws, such as, but not limited to, the Resource Conservation and Recovery Act of 1976, Comprehensive Environmental Response Compensation and Liability Act, Federal Emergency Planning and Community Right-to-Know Law, the Clean Air Act, the Clean Water Act, and the Toxic Substance Control Act, as any of the foregoing have been amended, and any Governmental Authorization or Order applicable to or affecting the Property or any other property (real or personal) used by or relating to a Party or issued pursuant to any Environmental Laws which pertains to, governs, or controls the generation, storage, remediation or removal of Contaminants or otherwise regulates the protection of health and the environment, including, but not limited to, any of the following activities, whether on site or off site if such could materially affect the site: (i) the emission, discharge, release, spilling or dumping of any Contaminant into the air, surface water, ground water, soil or substrata; or (ii) the use, generation, processing, sale, recycling, treatment, handling, storage, disposal, transportation, labeling or any other management of any Contaminant. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. "Executive Options" shall have the meaning ascribed to such term in Section 5.14 hereof. "GAAP" means generally accepted United States accounting principles, applied on a consistent basis. "Governmental Authorization" means any approval, consent, license, permit, waiver, or other authorization issued, granted, given, or otherwise made available by or under the authority of any Governmental Body or pursuant to any Legal Requirement. "Governmental Body" means any: (a) nation, state, county, city, town, village, district, or other jurisdiction of any nature; (b) federal, state, local, municipal, foreign, or other government; (c) governmental or quasi-governmental authority of any nature (including any governmental agency, branch, department, official, or entity and any court or other tribunal); (d) multi-national organization or body; (e) self-regulatory organization (including, with limitation, NASD); or (f) body exercising, or entitled to exercise, any administrative, executive, judicial, legislative, police, regulatory, or taxing authority or power of any nature. 51 "Intangibles" means all copyrights, trademarks, trade names, service marks, service names, licenses, patents, permits, jingles, proprietary information, technical information and data, machinery and equipment warranties, and other similar intangible property rights and interests (and any goodwill associated with any of the foregoing) applied for, issued to, or owned by a Party or under which a Party is licensed or franchised and that are used in the business and operations of a Party, together with any additions thereto between the date of this Agreement and the Closing Date. "Knowledge" means, (i) with respect to the Howtek Parties, the actual knowledge of its executive officers, and (ii) with respect to ISSI, the actual knowledge of its executive officers or the Principal Stockholders. "Leased Real Property" means all real property and all buildings and other improvements thereon and appurtenant thereto leased or held by a Party. "Legal Requirement" means any federal, state, local, municipal, foreign, international, multinational, self regulatory organization or court or other administrative order, constitution, law, ordinance, principle of common law, rule, regulation, statute, treaty, by-law, or the like. "Losses" means any loss, liability, damage, cost, or expense, including, without limitation, reasonable attorneys' fees and expenses. "Material Adverse Change" means since December 31, 2001, any material adverse change in the business, operations, properties, prospects, assets, or condition, of the Person referred to, or the occurrence of any event or the existence of any circumstance that constitutes a Material Adverse Effect; provided, however, that the divestiture by Howtek of its graphic arts and/or photographic business shall not be deemed a Material Adverse Change with respect to Howtek. "Material Adverse Effect" shall mean a material adverse effect on the business, prospects, operations, properties, financial condition, assets, liabilities or results of operations of the Person referred to, taken as a whole, or the ability of such Person to consummate the transactions contemplated by this Agreement. "Order" means any award, decision, injunction, judgment, decree, order, ruling, writ, determination, subpoena, or verdict entered, issued, made, or rendered by any court, administrative agency, or other Governmental Body or by any arbitrator. "Ordinary Course of Business" an action taken by a Person will be deemed to have been taken in the "Ordinary Course of Business" only if: (a) such action is consistent with the past practices of such Person and is taken in the ordinary course of the normal day-to-day operations of such Person; (b) such action is not required to be authorized by the board of directors of such Person (or by any Person or group of Persons exercising similar authority); and 52 (c) such action is similar in nature and magnitude to actions customarily taken, without any authorization by the board of directors (or by any Person or group of Persons exercising similar authority), in the ordinary course of the normal day-to-day operations of other Persons that are in the same line of business as such Person. "Parties" collectively means Howtek, Merger Sub, ISSI, and the Principal Stockholders, each a "Party." "Permitted Encumbrances" means (a) encumbrances of a landlord, or other statutory lien not yet due and payable, or landlord's liens arising in the Ordinary Course of Business, (b) encumbrances arising in connection with equipment or maintenance financing or leasing under the terms of the Contracts set forth on the Schedules, which Contracts have been made available to the Howtek Parties, (c) encumbrances for Taxes not yet delinquent or which are being contested in good faith and by appropriate proceedings if adequate reserves with respect thereto are maintained on a Party's books in accordance with generally accepted accounting principles, or (d) encumbrances that do not materially detract from the value of any of the assets of a Party or materially interfere with the use thereof as currently used. "Person" means an individual, corporation, association, partnership, joint venture, trust, estate, limited liability company, limited liability partnership, organization or other entity or Governmental Body. "Principal Stockholders" shall have the meaning ascribed to such term in the preamble. "Real Property" means all real property and all buildings and other improvements thereon and appurtenant thereto leased by a Party used in the business or operations of a Party. "Real Property Interests" means all interests in Leased Real Property, including fee estates, leaseholds and subleaseholds, purchase options, easements, licenses, rights to access, and rights of way, and all buildings and other improvements thereon and appurtenant thereto, owned or held by a Party that are used in the business or operations of a Party, together with any additions, substitutions and replacements thereof and thereto between the date of this Agreement and the Closing Date. "Related Person" means with respect to a particular individual: (a) each other member of such individual's Family; (b) any Person that is directly or indirectly controlled by such individual or one or more members of such individual's Family; (c) any Person in which such individual or members of such individual's Family hold (individually or in the aggregate) a Material Interest; and (d) any Person with respect to which such individual or one or more members 53 of such individual's Family serves as a director, officer, partner, executor, or trustee (or in a similar capacity). With respect to a specified Person other than an individual: (a) any Person that directly or indirectly controls, is directly or indirectly controlled by, or is directly or indirectly under common control with such specified Person; (b) any Person that holds a Material Interest in such specified Person; (c) each Person that serves as a director, officer, partner, executor, or trustee of such specified Person (or in a similar capacity); (d) any Person in which such specified Person holds a Material Interest; (e) any Person with respect to which such specified Person serves as a general partner or a trustee (or in a similar capacity); and (f) any Related Person of any individual described in clause (b) or (c). For purposes of this definition, (a) the "Family" of an individual includes (i) the individual, (ii) the individual's spouse, (iii) any other natural person who is related to the individual or the individual's spouse within the second degree, and (iv) any other natural person who resides with such individual, and (b) "Material Interest" means direct or indirect beneficial ownership (as defined in Rule 13d-3 under the Securities Exchange Act of 1934) of voting securities or other voting interests representing at least 5% of the outstanding voting power of a Person or equity securities or other equity interests representing at least 5% of the outstanding equity securities or equity interests in a Person. "RH Shares" shall have the meaning ascribed to such term in Section 5.16 hereof. "SEC" means the United States Securities and Exchange Commission. "Securities Act" means the Securities Act of 1933, as amended. "Tangible Personal Property" means all machinery, equipment, tools, vehicles, furniture, leasehold improvements, office equipment, plant, inventory, spare parts and other tangible personal property owned or held by a Party that is used or useful in the conduct of the business or operations of a Party, together with any additions, substitutions and replacements thereof and thereto between the date of this Agreement and the Closing Date. "Tax" or "Taxes" means any federal, state, local, or foreign income, gross receipts, windfall profits, severance, property, production, sales, use, license, excise, franchise, capital, transfer, employment, withholding, or other tax or similar governmental assessment, together with any interest, additions, or penalties with respect thereto and any interest in respect of such additions or penalties. 54 "Tax Authority" means any Governmental Body or other authority exercising any taxing or tax regulatory authority. "Tax Liability" means any liability for Taxes. "Taxable Period" means any taxable year or any other period that is treated as a taxable year with respect to which any Taxes may be imposed under any applicable statute, rule, or regulation. "Tax Proceeding" means any audit, examination, claim, or other administrative or judicial proceeding involving Taxes. "Tax Return" means any tax return, declaration of estimated tax, tax report or other tax statement (including supporting information), or any other similar filing required to be submitted to any Governmental Body with respect to any Taxes. 55 Pursuant to Item 601(b)(2) of Regulation S-K, the following is a list of omitted schedules to the Plan and Agreement of Merger. Howtek agrees to Supplementally provide complete copies of the foregoing schedules to the Securities and Exchange Commission upon its request. ISSI Schedules Schedule 3.1 Organization of ISSI Schedule 3.4 Conflicts Schedule 3.5 Governmental Consents Schedule 3.6 Real Property Schedule 3.7 Tangible Personal Property Schedule 3.8 Contracts Schedule 3.9 Intangibles Schedule 3.11 Financial Statements Schedule 3.12(a) Tax Matters Schedule 3.12(c) Tax Matters Schedule 3.13 Insurance Schedule 3.14 Personnel and Employee Benefit Plans Schedule 3.14(g) Labor Relations Schedule 3.15 Legal Actions and Orders Schedule 3.16 Environmental Compliance Schedule 3.17 Compliance with Legal Requirements Schedule 3.20 Capitalization Schedule 3.21 Relationships with Related Persons Schedule 3.22 Accounts; Lockboxes; Safe Deposit Boxes Schedule 3.25 Due Diligence Howtek Schedules Schedule 4.4 Capitalization Schedule 4.5(ii) Financial Statements Schedule 4.6 Governmental Authorizations Schedule 4.7 Tax Matters Schedule 4.7(c) Basis in Howtek Assets; Net Operating Loss Schedule 4.8 Insurance Schedule 4.9 Conduct of Business in Ordinary Course Schedule 4.10 Real Property Schedule 4.11 Contracts Schedule 4.12 Intangibles Schedule 4.13 Title to Properties Schedule 4.14 Personnel and Employee Benefits Schedule 4.14(g) Labor Relations Schedule 4.15 Legal Actions and Orders Schedule 4.16 Environmental Compliance 56 Schedule 4.17 Compliance with Legal Requirements Schedule 4.18 Relationships with Related Persons Schedule 5.1 Conduct of Howtek's Business Prior to Closing Schedule 5.14 Executive Options 57 EX-3.(E) 4 d50184_exh3e.txt CERTIFICATE OF AMENDMENT EXHIBIT 3(e) CERTIFICATE OF AMENDMENT OF THE CERTIFICATE OF INCORPORATION OF HOWTEK, INC. -------------------------------------------------------- Adopted in accordance with the provisions of Section 242 of the General Corporation Law of the State of Delaware -------------------------------------------------------- The undersigned, being the President of HOWTEK, INC. (the "Corporation"), a corporation existing under the laws of the State of Delaware, does hereby certify as follows: FIRST: That the Certificate of Incorporation of the Corporation has been amended as follows by striking out the whole of Article FOURTH thereof as it now exists and inserting in lieu and instead thereof a new Article FOURTH, reading as follows: "FOURTH: The total number of shares of capital stock which the Corporation shall have authority to issue is Twenty-Six Million (26,000,000) shares, of which Twenty-Five Million (25,000,000) shares shall be Common Stock, par value $.01 per share, and One Million (1,000,000) shares shall be Preferred Stock, par value $.01 per share. The Preferred Stock may be issued from time to time in one or more series. The Board of Directors of the Corporation is hereby expressly authorized to provide, by resolution or resolutions duly adopted by it prior to issuance, for the creation of each such series and to fix the designation and the powers, preferences, rights, qualifications, limitations and restrictions relating to the shares of each such series. The authority of the Board of Directors with respect to each series of Preferred Stock shall include, but not be limited to, determining the following: (a) the designation of the series and the number of shares to constitute such series (which number may be increased or decreased from time to time unless otherwise provided by the Board of Directors); (b) the dividend rate (or method of determining such rate), any conditions on which and times at which dividends are payable, the preference or relation which such dividends shall bear to the dividends payable on any other class or classes or of any other series of capital stock including the Preferred Stock, and whether such dividends shall be cumulative or non-cumulative; (c) whether the series will be redeemable (at the option of the Corporation or the holders of such shares or both, or upon the happening of a specified event) and, if so, the redemption prices and the conditions and times upon which redemption may take place and whether for cash, property or rights, including securities of the Corporation or another corporation; (d) whether the shares of such series shall be subject to the operation of a retirement or sinking fund and, if so, the extent to and manner in which any such retirement or sinking fund shall be applied to the purchase or redemption of the shares of such series for retirement or other corporate purposes and the terms and provisions relating to the operation thereof; (e) the conversion or exchange rights (at the option of the Corporation or the holders of such shares or both, or upon the happening of a specified event), if any, including the conversion or exchange times, prices, rates, adjustments and other terms of conversion or exchange; (f) whether the shares of such series shall have voting rights in addition to any voting rights provided as a matter of law and, if so, the terms of such voting rights, which may be general or limited; (g) the conditions or restrictions, if any, upon the creation of indebtedness of the Corporation or upon the issue or reissue or sale of any additional stock, including additional shares of such series or of any other series of Preferred Stock or of any other class; (h) the rights of the holders upon voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Corporation or upon any dissolution of the assets of the Corporation (including preferences over the Common Stock or other class or classes or series of capital stock including the Preferred Stock); (i) the preemptive rights, if any, to subscribe to additional issues of stock or securities of the Corporation; (j) the limitations and restrictions, if any, to be effective while any shares of such series are outstanding upon the payment of dividends or the making of other distributions on, and upon the purchase, redemption or other acquisition by the Corporation of, the Common Stock or shares of stock of any other class or any other series of Preferred Stock; and (k) such other special rights and privileges, if any, for the benefit of the holders of the Preferred Stock, as shall not be inconsistent with the provisions of the Corporation's Certificate of Incorporation, as amended, or applicable law. All shares of Preferred Stock of the same series shall be identical in all respects, except that shares of any one series issued at different times may differ as to dates, if any, from which dividends thereon may accumulate. All shares of Preferred Stock redeemed, purchased or otherwise acquired by the Corporation (including share surrendered for conversion) shall be cancelled and thereupon restored to the status of authorized but unissued shares of Preferred Stock undesignated as to series." SECOND: That such amendment has been duly adopted by the affirmative vote of the holders of a majority of the stock entitled to vote at a meeting of stockholders in accordance with the provisions of the General Corporation Law of the State of Delaware. Dated: September 28, 1999. HOWTEK, INC. By: /s/ W.Scott Parr --------------- W.Scott Parr EX-10.(B) 5 d50184_exh10b.txt RENEWAL OF LEASE EXHIBIT 10(b) RENEWAL OF LEASE Effective October 1, 2001, the Indenture of Lease (the "Lease") dated October 1, 1984 between Robert Howard ("Lessor") and Howtek, Inc. ("Lessee"), of the premises located at 21 Park Avenue, Hudson, NH, is renewed for a term of one (1) year at the base rent of $78,499.92, payable in twelve (12) monthly installments of $6,541.66. All other terms and conditions of the Lease remain in effect. LESSOR LESSEE HOWTEK, INC. /s/ Robert Howard BY:/s/ Annette Heroux - ------------------------- ----------------------- ROBERT HOWARD Chief Financial Officer EX-10.(D) 6 d50184_exh10d.txt REVOLVING LOAN AND SECURITY AGMT. EXHIBIT 10 (d) ADDENDUM NO. 13 REVOLVING LOAN AND SECURITY AGREEMENT CONVERTIBLE REVOLVING CREDIT PROMISSORY NOTE DATED OCTOBER 26, 1987 For consideration given and received, Robert Howard and Howtek, Inc. hereby agree to extend the repayment date in Paragraph D of the above referenced Convertible Revolving Credit Promissory Note, as amended, (the "Note") from January 4, 2002 to January 4, 2003. Also the Note hereafter will be a maximum principal sum of Three Million Dollars ($3,000,000). Effective the 29th day of December 2001. HOWTEK, INC. By: /s/ Annette Heroux /s/ Robert Howard -------------------------- ------------------- Title: Chief Financial Officer Robert Howard EX-23.(A) 7 d50184_exh23a.txt CONSENT OF INDEPENDENT CERT. PUB. ACCTS. EXHIBIT 23 (a) CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Howtek, Inc. Hudson, New Hampshire We hereby consent to the incorporation by reference in the Prospectuses constituting part of the Registration Statement on Form S-8 (No. 33-72534) and S-3 (No. 333-88867) of our report dated February 19, 2002, appearing in this Annual Report on Form 10-K of Howtek, Inc. for the year ended December 31, 2001. /s/ BDO SEIDMAN, LLP Boston, Massachusetts March 28, 2002 -----END PRIVACY-ENHANCED MESSAGE-----