-----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, DCf1SrQuCbmoHT8NtMoy58P//jlSRCfOvyqscGkY10KS/G3/2DwOB4Be5ZYPIK8+ heMKXKsqYj6ejPHgIn4+gg== 0001144204-04-003966.txt : 20040330 0001144204-04-003966.hdr.sgml : 20040330 20040330170830 ACCESSION NUMBER: 0001144204-04-003966 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ICAD 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: 04702319 BUSINESS ADDRESS: STREET 1: 4 TOWNSEND WEST, SUITE 17 CITY: NASHUA STATE: NH ZIP: 03063 BUSINESS PHONE: 603-882-5200 MAIL ADDRESS: STREET 1: 4 TOWNSEND WEST, SUITE 17 CITY: NASHUA STATE: NH ZIP: 03063 FORMER COMPANY: FORMER CONFORMED NAME: HOWTEK INC DATE OF NAME CHANGE: 19920703 10-K 1 v02294.txt UNITED STATES 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, 2003 ----------------- 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 ------ ICAD, INC. ---------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 02-0377419 --------------------------- ------------------ (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 4 Townsend West, Suite 17, Nashua, New Hampshire 03063 - ------------------------------------------------ -------- (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___. 1 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. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) YES NO 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 June 30, 2003 was $31,858,033. As of March 18, 2004, the registrant had 33,776,933 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, product market acceptance, possible technological obsolescence of products, increased competition, litigation and/or government regulation, changes in Medicare reimbursement policies, competitive factors, the effects of a decline in the economy in markets served by the Company and other risks detailed in this report and in the Company's other filings with the Securities and Exchange Commission. The words "believe", "demonstrate", "intend", "expect", "estimate", "anticipate", "likely", "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 iCAD(TM), Inc. ("iCAD" or the "Company") was incorporated in 1984 in the State of Delaware, as Howtek, Inc., and has sold and supported over 20,000 high quality, professional graphic arts, photographic and medical imaging systems worldwide. In 2001, iCAD elected to concentrate on its medical imaging and women's health businesses with an objective of expanding this business through increased product offerings. This goal was advanced in June 2002 with the acquisition of Intelligent Systems Software, Inc. ("ISSI"), a software company offering computer aided detection ("CAD") systems for breast cancer. Subsequently, on December 31, 2003, the Company merged with and acquired Qualia Computing, Inc., a privately held company based in Beavercreek Ohio, and its subsidiaries, including CADx Systems, Inc. (together "CADx"), bringing together two of the three companies approved by the US Food and Drug Administration (FDA) to market computer aided detection of breast cancer solutions in the United States. iCAD develops, engineers, manufactures and markets computer aided detection (CAD) products for the early detection of breast cancer and other health-care related applications. Early detection of breast cancer can save lives and often permits less costly, less invasive and less disfiguring cancer treatment options than when the cancer is detected at a later stage. Computer aided detection from iCAD can detect up to 25% of breast cancers an average of 14 months earlier than screening mammography alone. iCAD is the only independent, integrated digitizer hardware and CAD software company offering computer aided detection of breast cancer solutions. As such, we are able to reduce costs at each step in the CAD product design, production and assembly process. We believe our vertical integration of CAD and hardware development results in better integration of software and film digitizer components, lower production costs and reduced administrative overhead. These factors have allowed us to progressively enhance our CAD product line, while reducing the costs of our CAD products to many customers and allowing more women to realize the benefits inherent in the early detection of breast cancer. 3 The Company's CAD systems include proprietary software technology together with standard computer and display equipment. CAD systems for the film-based mammography market also include a radiographic film digitizer manufactured by the Company. iCAD also manufactures medical film digitizers for a variety of medical imaging and other applications. The Company manufactures and promotes the Company's film digitizer products to third party customers. The Company believes that iCAD's experience in providing film digitizers and software for medical picture archiving and communications (PACS) and telemedicine applications contributes to the successful integration of the Company's CAD products into networked and digital mammography environments. The Company's headquarters and its production and assembly facilities are located in southern New Hampshire. MERGER WITH QUALIA AND CADX AND SUBSEQUENT EVENTS On December 31, 2003, the Company completed the acquisition of CADx. This merger brings together two of the three companies approved by the FDA to market computer aided detection of breast cancer solutions in the United States. To complete the merger, iCAD issued 4,300,000 shares of its common stock, representing approximately 13% of the outstanding shares of iCAD common stock after the merger. Additionally, iCAD paid $1,550,000 in cash and executed a 36-month secured promissory note in the amount of $4,500,000 to purchase Qualia shares that were owned by two institutional investors. Integration of the acquired companies is substantially complete. During the first quarter of 2004 the Company assessed the opportunities to achieve post-merger operating economies, and identified cost-reduction opportunities in light of its distribution and product plans. As a result of this analysis management determined that operating expenses could be substantially reduced without detracting from the Company's ability to increase sales and focus on future products and markets. Cost-reduction actions taken by iCAD in the first quarter of 2004 included the closure of offices in Tampa, Florida and San Rafael, California; reductions in staffing effective March 31, 2004 of 39 of 110 previous full and part-time employees, and the reduction of duplication in marketing, administrative and other activities. As a result of these cost-reduction actions, the Company will report certain non-recurring severance and office closure expenses in the quarter ending March 31, 2004. Unless otherwise indicated or unless the context requires otherwise, the references to "iCAD", "we", "us", "our" or "combined companies", refer to the combined entities, iCAD, CADx Systems, Inc. and Qualia Computing, Inc., and its subsidiaries and references to "CADx" includes Qualia Computing, Inc. and its subsidiaries. 4 MARKET AND MARKET SHARE Computer Assisted Detection is used to provide physicians with support in detecting breast cancer at an early stage. There is a 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%. 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 annual mammography screening category within the next 5 years. A problem in this process, that the Company's CAD products seek to address, is that in routine screening of mammography films an estimated 20% or more (some reports suggest up to 30%) of identifiable breast cancers are missed as a result of radiologist oversight. In general, CAD as an adjunct to mammography screening is now reimbursable in the United States under federal and most third party insurance programs, providing economic support for the acquisition of CAD products by women's health care providers. In the United States, approximately 9,200 facilities are accredited to provide mammography screening. To date, the Company estimates that approximately 1,500 CAD systems have been sold into this market. Our combined companies account for approximately 340 of these systems, including approximately 240 systems sold during 2003. The Company believes its market share is increasing. During the fourth quarter of 2003, on a combined basis, the Company sold a total of approximately 115 CAD systems, excluding systems sold to new resellers for demonstration purposes and systems sold from the stock of iCAD, Inc.'s previous distributor. The Company believes its sales represented the majority of all computer aided detection of breast cancer systems sold during the fourth quarter of 2003, which would make iCAD, for the first time, the market leader in terms of unit shipments. The Company believes that the large majority of CAD systems sold to date have been sold to "early adopters", including academic institutions and customers with comparatively higher case volumes, a group that it estimates comprises less than one-third of the overall potential market for its products. The Company's Second Look(R) 200 system (formerly the iCAD iQ(TM) model), introduced in December 2003, is designed to provide a solution for the balance of the market, where lower case volumes require a lower cost, easy to use CAD solution Full Field Digital Mammography ("FFDM") systems, which eliminate the film used in conventional mammographic X-Rays, are now available from several vendors. These systems are expected to increase as a percentage of the installed base of mammography systems, as more clinics and women's health centers implement more fully digital imaging workflows. CAD technology, including the Company's, is applicable to mammographic images acquired through Digital Mammography systems. To date, the Company has sold 70 CAD solutions for digital mammography through its OEM partners and it believes that iCAD is the current sales leader in this part of the market. 5 The Company's Howtek(TM) medical digitizer products are used in the Company's CAD systems, and marketed to third parties for use in the computer aided detection market, in teleradiology and in medical image storage and management networks known as Picture Archiving and Communications Systems, or "PACS". Teleradiology is the practice of digitally transmitting medical x-ray images to another location for analysis, consultation or diagnostic interpretation. The Company's digitizers are used in this process to convert radiographic film to digital form, for transmission, communication or storage. ICAD COMPUTER AIDED DETECTION TECHNOLOGY AND PRODUCTS The Company's computer aided detection systems operate by analyzing multiple features and characteristics of a screening or diagnostic mammogram to recognize, identify and "mark" those combinations of features that may represent cancer. The system then presents the radiologist with a computerized "Second Look", or second opinion, helping to reduce overlooked cancers by 23%-28%. This analysis is accomplished by iCAD's cancer detection software, which encapsulates the knowledge from thousands of mammography cases that were presented during the product's development to "learn" the important distinguishing characteristics of cancerous versus normal tissue. iCAD's cancer detection software is developed using its proprietary QUALIA INSIGHT(TM) software development platform and technology. The Qualia Insight platform includes tools and programming structures that support and enhance the rapid creation and testing of computer solutions, which learn from and apply existing examples of a condition like breast cancer to support the review and decision of professionals seeking to identify that condition in practical medical applications. The Company believes that use of its Qualia Insight platform offers several key benefits over CAD products currently offered by its competitors, including reduced development time for initial software releases, reduced development time and increased opportunity for continuous product improvements and reduced development time and increased opportunity to apply core computer aided detection technology to CAD for lung and colon cancers and other applications. iCAD and CADx have been responsible for a range of innovations in CAD products, including: o the first system offering a clear upgrade path from film-based to digital mammography workflows o the first and only CAD system to search for and mark clinical asymmetries o the first system to offer printed CAD results o the first free-standing, eye-level radiologist review station o the ability to choose between soft copy and printed CAD results o the first system to offer multiple radiologist viewing stations o the first system to support up to twelve films in a patient study o the first system to report above each image the number of marks made by the CAD system o the first and only system that provides integration of relational database technologies to ensure patient history tracking and enhance integration with other information systems. 6 Other innovations incorporated into the Company's CAD products include the first use of bar code labels to improve workflow and reduce errors in case tracking; the first system to use the facility's own barcodes to identify and link to CAD results; the first system to integrate with a Mammography Information System, the first CAD system to offer an HL-7 interface to the medical facility's information system; the first CAD system supporting open architecture, standardized protocols and accessible data interfaces; the ability to share digitizers between CAD and medical PACS systems; and the first and only dual digitizer CAD system. iCAD also delivered the first digitizer designed for mammography and women's health applications; the first and only support for distributed patient databases, allowing remote scanning and remote access to patient information and test results; the first and only support for remote patient entry; the first bi-directional support for hospital and mammography information systems; the first leveraged operating lease for CAD systems; and the first fully-featured CAD system available at a price under $70,000. The most recent version of the Company's cancer detection software, SECOND LOOK 6.0, was approved by the FDA in October 2003, with up to 96.2 percent overall cancer detection sensitivity. Specificity, a measure of the number of marks created that do not represent an actual cancer, was as low as 1.6 False Positives (FP) per case. Increasingly, potential purchasers are considering marker rate in their buying decision. The performance of the Company's Second Look 6.0 cancer detection software represents a substantial reduction in markers over its previous cancer detection software, and compares favorably with the marking performance of its competitors. The innovative design of iCAD's software allows it to operate at multiple sensitivity points, providing the Radiologist with a selectable range of detection sensitivity and specificity appropriate to their clinical setting. In certain of iCAD's products, Second Look 6.0 provides the user with a choice of three operating points, one with higher sensitivity, another with lower false marks, and a median selection that optimizes sensitivity and specificity. Under the leadership of Dr. Steven Rogers, Qualia's founder and iCAD's Chief Scientist, the Company's technologies are also being applied to the early detection of breast cancer using ultrasound; the early detection of lung cancer utilizing low-dose spiral Computed Tomography (CT) and the early detection of colon cancer utilizing CT. With support provided through the FY2004 Defense Appropriations Bill, iCAD has begun collaboration with the Walter Reed Army Medical Center and the Windber Research Institute in Windber, PA, to develop and evaluate 3D CAD technology for breast imaging based on existing CAD and pattern analysis techniques for conventional mammograms. One objective of this research project is to use ultrasound imaging to reduce biopsies which prove to be unnecessary. Research programs in cardiovascular disease applications are also in the planning stages. The Company has applied for over 46 patents relating to many aspects of CAD, cancer detection and medical digitizer design. To date, the Company has been granted 12 patents, including general method patents it believes relate to a broad portfolio of potential medical applications for CAD. 7 PRODUCTS The Company believes that the Second Look brand has the greatest brand equity and recognition of any iCAD brand in the CAD market. For this reason, it has combined its iQ, MammoReader and Second Look products into one "Second Look(R)" branded line of CAD devices. In doing so, the Company believes it has created the broadest and most comprehensive line of CAD products available from any company, and associated it with a single well recognized and appropriate model brand. Case capacity, work flow, user interface, upgradeability, digital extensions and price are among the benefits used to distinguish Second Look models. Primary product descriptions are as follow:
- -------------------------------------------------------------------------------------------- iCAD Model(1) Suggested (Previous Cases/ Retail Designation) Day Selected Benefits Price - -------------------------------------------------------------------------------------------- Second Look(R)200 Up to Our economical solution for lower volume, value $69,950 (iCAD iQ) 20 oriented customers. o Fully Automatic workflow and processing o Compact, easy to use and easy to maintain. - -------------------------------------------------------------------------------------------- Second Look 400 Up to Our modular, extensible, network-ready solution for $99,950 (MammoReader) 80 value-oriented customers. o Network options include immediate HL-7 hospital information system interface; bi-directional PenRad, MRS and MagView mammography information system interfaces; fully compliant DICOM file-save capability o Open platform Hub and spoke CAD architecture o Distributed case entry, case processing and case reading allows physicians to network between offices o Multiple case-entry options o Unsorted, continuous film-feed reduces errors o Support for bar-coded workflows for productivity o Asymmetry included as indicator of potential cancers o Optional Radiologist review stations available - --------------------------------------------------------------------------------------------
- -------- (1) Specific designations subject to change 8
Second Look 500 Up to Our clinically advanced solution for customers $139,950 (Second Look) 80 seeking the best detection performance available, with immediate support for digital mammography. o Immediate availability of Second Look 6.0 cancer detection software for superior clinical performance o Selectable operating points adjust sensitivity and marking rate o Immediate, clear and cost effective upgrade path to support digital mammography o Operator-friendly graphical user interface o Simplified film loading o Use of existing bar code labels provides patient record continuity o Support for up to 12 films per patient ID ensures all films are on one record number o "Stat" case sequencing provides immediate availability for selected cases o Optional Radiologist review stations o Current accessories include PenRad, MRS and MagView mammography information system interfaces; o Fully compliant DICOM file-save capability - -------------------------------------------------------------------------------------------- Second Look 402 Up to Our high case load, uptime assurance $149,950 300 solution for high-case volume . o Dual film digitizers increase throughput and reduce critical downtime. o Network options include immediate HL-7 hospital information system interface; bi-directional PenRad, MRS and MagView mammography information system interfaces; fully compliant DICOM file-save capability o Support for Digital Mammography planned o Asymmetry included as indicator of potential cancers o Optional Radiologist review stations available o Support for bar-coded workflows o Multiple case-entry options o Unsorted, continuous film-feed reduces errors o Open platform Hub and spoke CAD supported o Distributed case entry, case processing and case reading - -------------------------------------------------------------------------------------------- Second Look Digital Varies Our solution for Digital Mammography. $120,000 by o Integrated computer aided detection for General Digital Electric Medical Systems Senographe Digital System Mammography System; available from GE Medical Systems. o Integrated computer aided detection for Fischer Imaging Corporation full-field Digital Mammography System; available from Fischer Imaging Corporation o Support for additional digital mammography systems planned. - --------------------------------------------------------------------------------------------
9
- -------------------------------------------------------------------------------------------- Second Look AD Up to Our combined digital and film-based CAD solution. $330,000 150 o Combines benefits of Second Look 500 and Second mixed Look Digital. film o Available from OEM as a complete solution and as & an upgrade to select, existing Second Look digital solutions. - -------------------------------------------------------------------------------------------- MultiRAD(TM) N/A Radiographic film digitizer for $14,995 - Digitizer OEM, CAD, Picture Archiving and Communications (PACS) and telemedicine $19,995 applications. - -------------------------------------------------------------------------------------------- Fulcrum(TM)Digitizer N/A Radiographic film digitizer for OEM and CAD $21,995 applications. - --------------------------------------------------------------------------------------------
MARKETING & SALES MARKETING The Company competes aggressively in three definable divisions of the computer aided detection market. In the high end part of the market, which accounts for most CAD purchases, to date, its Second Look 500 and dual digitizer CAD solutions are marketed on the basis of clinical superiority, productivity and value. New product models are planned to further address the demands and requirements of this market. The Company's competitor in this sector, historically the brand and market leader by virtue of a substantially longer period in the market and a substantially greater investment in advertising, marketing, and promotion, has in many cases been selected by a CAD purchaser without considering any alternatives. By coupling broader and more effective product distribution with improved marketing, including effective communication of the message that iCAD now offers more CAD alternatives than any other vendor, the Company believes it can substantially improve its market share in this division. The Company's first Second Look advertising, supported by complementary trade show participation, began in February 2004. One of the benefits of the merger is that the Company has increased its advertising and marketing efforts, while reducing overall the previous aggregate marketing budgets of the companies. Samples of the Company's advertising can be found on its website at www.icadmed.com. Information in its website is not part of this report. In the lower case volume division of the CAD market, where price and ease of use are key buying factors, the Company believes it is well positioned with the introduction of its iCAD iQ (now renamed Second Look 200) computer aided detection product. The Company's objective is to secure a leading market share in this newer market area. iCAD believes that the Second Look 200 is a category-defining CAD system, in the sense that it is the first product on the market that will allow lower-volume clinics to provide CAD services to women on a cost-effective basis. The Second Look 200 is simple to operate and self-training in nature, has been designed to fit within the limited space requirements of smaller mammography clinics, and is priced below currently available CAD systems. Commencing in the second quarter of 2004, the Company expects to undertake targeted advertising and marketing aimed specifically at promotion of Second Look 200 sales. 10 Furthermore, as early as the second quarter of 2004, the Second Look 200 will be made available to mammography facilities that cannot afford the outright purchase of a CAD system, through a simple `fee-per-procedure' program that the Company has already announced and branded ClickCAD(TM). Under the ClickCAD program, the Company plans and expects to install Second Look 200 systems in qualified mammography clinics at little or no up-front capital cost. The clinics will then pay iCAD a fee approximating $6.50 for each CAD procedure performed, an amount that represents less than 35% of the current standard $19.13 Federal reimbursement rate for CAD procedures. The Company believes that this program will allow mammography clinics to improve the health care delivered to women at risk, strengthen their marketing position in attracting and keeping patients concerned about breast cancer, reduce the legal risks associated with failure to detect early-stage cancers, and increase their net revenues. The Company has gained current sales leadership in the digital mammography division of the CAD market through an OEM sales relationship with General Electric Medical Systems and a new OEM sales relationship with Fischer Imaging Corporation. The Company's objective in this market sector is to provide exceptional support and service to its OEM customers and their end users, while continuing to expand product offerings and OEM sales channels. SALES Effective February 1, 2004, the Company consolidated its full-line sales channels to best promote and support its broad Second Look product line. iCAD Second Look products are now distributed nationally, on a non-exclusive basis, by SourceOne HealthCare Technologies, Inc., and by additional independent resellers, including members of the National Imaging Resellers (NIR) dealer group and Merry X-Ray Corporation. Overall, some 200 field sales personnel are now available to represent and promote iCAD products in the United States. SourceOne Healthcare Technologies, Inc. is the largest distributor of healthcare imaging equipment, supplies, accessories and services in the United States, and a supplier to all major medical group purchasing organizations, or GPOs. Previously, SourceOne was the primary sales channel for CAD products offered by R2 Technologies, Inc., the Company's competitor. Overall, SourceOne has sold and installed some 400 CAD systems for all of the companies that it has acted as a distributor, representing 25%-35% of all film-based CAD systems sold and installed in the United States, to date. To effectively support iCAD's expanded field sales presence, the Company has consolidated its field sales teams into nine geographic regions, each with a locally-based Regional Sales Manager responsible for all reseller and OEM sales activities in his or her region. The Company maintains a National Accounts Sales Manager to work with and support group purchasing activities and accounts, including iCAD's current relationships with Kaiser Permanente, Premier; Healthcare Services of New England; Radiology Partners, Inc.; MAGNET, Inc.; HealthTrust Purchasing; CareCore; and Consorta, Inc. 11 The Company's Second Look 200 system was introduced to the market in limited quantities at the end of 2003 and will be more broadly available beginning in the second quarter of 2004. Because the Second Look 200 system is designed to meet the needs of a broad population of lower-case-volume clinics, the Company has established a separate category of resellers, including many Merry X-Ray sales offices that will focus exclusively on promotion of the 200 product and its associated ClickCAD marketing program. The Company expects that SourceOne, with its well-developed direct marketing and telemarketing capabilities, will make an effective contribution to the 200 and ClickCAD promotional and sales achievements. The Company is currently upgrading the Second Look 200 model to include the new Second Look 6.0 cancer detection software, which improves cancer detection and reduces marking of areas that are not cancers. The Company believes this software upgrade is particularly valuable in lower-volume and fee-for-service applications, because the reduced marker rate will make training and use of the Second Look 200 easier. Expanded promotion of the Second Look 200 system and introduction of the ClickCAD fee per procedure program will follow this near-term product upgrade. During the fourth quarter of 2003, CADx Systems' began distribution of products for digital mammography through General Electric Medical Systems and Fischer Imaging Corporation. The Company expects to continue to market such products through its existing OEM relationships, and iCAD's objective is to secure additional OEM relationships that can contribute to the sales growth in 2004. COMPETITION The Company currently faces direct competition from R2 Technology, Inc., which received FDA approval to market its CAD systems for use in mammography screening and diagnostics substantially before iCAD. Historically, R2 has been considered the market leader. As a result of the Company's recent merger with Qualia and its CADx subsidiaries, the Company believes that iCAD now offers the broadest range of CAD solutions available, with performance equivalent or superior to its competitor's. With greatly expanded sales and distribution channels, the Company believes it is increasingly well positioned to compete with R2. Kodak, Inc. has recently announced that it has received an approvable letter from the FDA that is the precursor to receipt from the FDA of approval for it to market a mammography CAD solution. The Company also expects that other potential manufacturers will receive FDA approval to market competing CAD products in the near future. RISK FACTORS THE COMPANY'S BUSINESS IS SUBJECT TO A NUMBER OF RISKS INCLUDING THE RISKS SET FORTH BELOW. THE COMPANY HAS INCURRED SIGNIFICANT LOSSES AND THERE CAN BE NO ASSURANCE THAT THE COMPANY WILL BE ABLE TO ACHIEVE PROFITABILITY. 12 As of December 31, 2003, the Company has incurred losses in excess of $70 million in the aggregate since its inception, including a net loss of approximately $8.5 million during the year ended December 31, 2003. There can be no assurance that the Company will be able to achieve profitability. THE COMPANY'S MEDICAL DIGITIZER BUSINESS HAS BEEN ADVERSELY AFFECTED BY THE COMPANY'S ACQUISITION AND COMMERCIALIZATION OF A CAD PRODUCT LINE. Prior to acquisition of a CAD product line, the Company promoted its medical digitizer line to a variety of current and prospective customers offering or seeking to offer their own CAD products. With the acquisition of a CAD product line, the Company has entered into a competitive or potentially competitive position with respect to such current and prospective customers, which has, in some cases, led current and prospective customers to seek alternative suppliers of medical digitizers. The Company's sales and marketing efforts, moreover, have concentrated on CAD products during 2002 and 2003, and the Company has limited development and support of its medical digitizer product channels during this time. There can be no assurance that the Company's sales and marketing efforts will result in increased sales of CAD products or that sales of the Company's medical digitizer products will not continue to decline. THE COMPANY MAY NEED ADDITIONAL FINANCING TO IMPLEMENT ITS STRATEGY AND EXPAND ITS BUSINESS. The Company may need additional debt or equity financing to pursue its strategy and increase sales in the medical markets. Any financing that the Company needs may not be available at all and, if available, may not be available on terms that are acceptable to the Company. The failure to obtain financing on a timely basis, or on economically favorable terms, could prevent the Company from continuing its strategy or from responding to changing business or economic conditions, and could cause the Company to experience difficulty in withstanding adverse operating results or competing effectively. BECAUSE A PORTION OF THE COMPANY'S SALES ARE OUTSIDE THE UNITED STATES, THE COMPANY IS SUBJECT TO ADDITIONAL RISKS, INCLUDING DEVALUATIONS OF FOREIGN CURRENCIES, INSTABILITY IN KEY GEOGRAPHIC MARKETS, TARIFFS AND OTHER TRADE BARRIERS WHICH ARE NOT WITHIN THE COMPANY'S CONTROL. The Company's international sales subject the Company to the risk of loss in the event of devaluation of foreign currencies in which sales are made between the time of contract and payment. The Company does not enter into currency hedging transactions. In addition, the Company's international sales would be adversely affected by political, social or economic instability or the imposition of tariffs and other trade barriers in the geographic markets in which it sells its products. BECAUSE THE COMPANY FACES INTENSE COMPETITION FOR ITS PRODUCTS, PRICE DISCOUNTING OFTEN OCCURS AND MAY ADVERSELY AFFECT THE COMPANY'S OPERATING RESULTS. 13 The Company competes with a variety of companies for sales of its medical imaging products. As a result, discounting among manufacturers and distributors of the Company's products is intense. Increased price discounting could adversely effect the Company's gross margins and operating results. The Company cannot give any assurance that it will be able to effectively compete in the future or that it will not be required to discount its products to increase sales. THE COMPANY'S PRODUCTS MAY BECOME OBSOLETE. The Company's ability to compete effectively will depend, in large part, on its ability to offer state of the art products. The Company's competitors might develop and sell new products that are technically superior to the Company's current product line that could result in the Company's inability to sell existing products or its inability to sell its products without offering a significant discount. The Company cannot give any assurance that its products will not become obsolete in the future or that it will be able to upgrade its product line or introduce new products if required. THE COMPANY DEPENDS UPON A LIMITED NUMBER OF SUPPLIERS AND MANUFACTURERS FOR ITS PRODUCTS, AND CERTAIN COMPONENTS IN ITS PRODUCTS MAY BE AVAILABLE FROM A SOLE OR LIMITED NUMBER OF SUPPLIERS. The Company's products are generally either manufactured and assembled for it by a sole manufacturer, by a limited number of manufacturers or assembled by the Company from supplies it obtains from a limited number of suppliers. Critical components required to manufacture these products, whether by outside manufacturers or directly, may be available from a sole or limited number of component suppliers. The Company generally does not have long-term arrangements with any of its manufacturers or suppliers. The loss of a sole or key manufacturer or supplier would impair the Company's ability to deliver products to customers in a timely manner and would adversely affect the Company's sales and operating results. The Company's business would be harmed if any of its manufacturers or suppliers could not meet the Company's quality and performance specifications and quantity and timing requirements. 14 PROVISIONS OF THE COMPANY'S CORPORATE CHARTER DOCUMENTS AND DELAWARE LAW COULD DELAY OR PREVENT A CHANGE OF CONTROL. The Company's certificate of incorporation authorizes the board of directors to issue up to 1,000,000 shares of preferred stock. The preferred stock may be issued in one or more series, the terms of which may be determined at the time of issuance by the Company's s board of directors, without further action by stockholders, and may include, among other things, voting rights (including the right to vote as a series on particular matters), preferences as to dividends and liquidation, conversion and redemption rights, and sinking fund provisions. There are two series of preferred stock currently outstanding which have dividend and liquidation preferences over the Company's common stock. In addition, specific rights granted to future holders of preferred stock could be used to restrict the Company's ability to merge with, or sell its assets to a third party. The ability of the Company's board of directors to issue preferred stock could discourage, delay, or prevent a takeover of the Company thereby preserving control by the current stockholders. As a Delaware corporation, the Company is subject to the General Corporation Law of the State of Delaware, including Section 203, an anti-takeover law enacted in 1988. In general, Section 203 restricts the ability of a public Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder. Subject to exceptions, an interested stockholder is a person who, together with affiliates and associates, owns, or within three years did own, 15% or more of a corporation's voting stock. As a result of the application of Section 203, potential acquirers may be discouraged from attempting to acquire the Company, thereby possibly depriving its stockholders of acquisition opportunities to sell or otherwise dispose of its stock at above-market prices typical of acquisitions. THE PRICE OF THE COMPANY'S COMMON STOCK COULD BE VOLATILE. The Company's common stock is quoted on the NASDAQ SmallCap Market which has experienced, and is likely to experience in the future, significant price and volume fluctuations which could adversely affect the market price of the Company's common stock without regard to the operating performance. In addition, the trading price of the Company's common stock could be subject to significant fluctuations in response to actual or anticipated variations in the Company's quarterly operating results announcements by the Company or its competitors, factors affecting the medical imaging industry generally, changes in national or regional economic conditions, changes in securities analysts' estimates for the Company's competitors' or industry's future performance or general market conditions. The market price of the Company's common stock could also be affected by general market price declines or market volatility in the future or future declines or volatility in the prices of stocks for companies in the Company's industry. THE COMPANY IS SUBJECT TO EXTENSIVE REGULATION WITH POTENTIALLY SIGNIFICANT COSTS FOR COMPLIANCE. The iCAD system for computer aided detection of breast cancer is a medical device subject to extensive regulation by the FDA under the Federal Food, Drug, and Cosmetic Act. The FDA's regulations govern, among other things, product development, product testing, product labeling, product storage, pre-market clearance or approval, advertising and promotion, and sales and distribution. Unanticipated changes in existing regulatory requirements or adoption of new requirements could, following the merger, adversely affect the Company's business, financial condition and results of operations. 15 The FDA's Quality System Regulation requires that the Company's manufacturing operations follow elaborate design, testing, control, documentation and other quality assurance procedures during the manufacturing process. The Company is subject to FDA regulations covering labeling regulations, adverse event reporting, and the FDA's general prohibition against promoting products for unapproved or off-label uses. The Company's manufacturing facilities are subject to periodic unannounced inspections by the FDA and corresponding state agencies and international regulatory authorities for compliance with extensive regulatory requirements. Although the Company believes its manufacturing facilities are currently in compliance with applicable requirements, there can be no assurance that the FDA, following an inspection of these manufacturing facilities, would determine that they are in full compliance. The Company's failure to fully comply with applicable regulations could result in the issuance of warning letters, non-approvals, suspensions of existing approvals, civil penalties and criminal fines, product seizures and recalls, operating restrictions, injunctions, and criminal prosecution. In order to market and sell its CAD products in certain countries outside of the United States the Company must obtain and maintain regulatory approvals and comply with the regulations of those countries. These regulations, including the requirements for approvals, and the time required for regulatory review, vary from country to country. Obtaining and maintaining foreign regulatory approvals is an expensive and time consuming process. The Company cannot be certain that it will be able to obtain the necessary regulatory approvals timely or at all in any foreign country in which it plans to market its CAD products, and if the Company fails to receive such approvals, its ability to generate revenue may be significantly diminished. THE COMPANY MAY NOT BE ABLE TO OBTAIN REGULATORY APPROVAL FOR ANY OF THE OTHER PRODUCTS THAT IT MAY CONSIDER DEVELOPING. The Company has received FDA approvals only for its currently offered iCAD products. Before the Company is able to commercialize any other product, the Company must obtain regulatory approvals for each indicated use for that product. The process for satisfying these regulatory requirements is lengthy and will require the Company to comply with complex standards for research and development, testing, manufacturing, quality control, labeling, and promotion of products. THE COMPANY'S PRODUCTS MAY BE RECALLED EVEN AFTER THEY HAVE RECEIVED FDA APPROVAL OR CLEARANCE. 16 If the safety or efficacy of the Company's products is called into question, the FDA and similar governmental authorities in other countries may require the Company to recall its products. This is true even if a Company product received approval or clearance by the FDA or a similar governmental body. Such a recall could be the result of component failures, manufacturing errors or design defects, including defects in labeling. Such a recall would divert the focus of the Company's management and its financial resources and could materially and adversely affect its reputation with customers. REFORMS IN REIMBURSEMENT PROCEDURES BY MEDICARE OR OTHER THIRD-PARTIES MAY ADVERSELY AFFECT THE COMPANY'S BUSINESS. In the United States, Medicare and a number of commercial third-party payers provide reimbursements for the use of CAD in connection with mammography screening and diagnostics. In the future, however, these reimbursements may be unavailable or inadequate due to changes in applicable legislation or regulations, changes in attitudes toward the use of mammograms for broad screening to detect breast cancer or due to changes in the reimbursement policies of third-party payers. As a result, healthcare providers may be unwilling to purchase the Company's CAD products or any of the Company's future products, which could significantly harm the Company's business, financial condition and operating results. Acceptance of the Company's products outside of the United States depends, in part, upon the availability of similar reimbursements in the markets in which the Company intends to focus its international marketing activities. Reimbursements and health insurance systems in markets outside of the United States vary from country to country. If the Company is unable to qualify its products for reimbursement outside of the United States, the Company may not be able to gain international market acceptance for its products. There is no guaranty that any of the products which the Company contemplates developing will become eligible for reimbursements or health insurance coverage in the United States or abroad at favorable rates or even at all or maintain eligibility. THE SALES CYCLE FOR THE COMPANY'S PRODUCTS IS LENGTHY AND UNPREDICTABLE AND ITS QUARTERLY RESULTS WILL BE UNPREDICTABLE. Many of the customers of the Company's medical imaging products are institutional organizations, such as hospitals, with significant purchasing power and cyclical ordering practices. Although the Company's CAD system is currently less expensive than the devices of its competitors, the purchase of the iCAD CAD system requires a material capital expenditure that will likely require approval of the Company's customers' senior management and result in a lengthy sales and purchase order cycle. Consequently, the Company may be unable to accurately estimate its manufacturing and support requirements. The Company's larger institutional customers may also demand discounted prices on the Company's products. As a result, the Company's actual sales may differ significantly from its estimated sales and the Company may incorrectly allocate its resources. If the Company is unable to accurately project sales and allocate corresponding resources, it may incur substantial fluctuations in its operating results for any given quarter. 17 Even if the Company is able to achieve profitability in future fiscal periods, it may occur in a quarter with concentrated revenue. In that case, the Company would expect reduced revenue in the following quarter or quarters, and possibly a quarterly loss or quarterly losses. As a result, stockholders may not be able to rely upon the Company's operating results in any particular period as an indication of future performance. THE MEDICAL EQUIPMENT INDUSTRY IS LITIGIOUS, AND THE COMPANY HAS BEEN AND MAY BE SUED AGAIN FOR ALLEGEDLY VIOLATING THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS. The medical technology industry is characterized by a substantial amount of litigation and related administrative proceedings regarding patents and intellectual property rights. In addition, major medical device companies have used litigation against emerging growth companies as a means of gaining a competitive advantage. From time to time, the Company may learn of allegations or threats from third parties drawing its attention to their patent rights. There may be patent rights of which the Company is presently unaware. The Company anticipates that the costs associated with its legal defense against claims of patent infringement by a competitor in the CAD industry will have a material and adverse effect on its financial condition during the period of the litigation. Should third parties file patent applications or be issued patents claiming technology also claimed by the Company in pending applications, the Company may be required to participate in interference proceedings in the U.S. Patent and Trademark Office to determine the relative priorities of its inventions and the third parties' inventions. The Company could also be required to participate in interference proceedings involving any patents which may be issued to the Company and pending applications of another entity. An adverse outcome in an interference proceeding could require the Company to cease using the technology or to license rights from prevailing third parties. The Company is also aware of third parties whose business involves the use of CAD systems. Certain of these parties have issued patents or pending patent applications on technology that they may assert against the Company. Third parties may claim the Company is using their patented inventions and may go to court to stop the Company from engaging in its normal operations and activities. These lawsuits are expensive to defend and conduct and would also consume and divert the time and attention of the Company's management. A court may decide that the Company is infringing a third party's patents and may order it to cease the infringing activity. The court could also order the Company to pay damages for the infringement. These damages could be substantial and could harm the Company's business, financial condition and operating results. If the Company is unable to obtain any necessary license following a determination of infringement or an adverse determination in litigation or in interference or other administrative proceedings, the Company would have to redesign its products to avoid infringing a third party's patent and could temporarily or permanently have to discontinue manufacturing and selling some of its products. If this were to occur, it would negatively impact future revenue and would have a material adverse effect on the Company's business, financial condition and results of operations. 18 THE COMPANY MAY BE UNABLE TO PROTECT ITS INTELLECTUAL PROPERTY RIGHTS AND, CONSEQUENTLY, THE COMPANY'S COMPETITORS MAY BENEFIT FROM THE COMPANY'S EFFORTS AND COMPETE DIRECTLY AGAINST THE COMPANY. Presently, patent applications have been filed for aspects of the proprietary technology employed by the Company in its CAD and medical digitizer products. The Company's patent applications, or any patents which may be issued to it, may be challenged, invalidated or circumvented by third parties. Any patent ultimately issued to the Company may not be in a form that will be beneficial to the Company. To the extent the Company is unable to adequately protect any of the intellectual property used in connection with its current or any future products, competitors may take advantage of the situation and produce competing products, which could harm the Company's competitive position and ultimately harm its operating results. The Company also relies on a combination of copyright, trade secret and trademark laws, and nondisclosure, confidentiality agreements and other contractual restrictions to protect its proprietary technology. However, these legal means afford only limited protection and may not adequately protect the Company's rights or permit it to gain or keep any competitive advantage. The Company may not be able to prevent the unauthorized disclosure or misappropriation of its technical knowledge or other trade secrets by employees. If that were to occur, the Company's proprietary technologies and software applications would lose value and the Company's business, results or operations and financial condition could be materially adversely affected. Adverse events could undermine the Company's efforts to protect its intellectual property. The Company's competitors may be able to develop competing technologies or products that do not infringe any of the Company's intellectual property rights. Even if a competitor infringes the Company's intellectual property rights, the Company may be unable to bring, or prevail in, a suit to protect its rights. Furthermore, the laws of some foreign countries may not adequately protect the Company's intellectual property rights. As a result of all of these factors, the Company's efforts to protect its intellectual property may not be adequate, and the Company's competitors may independently develop similar competing technologies or products, duplicate the Company's products, or design around the Company's intellectual property rights. This would harm the Company's competitive position, decrease its market share, or otherwise harm its business. THE COMPANY MAY BE UNABLE TO SECURE LICENSES FOR ANY TECHNOLOGY WHICH MAY BE NECESSARY TO IMPROVE CURRENT OR FUTURE PRODUCTS. It is likely that the technology underlying the Company's existing and planned products may be fundamentally improved and that the resulting technology may be owned by third parties. As a result, the Company may be required to obtain licenses to this new technology to improve its current or future products. The cost of licensing such technology may significantly increase the unit cost of its products. 19 The Company may be unable to obtain favorable terms for licenses for this new technology or, alternatively, the owners of the technology may refuse to license it to the Company in order to maintain their own competitive advantage. In either case, the Company's products may not be competitive with the products manufactured by others. Even if the Company were able to obtain rights to a third party's patented intellectual property, these rights may be non-exclusive, thereby giving the Company's competitors access to the same intellectual property. SOME STUDIES HAVE QUESTIONED THE EFFICACY OF USING MAMMOGRAPHY AS A METHOD TO REDUCE MORTALITY. IF MAMMOGRAPHY PROVES TO BE LESS EFFECTIVE, THE COMPANY'S BUSINESS WOULD BE SERIOUSLY HARMED. IN ADDITION, COMPETING TECHNOLOGIES COULD REPLACE MAMMOGRAPHY AS THE PREFERRED METHOD FOR SCREENING FOR BREAST CANCER. The Company is aware that the efficacy of screening mammography to reduce mortality has been questioned in several publications. Even if unproven, this could lead to a reduction in the use of mammography as a tool to detect breast cancer in the United States and abroad. If mammography is ultimately proven to be ineffective, or if recommendations for regular mammograms were eliminated or reduced, the Company's business would certainly be seriously harmed. The Company is also aware of companies that are developing alternatives to traditional breast cancer detection, including refractive light, thermal technologies, breast ultrasound, magnetic resonance imaging and non-imaging tests. THE COMPANY MAY BE EXPOSED TO SIGNIFICANT PRODUCT LIABILITY FOR WHICH THE COMPANY MAY NOT BE ABLE TO PROCURE SUFFICIENT INSURANCE COVERAGE. The Company's business exposes it to potential product liability risks which are inherent in the testing, manufacturing, marketing and sale of medical imaging devices. If available at all, product liability insurance for the medical device industry generally is expensive. Currently, the Company has liability insurance coverage which it deems appropriate for its current stage of development. No assurance can be given that this level of coverage will be adequate or that adequate insurance coverage will be available in sufficient amounts or at a reasonable cost in the future, or that a product liability claim would not have a material adverse effect on the Company. THE COMPANY MAY NOT BE ABLE TO SUCCESSFULLY IMPLEMENT ITS CURRENT BUSINESS MODEL OR EFFECTIVELY MANAGE ITS GROWTH. The Company only commenced generating revenue from the sale of its first CAD product in 2002. Sales of the Company's products may not generate sufficient cash to support the Company's future operations. There can be no assurance that adequate funds for the Company's operations, whether from the Company's revenues, financial markets, collaborative or other arrangements with corporate partners, if any, or from other sources, will be available when needed or on terms attractive to the Company. The inability to obtain sufficient funds may require the Company to delay, scale back or eliminate some or all of its development activities, clinical studies and/or regulatory activities or to license third parties to commercialize products or technologies that the Company would otherwise seek to develop itself. No assurance can be given that any future technologies or products that may be developed by the Company will be successfully developed, commercialized or accepted by the marketplace or that sufficient revenues will be realized to support operations or future research and development programs. 20 To address these risks, the Company must, among other things, establish, maintain and increase its relationships with radiologists and other members of the health care industry, implement and successfully execute the Company's business and marketing strategies, respond to competitive developments, and attract, retain and motivate qualified personnel. There can be no assurance that the Company will be successful in addressing such risks, and the failure to do so could have a material adverse effect on the Company's business, financial condition and results of operations. THE COMPANY'S FUTURE PROSPECTS DEPEND ON ITS ABILITY TO RETAIN CURRENT KEY EMPLOYEES AND ATTRACT ADDITIONAL QUALIFIED PERSONNEL. The Company's success depends in large part on the abilities and continued service of the Company's executive officers and other key employees. The Company may not be able to retain the services of its executive officers and other key employees. The loss of executive officers or other key personnel could have a material adverse effect on the Company. In addition, in order to support the Company's continued growth, the Company will be required to effectively recruit, develop and retain additional qualified personnel. If the Company is unable to attract and retain additional necessary personnel, it could delay or hinder the Company's plans for growth. Competition for such personnel is intense, and there can be no assurance that the Company will be able to successfully attract, assimilate or retain sufficiently qualified personnel. The failure to retain and attract necessary personnel could have a material adverse effect on the Company's business, financial condition and results of operations. SOME OF THE COMPANY'S COMPETITORS HAVE SIGNIFICANTLY GREATER RESOURCES AND MAY PREVENT THE COMPANY FROM ACHIEVING OR MAINTAINING SIGNIFICANT MARKET SHARE. AS THE MARKET FOR CAD GROWS, COMPETITION FOR MAMMOGRAPHY PRODUCTS WILL LIKELY INCREASE. The medical equipment market is highly competitive and changes rapidly. Competitors in this market are highly sensitive to the introduction of new products and competitors. Other well known medical imaging equipment manufacturers have explored the possibility of introducing their own versions of CAD products into the market. Because many of these companies have significantly greater resources than the Company has, they may be able to respond more quickly to the evolving and emerging technologies in the market and they may be better suited to respond the changing needs of their customers. The financial strength of many of these companies may enable them to develop their own proprietary CAD products or acquire the Company's competitors to bring competing products to market more quickly. Additionally, some of these companies benefit from name recognition, established relationships with healthcare professionals, diversified product lines, established distribution channels, and greater product development, manufacturing, and sales and marketing resources. The Company currently faces direct competition from R2 Technology, Inc., which received FDA approval to market its CAD systems for use in mammography screening and diagnostics substantially before iCAD. The Company expects that as the market for CAD grows, other competitors may seek to introduce CAD products priced even lower than the Company. Customers seeking a low-cost CAD solution may prefer a competitor's lower-priced product to the Company's and may result in pricing cutting by the Company which will reduce its profit margin. 21 GOVERNMENT REGULATION The Company is subject to extensive regulation with potentially significant costs for compliance. The iCAD system for computer aided detection of breast cancer is a medical device subject to extensive regulation by the FDA under the Federal Food, Drug, and Cosmetic Act. The FDA's regulations govern, among other things, product development, product testing, product labeling, product storage, pre-market clearance or approval, advertising and promotion, and sales and distribution. Unanticipated changes in existing regulatory requirements or adoption of new requirements could adversely affect the Company's business, financial condition and results of operations. The FDA's Quality System Regulation requires that the Company's manufacturing operations follow elaborate design, testing, control, documentation and other quality assurance procedures during the manufacturing process. The Company is subject to FDA regulations covering labeling regulations, adverse event reporting, and the FDA's general prohibition against promoting products for unapproved or off-label uses. The Company's manufacturing facilities are subject to periodic unannounced inspections by the FDA and corresponding state agencies and international regulatory authorities for compliance with extensive regulatory requirements. Although the Company believes its manufacturing facilities are currently in compliance with applicable requirements, there can be no assurance that the FDA, following an inspection of these manufacturing facilities, would determine that they are in full compliance. The Company's failure to fully comply with applicable regulations could result in the issuance of warning letters, non-approvals, suspensions of existing approvals, civil penalties and criminal fines, product seizures and recalls, operating restrictions, injunctions, and criminal prosecution. In order to market and sell its CAD products in certain countries outside of the United States the Company must obtain and maintain regulatory approvals and comply with the regulations of those countries. These regulations, including the requirements for approvals, and the time required for regulatory review, vary from country to country. Obtaining and maintaining foreign regulatory approvals is an expensive and time consuming process. The Company cannot be certain that it will be able to obtain the necessary regulatory approvals timely or at all in any foreign country in which it plans to market its CAD products, and if the Company fails to receive such approvals, its ability to generate revenue may be significantly diminished. The Company may not be able to obtain regulatory approval for any of the other products that it has considered developing. The Company has received FDA approvals only for its currently offered iCAD products. Before the Company is able to commercialize any other product, the Company must obtain regulatory approvals for each indicated use for that product. The process for satisfying these regulatory requirements is lengthy and will require the Company to comply with complex standards for research and development, testing, manufacturing, quality control, labeling, and promotion of products. 22 The Company's products may be recalled even after it has received FDA approval or clearance. If the safety or efficacy of the Company's products are called into question, the FDA and similar governmental authorities in other countries may require the Company to recall its products. This is true even if the Company has previously received approval or clearance by the FDA or a similar governmental body. Such a recall could be the result of component failures, manufacturing errors or design defects, including defects in labeling. Such a recall would divert the focus of the Company's management and its financial resources and could materially and adversely affect its reputation with customers. SOURCES AND AVAILABILITY OF MATERIALS The Company depends upon a limited number of suppliers and manufacturers for its products, and certain components in its products may be available from a sole or limited number of suppliers. The Company's products are generally either manufactured and assembled for it by a sole manufacturer, by a limited number of manufacturers or assembled by the Company from supplies it obtains from a limited number of suppliers. Critical components required to manufacture these products, whether by outside manufacturers or directly, may be available from a sole or limited number of component suppliers. The Company generally does not have long-term arrangements with any of its manufacturers or suppliers. The loss of a sole or key manufacturer or supplier would impair the Company's ability to deliver products to customers in a timely manner and would adversely affect the Company's sales and operating results. The Company's business would be harmed if any of its manufacturers or suppliers could not meet the Company's quality and performance specifications and quantity and timing requirements. PATENTS AND LICENSES The Company has several patents covering its CAD and scanner technologies in the United States and certain foreign countries. These patents help the Company maintain a proprietary position in these markets, 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 domestically and internationally, and plans to file additional domestic and foreign applications when it believes such protection will benefit the Company. These patent applications relate to computer aided detection technology and to digitizer technology. 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. 23 To date, iCAD has applied for over 44 patents relating to current and future medical applications for iCAD's technology and products. The Company has been granted 14 patents, including a broad set of claims covering the combination computer analysis of mammography data and a human analysis of that same data in breast cancer detection, and extensions of the same concept from mammography to other medical imaging applications. 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. In February 2003 iCAD secured a patent license to United States, Canadian, and Japanese patents owned by Scanis, Inc., which relate broadly to computer aided detection of breast cancer. Rights to a European patent application covering similar inventions are also included. In conjunction with the patent license to iCAD, scanis entered into a multi-year, exclusive digitizer supply agreement with iCAD's wholly owned subsidiary, Howtek Devices Corporation. In consideration for the patent license from Scanis, Inc. the Company granted discounts to scanis with respect to future purchases of the Company's digitizer products. 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). MAJOR CUSTOMERS During the years ended December 31, 2003 and 2002 the Company had sales of $2,921,535 and $2,631,709, or 45% and 53% of sales, respectively, to Instrumentarium Imaging, Inc. and an accounts receivable balance of $156,003 and $1,190,990, respectively, due from this customer at December 31, 2003 and 2002. The Company did not have any major customers in 2001. 24 MANUFACTURING, CUSTOMER SUPPORT AND SERVICE The Company's New Hampshire facility is certified as a medical manufacturing facility by the FDA and complements three experienced contract manufacturing resources (two in New England and one in Colorado) that the Company uses to manufacture and assemble its products. The Company has manufactured complex professional or medical products, directly and through contract, since 1986. As part of the acquisition of CADx, iCAD will provide an increasing range of customer support resources through its 24-hour on-line web site and a centralized customer help desk, which deals with customer questions and issues, manages return-to-factory service requests, and dispatches and monitors field service operations from 8AM to 8PM EST on business days. The Company has centralized its front-line customer help service in its Ohio office, taking advantage of the existing, sophisticated phone and information systems available there. ENGINEERING AND PRODUCT DEVELOPMENT The Company spent $2,384,057, $1,626,001, and $751,467 on research and development activities during the years ended December, 2003, 2002 and 2001, respectively. The research and development expenses for 2003 are primarily attributed to the development of the Company's new Second Look 200 (formerly the iCAD iQ(TM) model), the Company's Fulcrum medical film digitizer and software development to support its CAD products. EMPLOYEES On March 1, 2004 the Company had 110 full and part-time employees. As a result of planned cost-reduction measures designed to improve the Company's operating results, implemented during the first quarter of 2004 and taking effect March 31, 2004, the Company expects to have reduced its workforce on such date to 71 full and part-time employees. 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, 2003 was approximately $863,000 as compared to approximately $338,000 on the corresponding date in 2002. Approximately $755,000 of the backlog, and orders believed to be firm, is as a result of the merger with CADx. 25 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. FINANCIAL 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 were $289,000 or 4% of total sales in 2003, $301,000 or 6% of total sales in 2002 and $944,000 or 20% of total sales in 2001. The Company's principal concentration of export sales was in Australia, which accounted for 35% of the Company's export sales in 2003 and 2001, with Europe accounting for 26% of the Company's export sales in 2002. The balance of the export sales was into Canada and the Far East. 26 ITEM 2. PROPERTIES The Company's principal executive office is located at 4 Townsend West, Suite 17, Nashua, New Hampshire. The facility consists of approximately 9,000 square feet of manufacturing, research and development and office space and is leased by the Company pursuant to a lease which expires December 31, 2006 at an annual rent of approximately $69,000. The Company leases a facility for its software research and development group located at 4902 Eisenhower Blvd, Suite 185, Tampa, Florida. The facility consists of approximately 2,670 square feet of research and development and office space and is leased by the Company pursuant to a lease, which expires July 31, 2007 at an annual rent of approximately $53,000. Additionally, the Company is required to pay real estate taxes and provide insurance. In addition, as a result of its acquisition of CADx on December 31, 2003, the Company leases a facility for its software research and development, customer service and administrative offices located at 2689 Commons Blvd, Suite 100, Beavercreek, Ohio. The facility consists of approximately 26,000 square feet of research and development and office space and is leased by the Company pursuant to a lease, which expires December, 2010 at an annual rate of approximately $416,000. Additionally, the Company is required to provide insurance and to pay real estate taxes, utilities, common area maintenance, cleaning and security. The lease amount increases annually throughout the life of the lease. The lease may be renewed for two additional terms of five years each. 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 27 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 "ICAD". The following table sets forth the range of high and low sale prices for each quarterly period during 2003 and 2002. Fiscal year ended High Low ---- --- December 31, 2003 - ----------------- First Quarter $2.490 $1.400 Second Quarter 2.440 1.630 Third Quarter 3.300 1.920 Fourth Quarter 6.610 2.510 Fiscal year ended December 31, 2002 First Quarter $3.500 $1.420 Second Quarter 3.250 2.010 Third Quarter 3.170 .950 Fourth Quarter 2.800 1.030 As of March 18, 2004 there were 348 holders of record of the Company's Common Stock. In addition, the Company believes that there are in excess of 700 holders of the Common Stock whose shares are held in "street name". 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 have dividend rights that are senior to holders of Common Stock. In connection with the December 31, 2003 acquisition by iCAD, Inc. of Qualia Computing, Inc. and its subsidiaries, including CADx Systems, Inc., iCAD issued to certain of the holders of the common stock, $.00001 par value of Qualia Computing, Inc., an aggregate of 4.3 million shares of iCAD common stock for their outstanding shares of Qualia Computing, Inc. held by them immediately prior to the Merger. The iCAD shares were issued in reliance on the exemptions from registration under Section 4(2) of the Securities Act of 1933 and Regulation D promulgated thereunder. See Item 7 Liquidity and Capital Resources for certain information regarding sales of the equity securities in a private placement on November 24, 2003, which sales were made pursuant to Section 4(2) and Regulation D of the Securities Act of 1933. See Item 12 for certain information with respect to the Company's equity compensation plans in effect at December 31, 2003. 28 ITEM 6. SELECTED FINANCIAL DATA
SELECTED STATEMENT OF OPERATIONS DATA YEAR ENDED DECEMBER 31, -------------------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Sales $ 6,520,306 $ 5,000,184 $ 4,835,297 $ 7,793,517 $ 6,663,230 Gross margin 3,578,643 (161,459) 898,891 1,900,027 1,594,124 Total operating expenses (11,662,396) (9,208,664) (3,439,557) (3,595,661) (3,789,306) Loss from operations (8,083,753) (9,370,123) (2,540,666) (1,695,634) (2,195,182) Interest expense - net (114,655) (48,167) (80,105) (132,014) (1,801,646) Net loss (8,198,408) (9,418,290) (2,620,771) (1,827,648) (3,996,828) Net loss available to common stockholders (8,342,666) (9,566,340) (2,775,821) (2,896,520) (3,996,828) Net loss per share (0.31) (0.46) (0.20) (0.22) (0.32) Weighted average shares outstanding basic and diluted 26,958,324 20,928,397 13,950,119 13,373,086 12,660,613 SELECTED BALANCE SHEET DATA AS OF DECEMBER 31, -------------------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Total current assets $11,115,003 $ 3,116,665 $ 3,586,602 $ 5,082,016 $ 4,457,910 Total assets 62,662,136 26,077,356 4,161,125 5,945,928 5,696,609 Total current liabilities 7,705,351 4,313,690 2,003,807 2,143,873 2,019,340 Loans payable to related parties, including current portion 3,630,000 200,000 500,000 1,400,000 1,140,000 Note payable, including current portion 4,608,390 173,916 178,870 -- -- Convertible Subordinated Debentures, including current portion 10,000 10,000 10,000 117,000 117,000 Stockholders' equity 47,895,630 21,455,276 2,039,557 2,902,055 2,920,269
29 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. CRITICAL ACCOUNTING POLICIES AND ESTIMATES In May 2002, the SEC proposed disclosure rules that would require registrants to include in Management's Discussion and Analysis a separate section regarding the application of critical accounting policies that discloses the critical accounting estimates that are made by a registrant in applying its accounting policies and information concerning the initial adoption of certain accounting policies that have a material impact on a registrant's financial presentation. Note 1 of the Notes to the Consolidated Financial Statements includes a summary of the significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. The following is a brief discussion of the more significant accounting policies and methods used by the Company. The financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require the Company to make estimates and assumptions. On an on-going basis, the Company evaluates its estimates related to the allowance for doubtful accounts, inventory and warranty reserves and the estimated useful lives of its fixed and identifiable intangible assets. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions and may have a material effect on financial information. Revenue is recognized when products are shipped to customers, provided that there are no uncertainties regarding customer acceptance, there is persuasive evidence of an arrangement, the sales price is fixed or determinable and collection of the related receivable is probable. Long-lived assets, such as intangible assets, other than goodwill, and 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. Goodwill is not amortized and is evaluated for impairment at least annually. Accounts receivable are customer obligations due under normal trade terms. The Company performs continuing credit evaluations of its customers' financial condition and generally does not require collateral. Senior management reviews accounts receivable on a periodic basis to determine if any receivables will potentially be uncollectible. The Company includes any accounts receivable balances that are determined to be uncollectible, along with a general reserve, in its overall allowance for doubtful accounts. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. 30 RESULTS OF OPERATIONS OVERVIEW iCAD(TM), Inc. ("iCAD" or the "Company") was incorporated in 1984 in the State of Delaware, as Howtek, Inc., and has sold and supported over 20,000 high quality, professional graphic arts, photographic and medical imaging systems worldwide. In 2001, iCAD elected to concentrate on its medical imaging and women's health businesses with an objective of expanding this business through increased product offerings. This goal was advanced in June 2002 with the acquisition of Intelligent Systems Software, Inc. ("ISSI"), a software company offering computer aided detection ("CAD") systems for breast cancer. Subsequently, on December 31, 2003, the Company merged with and acquired CADx Systems, Inc. and its parent company Qualia Computing, Inc. (together "CADx"), bringing together two of the three companies approved by the US Food and Drug Administration (FDA) to market computer aided detection of breast cancer solutions in the United States. iCAD develops, engineers, manufactures and markets computer aided detection (CAD) products for the early detection of breast cancer and other health-care related applications. Early detection of breast cancer can save lives and often permits less costly, less invasive and less disfiguring cancer treatment options than when the cancer is detected at a later stage. Computer aided detection from iCAD can detect 25% of breast cancers, an average of 14 months earlier than screening mammography alone. iCAD is the only independent, integrated digitizer hardware and CAD software company offering computer aided detection solutions. As such, we are able to reduce costs at each step in the CAD product design, production and assembly process. We believe our vertical integration of CAD and hardware development results in better integration of software and film digitizer components, lower production costs and reduced administrative overhead. These factors have allowed us to progressively enhance our CAD product line, while reducing the costs of our CAD products to many customers and allowing more women to realize the benefits inherent in the early detection of breast cancer. The Company's CAD systems include proprietary software technology together with standard computer and display equipment. CAD systems for the film-based mammography market also include a radiographic film digitizer manufactured by the Company. iCAD also manufactures medical film digitizers for a variety of medical imaging and other applications. The Company believes that iCAD's experience in providing film digitizers and software for medical picture archiving and communications (PACS) and telemedicine applications contributes to the successful integration of the Company's CAD products into networked and digital mammography environments. The Company's headquarters and its production and assembly facilities are located in southern New Hampshire. 31 MERGER WITH QUALIA AND CADX On December 31, 2003, the Company completed the acquisition of Qualia Computing, Inc., a privately held company based in Beavercreek, Ohio, and its subsidiaries, including CADx Systems, Inc. (together "CADx"). This merger brings together two of the three companies approved by the US Food and Drug Administration (FDA) to market computer aided detection of breast cancer solutions in the United States. The Company's objective in the acquisition of CADx was to achieve profitability and support accelerated development of future business and product opportunities in the medical imaging field. Since completion of the merger, iCAD has executed a methodical, step-by-step plan to increase revenues by consolidating sales channels and defining an industry-leading continuum of CAD products. The Company has also taken steps to reduce projected operating costs by approximately $4 million on an annualized basis. For these reasons, the Company does not believe that iCAD's reported results for the fourth quarter or full year 2003 are indicative of the Company's future prospects or financial results. Additional unaudited information on the combined financial performance of the combined companies for 2003 can be found in the Company's current report on form 8-K for the event dated February 24, 2004, which information and form 8-K is not incorporated in, or part of, this annual report. To complete the merger, iCAD issued 4,300,000 shares of its common stock in exchange for all outstanding shares of Qualia Computing Inc. and CADx Systems, Inc. This represents approximately 13% of the outstanding shares of iCAD common stock after the merger. Additionally, iCAD paid $1,550,000 in cash and executed a 36-month secured promissory note in the amount of $4,500,000 to purchase Qualia shares that were owned by two institutional investors. SUBSEQUENT REDUCTIONS IN OPERATING EXPENSES Operating expenses for the combined companies substantially exceeded those of iCAD alone. During the first quarter of 2004 the Company assessed the opportunities to achieve post-merger operating economies, and identified cost-reduction opportunities in light of its distribution and product plans. As a result of this analysis management determined that operating expenses could be substantially reduced without detracting from the Company's ability to increase sales and focus on future products and markets. Cost-reduction actions taken by iCAD in the first quarter of 2004 included the closure of offices in Tampa, Florida and San Rafael, California; reductions in staffing effective March 31, 2004 of 39 of 110 previous full and part-time employees, and the reduction of duplication in marketing, administrative and other activities. As a result of these cost-reduction actions, the Company will report certain non-recurring severance and office closure expenses in the quarter ending March 31, 2004. During the first quarter of 2004, the Company anticipates operating expenses, excluding non-recurring severance and office closure expenses, of between $4.8 million to $5.1 million. Based on cost reduction measures implemented in the first quarter of 2004, and on current assumptions regarding expected revenues, product and channel mix, the Company anticipates incurring operating expenses of between $3.9 million to $4.2 million for the quarter ending June 30, 2004. Of total projected operating expenses for this period, approximately 36% is expected to represent research, development and engineering expenses, approximately 31% is expected to represent sales and marketing expense (including sales commissions) and approximately 33% is expected to represent administrative and finance expenses. The Company's objective is to maintain operating expenses at relatively constant quarterly dollar levels through the third and fourth quarters of 2004, while achieving reductions in each expense category as a percentage of increasing sales. Actual results will differ. 32 YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002 Sales. Sales of the Company's CAD and medical imaging products for the year ended December 31, 2003 were $6,520,306, compared with sales of medical imaging products and total sales for the year ended December 31, 2002 of $4,288,628 and $5,000,184, respectively. This reflects an increase of 52% in medical sales and 30% in total sales from period to period. Sales increased in 2003 as a result of the addition of the CAD product line through acquisition of ISSI in June 2002. The Company believes that sales will increase in future periods as a result of its merger with CADx and the combination of its iQ, MammoReader and Second Look products into one "Second Look(R)" branded line of CAD devices. In doing so, the Company believes it has created the broadest and most comprehensive line of CAD products available from any company, and associated it with a single well recognized and appropriate model brand. Additionally, in the first quarter of 2004, the Company consolidated its full-line sales channels as part of its efforts to best promote and support its broad Second Look product line. iCAD Second Look products are now distributed nationally, on a non-exclusive basis, by SourceOne HealthCare Technologies, and by additional independent resellers, including members of the National Imaging Resellers (NIR) dealer group and Merry X-Ray Corporation. Overall, some 200 field sales personnel are now available to represent and promote iCAD products in the United States. During the first quarter of 2004, multiple changes in sales channels, sales management and organization, product naming, positioning and marketing have been implemented. In connection with the consolidation of sales channels and product lines, the Company has combined iCAD's IQ, MammoReader and Second Look products into one `Second Look(R)'-branded line of CAD solutions. As a result, the Company believes iCAD has created the broadest and most comprehensive line of CAD products available in the industry and associated it with a single, well-recognized and appropriate model brand. In anticipation of these changes in channels and product positioning, iCAD deferred key elements of its business plan prior to the merger, and this negatively impacted sales during the fourth quarter of 2003. In particular, iCAD suspended the development and training of an independent reseller network and deferred the launch of its lower-priced iCAD iQ product (now the Second Look 200) and its fee-per-service ClickCAD marketing initiative. These actions will also cause first quarter 2004 sales of the merged companies to trail the combined sales of the two companies during the fourth quarter of 2003. However, the Company expects sales growth to resume in the second quarter, and full year 2004 sales should substantially exceed the combined revenues of iCAD and CADx ($16.8 million) in 2003. Factors that are expected to play a significant role in future sales growth and profitability include the following: o Increased promotion and sale of the Company's Second Look 200 system, which offers a CAD solution to lower-case-volume clinics; 33 o Expansion of the products promoted by CADx' former distributor to include the full line of iCAD products, including the Second Look 200; o Increased sales contributions by independent resellers identified by iCAD prior to the merger, and o Promotion of iCAD's new ClickCAD fee-per-service marketing program. Gross Margin. Gross margin as a percentage of sales, for the year ended December 31, 2003, improved to 55% compared to (3%) for the same period in 2002, as a result of increasing sales of higher margin CAD products and write-offs of inventory recorded in the quarter ended June 30, 2002. In the second quarter of 2002 the Company incurred a charge to cost of sales consisting of a charge for an inventory reserve relating to its graphic arts and photographic products in the amount of $2,369,539. If such write-offs are excluded, gross margins as a percentage of sales, for the year ended December 31, 2003, improved to 55% compared to 49% for the year ended December 31, 2002. Although there can be no assurance of its future gross margin rate, the Company expects that future increases in gross margin as a percentage of sales will be achieved as a result of increasing sales of its higher margin CAD products and as production and other economies of scale resulting from the merger are realized. By applying its manufacturing experience and using existing supplier relationships, we expect to reduce component and manufacturing costs associated with the former CADx product line during 2004, with some associated cost savings expected in the manufacturing of previous iCAD products. Engineering and Product Development. Engineering and product development costs for the year ended December 31, 2002 increased from $1,626,001 in 2002 to $2,384,057 in 2003. The increase in engineering and product development costs resulted primarily from the Company's addition, as a result of its acquisition of ISSI in June 2002, of the software technology development group to support its CAD products. Additionally, the increase is attributed to the development of the Company's new Second Look 200 (formerly the iCAD iQ(TM) model) and tHe Fulcrum medical film digitizer. With the completion of the merger with CADx on December 31, 2003, the Company expects that engineering and product development costs will increase in absolute terms in 2004 compared to 2003, as the Company invests in new product development. Over the course of 2004, the Company expects engineering and product development costs will decline as a percentage of sales, as sales increase. Under the leadership of Dr. Steven Rogers, Qualia's founder and iCAD's Chief Scientist, the Company's technologies are also being applied to the early detection of breast cancer using ultrasound; the early detection of lung cancer utilizing low-dose spiral Computed Tomography (CT) and the early detection of colon cancer utilizing CT. With support provided through the FY2004 Defense Appropriations Bill, iCAD has begun collaboration with the Walter Reed Army Medical Center and the Windber Research Institute in Windber, PA, to develop and evaluate 3D CAD technology for breast imaging based on existing CAD and pattern analysis techniques for conventional mammograms. One objective of this research project is to use ultrasound imaging to reduce biopsies which prove to be unnecessary. Research programs in cardiovascular disease applications are also in the planning stages 34 General and Administrative. General and administrative expenses for the year ended December 31, 2003 increased by $844,645, from $6,595,076 in 2002 to $7,439,721 in 2003. The increase resulted from a write-off of $1,443,628 attributable to its distribution agreement with Instrumentarium Imaging, Inc., ("Instrumentarium"), which it assumed as part of the ISSI acquisition in 2002. This write-off came after assessing the performance of Instrumentarium in the third quarter 2003, and in light of the Company's implementation of alternative distribution channels, the Company elected to take a one-time write-off, thereby eliminating the distribution agreement as a depreciating asset. Additionally, during the third quarter of 2003, the Company accounted for over $2,702,000 in non-recurring expenses related to the settlement of R2 patent infringement litigation and legal expenses. In the settlement agreement with R2 the Company agreed to the following: o A payment of $1,250,000 by the Company to R2, of which $1,000,000 was paid in September 2003 with the remaining deferred and payable in equal installments on a quarterly basis through December 2005. o The Company issued to R2 shares of iCAD Common Stock valued at $750,000. o The Company also agreed to pay R2 certain continuing royalties, which were to be based on the category and configuration of products sold by iCAD. Subsequent to the settlement, R2 agreed to accept an additional 75,000 shares of iCAD Common Stock valued at $466,200 in full satisfaction of any royalties it otherwise would have been entitled to receive under the settlement agreement. o Further, iCAD granted R2 a partial credit against potential future purchases by R2 of iCAD digitizers worth up to $2,500,000 over five years to encourage R2 to purchase film digitizers manufactured by iCAD. This partial credit was meant to provide a significant purchasing advantage to R2, while maintaining a reasonable profit margin and creating additional economies of scale for iCAD. The Company is not able to estimate the volume of future purchases by R2, if any. Any discount from future purchases will be recognized at the time of sale of products to R2 During 2003 the Company recorded approximately $702,000 in legal and related expenses associated with the R2 litigation. Since the Company's acquisition of ISSI in June 2002, the Company has recorded approximately $1,857,000 in legal and related expenses associated with the R2 litigation. General and Administrative for 2002 included a $2,800,000 non-cash charge associated with the acquisition of ISSI, and accrued settlement costs of $383,000 for an action brought against the Company by The Massachusetts Institute of Technology and Electronics for Imaging, Inc ("MITEI"). Both of these charges were non-recurring in 2003. The action brought by MITEI against the Company was dismissed in the second quarter of 2003 and the accrual of $383,00 was reversed. Marketing and Sales. Marketing and sales expenses for the year ended December 31, 2003 increased 86% from $987,587 in 2002 to $1,838,618 in 2003. This increase is due primarily to the addition of sales support personnel engaged to develop a broad reseller channel for sale of the Company's CAD products, and advertising, direct mail, consulting, trade show and promotional expenses incurred in the third and fourth quarter of 2003. The Company expects marketing and sales expenses to increase in absolute terms during 2004 over 2003, as it continues to develop a more comprehensive sales and support capability and increase direct marketing and advertising activities. The Company expects marketing and sales expenses to decline as a percentage of sales over this period. Interest Expense. Net interest for the year ended December 31, 2003 increased 138% from $48,167 in 2002 to $114,655 in 2003. This increase is due primarily to an increase in loan balances. 35 Profit (Loss). As a result of the foregoing, the Company recorded a net loss of $8,198,408 or $0.31 per share for the year ended December 31, 2003 on sales of $6,520,306 compared to a net loss of $9,418,290 or $0.46 per share in 2002 on sales of $5,000,184. iCAD will report a net loss in the first quarter of 2004, before new contributions to sales become effective, and before implemented reductions in operating expenses are realized. As the year 2004 progresses, the Company expects sales levels to increase, and operating expenses to be reduced from first quarter 2004 levels. YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001 Sales. Sales for the year ended December 31, 2002 were $5,000,184, compared with sales of $4,835,297 for the year ended December 31, 2001. Sales increased during the third and fourth quarter of 2002 as a result of the addition of the CAD product line through acquisition of ISSI on June 28, 2002. CAD sales, which began upon the acquisition of ISSI, were $2,628,135 (53% of sales) for the year ended December 31, 2002. The shift in the Company's business focus, from graphic arts and photographic product lines to CAD imaging and medical digitizer products, was largely responsible for the reduced overall sales during the first and second quarters of 2002. Sales related to discontinued products totaled $711,556 for the year ended December 31, 2002. Gross Margin. Gross margin for the year ended December 31, 2002 decreased as a result of the write-offs of inventory relating to graphic arts and photographic products in the amount of $2,369,539. Before the write-offs, gross margin for the year ended December 31, 2002 increased to 49% from 19% in 2001, as a result of reduced production overhead and indirect production expenses and sales of its CAD and medical imaging products which had higher margins than the Company's graphic arts products. During the first quarter of 2003, iCAD initiated reduced, promotional pricing for group purchasers and existing customers of its distributor, Instrumentarium Imaging, Inc. and for customers of PenRad, Inc., a developer and vendor of mammography information systems. This pricing was intended to help provide the Company with information on the price elasticity of the CAD systems market, and to assist the Company in determining pricing for future products while promoting current sales. These factors were significant in determining how the Company could best exploit its comparative advantage in manufacturing costs. Products sold under this promotional and market analysis program reflected reduced transfer prices and reduced gross margins. Engineering and Product Development. Engineering and product development costs for the year ended December 31, 2002 increased from $751,467 in 2001 to $1,626,001 in 2002. The increase in engineering and product development costs resulted primarily from the Company's addition, as a result of its acquisition of ISSI, of a software technology development group to support its CAD products. Additionally, the Company continued its development of its Fulcrum medical film digitizer product and utilization of outside and contract engineering resources. 36 General and Administrative. General and administrative expenses increased from $1,124,710 in 2001 to $6,595,076 in 2002. The increase in general and administrative expenses resulted primarily from a one-time, $2,800,000 non-cash accounting charge associated with the placement of $2,000,000 in restricted common stock by ISSI immediately prior to the successful acquisition of ISSI by the Company. Pursuant to the acquisition agreement between the two companies, the sale of securities increased working capital and funded the promotion of the MammoReader product. Additional increases in general and administrative expenses in 2002 reflected non-recurring severance benefits and other expenses associated with reductions of staff resulting from the combination of ISSI and Howtek in the amount of $884,000, a write-off of fixed assets, including test equipment and software development costs, relating to the Company's graphic arts and photographic product lines totaling $417,004 and an accrued litigation cost of $383,000 in connection with the complaint filed against the Company by The Massachusetts Institute of Technology and Electronics for Imaging, Inc. Marketing and Sales. Marketing and sales expenses for the year ended December 31, 2002 decreased 37% from $1,563,380 in 2001 to $987,587 in 2002. This decrease was due primarily to the reduction of personnel, promotional and trade show expenses related to the Company's traditional graphic arts and FotoFunnel lines. Interest Expense. Net interest for the year ended December 31, 2002 decreased 40%, from $80,105 in 2001 to $48,167 in 2002. This decrease was due primarily to a decrease in loan balances and interest rates. As a result of the foregoing, the Company recorded a net loss of $9,418,290 or $0.46 per share for the year ended December 31, 2002 on sales of $5,000,184 compared to a net loss of $2,620,771 or $0.20 per share in 2001 on sales of $4,835,297. 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 $4,000,000 credit line under the Loan Agreement with its Chairman, Mr. Robert Howard, of which $370,000 was available at December 31, 2003. The Company's current operating and financial projections and plans indicate that current liquidity and capital resources are sufficient to support and sustain operations through 2004. If sales or cash collections are reduced from current expectations, or if expenses and cash requirements are increased, the Company may require additional financing. Historically, the Company has secured additional cash through additional extensions of credit by its Chairman, and believes such extensions, if required, are available. During 2003, the Company used $4,666,558 in cash from operations compared to $2,255,709 in 2002. The cash used in 2003 resulted primarily from the net loss of $8,408,590, offset partially by non-cash stock compensation, loss on disposal of assets, and depreciation and amortization totaling $3,648,565. During 2003, the Company used $1,468,194 in cash for investing activities compared to cash generated of $2,051,978 in 2002. The majority of the decrease in 2003 related to the cash used in the acquisition of CADx, to purchase Qualia shares owned by two institutional investors totaling $1,550,000. In 2002, the increase in cash related to the net cash acquired through the acquisition of ISSI totaling $2,202,040. 37 The Company does not anticipate any substantial capital purchases during 2004. Working capital increased $4,606,677 to $3,409,652 at December 31, 2003 from a deficit of $1,197,025 at December 31, 2002. The ratio of current assets to current liabilities at December 31, 2003 and 2002 was 1.4 and .7, respectively. These increases are due primarily to the private placement to institutional investors and the acquisition of CADx. On November 24, 2003, the Company sold 1,260,000 shares of its common stock for $5.00 per share in a private placement to institutional investors. The Company also issued to such investors' additional investment rights to purchase up to an additional 315,000 shares of its common stock at $5.00 per share. The net proceeds to the Company for the 1,260,000 shares sold were approximately $5,919,000. A total of 90,000 shares of the Company's common stock were issued in connection with the additional investment rights in 2004. The remaining shares expired unexercised. The net proceeds to the Company for the 90,000 shares sold were approximately $425,000. Ladenburg Thalmann & Co. Inc. served as placement agent for these transactions for which it received compensation in the amount of approximately $404,000 and a five year warrant to purchase 67,200 shares of the Company's Common Stock at $5.00 per share. On December 31, 2003, the Company completed the acquisition of CADx in exchange for 4,300,000 shares of iCAD's common stock to certain stockholders of Qualia Computing, Inc. Additonally, iCAD paid $1,550,000 in cash and executed a 36-month secured promissory note in the amount of $4,500,000 to purchase Qualia shares that were owned by two institutional investors. The following table summarizes, for the periods presented, the Company's future estimated cash payment under existing contractual obligations.
- ------------------------------------------------------------------------------------------------- Contractual Obligations Payments due by period - ------------------------------------------------------------------------------------------------- Total Less than 1-3 years 3-5 years More than 1 year 5 years - ------------------------------------------------------------------------------------------------- Long-Term Debt Obligations $ 8,238,390 $1,233,390 $7,005,000 $ - $ - - ------------------------------------------------------------------------------------------------- Lease Obligations $ 3,503,442 $ 520,047 $1,088,577 $ 936,106 $ 958,712 - ------------------------------------------------------------------------------------------------- Total Contractual Obligations $11,741,832 $1,753,437 $8,093,577 $ 936,106 $ 958,712 - -------------------------------------------------------------------------------------------------
EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 145, Rescission of FASB Statements SFAS Nos. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections. SFAS No. 145 rescinds Statement No. 4, Reporting Gains and Losses from Extinguishments of Debt, and an amendment of that Statement, FASB Statement No. 64 Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. SFAS No. 145 also rescinds FASB Statement No. 44, Accounting for Intangible Assets of Motor Carriers. SFAS No. 145 amends FASB Statement No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provision of SFAS No.145 related to the rescission of Statement No. 4 shall be applied in fiscal year beginning after May 15, 2002. The provisions of SFAS No. 145 related to Statement No. 13 should be for transactions occurring after May 15, 2002. Early application of the provisions of this Statement is encouraged. The adoption of SFAS No. 145 did not have any effect on the Company's financial statements. 38 In June 2002, the FASB issued SFAS No. 146 Accounting for Costs Associated with Exit or Disposal Activities. This statement superseded EITF No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. Under this statement, a liability or a cost associated with a disposal or exit activity is recognized at fair value when the liability is incurred rather than at the date of an entity's commitment to an exit plan as required under EITF 94-3. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early adoption permitted. The adoption of SFAS No. 146 did not have a significant impact on the Company's financial statements. In November 2002, the Emerging Issues Task Force ("EITF") reached consensus on Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. Revenue arrangements with multiple deliverables include arrangements which provide for the delivery or performance of multiple products, services and/or rights to use assets where performance may occur at different points in time or over different periods of time. EITF Issue No. 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of the guidance under this consensus did not have an impact on the Company's financial position, results of operations or cash flows. In November 2002, the FASB issued Interpretation ("FIN") No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which will significantly change current practice in the accounting for, and disclosure of, guarantees. FIN No. 45 requires that a guarantor recognize, at the inception of certain types of guarantees, a liability of the obligation undertaken in issuing the guarantee at fair value. The interpretation also requires significant new disclosures in the financial statements of the guarantor about its obligations under certain guarantees. The Company is required to apply the disclosure provisions of FIN No. 45 in its financial statements as of December 31, 2002. The accounting provisions of FIN No. 45 are applicable for guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN No. 45 did not have a material effect on the Company's financial statements and it does not expect the accounting provisions of this interpretation to have a material impact on its financial statements. In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51, ("FIN No. 46")" which requires all variable interest entities ("VIEs") to be consolidated by the primary beneficiary. The primary beneficiary is the entity that holds the majority of the beneficial interests in the VIE. In addition, the interpretation expands disclosure requirements for both variable interest entities that are consolidated, as well as VIEs from which the entity is the holder of a significant amount of the beneficial interests, but not the majority. The disclosure requirements of this interpretation are effective for all financial statements issued after January 31, 2003. The consolidation requirements of this interpretation are effective for all periods beginning after June 15, 2003. The Company does not have any VIEs, therefore the adoption of this interpretation did not have any effect on its results of operations or financial condition. 39 In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 requires that certain financial instruments, which under previous guidance were accounted for as equity, must now be accounted for as liabilities. The financial instruments affected include mandatory redeemable stock, certain financial instruments that require or may require the issuer to buy back some of its shares in exchange for cash or other assets and certain obligations that can be settled with shares of stock. SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003 and must be applied to existing financial instruments effective June 29, 2003. The adoption of this statement did not have a material effect on the Company's results of operations or financial condition. 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. ITEM 9A. CONTROLS AND PROCEDURES The Company, under the supervision and with the participation of its management, including its principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, the principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures are effective in reaching a reasonable level of assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission's rules and forms. The principal executive officer and principal financial officer also conducted an evaluation of internal control over financial reporting ("Internal Control") to determine whether any changes in Internal Control occurred during the quarter ended December 31, 2003 that have materially affected or which are reasonably likely to materially affect Internal Control. Based on that evaluation, there has been no such change during the quarter ended December 31, 2003. 40
PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. NAME AGE POSITION SINCE - ---- --- -------- ----- Robert Howard # 80 Chairman of the Board, and Director 1984 W. Scott Parr # 52 President, Chief Executive Officer, and Director 1998 Annette Heroux 47 Vice President of Finance, Chief Financial Officer 1999 James Harlan* 52 Director 2000 Brett Smith+ 34 Director 2000 Maha Sallam* 37 Executive Vice President, Director 2002 Elliot Sussman* 52 Director 2002 Steven Rogers+ 50 Chief Scientific Officer, Director 2004
+ Class I Director, current term expires in 2006 * Class II Director, current term expires in 2004 # Class III Director, current term expires in 2005 The Company's Certificate of Incorporation provides that the Company's Board of Directors is divided into three classes (Class I, Class II and Class III). At each Annual Meeting of stockholders, directors constituting one class are elected for a three-year term. Mr. Kevin Woods resigned his position as director in March 2004, to permit the Company to elect an additional independent director to the Company's Board of Directors. Under the terms of the amended and restated plan and agreement of merger, Steven Rogers, Qualia's founder and iCAD's Chief Scientist, was appointed to serve as a member of the Board of Directors of iCAD upon completion of the merger. Mr. Rogers was appointed by the Board of Directors to serve as a Class I director of iCAD, with a term expiring at the 2006 iCAD annual meeting of stockholders. In addition, under the amended and restated plan and agreement of merger, iCAD and Steven Rogers will appoint to iCAD's Board a mutually acceptable individual who qualifies as an "independent director" under NASDAQ's corporate governance rules. The independent director will be nominated to serve as a Class III director of iCAD, with a term expiring at the 2005 iCAD 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. 41 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 iCAD, Mr. Parr served as Divisional Director and a member of the Board of Directors of SABi International Ventures, Inc. where he was responsible for restructuring and upgrading certain U.S. 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. Annette Heroux joined the Company in October 1987 as Accounting Manager and was named Controller in October 1998 and Vice President of Finance, Chief Financial Officer in July 1999. Prior to joining the company, from 1980 to 1987, Ms. Heroux served as Finance and Administration Manager of Laurier, Inc., a semiconductor equipment manufacturer, where she was responsible for the financial reporting and administrative functions. From 1978 to 1980 Ms. Heroux was Accounting Manager for Hoodkroft Nursing Center, a skilled nursing facility, where she was responsible for patient insurance and financial records. James Harlan has been the Executive Vice President and Chief Financial Officer of HNG Storage Company, a natural gas storage, development and operations company since 1998. From 1991 to 1997 Mr. Harlan served as General Manager and Chief Financial Officer of Pacific Resources Group where he was responsible for the planning and financial development of various manufacturing and distribution businesses in Asia. 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. Brett Smith, the son of Mrs. Kit Howard, the wife of the Company's Chairman, has been the Chairman and Chief Executive Officer of ei3 Corporation, a provider of technology services to manufacturing companies utilizing advanced frame relay and internet technologies. Prior to joining ei3, from 1996 to 1999, Mr. Smith was a member of the restructuring team for Delta V Technologies, a subsidiary of Presstek, where he served as Director of Business Development. 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. Maha Sallam has been the Executive Vice President for the Company since June 2002. From 1997 until the acquisition of ISSI in June 2002, Dr. Sallam served as Director and Vice President of Regulatory Affairs and Clinical Testing and Secretary of ISSI. She was one of ISSI's founders and has over fourteen years of industry and research experience in image analysis including a doctoral dissertation, conference presentations and several publications on the automated analysis of digital mammograms. 42 Elliot Sussman is currently President and Chief Executive Officer of Lehigh Valley Hospital and Health Network, a position he has held since 1993. Dr. Sussman is the Leonard Parker Pool Professor of Health Systems Management, Professor of Medicine, and Professor of Health Evaluation Sciences at Pennsylvania State University's College of Medicine. Dr. Sussman served as a Fellow in General Medicine and a Robert Wood Johnson Clinical Scholar at the University of Pennsylvania, and trained as a resident at the Hospital of the University of Pennsylvania. Steven Rogers is the Company's Chief Scientific Officer. From 1997 until the acquisition of CADx on December 31, 2003, Dr. Rogers served as Chairman of the Board, Chief Executive Officer and President of Qualia, and the President of Qualia Financial Services, LLC since September 2002. Prior to joining Qualia, from 1984 to 1996 Dr. Rogers worked as a Professor of Electrical Engineering at the Air Force Institute of Technology. During his time in the U.S. Air Force designing smart weapons, Dr. Rogers published more than 200 technical papers in the areas of neural networks, pattern recognition, and optical processing and several textbooks including Introduction to Biological and Artificial Neural Networks for Pattern Recognition. Dr. Rogers is a Fellow of the IEEE and SPIE. After leaving the Air Force in 1996, Dr. Rogers served as the Director of Cognitive Systems at the Battelle Memorial Institute. Dr. Rogers left Battelle in 1999 to devote his full attention to Qualia. The Company has an audit committee of the Board of Directors ("Audit Committee") consisting of Messrs. Harlan, Smith and Sussman. Each member of the Audit Committee is an "independent director" under the rules of the National Association of Securities Dealers, Inc ("NASD") and the Company's Board has determined that James Harlan is the Audit Committee's financial expert under applicable SEC rules and NASD Marketplace Rules. Compliance with Section 16(a) of the Securities Exchange Act Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than 10 percent of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission ("SEC"). Officers, directors, and greater than 10 percent stockholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file. Based solely on the Company's review of copies of such forms received by the Company, the Company believes that during the year ended December 31, 2003, all filing requirements applicable to all officers, directors, and greater than 10% beneficial stockholders were complied with, except that: (i) Mr. Howard failed to timely file Form 4s to report additional loans made to the Company pursuant to the Convertible Revolving Promissory Note that is convertible into a total of 543,526 shares of the Company's common stock during the period from April, 2003 through August 1, 2003. 43 Code of Business Conduct and Ethics In light of the acquisition of CADx, the Company is in the process of developing a comprehensive Code of Business Conduct and Ethics to cover all of the employees of the combined companies. Copies of the Code of Business Conduct and Ethics, which is expected to be adopted by May 1, 2004, can be obtained, when available, upon written request, addressed to: iCAD, Inc. 4 Townsend West Nashua, NH 03063 Attention: Corporate Secretary ITEM 11. EXECUTIVE COMPENSATION. The following table provides information on the compensation provided by the Company during fiscal years 2003, 2002 and 2001 to the persons serving as the Company's Chief Executive Officer during fiscal 2003 and the Company's most highly compensated executive officers serving at the end of the 2003 fiscal year ("the Named Persons"). Included in this list are only those executive officers whose total annual salary and bonus exceeded $100,000 during the 2003 fiscal year.
SUMMARY COMPENSATION TABLE SECURITIES UNDERLYING NAME AND PRINCIPAL POSITION YEAR SALARY($) OPTION(#) --------------------------- ---- --------- ---------- W. Scott Parr President, Chief Executive Officer, Director..... 2003 191,600 -0- 2002 173,762 125,000 2001 145,669 4,000 Maha Y. Sallam Executive Vice President, Director............... 2003 132,489 -0- 2002 95,380 156,250 Annette L. Heroux Vice President of Finance, Chief Financial Officer 2003 111,814 -0- 2002 96,949 65,183 2001 85,639 3,000
OPTION GRANTS IN LAST FISCAL YEAR There were no stock options granted by the Company to the Named Person in 2003. 44 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 Persons and the fiscal year-end value of unexercised options.
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED UNEXERCISED OPTIONS AT IN-THE MONEY SHARES FY-END (#) OPTIONS AT ACQUIRED ON VALUE EXERCISABLE/ FY-END($) (1) NAME EXERCISE (#) REALIZED UNEXERCISABLE UNEXERCISABLE - --------------------- ------------ -------- ---------------- ------------------- W. Scott Parr (2) 0 0 531,518 / -0- 2,075,312 / -0- Maha Y. Sallam (2) 0 0 156,250 / -0- 431,000 / -0- Annette L. Heroux (2) 18,400 $89,352 100,645 / 13,455 356,197 / 50,187
(1) Based upon the closing price of the Common Stock on December 31, 2003, of $5.28 per share. (2) Options granted pursuant to the Company's merger and 1993, 2001 and 2002 Stock Option Plans. The Company does not have any employment agreements with its executive officers or key employees. SEPARATION AGREEMENTS WITH FORMER OFFICERS In September 2002, the Company entered into a Separation Agreement with each of W. Kip Speyer, the former Chief Executive Officer of iCAD and Gregory J. Stepic, the former Vice President of Finance of iCAD. The Separation Agreements acknowledged the resignations of each of Messrs. Speyer and Stepic and provided for severance payments to Messrs. Speyer and Stepic of $500,000 and $148,000, respectively, in lieu of any severance payments to which they may have been entitled to under their employment agreements. The severance payments, less any required withholding by the Company, are payable to Mr. Speyer in equal installments over a 30 month period and to Mr. Stepic in equal installments over a 12 month period, in each case subject to the right to accelerate payments upon the sale of the outstanding stock of the Company or upon a sale by the Company of substantially all of its assets. Under the Separation Agreements, each of Messrs. Speyer and Stepic was entitled to retain his outstanding options of the Company which remain exercisable in accordance with their respective terms. Also, pursuant to the Separation Agreements Messrs. Speyer and Stepic each agreed to remain bound by the confidentiality and non-competition provisions of their employment agreements for the periods set for in the employment agreements. 45 COMPENSATION OF DIRECTORS The Company does not pay cash compensation to members of its board of directors for their services as board members. The Company does reimburse members of the board for out-of-pocket expenses incurred for attendance at board and board committee meetings. 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 2003 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 2003 none of the executive officers of the Company served on the Board of Directors or Compensation Committee of any other entity. 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 18, 2004, 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 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. Unless otherwise indicated below, the address of each beneficial owner is c/o iCAD, Inc. 4 Townsend West, Suit 17, Nashua, New Hampshire 03063.
Number of Shares Name and Address of Title Beneficially Percentage Beneficial Owner of Class Owned (1) (2) of Class ---------------- -------- ---------------- ---------- Robert Howard Common 6,277,999(3) 17.9% 145 East 57th Street New York, New York 10022 Maha Sallam Common 2,322,520(4) 6.8% 4902 Eisenhower Blvd. Tampa, FL 33634 Donald Chapman Common 1,950,706(5) 5.6% 8650 South Ocean Drive Jenson Beach, FL 34957 Preferred Series A 4,600 74.8% Preferred Series B 680 52.9% W. Kip Speyer Common 1,818,000(6) 5.3% 10361 Parkstone Way Boca Raton, FL 33498 Steven Rogers Common 1,000,754 3.0% 2689 Commons Blvd. Beavercreek, OH 45431 W. Scott Parr Common 661,468(7) 1.9% Preferred Series A 550 8.9% Preferred Series B 50 3.9%
46
Edgar Ball Preferred Series B 200 15.6% PO Box 560726 Rockledge, FL 32956 John McCormick Preferred Series A 1,000 16.3% 11340 SW Aventine Circus Portland, OR 97219 Dr. Herschel Sklaroff Preferred Series B 100 7.8% 1185 Park Avenue New York, NY 10128 John Westerfield Preferred Series B 100 7.8% 4522 SW Bimini Circle N. Palm City, FL 34990 James Harlan Common 131,000(8) * Brett Smith Common 47,507(9) * Preferred Series B 20 1.6% Dr. Elliot Sussman Common 18,000(10) * Annette Heroux Common 105,645(11) * All current executive officers and Common 10,564,893(3),(4), & 29.3% directors as a group (8 persons) (7) through (11) Preferred Series A 550 8.9% Preferred Series B 70 5.4%
- --------- * Less than one percent 1) A person is deemed to be the beneficial owner of securities that can be acquired by such person within 60 days from March 18, 2004, 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 18, 2004, 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 20,000 shares beneficially owned by Mr. Howard's wife. 4) Includes 183,625 shares owned by Dr. Sallam's husband. Also includes options to purchase 56,250 shares of the Company's Common Stock at $0.80 per share and 100,000 shares at $3.49 per share. 5) 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. 47 6) Includes options to purchase 75,000 shares of the Company's Common Stock at $0.80 per share and 550,000 shares at $3.49 per share. 7) 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, 125,000 shares at $0.81 per share, 2,250 shares at $1.00 per share, 4,000 shares at $0.95 per share, 25,000 shares at $1.75 per share and 100,000 shares at $2.69 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. 8) Includes options to purchase 25,000 shares of the Company's Common Stock at $1.75 per share and 25,000 shares at $1.55 per share. 9) Includes options to purchase 25,000 shares of the Company's Common Stock at $3.00 per share and 6,667 shares at $1.55 per share. Also, includes 10,000 shares of Common Stock issuable upon conversion of 20 shares of Series B Convertible Preferred Stock. 10) Includes options to purchase 15,000 shares of the Company's Common Stock at $1.55 per share. 11) Includes options to purchase 6,600 shares of the Company's Common Stock at $0.81 per share, 3,000 shares at $0.95 per share, 23,317 shares at $1.13 per share, 6,728 shares at $1.55 per share, 1,000 shares at $1.72 per share, 35,000 shares at $1.75 per share and 25,000 shares at $2.69 per share. 48 EQUITY COMPENSATION PLAN The following table provides certain information with respect to all of the Company's equity compensation plans in effect as of December 31, 2003.
Number of securities remaining available for Number of securities to Weighted-average issuance under equity be issued upon exercise exercise price of compensation plans of outstanding options, outstanding options, (excluding securities warrants and rights warrants and rights reflected in column (a)) ------------------------------------------------------------------------- Plan Category: - ------------------------------------------------------------------------------------------------------- Equity compensation plans approved by security holders: 3,688,551 $2.08 69,612 - ------------------------------------------------------------------------------------------------------- Equity compensation 124,200 $4.58 -0- plans not approved by security holders (1): - ------------------------------------------------------------------------------------------------------- Total 3,812,751 $2.17 69,612 - -------------------------------------------------------------------------------------------------------
(1) Represents the aggregate number of shares of common stock issuable upon exercise of individual arrangements with option and warrant holders. These options and warrants are five years in duration, expire at various dates between December 31, 2004 and February 28, 2007, contain anti-dilution provisions providing for adjustments of the exercise price under certain circumstances and have termination provisions similar to options granted under stockholder approved plans. See Note 8 of Notes to the Consolidated Financial Statements for a description of the Company's Stock Option Plans. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The Company has a 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 $4,000,000. The Loan Agreement expires January 4, 2005, 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% with a minimum of 8%. Mr. Howard is entitled to convert outstanding advances made by him under the Loan Agreement 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 lesser of the market price at the time each advance is made or at the time of conversion. In 2003 the Company borrowed $3,430,000 pursuant to the Loan Agreement. As of December 31, 2003, $3,630,000 was owed by the Company and the Company had $370,000 available for future borrowings under the Loan Agreement. 49 ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES AUDIT FEES. The aggregate fees billed by BDO Seidman, LLP for professional services rendered for the audit of the Company's annual financial statements for the years ended December 31, 2003 and 2002, the review of the financial statements included in the Company's Forms 10-QSB and consents issued in connection with the Company's filings on Form SB-2 for 2003 and 2002 totaled $71,550 and $61,956, respectively. AUDIT-RELATED FEES. The aggregate fees billed by BDO Seidman, LLP for assurance and related services that are reasonably related to the performance of the audit or review of the Company's financial statements, for the years ended December 31, 2003 and 2002, and are not disclosed in the paragraph captions "Audit Fees" above, were $46,323 and $50,550, respectively. These charges were in relation to the Company's acquisitions and Form 8-K filing. TAX FEES. The aggregate fees billed by BDO Seidman, LLP for professional services rendered for tax compliance, for the years ended December 31, 2003 and 2002, were none and none, respectively. The aggregate fees billed by BDO Seidman, LLP for professional services rendered for tax advice and tax planning, for the years ended December 31, 2003 and 2002, were none and none, respectively. ALL OTHER FEES. The aggregate fees billed by BDO Seidman, LLP for products and services, other than the services described in the paragraphs captions "Audit Fees", "Audit-Related Fees", and "Tax Fees" above for the years ended December 31, 2003 and 2002, were none and none, respectively. The Audit Committee has established its pre-approval policies and procedures, pursuant to which the Audit Committee approved the foregoing audit services provided by BDO Seidman, LLP in 2003. Consistent with the Audit Committee's responsibility for engaging the Company's independent auditors, all audit and permitted non-audit services require pre-approval by the Audit Committee. The full Audit Committee approves proposed services and fee estimates for these services. The Audit Committee chairperson or their designee has been designated by the Audit Committee to approve any services arising during the year that were not pre-approved by the Audit Committee. Services approved by the Audit Committee chairperson are communicated to the full Audit Committee at its next regular meeting and the Audit Committee reviews services and fees for the fiscal year at each such meeting. Pursuant to these procedures, the Audit Committee approved the foregoing audit services provided by BDO Seidman, LLP. 50 PART IV ITEM 15. 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 56. ii. Financial Statement Schedule - See Index on page 56. 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 - the following documents are filed as exhibits to this Annual Report on Form 10-K: 2(a) 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. [incorporated by reference to Annex A of the Company's proxy statement/prospectus dated May 24, 2002 contained in the Registrant's Registration Statement on Form S-4, File No. 333-86454] 2(b) Amended and Restated Plan and Agreement of Merger dated as of December 15, 2003 among the Registrant, Qualia Computing, Inc., Qualia Acquisition Corp., Steven K. Rogers, Thomas E. Shoup and James Corbett.[Incorporated by reference to Exhibit 2(a) to the Registrant's Current Report on Form 8-K for the event dated December 31, 2003] 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] 51 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 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 [incorporated by reference to Exhibit 3(d) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2001]. 3(f) Certificate of Amendment of Certificate of Incorporation of the Registrant filed with the Secretary of State of the State of Delaware on June 28, 2002 [incorporated by reference to Exhibit 3.1 of the Registrant's Quarterly report on Form 10-Q for the quarter ended June 30, 2002]. 3(g) 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) 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(b) Letter Agreement dated June 28, 2002, amending the Revolving Loan and Security Agreement, and Convertible Revolving Credit Promissory Note between Robert Howard and Registrant dated October 26, 1987. 10(c) 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(d) 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]. 52 10(e) Certificate of Designation of 7% Series A Convertible Preferred Stock dated December 22, 1999. [incorporated by reference to Exhibit 10(i) to the Registrant's Report on Form 10-K for the year ended December 31, 1999]. 10(f) 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]. 10(g) Separation agreement dated September 24, 2002 between the Registrant and W. Kip Speyer [incorporated by reference to Exhibit 10.1 to the Registrant's quarterly report on Form 10-Q for the quarter ended September 30, 2002].* 10(h) Separation agreement dated September 30, 2002 between the Registrant and Gregory J. Stepic [incorporated by reference to Exhibit 10.2 to the Registrant's quarterly report on Form 10-Q for the quarter ended September 30, 2002].* 10(i) 1993 Stock Option Plan [incorporated by reference to Exhibit A to the Registrant's proxy statement on Schedule 14-A filed with the Securities and Exchange Commission on August 24, 1999].* 10(j) 2001 Stock Option Plan [incorporated by reference to Annex A of the Registrant's proxy statement on Schedule 14-A filed with the Securities and Exchange Commission on June 29, 2001].* 10(k) 2002 Stock Option Plan [incorporated by reference to Annex F to the Registrant's Registration Statement on Form S-4 (File No. 333-86454)].* 10(l) Exclusive Distribution Agreement between Intelligent Systems Software, Inc. and Instrumentarium Imaging, Inc., dated August 15, 2001 [incorporated by reference to Exhibit 10(l) to the Registrant's Report on Form 10-K for the year ended December 31, 2002]. ** 10(m) License Agreement between Scanis, Inc. and the Registrant dated February 18, 2003. [incorporated by reference to Exhibit 10(m) to the Registrant's Report on Form 10-K for the year ended December 31, 2002].** 53 21 Subsidiaries 23 Consent of BDO Seidman, LLP. 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. - ---------- * Denotes a management compensation plan or arrangement. ** Portions of these documents were omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment of the omitted portions. (b) During the quarter ended December 31, 2003 the Company filed a Form 8-K under Item 5 to report the November 2003 closing of private placement of its securities to certain institutional investors. The Company also furnished an 8-K under Item 12 to report its earnings for the quarter ended September 30, 2003. (c) Exhibits - See (a) iii above. (d) Financial Statement Schedule - See (a) ii above. 54 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. ICAD, INC. Date: March 30, 2004 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 30, 2004 Robert Howard /s/ W. Scott Parr President, Chief Executive - ---------------------- Officer, Director (Principal W. Scott Parr Executive Officer) March 30, 2004 /s/ Annette Heroux Vice President of Finance, - ---------------------- Chief Financial Officer Annette Heroux (Principal Accounting Officer) March 30, 2004 /s/ James Harlan Director March 30, 2004 - ---------------------- James Harlan /s/ Maha Sallam Director March 30, 2004 - ---------------------- Maha Sallam /s/ Brett Smith Director March 30, 2004 - ---------------------- Brett Smith /s/ Elliot Sussman Director March 30, 2004 - ---------------------- Elliot Sussman /s/ Steven Rogers Director March 30, 2004 - ---------------------- Steven Rogers 55 INDEX TO FINANCIAL STATEMENTS AND SCHEDULE Page ---- Report of Independent Certified Public Accountants 57 Consolidated Balance Sheets As of December 31, 2003 and 2002 58 Consolidated Statements of Operations For the years ended December 31, 2003, 2002 and 2001 59 Consolidated Statements of Stockholders' Equity For the years ended December 31, 2003, 2002 and 2001 60 Consolidated Statements of Cash Flows For the years ended December 31, 2003, 2002 and 2001 61 Notes to Consolidated Financial Statements 62-89 Schedule II - Valuation and Qualifying Accounts and Reserves 90 56 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors iCAD, Inc. Nashua, New Hampshire We have audited the accompanying consolidated balance sheets of iCAD, Inc. and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2003. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of ICAD, INC. and subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 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, Massachusetts February 27, 2004 57 ICAD, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, December 31, ------------- ------------- 2003 2002 ------------- ------------- Assets Current assets: Cash and equivalents $ 5,101,051 $ 1,091,029 Trade accounts receivable, net of allowance for doubtful accounts of $105,000 in 2003 and $40,000 in 2002 3,343,296 1,550,167 Inventory 2,123,642 390,349 Prepaid and other current assets 547,014 85,120 ------------- ------------- Total current assets 11,115,003 3,116,665 ------------- ------------- Property and equipment: Equipment 1,825,147 840,410 Leasehold improvements 26,489 8,051 Furniture and fixtures 133,562 22,271 ------------- ------------- 1,985,198 870,732 Less accumulated depreciation and amortization 717,635 579,545 ------------- ------------- Net property and equipment 1,267,563 291,187 ------------- ------------- Other assets: Patents, net of accumulated amortization 379,178 -- Technology intangibles, net of accumulated amortization 5,580,172 3,740,553 Tradename, Distribution agreements and other, net of accumulated amortization 1,115,000 1,513,228 Goodwill 43,205,220 17,415,723 ------------- ------------- Total other assets 50,279,570 22,669,504 ------------- ------------- Total assets $ 62,662,136 $ 26,077,356 ============= ============= Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 3,979,488 $ 2,232,262 Accrued interest 333,652 229,078 Accrued expenses 2,204,976 1,776,824 Convertible subordinated debentures 10,000 10,000 Current maturities of notes payable 1,233,390 65,526 ------------- ------------- Total current liabilities 7,761,506 4,313,690 Loans payable to related party 3,630,000 200,000 Notes payable, less current maturities 3,375,000 108,390 ------------- ------------- Total liabilities 14,766,506 4,622,080 ------------- ------------- Commitments and contingencies Stockholders' equity: Convertible preferred stock, $ .01 par value: authorized 1,000,000 shares; issued and outstanding 7,435 in 2003 and 8,550 in 2002, with the aggregate liquidation value of $1,257,500 in 2003 and $1,415,000 in 2002, plus 7% annual dividend 74 86 Common stock, $ .01 par value: authorized 50,000,000 shares; issued 33,704,809 in 2003 and 26,418,124 shares in 2002; outstanding 33,636,933 in 2003 and 26,350,248 shares in 2002 337,048 264,181 Additional paid-in capital 120,395,390 85,829,483 Accumulated deficit (71,886,618) (63,688,210) Treasury stock at cost (67,876 shares) (950,264) (950,264) ------------- ------------- Total Stockholders' equity 47,895,630 21,455,276 ------------- ------------- Total liabilities and stockholders' equity $ 62,662,136 $ 26,077,356 ============= =============
See accompanying notes to consolidated financial statements. 58 ICAD, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, -------------------------------------------- 2003 2002 2001 ------------ ------------ ------------ Sales $ 6,520,306 $ 5,000,184 $ 4,835,297 Cost of sales 2,941,663 5,161,643 3,936,406 ------------ ------------ ------------ Gross margin 3,578,643 (161,459) 898,891 ------------ ------------ ------------ Operating expenses: Engineering and product development 2,384,057 1,626,001 751,467 General and administrative 7,439,721 6,595,076 1,124,710 Marketing and sales 1,838,618 987,587 1,563,380 ------------ ------------ ------------ Total operating expenses 11,662,396 9,208,664 3,439,557 ------------ ------------ ------------ Loss from operations (8,083,753) (9,370,123) (2,540,666) Interest expense - net (includes $102,555, $26,761 and $114,952, respectively, to related parties) (114,655) (48,167) (80,105) ------------ ------------ ------------ Net loss (8,198,408) (9,418,290) (2,620,771) Preferred dividends 144,258 148,050 155,050 ------------ ------------ ------------ Net loss available to common stockholders $ (8,342,666) $ (9,566,340) $ (2,775,821) ============ ============ ============ Net loss per share Basic and diluted $ (0.31) $ (0.46) $ (0.20) Weighted average number of shares used in computing loss per share Basic and diluted 26,958,324 20,928,397 13,950,119
See accompanying notes to consolidated financial statements. 59 ICAD, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity
Preferred Stock Common Stock ------------------------- -------------------------- Additional Number of Number of Paid-in Accumulated Shares Issued Par Value Shares Issued Par Value Capital Deficit ------------- --------- ------------- ---------- ------------- ------------- Balance at December 31, 2000 9,550 $ 96 13,588,126 $ 135,881 $ 55,365,491 $ (51,649,149) 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 -- -- 1,432,910 14,329 1,591,364 -- Issuance of common stock for payment of dividends to investors -- -- 101,965 1,020 154,351 -- Preferred stock dividends -- -- -- -- (155,050) -- Net loss -- -- -- -- -- (2,620,771) ---------- --------- ------------- ---------- ------------- ------------- Balance at December 31, 2001 9,550 96 15,241,833 152,418 57,107,227 (54,269,920) Issuance of common stock pursuant to incentive stock option plan -- -- 150,454 1,505 159,004 -- Issuance of common stock relative to conversion of loan payable to related parties -- -- 215,517 2,155 497,845 -- Issuance of common stock relative to conversion of preferred stock (1,000) (10) 100,000 1,000 (990) -- Issuance of common stock to investor -- -- 250,000 2,500 497,500 -- Issuance of common stock relative to merger -- -- 10,400,000 104,000 27,569,500 -- Issuance of common stock for payment of dividends to investors -- -- 60,320 603 147,447 -- Preferred stock dividends -- -- -- -- (148,050) -- Net loss -- -- -- -- -- (9,418,290) ---------- --------- ------------- ---------- ------------- ------------- Balance at December 31, 2002 8,550 86 26,418,124 264,181 85,829,483 (63,688,210) Issuance of common stock pursuant to incentive stock option plan -- -- 616,640 6,166 855,134 -- Issuance of common stock relative to payment of accounts payable -- -- 600,000 6,000 2,015,600 -- Issuance of common stock relative to conversion of preferred stock (1,115) (11) 157,500 1,575 (1,564) -- Issuance of common stock in connection with legal settlement -- -- 325,954 3,260 1,212,940 -- Issuance of common stock relative to merger -- -- 4,300,000 43,000 24,467,000 -- Issuance of common stock relative to private offering -- -- 1,260,000 12,600 5,906,400 -- Issuance of stock options in payment for legal services -- -- -- -- 23,377 -- Compensation expense related to the extension of director stock options -- -- -- -- 87,285 -- Issuance of common stock for payment of dividends to investors -- -- 26,591 266 143,992 -- Preferred stock dividends -- -- -- -- (144,258) -- Net loss -- -- -- -- -- (8,198,408) ---------- --------- ------------- ---------- ------------- ------------- Balance at December 31, 2003 7,435 $ 74 33,704,809 337,048 $ 120,395,390 $ (71,886,618) ========== ========= ============= ========== ============= =============
Treasury Stockholders' Stock Equity ----------- ------------- Balance at December 31, 2000 $ (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 -- 1,605,693 Issuance of common stock for payment of dividends to investors -- 155,371 Preferred stock dividends -- (155,050) Net loss -- (2,620,771) ----------- ------------- Balance at December 31, 2001 (950,264) 2,039,557 Issuance of common stock pursuant to incentive stock option plan -- 160,509 Issuance of common stock relative to conversion of loan payable to related parties -- 500,000 Issuance of common stock relative to conversion of preferred stock -- -- Issuance of common stock to investor -- 500,000 Issuance of common stock relative to merger -- 27,673,500 Issuance of common stock for payment of dividends to investors -- 148,050 Preferred stock dividends -- (148,050) Net loss -- (9,418,290) ----------- ------------- Balance at December 31, 2002 (950,264) 21,455,276 Issuance of common stock pursuant to incentive stock option plan -- 861,300 Issuance of common stock relative to payment of accounts payable -- 2,021,600 Issuance of common stock relative to conversion of preferred stock -- -- Issuance of common stock in connection with legal settlement -- 1,216,200 Issuance of common stock relative to merger -- 24,510,000 Issuance of common stock relative to private offering -- 5,919,000 Issuance of stock options in payment for legal services -- 23,377 Compensation expense related to the extension of director stock options -- 87,285 Issuance of common stock for payment of dividends to investors -- 144,258 Preferred stock dividends -- (144,258) Net loss -- (8,198,408) ----------- ------------- Balance at December 31, 2003 $ (950,264) $ 47,895,630 =========== =============
See accompanying notes to consolidated financial statements. 60 ICAD, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, -------------------------------------------- 2003 2002 2001 ------------ ------------ ------------ Cash flows from operating activities: Net loss $ (8,198,408) $ (9,418,290) $ (2,620,771) ------------ ------------ ------------ Adjustments to reconcile net loss to net cash used by operating activities: Depreciation 138,090 143,809 242,335 Amortization 529,803 246,072 243,804 Loss on disposal of assets 1,443,628 473,350 -- Issuance of common stock for payment of legal settlement 1,216,200 -- -- Legal expense relative to issue of stock options and warrants 23,377 -- -- Compensation expense relative to extension of stock options 87,285 -- -- Compensation expense relative to issue of stock at merger -- 2,800,000 -- Changes in operating assets and liabilities (exclusive of acquisitions): Accounts receivable 685,960 (167,262) 391,368 Inventory (275,657) 2,207,149 79,913 Prepaid and other current assets (52,957) 4,026 74,722 Accounts payable 360,073 905,624 80,161 Accrued interest 104,574 25,779 114,045 Accrued expenses (728,526) 524,034 17,633 ------------ ------------ ------------ Total adjustments 3,531,850 7,162,581 1,243,981 ------------ ------------ ------------ Net cash used by operating activities (4,666,558) (2,255,709) (1,376,790) ------------ ------------ ------------ Cash flows from investing activities: Additions to patents, technology and other (264,225) -- (111,168) Additions to property and equipment (100,000) (150,062) (85,582) Acquisitions, net of cash acquired (1,103,969) 2,202,040 -- ------------ ------------ ------------ Net cash provided (used) by investing activities (1,468,194) 2,051,978 (196,750) ------------ ------------ ------------ Cash flows from financing activities: Issuance of common stock for cash 6,780,300 160,509 152,259 Proceeds from investor 3,430,000 500,000 -- Proceeds of convertible note payable to principal stockholder -- 750,000 480,000 Proceeds of note payable -- -- 193,492 Payment of demand note payable to principal stockholder -- (550,000) (80,000) Payment of note payable (65,526) (61,109) (14,622) Payment of convertible subordinated debentures -- -- (107,000) ------------ ------------ ------------ Net cash provided by financing activities 10,144,774 799,400 624,129 ------------ ------------ ------------ Increase (decrease) in cash and equivalents 4,010,022 595,669 (949,411) Cash and equivalents, beginning of year 1,091,029 495,360 1,444,771 ------------ ------------ ------------ Cash and equivalents, end of year $ 5,101,051 $ 1,091,029 $ 495,360 ============ ============ ============ Supplemental disclosure of cash flow information: Interest paid $ 1,965 $ 983 $ 10,530 ============ ============ ============ Non-cash items from financing activities: Conversion of loans and accrued interest payable to related parties into Common Stock $ -- $ 500,000 $ 1,605,693 ============ ============ ============ Conversion of accounts payable into related party loan payable $ -- $ -- $ 150,000 ============ ============ ============ Conversion of accounts payable into Common Stock $ 2,021,600 $ -- $ -- ============ ============ ============ Dividends payable with Common Stock $ 144,258 $ 148,050 $ 155,371 ============ ============ ============ Fair market value of iCAD common stock and common stock options issued to acquire capital stock of Qualia & ISSI $ 24,510,000 $ 27,673,500 $ -- ============ ============ ============ Net tangible assets of Qualia and ISSI acquired, excluding cash acquired of $446,031 and $2,202,040, respectively $ 1,317,092 $ 406,433 $ -- ============ ============ ============ Fair market value of identifiable intangible assets acquired from Qualia & ISSI, respectively $ 3,694,000 $ 5,437,000 $ -- ============ ============ ============
See accompanying notes to consolidated financial statements. 61 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) NATURE OF OPERATIONS AND USE OF ESTIMATES iCAD, Inc. and its subsidiaries (the "Company") designs, develops, manufactures and markets Computer Aided Detection (CAD) technology for mammography applications and medical film digitizers. The Company considers itself a single reportable business segment. The Company sells its products throughout the world through various distributors, resellers and systems integrators. See Note 10 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, software development costs and intangible assets. (b) PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries that were acquired during 2002 and 2003, Howtek Devices Corporation, ISSI Acquisition, Inc., Qualia Acquisition Corporation, CADx Systems, Inc., CADx Medical Systems Inc., CADx Systems Ltd. and CADx Medical SARL. Any material intercompany transactions and balances have been eliminated in consolidation. In the fourth quarter of 2003 the Howtek Devices Corporation and ISSI Acquisition, Inc., subsidiaries were dissolved and merged into iCAD, Inc. (c) ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS Accounts receivable are customer obligations due under normal trade terms. The Company performs continuing credit evaluations of its customers' financial condition and generally does not require collateral. Senior management reviews accounts receivable on a periodic basis to determine if any receivables will potentially be uncollectible. The Company includes any accounts receivable balances that are determined to be uncollectible, along with a general reserve, in its overall allowance for doubtful accounts. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. Based on the information available to the Company, it believes the allowance for doubtful accounts as of December 31, 2003 is adequate. However, actual write-offs might exceed the recorded allowance. 62 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) (d) 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 $129,000 and $1,995,000, respectively, for 2003 and raw material and finished goods of approximately $161,000 and $229,000, respectively, for 2002. During the quarter ended June 30, 2002, the Company wrote down inventory related to its discontinued graphic arts and photographic product lines to its estimated salvage value of zero. The write down for the year ended December 31, 2002 totaled approximately $2,370,000. (e) 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). (f) PATENTS The costs for patents are being amortized over the estimated useful life of the respective assets using the straight-line method. Patents related to discontinued product lines with net book values totaling $10,086 were written off during 2002. (g) SOFTWARE DEVELOPMENT COSTS Software development costs for application software and application software enhancements were capitalized subsequent to the establishment of their technological feasibility (as defined in Statement of Financial Accounting Standards No. 86). The Company capitalized $101,875 of internally developed and externally purchased software costs during fiscal 2001. No amounts were capitalized during 2002 and 2003. The capitalized software balances were presented net of accumulated amortization. Capitalized software costs were amortized using the straight-line method over their estimated economic lives (36 months). All software developments costs, which related to discontinued product lines, with net book values totaling $170,202, were written off during 2002. As of December 31, 2003 software development costs was zero. (h) REVENUE RECOGNITION Revenue is recognized when products are shipped to customers, provided that there are no uncertainties regarding customer acceptance, there is persuasive evidence of an arrangement, the sales price is fixed or determinable and collection of the related receivable is probable. 63 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) (i) 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. (j) WARRANTY COSTS The Company's products are generally under warranty against defects in material and workmanship from a 90 day to 2 year period, depending on the product. The Company established a Warranty reserve in the amount of $100,000 in 2003. Warranty costs were not material in any prior periods presented. (k) 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 (g) above) which are capitalized. (l) 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". (m) 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. (n) 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. 64 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) (o) LONG LIVED ASSETS Long-lived assets, such as intangible assets, other than goodwill, and 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. Intangible assets subject to amortization consists primarily of patents, technology intangibles, trade name and distribution agreements purchased in the acquisition of ISSI in June, 2002 and CADx in December, 2003 (See Note 2). These assets are amortized on a straight-line basis over their estimated useful lives of 2 to 10 years. For the years ended December 31,
-------------- ------------ -------------------- Weighted Average 2003 2002 Useful Life -------------- ------------ -------------------- -------------- ------------ -------------------- Gross carrying amount: Patents $ 389,178 - 5 years Technology $ 6,160,822 $3,871,000 10 years Trade name $ 248,000 - 10 years Distribution agreements $ 867,000 $1,566,000 2-3 years -------------- ------------ -------------- ------------ Total intangible assets $ 7,665,000 $5,437,000 Accumulated amortization Patent $ 10,000 - Technology $ 580,650 $ 130,447 Trade name - - Distribution agreements - $ 52,772 -------------- ------------ -------------- ------------ Total Accumulated $ 590,650 $ 183,219 amortization: -------------- ------------ Intangible assets, net $ 7,074,350 $5,253,781 ============== ============
Amortization expense related to intangible assets was $530,000, $246,000 and $244,000 for the years ended December 31, 2003, 2002, and 2001, respectively. Estimated amortization of our intangible assets for the next five fiscal years is as follows including amortization expense related to intangibles from our acquisitions of ISSI in 2002 and CADx in 2003: 65 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) (o) LONG LIVED ASSETS (continued) Estimated amortization expense For the year ended December 31, 2004 $1,003,000 For the year ended December 31, 2005 1,003,000 For the year ended December 31, 2006 870,000 For the year ended December 31, 2007 670,000 For the year ended December 31, 2008 645,000 In the third quarter of 2003, the Company recorded a one-time write-off of $1,443,628 for the remaining asset, net of accumulated amortization, attributable to its distribution agreement with Instrumentarium, which the Company assumed as part of the ISSI acquisition. This write-off came after assessing the performance of Instrumentarium under the distribution agreement, and in light of the Company's implementation of alternative distribution channels. This charge is included in general and administrative expenses. (p) GOODWILL 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 supersedes APB Opinion No. 17, "Intangible Assets", and 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. Goodwill arose in connection with the ISSI acquisition in June 2002 and with CADx at December 31, 2003. See Note 2. 66 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) (q) STOCK-BASED COMPENSATION The Company applies APB Opinion 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its stock option 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. The Company provides proforma disclosures of compensation expense under the fair value method of SFAS No. 123, "Accounting for Stock-Based Compensation," and SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure". 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 2003: no dividends paid; expected volatility of 80.8%; risk-free interest rates of 2.91%, 2.34%, 2.63%, 2.60%, 3.06% and 3.34%; and expected lives of 4 to 5 years. The weighted-average assumptions used for grants in 2002 were: no dividends paid; expected volatility of 80.3%; risk-free interest rates of 2.01%, 4.86%, 3.37%, 1.79% and 1.56%; and expected lives of 1 and 9 years. The weighted-average assumptions used for grants in 2001 were: no dividends paid; expected volatility of 75.9%; risk-free interest rates of 4.78% and 3.87%; and expected lives of 1 to 4 years. Had compensation cost for the Company's option plans been determined using the fair value method at the grant dates, the effect on the Company's net loss and loss per share for the years ended December 31, 2003, 2002 and 2001 would have been as follows: 2003 2002 2001 ------------ ------------ ------------ Net loss available to common stockholders as reported $ (8,342,666) $ (9,566,340) $ (2,775,821) Add: Stock-based employee compensation expense included in reported net income -- -- -- Deduct: Total stock-based employee compensation determined under fair value method for all awards (204,455) (1,820,855) (142,210) ------------ ------------ ------------ Pro forma net loss $ (8,547,121) $(11,387,195) $ (2,918,031) ============ ============ ============ Basic and diluted loss per share As reported $(.31) $(.46) $(.20) Pro forma $(.32) $(.54) $(.21) 67 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) (r) ADVERTISING The Company expenses advertising costs as incurred. Advertising expense for the years ended December 31, 2003, 2002 and 2001 was $250,000, $125,000 and $151,000, respectively. (s) RECENTLY ISSUED ACCOUNTING STANDARDS In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 145, Rescission of FASB Statements SFAS Nos. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections. SFAS No. 145 rescinds Statement No. 4, Reporting Gains and Losses from Extinguishments of Debt, and an amendment of that Statement, FASB Statement No. 64 Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. SFAS No. 145 also rescinds FASB Statement No. 44, Accounting for Intangible Assets of Motor Carriers. SFAS No. 145 amends FASB Statement No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provision of SFAS No.145 related to the rescission of Statement No. 4 shall be applied in fiscal year beginning after May 15, 2002. The provisions of SFAS No. 145 related to Statement No. 13 should be for transactions occurring after May 15, 2002. Early application of the provisions of this Statement is encouraged. The adoption of SFAS No. 145 did not have any effect on the Company's financial statements. In June 2002, the FASB issued SFAS No. 146 Accounting for Costs Associated with Exit or Disposal Activities. This statement superseded EITF No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. Under this statement, a liability or a cost associated with a disposal or exit activity is recognized at fair value when the liability is incurred rather than at the date of an entity's commitment to an exit plan as required under EITF 94-3. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early adoption permitted. The adoption of SFAS No. 146 did not have a significant impact on the Company's financial statements. In November 2002, the Emerging Issues Task Force ("EITF") reached consensus on Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. Revenue arrangements with multiple deliverables include arrangements which provide for the delivery or performance of multiple products, services and/or rights to use assets where performance may occur at different points in time or over different periods of time. EITF Issue No. 00-21 is effective for revenue 68 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) 1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) (s) RECENTLY ISSUED ACCOUNTING STANDARDS (continued) arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of the guidance under this consensus did not have an impact on the Company's financial position, results of operations or cash flows. In November 2002, the FASB issued Interpretation ("FIN") No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which will significantly change current practice in the accounting for, and disclosure of, guarantees. FIN No. 45 requires that a guarantor recognize, at the inception of certain types of guarantees, a liability of the obligation undertaken in issuing the guarantee at fair value. The interpretation also requires significant new disclosures in the financial statements of the guarantor about its obligations under certain guarantees. The Company is required to apply the disclosure provisions of FIN No. 45 in its financial statements as of December 31, 2002. The accounting provisions of FIN No. 45 are applicable for guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN No. 45 did not have a material effect on the Company's financial statements and it does not expect the accounting provisions of this interpretation to have a material impact on its financial statements. In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51, ("FIN No. 46")" which requires all variable interest entities ("VIEs") to be consolidated by the primary beneficiary. The primary beneficiary is the entity that holds the majority of the beneficial interests in the VIE. In addition, the interpretation expands disclosure requirements for both variable interest entities that are consolidated, as well as VIEs from which the entity is the holder of a significant amount of the beneficial interests, but not the majority. The disclosure requirements of this interpretation are effective for all financial statements issued after January 31, 2003. The consolidation requirements of this interpretation are effective for all periods beginning after June 15, 2003. The Company does not have any VIEs, therefore the adoption of this interpretation did not have any effect on its results of operations or financial condition. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 requires that certain financial instruments, which under previous guidance were accounted for as equity, must now be accounted for as liabilities. The financial instruments affected include mandatorily redeemable stock, certain financial instruments that require or may require the issuer to buy back some of its shares in exchange for cash or other assets and certain obligations that can be settled with shares of stock. SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003 and must be applied to existing financial instruments effective June 29, 2003. The adoption of this statement did not have a material effect on the Company's results of operations or financial condition. 69 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (2) ACQUISITIONS (a) ACQUISITION OF CADx On December 31, 2003, the Company completed the acquisition of CADx. This merger brings together two of the three companies approved by the FDA to market computer aided detection of breast cancer solutions in the United States. To complete the merger, iCAD issued a total of 4,300,000 shares of its common stock, representing approximately 13% of the outstanding shares of iCAD common stock after the merger. The value of the Company's Common Stock issued was based upon a per share value of $5.70, equal to the closing price on November 28, 2003, the day the acquisition was announced. Additionally, iCAD paid $1,550,000 in cash and executed a 36-month secured promissory note in the amount of $4,500,000 to purchase Qualia shares that were owned by two institutional investors. The acquisition was accounted for as a purchase on December 31, 2003, and accordingly, the operations of CADx are not included in the consolidated financial statements but will commence on January 1, 2004. The purchase price has been allocated to net assets acquired based upon an appraisal of their fair values, but the allocation is subject to further adjustment. The following is a summary of the estimated fair values of the assets acquired and liabilities assumed as of the date of acquisition: Current assets $ 4,791,693 Property and equipment 850,241 Identifiable intangible assets 3,694,000 Goodwill 25,789,497 Current liabilities (3,878,811) ----------- Purchase price $31,246,620 =========== The goodwill of $25,789,497 is not expected to be deductible for income tax purposes. The unaudited proforma operating results for the Company, assuming the acquisition of CADx occurred as of January 1, 2003, are as follows: Years ended December 31, 2003 --------------------------------------------------------------------- Sales $ 16,219,443 Loss from operations $( 14,553,691) Net loss $(15,087,642) Net loss per share: Basic and diluted $(0.57) 70 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (2) ACQUISITIONS (continued) (b) ACQUISITION OF ISSI On June 28, 2002, the Company completed the acquisition of Intelligent Systems Software, Inc. ("ISSI") pursuant to a plan and agreement of merger. The Company acquired all of the issued and outstanding capital stock of ISSI, a privately held company based in Boca Raton, Florida. The Company initiated the merger with the intention of improving its competitive position in the CAD market place for products of the combined companies. In the merger, the Company issued a total of 10,400,000 shares of its common stock to the ISSI stockholders, including 2,000,000 shares of the Company's common stock which were issued to a corporation owned by the Chairman of the Company, Mr. Robert Howard, in exchange for shares of ISSI Common Stock purchased by the corporation immediately prior to the merger, as approved by the Company's shareholders and in accordance with the provisions of the merger agreement. The value of the Company's Common Stock issued was based upon a per share value of $3.20, equal to the closing price on February 19, 2002, the day the acquisition was announced. In connection with the 2,000,000 shares issued to the corporation owned by Mr. Howard, the Company recorded compensation expense of $2,800,000, which represented the amount that the fair market value of iCAD common shares issued exceeded the consideration paid for ISSI common stock. The acquisition was accounted for as a purchase, and accordingly, the operations of ISSI are included in the consolidated financial statements since the effective date, the close of business on June 28, 2002 through December 31, 2002. The purchase price has been allocated to net assets acquired based upon an appraisal of their fair values. Following is a summary of the estimated fair values of the assets acquired and liabilities assumed as of the date of acquisition: Current assets $ 3,180,347 Property and equipment 246,613 Identifiable intangible assets 5,437,000 Goodwill 17,415,723 Current liabilities (762,332) Notes payable (56,155) ----------- Purchase price $25,461,196 =========== The goodwill of $17,415,723 is not deductible for income tax purposes. 71 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (2) ACQUISITIONS (continued) (b) ACQUISITION OF ISSI (continued) The unaudited proforma operating results for the Company, assuming the acquisition of ISSI occurred as of January 1, 2002, are as follows: Year ended December 31, 2002 ------------------------------------------------ Sales $ 6,246,432 Loss from operations $ (9,991,795) Net loss $(10,039,962) Net loss per share: Basic and diluted $(0.39) (3) RESTRUCTURING CHARGES (a) DISCONTINUED PRODUCT LINES During the second quarter of 2002, the Company implemented a plan whereby it would no longer support its graphic arts and photographic product lines and would concentrate its efforts in the medical imaging and CAD business. In connection therewith, the Company wrote off all inventories, fixed assets and intangible assets related to the discontinued product lines down to their estimated salvage values. Accordingly, during 2002 the Company recorded charges for the write off of inventory of approximately $2,370,000, fixed assets of approximately $237,000 and intangible assets of approximately $180,000. During the fourth quarter of 2002, the Company concluded the licensing and divestiture of the discontinued product lines. The license agreement provided for the sale of all tangible and intangible assets related to the product lines. Total consideration of $188,117 was paid through the assumption of certain liabilities of the Company and is included in the cost of sales in the accompanying consolidated statements of operations for the year ended December 31, 2002. In accordance with the licensing agreement any sales by the licensee will result in royalty revenue to the Company. Royalty revenues are earned as a flat fee for each unit sold by the licensee. No royalty revenue was received in 2003. 72 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (3) RESTRUCTURING CHARGES (continued) (b) CLOSURE OF BOCA RATON OFFICE During the third quarter of 2002, the Company's first quarter of combined operations, iCAD's management and directors evaluated the Company's organization and operations to identify and eliminate redundancies and inefficiencies created through the merger of Howtek and ISSI. As a consequence, the Company negotiated the resignations of three members of senior management, and took action to close the Company's office in Boca Raton, Florida in 2003 resulting in a one time charge of $884,000. Charges recorded in connection with separation agreements negotiated with its former Chief Executive Officer and Vice President of Finance totaled approximately $790,000. The cost of closing the Boca Raton office totaled approximately $94,000 and represented remaining amounts due under the non-cancelable operating lease for the facility. The total charge is included in general and administrative expenses in the accompanying consolidated statement of operations. As of December 31, 2002 approximately $110,000 of severance and closing costs were paid and charged against the liability. Severance and closing costs accrued as of December 31, 2002 totaled approximately $774,000, with $449,000 paid in 2003 and expected payments of $269,000 and $56,000 for 2004 and 2005, respectively. (4) RELATED PARTY TRANSACTIONS (a) LOAN PAYABLE TO PRINCIPAL STOCKHOLDER The Company has a 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 $4,000,000. The Loan Agreement expires January 4, 2005, 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% with a minimum of 8%. Mr. Howard is entitled to convert outstanding advances made by him under the Loan Agreement 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 lesser of the market price at the time each advance is made or at the time of conversion. During the first quarter of 2002, Mr. Howard converted $500,000 of advances made under the Loan Agreement into 215,517 shares of restricted common stock of the Company. In the second quarter of 2002 the Company borrowed $250,000 and in November 2002 the Company repaid Mr. Howard $50,000 pursuant to the Loan Agreement. In 2003 the Company borrowed $3,430,000 pursuant to the Loan Agreement. 73 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (4) RELATED PARTY TRANSACTIONS (continued) (a) LOAN PAYABLE TO PRINCIPAL STOCKHOLDER (continued) As of December 31, 2003, $3,630,000 was owed by the Company and the Company had $370,000 available for future borrowings under the Loan Agreement. The Company had Secured Demand Notes and Security Agreements (the "Notes") owed to Mr. Robert Howard, totaling $500,000 as of December 31, 2001. The principal of these Notes was 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. Payment of the Notes was secured by a security interest in certain assets of the Company. In March 2002 the Company repaid the principal balance due in the amount of $500,000 and the Notes were discharged. (b) PREMISES LEASE AND OTHER EXPENSES The Company conducted its operations in premises owned by Mr. Robert Howard, pursuant to a lease, which expired January 31, 2003. As of December 31, 2002, future minimum lease payments under this lease are $6,542 for 2003. The Company was required to pay real estate taxes, provide insurance and maintain the premises. Total rent paid under this lease for each of the years ended December 31, 2002 and 2001 was $78,500. In January 2003, the Company relocated its principal executive offices. See Note 11 (a) of the Notes to Consolidated Financial Statements. (5) ACCRUED EXPENSES Accrued expenses consist of the following at December 31, 2003 and 2002: 2003 2002 ---------- ---------- Accrued office closure and related costs $ -- $ 774,332 Accrued litigation -- 383,000 Accrued legal settlement 250,000 -- Accrued salary and related expenses 1,273,559 178,127 Accrued warranty expense 100,000 -- Other accrued expenses 364,917 441,365 Unearned revenue 216,500 -- ---------- ---------- $2,204,976 $1,776,824 ========== ========== 74 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (6) CONVERTIBLE SUBORDINATED DEBENTURES The Company has a 9% Convertible Subordinated Debentures (the "Debentures"), which became due December 1, 2001. Interest on the Debentures was 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, $2,064,000 were converted into 2,064,000 shares of Common Stock, at the conversion price of $1.00 per share. In December 2001, $107,000 of its Debentures were presented for payment. As of December 31, 2002 and 2003 the Company's outstanding balance on its Debentures was $10,000. (7) NOTES PAYABLE On December 31, 2003, the Company completed the acquisition of CADx. To complete the merger, the Company executed a secured promissory note in the amount of $4,500,000 issued in favor of CADx Canada which is payable over 36 months and bears interest at the rate per annum equal to the greater of (i) 6.25% or (iii) the prime rate plus 1%. The note is secured by the assets of iCAD. Maturity of the note payable is as follows: Year ending Principal 2004 $1,125,000 2005 1,500,000 2006 1,500,000 2007 375,000 In connection with the acquisition of ISSI, the Company assumed two convertible promissory notes payable with an original principal amount totaling $56,155. The Company is required to make quarterly interest payments on the outstanding principal balance at a rate of 7% per annum. The convertible promissory notes payable mature in November 2004 at which time any outstanding principal balance is due. The convertible promissory notes payable give the holder the right at any time to convert the then outstanding principal and any accrued interest balances into share of common stock based on the conversion rate of $0.89 per share of the Company's common stock. 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, 2003, the Company owed $52,235 pursuant to the Note. Principal monthly payments are due through September 2004. 75 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (8) STOCKHOLDERS' EQUITY (a) PREFERRED STOCK 7% Series A Convertible 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 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 $7.00 per annum per share, payable annually, subject to appropriate adjustment by the Board of Directors of the Company in the event of any stock split, dividend or similar division of shares of Series A Preferred. Dividends are payable annually, in arrears, on the last day of December in each year. On April 12, 2000, the Company sold, in private transactions, a total of 2,250 shares of its 7% Series A Preferred Stock ($.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. 76 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) 8) STOCKHOLDERS' EQUITY (continued) (a) PREFERRED STOCK (continued) In 2003, Dr. Lawrence Howard converted 1,000 shares of the Company's Series A Preferred Stock into 100,000 shares the Company's Common Stock. 7% Series B Convertible Preferred Stock. 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 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 $70.00 per annum per share, payable annually, subject to appropriate adjustment by the Board of Directors of the Company in the event of any stock split, dividend or similar division of shares of Series B Preferred. Dividends are payable annually, in arrears, on the last day of December in each year. In October 2000 the Company sold, in private transactions, a total of 1,400 shares of its 7% Series B Preferred Stock ($.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. 77 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (8) STOCKHOLDERS' EQUITY (continued) (a) PREFERRED STOCK (continued) The 1,400 shares of 7% Series B 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. In 2003, 115 shares of the Company's Series B Preferred Stock were converted by unrelated parties into 57,500 shares the Company's Common Stock. (b) STOCK OPTIONS The Company has four stock option plans, which are described as follows: The Howtek, Inc. 1993 Stock Option Plan" ("The 1993 Plan"). ----------------------------------------------------------- The 1993 Plan (the "Plan") was adopted in November 1993. 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 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. No new options can be granted under this 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. 78 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (8) STOCKHOLDERS' EQUITY (continued) (b) STOCK OPTIONS (continued) 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. The Howtek, Inc. 2002 Stock Option Plan, ("The 2002 Plan"). ----------------------------------------------------------- The 2002 Plan was adopted in June 2002, at the Annual Meeting of Stockholders. The 2002 Plan provides for the granting of non-qualifying and incentive stock options to employees and other persons to purchase up to an aggregate of 500,000 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 2002 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 2002 Plan are generally exercisable over a ten year period. Intelligent Systems Software 2001 Stock Option Plan ---------------------------------------------------- In connection with iCAD's acquisition of Intelligent Systems Software, Inc. in June 2002, iCAD assumed options granted under Intelligent Systems Software's 2001 Stock Option Plan to purchase 400,000 shares of Intelligent Systems Software's common stock, which options were converted upon such acquisition into the right to purchase 500,000 shares of iCAD's common stock in accordance with the terms and conditions set forth in such 2001 Stock Option Plan. 79 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (8) 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, 2001 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 Granted 2,483,445 $ .80-$3.49 $2.42 Exercised (150,454) $ .80-$1.75 $1.07 Cancelled (34,832) $1.72-$3.49 $2.24 --------------------------------------- Outstanding, December 31, 2002 3,774,748 $ .80-$3.49 $2.04 Granted 911,500 $1.64-$4.91 $2.09 Exercised (616,640) $ .80-$3.49 $1.40 Cancelled (381,057) $ .81-$3.49 $2.41 --------------------------------------- Outstanding, December 31, 2003 3,688,551 $ .80-$4.91 $2.12 ======================================= Exercisable at year-end 2001 1,078,641 $ .81-$3.00 $1.27 2002 2,976,918 $ .80-$3.49 $2.05 2003 2,598,682 $ .80-$3.49 $2.19 Available for future grants 2003 69,612 The weighted-average fair value of options granted during the year was $1.25 per option for 2003, $1.49 per option for 2002 and $0.61 per option for 2001. The weighted-average remaining contractual life of stock options outstanding for all plans at December 31, 2003 was 7.7 years. 80 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (8) STOCKHOLDERS' EQUITY (continued) (b) STOCK OPTIONS (continued) The following table summarizes information about stock options outstanding at December 31, 2003:
$.80 $1.00 $1.50 to to to Range of Exercise Prices: $.95 $1.13 $4.91 --------------------------- Outstanding options: Number outstanding at December 31, 2003 563,934 327,390 2,797,227 Weighted average remaining contractual life (years) 6.6 4.3 8.3 Weighted average exercise price $.83 $1.13 $2.50 Exercisable options: Number outstanding at December 31, 2003 523,934 327,390 1,747,358 Weighted average remaining contractual life (years) 6.5 4.3 7.9 Weighted average exercise price $.82 $1.13 $2.80
(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, 2003, 2002 and 2001, but not included in the calculation of diluted net loss per share because such shares are antidilutive:
2003 2002 2001 --------- --------- --------- Stock options 3,688,551 3,774,748 1,476,589 Stock warrants 124,200 57,000 57,000 Convertible Revolving Promissory Note 1,261,136 80,000 -- Convertible Series A Preferred Stock 615,000 715,000 815,000 Convertible Series B Preferred Stock 642,500 700,000 700,000
81 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (8) STOCKHOLDERS' EQUITY (continued) (d) PRIVATE PLACEMENT On November 24, 2003, the Company sold 1,260,000 shares of its common stock for $5.00 per share in a private placement to institutional investors. The Company also issued to such investors' additional investment rights to purchase up to an additional 315,000 shares of its common stock at $5.00 per share. The net proceeds to the Company for the 1,260,000 shares sold were approximately $5,919,000. A total of 90,000 shares of the Company's common stock were issued in connection with the additional investment rights in 2004. The remaining shares expired unexercised. The net proceeds to the Company for the 90,000 shares sold were approximately $425,000. Ladenburg Thalmann & Co. Inc. served as placement agent for these transactions for which it received compensation in the amount of approximately $404,000 and a five year warrant to purchase 67,200 shares of the Company's Common Stock at $5.00 per share. (e) STOCK SUBSCRIPTION WARRANTS On November 24, 2003 the Company issued a common stock purchase warrant (the "2003 Warrant") to Ladenburg Thalmann & Co., Inc. (the "Agent"), that served as a placement agent for the private placement transaction. The warrants were issued for placement services, for which the Agent received a five-year warrant. The 2003 Warrant entitles the Agent to purchase from the Company up to 67,200 shares of the Company's common stock at $5.00 per share. The Agent may exercise the Warrant at any time or from time to time on or prior to November 24, 2008. 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 New 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 New Warrant at any time or from time to time on or prior to February 28, 2005. The Company estimated the fair value of the New Warrant at the date of issue to be $12,818 using the Black-Scholes option-pricing model. The value of the New Warrant was expensed in 2000. 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. 82 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (8) STOCKHOLDERS' EQUITY (continued) (e) STOCK SUBSCRIPTION WARRANTS (continud) At December 31, 2003 there are 124,200 warrants outstanding that are exercisable at the following prices: Warrants Exercise Price -------------------- ---------------- 67,200 $5.00 7,000 $3.00 50,000 $2.50 No warrants were exercised in 2001, 2002 or 2003. (9) INCOME TAXES As a result of the 2003, 2002 and 2001 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: 2003 2002 ------------ ------------ Inventory (Section 263A) $ (86,000) $ (393,000) Inventory reserves (39,000) (24,000) Receivable reserves (36,000) (14,000) Other accruals (24,000) (24,000) Accumulated depreciation 353,000 9,000 Acquisition related intangibles 3,494,000 2,102,000 Tax credits (2,530,000) (2,459,000) NOL carry forward (13,927,000) (14,351,000) ------------ ------------ Gross deferred tax asset (12,795,000) (15,154,000) Deferred tax assets valuation allowance $ 12,795,000 $ 15,154,000 ------------ ------------ Net deferred tax assets $ -0- $ -0- ============ ============ As of December 31, 2003, the Company has net operating loss carryforwards totaling approximately $43,800,000. 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: 83 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (9) INCOME TAXES (continued) Expiration date Amount of remaining NOL --------------- ----------------------- 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 2022 5,800,000 2023 8,400,000 In addition the Company has available tax credit carryforwards (adjusted to reflect provisions of the Tax Reform Act of 1986) of approximately $2,530,000, which are available to offset future taxable income and income tax liabilities, when earned or incurred. These amounts expire in various years through 2023. (10) 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 were $288,708 or 4% of total sales in 2003, $301,000 or 6% of total sales in 2002 and $944,000 or 20% of total sales in 2001. The Company's principal concentration of export sales was in Australia, which accounted for 35% of the Company's export sales in 2003 and 2001, with Europe accounting for 26% of the Company's export sales in 2002. The balance of the export sales was into Canada and the Far East. As of December 31, 2003 and 2002 the Company had outstanding receivables of $65,079 and $15,000, respectively, from distributors of its products who are located outside of the United States. 84 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (10) SALES INFORMATION (continued) (b) MAJOR CUSTOMERS During the years ended December 31, 2003 and 2002 the Company had sales of $2,921,535 and $2,631,709, or 45% and 53% of sales, respectively, to Instrumentarium Imaging, Inc. and an accounts receivable balance of $156,003 and $1,190,990, respectively, due from this customer at December 31, 2003 and 2002. The Company did not have any major customers in 2001. (c) PRODUCT INFORMATION The Company's revenues by product line are as follows: For the year ended December 31, 2003 2002 2001 ---------- ---------- ---------- CAD $4,229,622 $2,628,135 $ -- Medical imaging 2,290,684 1,660,493 2,315,738 FotoFunnel -- 274,169 988,199 Graphic arts -- 437,387 1,531,360 ---------- ---------- ---------- Total $6,520,306 $5,000,184 $4,835,297 ========== ========== ========== (11) COMMITMENTS AND CONTINGENCIES (a) LEASE OBLIGATIONS As of December 31, 2003, the Company had three lease obligations related to its facilities. The Company's principal executive office is located in Nashua, New Hampshire. The facility consists of manufacturing, research and development and office space and is leased by the Company pursuant to a lease which expires December 31, 2006 at an annual rent of approximately $69,200. The Company leases a facility for its software research and development group in Tampa, Florida. The facility consists of research and development and office space and is leased by the Company pursuant to a lease, which expires July 31, 2007 at an annual rent of approximately $53,000. Additionally, the Company is required to pay real estate taxes and provide insurance. 85 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (11) Commitments and Contingencies (continued) (a) LEASE OBLIGATIONS (continued) In addition, as a result of its acquisition of CADx on December 31, 2003, the Company leases a facility for its software research and development, customer service and administrative offices located in Beavercreek, Ohio. The facility consists of research and development and office space and is leased by the Company pursuant to a lease, which expires December, 2010 at an annual rate of approximately $416,000. Additionally, the Company is required to pay real estate taxes, utilities, common area maintenance, cleaning, security and provide insurance. The lease amount increases annually throughout the life of the lease. The lease may be renewed for two additional terms of five years each. Rental expense for all leases for the years ended December 31, 2003, 2002 and 2001 was $125,797, $198,429 and $78,500, respectively. Future minimum rental payments due under these agreements as of December 31, 2003 are approximately as follows: Fiscal Year Amount ----------- ---------- 2004 $ 520,000 2005 536,000 2006 552,000 2007 478,000 2008 459,000 2009 472,000 2010 486,000 ---------- $3,503,000 ========== 86 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (11) COMMITMENTS AND CONTINGENCIES (continued) (b) LITIGATION The Company has been dismissed from a complaint filed against the Company in the United States District Court for the Eastern District of Texas, entitled The Massachusetts Institute of Technology and Electronics for Imaging, Inc. v. Abacus Software Inc. et al. Case No. 501CV344. The plaintiff claimed initially that the Company had infringed a United States patent alleged to cover color reproduction system technology through sale of certain Company products to customers in the graphic arts/prepress and photographic markets. The Company has no liability in this matter, and anticipates no further legal expenses will be incurred with respect to this litigation. As a result, general and administrative expenses incurred during the first quarter of 2003 were reduced by the reversal of the accrued settlement cost in the amount of $383,000. On June 3, 2002, ISSI was sued in United States District Court for the District of Delaware by R2 Technology, Inc. and Shih-Ping Wang. The lawsuit alleged that ISSI's MammoReader device infringes certain patents owned by the plaintiff. The complaint requested treble damages, but did not specify the amount of damages sought. The complaint also sought to enjoin ISSI from further infringement. On July 11, 2002, subsequent to the acquisition of ISSI by the Company, the plaintiffs amended their complaint to add the Company and its subsidiary ISSI Acquisition Corp. as additional parties. In July 2003, the Company filed suit in the United States District Court for the District of New Hampshire against R2 for infringement of certain patents licensed by the Company. The complaint requested treble damages, costs and legal fees, but did not specify the amount of damages sought. On September 8, 2003, the Company announced the settlement of all patent infringement litigation with R2. Under the terms of the settlement, both actions were dismissed with prejudice and iCAD was granted a non-exclusive license to the patents named in the suit filed by R2. In connection with the settlement of the suit, iCAD agreed to pay R2 an aggregate of $1,250,000, of which $1,000,000 was paid in September 2003, with $250,000 deferred and payable in equal installments on a quarterly basis through December, 2005. In addition, iCAD issued to R2 250,954 shares of iCAD Common Stock valued at $750,000 and has filed a registration statement intended to cover the resale of the shares by R2. iCAD also agreed to certain continuing royalties, which are based on the category and configuration of products sold by iCAD. Further, iCAD granted R2 a partial credit against potential future purchases by R2 of iCAD digitizers worth up to $2,500,000 over five years to encourage R2 to purchase film digitizers manufactured by iCAD. This partial credit is not accounted for in the Company's financial statements as it was meant to provide a significant purchasing advantage to R2, while maintaining a reasonable profit margin and creating additional 87 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (11) COMMITMENTS AND CONTINGENCIES (continued) (b) LITIGATION (continued) economies of scale for iCAD. In November 2003, R2 agreed to accept an additional 75,000 shares of iCAD Common Stock valued at $466,200, in satisfaction of any royalties it otherwise would have been entitled to receive under the settlement agreement. The value of the Company's Common Stock issued was based upon a per share value of $6.216, equal to the closing price on November 18, 2003, the date of the agreement. These charges are included in general and administrative expenses. (12) FINANCIAL INSTRUMENTS The carrying amounts of financial instruments, including cash and equivalents, accounts receivable, accounts payable, accrued expenses, loan payable to related parties, notes payable and convertible debentures and other convertible debt approximated fair value as of December 31, 2003 and 2002, due to either short maturity or terms similar to those available to similar companies in the open market. (13) QUARTERLY FINANCIAL DATA (unaudited) Net Gross Net (Loss) 2003 sales profit income (loss) per share ---- ----------- ----------- ------------- --------- First quarter $ 2,214,012 $ 1,304,427 $ 76,558 $ 0.00 Second quarter $ 1,337,517 $ 744,934 $(1,285,144) $ (0.05) Third quarter $ 1,387,100 $ 655,493 $(5,395,367) $ (0.20) Fourth quarter $ 1,581,677 $ 873,789 $(1,594,455) $ (0.06) 2002 ---- First quarter $ 775,633 $ 180,221 $ (521,122) $ (0.04) Second quarter $ 776,600 $(2,665,747) $(7,359,510) $ (0.47) Third quarter $ 1,286,966 $ 727,887 $(1,640,665) $ (0.06) Fourth quarter $ 2,160,985 $ 1,596,180 $ 103,007 $ 0.00 The 2003 totals above are reflective of the Company's decision, in the third quarter of 2003, to write-off $1,443,628 attributable to its distribution agreement with Instrumentarium. This write-off came after assessing the performance of Instrumentarium in the third quarter 2003, and in light of the Company's implementation of alternative distribution channels, the Company elected to take a one-time write-off, thereby eliminating the distribution agreement as a depreciating asset. Additionally, during the third quarter of 2003, 88 ICAD, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (13) QUARTERLY FINANCIAL DATA (unaudited) (continued) the Company accounted for over $2,702,000 in non-recurring expenses related to the settlement of R2 patent infringement litigation and legal expenses. In addition, the Company issued to R2 shares of iCAD Common Stock valued at $750,000. In the fourth quarter 2003, R2 agreed to accept an additional 75,000 shares valued at $466,200 of iCAD Common Stock in satisfaction of any royalties it otherwise would have been entitled to receive under the settlement agreement. During this period the Company recorded approximately $702,000 in legal and related expenses associated with the R2 litigation. The 2002 totals are reflective of the Company's decision in the second quarter of 2002 to no longer support its graphic arts and photographic product lines. In connection with the discontinuance, the Company recorded charges related to the write off of inventory, fixed assets and intangible assets related to those product lines. Total charges incurred during the second quarter of 2002 related to the write off amounted to $2,786,540. Results for the third and fourth quarters of 2002 include the operations of ISSI which was acquired on June 28, 2002. During the fourth quarter of 2002, the Company recorded sales of $188,177 related to the licensing and divestiture of discontinued product lines. (14) SUBSEQUENT EVENTS On December 31, 2003, the Dompany completed the acquisition of CADx. Integration of the acquired companies is substantially complete. Operating expenses for the combined icad and CADx companies substantially exceeded those of iCAD alone. During the first quarter of 2004 the Company assessed the opportunities to achieve post-merger operating economies, and identified cost-reduction opportunities in light of its distribution and product plans. As a result of this analysis management determined that operating expenses could be substantially reduced without detracting from the Company's ability to increase sales and focus on future products and markets. Cost-reduction actions taken by iCAD in the first quarter of 2004 included the closure of offices in Tampa, Florida and San Rafael, California; reductions in staffing effective March 31, 2004 of 39 of 110 previous full and part-time employees, and the reduction of duplication in marketing, administrative and other activities. As a result of these cost-reduction actions, the Company will report certain non-recurring severance and office closure expenses in the quarter ending March 31, 2004. 89 ICAD, INC. AND SUBSIDIARIES 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, 2003: Allowance for Doubtful Accounts $ 40,000 $ 100,134 $ 35,134 (1) $ 105,000 Inventory Reserve $ 70,000 $ 10,572 $ (34,428)(2) $ 115,000 Year End December 31, 2002: Allowance for Doubtful Accounts $ 165,000 $ 26,560 $ 151,560 (1) $ 40,000 Inventory Reserve $ 700,000 $2,622,151 $3,252,151 (2) $ 70,000 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
(1) Represents the amount of accounts charged off. (2) Represents inventory written off and disposed of. 90 EX-10 3 v02294_ex10b.txt EXHIBIT 10 (b) REVOLVING LOAN AND SECURITY AGREEMENT CONVERTIBLE REVOLVING CREDIT PROMISSORY NOTE DATED OCTOBER 26, 1987 ADDENDUM NO. 14 For consideration given and received, Robert Howard and iCAD, 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, 2004 to January 4, 2005. Also the Note hereafter will be a maximum principal sum of Four Million Dollars ($4,000,000). Effective the 31st. day of December 2003. ICAD, INC. By: /s/ Annette Heroux /s/ Robert Howard -------------------------- ------------------------ Title: Chief Financial Officer Robert Howard EX-21 4 v02294_ex21.txt EXHIBIT 21 Subsidiaries of iCAD, Inc. - -------------------------------------------------------------------------------- Jurisdiction of Incorporation/ Name Organization - -------------------------------------------------------------------------------- Qualia Acquisition Corporation Delaware - -------------------------------------------------------------------------------- CADx Systems, Inc. Delaware - -------------------------------------------------------------------------------- CADx Medical Systems Inc. Canada - -------------------------------------------------------------------------------- CADx Systems Ltd. Ireland - -------------------------------------------------------------------------------- CADx Medical SARL France A subsidiary of CADx Systems Ltd. - -------------------------------------------------------------------------------- EX-23 5 v02294_ex23.txt EXHIBIT 23 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS iCAD, Inc. Nashua, New Hampshire We hereby consent to the incorporation by reference in the Prospectuses constituting part of the Registration Statements on Form S-8 (No. 33-72534) and (No. 333-99973) and on From S-3 (No. 333-112689), (333-110977) and (333-109692) of our report dated February 27, 2004, appearing in this Annual Report on Form 10-K of iCAD, Inc. for the year ended December 31, 2003. /s/ BDO SEIDMAN, LLP Boston, Massachusetts March 30, 2004 EX-31.1 6 v02294_ex31-1.txt EXHIBIT 31.1 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER I, W. Scott Parr, Chief Executive Officer of iCAD, Inc, certify that: 1. I have reviewed this Annual Report on Form 10-K for the fiscal year ended December 31, 2003 of iCAD, Inc..; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and; c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and; 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 30, 2004 /s/ W. Scott Parr ------------------------- W. Scott Parr Chief Executive Officer EX-31.2 7 v02294_ex31-2.txt EXHIBIT 31.2 CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER I, Annette Heroux, Chief Financial Officer of iCAD, Inc, certify that: 1. I have reviewed this Annual Report on Form 10-K for the fiscal year ended December 31, 2003 of iCAD, Inc..; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and; c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and; 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 30, 2004 /s/ Annette Heroux ------------------------ Annette Heroux Chief Financial Officer EX-32.1 8 v02294_ex32-1.txt EXHIBIT 32.1 ICAD, INC. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of iCAD, Inc.'s (the "Company") on Form 10-K for the fiscal year ended December 31, 2003 (the "Report"), I W. Scott Parr, the Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ W. Scott Parr ------------------------ W. Scott Parr Chief Executive Officer Date: March 30, 2004 A signed original of this written statement required by Section 906 has been provided to iCAD, Inc. and will be retained by iCAD, Inc. and furnished to the Securities and Exchange Commission upon request. EX-32.2 9 v02294_ex32-2.txt EXHIBIT 32.2 ICAD, INC. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of iCAD, Inc.'s (the "Company") on Form 10-K for the fiscal year ended December 31, 2003 (the "Report"), I Annette Heroux, the Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Annette Heroux ------------------------ Annette Heroux Chief Financial Officer Date: March 30, 2004 A signed original of this written statement required by Section 906 has been provided to iCAD, Inc. and will be retained by iCAD, Inc. and furnished to the Securities and Exchange Commission upon request. -----END PRIVACY-ENHANCED MESSAGE-----