Digirad Corporation
DIGIRAD CORP (Form: S-1/A, Received: 10/05/2001 17:15:16)      
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 5, 2001

REGISTRATION NO. 333-68256



 

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

AMENDMENT NO. 1
TO
FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

DIGIRAD CORPORATION

(Exact Name of Registrant as Specified in its Charter)

           DELAWARE                                  3845                                33-0145723
(State or Other Jurisdiction of          (Primary Standard Industrial                 (I.R.S. Employer
Incorporation or Organization)           Classification Code Number)               Identification Number)


9350 TRADE PLACE
SAN DIEGO, CALIFORNIA 92126-6334
(858) 578-5300

(Address, Including Zip Code, and Telephone Number, Including Area Code, of
Registrant's Principal Executive Offices)


R. SCOTT HUENNEKENS
CHIEF EXECUTIVE OFFICER
DIGIRAD CORPORATION
9350 TRADE PLACE
SAN DIEGO, CALIFORNIA 92126-6334
(858) 578-5300

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code,
of Agent for Service)


 

COPIES TO:

    MARTIN C. NICHOLS, ESQ.                               J. VAUGHAN CURTIS, ESQ.
BROBECK, PHLEGER & HARRISON LLP                              ALSTON & BIRD LLP
      12390 EL CAMINO REAL                                     90 PARK AVENUE
  SAN DIEGO, CALIFORNIA 92130                             NEW YORK, NEW YORK 10016
         (858) 720-2500                                        (212) 210-9511


APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT.


If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. / /

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / /

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / /

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / /

If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. / /


THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO
SECTION 8(a), MAY DETERMINE.




THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
PRELIMINARY PROSPECTUS SUBJECT TO COMPLETION OCTOBER 5, 2001


Shares

[LOGO]

DIGIRAD CORPORATION
Common Stock


This is our initial public offering of shares of our common stock. No public market currently exists for our common stock.

We currently anticipate the initial public offering price to be between $ and $ per share. We have applied to have our common stock approved for quotation on the Nasdaq National Market under the symbol "DRAD."

 
BEFORE BUYING ANY SHARES, YOU SHOULD READ THE DISCUSSION OF MATERIAL RISKS OF INVESTING IN OUR COMMON STOCK IN "RISK FACTORS" BEGINNING ON PAGE 6.

NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

                                                              PER SHARE      TOTAL
-------------------------------------------------------------------------------------
Public offering price                                          $          $
-------------------------------------------------------------------------------------
Underwriting discounts and commissions                         $          $
-------------------------------------------------------------------------------------
Proceeds, before expenses, to us                               $          $
-------------------------------------------------------------------------------------

The underwriters may also purchase up to shares of common stock from us at the public offering price, less the underwriting discounts and commissions, within 30 days from the date of this prospectus. If the underwriters exercise the option in full, the total underwriting discounts and commissions will be $ , and our total proceeds before expenses will be $ .

The underwriters are offering the common shares as set forth under "Underwriting." Delivery of the shares will be made on or about , 2001.

UBS WARBURG FIRST UNION SECURITIES, INC.


The date of this prospectus is , 2001.


 
MIDDLE TOP:

The words "Charting the Future of Nuclear Medicine."

                  TOP LEFT:                                      TOP RIGHT:
  Graphic: Photo of technician working at a    Graphic: Photo of a DIGIRAD-TM- mobile nuclear
            wire-bonding machine.              imaging services unit with technician standing
                                                 between a Digirad SPECTour(SM) Chair and a
                                                 Digirad Imaging acquisition and processing
                                                system in front of a van bearing the Digirad
                                                          Imaging Solutions logo.

                 CENTER LEFT:                                  CENTER RIGHT:
    Graphic: Photo showing nuclear imaging       Graphic: Photo of computer screen showing
 procedure being performed on patient using a  vertical, horizontal and short access fuse of
DIGIRAD-TM- acquisition and processing system           the heart's left ventricle.
      and a DIGIRAD SPECTour(SM) Chair.

                                                               BOTTOM RIGHT:
                                                  Graphic: Photo of a DIGIRAD-TM- detector
                                                                  module.

BOTTOM MIDDLE:

DIGIRAD LOGO.


You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with any other information. We are offering to sell, and seeking offers to buy, our common shares only in jurisdictions where these offers and sales are permitted. The information in this prospectus is accurate only as of the date of this prospectus, regardless of the time of the delivery of this prospectus or of any sale of our common stock.

 
TABLE OF CONTENTS


Prospectus summary.....................         1

The offering...........................         4

Summary financial and operating data...         5

Risk factors...........................         6

Forward-looking information............        19

Market and industry data and
  forecasts............................        19

Use of proceeds........................        20

Dividend policy........................        20

Capitalization.........................        21

Dilution...............................        23

Selected historical financial and
  operating data.......................        25

Management's discussion and analysis of
  financial condition and results of
  operations...........................        27

Business...............................        35

Management.............................        57

Certain relationships and related
  transactions.........................        68

Principal stockholders.................        71

Description of capital stock...........        73

Shares eligible for future sale........        78

Material United States federal tax
  consequences to non-United States
  holders of common stock..............        80

Underwriting...........................        83

Legal matters..........................        85

Experts................................        85

Where you can find more information....        85

Index to consolidated financial
  statements...........................       F-1

Through and including , 2001 (the 25th day after commencement of this offering), federal securities law may require all dealers selling our common stock, whether or not participating in this offering, to deliver a prospectus. This delivery requirement is in addition to the obligation of dealers to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions.

We have filed applications for federal trademark registrations and claim rights in 2020TC Imager(TM), NOTEBOOK IMAGER(TM), FLEXIMAGING(SM), SPECTour(TM), DIGISPECT(SM), DIGIRAD(TM), DIGIRAD (and design)(TM) and DIGIRAD IMAGING SOLUTIONS(SM). This prospectus may also refer to trade names and trademarks of other companies.

As used in this prospectus, references to "we," "our," "us" and Digirad refer to Digirad Corporation and its subsidiaries, unless the context otherwise requires.


 
Prospectus summary

This summary highlights information contained elsewhere in this prospectus. You should read the entire prospectus carefully, especially the risks of investing in shares of our common stock, which we discuss under the heading "Risk factors" beginning on page 6, and the financial statements and related notes before making an investment decision.

OVERVIEW

We are the first and only company to have developed and commercialized a solid-state, digital gamma camera. A gamma camera is the preferred technology used in nuclear imaging. Nuclear imaging offers the ability to non-invasively measure physiological activity, including blood flow and organ function. We believe that our technology will allow us to become a leading provider of gamma cameras and mobile nuclear cardiac imaging services. Our patented solid-state camera offers many advantages over a conventional vacuum tube camera, such as smaller size, increased mobility, increased durability, improved image quality, expanded clinical applications and enhanced patient comfort. All other gamma cameras on the market currently use conventional vacuum tube technology. We believe the features and benefits of our technology will encourage healthcare providers to choose our camera over conventional cameras for both initial and replacement purchases. In addition, because of our camera's increased mobility and durability, we believe it is ideally suited for use in a mobile imaging services application that has not been widely available until now. We are initially focusing on the nuclear cardiology segment of the nuclear imaging market, which is the largest and fastest growing segment of that market.

Our proprietary technology allows for both a significant reduction in the size of a gamma camera and a significant improvement in spatial resolution, which is a measurement of the quality of the image produced. Conventional gamma camera photo-detectors are approximately four inches in height. Our photo-detectors are only 0.012 inches high, providing an approximate 350-to-1 reduction in detector size that makes the camera both thinner and lighter. While conventional cameras use an average calculation to approximate the location of the gamma rays used to create the image, our cameras determine the precise location of these gamma rays. This improves spatial resolution and allows our camera to offer a significant improvement in image quality over the conventional vacuum tube technology.

We are currently addressing the rapidly growing nuclear cardiology market in the following two ways:

- NUCLEAR CAMERA SALES--We are selling our camera and related products to physician offices, imaging centers, hospitals and research laboratories, thus providing customers with a technologically advanced alternative to conventional vacuum tube gamma cameras.

- MOBILE NUCLEAR CARDIAC IMAGING SERVICES--We are also providing mobile nuclear imaging services, as described in this prospectus, to physician offices, including cardiology and internal medicine practices. Our turn-key mobile imaging solution provides on-site access to all the benefits of our advanced diagnostic imaging technology, without requiring customers to make an up-front payment, hire additional personnel, obtain regulatory approval or establish a dedicated nuclear imaging suite. Our service model enables physicians to capture the revenue that would have otherwise been lost because the patient was referred elsewhere. In addition, it provides us with a recurring revenue stream from the servicing of our customers on a routine basis.

We began commercial production of our first solid-state, digital gamma camera product, marketed as the DIGIRAD-TM- 2020TC Imager-TM- camera, in January 2000 and shipped our first unit in March 2000. From our first shipment through June 30, 2001, we had received orders for 117 cameras, 59 of which had been shipped. We established our mobile nuclear cardiac imaging services operations in the second half of 2000. As of June 30, 2001, we were providing nuclear cardiac imaging services to approximately 101 physician offices in California, Delaware, Florida, Indiana, Maryland, New Jersey,

1

North Carolina, Ohio and Pennsylvania. During the six month period ended June 30, 2001, our mobile imaging services business performed approximately 6,900 imaging procedures.

INDUSTRY OVERVIEW

NUCLEAR IMAGING

Nuclear medicine is used primarily in cardiovascular, oncology and neurological applications. Nuclear imaging offers the ability to non-invasively measure varying degrees of physiological activity, including blood flow, organ function, metabolic activity, biochemical activity, and other functional activity within the body. According to a 2001 study by Frost & Sullivan, a leading marketing consulting company, there were approximately 15.5 million nuclear imaging procedures performed in the U.S. in 2000. We believe over 25 million procedures were performed worldwide. The market consists of two primary technologies, gamma cameras and dedicated positron emission tomography, or PET, machines. Frost & Sullivan states that gamma cameras are currently the preferred choice for the majority of nuclear medicine procedures. The most widely used type of gamma camera is a single photon emission computed tomography, or SPECT, camera.

TRENDS IN NUCLEAR CARDIAC IMAGING

Nuclear cardiology is the largest and fastest growing segment of the nuclear imaging market. Frost & Sullivan reports that of the 15.5 million nuclear imaging procedures performed in the U.S. in 2000, 7.9 million, or 51%, were cardiology related procedures. The nuclear cardiology procedure volume is expected to grow by approximately 25% annually over the next 5 years. Increasingly, a nuclear cardiac imaging procedure is the first non-invasive, diagnostic imaging procedure performed on patients with suspected heart disease. Given the clinical advantages of nuclear cardiac images, many payors are requiring nuclear studies prior to the more invasive and expensive diagnostic and therapeutic procedures.

Reasons for the rapid growth in nuclear cardiac imaging procedures include:

- Valuable clinical information;

- Cost-effectiveness;

- Non-invasive nature;

- Established reimbursement; and

- An increase in heart disease.

Frost & Sullivan divides the nuclear cardiac imaging procedure market into four segments: hospital in-patient, hospital out-patient, cardiology practices and diagnostic imaging centers. Although a number of cardiology practices with more than five cardiologists have incorporated nuclear medicine into their practice setting, most nuclear cardiology procedures are currently referred to hospitals and imaging centers, where the cardiologist loses clinical control and receives minimal or no economic benefit.

DIGIRAD'S MARKET OPPORTUNITY

Our technology allows us to address the following two markets:

- NUCLEAR CAMERA SALES--Frost & Sullivan projects that the U.S. gamma camera market for nuclear imaging will be approximately $325 million in 2001, and is expected to grow at an average annual rate of approximately 5% from 2001 to 2007. We estimate that the non-U.S. gamma camera market is approximately $300 million. In addition, we estimate that the market for technical services is an additional 10% to 15% of a camera's purchase price per year over the life of the contract, which is typically 5 years.

2

- MOBILE NUCLEAR CARDIAC IMAGING SERVICES--We believe the market opportunity for our mobile nuclear imaging services business is approximately $2.6 billion. This market size is based on our target market of procedures performed in hospital, outpatient facilities, diagnostic imaging centers, physician offices and the following:

- A report by Frost & Sullivan that approximately 7.9 million nuclear cardiac imaging procedures were performed in the U.S. in 2000;

- Frost & Sullivan's estimate, based on a more limited study, that approximately 56% of U.S. nuclear cardiac imaging procedures were performed in a hospital outpatient facility, diagnostic imaging center or physician office in 2000; and

- Our average net revenue of approximately $600 per procedure.

Our proprietary technology enables physicians to perform office-based nuclear imaging procedures that were previously referred elsewhere, with limited disruption to their current practice. Therefore, we believe our solutions will accelerate the transition of nuclear cardiac imaging procedures to non-hospital sites, in particular cardiology and internal medicine practices.

THE DIGIRAD SYSTEM

Our proprietary technology has enabled us to develop a gamma camera with many unique features. Some of the features of the DIGIRAD-TM- solid-state camera are outlined below:

- SMALLER SIZE--Our 425-pound camera and 350-pound SPECTour-TM- chair require only 7 feet by 9 feet of working space vs. a 1,500 to 5,000 pound vacuum tube SPECT camera that requires a dedicated room with reinforced floors;

- INCREASED MOBILITY--The mobility of our camera facilitates our imaging services business as opposed to vacuum tube cameras that are typically permanently installed in hospitals or imaging centers;

- INCREASED DURABILITY--Our camera is relatively insensitive to physical shock or temperature variations and should offer much greater reliability than a vacuum tube camera whose single scintillation crystal is easily damaged;

- IMPROVED IMAGE QUALITY--Images on the perimeter of our detector heads are as clear as images at the center while the best image quality on a vacuum tube camera is obtained only in the center;

- EXPANDED CLINICAL APPLICATIONS--Our smaller and lighter camera heads are more flexible than vacuum tube camera heads and can be used in multiple applications throughout the hospital; and

- ENHANCED PATIENT COMFORT--With our camera, patients sit upright with their arms resting in front of them rather than having to lie and hold their arms above their head as vacuum tube cameras require.

OUR BUSINESS STRATEGY

Our goal is to rapidly expand our business and increase our revenues by offering a complete nuclear imaging solution to physician offices, imaging centers, hospitals and research laboratories. The key elements of our business strategy include:

- Leveraging our proprietary technology to increase sales of products and imaging services;

- Aggressively targeting the growing nuclear cardiology market;

- Expanding our integrated, direct sales force;

- Leveraging our proprietary manufacturing processes to reduce costs and improve performance;

- Expanding acceptance of additional clinical applications; and

- Continuing technological development.

Our principal executive offices are located at 9350 Trade Place, San Diego, CA 92126-6334. Our telephone number is (858) 578-5300. We maintain a web site on the Internet at www.digirad.com. Our web site, and the information contained therein, is not a part of this prospectus.

3

The offering

 

Common stock we are offering.................  shares

Common stock to be outstanding after this
  offering...................................  shares

Proposed Nasdaq National Market symbol.......  DRAD

Use of proceeds..............................  Repayment of approximately $5.7 million of
                                               outstanding debt and general corporate
                                               purposes, including product development,
                                               marketing, capital expenditures and working
                                               capital.

Risk factors.................................  Investing in our common stock involves
                                               significant risks. See "Risk factors."

The total number of outstanding shares of our common stock includes:

- 4,526,474 shares of our common stock outstanding as of August 23, 2001; and

- 29,748,030 shares of common stock issuable upon the automatic conversion of all shares of preferred stock outstanding as of August 23, 2001 in connection with this offering.

The total number of outstanding shares of our common stock above does not include:

- the issuance of up to 5,952,426 shares of common stock upon the exercise of stock options outstanding as of August 23, 2001 at a weighted average exercise price of $0.64 per share;

- the issuance of up to 603,578 shares of common stock upon the exercise of warrants outstanding as of August 23, 2001 at a weighted average exercise price of $2.59 per share, of which warrants to purchase 65,875 shares will expire if not exercised at the time of this offering and warrants to purchase 60,000 shares will expire if a consulting agreement is terminated before July 31, 2002;

- the issuance of up to 250,000 shares of common stock, as well as additional shares of common stock issuable based upon future earnings results, as additional consideration in connection with our acquisitions of Nuclear Imaging Systems, Inc. and Florida Cardiology and Nuclear Medicine Group;

- the issuance of up to 4,725,883 shares of common stock reserved for future issuance under our stock option plans; and

- the issuance of 10,000 shares of common stock at fair market value for every three of our digital cameras sold by a consultant, up to a maximum of 40,000 shares, and thereafter 1,500 shares of common stock at fair market value for each of our digital cameras sold by the consultant, in each case upon the exercise of warrants issuable to the consultant.

Unless we indicate otherwise, information throughout this prospectus reflects:

- no exercise of the over-allotment option granted to the underwriters;

- the automatic conversion of all outstanding shares of preferred stock into shares of common stock in connection with this offering; and

- a one-for- reverse stock split of our outstanding shares of common stock to be effected in connection with this offering.

4

Summary financial and operating data

The following table summarizes our financial data and provides selected operating data. The summary financial data for the years ended December 31, 1998, 1999, and 2000, are derived from our audited financial statements. We have also included data from our unaudited financial statements for the six months ended June 30, 2000 and 2001 and as of June 30, 2001. You should read this data together with our financial statements and related notes included elsewhere in this prospectus and the information under "Selected historical financial and operating data" and "Management's discussion and analysis of financial condition and results of operations."

 

                                                                                                              SIX MONTHS ENDED
                                                                       YEARS ENDED DECEMBER 31,                   JUNE 30,
                                                                 ------------------------------------      ----------------------
STATEMENT OF OPERATIONS DATA:                                        1998          1999          2000          2000          2001
                                                                   (In thousands, except per share and selected operating data)
---------------------------------------------------------------------------------------------------------------------------------
Revenues:
  Products.................................................      $   340       $    284      $  5,815      $ 1,456       $ 9,802
  Imaging services.........................................           --             --         1,260           --         4,217
  Licensing and other......................................        1,581             --            --           --            --
                                                                 -------       --------      --------      -------       -------
    Total revenues.........................................        1,921            284         7,075        1,456        14,019
Cost of revenues:
  Products.................................................          388            265         9,834        3,602         6,438
  Imaging services.........................................           --             --           839           --         3,394
                                                                 -------       --------      --------      -------       -------
    Total cost of revenues.................................          388            265        10,673        3,602         9,832
                                                                 -------       --------      --------      -------       -------
Gross profit (loss)........................................        1,533             19        (3,598)      (2,146)        4,187
Operating expenses:
  Research and development.................................        5,426         10,063         2,372        1,083         1,327
  Sales and marketing......................................          623          1,455         3,586        1,291         4,028
  General and administrative...............................        2,533          1,967         2,878        1,072         2,899
  Amortization of intangible assets........................           --             --           209            3           315
  Stock-based compensation.................................           --             --           296           --         1,063
                                                                 -------       --------      --------      -------       -------
    Total operating expenses...............................        8,582         13,485         9,341        3,449         9,632
                                                                 -------       --------      --------      -------       -------
Loss from operations.......................................       (7,049)       (13,466)      (12,939)      (5,595)       (5,445)
Other income (expense), net................................          857            274          (537)         (97)         (401)
                                                                 -------       --------      --------      -------       -------
Net loss...................................................      $(6,192)      $(13,192)     $(13,476)     $(5,692)      $(5,846)
                                                                 =======       ========      ========      =======       =======
Net loss applicable to common stockholders.................      $(6,192)      $(13,192)     $(13,524)     $(5,692)      $(5,902)
                                                                 =======       ========      ========      =======       =======
Basic and diluted net loss per share(1):
  Historical...............................................      $ (1.87)      $  (3.90)     $  (3.61)     $ (1.65)      $ (1.35)
                                                                 =======       ========      ========      =======       =======
  Pro forma................................................                                  $  (0.53)                   $ (0.19)
                                                                                             ========                    =======
Shares used to compute basic and diluted net loss per
  share(1):
  Historical...............................................        3,306          3,381         3,745        3,455         4,366
                                                                 =======       ========      ========      =======       =======
  Pro forma................................................                                    25,474                     30,436
                                                                                             ========                    =======
SELECTED OPERATING DATA:
Product sales
  Number of gamma cameras sold to third parties............           --             --            23            6            36
Imaging services
  Number of imaging procedures performed...................           --             --             *           --         6,953

 

                                                                          AS OF JUNE 30, 2001
                                                              --------------------------------------------
                                                                                              PRO FORMA AS
BALANCE SHEET DATA:                                             ACTUAL     PRO FORMA(2)        ADJUSTED(3)
----------------------------------------------------------------------------------------------------------
Cash and cash equivalents...................................  $  3,510      $11,920
Working capital.............................................  $  4,504      $12,914
Total assets................................................  $ 28,557      $36,967
Long-term debt..............................................  $  5,811      $ 5,811
Redeemable convertible preferred stock......................  $ 58,109      $    --
Total stockholders' equity (deficit)........................  $(48,111)     $18,408


(1) Please see Note 1 to our financial statements for an explanation of the method used to calculate the historical and pro forma net loss per share and the number of shares used in the computation of per share amounts.

(2) The pro forma balance sheet data give effect to the sale of 2,618,462 shares of Series F preferred stock in August 2001 and the automatic conversion of all shares of preferred stock outstanding as of August 23, 2001 into 29,748,030 shares of common stock in connection with this offering.

(3) The pro forma as adjusted balance sheet data give effect to the sale of shares of our common stock in this offering at an assumed initial public offering price of $ per share and the application of the net proceeds to repay a portion of our outstanding indebtedness.

* Not available because the methodology for tracking the number of procedures performed in 2000 under acquired customer contracts was not consistent with our current methodology.

5


Risk factors

IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, THE FOLLOWING RISK FACTORS SHOULD BE CAREFULLY CONSIDERED IN EVALUATING US AND OUR BUSINESS BEFORE PURCHASING ANY OF THE COMMON STOCK BEING OFFERED. INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK AND SHOULD BE REGARDED AS SPECULATIVE. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS COULD BE MATERIALLY HARMED, OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY AND ADVERSELY AFFECTED, AND THE MARKET PRICE OF OUR COMMON STOCK COULD DECLINE AND YOU COULD LOSE ALL OR A PART OF YOUR INVESTMENT. THE CAUTIONARY STATEMENTS MADE IN THIS PROSPECTUS SHOULD BE READ AS BEING APPLICABLE TO ALL RELATED FORWARD-LOOKING STATEMENTS WHEREVER THEY APPEAR IN THIS PROSPECTUS.

RISKS RELATING TO OUR BUSINESS

IF OUR SOLID-STATE, DIGITAL GAMMA CAMERA AND NUCLEAR IMAGING SERVICES ARE NOT ACCEPTED BY PHYSICIANS OR OTHER HEALTHCARE PROVIDERS, WE MAY BE UNABLE TO ACHIEVE PROFITABILITY.

Our solid-state, digital gamma camera technologies represent a new approach in the nuclear imaging market, and we have sold our products only in limited quantities. Our success in this market depends on whether potential customers view our new technology as effective and economically beneficial. We do not know the rate at which physicians or other healthcare providers will adopt our products or imaging services, if at all, or the rate at which they will purchase them in the future, if at all. There can be no assurances that we can attract future customers on acceptable terms that will enable us to develop a sustainable, profitable business. If third-party payors do not accept our products or imaging services or deny adequate payment to physicians and other healthcare providers using our products and services, this may adversely affect acceptance of our products. Acceptance of our products and imaging services by physicians, including physicians who do not currently use cardiac imaging products, is essential to our success and may require us to overcome resistance to a new technology for cardiac imaging services. Our failure to do any of these things may prevent us from selling sufficient quantities of our products and imaging services to be profitable.

WE HAVE RECENTLY INTRODUCED OUR PRODUCT INTO THE MARKETPLACE AND MAY NOT SUCCEED OR BECOME PROFITABLE.

We have not been profitable since our inception. We have incurred substantial costs to develop, introduce and enhance our solid-state, digital gamma camera. As of June 30, 2001, we had an accumulated deficit of approximately $51.0 million. We shipped our first product in March 2000. We expect to incur substantial additional expenses in the future as we continue to conduct research and development efforts on newer generation products and increase sales and marketing efforts on our recently released, first generation products. Furthermore, planned expansion of manufacturing operations and expansion in the nuclear imaging services market will result in significant expenses over the next several years that may not be offset by significant revenues. We expect that a majority of our revenues for the near term and our ability to achieve profitability will depend upon our ability to successfully market our solid-state, digital gamma camera and our successful expansion into the nuclear imaging services market. We will need to begin generating significant revenues to achieve profitability. Due to our limited operating history, it is difficult to predict when, if ever, we will be profitable and to evaluate our business or prospects. Our business strategies, including our expansion in the nuclear imaging services market, may not be successful and we may not be profitable in any future period. Even if we do become profitable, we cannot ensure investors that we can sustain or


6

RISK FACTORS

increase profitability on a quarterly or annual basis in the future. If our revenues grow more slowly than anticipated, or if our operating expenses exceed our expectations, our business will be adversely affected. You should consider our business and prospects in light of the risks and uncertainties encountered by new technology companies in evaluating whether to invest in our common stock.

WE MAY NOT HAVE THE RESOURCES REQUIRED TO SUCCESSFULLY COMPETE IN OUR HIGHLY COMPETITIVE INDUSTRY, WHICH MAY MAKE IT DIFFICULT TO PENETRATE THE PRODUCT AND SERVICES MARKETS.

The existing market for nuclear imaging products, including cardiac imaging, is well established and intensely competitive. In addition, we are seeking to develop new markets for our solid-state, digital gamma camera products. In particular, we are working aggressively to further develop the mobile cardiac imaging services market. Our failure to diversify our revenue streams by successfully increasing both product sales and mobile imaging services could cause significant volatility in our overall results. Competitive pressure may make it difficult for us to acquire and retain customers and may require us to reduce the price of our products and imaging services. Our primary competitors have better name recognition, significantly greater financial resources and existing relationships with some of our potential customers, among other competitive advantages. Our competitors may be able to use their existing relationships to discourage customers from purchasing our products and imaging services. We expect competition to increase as potential and existing competitors begin to enter these new markets or modify their existing products and services to compete directly with ours. In addition, our competitors may be able to devote greater resources to the development, promotion and sale of new or existing products and services, thereby allowing them to respond more quickly to new or emerging technologies and changes in customer requirements.

OUR PUBLIC PERCEPTION COULD BE HARMED IF WE EXPERIENCE TECHNICAL PROBLEMS WITH THE NEW TECHNOLOGIES USED IN OUR CAMERAS OR IF SHIPMENTS OF OUR PRODUCTS ARE DELAYED, WHICH WOULD CAUSE US TO LOSE CUSTOMERS AND REVENUES.

Our solid-state, digital gamma camera technologies have only recently been introduced into the marketplace. As these technologies are increasingly used by more customers, significant defects may emerge. In addition, if our cameras are perceived as being difficult to use or causing discomfort to patients, our public image may be impaired. Public perception may also be impaired if we fail to deliver our products in a timely manner due to difficulties with our suppliers and vendors or due to our inability to efficiently manufacture and assemble products. A tarnished reputation could result in a loss of customers and revenues even after any quality or delivery problems are resolved. Additionally, we expect that problems or perceived problems with our products could adversely impact the commercial success of our imaging services business.

WE MAY EXPERIENCE SIGNIFICANT FLUCTUATIONS IN OUR QUARTERLY RESULTS.

Our future operating results will depend on numerous factors, many of which we do not control. Changes in any or all of these factors could cause our operating results to fluctuate and increase the volatility of the market price of our common stock. Some of these factors include:

- demand for our products and our ability to meet such demand;

- product and price competition;

- changes in the costs of components;


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RISK FACTORS

- success of our sales and distribution channels;

- successful development and commercialization of new and enhanced products on a timely basis;

- timing of significant orders and shipments;

- timing of and possible delay in our receiving approval for necessary regulatory licenses;

- timing of new product introductions and product enhancements by us or our competitors; and

- timing and magnitude of our expenditures.

Accordingly, we believe that quarterly sales and operating results may vary significantly in the future and that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indicators of future performance. We cannot assure you that our sales will increase or be sustained in future periods or that we will be profitable in any future period.

In addition, we experience seasonality in the service of our DIS customers. For example, our study volumes typically decline from our second fiscal quarter to our third fiscal quarter due to summer holidays and vacation schedules. We may also experience declining study volumes in December due to holidays and in the first quarter due to weather conditions in certain parts of the country. These seasonal factors may lead to fluctuations in our quarterly operating results. It is difficult for us to evaluate the degree to which the summer slowdown, winter holiday variations and weather conditions may make our revenues unpredictable in the future. We may not be able to reduce our expenses, including our debt service obligations, quickly enough to respond to these declines in revenue, which would make our business difficult to operate and would harm our financial results. If this happens, the price of our common stock may decline.

OUR RELIANCE ON A LIMITED NUMBER OF CUSTOMERS MAY CAUSE OUR SALES TO BE VOLATILE.

We currently have a small number of customers, whom we typically bill after the delivery of our products and imaging services. As of June 30, 2001, we had received orders for 117 cameras, 58 of which have not yet been delivered and paid for, and we had signed contracts with 101 customers to use our mobile imaging services. If these orders were to be cancelled, or our imaging service customers stopped using our service or do not renew their service agreements with us, our business would be harmed. Furthermore, in view of this small customer base, our failure to gain additional customers, the loss of any current customers or a significant reduction in the level of imaging services provided to any one customer could harm our business, financial condition and results of operations.

THE SALES CYCLE FOR OUR PRODUCTS IS TYPICALLY LENGTHY, CAUSING SIGNIFICANT FLUCTUATIONS IN OUR REVENUE.

Our sales efforts for our cameras are dependent on the capital expenditures budgets of our potential customers. Often our potential customers require a significant amount of time to plan for major purchases, such as our camera. We may expend substantial funds and management effort long before we actually sell our products and with no assurance that we will ultimately be successful. Even if we are successful in such sales, a long sales cycle makes it more difficult for us to accurately evaluate and predict our sales and operating performance. Our revenues may fluctuate significantly from quarter to quarter and any shortfalls from estimates expected by securities or industry analysts could have an immediate and significant adverse effect on our stock price.


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RISK FACTORS

WE CURRENTLY MANUFACTURE OUR PRODUCTS IN LIMITED QUANTITIES AND HAVE LIMITED SALES AND DISTRIBUTION CAPABILITIES.

We currently manufacture our products in limited quantities, and to become profitable, we must manufacture our products in greater quantities. As we expand production, we may encounter difficulties in obtaining adequate supplies of components, additional employees and maintaining the high quality of our products. We may be unable to expand production and accomplish these objectives without incurring substantially increased costs, which may reduce our ability to become profitable or reduce our profitability.

We have established a direct sales team, an independent distributor network in the United States and Canada, and a corporate partner in Japan to sell our products and imaging services both domestically and internationally. Our future revenue growth will depend in large part on our success in maintaining and expanding these sales and distribution channels, which may be an expensive and time-consuming process. We are highly dependent upon the efforts of talented sales employees in increasing our revenue. We face intense competition for qualified sales employees and may be unable to attract and retain such personnel, which would adversely affect our ability to expand and maintain our distribution network. If we are unable to expand and maintain our direct sales team or distribution network, we may be unable to sell enough of our products and imaging services for our business to be profitable.

WE MAY BE HARMED BY HIGHER ENERGY COSTS AND INTERRUPTED POWER SUPPLIES RESULTING FROM THE ELECTRICAL POWER SHORTAGES CURRENTLY AFFECTING CALIFORNIA.

Our corporate headquarters and manufacturing facilities are located in San Diego, California. Electrical power is vital to our operations and we rely on a continuous power supply to conduct our operations. California is in the midst of a power crisis and has recently experienced significant power shortages. In the event of an acute power shortage, the California system operator has on some occasions implemented, and may in the future continue to implement, rolling blackouts throughout California. If our energy costs substantially increase or blackouts interrupt our power supply frequently or for more than a few days, we may have to reduce or temporarily discontinue our normal operations. In addition, the cost of our research and development efforts may increase because of the disruption to our operations. Any such reduction or disruption of our operations at our facilities could harm our business.

WE FACE RISKS IN OUR INTERNATIONAL MARKETS.

As we expand internationally, we will need to hire, train and retain qualified personnel in countries where language, cultural or regulatory impediments may exist. We cannot assure you that vendors, physicians or other involved parties in foreign markets will accept our products, imaging services and business practices. International revenues are subject to inherent risks, including:

- costs of localizing product and service offerings for foreign markets;

- difficulties in staffing and managing foreign operations;

- reduced protection for intellectual property rights in some countries;

- difficulties and delays in accounts receivable collection;

- fluctuating currency exchange rates;

- changes in regulatory requirements;


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RISK FACTORS

- burdens of complying with a wide variety of foreign laws and labor practices; and

- conforming our business model to operate under government-run health care systems.

WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH COULD CAUSE US TO LOSE THOSE RIGHTS OR SUBJECT US TO INCREASED COSTS.

Our success and ability to compete depends on our licensed and internally-developed technology. If we are unable to protect our proprietary rights, we could face increased competition from our competitors or incur increased costs. We protect our proprietary technology through a combination of patent, copyright, trade secret and trademark law. We also enter into confidentiality or license agreements with our employees, consultants and corporate partners, and generally control access to, and the distribution of, our products, designs, documentation and other proprietary information. We cannot be sure that our pending patent applications will result in issued patents. In addition, our issued patents or pending applications may be challenged or circumvented by our competitors. Despite our efforts to protect our intellectual property rights, unauthorized parties may attempt to obtain and use information or technologies, which we regard as proprietary. Policing unauthorized use of our intellectual property will be difficult and we cannot be certain that we will be able to prevent misappropriation of our technology, particularly in countries where the laws may not protect our proprietary rights as fully as in the United States.

OUR COMPETITORS MAY CLAIM OUR TECHNOLOGY OR PRODUCTS INFRINGE UPON THE TECHNOLOGY COVERED BY THEIR PATENTS OR PATENT APPLICATIONS, WHICH COULD RESULT IN THE LOSS OF OUR RIGHTS, SUBJECT US TO LIABILITY AND DIVERT MANAGEMENT'S ATTENTION.

Many of our competitors in the nuclear imaging business hold issued patents and have filed, or may file, patent applications. Any claims by our competitors that we are infringing their technology, with or without merit, could be time-consuming to defend, result in costly litigation, divert management's attention and resources, cause product shipment delays, require us to enter into royalty or licensing agreements, prevent us from manufacturing or selling some or all of our products, or result in our liability to one or more of these competitors. If a third party makes a successful claim of patent infringement against us, we may be unable to license the infringed or similar technology on acceptable terms, if at all, which may prevent us from manufacturing or selling our products. If we are forced to enter into license agreements for infringed technology, royalties paid under these agreements may increase our costs to manufacture our products. If we cannot raise the price of our products to recover royalties that we have paid without losing customers, our financial results would be negatively impacted.

WE RELY SIGNIFICANTLY ON THIRD-PARTY VENDORS TO MANUFACTURE COMPONENTS FOR OUR SOLID-STATE, DIGITAL GAMMA CAMERAS, WHICH COULD RESULT IN DELIVERY DELAYS, LOSS OF CUSTOMERS AND LOSS OF REVENUES.

We contract with a limited number of independent suppliers to produce components that we use in the manufacture of our products. Specifically, we currently use one vendor to supply the crystal arrays used in the manufacture of our gamma camera. If this vendor experiences difficulty in the production of the crystal arrays or in meeting our standards, we may have delays in the production of our gamma camera. This vendor could experience financial, operational, production or quality assurance difficulties or a catastrophic event that reduces or interrupts delivery of crystal arrays to us. In addition, to our knowledge, there are only three suppliers in the world who produce these crystal


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RISK FACTORS

arrays. While we have established a second vendor source and are evaluating a third source to meet our future requirements, establishing alternative arrangements could take several months. If we are required to switch vendors, the manufacture and delivery of our products could be interrupted for an extended period of time and may cause the loss of both customers and revenue. Deliveries from our current third-party vendor or any substitute vendor may also be delayed because of the potential inability of these vendors to meet high demand for their products from their other customers. We cannot guarantee that alternative suppliers will be able to meet our future requirements or that alternative sources will be available to us at favorable prices, if at all. Our ability to manufacture and deliver products in a timely manner could be harmed if these vendors fail to maintain an adequate supply of these crystal arrays.

OUR PRODUCTS MAY BECOME OBSOLETE, WHICH COULD CAUSE US TO LOSE CUSTOMERS OR INCUR SUBSTANTIAL COSTS.

Our products could become obsolete or unmarketable if other products utilizing new technologies are introduced by our competitors or new industry standards emerge. If we are unable to react to these events we may lose customers and revenues. To be successful, we will need to continually enhance our products and to design, develop and market new products that successfully respond to any competitive developments, all of which may be expensive or time consuming. Our failure to do so could have a material adverse effect on our business, financial condition and results of operations.

LOSS OF KEY EXECUTIVES AND FAILURE TO ATTRACT QUALIFIED MANAGERS, ENGINEERS AND SALES PERSONS COULD LIMIT OUR GROWTH AND NEGATIVELY IMPACT OUR OPERATIONS.

Our future performance is dependent on the efforts of our key technical, sales and managerial personnel and our ability to retain them, particularly R. Scott Huennekens, Gary J.G. Atkinson, Richard L. Conwell, Robert E. Johnson, David M. Sheehan and John F. Sheridan. Furthermore, our future success will depend in part upon our ability to identify, hire and retain additional key management and sales personnel, engineers and technicians. Given the intense competition for such qualified personnel, there can be no assurance that we will be able to continue to attract and retain the personnel necessary to develop our business. Failure to attract and retain key personnel could have an adverse effect on our business, financial condition and results of operations. We do not have any employment agreements with any of our employees. We do not maintain key person insurance on any of our employees.

IF WE BECOME SUBJECT TO PRODUCT LIABILITY OR WARRANTY CLAIMS, WE MAY EXPERIENCE REDUCED DEMAND FOR OUR PRODUCTS OR BE REQUIRED TO PAY DAMAGES THAT EXCEED OUR INSURANCE LIMITATIONS.

The sale and support of our products entails the risk of product liability or warranty claims, such as those based on claims that the failure of one of our products resulted in a misdiagnosis, among other issues. The medical instrument industry in general has been subject to significant products liability litigation. We may incur significant liability in the event of such litigation. Although we maintain product liability insurance, we cannot be sure that this coverage is adequate or that it will continue to be available on acceptable terms, if at all. We also may face warranty exposure, which could adversely affect our operating results. Any unforeseen warranty exposure or insufficient insurance could harm our business, financial condition and results of operations.


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RISK FACTORS

WE MAY NOT BE ABLE TO ACHIEVE THE EXPECTED BENEFITS FROM ANY FUTURE ACQUISITIONS WHICH WOULD ADVERSELY AFFECT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Although we have no current plans for acquisitions, if we decide to acquire any other business and cannot successfully integrate such future acquisitions, we may not realize anticipated operating advantages and cost savings. The integration of companies that have previously operated separately involves a number of risks, including:

- demands on management related to the increase in our size after an acquisition;

- the diversion of our management's attention from the management of daily operations to the integration of operations;

- difficulties in the assimilation and retention of employees;

- potential adverse effects on operating results; and

- challenges in retaining clients.

Successful integration of operations will depend upon our ability to manage those operations and to eliminate redundant and excess costs. Because of difficulties in combining operations, we may not be able to achieve the cost savings and other related benefits that we would hope to achieve after the completion of these acquisitions which could harm our financial condition and results of operations.

RISKS RELATED TO GOVERNMENT REGULATION

WE MUST BE LICENSED TO HANDLE AND USE HAZARDOUS MATERIALS AND MAY BE LIABLE FOR CONTAMINATION OR OTHER HARM CAUSED BY HAZARDOUS MATERIALS THAT WE USE.

We use hazardous and radioactive materials in our research, development and manufacturing processes and the provision of our imaging services and must be licensed to handle such materials. We are currently licensed in all states in which we operate, and there can be no assurances that we will be able to retain these licenses indefinitely. In addition, we must become licensed in all states in which we plan to expand. Obtaining these additional licenses is an expensive and time consuming process, and in some cases we may not be able to obtain these licenses at all. We are subject to federal, state and local regulation governing the use, handling, storage and disposal of hazardous materials. We cannot completely eliminate the risk of contamination or injury resulting from hazardous materials and we may incur liability as a result of any contamination or injury. We have incurred and may continue to incur expenses related to compliance with environmental laws. Such future expenses or liability could have a significant negative impact on our business, financial condition and results of operations. Further, we cannot assure you that the cost of complying with these laws and regulations will not increase materially in the future.

WE AND OUR CUSTOMERS DEPEND ON PAYMENTS FROM GOVERNMENT HEALTHCARE PROGRAMS AND THIRD-PARTY PAYORS. ANY FUTURE REDUCTION IN THESE PAYMENTS COULD CAUSE US TO LOSE CUSTOMERS AND REVENUES.

We expect that substantially all of our revenues in the foreseeable future will be derived from the sale of products or the providing of imaging services in the nuclear imaging market. Our imaging services model consists of two primary delivery options. Under our first option, which we refer to as "mixed billing," we provide the technical component of nuclear imaging services and bill either the physician or the patient's third party payor, such as Medicare. We also bill the patient for any copayment. The


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RISK FACTORS

physician performs and bills for the technical component, such as the interpretation of the test. Under our second option, we lease cameras, related equipment and technical personnel to physicians on a turn-key basis so that they may deliver imaging services to their patients. The physician then bills globally for both the technical and professional component. When we refer to "imaging services" in this prospectus, we are referring both to our mixed billing option and our leasing services option.

Our success in the foreseeable future depends directly upon the financial success of the customers who either buy our cameras or use our imaging services, and their continued demand for our products and imaging services. These customers generally rely on third-party payors, principally federal Medicare, and private health insurance plans, to pay for all or a portion of the cost of imaging procedures. We also rely on these third-party payors for payment of the technical services component provided as part of our Digirad Imaging Solutions imaging services. Some third-party payors, including some state Medicaid programs, currently do not cover our services, and it is possible that other payors will adopt coverage restrictions that adversely affect us in the future. We may be unable to sell our products or imaging services on a profitable basis if third-party payors deny coverage or reduce current levels of payment.

Third-party payors continue to undertake efforts to contain or reduce healthcare costs through various means, including the movement to managed care systems where healthcare providers contract to provide comprehensive healthcare for a fixed fee per patient. These efforts to reduce healthcare costs may make third-party payors unwilling to reimburse patients or healthcare providers for our imaging services or allow only specific providers to provide imaging services, which would reduce demand for our imaging services, and in turn, our products as well. To the extent that such efforts adversely affect the business, financial conditions and profitability of our customers, our customers may be less able to afford our products and our imaging services, which may cause our sales to decrease.

COMPLIANCE WITH EXTENSIVE PRODUCT REGULATIONS COULD BE EXPENSIVE AND TIME-CONSUMING AND ANY FAILURE TO COMPLY WITH THESE REGULATIONS COULD HARM OUR ABILITY TO SELL AND MARKET OUR PRODUCTS AND IMAGING SERVICES.

U.S. and foreign regulatory agencies, including the United States Food and Drug Administration, or the FDA, and comparable international agencies, govern the testing, marketing and registration of new medical devices or modifications to medical devices, in addition to regulating manufacturing practices, reporting, labeling and record keeping procedures. The regulatory process makes it longer, harder and more costly to bring our products to market, and we cannot assure you that any of our future products will be approved. All of our planned services, products and manufacturing activities, as well as the manufacturing activities of third-party medical device manufacturers who supply components to us, are subject to this regulation. We and such third-party manufacturers are or will be required to:

- undergo rigorous inspections by domestic and international agencies;

- obtain the prior approval of these agencies before we can market and sell our products; and

- satisfy content requirements for all of our sales and promotional materials.

Compliance with the regulations of these agencies may delay or prevent us from introducing new or improved products, which could in turn affect our ability to achieve or maintain a profitable level of sales. We may be subject to sanctions, including monetary fines and criminal penalties, the temporary or permanent suspension of operations, product recalls and marketing restrictions, if we fail to comply with the laws and regulations pertaining to our business. Our third-party component manufacturers may also be subject to the same sanctions and, as a result, may be unable to supply components for our products. Any failure to retain governmental approvals that we currently hold or obtain additional


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RISK FACTORS

similar approvals could prevent us from successfully marketing our technology and could harm our operating results. Furthermore, changes in the applicable governmental regulations could prevent further commercialization of our technologies and harm our business.

Even if regulatory approval or clearance of a product is granted, regulatory agencies could impose limitations on uses for which the product may be labeled and promoted. Further, for a marketed product, its manufacturer and manufacturing facilities are subject to periodic review and inspection. Later discovery of problems with a product, manufacturer or facility may result in restrictions on the product, manufacturer or facility, including withdrawal of the product from the market or other enforcement actions.

WE WILL SPEND CONSIDERABLE TIME AND MONEY COMPLYING WITH FEDERAL AND STATE REGULATIONS AND, IF WE ARE UNABLE TO FULLY COMPLY WITH SUCH REGULATIONS, WE COULD FACE SUBSTANTIAL PENALTIES.

We are directly or indirectly through our clients subject to extensive regulation by both the federal government and the states in which we conduct our business. The laws that directly or indirectly affect our ability to operate our business include, but are not limited to, the following:

- the federal Medicare and Medicaid Anti-Kickback Law, which prohibits persons from soliciting, offering, receiving or providing remuneration, directly or indirectly, in cash or in kind, to induce either the referral of an individual, or furnishing or arranging for a good or service, for which payment may be made under federal healthcare programs such as the Medicare and Medicaid Programs;

- the federal False Claims Act, which imposes civil and criminal liability on individuals and entities who submit, or cause to be submitted, false or fraudulent claims for payment to the government;

- the federal Health Insurance Portability and Accountability Act of 1996, which prohibits executing a scheme to defraud any healthcare benefit program, including private payors;

- the federal False Statements Statute, which prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false statement in connection with the delivery of or payment for healthcare benefits, items or services;

- the federal physician self-referral prohibition, commonly known as the Stark Law, which, in the absence of a statutory or regulatory exception, prohibits the referral of Medicare or Medicaid patients by a physician to an entity for the provision of certain designated healthcare services, if the physician or a member of the physician's immediate family has an ownership interest in, or a compensation arrangement with, the entity and also prohibits that entity from submitting a bill to a federal payor for services rendered pursuant to a prohibited referral;

- the federal Food, Drug and Cosmetic Act, which regulates the sale, manufacture, administration and prescribing of drugs;

- state law equivalents of the foregoing; and

- state laws that prohibit the practice of medicine by non-physicians and fee-splitting arrangements between physicians and non-physicians.

If our operations are found to be in violation of any of the laws described above or the other governmental regulations to which we or our clients are subject, we may be subject to the applicable penalty associated with the violation, including civil and criminal penalties, damages, fines and the curtailment or restructuring of our operations. Any penalties, damages, fines, curtailment or


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RISK FACTORS

restructuring of our operations would adversely affect our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses, divert our management's attention from the operation of our business and damage our reputation. For a more detailed discussion of the various state and federal regulations to which we are subject see "Business-- Government Regulation."

HEALTHCARE REFORM LEGISLATION COULD LIMIT THE PRICES WE CAN CHARGE FOR OUR IMAGING SERVICES, WHICH WOULD REDUCE OUR REVENUES AND HARM OUR OPERATING RESULTS.

In addition to extensive existing government healthcare regulation, there are numerous initiatives at the federal and state levels for comprehensive reforms affecting the payment for and availability of healthcare services, including a number of proposals that would significantly limit reimbursement under the Medicare and Medicaid Programs. It is not clear at this time what proposals, if any, will be adopted or, if adopted, what effect these proposals would have on our business. Aspects of certain of these healthcare proposals, such as reductions in the Medicare and Medicaid Programs and containment of healthcare costs on an interim basis by means that could include a short-term freeze on prices charged by healthcare providers, could limit the demand for our imaging services or affect the revenue per procedure that we can collect, which would harm our business and results of operations.

THE IMPACT OF RECENTLY ENACTED FEDERAL LAWS COULD HAVE A NEGATIVE IMPACT ON CAMERA SALES TO HOSPITALS DESIRING TO USE THE CAMERA IN OUT-PATIENT FACILITIES.

In order for institutional healthcare providers, such as hospitals, to be eligible for cost-based Medicare reimbursement for their out-patient facilities, these facilities must meet specific requirements. If these requirements are met, a facility will be classified as "provider-based" and therefore eligible for cost-based Medicare reimbursement, which is potentially more favorable than other types of Medicare reimbursement. However, recently promulgated federal regulations affect the ability of a Medicare provider to include a facility as provider-based for purposes of Medicare reimbursement. While recent federal legislation offers some relief for facilities previously recognized as provider-based, some of our hospital customers may have difficulty qualifying their out-patient facilities for provider-based status. If a hospital customer cannot obtain provider-based status for their out-patient nuclear imaging facility and therefore may not be eligible for cost-based Medicare reimbursement, then the provider may not purchase a camera from us.

THE APPLICATION OF STATE CERTIFICATE OF NEED REGULATIONS COULD HARM OUR BUSINESS AND FINANCIAL RESULTS.

Some states currently require, or may require in the future, a certificate of need or similar regulatory approval prior to the acquisition of high-cost capital items including diagnostic imaging systems or provision of diagnostic imaging services by us or our clients. In many cases, a limited number of these certificates are available in a given state. If we or our clients are unable to obtain the applicable certificate or approval or additional certificates or approvals necessary to expand our operations, these regulations may limit or preclude our operations in the relevant jurisdictions.


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RISK FACTORS

IF WE FAIL TO COMPLY WITH VARIOUS LICENSURE, OR CERTIFICATION STANDARDS, WE MAY BE SUBJECT TO LOSS OF LICENSURE OR CERTIFICATION, WHICH WOULD ADVERSELY AFFECT OUR OPERATIONS.

All of the states in which we operate require that the imaging technicians that operate our camera be licensed or certified. Obtaining such licenses may take significant time as we expand into additional states. Further, we are currently enrolled by Medicare contractors, or "carriers", as an independent diagnostic testing facility, or IDTF, in five (5) states and are seeking such enrollment by Medicare contractors in additional states. Enrollment is essential for us to receive payment for healthcare services directly from Medicare. There can be no assurances we will be able to maintain such enrollment or that we will be able to gain such enrollment in other states. Any lapse in our licenses or enrollment, or the licensure or certification of our technicians, could increase our costs and adversely affect our operations and financial results.

In the healthcare industry, various types of organizations are accredited to facilitate meeting certain Medicare certification requirements, expedite third-party payment, and fulfill state licensure requirements. Some managed care providers prefer to contract with accredited organizations. Thus far, we have not found it necessary to seek or obtain accreditation from any established accreditation agency. If it becomes necessary for us to do so in the future in order to satisfy the requirements of third party payors or regulatory agencies, there can be no assurances that we will be able to obtain or continuously maintain this accreditation.

RISKS RELATED TO THIS OFFERING

CONCENTRATION OF OWNERSHIP OF OUR COMMON STOCK AMONG OUR EXISTING EXECUTIVE OFFICERS, DIRECTORS AND PRINCIPAL STOCKHOLDERS MAY PREVENT NEW INVESTORS FROM INFLUENCING SIGNIFICANT CORPORATE DECISIONS.

Upon completion of this offering, our executive officers, directors and beneficial owners of 5% or more of our common stock and their affiliates will, in aggregate, beneficially own approximately % of our outstanding common stock or % if the underwriters' over-allotment option is exercised in full. As a result, these persons, acting together, may have the ability to determine the outcome of matters submitted to our stockholders for approval, including the election and removal of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, such persons, acting together, may have the ability to control the management and affairs of our company. Accordingly, this concentration of ownership may harm the market price of our common stock by:

- delaying, deferring or preventing a change in control of our company;

- impeding a merger, consolidation, takeover or other business combination involving our company; or

- discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of our company.

Please see "Principal stockholders" for additional information on concentration of ownership of our common stock.


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RISK FACTORS

THERE MAY NOT BE AN ACTIVE, LIQUID TRADING MARKET FOR OUR COMMON STOCK.

We cannot assure you that there will be an active trading market for our common stock following this offering. You may not be able to sell your shares quickly or at the market price if trading in our stock is not active. The initial public offering price was determined by negotiations between us and the representatives of the underwriters based upon a number of factors. The initial public offering price may not be indicative of prices that will prevail in the trading market. Please see "Underwriting" for more information regarding our arrangement with the underwriters and the factors considered in setting the initial public offering price.

OUR STOCK PRICE COULD BE VOLATILE, AND YOUR INVESTMENT COULD SUFFER A DECLINE IN VALUE WHICH MAY PREVENT INVESTORS IN OUR COMMON STOCK FROM SELLING THEIR SHARES ABOVE THE INITIAL PUBLIC OFFERING PRICE.

The trading price of our common stock is likely to be highly volatile and could be subject to wide fluctuations in price in response to various factors, many of which are beyond our control, including:

- actual or anticipated variations in quarterly operating results;

- announcements of technological innovations by us or our competitors;

- new products or services introduced or announced by us or our competitors;

- changes in financial estimates by securities analysts;

- conditions or trends in the medical device industry and the imaging service industry;

- changes in the market valuations of other similar companies;

- announcements by us of significant acquisitions, strategic partnerships, joint ventures or capital commitments;

- adverse action by regulatory agencies or changes in law;

- additions or departures of key personnel; and

- sales of our common stock.

In addition, the stock market in general, and the Nasdaq National Market in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of listed companies. Further, there has been particular volatility in the market prices of securities of medical device companies and imaging services companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market price of a company's securities, securities class-action litigation has often been instituted against that company. Such litigation, if instituted against us, could result in substantial costs and a diversion of management's attention and resources, which could seriously harm our business, financial condition and results of operations.

THE LARGE NUMBER OF SHARES ELIGIBLE FOR PUBLIC SALE AFTER THIS OFFERING COULD CAUSE OUR STOCK PRICE TO DECLINE.

Sales of substantial amounts of our common stock in the public market after this offering could seriously harm prevailing market prices for our common stock. These sales might make it difficult or impossible for us to sell additional securities when we need to raise capital. Based upon the number of


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RISK FACTORS

shares outstanding at August 23, 2001, upon the closing of this offering, we will have outstanding shares of common stock, assuming no exercise of the underwriters' over-allotment option and no exercise of options or warrants to purchase shares of our common stock. Of these shares, the shares being sold in this offering will be freely tradeable without restriction or further registration under the Securities Act of 1933, unless these shares are purchased by "affiliates" as that term is defined in Rule 144 of the Securities Act of 1933. The remaining shares of our common stock were issued and sold by us in reliance on exemptions from the registration requirements of the Securities Act of 1933. These shares may be sold in the public market only if they are registered or if they qualify from an exemption, such as Rule 144 or 701 under the Securities Act of 1933.

Please see "Shares eligible for future sale" for a description of the number of shares which may be sold by existing stockholders in the future.

INVESTORS IN THIS OFFERING WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION.

The initial public offering price will be substantially higher than the pro forma book value per share of our common stock. Purchasers of common stock in this offering will experience immediate and substantial dilution in the pro forma net tangible book value of their stock of $ per share, assuming an initial public offering price for our common stock of $ per share. This dilution is due in large part to the fact that prior investors paid an average price of $ per share when they purchased their shares of common stock, which is substantially less than the assumed initial public offering price of $ per share.

WE HAVE NOT PAID DIVIDENDS AND DO NOT ANTICIPATE PAYING DIVIDENDS ON OUR COMMON STOCK IN THE FORESEEABLE FUTURE.

We currently anticipate that we will retain all future earnings, if any, to finance the growth and development of our business and do not anticipate paying cash dividends on our common stock in the foreseeable future. Any payment of cash dividends will depend upon our financial condition, capital requirements, earnings and other factors deemed relevant by our board of directors. Under the terms of some of our credit agreements, we are restricted from paying cash dividends and making other distributions to our stockholders.

ANTI-TAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW COULD MAKE A THIRD-PARTY ACQUISITION OF US DIFFICULT OR DECREASE THE PRICE INVESTORS MIGHT BE WILLING TO PAY FOR OUR COMMON STOCK IN THE FUTURE.

The anti-takeover provisions in our certificate of incorporation, our bylaws and Delaware law could make it more difficult for a third party to acquire us without approval of our board of directors. As a result of these provisions, we could delay, deter or prevent a takeover attempt or third-party acquisition that our stockholders consider to be in their best interests, including a takeover attempt that results in a premium over the market price for the shares held by our stockholders. Please see "Description of capital stock" for more information on these anti-takeover provisions.


18


Forward-looking information

This prospectus may contain forward-looking statements relating to our operations and strategy that are based on our current expectations, estimates and projections. Words such as "expect," "intend," "plan," "project," "believe," "estimate" and other similar expressions are used to identify such forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Further, any forward-looking statements are based upon assumptions as to future events that may not prove to be accurate. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. We undertake no obligation to publicly update any forward-looking statement for any reason, even if new information becomes available or other events occur in the future.

A number of important factors could cause actual results to differ materially from those indicated by such forward-looking statements. Such factors include, among others, those set forth in this prospectus under the heading "Risk factors."

Market and industry data and forecasts

This prospectus includes market and industry data and forecasts that we obtained from market research, consultant surveys, publicly available information and industry publications and surveys, and internal company surveys. Reports prepared or published by Frost & Sullivan were the primary sources for third-party industry data and forecasts. Industry surveys, publications, consultant surveys and forecasts generally state they obtain the information contained therein from sources believed to be reliable, but there can be no assurance as to the accuracy and completeness of such information. We have not independently verified any of the data from third-party sources nor have we ascertained the underlying economic assumptions relied upon therein. Similarly, independent sources have not verified internal company surveys, industry forecasts and market research, which we believe to be reliable based upon management's knowledge of the industry. In addition, we do not know what assumptions regarding general economic growth are used in preparing the forecasts we cite.


19


Use of proceeds

We expect to receive approximately $ million in net proceeds from the sale of shares of common stock in this offering at an assumed initial public offering price of $ per share, or approximately $ million if the underwriters' over-allotment option is exercised in full, after deducting underwriting discounts and commissions and estimated offering expenses, which we expect to be approximately $ million, or approximately $ million if the underwriters' over-allotment option is exercised in full.

We intend to use approximately $5.7 million of the net proceeds of this offering to repay in full the following outstanding debt or financing obligations:

- approximately $2,500,000, including principal, accrued and unpaid interest and prepayment penalties, under working capital term loans, with interest rates ranging from 13.53% to 14.4%;

- approximately $2,500,000, including principal, accrued and unpaid interest and prepayment penalties, under a line of credit with an interest rate of prime plus 2% (which was 8% at June 30, 2001); and

- approximately $730,000, including principal, accrued and unpaid interest and prepayment penalties, under a line of credit with an interest rate at the greater of prime plus 1.25% or 10.25% (which was 10.25% at June 30, 2001).

The working capital term loans that we are repaying with proceeds from this offering were issued under a loan and security agreement with MMC/GATX Partnership No. 1 dated October 1999, as amended in August 2000 and November 2000, and the proceeds were used to fund expansion of our manufacturing operations. These term loans require monthly amortization and the final payment is due November 2002.

The lines of credit that we are repaying with proceeds from this offering were funded under various loan and security agreements, and the proceeds were used to fund general corporate working capital requirements.

We intend to use the remainder of the net proceeds primarily for general corporate purposes, including product development, marketing, capital expenditures and working capital. We may also use a portion of the proceeds of this offering for acquisitions or investments in complementary businesses. We have no current plans, arrangements or understandings related to any acquisition or investment.

The amounts and timing of any such use may vary significantly depending upon a number of factors, including our revenue growth, asset growth, cash flows and acquisition activities. Pending such uses, the net proceeds of this offering will be invested in short-term, investment-grade, interest-bearing securities. We currently anticipate that the net proceeds to be received by us from this offering and existing cash balances will be sufficient to satisfy our operating cash needs for at least 12 months following the closing of this offering. See "Management's discussion and analysis of financial condition and results of operations--Liquidity and Capital Resources."

Dividend policy

We have never declared or paid any cash dividends on our common stock. We do not expect to pay any cash dividends for the foreseeable future. We currently intend to retain future earnings, if any, to finance the expansion of our business. Any future determination to pay cash dividends will be at the discretion of our board of directors and will be dependent on our financial condition, operating results, capital requirements and other factors that our board deems relevant.


20


Capitalization

The following table sets forth our capitalization as of June 30, 2001:

- on an actual basis;

- on a pro forma basis to give effect to the issuance of 2,618,462 shares of Series F preferred stock in August 2001 and the automatic conversion of all shares of preferred stock outstanding as of August 23, 2001 into 29,748,030 shares of common stock in connection with this offering; and

- on a pro forma as adjusted basis to give effect to the sale of shares of our common stock in this offering at an assumed initial public offering price of $ per share and the application of the net proceeds to repay a portion of our outstanding indebtedness.

You should read this table together with "Use of proceeds," "Management's discussion and analysis of financial condition and results of operations" and the consolidated financial statements and related notes included elsewhere in this prospectus.

 

                                                                         JUNE 30, 2001
                                                              -----------------------------------
                                                                                       PRO FORMA
                                                               ACTUAL    PRO FORMA    AS ADJUSTED
                                                                        (in thousands)
-------------------------------------------------------------------------------------------------
Cash and cash equivalents...................................  $  3,510    $ 11,920
                                                              ========    ========

Total debt:
  Current portion of long-term debt.........................     5,614       5,614
  Long-term debt, net of current portion....................     5,076       5,076
  Notes payable to stockholders.............................       735         735

Redeemable convertible preferred stock:
  Authorized shares--27,582,646 actual, 10,000,000 pro forma
    and pro forma as adjusted; Issued and outstanding
    shares--27,129,568 actual, none pro forma and pro forma
    as adjusted.............................................    58,109          --

Stockholders' equity (deficit):
  Common Stock:
    Authorized shares--38,091,807 actual, 250,000,000 pro
      forma and pro forma as adjusted; Issued and
      outstanding shares--4,574,603 actual, 34,322,633 pro
      forma and       pro forma as adjusted.................         5          34
  Additional paid-in capital................................     4,707      71,197
  Deferred compensation.....................................    (1,713)     (1,713)
  Notes receivable from stockholders........................      (112)       (112)
  Accumulated deficit.......................................   (50,998)    (50,998)
                                                              --------    --------
  Total stockholders' equity (deficit)......................   (48,111)     18,408
                                                              --------    --------
  Total capitalization......................................  $ 21,423    $ 29,833
                                                              ========    ========

The table above does not include:

- the issuance of up to 5,952,426 shares of common stock upon the exercise of stock options outstanding as of August 23, 2001 at a weighted average exercise price of $0.64 per share;

- the issuance of up to 603,578 shares of common stock upon the exercise of warrants outstanding as of August 23, 2001 at a weighted average exercise price of $2.59 per share, of which warrants


21

CAPITALIZATION

to purchase 65,875 shares will expire if not exercised at the time of this offering and warrants to purchase 60,000 shares will expire if a consulting agreement is terminated before July 31, 2002;

- the issuance of up to 250,000 shares of common stock, as well as additional shares of common stock issuable based upon future earnings results, as additional consideration in connection with our acquisitions of Nuclear Imaging Systems, Inc. and Florida Cardiology and Nuclear Medicine Group;

- the issuance of up to 4,725,883 shares of common stock reserved for future issuance under our stock option plans; and

- the issuance of 10,000 shares of common stock at fair market value for every three of our digital cameras sold by a consultant, up to a maximum of 40,000 shares, and thereafter 1,500 shares of common stock at fair market value for each of our digital cameras sold by the consultant, in each case upon the exercise of warrants issuable to the consultant.


22


Dilution

If you invest in our common stock, your interest will be diluted to the extent of the difference between the initial public offering price per share of our common stock and the pro forma net tangible book value per share of our common stock after this offering.

Pro forma net tangible book value per share represents the amount of total tangible assets less total liabilities, divided by the pro forma number of shares of common stock then outstanding. Our pro forma net tangible book value at June 30, 2001, would have been $15.9 million, or $ per share of common stock, after giving effect to the issuance of 2,618,462 shares of Series F preferred stock in August 2001 and the automatic conversion of all shares of preferred stock outstanding as of August 23, 2001 into 29,748,030 shares of common stock in connection with this offering. After giving further effect to the sale of shares of common stock in this offering at an assumed initial public offering price of $ per share, and after deducting estimated underwriting discounts and commissions and estimated offering expenses, our pro forma net tangible book value at June 30, 2001, would have been $ million, or $ per share. This represents an immediate increase in pro forma net tangible book value of $ per share to existing stockholders and an immediate dilution of $ per share to new investors purchasing common stock in this offering. The following table illustrates this per share dilution:

 

Assumed initial public offering price per share.............           $
  Pro forma net tangible book value per share before this
    offering................................................  $
  Increase attributable to new investors in this offering...
                                                              ------
Pro forma net tangible book value per share after this
  offering..................................................           $
                                                                       ------
Dilution in pro forma net tangible book value per share to
  new investors after this offering.........................           $
                                                                       ======

The following table summarizes as of June 30, 2001, on the pro forma basis described above, the total number of shares of common stock purchased from us, the total consideration paid to us, and the average price per share paid by existing stockholders and by new investors purchasing shares of common stock from us in this offering at an assumed initial public offering price of $ per share and before deducting underwriting discounts and commissions and estimated offering expenses:

 

                                        SHARES PURCHASED        TOTAL CONSIDERATION
                                     ----------------------   -----------------------       AVERAGE PRICE
                                       NUMBER      PERCENT       AMOUNT      PERCENT          PER SHARE
---------------------------------------------------------------------------------------------------------
Existing stockholders..............  34,322,633          %    $68,071,703          %            $1.98
New investors......................                                                             $
                                     ----------     -----     -----------     -----             -----
Total..............................                      %    $                    %            $
                                     ==========     =====     ===========     =====             =====

If the underwriters exercise their over-allotment option in full, the following will occur:

- our pro forma net tangible book value after the offering will increase $ per share to existing stockholders and our pro forma net tangible book value after the offering will be diluted $ per share to new investors;

- the percentage of shares of our common stock held by existing stockholders will decrease to approximately % of the total number of shares of our common stock outstanding after this offering; and

- the number of shares of our common stock held by new investors will increase to , or approximately % of the total number of shares of our common stock outstanding after this offering.


23

DILUTION

The tables and calculations above assume no issuance of the following shares described below:

- the issuance of up to 5,952,426 shares of common stock upon the exercise of stock options outstanding as of August 23, 2001 at a weighted average exercise price of $0.64 per share;

- the issuance of up to 603,578 shares of common stock upon the exercise of warrants outstanding as of August 23, 2001 at a weighted average exercise price of $2.59 per share, of which warrants to purchase 65,875 shares will expire if not exercised at the time of this offering and warrants to purchase 60,000 shares will expire if a consulting agreement is terminated before July 31, 2002;

- the issuance of up to 250,000 shares of common stock, as well as additional shares of common stock issuable based upon future earnings results, as additional consideration in connection with our acquisitions of Nuclear Imaging Systems, Inc. and Florida Cardiology and Nuclear Medicine Group;

- the issuance of up to 4,725,883 shares of common stock reserved for future issuance under our stock option plans; and

- the issuance of 10,000 shares of common stock at fair market value for every three of our digital cameras sold by a consultant, up to a maximum of 40,000 shares, and thereafter 1,500 shares of common stock at fair market value for each of our digital cameras sold by the consultant, in each case upon the exercise of warrants issuable to the consultant.

If we assume the exercise of all stock options and warrants outstanding as of August 23, 2001, our pro forma net tangible book value after the offering will increase $ per share to existing stockholders and our pro forma net tangible book value after the offering will be diluted $ per share to new investors.

To the extent that any of the other shares of common stock described above are issued, there will be further dilution to new investors. See "Capitalization," "Management--Benefit Plans," and the notes to our consolidated financial statements included elsewhere in this prospectus for further information.


24


Selected historical financial and operating data

Our selected statement of operations data for the years ended December 31, 1996 and 1997, and our selected balance sheet data as of December 31, 1996, 1997 and 1998, are derived from our audited consolidated financial statements for such years and as of such dates, which are not included in this prospectus. Our selected statement of operations data for the years ended December 31, 1998, 1999 and 2000 and our selected balance sheet data as of December 31, 1999 and 2000, are derived from our audited financial statements for such years and as of such dates, which are included elsewhere in this prospectus. Our selected statement of operations data for the six month periods ended June 30, 2000 and 2001, and our selected balance sheet data as of June 30, 2001, are derived from our unaudited financial statements for such years and as of such date, which are included elsewhere in this prospectus. The unaudited financial statements include all adjustments, consisting of normal recurring accruals, which we consider necessary for a fair representation of the financial position and the results of operations for these periods.

Operating results for the six months ended June 30, 2001 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2001. You should read the data set forth below in conjunction with "Management's discussion and analysis of financial condition and results of operations" and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

                                                                                                                 SIX MONTHS
                                                                    YEARS ENDED DECEMBER 31,                   ENDED JUNE 30,
STATEMENT OF OPERATIONS DATA:                         ----------------------------------------------------   -------------------
                                                          1996       1997       1998       1999       2000       2000       2001
                                                             (In thousands, except per share and selected operating data)
--------------------------------------------------------------------------------------------------------------------------------
Revenues:
  Products..........................................  $   101    $   167    $   340    $    284   $  5,815   $ 1,456    $ 9,802
  Imaging services..................................       --         --         --          --      1,260        --      4,217
  Licensing and other...............................      487        252      1,581          --         --        --         --
                                                      -------    -------    -------    --------   --------   -------    -------
    Total revenues..................................      588        419      1,921         284      7,075     1,456     14,019
Cost of revenues:
  Products..........................................      687        417        388         265      9,834     3,602      6,438
  Imaging services..................................       --         --         --          --        839        --      3,394
                                                      -------    -------    -------    --------   --------   -------    -------
    Total cost of revenues..........................      687        417        388         265     10,673     3,602      9,832
                                                      -------    -------    -------    --------   --------   -------    -------
Gross profit (loss).................................      (99)         2      1,533          19     (3,598)   (2,146)     4,187
Operating expenses:
  Research and development..........................    1,602      4,073      5,426      10,063      2,372     1,083      1,327
  Sales and marketing...............................      121        557        623       1,455      3,586     1,291      4,028
  General and administrative........................      609      1,198      2,533       1,967      2,878     1,072      2,899
  Amortization of intangible assets.................       --         --         --          --        209         3        315
  Stock-based compensation..........................       --         --         --          --        296        --      1,063
                                                      -------    -------    -------    --------   --------   -------    -------
    Total operating expenses........................    2,332      5,828      8,582      13,485      9,341     3,449      9,632
                                                      -------    -------    -------    --------   --------   -------    -------
Loss from operations................................   (2,431)    (5,826)    (7,049)    (13,466)   (12,939)   (5,595)    (5,445)
Other income (expense), net.........................      (71)      (552)       857         274       (537)      (97)      (401)
                                                      -------    -------    -------    --------   --------   -------    -------
Net loss............................................  $(2,502)   $(6,378)   $(6,192)   $(13,192)  $(13,476)  $(5,692)   $(5,846)
                                                      =======    =======    =======    ========   ========   =======    =======
Net loss applicable to common stockholders..........  $(2,502)   $(6,378)   $(6,192)   $(13,192)  $(13,524)  $(5,692)   $(5,902)
                                                      =======    =======    =======    ========   ========   =======    =======
Basic and diluted net loss per share(1):
  Historical........................................  $ (0.77)   $ (1.95)   $ (1.87)   $  (3.90)  $  (3.61)  $ (1.65)   $ (1.35)
                                                      =======    =======    =======    ========   ========   =======    =======
  Pro forma.........................................                                              $  (0.53)             $ (0.19)
                                                                                                  ========              =======
Shares used to compute basic and diluted net loss
  per share(1):
  Historical........................................    3,256      3,273      3,306       3,381      3,745     3,455      4,366
                                                      =======    =======    =======    ========   ========   =======    =======
  Pro forma.........................................                                                25,474               30,436
                                                                                                  ========              =======


25

 
SELECTED HISTORICAL FINANCIAL AND OPERATING DATA

                                                                                                                 SIX MONTHS
                                                                    YEARS ENDED DECEMBER 31,                   ENDED JUNE 30,
STATEMENT OF OPERATIONS DATA:                         ----------------------------------------------------   -------------------
                                                          1996       1997       1998       1999       2000       2000       2001
                                                             (In thousands, except per share and selected operating data)
--------------------------------------------------------------------------------------------------------------------------------
SELECTED OPERATING DATA:
Product sales
  Number of gamma cameras sold to third parties.....       --         --         --          --         23         6         36
Imaging services
  Number of imaging procedures performed............       --         --         --          --          *        --      6,953


(1) Please see Note 1 to our financial statements for an explanation of the method used to calculate the historical and pro forma net loss per share and the number of shares used in the computation of per share amounts.

* Not available because the methodology for tracking the number of procedures performed in 2000 under acquired customer contracts was not consistent with our current methodology.

 

                                                                    AS OF DECEMBER 31,
BALANCE SHEET DATA                                 ----------------------------------------------------        AS OF
                                                       1996       1997       1998       1999       2000    JUNE 30, 2001
                                                                               (In thousands)
-------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents........................  $ 5,634    $ 19,293   $ 13,680   $  2,626   $  6,555      $  3,510
Working capital..................................  $ 5,344    $ 18,382   $ 12,636   $    801   $  5,481      $  4,504
Total assets.....................................  $ 6,576    $ 20,697   $ 16,365   $  5,699   $ 23,207      $ 28,557
Long-term debt...................................  $ 6,756    $    735   $    735   $  2,156   $  5,679      $  5,811
Redeemable convertible preferred stock...........  $ 4,759    $ 30,759   $ 32,259   $ 32,259   $ 52,255      $ 58,109
Total stockholders' equity (deficit).............  $(5,461)   $(11,833)  $(17,990)  $(31,050)  $(43,322)     $(48,111)


26


Management's discussion and analysis of financial condition and results of operations

YOU SHOULD READ THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS IN CONJUNCTION WITH THE FINANCIAL STATEMENTS AND THE NOTES TO THOSE STATEMENTS INCLUDED ELSEWHERE IN THIS PROSPECTUS. THIS DISCUSSION MAY CONTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. AS A RESULT OF MANY FACTORS, SUCH AS THOSE SET FORTH UNDER "RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS, OUR ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS.

OVERVIEW

We are the first and only company to have developed and commercialized a solid-state, digital gamma camera for use in nuclear medicine. We sell our solid-state, digital gamma cameras and related equipment to physician practices, imaging centers, hospitals and research laboratories in the United States, Canada and Japan. We also use our proprietary technology to provide mobile nuclear imaging services to physician offices and imaging centers through our Digirad Imaging Solutions business unit, or DIS.

We incorporated as San Diego Semiconductor in 1985. In 1994, we changed our name to Digirad Corporation and began development of a solid-state gamma camera for nuclear imaging applications. Between 1994 and 1998, we developed and tested our proprietary technology, financing our research operations with equity investments. We began production of the current generation solid-state digital gamma camera in 1999, and commercial shipments commenced in March 2000. As of June 30, 2001, we had taken orders for 117 gamma cameras, of which 59 have been shipped. We expect that 38 units in our backlog will be shipped by December 31, 2001 with the remainder expected to be shipped in 2002.

In the second half of 2000, we formed DIS to provide turn-key nuclear cardiac imaging services to physician offices. We entered the service business via the strategic acquisition of certain assets of two operators that provide us with both critical mass and platforms for growth of our imaging services business:

- During the third quarter of 2000, we acquired some of the customer contracts and select assets relating to the mobile nuclear imaging services of Florida Cardiology and Nuclear Medicine Group, a provider of mobile and fixed site nuclear imaging services in Florida. At the time of the acquisition, Florida Cardiology was operating two mobile routes.

- During the fourth quarter of 2000, we acquired some of the customer contracts and select assets relating to the mobile nuclear imaging services of Nuclear Imaging Systems, Inc. and Cardiovascular Concepts, P.C., which together provided mobile and fixed site nuclear imaging services in New Jersey, North Carolina, Maryland and Pennsylvania. At the time of the acquisition, these two companies were operating nine mobile routes.

We have incurred substantial operating losses since our inception. As of June 30, 2001, our accumulated deficit was $51.0 million. We expect to spend substantial additional amounts to increase marketing, direct sales, imaging services, training and customer support needed to support our increasing revenues.

We derive revenues both from selling our products and providing imaging services. We generated approximately 70% of our revenues for the six months ended June 30, 2001 from sales of our


27

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

products. Our product revenue consists of sales of solid-state gamma cameras, custom designed chairs and accessories such as printers and collimators. We generated approximately 30% of our revenues for the six months ended June 30, 2001 from our imaging services business. We derive our imaging services revenue from the provision of mobile nuclear imaging services. We provide mobile nuclear imaging services to physician offices, which include cardiology and internal medicine practices, on a turn-key basis utilizing our proprietary DIGIRAD(TM) 2020TC Imager(TM) gamma camera and the SPECTour(TM) chair. We offer this imaging service on a contract basis, with the typical contract length being one to three years and comprised of one day of service per week. As we continue to grow, we expect our imaging services revenue to account for a majority of total revenues.

We sell our products to customers in North America and Japan. A relatively small number of customers account for a significant percentage of our revenues. For the year ended December 31, 2000, three product customers accounted for 15.9%, 11.6% and 10.1% of our consolidated revenues. However, for the six months ended June 30, 2001, no product customers accounted for 10% or more of consolidated revenues. No imaging services customer accounted for 10% or more of our consolidated revenues for the year ended December 31, 2000 or the six months ended June 30, 2001.

We experience seasonality in the service of our DIS customers. For example, our study volumes typically decline from our second fiscal quarter to our third fiscal quarter due to summer holidays and vacation schedules. We may also experience declining study volumes in December due to holidays and in the first quarter due to weather conditions in certain parts of the country. These seasonal factors may lead to fluctuations in our quarterly operating results. It is difficult for us to evaluate the degree to which the summer slowdown, winter holiday variations and inclement weather may make our revenues unpredictable in the future. We may not be able to reduce our expenses, including our debt service obligations, quickly enough to respond to these declines in revenue, which would make our business difficult to operate and would harm our financial results.

RESULTS OF OPERATIONS

COMPARISON OF SIX MONTHS ENDED JUNE 30, 2001 AND 2000

REVENUES

TOTAL REVENUES--Total revenues increased to $14.0 million for the six months ended June 30, 2001 from $1.5 million for the comparable period in 2000.

PRODUCTS--Our product revenue increased to $9.8 million for the six months ended June 30, 2001 from $1.5 million for the comparable period in 2000. This increase was due to increased sales of our gamma cameras, from six in the first six months of 2000 to 36 in the comparable period in 2001. Our backlog of gamma camera orders was 58 as of June 30, 2001. Product revenue accounted for 70% of total revenues for the first six months of 2001 versus 100% for the first six months of 2000.

IMAGING SERVICES--Our imaging services revenue was $4.2 million for the six months ended June 30, 2001. We did not have any imaging services revenue during the six months ended June 30, 2000, as we did not start this business until the second half of 2000. We performed approximately 6,900 procedures for the six months ended June 30, 2001, and were operating 18 mobile servicing routes as of June 30, 2001. Imaging services revenue accounted for 30% of total revenues for the first six months of 2001.

COST OF REVENUES

TOTAL COST OF REVENUES--Total cost of revenues increased to $9.8 million for the six months ended June 30, 2001 from $3.6 million for the same period in 2000.


28

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

PRODUCTS--Cost of product revenue consists primarily of materials, labor and other costs associated with the products we sell. Our cost of product revenue increased to $6.4 million for the six months ended June 30, 2001 from $3.6 million for the comparable period in 2000. The increase in the cost of product revenue for the first six months of 2001 was due primarily to the increase in the volume of cameras and accessories sold. However, cost reductions in the manufacturing process partially offset the increase. As a percentage of product revenue, cost of product revenue was 66% in the first six months of 2001.

IMAGING SERVICES--Cost of imaging services revenue consists primarily of labor, radiopharmaceuticals, equipment depreciation and other costs associated with provision of services. Our cost of imaging services revenue was $3.4 million for the six months ended June 30, 2001. There was no cost of imaging services revenue for the comparable period in 2000. As a percentage of imaging services revenue, cost of services revenue was 81% in the first six months of 2001.

GROSS PROFIT

TOTAL GROSS PROFIT--Total gross profit increased to $4.2 million for the six months ended June 30, 2001 from a loss of $2.1 million for the comparable period in 2000.

PRODUCTS--Our product gross profit increased to $3.4 million for the six months ended June 30, 2001 from a loss of $2.1 million for the comparable period in 2000. This increase was primarily due to reductions in our cost per unit from volume discounts, design modifications, and better utilization of our manufacturing capacity. Although we expect continued gross profit improvements with increased sales as we better utilize our existing manufacturing capacity and benefit from economies of scale, we expect such improvements, if any, to occur at a slower rate than those experienced between 2000 and 2001.

IMAGING SERVICES--Our imaging services gross profit was $0.8 million for the six months ended June 30, 2001. There was no comparable gross profit from imaging services for the six months ended June 30, 2000 because at that date we had not yet entered the imaging services business.

OPERATING EXPENSES

RESEARCH AND DEVELOPMENT--Research and development expenses consist primarily of costs associated with the design, development, testing, deployment and enhancement of our products and manufacturing capabilities. Research and development expenses increased to $1.3 million for the six months ended June 30, 2001 from $1.1 million in the comparable period in 2000. An increase in headcount, materials and other direct and indirect costs in support of our continued product development account primarily for the increase in research and development expenses for the first six months of 2001. For the first six months of 2001, research and development expenses amounted to 9% of total revenue.

SALES AND MARKETING--Sales and marketing expenses consist primarily of salaries, commissions, bonuses, recruiting costs, travel, marketing materials and trade shows. Sales and marketing expenses increased to $4.0 million for the six months ended June 30, 2001 from $1.3 million in the comparable period in 2000. Our continued development of our sales and marketing functions to support the sales of our gamma camera and the growth of our mobile nuclear imaging services business accounted primarily for the increase in sales and marketing expenses. For the first six months of 2001, sales and marketing expenses amounted to 29% of total revenue.

GENERAL AND ADMINISTRATIVE--General and administrative expenses consist primarily of salaries and other related costs for finance, human resources and other personnel, as well as accounting, legal and other professional fees. General and administrative expenses increased to $2.9 million for the six


29

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

months ended June 30, 2001 from $1.1 million in the comparable period in 2000. Increased headcount and related costs account primarily for the increase in general and administrative expenses. For the first six months of 2001, general and administrative expenses amounted to 21% of total revenue.

AMORTIZATION OF INTANGIBLE ASSETS--Intangible assets primarily represent acquired customer contracts, a covenant not-to-compete, and the capitalized costs related to our patent and trademark portfolio. Amortization of intangibles increased to $315,000 for the six months ended June 30, 2001 from $3,000 in the comparable period in 2000. The acquisition of customer contracts from Florida Cardiology and Nuclear Imaging Systems, Inc. in the third and fourth quarters of 2000 primarily accounted for the increase in amortization of intangible assets.

DEFERRED COMPENSATION AND OTHER NON-CASH STOCK COMPENSATION CHARGES--Deferred stock compensation represents the difference between the estimated fair value of our common stock and the exercise price of options at the date of grant. In connection with the grant of stock options to employees and directors, we recorded deferred compensation of $2.0 million for the six months ended June 30, 2001. We recorded this amount as a component of stockholders' equity and will amortize the amount as a charge to operations over the vesting period of the options. We recorded amortization of deferred compensation and other non-cash compensation charges of $1.1 million for the six months ended June 30, 2001. The compensation charges relate to cost of revenues, research and development, sales and marketing, and general and administrative expenses in the amount of $197,000, $61,000, $421,000 and $384,000, respectively, for the six months ended June 30, 2001. No deferred compensation was incurred or amortized during the six months ended June 30, 2000.

INTEREST EXPENSE

Interest expense increased to $545,000 for the six months ended June 30, 2001 from $221,000 for the comparable period in 2000. Increased borrowing under notes payable and capital leases in the latter part of 2000 and the first six months of 2001 account primarily for the increase in interest expense.

INTEREST INCOME

Interest income increased moderately to $145,000 for the six months ended June 30, 2001 from $124,000 for the comparable period in 2000 primarily due to slightly higher average cash balances.

NET LOSS

Net loss increased to $5.8 million for the six months ended June 30, 2001 from $5.7 million in the comparable period in 2000 as a result of the factors described above.

COMPARISON OF YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

REVENUES

TOTAL REVENUES--Total revenues increased to $7.1 million in 2000 from $0.3 million in 1999. Total revenues decreased in 1999 from $1.9 million in 1998. The decrease in 1999 from 1998 was due to $1.6 million of non-recurring license fees and milestone payments recognized in 1998 under a collaborative supply and development agreement.

PRODUCTS--Our product revenue increased to $5.8 million in 2000 from $0.3 million in 1999 and $0.3 million in 1998. Sales of our gamma cameras, first sold in 2000, account for the increase in product revenue. Product revenue accounted for 82% of total revenues in 2000 versus 100% in 1999 and 18% in 1998.

IMAGING SERVICES--Our imaging services revenue was $1.3 million in 2000. We did not have any imaging services revenue in 1999 or 1998. The 2000 imaging services revenue was the result of our


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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

entry into the mobile nuclear imaging services business. Imaging services revenue accounted for 18% of total revenues in 2000.

COST OF REVENUES

TOTAL COST OF REVENUES--Total cost of revenues increased to $10.7 million in 2000 from $0.3 million in 1999 and $0.4 million in 1998.

PRODUCTS--Our cost of product revenue increased to $9.8 million in 2000 from $0.3 million in 1999 and $0.4 million in 1998. Costs associated with the launch of our gamma cameras were the primary reason for the increase in cost of product revenue in 2000.

IMAGING SERVICES--Our cost of imaging services revenue was $0.8 million in 2000. There was no cost of service revenue for 1999 or 1998. As a percentage of imaging services revenue, cost of service revenue was 67% in 2000.

OPERATING EXPENSES

RESEARCH AND DEVELOPMENT--Research and development expenses decreased to $2.4 million in 2000 from $10.1 million in 1999. Research and development expenses increased in 1999 from $5.4 million in 1998. Our transition from development to production prior to the first shipments of our gamma cameras in the first quarter of 2000 was the primary reason for the decrease in research and development expenses. Most direct and indirect expenses charged to research and development expenses in 1999 and 1998 were accounted for as manufacturing expenses in 2000 when we began commercial production. Research and development expenses amounted to 34% of total revenues in 2000. The increase in research and development expenses from 1998 to 1999 was related primarily to an increase in headcount, materials and other direct and indirect costs for the completion of alpha and beta units of our gamma camera.

SALES AND MARKETING--Sales and marketing expenses increased to $3.6 million in 2000 from $1.5 million in 1999 and $0.6 million in 1998. These increases in sales and marketing expense were related primarily to the build out of our sales infrastructure to support the sales of our gamma camera and the start-up of our mobile nuclear imaging services business. Sales and marketing expenses amounted to 51% of total revenues in 2000.

GENERAL AND ADMINISTRATIVE--General and administrative expenses increased to $2.9 million in 2000 from $2.0 million in 1999 and decreased in 1999 from $2.5 million in 1998. The changes in general and administrative expense were primarily due to corresponding changes in headcount and related costs. General and administrative expenses amounted to 41% of total revenues in 2000.

AMORTIZATION OF INTANGIBLE ASSETS--Amortization of intangible assets was $209,000 in 2000. We had no significant intangible asset amortization in 1999 and 1998. The acquisition of customer contracts from Florida Cardiology and Nuclear Imaging Systems, Inc. primarily accounted for the increase.

DEFERRED COMPENSATION AND OTHER NON-CASH STOCK COMPENSATION CHARGES--In connection with the grant of stock options to employees and directors, we recorded deferred compensation of $0.8 million for 2000. We recorded this amount as a component of stockholders' equity and will amortize the amount as a charge to operations over the vesting period of the options. We recorded amortization of deferred compensation and other non-cash stock compensation charges of $0.3 million during 2000. The compensation charges relate to cost of revenues, research and development, sales and marketing, and general and administrative expenses in the amount of $64,000, $6,000, $37,000, and $189,000, respectively, during 2000.


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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

INTEREST EXPENSE

Interest expense increased to $780,000 in 2000 from $87,000 in 1999 and $46,000 in 1998. The addition of $2.0 million in notes payable for general corporate purposes and working capital, as well as a $4.2 million increase in capital leases, were the primary reasons for the increase in interest expense.

INTEREST INCOME

Interest income decreased to $243,000 in 2000 from $360,000 in 1999 and $903,000 in 1998. Declining average cash balances resulting from operational spending along with asset and property and equipment acquisitions are primarily responsible for the decrease in interest income.

NET LOSS

Net loss increased to $13.5 million in 2000 from $13.2 million in 1999 and $6.2 million in 1998 as a result of the factors described above.

 
LIQUIDITY AND CAPITAL RESOURCES

We have funded our operations principally through private equity financings supplemented with long-term debt and equipment financing arrangements. The equity investments were in the form of six series of preferred stock offerings between March 1995 and August 2001, which yielded aggregate net proceeds totaling approximately $66 million. At June 30, 2001, our outstanding borrowings totaled $11.4 million.

As of June 30, 2001, cash and cash equivalents totaled $3.5 million compared to $6.6 million at December 31, 2000. We currently invest our cash reserves in United States investment grade corporate-debt securities with maturities not exceeding 12 months and money market funds.

Net cash used in operating activities amounted to approximately $15.0 million, $12.1 million, $5.5 million and $9.1 million for the years ended December 31, 2000, 1999, 1998 and for the six months ended June 30, 2001, respectively. For these periods, net cash used in operating activities resulted primarily from operating losses and net increases in accounts receivable and inventories resulting from the growth in our business.

Net cash used in investing activities amounted to approximately $7.2 million, $0.9 million, $1.7 million and $2.5 million for the years ended December 31, 2000, 1999, 1998 and the six months ended June 30, 2001, respectively. Investing activities consist primarily of capital expenditures and asset acquisitions.

Net cash provided by financing activities amounted to approximately $26.2 million, $2.0 million, $1.5 million and $8.6 million for the years ended December 31, 2000, 1999, 1998 and the six months ended June 30, 2001, respectively. Private placement of preferred stock and proceeds from bank borrowings and lease financings were primarily responsible for the net cash provided by financing activities. We raised $17.9 million in 2000 and $5.8 million in the first six months of 2001 through the private placement of Series E preferred stock. In addition, we raised an additional $8.4 million in August 2001 through the private placement of Series F preferred stock.

In July 2001, we entered into an agreement with a bank for a $4.3 million revolving line of credit to provide working capital for the product business. Borrowings under the line of credit accrue interest at the bank's floating prime rate plus 2% and are limited based on a formula that takes into account eligible amounts of accounts receivables, inventory and other factors. We are required to make monthly interest payments on this line of credit, which expires in July 2002 with any unpaid balance


32

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

due upon expiration. At June 30, 2001, the outstanding balance under this facility was $2.4 million. We intend to repay this loan in full with proceeds from this offering.

In January 2001, we entered into a loan and security agreement for a revolving line of credit to provide working capital for our imaging services business. We are authorized to draw up to $2.5 million and can draw an additional $2.5 million upon approval by the lender's credit committee. The borrowings under the line of credit accrue interest at the higher of prime plus 1.25% or 10.25%. The revolving line of credit expires in January 2004. As of June 30, 2001, the outstanding balance under this loan and security agreement totaled $0.6 million. We intend to repay this loan in full with proceeds from this offering.

In November 1999, we entered into a bank loan and security agreement to borrow up to $3.0 million. In August 2000, we modified the November 1999 loan agreement to borrow an additional $1.0 million. Borrowings under this agreement accrue interest at rates between 13.53% and 14.4%. We are required to make monthly principal and interest payments of $156,273 through November 2002. As of June 30, 2001, $2.4 million is outstanding under these loan and security agreements. We intend to repay this loan in full with proceeds from this offering.

We have notes payable to stockholders totaling $0.7 million, which bear interest at 6.35% per year. The notes mature on December 31 of the year immediately following the first year in which the Company generates cash from operations, which is expected to be after 2001.

As of June 30, 2001, we had capital lease obligations totaling $5.5 million. These obligations are secured by the specific equipment financed under each lease and will be repaid monthly over the lease terms, which range from 36 to 63 months.

As of December 31, 2000, we had federal and California income tax net operating loss carryforwards of approximately $39.9 million and $27.9 million, respectively. The difference between the federal and California tax operating loss carryforwards is primarily attributable to the 50% limitation in the utilization of California tax net operating loss carryforwards. The federal and California tax net operating loss carryforwards will begin to expire in 2006 and 2002, respectively, unless previously used. We also have federal and California research and development and other tax credit carryforwards of approximately $1.6 million and $1.3 million, respectively, which will begin to expire in 2005 unless previously used. We have provided a 100% valuation allowance against the related deferred tax assets as realization of such tax benefits is not assured. Our ability to use the net operating losses and credits may be subject to substantial annual limitations due to the "change of ownership" provisions of the Internal Revenue Code and similar state provisions. The annual limitation may result in the expiration of the net operating losses before utilization.

We believe that our existing cash and cash equivalents, revenues to be derived from the sale of our products and imaging services, current and anticipated credit facilities and the net proceeds of this offering will be sufficient to fund our operations for at least twelve months. However, our future capital requirements will depend on numerous factors, including market acceptance of our products and imaging services, the resources we devote to expanding the market for our current products and imaging services and to developing new products, regulatory changes, competition and technological developments, and potential future merger and acquisition activity.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk for changes in interest rates relates primarily to the increase or decrease in the amount of interest income we can earn on our investment portfolio and on the increase or decrease in the amount of interest expense we must pay with respect to our various outstanding debt


33

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

instruments. Our risk associated with fluctuating interest rates is limited, however, to certain of our long-term debt and capital lease obligations, the interest rates under which are closely tied to market rates, and our investments in interest rate sensitive financial instruments. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. We attempt to ensure the safety and preservation of our invested principal funds by limiting default risk, market risk and reinvestment risk. We mitigate default risk by investing in investment grade securities. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our interest sensitive financial instruments. Declines in interest rates over time will, however, reduce our interest income while increases in interest rates over time will increase our interest expense.

INFLATION

We do not believe that inflation has had a material impact on our business or operating results during the periods presented.

RECENT ACCOUNTING PRONOUNCEMENTS

On January 1, 2001, we adopted Statement of Financial Accounting Standards, or SFAS, No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This statement establishes accounting and reporting standards requiring that every derivative instrument, including certain derivative instruments imbedded in other contracts, be recorded in the balance sheet as either an asset or liability measured at its fair value. The statement also requires that changes in the derivative's fair value be recognized in earnings unless specific hedge accounting criteria are met. We believe the adoption of SFAS No. 133 will not have an effect on our financial statements because we do not engage in derivative or hedging activities.

In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, BUSINESS COMBINATIONS, and SFAS No. 142, GOODWILL AND INTANGIBLE ASSETS. SFAS No. 141 is effective for all business combinations completed after June 30, 2001. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001; however, certain provisions of this Statement apply to goodwill and other intangible assets acquired between July 1, 2001 and the effective date of SFAS No. 142. Major provisions of these statements and their effective dates for the Company are as follows: (i) all business combinations initiated after June 30, 2001 must use the purchase method of accounting. The pooling of interest method of accounting is prohibited except for transactions initiated before July 1, 2001; (ii) intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability; (iii) goodwill and intangible assets with indefinite lives acquired after June 30, 2001, will not be amortized. Effective January 1, 2002, all previously recognized goodwill and intangible assets with indefinite lives will no longer be subject to amortization; (iv) effective January 1, 2002, goodwill and intangible assets with indefinite lives will be tested for impairment annually and whenever there is an impairment indicator and (v) all acquired goodwill must be assigned to reporting units for purpose of impairment testing and segment reporting. The Company is currently evaluating the impact that SFAS Nos. 141 and 142 will have on its financial reporting requirements.


34


Business

OVERVIEW

We are the first and only company to have developed and commercialized a solid-state, digital gamma camera for use in nuclear medicine. We believe this will allow us to become a leading provider of gamma cameras and mobile nuclear cardiac imaging services. Our patented solid-state camera offers many advantages over a conventional vacuum tube camera, such as smaller size, increased mobility, increased durability, improved image quality, expanded clinical applications and enhanced patient comfort. All other gamma cameras on the market currently use conventional vacuum tube technology. We believe the features and benefits of our technology will encourage healthcare providers to choose our camera over conventional cameras for both initial and replacement purchases. In addition, because of our camera's increased mobility and durability, we believe it is ideally suited for use in a mobile imaging services application that has not been widely available until now. We are initially focusing on the nuclear cardiology segment of the nuclear imaging market, which is the largest and fastest growing segment of that market.

Our proprietary technology allows for both a significant reduction in the size of a gamma camera and a significant improvement in spatial resolution which is a measurement of the quality of the image produced. Conventional gamma camera photo-detectors are approximately four inches in height. Our photo-detectors are only 0.012 inches high, providing an approximate 350-to-1 reduction in detector size that makes the camera both thinner and lighter. While conventional cameras use an average calculation to approximate the location of the gamma rays used to create the image, our cameras determine the precise location of these gamma rays. This improves spatial resolution and allows our camera to offer a significant improvement in image quality over the conventional vacuum tube technology.

We are currently addressing the rapidly growing nuclear cardiology market in the following two ways:

- NUCLEAR CAMERA SALES--We are selling our camera and related products to physician offices, imaging centers, hospitals and research laboratories, thus providing customers with a technologically advanced alternative to conventional vacuum tube gamma cameras.

- MOBILE NUCLEAR CARDIAC IMAGING SERVICES--We are also providing mobile nuclear imaging services, as described in this prospectus, to physician offices, including cardiology and internal medicine practices. Our turn-key mobile imaging solution provides on-site access to all the benefits of our advanced diagnostic imaging technology, without requiring customers to make an up-front payment, hire additional personnel, obtain regulatory approval or establish a dedicated nuclear imaging suite. Our service model enables physicians to capture the revenue that would have otherwise been lost because the patient was referred elsewhere. In addition, it provides us with a recurring revenue stream from the servicing of our customers on a routine basis.

We began commercial production of our first solid-state, digital gamma camera product, marketed as the DIGIRAD-TM- 2020TC Imager-TM- gamma camera, in January 2000 and shipped our first unit in March 2000. From our first shipment through June 30, 2001, we had received orders for 117 cameras, 59 of which had been shipped. We expect that 38 units in our backlog will be shipped by December 31, 2001 with the remainder expected to be shipped in 2002. In addition to numerous independent cardiologists, customers that have purchased our cameras include hospitals, such as The University of Texas M.D. Anderson Cancer Center and Children's Hospital Boston and research laboratories, such as the Proctor & Gamble Company and Nihon Medi-Physics Co., Ltd. Of the 117 cameras, 111 were ordered by customers in the United States and six were purchased by customers in


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Japan. For the fiscal year ended December 31, 2000, three of our product customers each accounted for over ten percent of our consolidated revenues.

We established our mobile nuclear cardiac imaging services operations in the third quarter of 2000. As of June 30, 2001, we were providing nuclear cardiac imaging services to approximately 101 physician offices in California, Delaware, Florida, Indiana, Maryland, New Jersey, North Carolina, Ohio and Pennsylvania, and were operating 18 mobile servicing routes, each of which is serviced by one van and one camera. During the six month period ended June 30, 2001, our mobile imaging services business performed approximately 6,900 imaging procedures. No one physician office has accounted for more than ten percent of our consolidated revenues.

We intend to continue expanding our imaging services business throughout the United States, and we have completed license applications to expand into another 12 states.

INDUSTRY OVERVIEW

DIAGNOSTIC IMAGING

Diagnostic imaging technology generates representations of the internal anatomy or physiology, primarily through non-invasive means. Diagnostic imaging facilitates the early diagnosis of diseases and disorders, often minimizing the cost and amount of care required and reducing the need for more costly and invasive procedures. Currently, there are five major types of non-invasive diagnostic imaging technologies available: x-ray; magnetic resonance imaging, or MRI; computerized tomography, or CT; ultrasound; and nuclear imaging.

The first four of these technologies, x-ray, MRI, CT and ultrasound primarily allow the physician to see the anatomical structure of internal organs. Anatomical imaging offers the physician a limited structural assessment of the patient's anatomy. Nuclear imaging, however, offers the ability to non-invasively measure varying degrees of physiological activity, including blood flow, organ function, metabolic activity, biochemical activity, and other functional activity within the body. This functional information allows for the earlier diagnosis of certain diseases than the information provided by anatomical imaging procedures.

NUCLEAR IMAGING

Nuclear medicine is used primarily in cardiovascular, oncology and neurological applications. According to a 2001 study by Frost & Sullivan, a leading marketing consulting company, there were approximately 15.5 million nuclear imaging procedures performed in the U.S. in 2000. We believe over 25 million procedures were performed worldwide. The nuclear imaging market consists of two primary technologies, gamma cameras and dedicated positron emission tomography, or PET, machines. Frost & Sullivan states that gamma cameras are currently the preferred choice for the majority of nuclear medicine procedures. The most widely used type of gamma camera is a single photon emission computed tomography, or SPECT, camera.

In a typical nuclear imaging procedure, the patient is injected with a small amount of radioactive drug, or radiopharmaceutical, which is quickly broken down by the body. Depending on the composition of the radiopharmaceutical, the functionality of the tissue and the procedure being used, the radiopharmaceutical localizes differently in normal versus abnormal tissues. The physician uses images taken from a gamma camera and related clinical information to evaluate the physiological performance of the organ being examined.


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TRENDS IN NUCLEAR CARDIAC IMAGING

Nuclear cardiology is the largest and fastest growing segment of the nuclear imaging market. Frost & Sullivan reports that of the 15.5 million nuclear imaging procedures done in the U.S. in 2000, 7.9 million, or 51%, were cardiology related procedures. Nuclear imaging of the heart provides healthcare professionals valuable information related to blood flow, to, through, and from the heart as well as information on the heart muscle. Radiopharmaceuticals are unique in their ability to remain in the heart muscle, enabling visualization during a nuclear cardiac imaging procedure.

Increasingly, a nuclear cardiac imaging procedure is the first non-invasive, diagnostic imaging procedure performed on patients with suspected heart disease. Following a nuclear study, patients with suspected heart disease will often be referred to more invasive diagnostic or therapeutic treatments. These treatments may include: angiography, an x-ray procedure by which catheters are inserted into an artery or vein to take pictures of blood vessels; angioplasty, a procedure by which catheters with balloon tips are used to widen narrowed arteries; or cardiac surgery. Given the clinical advantages of nuclear cardiac images, many payors are requiring nuclear studies prior to the more invasive and expensive diagnostic and therapeutic procedures.

The number of nuclear cardiac imaging procedures grew approximately 23% from 1999 to 2000, and is projected to grow 25% in 2001. Additionally, outpatient cardiology is projected to grow 25% annually from 2001 to 2005. Reasons for the rapid growth in nuclear cardiac imaging procedures include:

- Valuable clinical information;

- Cost-effectiveness;

- Non-invasive nature;

- Established reimbursement; and

- An increase in heart disease.

Frost & Sullivan divides the nuclear cardiac imaging procedure market into four segments: hospital in-patient, hospital out-patient, cardiology practices and diagnostic imaging centers. Traditionally, nuclear medicine procedures have been performed in hospitals under the supervision of nuclear physicians. Although a number of cardiology practices with more than five cardiologists have incorporated nuclear medicine into their practice setting, most nuclear cardiac procedures are currently referred to hospitals and imaging centers, where the cardiologist loses clinical control and receives minimal or no economic benefit.

DIGIRAD'S MARKET OPPORTUNITY

Our technology allows us to address the following two markets:

- NUCLEAR CAMERA SALES--Frost & Sullivan projects that the U.S. gamma camera market for nuclear imaging will be approximately $325 million in 2001, and is expected to grow at an average annual rate of approximately 5% from 2001 to 2007. We estimate that the non-U.S. gamma camera market is approximately $300 million. In addition, we estimate that the market for technical services is an additional 10% to 15% of a camera's purchase price per year over the life of the contract, which is typically 4 to 5 years.

- MOBILE NUCLEAR CARDIAC IMAGING SERVICES--We believe the market opportunity for our mobile nuclear imaging services business is approximately $2.6 billion. This market size is based on our target market of procedures performed in hospital, outpatient facilities, diagnostic imaging centers, physician offices and the following:


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- A report by Frost & Sullivan that approximately 7.9 million nuclear cardiac imaging procedures were performed in the U.S. in 2000;

- Frost & Sullivan's estimate, based on a more limited study, that approximately 56% of U.S. nuclear cardiac imaging procedures were performed in a hospital outpatient facility, diagnostic imaging center or physician office in 2000; and

- Our average net revenue of approximately $600 per procedure.

Our proprietary technology enables physicians to perform office-based nuclear imaging procedures that were previously referred elsewhere, with limited disruption to their current practice. Therefore, we believe our solutions will accelerate the transition of nuclear cardiac imaging procedures to non-hospital sites, in particular cardiology and internal medicine practices.


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THE DIGIRAD ADVANTAGE

Our proprietary technology has enabled us to develop a gamma camera with many unique features compared to conventional gamma cameras. The following chart summarizes some of the major advantages of the Digirad solid-state camera versus conventional vacuum tube gamma cameras:

                    DIGIRAD SOLID-STATE CAMERA                  VACUUM TUBE CAMERA
              --------------------------------------  --------------------------------------
SMALLER SIZE  425-pound camera and 350-pound          1,500 to 5,000 pound SPECT camera is
              SPECTour-TM- chair requires only 7      large and virtually immobile. Requires
              feet by 9 feet of working space. Can    a dedicated room, reinforced floors
              be used in physicians' offices without  and extensive room renovations.
              requiring additional dedicated space.

INCREASED     The mobility of our camera facilitates  Typically, cameras are permanently
MOBILITY      our imaging services business. In       installed in hospitals or imaging
              addition, hospitals can use in          centers, thus requiring a physician to
              examination rooms or easily roll it     transfer patients there for their
              out for use in emergency rooms,         nuclear cardiac imaging studies.
              operating rooms, intensive care units
              or critical care units for bedside
              applications.

INCREASED     Relatively insensitive to physical      Single scintillation crystal is easily
DURABILITY    shock or temperature variations.        damaged and/or destroyed by physical
              Lightweight detector head is easily     shock and/or temperature variations,
              supported and should offer much         leading to expensive and
              greater reliability and lower           time-consuming replacement. Heavy
              maintenance costs.                      detector heads cause reliability
                                                      issues because of the complicated
                                                      supports required for such weight.
                                                      Expensive to maintain.

IMPROVED      Images on the perimeter of the          Best image quality obtained only in
IMAGE         detector head are as clear as images    center of camera, or its "sweet spot."
QUALITY       at the center. Offers fixed intrinsic   Spatial resolution is based on
              spatial resolution at any energy, and   probabilistic algorithms that are a
              true digital positioning that           function of gamma ray energy.
              pinpoints the source of gamma           Intrinsic spatial resolution varies
              radiation.                              with gamma ray energy.

EXPANDED      Smaller and lighter camera head can     Heads are less flexible and have a
CLINICAL      easily be shifted to various angles     limited number of available positions.
APPLICATIONS  and positions, providing ability to
              use in multiple applications in many
              areas of the hospital.

ENHANCED      Patients sit upright with their arms    Patients required to lie down for the
PATIENT       resting in front of them.               procedure while holding their arms
COMFORT                                               above their heads for an extended
                                                      period of time.


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BUSINESS

OUR BUSINESS STRATEGY

Our goal is to rapidly expand our business and increase our revenues by offering a complete nuclear imaging solution to physician offices, imaging centers, hospitals and research laboratories. The key elements of our business strategy include:

- LEVERAGE OUR PROPRIETARY TECHNOLOGY TO INCREASE SALES OF PRODUCTS AND
IMAGING SERVICES--Our proprietary technology provides us with the unique opportunity to capitalize on both the camera sales and mobile imaging services market. We intend to increase sales of our camera and related products by capturing increased market share in existing channels and selling to physicians who can now for the first time place our camera into their practice with limited disruption. We also plan on increasing the number of routes and cardiologists served through our imaging services business, allowing office-based physicians to offer patients the convenience of receiving high quality nuclear imaging services in the office setting. In addition, our imaging services model, which includes a leasing services option, provides us with a recurring revenue stream through the servicing of our customers on a routine basis;

- AGGRESSIVELY TARGET THE GROWING NUCLEAR CARDIOLOGY MARKET--Our sales force
is primarily focused on the cardiology market, the largest and fastest growing segment of the nuclear imaging market. While we also sell our products to hospitals and imaging centers, our main focus is to office-based cardiologists and internal medicine practices. We are currently the only company to commercially offer office-based cardiologists a small, mobile, solid-state, digital gamma camera solution. This allows cardiologists to capture business that is currently referred to hospitals or imaging centers, creating additional income, and improving the service they provide to their patients;

- EXPAND OUR INTEGRATED, DIRECT SALES FORCE--We use a direct sales force, supplemented by distributors internationally and in selected domestic geographies. This improves our ability to control our customer interface as well as focus and direct our sales efforts to a much greater extent than if we relied solely on third-party distributors. Investing in our own direct sales organization allows us to build a distribution asset that can be of great value over time as we look to grow the business by potentially providing additional products and services through this sales channel. Our direct sales force is integrated, in that there is a sales team within each geographic region that shares responsibility for customers and overall results. Although each member of the team has a particular focus, either selling cameras or imaging services, collectively, they are responsible for the success of the geographic region. This allows us to better forecast sales and manage the cost of our selling efforts, better meet the demands of our customers, and truly offer our customers a solution tailored to their needs;

- LEVERAGE OUR PROPRIETARY MANUFACTURING PROCESSES--We believe our
manufacturing process gives us a key competitive advantage by enabling us to manufacture products that use our proprietary technology in a cost efficient manner. Our manufacturing strategy combines our internal design expertise and proprietary process technology with the advanced manufacturing capabilities and capacity of our strategic manufacturing relationships. We have achieved, and anticipate additional, significant reductions in our manufacturing costs due to increased production volumes, improved yields and product design enhancements;

- EXPAND ACCEPTANCE OF ADDITIONAL CLINICAL APPLICATIONS--The design of our
camera provides the capability to perform some nuclear imaging procedures that were not previously available. Additionally, our current technology allows nuclear imaging to be performed in locations within the hospital, including the operating room, emergency department, ICU, and bedside. We are working with clinicians to understand the ways in which they use our camera to validate the use of


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our camera for these new clinical applications. In addition, we believe that these new applications of our camera do not constitute new procedures for which we would have to obtain further regulatory approval. We believe this validation will increase the number of hospitals interested in purchasing our camera; and

- CONTINUE TECHNOLOGICAL DEVELOPMENT--We continue to refine and improve our proprietary solid-state detector technology. By improving our technology, we plan to improve the performance of our cameras while at the same time reduce manufacturing costs. We also plan on designing and building a large field of view gamma camera using our technology that will expand clinical applications for our product. In addition, we plan to expand our technology for other uses such as computed tomography, which generates three-dimensional images of the body's internal organs. We also plan to develop gamma cameras specifically designed for research.

CURRENT PRODUCTS

2020TC IMAGER-TM- CAMERA--Our initial product is the 2020TC Imager camera, which has an imaging area of eight inches by eight inches. The imaging area of most conventional vacuum tube cameras is approximately fifteen inches by twenty inches. In addition, in significant contrast to conventional vacuum tube camera heads, which are typically greater than 14 inches thick and weigh upwards of 1,500 pounds, our imager heads are less than four inches thick and weigh about 60 pounds. The DIGIRAD 2020TC Imager provides true camera mobility, solid-state reliability, excellent image quality and expanded clinical applications. Approximately 75% of all nuclear imaging procedures are organ-specific rather than whole body imaging. Our 2020TC Imager can perform all organ specific imaging because these procedures do not require the large field-of-view associated with the conventional gamma camera imaging heads.

SPECTOUR(TM) CHAIR--Unlike conventional systems where the patient lies on their back with their left arm above their head while the camera circles around the patient, the DIGIRAD SPECTour chair allows the patient to be seated upright with their arms resting at shoulder level as they slowly rotate in front of the 2020TC Imager camera's head. The seated position produces improved image quality and is more comfortable to the patient.

SPECTPAK-TM---This product was recently introduced in the second quarter of 2001 and is sold exclusively to the nuclear cardiology market. It combines a modified, feature enhanced version of our 2020TC Imager camera with our SPECTour chair, to provide a more optimal product for the cardiology market segment.

We have developed an image acquisition and processing software system for the DIGIRAD 2020TC Imager camera and SPECTour chair under a license agreement with Segami Corporation. The image acquisition software is designed to take advantage of the unique characteristics of our solid-state detector technology. The processing software is Segami's industry popular Mirage-TM- package. It runs on a Microsoft NT platform and has a graphical user interface.

PRODUCTS UNDER DEVELOPMENT

We plan to introduce a next generation single platform device that incorporates our camera and chair into one unit in late 2002. This configuration is designed to enhance image quality in cardiac applications and requires less working space.

We intend to introduce a multiple-head large field-of-view camera in 2003. This camera will be suitable for whole body imaging and will compete directly with the current large field of view vacuum


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tube designs. We believe that we will be able to offer significantly improved products based on solid-state detector technology such as a camera head that can be placed closer to the body and multiple heads that will decrease the processing time.

OPERATIONS

MANUFACTURING

We have been manufacturing our cameras since March 2000. Our manufacturing strategy combines our internal design expertise and proprietary process technology with the advanced manufacturing capabilities and capacities of third parties. We believe our manufacturing processes give us a key competitive advantage by enabling us to manufacture products that use our proprietary technology in a cost-efficient manner.

The general manufacturing process for the detector module includes procurement of key components from key semiconductor manufacturers. We first perform electrical tests on these components and then we deliver these components to microelectronics packaging, either to our internal operation or to third parties, for component sub-assembly. We then perform final assembly of the detector module and test the detector module. The detector modules are then assembled into a motherboard that is mounted in the camera detector head. The camera's mechanical and electronics systems are assembled separately in our facilities. As is done with the modules, the key components of the camera's mechanical and electrical systems are designed by us, and either outsourced or built internally. These key components include a personal computer, power supplies, cooling system, liquid crystal display, controller boards, data acquisition and communication system, and the mechanical structure of the camera. We perform sub-assembly tests and final system performance tests in our facilities.

All components used in the product are available from multiple sources with the exception of the Segami image acquisition and processing software. All suppliers of critical materials, components and subassemblies undergo ongoing quality certification by us, with the objective of maintaining strong relationships with the best suppliers. We utilize enterprise resource planning software and collaborative web-based software to ensure efficient and secure handling of inventory and material. The enterprise resource planning software helps us to manage our inventory and materials by centralizing our purchasing procedures, monitoring our inventory supplies and streamlining our billing methods. The collaborative web-based software is a secure electronic network that enables our employees to access our documents from anywhere in the world via the Internet.

We successfully completed a certification audit performed by the state of California's Food and Drug Branch in the first quarter of 2000. As part of this audit, the California Food and Drug Branch recognized our compliance with the "Good Manufacturing Practices" requirements of the federal Food and Drug Administration, or the FDA. The FDA has issued us an Establishment Registration. We have also obtained pre-market clearance from the FDA, enabling us to market our 2020TC Imager camera and SPECTour chair. California's Food and Drug Branch also issued us a State of California Medical Device Manufacturing License. We also received regulatory approval from the Japanese Ministry of Health in October 2000, which is similar to our FDA Establishment Registration, and expect to receive a Canadian Medical Device license in the third quarter of 2001. In addition, the Canadian government requires approval of a gamma camera model by the Canadian Standards Association before the model can be sold in Canada, and we expect to receive such approval in the third quarter of 2001. In conjunction with implementing Good Manufacturing Practices and product safety standards, we expect to obtain a product approval in the third quarter of 2001 from Underwriters Laboratories Inc. Underwriters Laboratories Inc. is an independent, not-for-profit product safety testing and certification organization, and some gamma camera customers in the United States require that the model of the


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camera they purchase pass a test developed for medical products by this organization. In early 2002, we plan to initiate the drive for ISO-9000 quality certification with the expectation of receiving certification in late 2002. ISO-9000 is a compilation of quality standards promulgated by the International Organization for Standardization, and a manufacturer that has been certified to use a quality program that meets ISO-9000 does not have to independently test each product that it sells in the European Community.

IMAGING SERVICES

Our imaging services business is operated by our Digirad Imaging Solutions business unit. We established our imaging services operations in the third and fourth quarters of 2000 by acquiring certain assets of two regional providers of mobile nuclear imaging services. As of June 30, 2001, we were operating 18 mobile routes, each of which is serviced by one van and camera, and were providing nuclear cardiac imaging services to approximately 101 physician offices in California, Delaware, Florida, Indiana, Maryland, New Jersey, North Carolina, Ohio, and Pennsylvania. In addition, we have completed licenses or license applications and plan to expand into another 12 states in 2001.

Our imaging services model consists of two primary delivery options. Under our first option, which we refer to as "mixed billing," we provide the technical component of nuclear imaging services and bill either the physician or the patient's third party payor, such as Medicare, on a per procedure basis. When we bill some third party payors, such as Medicare, we also bill the patient for any copayment. The physician performs and bills for the technical component, such as the interpretation of the test. Under our second option, we lease cameras, related equipment and technical personnel to physicians on a turn-key basis so that they may deliver imaging services to their patients. The physician then bills globally for both the technical and professional component. The physician pays us on a fixed daily lease basis. When we refer to "imaging services" in this prospectus, we are referring both to our mixed billing option and our leasing services option. We provide services under a minimum one year contract.

We intend to provide our imaging services in two ways:

- MOBILE ROUTES: Currently, all of our mobile imaging services are performed using mobile routes. We provide a 2020TC Imager camera, a SPECTour chair, equipment used to handle and measure the radiopharmaceuticals used in the procedure, nuclear technician and other services to a clinician's office on a daily lease basis or a combination of direct payor billing and fee per study basis; and

- FIXED SITES: We may, in the future, deliver services using fixed sites. We would install a 2020TC Imager camera, a SPECTour chair, and hot lab equipment in a clinician's office or other site. Also, we would provide the nuclear technician and other services to the clinician or site on a per month or other periodic basis.

We seek to maximize revenue, cash flow and return on assets by actively managing our fleet to maximize utilization. We employ logistics management systems and typically schedule imaging services vans for one day per week at a particular physician's office. Generally, each van consists of a 2020TC Imager camera, a SPECTour chair, equipment used to handle and measure the radiopharmaceuticals used in the procedure, a nuclear medicine technician and a clinical assistant. The vans are typically operated from a regionally-centralized base location and stored at the base location each evening. Radiopharmaceuticals are ordered each day in sufficient quantity for the next day's scheduled procedures and are delivered in the morning before the van leaves for its scheduled appointments from the base location.


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SALES AND DISTRIBUTION

We sell our camera products and our imaging services through a direct sales force, supplemented by two independent distributors in the United States, an independent distributor in Canada and a corporate partner in Japan. Our direct sales force in the United States is responsible for selling both gamma cameras and imaging services. We utilize a team selling approach with Territory Managers, and Sales Representatives. Our Territory Managers typically have over 10 years of experience selling sophisticated capital equipment in the medical market and focus primarily on selling our gamma cameras to end users. Our Sales Representatives typically have over five years of selling experience and focus primarily on selling the imaging services solutions, which are marketed under the Digirad Imaging Solutions name. In addition, our selling teams include Sales Specialists, which focus on pre-sales support, and Application Specialists, which focus on post-sales training and support. Both the Sales Specialist and Application Specialist positions require significant prior work experience as a Nuclear Medicine Clinical Technologist. We will maintain independent distributors in those territories where the distributor has demonstrated a commitment to our business by providing dedicated resources, and where acceptable performance metrics are met.

Our target markets for the sale of our camera are cardiology practices, hospitals, and imaging centers. Our experience to date suggests the sales cycle for camera sales typically ranges from 90 to 180 days for a cardiology practice and from 180 to 365 days for a hospital, with imaging centers being somewhere in between. The complexity of the buying organization and their budgeting/purchasing process for capital equipment determine the length of the sales cycle.

Our target markets for our mobile nuclear imaging services are primarily cardiology practices. Our experience to date indicates the sales cycle for these imaging services customers is generally between 21 and 90 days.

Currently, our United States direct sales organization is made up of a Vice President of Sales, a Western Region Director, an Eastern Region Director, a Southern Region Director, eleven direct Territory Managers, eleven Sales Representatives, four Sales Specialists and three Application Specialists. Additionally, we have three direct technical service technicians that interact with our independent technical service provider around the country. Our independent technical service provider is Universal Service Trends, which has over 50 technicians covering the entire continental United States.

Though our sales have been primarily focused on the domestic market, we have established sales channels for international expansion into Japan and Canada. In January 2000, we entered into a distribution agreement with Mitsui Corporation to distribute DIGIRAD-TM- products in Japan, primarily to hospitals. In conjunction with this distribution agreement, Mitsui made a $1 million equity investment in Digirad in March 2000. We received Japanese Ministry of Health regulatory approval in October 2000. Product shipments and sales started in Japan in the fourth quarter of 2000, and as of June 30, 2001, we had sold six units in Japan. In Canada, we currently have a distributor representing Digirad and expect Canadian sales and shipments to begin in the fourth quarter of 2001.

All of our cameras are warranted for one year after shipment. The philosophy of our warranty service is to locate in the field and replace faulty assemblies with workable units from the service inventory. This approach is greatly facilitated by the design of the 2020TC Imager camera because all of our cameras are equipped with diagnostic software and a telephone modem enabling the diagnostic software to be accessed remotely. This capability allows us to assist field service personnel in rapidly locating a faulty assembly, and because no critical assembly weighs more than 50 pounds, shipping assemblies is easily accomplished via air courier. Service contracts supplement to the one year warranty


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for nuclear medicine equipment are typically four to five years in length, and cost the customer 10% to 15% of the purchase price of the cameras annually.

MARKETING

We formally launched the 2020TC Imager camera and the SPECTour chair at the Society of Nuclear Medicine meeting in June 1999 in Los Angeles. We began limited product shipments in March 2000, and began full product release in July 2000. Our continuing marketing efforts include the following:

- Establishing Centers of Excellence for demonstration sites and clinical studies;

- Participating in major trade show exhibits at meetings sponsored by organizations such as the American College of Cardiology, the American Heart Association, the Society of Nuclear Medicine, the Radiological Society of North America, the European Association of Nuclear Medicine and the Japanese Society of Nuclear Medicine;

- Advertising in key nuclear medicine and cardiology journals;

- Developing an active medical advisory board;

- Participating in clinical studies and authoring publications through the Digirad North American Working Group;

- Sending direct mailings to cardiology and nuclear medicine clinicians and decision makers;

- Preparing sales collateral material, including product brochures, product CDs, specification sheets, training materials, presentation materials, and image sheets; and

- Participating in the American College of Nuclear Physicians.

We have been very active in the nuclear medicine community over the last five years and exhibited earlier prototypes of our product at the last five Society of Nuclear Medicine meetings. We plan to pursue strategic alliances and co-promotional efforts with appropriate partners. Such partners may be pharmaceutical companies selling radiopharmaceuticals, imaging companies, radiopharmacies, or cardiology companies. These partnerships may consist of marketing partnerships, joint development efforts, or manufacturing alliances.

TECHNOLOGY

OVERVIEW

The challenge of any camera system is to accurately map the spatial location of the objects in its field-of-view from the real world to the camera's world. Optical cameras use lenses to focus the light from a large real-world image field onto a small image plane where a detector (film or electronic) is located. However, since gamma rays cannot be focused, the area of the detector of a gamma camera must be approximately as large as the area of the object being imaged.

CONVENTIONAL TECHNOLOGY

It is very difficult to build a gamma detector that can directly convert the kinetic energy of a gamma ray photon into an electrical charge. Therefore, most gamma ray detectors employ a scintillation crystal, or scintillator, to convert the high energy of a single gamma ray photon into a large number of low energy optical photons. The vast majority of nuclear medicine gamma cameras in use today use a single crystal sheet as the scintillator. The area of this crystal defines the field of view of the camera. Typical fields of view range from 64 square inches to 300 square inches.


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Once the gamma rays are converted into optical photons, these photons are then converted into electrical charges by the next part of the detector, the photo-detector. Almost all gamma cameras in use today use vacuum tube devices called photomultiplier tubes as their photo-detectors. The typical photomultiplier tube has a photosensitive surface of approximately 7 square inches. In order to cover the entire field of view of the scintillation crystal, square or hexagonal shaped photomultiplier tubes are packed together in an array of anywhere from nine to 100 tubes. Optical photons striking anywhere on the surfaces of the photomultiplier tubes are converted into electrons which are then multiplied to produce a small electrical current output. These electronic charges are then passed to the final part of the detector, the readout electronics, and then into the camera's computer system to be processed into the digital images viewed by the physician.

A problem with the conventional gamma camera is that it attempts to use an array of photomultiplier tubes, to spatially resolve the point at which a gamma ray strikes the surface of the camera. This method, called the Anger method, can only estimate where the gamma ray strikes. It does so by combining the output signals of all of the photomultiplier tubes and computing a position as a function of the weighted average of the individual photomultiplier tube signals.

Because there can be considerable discrepancies between where the gamma ray is reported to have struck the detector versus where it actually struck the detector, Anger style gamma cameras can produce blurred images, which in turn can impede the physician's ability to accurately read the image. While there has been a large amount of effort spent in improving the performance of Anger style gamma cameras, the underlying problem still exists: a single-scintillation crystal, multi-photomultiplier tube based detector must rely upon probabilistic position estimation.

DIGIRAD'S TECHNOLOGY

Digirad has overcome the fundamental drawback of the Anger method by constructing a detector which provides total certainty of the spatial location of the gamma ray. We achieve this certainty by dividing or segmenting the detector into a large array of individual detection elements whose size equals the spatial resolution desired, in our case, 3 millimeters by 3 millimeters. A gamma ray emitted from a patient strikes the detector and the spatial location of this event is mapped directly to the image. The response function of our segmented detector is much more precise than that of the Anger style photomultiplier tube. Furthermore, a segmented detector processes gamma ray events in parallel; each pixel is an independent detector. In a single-crystal, Anger style detector, events are processed in a series, one event at a time. In general, this means segmented gamma cameras can achieve much higher gamma ray detection rates than single-crystal gamma cameras.

Previous attempts to construct a segmented detector by both industry groups and academics have been unsuccessful, primarily due to the Anger camera's photodetector. Given their relative size, instability, and numerous other factors, Anger style photomultiplier tubes are unsuitable for use in a segmented detector. A more optimal photodetector is a high-performance silicon photodiode. Silicon photodiodes can be packed closer, provide solid-state reliability, and are more efficient at converting the scintillation photons coming from the scintillation crystal. However, technical difficulties in producing high quality photodiodes that are reliable and can be used for gamma cameras have been a major impediment to their use in this application.

We have developed a photodiode that meets these stringent performance requirements. In addition, over the last 2 years, we have developed a patent pending manufacturing process for cost-effectively producing these photodiodes in volume. Our use of silicon photodiodes as photodetectors has, in turn, enabled the use of a more efficient scintillation crystal in the DIGIRAD-TM- detector module. A photomultiplier tube is at peak efficiency using blue wavelengths of light. Therefore, conventional gamma cameras use a single, planar crystal of thallium activated sodium iodide, or NaI(Tl), which


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emits blue wavelengths of light during scintillation. Silicon photodiodes, however, are most sensitive to the longer wavelengths of the visible spectrum. For this reason, thallium activated cesium iodide, or CsI(Tl), is a better scintillator for silicon photodiodes than NaI(Tl). Significantly, CsI(Tl) is also 36% more efficient than NaI(Tl) at converting the energy of the gamma ray to optical photons. In addition, CsI(Tl) is denser, and is therefore better at absorbing gamma rays, than NaI(Tl); a 6 millimeter thick CsI(Tl) detector absorbs the same number of 140 keV gamma rays as does a 9 millimeter thick NaI(Tl) scintillator. The DIGIRAD camera uses a six millimeter thick CsI(Tl) segmented scintillation crystal.

The key components of the segmented CsI(Tl) scintillation crystal, silicon photodiode and readout electronics are all packaged into a detector module. Our detector module is designed so that it can be tiled with several other modules to create a large area detector of essentially any shape. Digirad holds several patents covering this concept of modules than can be tiled.

The current DIGIRAD 2020TC Imager camera uses 32 modules to create its 8 inch by 8 inch detection area. The array of detection modules is then placed behind a collimator and into a lead-shielded head case. A collimator is a device constructed from lead with thousands of small parallel holes that are aligned perpendicular to the camera's detector surface. The collimator's purpose is to only allow gamma rays that are perpendicular to the camera surface to be detected, thereby helping prevent blurred images. Below is a view of the 2020TC Imager camera detector head assembly and illustrates the arrangement of the modules, collimator and lead-shielded head case.

[Picture of detection head.]

THE DIGIRAD CAMERA'S TECHNICAL ADVANTAGES

SMALLER SIZE--The main advantage that our photodiode technology provides is a significant reduction in the size of a gamma camera. As previously described, a conventional gamma camera uses photomultiplier tubes, 4 inches in height, as its photo-detectors. The photo-detectors in our camera are silicon photodiodes,
0.012 inches in height. This almost 350-to-1 reduction in the photo-detector size enables the DIGIRAD camera head to be significantly thinner than a conventional camera's head. Furthermore, because all gamma camera heads are lead-shielded, the much thinner DIGIRAD camera head is also much lighter. The smaller, lighter head of the DIGIRAD camera results in a smaller and lighter overall camera assembly, which increases the mobility of the camera and its scope of clinical applications.


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[Picture of photo multiplier tube versus Digirad photodiode.]

IMAGE QUALITY--Digirad's segmented gamma camera offers significant improvement in intrinsic image quality compared to conventional Anger style cameras because the DIGIRAD camera's detector is segmented. Segmentation offers fixed intrinsic spatial resolution which provides for true digital positioning. Today, the word "digital" is used in virtually every gamma camera sold. While this can describe various aspects of the electronics and the stage at which the signals are converted from their inherent analog type to a digital signal, only a segmented detector has true digital event positioning. We call this process Digital Position Sensing(SM).

LARGER USEFUL FIELD OF VIEW / LESS "DEAD SPACE"--Another advantage of the DIGIRAD camera is that our detector head has a larger useful field of view. In an Anger style camera, gamma rays that strike the perimeter of the scintillation crystal are viewed by fewer photomultiplier tubes than those striking in the middle of the crystal. Because the Anger camera requires input from multiple photomultiplier tubes in order to calculate an average spatial position, this creates an area of dead space around the edge of the detector head in which the image is not useful. As a result, the useful field of view on Anger style cameras is smaller than the area of the detector. However, Digital Position Sensing eliminates any dead space around the edge of the detector head, thus making the useful field of view on the DIGIRAD camera almost equal to the entire area of the detector surface.

ENHANCED OPERABILITY AND RELIABILITY--In addition to a smaller size gamma camera, our solid-state technology enables a more convenient to operate, power efficient and more reliable gamma camera. Conventional Anger style gamma cameras must be powered continuously in order to temperature stabilize their vacuum photomultiplier tubes, which complicates significantly the design and construction of portable Anger style cameras. Since Anger cameras draw electrical power 24 hours per day, they dissipate heat that must be removed by a heating and ventilation system. The DIGIRAD camera does not need to be powered continuously and is ready to image minutes after turn on. These qualities enable a DIGIRAD unit to be mobile and also saves on electrical power; less power is required to operate the camera and cool the room in which it is operated. Solid-state detectors are more mechanically rugged than photomultiplier tubes. The shock of crossing a curb cut or a door threshold will not change the performance characteristics of our solid-state detector as it can with a


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photomultiplier tube. Our solid-state detectors also can tolerate more rapid changes in temperature than can an Anger style camera, another important capability for a portable camera that is moved in and out of buildings and vehicles.

INTELLECTUAL PROPERTY

We have developed a broad intellectual property portfolio that includes overall product, component level and process patents. Currently, we have 15 patents issued and have eight additional patents pending in the United States. We also have one patent licensed from a third party for exclusive use in nuclear imaging. The Japanese and European equivalents for several of these United States patents are pending, with one Japanese and one Korean patent issued. In addition to our broad solid-state detector and photodiode technology patents, we hold specific patents for an alternative solid-state method using Cadmium Zinc Telluride, or CZT, that we previously pursued for use in gamma cameras. While each of our patents apply to nuclear medicine, many also apply to the construction of area detectors for other types of medical imagers and imaging methods. A summary of our intellectual property portfolio is as follows:

- Fifteen United States patents issued;

- One Japanese patent issued;

- One Korean patent issued;

- Eight utility applications that are pending with the United States Patent and Trademark Office, with office actions having been received on two; and

- One provisional application is in progress.

We believe it would be difficult to develop an economically viable competitive solid-state, digital gamma camera without infringing our patents.

 
COMPETITION

CAMERA SALES--The major manufacturers of nuclear medicine cameras, all of whose cameras are based on the conventional vacuum tube technology, include Philips Medical Systems through its subsidiary ADAC Laboratories, General Electric Medical Systems, Siemens Medical Systems, Marconi Medical Systems (pending acquisition by Phillips Medical Systems) and Toshiba Medical Systems. All of these competitors offer a full line of imaging cameras for each diagnostic imaging technology, including x-ray, magnetic resonance imaging, computed tomography, ultrasound and nuclear medicine. The possibility exists that one or more of these companies could decide to develop its own solid-state, digital gamma camera. However, we believe it would be difficult to develop an economically viable competitive camera without infringing our patents.


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IMAGING SERVICES--Competition in the mobile nuclear imaging services business is limited. Competitors tend to be small, undercapitalized businesses employing conventional vacuum tube cameras that must be transported in large trucks and cannot be moved in and out of physician offices. We expect to have a distinct competitive advantage by controlling the enabling technology that provides the convenience, quality and high level of service physicians will expect. As a result, we believe that our imaging services business will have a proprietary technological position. Additionally, we do not expect competition in the mobile imaging service business from traditional nuclear imaging manufacturers because their focus is on camera sales to hospitals.

GOVERNMENT REGULATION

Our business is subject to extensive federal and state government regulation. Some of these laws have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. In addition, these laws and their interpretations are subject to change.

FRAUD AND ABUSE LAWS

The healthcare industry is subject to extensive federal, state and local regulation relating to licensure, conduct of operations, ownership of facilities, addition of facilities and services and payment for services.

In particular, the federal Anti-Kickback Law prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or furnishing or arranging for a good or service, for which payment may be made under a federal healthcare program such as the Medicare and Medicaid programs. The definition of "remuneration" has been broadly interpreted to include gifts, discounts, the furnishing of supplies or equipment, credit arrangements, payments of cash and waivers of payments. The statute itself has been broadly interpreted to mean that if any ONE purpose of an arrangement involving remuneration is to induce referrals of federal healthcare covered business, the statute has been violated. The penalties for violating the Anti-Kickback Law can be severe. These sanctions include criminal penalties and civil sanctions, including fines, imprisonment and possible exclusion from Medicare, Medicaid and other federal healthcare Programs.

The Anti-Kickback Law is broad, and it prohibits many arrangements and practices that are lawful in businesses outside of the healthcare industry. Recognizing that the Anti-Kickback law is broad and may technically prohibit many innocuous or beneficial arrangements within the healthcare industry, the United States Department of Health and Human Services has issued a series of regulations, known as the "safe harbors," beginning in July of 1991. These regulations set forth certain safe harbors which, if all applicable requirements are met, will assure healthcare providers and other parties that they will not be prosecuted under the Anti-Kickback Law. Additional provisions providing similar protections have been published intermittently since 1991. Although full compliance with all applicable safe harbors ensures against prosecution under the Anti-Kickback Law, the failure of a transaction or arrangement to fit within one or more safe harbors does not necessarily mean that the transaction or arrangement is illegal or that prosecution under the Anti-Kickback Law will be pursued. However, conduct and business arrangements that do not fully satisfy each applicable safe harbor may result in increased scrutiny by government enforcement authorities such as the Office of the Inspector General of the United States Department of Health and Human Services, or OIG. To provide specific guidance on the application of the Anti-Kickback Law, Congress required the OIG to implement an advisory opinion process. In an advisory opinion, the OIG may determine that it will not sanction the advisory opinion's requestor even if the arrangement or practice in question technically violates the


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Anti-Kickback Law. Although these advisory opinions are binding on the OIG and the parties requesting the opinions, no third-party may legally rely on them.

Many states have adopted laws similar to the Anti-Kickback Law. Some of these state prohibitions apply to referral of patients for healthcare services reimbursed by any source, not only the Medicare and Medicaid programs. Some of these state prohibitions may be more restrictive than the Anti-Kickback Law in material respects, and the federal safe harbors may not apply.

Our nuclear imaging services model includes providing services and supplies to physicians, for which the physicians pay us, for the use in treating their privately insured patients. These physicians also refer Medicare patients to us, for which we bill the Medicare program directly. This type of arrangement, if not properly structured, may violate the Anti-Kickback Law and also raises issues under another Medicare statute, 42 U.S.C. Section 1320a-7(b)(6). That statute prohibits providers from charging Medicare substantially in excess of the provider's usual and customary charges unless the Secretary of Health and Human Services finds good cause. We have attempted to structure such arrangements and our other services to comply with the Anti-Kickback Law and similar state laws, as well as with 42 U.S.C. Section 1320a-7(b)(6). However, there can be no assurances to this effect. We have attempted to structure our business arrangements for the provision of single photon emission imaging and other services comply with the Anti-Kickback Law and similar state laws, but there can be no assurances to this effect.

In addition, the Ethics in Patient Referral Act of 1989, commonly referred to as the federal physician self-referral prohibition or Stark Law, prohibits physician referrals of Medicare patients to an entity for certain designated healthcare services if the physician or an immediate family member has an ownership interest in, or compensation arrangement with, the entity and no statutory or regulatory exception applies. It also prohibits an entity receiving a prohibited referral from billing and collecting for services rendered pursuant to such referral. Initially, the Stark Law applied only to clinical laboratory services and regulations applicable to clinical laboratory services were issued in 1995. Earlier that same year, the Stark Law's self-referral prohibition expanded to additional goods and services, including radiology services, magnetic resonance imaging, computerized axial tomograph scans, and ultrasound services. In 1998, the Healthcare Financing Administration, now known as the Centers for Medicare and Medicaid Services, or CMS, published proposed rules for the remaining designated healthcare services, that would have included nuclear imaging within the meaning of "radiology services." However, in January of 2001, CMS published a final rule which it characterized as the first phase of what will be a two-phase final rule, which reversed this position and indicated that nuclear medicine would not be a service covered under the Stark Law. CMS has also indicated that other supplies provided by us do not constitute designated healthcare services. However, it is possible that CMS will again reverse its interpretation in the future to include nuclear imaging as a Stark covered service, or that such supplies could be interpreted in the future to constitute designated healthcare services under the Stark Law.

A person who engages in a scheme to circumvent the Stark Law's prohibitions may be fined up to $100,000 for each such arrangement or scheme. In addition, anyone who presents or causes to be presented a claim to the Medicare program in violation of Stark is subject to monetary penalties of up to $15,000 per service, an assessment of several times the amount claimed, and possible exclusion from participation in federal healthcare programs. Claims submitted in violation of Stark may also be subject to liability under the federal False Claims Act and its whistleblower provisions (as discussed below).

Several states in which we operate have enacted or are considering legislation that prohibits physician self-referral arrangements and/or requires physicians to disclose any financial interest they may have


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with a healthcare provider to their patients when referring patients to that provider. Possible sanctions for violating state physician self-referral laws vary, but may include loss of license and civil and criminal sanctions. State laws vary from jurisdiction to jurisdiction and, at least in certain states, are more restrictive than the federal Stark Law in a number of material respects. In certain states, these restrictions may add considerable expense to or limit altogether the types of business models we may successfully utilize. Some states have indicated they will interpret their own self-referral statutes the same way that the Centers for Medicare & Medicaid Services interpret the Stark Law, but it is possible the states will interpret their own laws differently in the future. We have attempted to structure our operations to comply with these federal and state physician self-referral prohibition laws, but there can be no assurances to this effect.

The Health Insurance Portability and Accountability Act of 1996 created two new federal crimes: healthcare fraud and false statements relating to healthcare matters. The healthcare fraud statute prohibits knowingly and willfully executing a scheme to defraud any healthcare benefit program, including private payors. A violation of this statute is a felony and may result in fines, imprisonment or exclusion from government sponsored programs. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services. A violation of this statute is a felony and may result in fines or imprisonment. The Health Insurance Portability and Accountability Act of 1996 also will require us to follow federal privacy, security and transaction standards for the transmission, storage and use of individually identifiable health information, which may add significant costs and potential burden to our operations. A violation of these privacy standards may result in criminal and civil penalties.

Both federal and state government agencies are continuing heightened and coordinated civil and criminal enforcement efforts. As part of announced enforcement agency work plans, the federal government will continue to scrutinize, among other things, the billing practices of hospitals and other providers of healthcare services. The federal government also has increased funding to fight healthcare fraud, and it is coordinating its enforcement efforts among various agencies, such as the United States Department of Justice, the OIG, and state Medicaid fraud control units. We believe that the healthcare industry will continue to be subject to increasing government scrutiny and investigations.

FEDERAL FALSE CLAIMS ACT

Another trend affecting the healthcare industry is the increased use of the federal False Claims Act and, in particular, actions under the False Claims Act's "whistleblower" provisions. Those provisions allow a private individual to bring actions on behalf of the government alleging that the defendant has defrauded the federal government. After the individual has initiated the lawsuit, the government must decide whether to intervene in the lawsuit and to become the primary prosecutor. If the government declines to join the lawsuit, then the individual may choose to pursue the case alone, in which case the individual's counsel will have primary control over the prosecution, although the government must be kept apprised of the progress of the lawsuit. Whether or not the federal government intervenes in the case, it will receive the majority of any recovery. If the litigation is successful, the individual is entitled to no less than 15%, but no more than 30%, of whatever amount the government recovers. The percentage of the individual's recovery varies, depending on whether the government intervened in the case and other factors.

Recently, the number of suits brought against healthcare providers by private individuals has increased dramatically, many of which are still under seal from the public. In addition, various states are considering or have enacted laws modeled after the federal False Claims Act. We are unable to predict whether we will be subject to future actions or the impact of any future actions.


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When a person is determined to have violated the federal False Claims Act, it must pay three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 to $11,000 for each separate false claim. There are many potential bases for liability under the federal False Claims Act. Liability arises, primarily, when an entity knowingly submits, or causes another to submit, a false claim for reimbursement to the federal government. Although simple negligence should not give rise to liability, submitting a claim with reckless disregard or deliberate ignorance of its truth or falsity could result in substantial civil liability.

UNLAWFUL PRACTICE OF MEDICINE AND FEE SPLITTING

The marketing and operation of our diagnostic imaging systems are subject to state laws prohibiting the practice of medicine by non-physicians, or the employment or excessive control of the medical judgment of physicians by non-physicians (often referred to as the corporate practice of medicine). We have attempted to structure our operations so that they do not involve the practice of medicine, or violate corporate practice of medicine statutes. For example, all professional medical services relating to our operations, including the interpretation of scans and related diagnoses, are separately provided by licensed physicians not employed by us. Some states also have laws that prohibit any fee-splitting arrangement between a physician and a non-physician. We have also attempted to structure our operations so that they do not violate these state laws with respect to fee splitting. However, there can be no such assurance to that effect with respect to these two sets of laws.

CERTIFICATE OF NEED LAWS

Some states require a certificate of need, or similar regulatory approval, prior to the acquisition of high-cost capital items or services, including diagnostic imaging systems or provision of diagnostic imaging services by us or our clients. Certificate of need regulations may limit or preclude us or our clients from providing diagnostic imaging services or systems.

REIMBURSEMENT

We derive a substantial percentage of our revenues from government programs, such as Medicare, or direct billings to physicians. We derive a smaller percentage of our revenues from direct billings to other third-party payors. Services for which we submit direct billings for Medicare patients typically are reimbursed by Medicare on a fee schedule basis.

As a result of federal cost-containment legislation that has been in effect for many years, Medicare generally pays for inpatient services under a prospective payment system based upon a fixed amount for each Medicare patient discharge. Each discharge is classified into one of many diagnosis related groups. A pre-determined payment amount covers all inpatient operating costs, regardless of the services actually provided or the length of the patient's stay. Because Medicare reimburses most hospitals for all services rendered to a Medicare inpatient on the basis of a pre-determined amount based on the diagnosis related groups, most hospitals, and all free-standing facilities, cannot be separately reimbursed by Medicare for a single photon emission imaging scan or other procedure performed on hospital inpatients. Many state Medicaid programs have adopted comparable payment policies.

On August 1, 2000, the Centers for Medicare and Medicaid Services implemented a Medicare outpatient prospective payment system under which services and items furnished in hospital outpatient departments are reimbursed using a pre-determined amount for each ambulatory payment classification. Each ambulatory payment classification is based on the specific procedures performed and items furnished during a patient visit. Certain items and services are paid on a fee schedule, and hospitals are reimbursed additional amounts for certain drugs, biologics and new technologies. We


53

BUSINESS

cannot predict what impact the new Medicare outpatient reimbursement system will have on the demand for our cameras and services from hospitals.

MEDICARE BILLING AND ENROLLMENT

We can bill Medicare directly for services only to the extent we are enrolled as an independent diagnostic testing facility. Medicare has delegated the function of enrollment to contractors known as the Medicare carriers, each of whose jurisdiction varies, as some carriers govern several states, some just one state and some just a portion of a state. Although federal regulations and program memoranda from the Centers for Medicare and Medicaid Services set forth uniform rules governing independent diagnostic testing facility billing and enrollment, each carrier is free to interpret these rules to a certain extent. For example, an independent diagnostic testing facility is required to have one or more supervising physicians, each of whom meets certain proficiency requirements; these precise proficiency requirements vary from carrier to carrier. The nature of a particular carrier's proficiency and other requirements may add considerable expense to or limit the types of business models we may be able to utilize successfully in the carrier's jurisdiction.

Part of our business involves the leasing of equipment and personnel to physicians, who then bill Medicare and other third party payors directly for nuclear imaging services. Medicare rules permit physicians to bill for certain diagnostic tests performed using leased equipment and personnel, and to receive payment based on the applicable Medicare fee schedule, if certain conditions are satisfied. We have attempted to structure our equipment and personnel leases so that physicians are able to bill in this manner if they comply with the terms of the leases, but there can be no assurance to that effect. If any of our leasing physicians are deemed not to meet these conditions, payment to the affected physicians could be denied or recouped. If the failure to comply is deemed to be "knowing" and/or "willful," as defined in federal statutes, the government could seek to impose fines or penalties. This may require us to restructure our agreements with these physicians and/or respond to any resultant claims by physicians or the government.

NON-GOVERNMENTAL THIRD PARTY PAYOR LIMITATIONS

Non-governmental third party payors, such as commercial health maintenance organizations, or HMOs, preferred provider organizations, or PPOs, and other insurers, may impose varying requirements and limitations on our ability to receive payment directly for services we provide. For instance, some payors will not reimburse us separately for the nuclear imaging tests we perform, and instead require that reimbursement be paid only on a "global" basis to the physician who provides the professional interpretation of the nuclear imaging test. Such payor requirements and limitations restrict the types of business models we can successfully utilize for patients covered by these payors.

PHARMACEUTICAL LAWS

Our services involve radiopharmaceuticals and other substances regulated as drugs by state and federal agencies, including the federal Food and Drug Administration and state pharmacy boards. These agencies administer laws governing the manufacturing, distribution, use, administration and prescribing of drugs. These laws include the federal Food, Drug and Cosmetic Act, state food and drug laws and state pharmacy acts. Some of our activities may be deemed to require additional permits or licensure under laws which impose substantial restrictions on who can qualify for such permits or licensure. If any of these agencies deemed our activities to require additional permits or licensure, we would be required to either obtain such permits or licensure, if possible, or modify the types of business models we can utilize in the affected jurisdiction(s).


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BUSINESS

ENVIRONMENTAL, HEALTH AND SAFETY LAWS

Our imaging services involve the controlled storage, use and disposal of material containing radioactive isotopes. While this material has a short half-life, meaning it quickly breaks down into inert, or non-radioactive substances, using such materials presents the risk of accidental environmental contamination and physical injury. We are subject to federal, state and local regulations governing the use, storage, handling and disposal of materials and waste products. Although we believe that our safety procedures for handling and disposing of these hazardous materials comply with the standards prescribed by law and regulation, we cannot completely eliminate the risk of accidental contamination or injury from those hazardous materials. In the event of an accident, we could be held liable for any damages that result, and any liability could exceed the limits or fall outside the coverage of our insurance. We may not be able to maintain insurance on acceptable terms, or at all. We could incur significant costs and the diversion of our management's attention in order to comply with current or future environmental laws and regulations. We have not had material expenses related to environmental, health and safety laws or regulations to date and we have no inspection for which a plan of correction has not been accepted.

U.S. FOOD AND DRUG ADMINISTRATION, OR FDA, AND STATE OR FOREIGN APPROVALS

The manufacture and sale of medical devices intended for commercial distribution are subject to extensive governmental regulation in the United States. Medical devices are regulated in the United States primarily by the FDA and also by certain similar state agencies, such as the California Food and Drug Branch. The FDA requires that medical devices be manufactured in registered establishments. California's Food and Drug Branch requires medical device manufacturers to obtain a Medical Device Manufacturing License.

As part of the regulatory framework, medical devices require pre-market clearance (demonstrating substantial equivalence to a legally marketed device) or pre-market approval (indicating the device is safe and effective for intended use) prior to commercial distribution. In addition, certain material changes or modifications to, and changes in intended use of, medical devices also are subject to FDA review and clearance or approval. The FDA regulates the research, testing, manufacture, safety, effectiveness, labeling, storage, record keeping, promotion and distribution of medical devices in the United States and the export of unapproved medical devices from the United States to other countries. Noncompliance with applicable requirements can result in failure of the government to grant pre-market clearance or approval for devices, withdrawal or suspension of approval, total or partial suspension of production, fines, injunctions, civil penalties, refunds, recall or seizure of products and criminal prosecution. The State of California imposes similar state requirements and may impose similar sanctions on us.

One way a new device can be introduced into the market in the United States is for the manufacturer or distributor to obtain FDA clearance by a 510(k) notification that such device is substantially equivalent to a prior approved device. The FDA requires a rigorous demonstration of substantial equivalence. A medical device manufacturer must obtain a new 510(k) each time it makes a change or modification to a legally marketed device that could significantly affect the safety or effectiveness of the device, or where there is a major change or modification in the intended use of the device or a new indication for use of the device. When any change or modification is made to a device or its intended use, the manufacturer is expected to make the initial determination as to whether the change or modification is of a kind that would necessitate the filing of a new 510(k). We have received 510(k) clearance to market our 2020TC Imager camera and SPECTour chair, and may require similar FDA clearances for additional products or improvements to our current products.


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BUSINESS

Any products manufactured or distributed by us are subject to continuing regulation by the FDA and the State of California, which includes record keeping requirements, reporting of adverse experience with the use of the device, Good Manufacturing Practices requirements and post-market surveillance. It may also include post-market registry and other actions deemed necessary by the FDA.

Sales of medical device products outside the United States are subject to foreign regulatory requirements that vary from country to country. The time required to obtain approvals required by foreign countries may be longer or shorter than that required for FDA clearance, and requirements for licensing may differ from FDA requirements.

We will spend considerable time and effort to comply with the FDA, state, and foreign regulatory requirements described above. Any failure to obtain and maintain compliance with such requirements could have a material adverse effect on our business and subject us to sanction.

FACILITIES

As of June 30, 2001, we lease in aggregate approximately 48,000 square feet in San Diego, California. These facilities serve as our executive headquarters and as the base for our marketing and product support operations, research and development and manufacturing activities. These leased facilities also include approximately 7,000 square feet of clean room space.

In addition, Digirad Imaging Solutions, our wholly-owned subsidiary, leases office space in eight locations in Indiana, Maryland, New Jersey, North Carolina, Ohio, Pennsylvania and Florida which together represent approximately 18,000 combined square feet of office space These leased facilities serve as a base for the marketing and imaging services operations of Digirad Imaging Solutions.

 
EMPLOYEES

As of June 30, 2001, we had 257 employees, including 18 in our research and development department, 43 in our sales and marketing department, 105 in our manufacturing department, 25 in general and administrative functions and 66 in mobile imaging services operations. We believe that our relations with our employees are good.

LEGAL PROCEEDINGS

In July 2001, we were served with notice that a complaint had been filed by Medical Management Concepts, Inc. in the United States District Court for the Eastern District of Pennsylvania. The complaint alleges, among other things, breach of the terms of a Services Agreement and an Employee Lease Agreement, each dated September 2000 and entered into by and between our wholly owned subsidiary, Digirad Imaging Systems, Inc., and Medical Management Concepts as part of our acquisition of some of the customer contracts and select assets relating to the mobile nuclear imaging services of Nuclear Imaging Systems, Inc. and Cardiovascular Concepts, P.C. This complaint seeks recovery of damages for approximately $81,000 plus 12.5% of the adjusted estimated net revenue generated from gross sums billed to our mobile nuclear imaging customers from May 1, 2001 to October 31, 2003. We intend to vigorously defend against this complaint.


56


 
Management

EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES

The following table sets forth certain information regarding our executive officers, key employees and directors as of August 23, 2001:

NAME                                                         AGE            POSITION(S)
-----------------------------------------------------------------------------------------------------------------------
EXECUTIVE OFFICERS AND KEY EMPLOYEES:
R. Scott Huennekens................................  37                     President, Chief Executive Officer and
                                                                            Director
Gary J.G. Atkinson.................................  49                     Vice President of Finance and Chief
                                                                            Financial Officer
Richard L. Conwell.................................  50                     Vice President of Marketing
Robert E. Johnson..................................  44                     Vice President of Sales and Service
John F. Sheridan...................................  46                     Vice President of Operations
David M. Sheehan...................................  38                     President, Digirad Imaging Solutions, Inc.

DIRECTORS:
Timothy J. Wollaeger(1)............................  57                     Chairman of the Board of Directors
R. King Nelson(2)..................................  44                     Director
Brad Nutter........................................  49                     Director
Kenneth E. Olson(1)(2).............................  64                     Director
Douglas Reed, M.D.(2)..............................  47                     Director


(1) Members of Compensation Committee

(2) Members of Audit Committee

R. SCOTT HUENNEKENS has been our President and a member of our board of directors since May 1999 and our Chief Executive Officer since June 1999. Prior to being appointed as our President and Chief Executive Officer, from March 1997 to April 1999, Mr. Huennekens served as our Chief Financial Officer and Vice President of Sales and Marketing. Prior to joining us, from July 1993 to March 1997, Mr. Huennekens held various positions at Baxter Healthcare Corporation, a medical products and services company, including Vice President of Sales & Marketing for the Novacor division and its sales of left ventricular assist devices, and Business Unit Manager/Director of Marketing for the Bentley division and its sales of cardiopulmonary products. Mr. Huennekens is a Certified Public Accountant and received a B.S. in business administration from the University of Southern California and an M.B.A. from the Harvard Business School.

GARY J.G. ATKINSON has been our Vice President of Finance and Chief Financial Officer since May 2001. Prior to joining us, from April 2000 to February 2001, Mr. Atkinson served as Chief Financial Officer at Situs Corporation, a company which develops drugs and drug delivery devices for intravesical applications. Prior to that, from November 1992 to April 2000, Mr. Atkinson served as Vice President of Finance at Isis Pharmaceuticals, a publicly held pharmaceutical research and development company. Mr. Atkinson is a Certified Public Accountant and received a B.S. from Brigham Young University.

RICHARD L. CONWELL has been our Vice President of Marketing since January 2001. From January 1998 to January 2001, Mr. Conwell served as our Vice President of Research and Development. From June 1995 to January 1998, Mr. Conwell served as our Vice President of Operations. Prior to joining us, Mr. Conwell served as Vice President of Thermo Gamma-Metrics, a company which develops and markets on-line, high-speed process-optimization systems for raw-materials analysis, where he was


57

MANAGEMENT

responsible for the company's bulk material analyzer business. Mr. Conwell received a B.S. in physics and computer science from Ball State University.

ROBERT E. JOHNSON has been our Vice President of Sales and Service since April 1999. Prior to joining us, from February 1993 to March 1999, Mr. Johnson served as Region Vice President and Vice President of United States Sales for ADAC Laboratories, a provider of nuclear medicine and radiation therapy planning systems. Prior to that, Mr. Johnson held various sales management and sales positions with Siemens Medical Systems, a company that develops and manufactures medical equipment. Mr. Johnson received a B.A. in marketing from the University of South Florida.

JOHN F. SHERIDAN has been our Vice President of Operations since March 1998 and leads the development and manufacturing efforts for our scintillator/photodiode detector system. Prior to joining us, from October 1983 to March 1998, Mr. Sheridan held various positions, including Director of Operations, at Analog Devices, Inc., a semiconductor company that develops, manufacturers and markets high performance integrated circuits used in signal-processing applications. Mr. Sheridan received a B.S. in chemistry from the University of West Florida and an M.B.A. from Boston University.

DAVID M. SHEEHAN has been the President of Digirad Imaging Solutions, Inc., our wholly owned subsidiary, since September 2000. Prior to joining us, from May 1999 to September 2000, Mr. Sheehan served as the President and Chief Executive Officer of Rapidcare.com, an e-health company that connects physicians with families and children who suffer from chronic disease. Prior to that, from May 1997 to May 1999, Mr. Sheehan served as Vice President of Sales & Marketing for a division of Baxter Healthcare Corporation which provided cardiopulmonary services to hospitals. Prior to that, from July 1991 to May 1997, Mr. Sheehan worked at Haemonetics Corporation, a supplier of blood processing services and equipment, in various sales, marketing, and business development positions. Mr. Sheehan received a B.S. in mechanical engineering from Worcester Polytechnic Institute and an M.B.A. from the Tuck School of Business at Dartmouth College.

TIMOTHY J. WOLLAEGER has been a member of our board of directors since June 1994, and our Chairman since January 1996. In addition, Mr. Wollaeger served as our Chief Executive Officer in May 1999. Mr. Wollaeger is the general partner of Kingsbury Associates, L. P., a venture capital firm he founded in December 1993 which focuses on investments in the healthcare industry. From May 1990 until December 1993, Mr. Wollaeger served as Senior Vice President and a director of Columbia Hospital Corporation, a hospital management company now known as HCA Healthcare Corporation. From October 1986 until July 1993, Mr. Wollaeger was a general partner of Biovest Partners, a seed venture capital firm. Mr. Wollaeger is chairman of the board of directors of Biosite Incorporated. Mr. Wollaeger received a B.A. in economics from Yale University and an M.B.A. from Stanford University.

R. KING NELSON has been a member of our board of directors since May 2000. Since May 1999, Mr. Nelson has served as the Chief Executive Officer of VenPro Corporation, a medical device company which develops bioprosthetic implants for venous vascular and cardiovascular medicine. Prior to that, from January 1996 to December 1998, Mr. Nelson served as President of the perfusion service business of Baxter Healthcare Corporation. Prior to that, from January 1980 to December 1995, Mr. Nelson held various positions at Baxter Healthcare Corporation. Mr. Nelson received a B.S. from Texas Tech University and an M.B.A. in international business from the University of Miami.

BRAD NUTTER has been a member of our board of directors since August 2001. From February 2000 to October 2000, Mr. Nutter served as Executive Vice President of Gambro AB, an international medical technology and healthcare company, and President and Chief Executive Officer of Gambro Healthcare, a division of Gambro AB which provides dialysis services to out-patient centers. Prior to that, from


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MANAGEMENT

June 1997 to January 2000, Mr. Nutter served as Executive Vice President and Chief Operating Officer of Syncor International Corporation, an international provider of radiopharmaceuticals and medical imaging services. From May 1996 to June 1997, Mr. Nutter served as a partner at The Align Group, a privately-held international healthcare marketing organization, which Mr. Nutter founded. Prior to that, from January 1995 to April 1996, Mr. Nutter held various positions, including Senior Vice President of Corporate Marketing, at Sunrise Medial, Inc., an international healthcare manufacturer of homecare and institutional products. Mr. Nutter received a B.A. in business administration from Texas Christian University.

KENNETH E. OLSON has been a member of our board of directors since March 1996. From December 1990 to February 1996 and from March 1997 to June 1998, Mr. Olson served as Chief Executive Officer at Proxima Corporation, a supplier of display projection systems for professional desktop computers. Mr. Olson also serves on the board of directors for Avanir Pharmaceuticals and WD-40 Company. Mr. Olson received a B.S. in electrical engineering from the University of California at Los Angeles and an M.B.A. from Pepperdine University.

DOUGLAS REED, M.D. has been a member of our board of directors since September 2000. He is a managing director of Vector Fund Management, a venture capital firm which focuses on investments in the life sciences and healthcare industry. Prior to that, from October 1998 to July 2000, Dr. Reed served as Vice President of Business Development for GelTex Pharmaceuticals, Inc., a company that develops and markets non-absorbed polymer drugs. From April 1996 to September 1998, Dr. Reed served as Vice President of Business Development at NPS Pharmaceuticals, Inc., a company which develops small molecule drugs and recombinant peptides. From June 1988 to April 1996, Dr. Reed served as Vice President at S.R. One, Limited, a venture capital fund focused on investments in biopharmaceuticals and the life sciences. Dr. Reed received a B.A. in biology and an M.D., each from the University of Missouri--Kansas City, and an M.B.A. from the Wharton School at the University of Pennsylvania. Dr. Reed is board certified as a neuro-radiologist and has held faculty positions at the University of Washington and Yale University in the department of radiology.

COMPOSITION OF OUR BOARD OF DIRECTORS

We currently have six directors. Upon completion of this offering, our amended and restated certificate of incorporation will provide for a classified board of directors consisting of three classes of directors, each serving a staggered three-year term. As a result, a portion of our board of directors will be elected each year. To implement the classified structure, two of the nominees to the board of directors will be elected to a one-year term, two will be elected to a two-year term and two will be elected to a three-year term. After the offering, directors will be elected for three-year terms. Dr. Reed and Mr. Nutter will be designated Class I Directors, whose terms expire at the 2002 annual meeting of stockholders. Messrs. Olson and Wollaeger will be designated Class II Directors, whose terms expire at the 2003 annual meeting of stockholders. Messrs. Huennekens and Nelson will be designated the Class III Directors, whose terms expire at the 2004 annual meeting of the stockholders. This classification of the board of directors may delay or prevent a change in control of our company or in our management. See "Description of capital stock--Possible Anti-Takeover Matters."

BOARD COMMITTEES

- AUDIT COMMITTEE--The audit committee of the board of directors reviews, acts on and reports to the board of directors with respect to various auditing and accounting matters, including the recommendation of our auditors, the scope of the annual audits, fees to be paid to the auditors, the performance of our independent auditors and our accounting practices. As of the closing of this offering, the members of the audit committee will be Messrs. Nelson and Olson and Dr. Reed.


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Management

- COMPENSATION COMMITTEE--The compensation committee of the board of directors recommends, reviews and oversees the salaries, benefits and stock option plans for our executive officers, employees, consultants, directors and other individuals compensated by us. The compensation committee also administers our compensation plans. As of the closing of this offering, the members of the compensation committee will be Messrs. Olson and Wollaeger.

DIRECTOR COMPENSATION

All directors are reimbursed for the reasonable expenses of attending the meetings of the board of directors or committees. We will also be granting options to our outside directors as compensation, as described below under the heading "Benefit plans--Automatic Option Grant Program."

From time to time during the fiscal year ended December 31, 2000, some of our directors were granted options to purchase shares of our common stock under our 1998 Stock Option/Stock Issuance Plan. For information concerning these grants, please see the description under the heading "Certain relationships and related transactions--Option Agreements with Directors."

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

Our compensation committee consists of Messrs. Olson and Wollaeger. Neither member of the compensation committee is currently an officer or employee of ours. Mr. Wollaeger served as our Chief Executive Officer for the month of May 1999. Prior to the formation of the compensation committee, the board of directors as a whole made decisions relating to compensation of our executive officers. Upon completion of this offering, the compensation committee will make all compensation decisions regarding our executive officers.

EXECUTIVE COMPENSATION

The following table sets forth the compensation received during the fiscal year ended December 31, 2000 by our Chief Executive Officer, the three other most highly compensated executive officers who were serving at the end of the fiscal year ended December 31, 2000 whose annual salaries and bonuses exceeded $100,000 and to David M. Sheehan, the President of Digirad Imaging Solutions. We refer to these officers as our named executive officers in other parts of this prospectus.


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MANAGEMENT

EXECUTIVE COMPENSATION TABLE


                                                                                                LONG-TERM
                                                                                               COMPENSATION
                                                                                                  AWARDS
                                                                                              --------------
                                                                                                NUMBER OF
                                                                  ANNUAL COMPENSATION           SECURITIES
                                                            -------------------------------     UNDERLYING
NAME AND PRINCIPAL POSITION(S)                               SALARY      BONUS      OTHER        OPTIONS
------------------------------------------------------------------------------------------------------------
R. Scott Huennekens ......................................  $213,462    $70,000         --       575,000
  President and Chief Executive Officer
Robert E. Johnson ........................................  $155,423         --    $85,000(1)    200,000
  Vice President of Sales and Service
John F. Sheridan .........................................  $171,904    $35,000    $19,800(2)    150,000
  Vice President of Operations
Richard L. Conwell .......................................  $152,557    $15,000         --        50,000
  Vice President of Marketing
David M. Sheehan(3) ......................................  $ 47,308    $ 9,500         --       400,000
  President, Digirad Imaging Solutions


(1) Consists of commissions paid to Mr. Johnson for the fiscal year ended December 31, 2000.

(2) Consists of $15,000 paid to Mr. Sheridan for relocation expenses and $4,800 in benefits received under our health and benefit plans.

(3) Mr. Sheehan commenced his employment as President of Digirad Imaging Solutions, Inc. in September 2000 with an annual base salary of $175,000.

OPTION GRANTS

The following table sets forth information concerning stock options granted to our named executive officers during the fiscal year ended December 31, 2000:

 
OPTION GRANTS IN LAST FISCAL YEAR


                                                                                     POTENTIAL               POTENTIAL
                                         INDIVIDUAL GRANTS                      REALIZABLE VALUE AT     REALIZABLE VALUE AT
                       -----------------------------------------------------      ASSUMED ANNUAL          ASSUMED ANNUAL
                        NUMBER OF    PERCENTAGE OF                                RATES OF STOCK          RATES OF STOCK
                       SECURITIES    TOTAL OPTIONS    EXERCISE                  PRICE APPRECIATION      PRICE APPRECIATION
                       UNDERLYING      GRANTED TO       PRICE                   FOR OPTION TERM(1)      FOR OPTION TERM(2)
                         OPTIONS      EMPLOYEES IN       PER      EXPIRATION   ---------------------   ---------------------
NAME                     GRANTED      FISCAL YEAR       SHARE        DATE         5%          10%         5%          10%
----------------------------------------------------------------------------------------------------------------------------
R. Scott Huennekens..    575,000         22.3%          $0.35      03/09/10    $126,565    $320,741
Robert E. Johnson....    200,000          7.8%          $0.35      03/09/10    $ 44,023    $111,562
John F. Sheridan.....    150,000          5.8%          $0.35      03/09/10    $ 33,017    $ 83,671
Richard L. Conwell...     50,000          1.9%          $0.35      03/09/10    $ 11,006    $ 27,890
David M. Sheehan.....    400,000         15.5%          $0.50      12/29/10    $125,779    $318,748


(1) Potential realizable value is based upon fair market value of our common stock on the grant date of the options as determined by our board of directors.

(2) Potential realizable value is based upon the initial public offering price of our common stock of $ .


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MANAGEMENT

The figures above represent options to purchase shares of our common stock granted under our 1998 Stock Option/Stock Issuance Plan. We granted options to purchase an aggregate of 2,574,964 shares of our common stock in 2000. The options granted to our employees typically vest in a 25% increment on the first annual anniversary of the date of grant and thereafter vest on a daily basis over a three-year period. The options granted to the named executive officers listed in the table above began to vest on a daily basis over a four-year period beginning on each of their respective dates of grant. Options granted to the persons listed above expire 10 years from the dates of grant.

The potential realizable value at assumed annual rates of stock price appreciation for the option term represents hypothetical gains that could be achieved for the respective options if exercised at the end of the option term. The 5% and 10% assumed annual rates of compounded stock price appreciation are required by rules of the Securities and Exchange Commission and do not represent our estimate or projection of our future common stock prices. These amounts represent assumed rates of appreciation in the value of our common stock from the fair market value on the date of grant. Actual gains, if any, on stock option exercises are dependent on the future performance of our common stock and overall stock market conditions. The actual value realized may be greater or less than the potential realizable value set forth in the table.

We have never granted any stock appreciation rights.

OPTIONS EXERCISED AND YEAR-END VALUES

The following table sets forth information concerning the number and value of options exercised by each of the named executive officers as of December 31, 2000 and the number and value of unexercised options held by each of the named executive officers as of December 31, 2000. Options shown as exercisable in the table below are immediately exercisable; however, we have the right to purchase the shares of common stock underlying some of these options upon termination of the holder's employment with us. There was no public trading price for the common stock as of December 31, 2000. Accordingly, the value of unexercised in-the-money options at December 31, 2000 represents an amount equal to the difference between the assumed fair market value of $0.50 of the common stock as determined by our board of directors and the applicable exercise price per share, multiplied by the number of unexercised in-the-money options. An option is in-the-money if the fair market value of the underlying shares exceeds the exercise price of the options.

 
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES


                                                       NUMBER OF SECURITIES
                                                      UNDERLYING UNEXERCISED         VALUE OF UNEXERCISED
                                                            OPTIONS AT              IN-THE-MONEY OPTIONS AT
                         SHARES                         DECEMBER 31, 2000            DECEMBER 31, 2000(2)
                       ACQUIRED ON      VALUE      ----------------------------   ---------------------------
NAME                    EXERCISE     REALIZED(1)   EXERCISABLE   UNEXERCISABLE    EXERCISABLE   UNEXERCISABLE
-------------------------------------------------------------------------------------------------------------
R. Scott
  Huennekens.........    28,572        $4,286       1,221,428          --          $216,214           --
Robert E. Johnson....    28,572        $4,286         421,428          --          $ 63,214           --
John F. Sheridan.....    28,572        $4,286         496,428          --          $ 94,464           --
Richard L. Conwell...    28,572        $4,286         346,428          --          $ 76,964           --
David M. Sheehan.....        --            --         400,000          --                --           --


                          VALUE OF UNEXERCISED
                         IN-THE-MONEY OPTIONS AT
                          DECEMBER 31, 2000(3)
                       ---------------------------
NAME                   EXERCISABLE   UNEXERCISABLE
---------------------  ---------------------------
R. Scott
  Huennekens.........                      --
Robert E. Johnson....                      --
John F. Sheridan.....                      --
Richard L. Conwell...                      --
David M. Sheehan.....                      --


(1) Amount based on the difference between the fair market value of our common stock on the date of exercise as determined by our board of directors, and the exercise price of the option.


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MANAGEMENT

(2) Amount based on the difference between the fair market value of our common stock on December 31, 2000 of $0.50, as determined by our board of directors, and the exercise price of the option.

(3) Amount based on the difference between the initial public offering price of our common stock and the exercise price of the option.

BENEFIT PLANS

2001 STOCK INCENTIVE PLAN

INTRODUCTION--Our 2001 Stock Incentive Plan is intended to serve as the successor equity incentive program to our 1995 Stock Option Plan, 1997 Stock Option/Stock Issuance Plan and 1998 Stock Option/Stock Issuance Plan, which we collectively refer to as our predecessor plans. Our 2001 incentive plan is to be adopted by our board of directors, and we intend to seek the approval of our stockholders, prior to the closing of this offering. Our 2001 incentive plan will become effective on the date the underwriting agreement for this offering is signed. At that time, all outstanding options under the predecessor plans will be transferred to our 2001 incentive plan, and no further option grants will be made under those predecessor plans. The transferred options will continue to be governed by their existing terms, unless our compensation committee elects to extend one or more features of our 2001 incentive plan to those options. Except as otherwise noted below, the transferred options will have substantially the same terms as in effect for grants made under the discretionary option grant program of our 2001 incentive plan.

SHARE RESERVE--Twelve million shares of common stock have been authorized for issuance under our 2001 incentive plan. Such share reserve consists of the number of shares we estimate will be carried over from our predecessor plans, including the shares subject to outstanding options thereunder, plus an additional increase of approximately 3,500,000 shares. The number of shares of common stock reserved for issuance under our 2001 incentive plan will automatically increase on the first trading day in January each calendar year, beginning in calendar year 2002, by an amount equal to 2% of the total number of shares of common stock outstanding on the last trading day in December of the preceding calendar year.

EQUITY INCENTIVE PROGRAMS--Our 2001 incentive plan is divided into five separate components:

- the discretionary option grant program, under which eligible individuals in our employ or service may be granted options to purchase shares of common stock at an exercise price not less than 100% of the fair market value of those shares on the grant date;

- the stock issuance program, under which such individuals may be issued shares of common stock directly, through the purchase of such shares at a price not less than 100% of their fair market value at the time of issuance or as a bonus tied to the attainment of performance milestones or the completion of a specified period of service;

- the salary investment option grant program, under which our executive officers and other highly compensated employees may be given the opportunity to apply a portion of their base salary to the acquisition of special below-market stock option grants;

- the automatic option grant program, under which option grants will automatically be made at periodic intervals to our non-employee board members to purchase shares of common stock at an exercise price equal to 100% of the fair market value of those shares on the grant date; and

- the director fee option grant program, under which our non-employee board members may be given the opportunity to apply a portion of the annual retainer fee otherwise payable to them in cash each year to the acquisition of special below-market option grants.


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MANAGEMENT

ELIGIBILITY--The individuals eligible to participate in our 2001 incentive plan include our officers and other employees, our non-employee board members and any consultants we hire.

ADMINISTRATION--The discretionary option grant program and the stock issuance program will be administered by the compensation committee. This committee will determine which eligible individuals are to receive option grants or stock issuances under those programs, the time or times when such option grants or stock issuances are to be made, the number of shares subject to each such grant or issuance, the status of any granted option as either an incentive stock option or a non-statutory stock option under the federal tax laws, the vesting schedule to be in effect for the option grant or stock issuance and the maximum term for which any granted option is to remain outstanding. The compensation committee will also have the exclusive authority to select the executive officers and other highly compensated employees who may participate in the salary investment option grant program in the event that program is activated for one or more calendar years.

PLAN FEATURES--Our 2001 incentive plan will include the following features:

- the exercise price for the shares of common stock subject to option grants made under our 2001 incentive plan may be paid in cash or in shares of common stock valued at fair market value on the exercise date. The option may also be exercised through a same-day sale program without any cash outlay by the optionee. In addition, the plan administrator may provide financial assistance to one or more optionees in the exercise of their outstanding options or the purchase of their unvested shares by allowing such individuals to deliver a full-recourse, interest-bearing promissory note in payment of the exercise price and any associated withholding taxes incurred in connection with such exercise or purchase;

- the compensation committee will have the authority to cancel outstanding options under the discretionary option grant program, including options transferred from the predecessor plans, in return for the grant of new options for the same or a different number of option shares with an exercise price per share based upon the fair market value of our common stock on the new grant date; and

- stock appreciation rights are authorized for issuance under the discretionary option grant program. Such rights will provide the holders with the election to surrender their outstanding options for an appreciation distribution from us equal to the fair market value of the vested shares of common stock subject to the surrendered option, less the aggregate exercise price payable for those shares. Such appreciation distribution may be made in cash or in shares of common stock. None of the outstanding options under our predecessor plans contain any stock appreciation rights.

The 2001 incentive plan will include the following change in control provisions which may result in the accelerated vesting of outstanding option grants and stock issuances:

- in the event that we are acquired by merger or asset sale, each outstanding option under the discretionary option grant program which is not to be assumed by the successor corporation will automatically accelerate in full, and all unvested shares under the discretionary option grant and stock issuance programs will immediately vest, except to the extent our repurchase rights with respect to those shares are to be assigned to the successor corporation;

- the compensation committee will have complete discretion to structure one or more options under the discretionary option grant program so those options will vest as to all the option shares in the event those options are assumed in the acquisition but the optionee's service with us or the acquiring entity is subsequently terminated. The vesting of outstanding shares under the stock issuance program may be accelerated upon similar terms and conditions;


64

MANAGEMENT

- the compensation committee will also have the authority to grant options which will immediately vest in the event we are acquired, whether or not those options are assumed by the successor corporation;

- the compensation committee may grant options and structure repurchase rights so that the shares subject to those options or repurchase rights will immediately vest in connection with a successful tender offer for more than 50% of our outstanding voting stock or a change in the majority of our board through one or more contested elections for board membership. Such accelerated vesting may occur either at the time of such transaction or upon the subsequent termination of the individual's service; and

- the options currently outstanding under our predecessor plans will immediately vest in the event we are acquired by merger or sale of substantially all our assets, unless those options are assumed by the acquiring entity or our repurchase rights with respect to any unvested shares subject to those options are assigned to such entity. However, a number of those options may also contain a special acceleration provision pursuant to which the shares subject to those options will immediately vest upon an involuntary termination of the optionee's employment within 18 months following an acquisition in which the repurchase rights with respect to those shares are assigned to the acquiring entity.

SALARY INVESTMENT OPTION GRANT PROGRAM--In the event the compensation committee elects to activate the salary investment option grant program for one or more calendar years, each of our executive officers and other highly compensated employees selected for participation may elect, prior to the start of the calendar year, to reduce his or her base salary for that calendar year by a specified dollar amount not less than $10,000 nor more than $50,000. Each selected individual who files such a timely election will automatically be granted, on the first trading day in January of the calendar year for which his or her salary reduction is to be in effect, an option to purchase that number of shares of common stock determined by dividing the salary reduction amount by two-thirds of the fair market value per share of our common stock on the grant date. The option will be exercisable at a price per share equal to one-third of the fair market value of the option shares on the grant date. As a result, the option will be structured so that the fair market value of the option shares on the grant date less the exercise price payable for those shares will be equal to the amount by which the optionee's salary is reduced under the program. The option will become exercisable in a series of 12 equal monthly installments over the calendar year for which the salary reduction is to be in effect.

AUTOMATIC OPTION GRANT PROGRAM--Under the automatic option grant program, each individual who first becomes a non-employee board member at any time after the completion of this offering will automatically receive on the date such individual joins the board an option grant for a number of shares of common stock to be determined prior to the closing of this offering, provided such individual has not been in our prior employ. In addition, on the date of each annual stockholders meeting held after the completion of this offering, each non-employee board member who is to continue to serve as a non-employee board member, including each of our current non-employee board members, will automatically be granted an option to purchase a number of shares of common stock to be determined prior to the closing of this offering, provided such individual has served on our board for at least six months.

Each automatic grant will have an exercise price per share equal to the fair market value per share of our common stock on the grant date and will have a term of 10 years, subject to earlier termination following the optionee's cessation of board service. The option will be immediately exercisable for all of the option shares; however, we may repurchase, at the exercise price paid per share, any shares purchased under the option which are not vested at the time of the optionee's cessation of board


65

MANAGEMENT

service. The shares subject to each initial automatic option grant will vest in a series of 3 successive annual installments upon the optionee's completion of each year of board service over the 3-year period measured from the grant date. The shares subject to each annual automatic option grant will vest upon the optionee's completion of one year of board service measured from the grant date. However, the shares will immediately vest in full upon certain changes in control or ownership or upon the optionee's death or disability while a board member.

DIRECTOR FEE OPTION GRANT PROGRAM--Should the director fee option grant program be activated in the future, each non-employee board member will have the opportunity to apply all or a portion of any cash retainer fee for the year to the acquisition of a below-market option grant. The option grant will automatically be made on the first trading day in January in the year for which the retainer fee would otherwise be payable in cash. The option will have an exercise price per share equal to one-third of the fair market value of the option shares on the grant date, and the number of shares subject to the option will be determined by dividing the amount of the retainer fee applied to the program by two-thirds of the fair market value per share of our common stock on the grant date. As a result, the option will be structured so that the fair market value of the option shares on the grant date less the exercise price payable for those shares will be equal to the portion of the retainer fee applied to that option. The option will become exercisable in a series of 12 equal monthly installments over the calendar year for which the election is to be in effect. However, the option will become immediately exercisable for all the option shares upon the optionee's death or disability while serving as a board member.

Our 2001 incentive plan will also have the following features:

- outstanding options under the salary investment and director fee option grant programs will immediately vest if we are acquired by a merger or asset sale or if there is a successful tender offer for more than 50% of our outstanding voting stock or a change in the majority of our board through one or more contested elections;

- limited stock appreciation rights will automatically be included as part of each grant made under the salary investment option grant program and the automatic and director fee option grant programs, and these rights may also be granted to one or more officers as part of their option grants under the discretionary option grant program. Options with this feature may be surrendered to us upon the successful completion of a hostile tender offer for more than 50% of our outstanding voting stock. In return for the surrendered option, the optionee will be entitled to a cash distribution from us in an amount per surrendered option share based upon the highest price per share of our common stock paid in that tender offer; and

- the board may amend or modify the 2001 incentive plan at any time, subject to any required stockholder approval. The 2001 incentive plan will terminate no later than ten years after the completion of this offering.

EMPLOYMENT ARRANGEMENTS

None of our employees are employed for a specified term, and each employee's employment with us is subject to termination at any time by either party for any reason, with or without cause.

All of our current employees have entered into agreements with us which contain restrictions and covenants relating to the protection of our confidential information.


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MANAGEMENT

LIMITATIONS ON DIRECTORS' LIABILITY AND INDEMNIFICATION

Our certificate of incorporation limits the liability of directors to the maximum extent permitted by Delaware law. Delaware law provides that directors of a corporation will not be personally liable for monetary damages for breach of their fiduciary duties as directors, except liability for:

- any breach of their duty of loyalty to the corporation or its stockholders;

- acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law;

- unlawful payments of dividends or unlawful stock repurchases or redemptions; and

- any transaction from which the director derived an improper personal benefit.

The limitation of liability does not apply to liabilities arising under the federal securities laws and does not affect the availability of equitable remedies such as injunctive relief or rescission. Our certificate of incorporation and bylaws provide that we will indemnify our directors and officers and may indemnify our employees and other agents to the fullest extent permitted by law. We believe that indemnification under our bylaws covers at least negligence on the part of indemnified parties. Our bylaws also permit us to secure insurance on behalf of any officer, director, employee or other agent for any liability arising out of his or her actions in their capacity as an officer, director, employee or other agent, regardless of whether the bylaws would permit indemnification.

We have entered into agreements to indemnify our directors and executive officers, in addition to the indemnification provided for in our bylaws. These agreements, among other things, provide for indemnification for judgments, fines, settlement amounts and expenses, including attorneys' fees incurred by the director, or executive officer in any action or proceeding, including any action by or in our right, arising out of the person's services as a director or executive officer, any of our subsidiaries or any other company or enterprise to which the person provides services at our request. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers.

At present, there is no pending litigation or proceeding involving any of our directors, officers or employees in which indemnification is sought, nor are we aware of any threatened litigation that may result in claims for indemnification.


67


Certain relationships and related transactions

 
SALES OF SECURITIES

SERIES E PREFERRED STOCK FINANCING--From June 1998 to June 2000, we issued and sold 4,004,965 shares of Series E preferred stock to 17 accredited investors at a price of $3.036 per share. The shares of Series E preferred stock will automatically convert into 4,004,965 shares of common stock in connection with this offering. Investors owning 5% or more of our capital stock who participated in this transaction include:

                                                                                    NUMBER OF SHARES OF
                                                                                        COMMON STOCK
                                                                  NUMBER OF            ISSUABLE UPON
                                                              SHARES OF SERIES E   CONVERSION OF SERIES E
INVESTORS                                                      PREFERRED STOCK        PREFERRED STOCK
---------------------------------------------------------------------------------------------------------
Entities affiliated with Kingsbury Associates...............       329,380                329,380
Entities affiliated with Sorrento Associates................       329,380                329,380
Entities affiliated with Vector Fund Management.............       329,379                329,379

Mr. Wollaeger, one of our directors, is a general partner of Kingsbury Associates, L.P., which is a general partner of Kingsbury Capital Partners, L.P., I, Kingsbury Capital Partners, L.P., II, Kingsbury Capital Partners, L.P., III and Kingsbury Capital Partners, L.P., IV. In this prospectus, we refer to Kingsbury Capital Partners, L.P., I, Kingsbury Capital Partners, L.P., II, Kingsbury Capital Partners, L.P., III and Kingsbury Capital Partners, L.P., IV, collectively, as entities affiliated with Kingsbury Associates.

In this prospectus, we refer to Sorrento Growth Partners I, L.P., Sorrento Ventures II, L.P., Sorrento Ventures III, L.P. and Sorrento Ventures CE, L.P., collectively, as entities affiliated with Sorrento Associates.

Dr. Reed, one of our directors, is a managing director of Vector Fund Management, L.L.C., which is a general partner of Vector Later-Stage Equity Fund, L.P., and is a managing director of Vector Fund Management, II, L.L.C., which is a general partner of Vector Later-Stage Equity Fund II, L.P. and Vector Later-Stage Equity Fund II (Q.P.), L.P. In this prospectus, we refer to Vector Later-Stage Equity Fund, L.P., Vector Later-Stage Equity Fund II, L.P., and Vector Later-Stage Equity Fund II (Q.P.), L.P., collectively, as entities affiliated with Vector Fund Management.

BRIDGE LOAN FINANCING AND ADDITIONAL SERIES E PREFERRED STOCK FINANCING--In September 2000, we issued and sold an aggregate of $2,000,000 of convertible promissory notes to 5 accredited investors. In November 2000, the convertible promissory notes automatically converted into 658,759 shares of Series E preferred stock at a price of $3.036 per share. In addition, in consideration for the bridge loans, we issued to the investors warrants to purchase up to 65,875 shares of our Series E preferred stock at an exercise price of $3.036 per share. These warrants will terminate in connection with this


68

 
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

offering if not previously exercised. Investors owning 5% or more of our capital stock who participated in this transaction include:

                                                 NUMBER OF                                AGGREGATE NUMBER OF
                                             SHARES OF SERIES E         NUMBER OF           SHARES OF COMMON
                           AGGREGATE          PREFERRED STOCK          WARRANTS TO        STOCK ISSUABLE UPON
                           PRINCIPAL            ISSUED UPON              PURCHASE        CONVERSION OF SERIES E
                           AMOUNT OF           CONVERSION OF        SHARES OF SERIES E    PREFERRED STOCK AND
INVESTORS               PROMISSORY NOTE       PROMISSORY NOTES       PREFERRED STOCK            WARRANTS
---------------------------------------------------------------------------------------------------------------
Entities affiliated
  with Kingsbury
  Associates..........     $1,000,000             329,380                 32,938                362,318
Entities affiliated
  with Vector Fund
  Management..........     $  500,000             164,689                 16,468                181,157

 
ADDITIONAL SERIES E PREFERRED STOCK FINANCING--From November 2000 to April 2001, we issued and sold 5,125,463 shares of Series E preferred stock to 34 accredited investors at a price of $3.036 per share. The shares of Series E preferred stock will automatically convert into 5,125,463 shares of common stock in connection with this offering. Investors owning 5% or more of our capital stock who participated in this transaction include:

                                                                                    NUMBER OF SHARES OF
                                                                                        COMMON STOCK
                                                                  NUMBER OF            ISSUABLE UPON
                                                              SHARES OF SERIES E   CONVERSION OF SERIES E
INVESTORS                                                      PREFERRED STOCK        PREFERRED STOCK
---------------------------------------------------------------------------------------------------------
Entities affiliated with Merrill Lynch Ventures.............       658,761                658,761
Entities affiliated with Kingsbury Associates...............       454,380                454,380
Entities affiliated with Vector Fund Management.............       164,689                164,689
Palavacinni Partners, LLC...................................        24,703                 24,703

In this prospectus, we refer to Merrill Lynch Ventures, LLC and Merrill Lynch Ventures, L.P. 2001, collectively, as entities affiliated with Merrill Lynch Ventures.

Dr. Reed, one of our directors, is a member of Palavacinni Partners, LLC.

SERIES F PREFERRED STOCK FINANCING--In August 2001, we issued and sold 2,618,462 shares of Series F preferred stock to 25 accredited investors at a price of $3.25 per share. The shares of Series F preferred stock will automatically convert into 2,618,462 shares of common stock in connection with


69

 
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

this offering. Investors owning 5% or more of our capital stock and directors who participated in this transaction include:

                                                                                    NUMBER OF SHARES OF
                                                                                        COMMON STOCK
                                                                  NUMBER OF            ISSUABLE UPON
                                                              SHARES OF SERIES F   CONVERSION OF SERIES F
INVESTORS                                                      PREFERRED STOCK        PREFERRED STOCK
---------------------------------------------------------------------------------------------------------
Entities affiliated with Kingsbury Associates...............       184,616                184,616
Entities affiliated with Vector Fund Management.............       153,847                153,847
Entities affiliated with Merrill Lynch Ventures.............       107,692                107,692
Entities affiliated with Sorrento Associates................        76,923                 76,923
Kenneth E. Olson Trust dated March 16, 1989.................        30,769                 30,769
Palavacinni Partners, LLC...................................        20,000                 20,000

Mr. Olson, one of our directors, is the trustee of the Kenneth E. Olson Trust dated March 16, 1989.

Dr. Reed, one of our directors, is a member of Palavacinni Partners, LLC.

REGISTRATION RIGHTS--In connection with the preferred stock financings referenced above, we entered into agreements with the investors providing for registration rights with respect to their shares. For a more complete description of the rights we granted to these stockholders, please see "Description of capital stock--Registration Rights."

For additional information regarding the sale of securities to executive officers, directors and holders of more than 5% of our outstanding common stock, please see "Principal stockholders."

 
OPTION AGREEMENTS WITH DIRECTORS

Since January 1, 1998, we have granted options to purchase shares of our common stock to our directors in the following transactions:

NAME OF DIRECTOR                                     DATE OF GRANT    NUMBER OF SHARES    EXERCISE PRICE
--------------------------------------------------------------------------------------------------------
Kenneth E. Olson .................................  April 1998               3,000            $0.21
                                                    April 1998               3,000            $0.25
                                                    December 1998            5,000            $0.35
                                                    May 1999                 3,000            $0.35
                                                    March 2000               5,000            $0.35
                                                    May 2000                30,000            $0.50
                                                    March 2001               5,000            $1.00

R. Scott Huennekens ..............................  December 1998          225,000            $0.35
                                                    May 1999               220,000            $0.35
                                                    March 2000             575,000            $0.35
                                                    January 2001           120,000            $1.00

R. King Nelson ...................................  May 2000                50,000            $0.50
                                                    March 2001               5,000            $1.00

Timothy J. Wollaeger..............................  November 2000           30,000            $0.50

Brad Nutter.......................................  August 2001             50,000            $1.50


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Principal stockholders

The following table sets forth information with respect to the beneficial ownership of our common stock as of August 23, 2001, as adjusted to reflect the sale of the shares of common stock in this offering by:

- each person or group of affiliated persons who we know beneficially owns 5% or more of our common stock;

- each of our named executive officers listed in "Executive Compensation" above and our current Vice President and Chief Financial Officer;

- each of our current directors; and

- all of the executive officers and directors as a group.

Beneficial ownership is calculated according to the rules of the Securities and Exchange Commission. Except as indicated in the footnotes to this table, the persons named in the table have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them, subject to community property laws where applicable. The number of shares beneficially owned by a person includes the number of shares underlying options and warrants that are exercisable within 60 days from August 23, 2001. These shares are also deemed outstanding for the purpose of computing the percentage of outstanding shares owned by the person. The shares are not deemed outstanding, however, for the purpose of computing the percentage ownership of any other person. Percentage ownership is based upon 34,274,504 shares of common stock outstanding at August 23, 2001, assuming the conversion of all outstanding shares of preferred stock into common stock. Unless otherwise indicated, the address for each of the following stockholders is: c/o Digirad Corporation, 9350 Trade Place, San Diego, California 92126-6334.

 

                                                                                         PERCENTAGE OF
                                                                                      SHARES BENEFICIALLY
                                                    NUMBER OF     NUMBER OF SHARES           OWNED
                                                       SHARES   UNDERLYING OPTIONS   ----------------------
                                                 BENEFICIALLY         AND WARRANTS     BEFORE         AFTER
NAME AND ADDRESS OF BENEFICIAL OWNER                    OWNED   BENEFICIALLY OWNED   OFFERING      OFFERING
-----------------------------------------------------------------------------------------------------------
Entities affiliated with Kingsbury
  Associates(1)................................    6,615,721          132,938          19.2%
  3655 Nobel Drive, Suite 490
  San Diego, CA 92122
Entities affiliated with Vector Fund
  Management(2)................................    5,106,807           16,468          14.9%
  1751 Lake Cook Road, Suite 350
  Deerfield, IL 60015
Entities affiliated with Sorrento
  Associates(3)................................    4,506,524               --          13.1%
  4370 La Jolla Village Drive,
    Suite 1040
  San Diego, CA 92122
Entities affiliated with Merrill Lynch
  Ventures(4)..................................    2,234,051               --           6.5%
  2 World Financial Center, 31st Floor
  New York, NY 10281
R. Scott Huennekens............................    1,370,000        1,341,428           3.8%
Robert E. Johnson..............................      550,000          521,428           1.6%
John F. Sheridan...............................      575,000          546,428           1.7%
Richard L. Conwell.............................      400,000          371,428           1.2%
Gary J.G. Atkinson.............................      250,000          250,000             *
David M. Sheehan...............................      410,000          410,000           1.2%
Timothy J. Wollaeger(5)........................    6,645,721          132,938          19.3%
R. King Nelson.................................       55,000           55,000             *
Brad Nutter....................................       50,000           50,000             *
Kenneth E. Olson(6)............................      296,770          166,000             *
Douglas Reed, M.D.(7)..........................    5,151,510           16,468          15.0%
All Executive Officers and Directors as a Group
  (11 persons).................................   15,754,001        3,811,712          41.3%

* Less than one percent.


71

PRINCIPAL STOCKHOLDERS

(1) In this prospectus, we refer to Kingsbury Capital Partners, L.P., I, Kingsbury Capital Partners, L.P., II, Kingsbury Capital Partners, L.P., III, and Kingsbury Capital Partners, L.P., IV, collectively, as entities affiliated with Kingsbury Capital Partners. Timothy J. Wollaeger, a member of our board of directors, is a general partner of Kingsbury Associates, L.P., which is a general partner of each of the previously-mentioned investment funds, and Mr. Wollaeger shares investment and voting power over these shares with the other general partners of Kingsbury Associates, L.P. Mr. Wollaeger disclaims beneficial ownership of such shares, except to the extent of his pecuniary interest, if any.

(2) In this prospectus, we refer to Vector Later-Stage Equity Fund, L.P., Vector Later-Stage Equity Fund II, L.P., and Vector Later-Stage Equity Fund II (Q.P.), L.P., collectively, as entities affiliated with Vector Fund Management. Douglas Reed, M.D., a member of our board of directors, is a managing director of the general partner of each of the previously-mentioned investment funds, and Dr. Reed shares investment and voting power over these shares with the other managing directors of each of the general partners of these funds. Dr. Reed disclaims beneficial ownership of all such shares, except to the extent of his pecuniary interest, if any.

(3) In this prospectus, we refer to Sorrento Growth Partners I, L.P., Sorrento Ventures II, L.P., Sorrento Ventures III, L.P., and Sorrento Ventures CE, L.P., collectively, as entitles affiliated with Sorrento Associates.

(4) In this prospectus, we refer to Merrill Lynch Ventures, LLC and Merrill Lynch Ventures, L.P. 2001, collectively, as entitles affiliated with Merril Lynch Ventures.

(5) Includes 6,615,721 shares held by entities affiliated with Kingsbury Associates and 30,000 shares of common stock held by Mr. Wollaeger.

(6) Includes 130,770 shares held by the Kenneth E. Olson Trust dated March 16, 1989 and options to purchase 166,000 shares of common stock held by Mr. Olson.

(7) Includes 5,106,807 shares held by entities affiliated with Vector Fund Management and 44,703 shares held by Palivacinni Partners, LLC. Dr. Reed is a member of Palivacinni Partners, LLC and shares investment and voting power over these shares with the other members. Dr. Reed disclaims beneficial ownerhip of such shares except to the extent of his pecuniary interest, if any.


72


Description of capital stock

Upon the closing of this offering, our authorized capital stock will consist of 250,000,000 shares of common stock, $0.001 par value per share, and 10,000,000 shares of undesignated preferred stock, $0.001 par value per share.

The following description of our capital stock does not purport to be complete and is subject to and qualified by our certificate of incorporation and bylaws, which are included as exhibits to the registration statement of which this prospectus forms a part, and by the provisions of applicable Delaware law.

COMMON STOCK

As of August 23, 2001, there were 4,526,474 shares of common stock outstanding. There will be shares of common stock outstanding upon the closing of this offering, which gives effect to the shares of common stock offered by us in this offering and the conversion of shares of preferred stock as discussed below. The outstanding shares of common stock are, and the shares offered by us in this offering will be, when issued in consideration for payment thereof, fully paid and nonassessable.

The following summarizes the rights of holders of our common stock:

- the holders of our common stock are entitled to dividends and other distributions as may be declared from time to time by the board of directors out of funds legally available for that purpose, if any;

- the holders of common stock have no preemptive or other subscription rights to purchase shares of our stock, nor are they entitled to the benefits of any redemption or sinking fund provisions;

- each holder of shares of common stock is entitled to one vote per share on all matters to be voted on by stockholders generally, including the election of directors;

- there are no cumulative voting rights; and

- upon our liquidation, dissolution or winding up, the holders of shares of common stock will be entitled to share ratably in the distribution of all of our assets remaining available for distribution after satisfaction of all our liabilities and the payment of the liquidation preference of any outstanding preferred stock.

PREFERRED STOCK

As of August 23, 2001, there were 29,748,030 shares of redeemable convertible preferred stock outstanding. All outstanding shares of redeemable convertible preferred stock will be converted into 29,748,030 shares of common stock in connection with this offering and such shares of redeemable convertible preferred stock will no longer be authorized, issued or outstanding. In addition, if the final price per share of shares in this offering is less then $ per share, a small number of additional shares of common stock will be issued upon conversion of the Series F preferred stock.

Upon the closing of this offering, our board of directors will be authorized, without further stockholder approval, to issue from time to time one or more series of preferred stock and to fix or alter the designations, powers, preferences, rights and any qualifications, limitations or restrictions of the shares of such series, including:

- the number of shares constituting the series and the distinctive designation of the series;


73

DESCRIPTION OF CAPITAL STOCK

- the dividend rate on the share of the series, whether dividends will be cumulative, and if so, from which date or dates, and the relative rights of priority, if any, of payment of dividends on shares of the series;

- whether the series will have conversion privileges and, if so, the terms and conditions of conversion;

- whether the series will have a sinking fund for the redemption or purchase of shares of that series, and, if so, the terms and amount of the sinking fund;

- whether or not the shares of the series will be redeemable or exchangeable, and, if so, the dates, terms and conditions of redemption or exchange, as the case may be;

- whether the series will have voting rights in addition to the voting rights provided by law, and if so, the terms of the voting rights; and

- the rights of the shares of the series in the event of our voluntary or involuntary liquidation, dissolution or winding up and the relative rights or priority, if any, of payment of shares of the series.

The board of directors may authorize the issuance of preferred stock with terms and conditions which could discourage a takeover or other transaction that holders of some or a majority of common stock might believe to be in their best interests or in which holders of common stock might receive a premium for their shares over the then market price.

We have no present plans to issue any shares of preferred stock.

WARRANTS

As of August 23, 2001, we had outstanding warrants to purchase 603,578 shares of common stock, at a weighted average exercise price of $2.59 per share. Of the outstanding warrants, warrants to purchase 65,875 shares will terminate upon the closing of this offering and warrants to purchase 60,000 shares will expire if a consulting agreement is terminated before July 31, 2002.

In addition, we have entered into a consulting agreement under which we will issue additional warrants to purchase 10,000 shares of common stock at fair market value for every three digital cameras sold by the consultant, up to a maximum of 40,000 shares, and thereafter issue warrants to purchase 1,500 shares of common stock at fair market value for each of our digital cameras sold by the consultant.

OPTIONS

As of August 23, 2001, options to purchase an aggregate total of 5,952,426 shares of common stock were outstanding under our 1995 Stock Option Plan, our 1997 Stock Option/Stock Issuance Plan and our 1998 Stock Option/Stock Issuance Plan. Options to purchase a total of 4,725,883 shares of common stock remain available for grant under our option plans. Please see "Management--Benefit Plans" and "Shares eligible for future sale" for a detailed description of the stock option plans.

REGISTRATION RIGHTS

The holders of the shares of common stock which will be issued upon conversion of the preferred stock in connection with this offering, which holders are referred to below as our preferred investors, have the right to cause us to register their shares under the Securities Act of 1933 as follows:

- DEMAND REGISTRATION RIGHTS: Preferred investors holding at least 30% of the shares of common stock issued upon conversion of the preferred stock have the right to demand that we register their


74

DESCRIPTION OF CAPITAL STOCK

shares, subject to limitations, commencing one year after the effective date of the registration statement for this offering. We are not required to effect more than two registrations pursuant to such demand registration rights;

- PIGGYBACK REGISTRATION RIGHTS: In the event we propose to register any shares of common stock either for our account or for the account of other security holders, our preferred investors are entitled to receive notice of such registration and to have their shares included in any such registration, subject to limitations; and

- S-3 REGISTRATION RIGHTS: At any time after we become eligible to file a registration statement on Form S-3, our preferred investors may require us to file up to two registration statements on Form S-3 during any twelve month period with respect to their shares of common stock, subject to limitations.

These registration rights are subject to conditions and limitations, among them the right of the underwriters of an offering to limit the number of shares of common stock held by our preferred investors to be included in a registration. We are generally required to bear all of the expenses of all such registrations, including the reasonable fees of a single counsel acting on behalf of all selling holders, but excluding underwriting discounts and selling commissions. Registration of any of the shares of common stock held by our preferred investors would result in such shares becoming freely tradable without restriction under the Securities Act of 1933 immediately upon effectiveness of such registration.

POSSIBLE ANTI-TAKEOVER MATTERS

GENERAL--Provisions of Delaware law, as well as our certificate of incorporation and bylaws, could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from acquiring, control of us. Such provisions could limit the price that some investors might be willing to pay in the future for our common stock. These provisions of Delaware law and our certificate of incorporation and bylaws may also have the effect of discouraging or preventing certain types of transactions involving an actual or threatened change of control of us, including unsolicited takeover attempts, even though such a transaction may offer our stockholders the opportunity to sell their stock at a price above the prevailing market price.

DELAWARE TAKEOVER STATUTE--We are subject to the "business combination" provisions of Section 203 of the Delaware General Corporation Law. Subject to certain exceptions, Section 203 prohibits a publicly-held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless:

- the transaction is approved by the board of directors prior to the date the interested stockholder obtained interested stockholder status;

- upon consummation of the transaction that resulted in the stockholders becoming an interested stockholder, the interested stockholder owned at least 85% of our voting stock outstanding at the time the transaction commenced, excluding for purposes of determining the number of shares outstanding those shares owned by (a) persons who are directors and also officers and (b) employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or

- at or subsequent to the date the person became an interested stockholder, the business combination is approved by the board of directors and authorized at an annual or special meeting of


75

DESCRIPTION OF CAPITAL STOCK

stockholders by the affirmative vote of at least two-thirds of the outstanding voting stock that is not owned by the interested stockholder.

A "business combination" includes mergers, asset sales and other transactions resulting in a financial benefit to the interested stockholder. Subject to certain exceptions, an "interested stockholder" is a person who, together with affiliates and associates, owns, or within three years did own, 15% or more of the corporation's voting stock. This statute could prohibit or delay the accomplishment of mergers or other takeover or change in control attempts with respect to us and, accordingly, may discourage attempts to acquire us.

CHARTER AND BYLAW PROVISIONS--In addition, certain provisions of our certificate of incorporation and bylaws summarized in the following paragraphs may be deemed to have an anti-takeover effect and may delay, defer or prevent a tender offer or takeover attempt that a stockholder might consider in its best interest, including those attempts that might result in a premium over the then market price for the shares held by stockholders.

- CLASSIFIED BOARD OF DIRECTORS; REMOVAL; FILLING VACANCIES AND AMENDMENT: Our
certificate of incorporation and bylaws provide that the board will be divided into three classes of directors serving staggered, three-year terms. The classification of the board has the effect of requiring at least two annual stockholder meetings, instead of one, to replace a majority of members of the board. Subject to the rights of the holders of any outstanding series of preferred stock, the certificate of incorporation authorizes only the board to fill vacancies, including newly created directorships. Accordingly, this provision could prevent a stockholder from obtaining majority representation on the board by enlarging the board of directors and filling the new directorships with its own nominees. The certificate of incorporation also provides that directors may be removed by stockholders only for cause and only by the affirmative vote of holders of two-thirds of the outstanding shares of voting stock.

- STOCKHOLDER ACTION; SPECIAL MEETING OF STOCKHOLDERS: The certificate of
incorporation provides that stockholders may not take action by written consent, but may only take action at duly called annual or special meetings of stockholders. The certificate of incorporation further provides that special meetings of our stockholders may be called by the chairman of the board of directors, the chief executive officer or a majority of the board of directors. This limitation on the right of stockholders to call a special meeting could make it more difficult for stockholders to initiate actions that are opposed by the board of directors. These actions could include the removal of an incumbent director or the election of a stockholder nominee as a director. They could also include the implementation of a rule requiring stockholders' ratification of specific defensive strategies that have been adopted by the board of directors with respect to unsolicited takeover bids. In addition, the limited ability of the stockholders to call a special meeting of stockholders may make it more difficult to change the existing board and management.

- ADVANCE NOTICE REQUIREMENTS FOR STOCKHOLDER PROPOSALS AND DIRECTOR
NOMINATION: The bylaws provide that stockholders seeking to bring business before an annual meeting of stockholders, or to nominate candidates for election as directors at an annual meeting of stockholders, must provide timely notice thereof in writing. To be timely, a stockholder's notice must be delivered to or mailed and received at our principal executive offices not less than 120 days prior to the date of our annual meeting. The bylaws also specify certain requirements as to the form and content of a stockholder's notice. These provisions may preclude stockholders from bringing matters before an annual meeting of stockholders or from making nominations for directors at an annual meeting of stockholders.

- AUTHORIZED BUT UNISSUED SHARES: The authorized but unissued shares of common stock and preferred stock are available for future issuance without stockholder approval. These additional


76

DESCRIPTION OF CAPITAL STOCK

shares may be utilized for a variety of corporate purposes, including future public offerings to raise additional capital, corporate acquisitions, employee benefit plans and "poison pill" rights plans. The existence of authorized but unissued shares of common stock and preferred stock could render more difficult or discourage an attempt to obtain control of us by means of a proxy contest, tender offer, merger or otherwise.

NASDAQ NATIONAL MARKET

We have applied to list our common stock on the Nasdaq National Market under the trading symbol "DRAD."

 
 
TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for the common stock is              .

--------------------------------------------------------------------------------
                                                                              77


--------------------------------------------------------------------------------

Shares eligible for future sale

Prior to this offering, there has been no public market for our common stock. We cannot predict what effect, if any, market sales of shares or the availability of shares for sale will have on the market price of our common stock prevailing from time to time. The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market after this offering, or the perception that such sales could occur. Such sales also might make it more difficult for us to sell equity securities in the future at a time and price that we deem appropriate. Based upon the number of shares outstanding at August 23, 2001, upon the closing of this offering, we will have shares of common stock outstanding, assuming no exercise of the underwriters' over-allotment option and no exercise of options or warrants to purchase shares of our common stock. Of these shares, the shares being sold in this offering will be freely tradable without restriction or further registration under the Securities Act of 1933, unless these shares are purchased by "affiliates" as that term is defined in Rule 144 under the Securities Act of 1933. The remaining shares of our common stock were issued and sold by us in reliance on exemptions from the registration requirements of the Securities Act of 1933. These shares may be sold in the public market only if they are registered or if they qualify for an exemption from registration, such as Rule 144 or 701 under the Securities Act of 1933, which are summarized below. The remaining shares are eligible for sale in the public market as follows:

 
ELIGIBILITY OF RESTRICTED SHARES FOR SALE IN THE PUBLIC MARKET

                                                                        NUMBER
DATE                                                                 OF SHARES
------------------------------------------------------------------------------
After the date of this prospectus (subject, in some cases,
  to volume limitations)....................................
At various times after 90 days from the date of this
  prospectus (subject, in some cases, to volume
  limitations)..............................................
At various times after 180 days from the date of this
  prospectus (subject, in some cases, to volume
  limitations)..............................................

RULE 144

In general, under Rule 144 of the Securities Act of 1933 as currently in effect, beginning 90 days after the date of this offering, a person who has beneficially owned shares of our common stock for at least one year is entitled to sell, within any three month period, a number of shares of our common stock that does not exceed the greater of:

- 1% of the number of shares of common stock then outstanding; or

- the average weekly trading volume in our common stock during the four calendar weeks preceding the date on which notice of such sale is filed with the Securities and Exchange Commission.

Sales made under Rule 144 must also comply with manner of sale and notice requirements and are subject to the availability of current public information about us.

RULE 144(k)

Under Rule 144(k) of the Securities Act of 1933 as currently in effect, a person who is not deemed to have been our affiliate at any time during the 90 days preceding a sale, and who has beneficially


78

SHARES ELIGIBLE FOR FUTURE SALE

owned the shares proposed to be sold for at least two years, would be entitled to sell such shares under Rule 144(k) without regard to the volume limitations or the manner of sale, notice or public information requirements of Rule 144.

RULE 701

Under Rule 701 of the Securities Act of 1933 as currently in effect, any of our employees, consultants, directors or advisors who have purchased shares from us under a stock option plan or other written agreement can resell those shares 90 days after the effective date of this offering in reliance on Rule 144 but without complying with some of its restrictions, including the holding period. The sale of such shares may still remain subject, however, to contractual restrictions contained in lock-up agreements, described below.

LOCK-UP AGREEMENTS

Each of our stockholders and holders of options and warrants to purchase shares of our common stock who individually own more than 1% of our common stock (assuming the exercise of such options or warrants), as well as each of our directors and officers, have entered into lock-up agreements pursuant to which they have agreed that they will not offer, sell, contract to sell, pledge or otherwise dispose of, directly or indirectly, any shares of our common stock or any securities convertible into, or exercisable or exchangeable for, our common stock without the prior written consent of UBS Warburg for a period of 180 days from the date of this offering. Collectively, over 90% of our issued or issuable shares prior to this offering are subject to this lock-up agreement. Upon expiration of the lock-up agreements, shares will become eligible for sale in the public market, subject to volume and holding requirements of Rule 144 or 701 of the Securities Act of 1933.

STOCK PLANS

Following 90 days after the date of this prospectus, shares issued upon the exercise of options that we granted prior to the date of this offering will also be eligible for sale in the public market under Rule 701 of the Securities Act of 1933, as described above. As of August 23, 2001, options to purchase a total of 5,952,426 shares of common stock were outstanding. Each option grant is subject to a market stand-off provision, which allows us to restrict the sale of shares obtained through the exercise of options for up to 180 days from the date of this offering. Of these shares, shares may be eligible for sale in the public market beginning 180 days from the date of this prospectus.

We also intend to file a registration statement to register for resale an additional shares of common stock for issuance under our stock option plans. This registration statement will become effective immediately upon filing. Shares of common stock registered under this registration statement will be available for sale in the public market from time to time subject to vesting and the expiration of the market stand-off provisions referred to above.


79


Material United States federal tax consequences to non-United States holders of common stock

The following is a general discussion of the material United States federal income and estate tax considerations with respect to the ownership and disposition of our common stock applicable to non-U.S. holders. In general, a "Non-U.S. Holder" is any holder of our common stock other than:

- a citizen or individual resident of the United States,

- a corporation or other entity created or organized in the United States or under the laws of the United States or of any state or political subdivision of the United States,

- an estate, the income of which is included in gross income for United States federal income tax purposes regardless of its source, or

- a trust whose administration is subject to the primary supervision of a United States court and which has one or more United States persons who have the authority to control all substantial decisions of the trust.

This discussion is based on current provisions of the Internal Revenue Code, Treasury Regulations promulgated under the Internal Revenue Code, judicial opinions, published positions of the Internal Revenue Service, and all other applicable authorities, all of which are subject to change, possibly with retroactive effect. This discussion does not address all aspects of United States federal income and estate taxation or any aspects of state, local, or non-U.S. taxation, nor does it consider any specific facts or circumstances that may apply to particular Non-U.S. Holders that may be subject to special treatment under the United States federal income tax laws, such as insurance companies, tax-exempt organizations, financial institutions, brokers, dealers in securities, and United States expatriates.

PROSPECTIVE INVESTORS ARE URGED TO CONSULT THEIR TAX ADVISORS REGARDING THE UNITED STATES FEDERAL, STATE, LOCAL AND NON-U.S. INCOME AND OTHER TAX CONSIDERATIONS OF ACQUIRING, HOLDING AND DISPOSING OF SHARES OF COMMON STOCK.

DIVIDENDS--In general, dividends paid to a Non-U.S. Holder will be subject to United States withholding tax at a 30% rate of the gross amount, or a lower rate prescribed by an applicable income tax treaty, unless the dividends are effectively connected with a trade or business carried on by the Non-U.S. Holder within the United States. Dividends that are effectively connected with such a United States trade or business generally will not be subject to United States withholding tax if the Non-U.S. Holder files the required forms, including IRS Form W-8ECI, or any successor form, with the payor of the dividend, and generally will be subject to United States federal income tax on a net income basis, in the same manner as if the Non-U.S. Holder were a resident of the United States. A corporate Non-U.S. Holder that receives effectively connected dividends may be subject to an additional branch profits tax at a rate of 30%, or at a lower rate as may be specified by an applicable income tax treaty, on the repatriation from the United States of its "effectively connected earnings and profits," subject to adjustments.

Under Treasury Regulations generally effective for payments made after December 31, 2000, referred to in this prospectus as the "Final Regulations," a Non-U.S. Holder will be required to satisfy certification requirements, directly or through an intermediary, in order to claim a reduced rate of withholding under an applicable income tax treaty. A Non-U.S. Holder generally certifies entitlement to benefits under a treaty by providing an IRS Form W-8BEN. In addition, under the Final Regulations, in the case of dividends paid to a foreign partnership, the certification requirement would


80

MATERIAL UNITED STATES FEDERAL TAX CONSEQUENCES TO NON-UNITED STATES HOLDERS OF COMMON STOCK

generally be applied to the partners of the partnership, unless the partnership agrees to become a "withholding foreign partnership," and the partnership would be required to provide various information, including a United States taxpayer identification number. The Final Regulations also provide "look-through" rules for tiered partnerships.

A Non-U.S. Holder of our common stock that is eligible for a reduced rate of United States federal income tax withholding under a tax treaty may obtain a refund of any excess amounts withheld by filing an appropriate claim for refund with the IRS.

GAIN ON SALE OR OTHER DISPOSITION OF COMMON STOCK--In general, a Non-U.S. Holder will not be subject to United States federal income tax on any gain realized upon the sale or other taxable disposition of the holders shares of common stock unless:

- the gain is effectively connected with a trade or business carried on by the Non-U.S. Holder within the United States, in which case the branch profits tax discussed above may also apply if the Non-U.S. Holder is a corporation,

- the Non-U.S. Holder is an individual who holds shares of common stock as a capital asset and is present in the United States for 183 days or more in the taxable year of disposition and various other conditions are met,

- the Non-U.S. Holder is subject to tax under the provisions of the Internal Revenue Code regarding the taxation of United States expatriates, or

- we are or have been a "U.S. real property holding corporation" within the meaning of Section 897(c)(2) of the Internal Revenue Code at any time within the shorter of the five-year period preceding such disposition or such holders holding period. We do not believe that we are, and do not anticipate becoming, a United States real property holding corporation.

BACKUP WITHHOLDING AND INFORMATION REPORTING--Generally, we must report annually to the IRS the amount of dividends paid, the name and address of the recipient, and the amount, if any, of tax withheld. A similar report is sent to the recipient. These information reporting requirements apply even if withholding was not required because the dividends were effectively connected dividends or withholding was reduced by an applicable income tax treaty. Under tax treaties or other agreements, the IRS may make its reports available to tax authorities in the recipients country of residence.

Payments made to a Non-U.S. Holder that is not an exempt recipient generally will be subject to backup withholding at a rate of 31%, rather than withholding at a 30% rate or lower treaty rate discussed above, unless a Non-U.S. Holder certifies as to its foreign status, which certification may be made on IRS Form W-8 BEN.

Proceeds from the disposition of common stock by a Non-U.S. Holder effected by or through a United States office of a broker will be subject to information reporting and to backup withholding at a rate of 31% of the gross proceeds unless the Non-U.S. Holder certifies to the payor under penalties of perjury as to, among other things, its address and status as a Non-U.S. Holder or otherwise establishes an exemption. Generally, United States information reporting and backup withholding will not apply to a payment of disposition proceeds if the transaction is effected outside the United States by or through a non-United States office of a broker. However, if the broker is, for United States federal income tax purposes, a United States person, a controlled foreign corporation, a foreign person who derives 50% or more of its gross income for specified periods from the conduct of a United States trade or business, specified United States branches of foreign banks or insurance companies, or, a


81

MATERIAL UNITED STATES FEDERAL TAX CONSEQUENCES TO NON-UNITED STATES HOLDERS OF COMMON STOCK

foreign partnership with various connections to the United States, information reporting but not backup withholding will apply unless:

- the broker has documentary evidence in its files that the holder is a Non-U.S. Holder and other conditions are met; or

- the holder otherwise establishes an exemption.

Backup withholding is not an additional tax. Rather, the United States federal income tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. If backup withholding results in an overpayment of United States federal income taxes, a refund may be obtained, provided the required documents are filed with the IRS.

ESTATE TAX--Our common stock owned or treated as owned by an individual who is not a citizen or resident, as defined for United States federal estate tax purposes, of the United States at the time of death will be included in the individuals gross estate for United States federal estate tax purposes, unless an applicable estate tax treaty provides otherwise.


82


 
Underwriting

We and the underwriters for the offering named below have entered into an underwriting agreement concerning the shares being offered. Subject to conditions, each underwriter has severally agreed to purchase the number of shares indicated in the following table. UBS Warburg LLC and First Union Securities, Inc. are the representatives of the underwriters.

                                                                NUMBER OF
UNDERWRITER                                                        SHARES
-------------------------------------------------------------------------
UBS Warburg LLC.............................................
First Union Securities, Inc.................................
                                                               ---------
Total.......................................................
                                                               =========

If the underwriters sell more shares than the total number set forth in the table above, the underwriters have a 30-day option to buy from us up to an additional shares at the initial public offering price less the underwriting discounts and commissions to cover these sales. If any shares are purchased under this option, the underwriters will severally purchase shares in approximately the same proportion as set forth in the table above. The following table shows the per share and total underwriting discounts and commissions we will pay to the underwriters. These amounts are shown assuming both no exercise and full exercise of the underwriters' option to purchase up to an additional shares.

 

                                                           NO EXERCISE   FULL EXERCISE
--------------------------------------------------------------------------------------
Per share................................................  $              $
Total....................................................  $              $

We estimate that the total expenses of the offering payable by us, excluding underwriting discounts and commissions, will be approximately $ .

Shares sold by the underwriters to the public will initially be offered at the initial public offering price set forth on the cover of this prospectus. Any shares sold by the underwriters to securities dealers may be sold at a discount of up to $ per share from the initial public offering price. Any of these securities dealers may resell any shares purchased from the underwriters to other brokers or dealers at a discount of up to $ per share from the initial public offering price. If all the shares are not sold at the initial public offering price, the representatives may change the offering price and the selling terms. The underwriters have informed us that they do not expect discretionary sales to exceed % of the shares of common stock to be offered.

Our company and each of our directors, officers and our stockholders and optionholders owning 1% or more of our common stock (assuming the exercise of such options) have agreed with the underwriters not to offer, sell, contract to sell, hedge or otherwise dispose of, directly or indirectly, or file with the SEC a registration statement under the Securities Act of 1933 relating to, any shares of our common stock or securities convertible into or exchangeable for shares of common stock during the period from the date of this prospectus continuing through the date 180 days after the date of this prospectus, without the prior written consent of UBS Warburg LLC.

The underwriters have reserved for sale, at the initial public offering price, shares of our common stock being offered for sale to our customers and business partners. At the discretion of


83


our management, other parties, including our employees, may participate in the reserved shares program. The number of shares available for sale to the general public in the offering will be reduced to the extent these persons purchase reserved shares. Any reserved shares not so purchased will be offered by the underwriters to the general public on the same terms as the other shares.

Prior to this offering, there has been no public market for our common stock. The initial public offering price was negotiated by us and the representatives. The principal factors to be considered in determining the initial public offering price included:

- the information set forth in this prospectus and otherwise available to the representatives;

- the history and the prospects for the industry in which we compete;

- the ability of our management;

- our prospects for future earnings, the present state of our development and our current financial position;

- the general condition of the securities markets at the time of this offering; and

- recent market prices of, and demand for, publicly traded common stock of comparable companies.

In connection with the offering, the underwriters may purchase and sell shares of our common stock in the open market. These transactions may include short sales, stabilizing transactions and purchases to cover positions created by short sales. Short sales involve the sale by the underwriters of a greater number of shares than they are required to purchase in the offering. "Covered" short sales are sales made in an amount not greater than the underwriters' option to purchase additional shares from us in the offering. The underwriters may close out any covered short position by either exercising their option to purchase additional shares or purchasing shares in the open market. In determining the source of shares to close out the covered short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase shares through the overallotment option. "Naked" short sales are any sales in excess of the overallotment option. The underwriters must close out any naked short position by purchasing shares in the open market. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the common stock in the open market after pricing that could adversely affect investors who purchase in the offering.

Stabilizing transactions consist of bids or purchases made for the purpose of preventing or retarding a decline in the market price of our common stock while the offering is in progress. The underwriters also may impose a penalty bid. This occurs when a particular underwriter repays to the underwriters a portion of the underwriting discount received by it because the representatives have repurchased shares sold by or for the account of that underwriter in stabilizing or short covering transactions. These activities by the underwriters may stabilize, maintain or otherwise affect the market price of our common stock. As a result, the price of our common stock may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued by the underwriters at any time. These transactions may be effected on the Nasdaq National Market, in the over-the-counter market or otherwise.

We have agreed to indemnify the several underwriters against liabilities, including liabilities under the Securities Act of 1933, and to contribute to payments that the underwriters may be required to make in respect thereof.


84


Legal matters

The validity of the shares of common stock offered in this prospectus will be passed upon for us by Brobeck, Phleger & Harrison LLP, San Diego, California. Certain legal matters in connection with the offering will be passed upon for the underwriters by Alston & Bird LLP, New York, New York.

Experts

The consolidated financial statements as of December 31, 1999 and 2000, and for each of the three years in the period ended December 31, 2000, included in this prospectus and registration statement have been audited by Ernst & Young, LLP, independent auditors, as stated in their report appearing in this prospectus and registration statement, and are included in reliance upon the report of that firm given upon their authority as experts in accounting and auditing.

Where you can find more information

We have filed with the SEC a registration statement on Form S-1 (including the exhibits, schedules and amendments to the registration statement) under the Securities Act of 1933 with respect to the shares of common stock to be sold in this offering. This prospectus does not contain all the information set forth in the registration statement. For further information with respect to our company and the shares of common stock to be sold in this offering, reference is made to the registration statement. Statements contained in this prospectus as to the contents of any contract, agreement or other document referred to are not necessarily complete, and in each instance reference is made to the copy of such contract, agreement or other document filed as an exhibit to the registration statement, each such statement being qualified in all respects by such reference.

Our SEC filings, including the registration statement, are also available to you on the Commission's website (http://www.sec.gov). You may read and copy all or any portion of the registration statement or any other information we file at the SEC's public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. You can request copies of these documents, upon payment of a duplicating fee, by writing to the SEC. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference rooms.

As a result of this offering, we will become subject to the information and reporting requirements of the Securities Exchange Act of 1934, and in accordance with those requirements, we will file periodic reports, proxy statements and other information with the SEC. Upon approval of the common stock for quotation on the Nasdaq National Market, such reports, proxy and information statements and other information may also be inspected at the offices of Nasdaq Operations, 1735 K Street, N.W., Washington, D.C. 20006.


85


INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                                                                  PAGE
----------------------------------------------------------------------
Report of Ernst & Young LLP, Independent Auditors...........     F-2

Consolidated Balance Sheets as of December 31, 1999 and 2000
  and June 30, 2001 (unaudited).............................     F-3

Consolidated Statements of Operations for the years ended
  December 31, 1998, 1999 and 2000 and the six months ended
  June 30, 2000 and 2001 (unaudited)........................     F-4

Consolidated Statements of Stockholders' Equity (Deficit)
  for the years ended December 31, 1998, 1999 and 2000 and
  the six months ended June 30, 2001 (unaudited)............     F-5

Consolidated Statements of Cash Flows for the years ended
  December 31, 1998, 1999 and 2000 and the six months ended
  June 30, 2000 and 2001 (unaudited)........................     F-6

Notes to Consolidated Financial Statements..................     F-7


F-1


REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Digirad Corporation

We have audited the accompanying consolidated balance sheets of Digirad Corporation as of December 31, 1999 and 2000, and the related statements of operations, stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Digirad Corporation at December 31, 1999 and 2000, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States.


                                                           /s/ ERNST & YOUNG LLP

San Diego, California
June 5, 2001, except for the first paragraph of Note 4 and
Note 11, as to which the date is August 23, 2001.



F-2

 
DIGIRAD CORPORATION

CONSOLIDATED BALANCE SHEETS

                                                                                            PRO FORMA
                                                 DECEMBER 31,                             STOCKHOLDERS'
                                          ---------------------------                        EQUITY
                                              1999           2000        JUNE 30, 2001    JUNE 30, 2001
                                                                         (unaudited)       (unaudited)
--------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
  Cash and cash equivalents.............  $  2,625,713   $  6,555,281    $  3,510,477
  Accounts receivable, net..............            --      3,054,021       4,987,020
  Inventories, net......................       288,788      3,875,961       7,765,410
  Other current assets..................       221,162        590,644         989,732
                                          ------------   ------------    ------------
Total current assets....................     3,135,663     14,075,907      17,252,639
Property and equipment, net.............     2,151,484      6,307,967       7,910,174
Intangibles, net........................       412,157      2,823,535       2,557,619
Other assets............................            --             --         836,880
                                          ------------   ------------    ------------
Total assets............................  $  5,699,304   $ 23,207,409    $ 28,557,312
                                          ============   ============    ============
LIABILITIES AND STOCKHOLDERS' EQUITY
  (DEFICIT)
Current liabilities:
  Accounts payable......................  $  1,290,581   $  2,622,778    $  3,557,442
  Accrued compensation..................       500,859      1,078,517       1,451,275
  Accrued warranty......................        22,523      1,034,000         832,759
  Other accrued liabilities.............       106,245        925,138       1,292,969
  Current portion of debt...............       414,672      2,934,580       5,613,945
                                          ------------   ------------    ------------
Total current liabilities...............     2,334,880      8,595,013      12,748,390
Long-term debt, net of current
  portion...............................     1,420,758      4,944,422       5,075,883
Notes payable to stockholders...........       735,000        735,000         735,000
Commitments and contingencies
Redeemable convertible preferred stock--
  $.001 par value; 18,690,839,
  27,129,568 and 27,582,646 shares
  authorized at December 31, 1999, 2000
  and June 30, 2001 (unaudited),
  respectively; 18,493,211, 25,190,857
  and 27,129,568 shares issued and
  outstanding at December 31, 1999, 2000
  and June 30, 2001, respectively;
  liquidation value--$52,593,153 and
  $58,479,080 at December 31, 2000 and
  June 30, 2001 (unaudited),
  respectively. None outstanding pro
  forma (unaudited).....................    32,259,100     52,254,742      58,109,136     $         --
Stockholders' equity (deficit):
  Common stock--$.001 par value;
    27,000,000, 36,438,729 and
    38,091,807 shares authorized at
    December 31, 1999, 2000 and
    June 30, 2001 (unaudited),
    respectively; 3,401,034, 4,364,040
    and 4,574,603 shares issued and
    outstanding at December 31, 1999,
    2000 and June 30, 2001 (unaudited),
    respectively, 31,704,170 shares
    outstanding pro forma (unaudited)...         3,401          4,364           4,575           31,704
  Additional paid-in capital............       523,055      2,393,036       4,707,535       62,789,542
  Deferred compensation.................            --       (536,820)     (1,712,989)      (1,712,989)
  Notes receivable from stockholders....        (4,180)       (85,919)       (111,919)        (111,919)
  Accumulated deficit...................   (31,572,710)   (45,096,429)    (50,998,299)     (50,998,299)
                                          ------------   ------------    ------------     ------------
Total stockholders' equity (deficit)....   (31,050,434)   (43,321,768)    (48,111,097)    $  9,998,039
                                          ------------   ------------    ------------     ============
Total liabilities and stockholders'
  equity (deficit)......................  $  5,699,304   $ 23,207,409    $ 28,557,312
                                          ============   ============    ============

See accompanying notes.


F-3

 
DIGIRAD CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

                                                                                   SIX MONTHS ENDED
                                           YEARS ENDED DECEMBER 31,                    JUNE 30,
                                   -----------------------------------------   -------------------------
                                          1998           1999           2000          2000          2001
                                                                               (unaudited)   (unaudited)
--------------------------------------------------------------------------------------------------------
REVENUES:
  Products.......................  $   339,802   $    283,889   $  5,815,474   $1,456,480    $ 9,802,365
  Imaging services...............           --             --      1,259,948           --      4,216,575
  Licensing and other............    1,581,167             --             --           --             --
                                   -----------   ------------   ------------   -----------   -----------
Total revenues...................    1,920,969        283,889      7,075,422    1,456,480     14,018,940

COST OF REVENUES:
  Products.......................      388,172        264,545      9,834,351    3,601,803      6,437,769
  Imaging services...............           --             --        839,296           --      3,394,363
                                   -----------   ------------   ------------   -----------   -----------
Total cost of revenues...........      388,172        264,545     10,673,647    3,601,803      9,832,132
                                   -----------   ------------   ------------   -----------   -----------
Gross profit (loss)..............    1,532,797         19,344     (3,598,225)  (2,145,323)     4,186,808

OPERATING EXPENSES:
  Research and development.......    5,425,678     10,062,957      2,372,412    1,082,770      1,327,317
  Sales and marketing............      622,881      1,455,292      3,585,433    1,291,098      4,027,934
  General and administrative.....    2,533,452      1,967,050      2,878,199    1,071,668      2,898,832
  Amortization of intangible
    assets.......................           --             --        208,624        3,347        314,532
  Stock-based compensation.......           --             --        296,187           --      1,063,043
                                   -----------   ------------   ------------   -----------   -----------
Total operating expenses.........    8,582,011     13,485,299      9,340,855    3,448,883      9,631,658
                                   -----------   ------------   ------------   -----------   -----------
Loss from operations.............   (7,049,214)   (13,465,955)   (12,939,080)  (5,594,206)    (5,444,850)
Interest income..................      903,294        360,476        242,831      123,736        144,732
Interest expense.................      (46,041)       (86,942)      (780,123)    (220,704)      (545,391)
                                   -----------   ------------   ------------   -----------   -----------
Net loss.........................   (6,191,961)   (13,192,421)   (13,476,372)  (5,691,174)    (5,845,509)
Accretion of deferred issuance
  costs on preferred stock.......           --             --        (47,347)          --        (56,361)
                                   -----------   ------------   ------------   -----------   -----------
Net loss applicable to common
  stockholders...................  $(6,191,961)  $(13,192,421)  $(13,523,719)  $(5,691,174)  $(5,901,870)
                                   ===========   ============   ============   ===========   ===========
Basic and diluted net loss per
  share..........................  $     (1.87)  $      (3.90)  $      (3.61)  $    (1.65)   $     (1.35)
                                   ===========   ============   ============   ===========   ===========
Shares used to compute basic and
  diluted net loss per share.....    3,305,804      3,380,530      3,745,049    3,454,822      4,366,429
                                   ===========   ============   ============   ===========   ===========
----------
The composition of stock-based
  compensation is as follows:
  Cost of revenues...............                               $     64,392                 $   196,809
  Research and development.......                                      5,954                      61,116
  Sales and marketing............                                     36,950                     421,264
  General and administrative.....                                    188,891                     383,854
                                                                ------------                 -----------
                                                                $    296,187                 $ 1,063,043
                                                                ============                 ===========

See accompanying notes.


F-4

 
DIGIRAD CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

YEARS ENDED DECEMBER 31, 1998, 1999 AND 2000 AND THE SIX MONTHS ENDED JUNE 30,
2001(UNAUDITED)

                                                                                    NOTES
                               COMMON STOCK    ADDITIONAL                      RECEIVABLE                              TOTAL
                       --------------------       PAID-IN         DEFERRED           FROM     ACCUMULATED      STOCKHOLDERS'
                          SHARES     AMOUNT       CAPITAL     COMPENSATION   STOCKHOLDERS         DEFICIT   EQUITY (DEFICIT)
----------------------------------------------------------------------------------------------------------------------------
Balance at
  December 31,
  1997...............  3,284,423    $3,284    $  351,509     $        --      $      --     $(12,188,328)     $(11,833,535)
  Exercise of common
    stock options....     80,886        81        35,058              --             --               --            35,139
  Net loss...........         --        --            --              --             --       (6,191,961)       (6,191,961)
                       ---------    ------    ----------     -----------      ---------     ------------      ------------
Balance at
  December 31,
  1998...............  3,365,309     3,365       386,567              --             --      (18,380,289)      (17,990,357)
  Exercise of common
    stock options....     35,725        36        10,324              --         (4,180)              --             6,180
  Issuance of
    warrants in
    conjunction with
    debt.............         --        --       126,164              --             --               --           126,164
  Net loss...........         --        --            --              --             --      (13,192,421)      (13,192,421)
                       ---------    ------    ----------     -----------      ---------     ------------      ------------
Balance at
  December 31,
  1999...............  3,401,034     3,401       523,055              --         (4,180)     (31,572,710)      (31,050,434)
  Repayment of note
    receivable from
    stockholder......         --        --            --              --          4,180               --             4,180
  Exercise common
    stock options....    663,006       663       195,168              --        (85,919)              --           109,912
  Issuance of common
    stock in asset
    acquisitions
    (Note 2).........    300,000       300       410,700              --             --               --           411,000
  Commitment to issue
    common stock
    (Note 2).........         --        --       172,000              --             --               --           172,000
  Issuance of
    warrants in
    conjunction with
    debt.............         --        --       259,106              --             --               --           259,106
  Issuance of options
    and warrants to
    consultants......         --        --        32,272              --             --               --            32,272
  Deferred
    compensation.....         --        --       800,735        (800,735)            --               --                --
  Amortization of
    deferred
    compensation.....         --        --            --         263,915             --               --           263,915
  Net loss...........         --        --            --              --             --      (13,476,372)      (13,476,372)
  Accretion of
    deferred issuance
    costs on
    preferred
    stock............         --        --            --              --             --          (47,347)          (47,347)
                       ---------    ------    ----------     -----------      ---------     ------------      ------------
Balance at
  December 31,
  2000...............  4,364,040     4,364     2,393,036        (536,820)       (85,919)     (45,096,429)      (43,321,768)
  Exercise of common
    stock options
    (unaudited)......    214,128       214        76,637              --        (26,000)              --            50,851
  Repurchase of
    unvested
    restricted stock
    (unaudited)......     (3,565)       (3)       (1,350)             --             --               --            (1,353)
  Issuance of options
    and warrants to
    consultants
    (unaudited)......         --        --       243,029              --             --               --           243,029
  Deferred
    compensation
    (unaudited)......         --        --     1,996,183      (1,996,183)            --               --                --
  Amortization of
    deferred
    compensation
    (unaudited)......         --        --            --         820,014             --               --           820,014
  Net loss
    (unaudited)......         --        --            --              --             --       (5,845,509)       (5,845,509)
  Accretion of
    deferred issuance
    costs on
    preferred stock
    (unaudited)......         --        --            --              --             --          (56,361)          (56,361)
                       ---------    ------    ----------     -----------      ---------     ------------      ------------
Balance at June 30,
  2001(unaudited)....  4,574,603    $4,575    $4,707,535     $(1,712,989)     $(111,919)    $(50,998,299)     $(48,111,097)
                       =========    ======    ==========     ===========      =========     ============      ============

See accompanying notes.


F-5

 
DIGIRAD CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

                                                                                                 SIX MONTHS ENDED
                                                        YEARS ENDED DECEMBER 31,                     JUNE 30,
                                               ------------------------------------------   ---------------------------
                                                       1998           1999           2000           2000           2001
                                                                                             (unaudited)    (unaudited)
-----------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
  Net loss...................................  $(6,191,961)   $(13,192,421)  $(13,476,372)  $(5,691,174)   $(5,845,509)
  Adjustments to reconcile net loss to net
    cash used by operating activities:
    Depreciation and amortization............      573,030         733,947        939,959       367,794        866,516
    Amortization of intangibles..............           --              --        208,624         3,347        314,530
    Amortization of deferred compensation....           --              --        263,915            --        820,014
    Amortization of debt discount related to
      warrants issued in conjunction with
      debt...................................           --           6,942        174,949        20,957         55,482
    Stock options and warrants issued to
      consultants............................           --              --         32,272         2,640        243,029
    Changes in operating assets and
      liabilities:
      Accounts receivable....................      (83,977)        113,296     (2,952,106)   (1,298,786)    (1,932,999)
      Other assets...........................     (106,223)       (306,711)      (361,853)     (202,442)    (1,235,968)
      Inventories............................           --              --     (3,587,173)   (3,448,369)    (3,889,449)
      Accounts payable.......................      621,590         300,109      1,373,532       166,684        934,664
      Accrued compensation...................       (7,833)        169,122        577,657       130,593        372,758
      Accrued warranty and other accrued
        liabilities..........................     (267,700)         89,682      1,789,035       860,592        166,590
                                               -----------    ------------   ------------   -----------    -----------
Net cash used by operating activities........   (5,463,074)    (12,086,034)   (15,017,561)   (9,088,164)    (9,130,342)

INVESTING ACTIVITIES
  Asset acquisitions.........................           --              --     (2,172,000)           --             --
  Purchases of property and equipment........   (1,559,695)       (916,649)    (5,040,938)     (894,265)    (2,468,723)
  Patents and other assets...................     (103,859)        (12,664)       (30,050)        2,530        (48,614)
                                               -----------    ------------   ------------   -----------    -----------
Net cash used by investing activities........   (1,663,554)       (929,313)    (7,242,988)     (891,735)    (2,517,337)

FINANCING ACTIVITIES
  Net issuances of common stock..............       35,139           6,180        109,912        15,888         49,498
  Net borrowings under line of credit........           --              --        788,348            --      2,168,675
  Proceeds from issuance of notes payable....           --       2,000,000      4,000,000     1,000,000             --
  Repayment of obligation under notes
    payable..................................           --         (45,349)      (812,691)     (353,805)      (741,646)
  Net proceeds from sale of preferred
    stock....................................    1,500,000              --     17,948,295    10,637,321      5,798,033
  Proceeds from lease financing..............           --              --      4,239,075            --      1,596,708
  Repayment of obligations under capital
    leases...................................      (21,341)             --        (87,002)           --       (268,393)
  Repayment of note receivable from
    stockholder..............................           --              --          4,180            --             --
                                               -----------    ------------   ------------   -----------    -----------
Net cash provided by financing activities....    1,513,798       1,960,831     26,190,117    11,299,404      8,602,875
                                               -----------    ------------   ------------   -----------    -----------
Net increase (decrease) in cash and cash
  equivalents................................   (5,612,830)    (11,054,516)     3,929,568     1,319,505     (3,044,804)
Cash and cash equivalents at beginning of
  period.....................................   19,293,059      13,680,229      2,625,713     2,625,713      6,555,281
                                               -----------    ------------   ------------   -----------    -----------
Cash and cash equivalents at end of period...  $13,680,229    $  2,625,713   $  6,555,281   $ 3,945,218    $ 3,510,477
                                               ===========    ============   ============   ===========    ===========
SUPPLEMENTAL INFORMATION:
Cash paid during the period for interest.....  $    59,283    $     89,526   $    480,576   $   208,222    $   553,102
                                               ===========    ============   ============   ===========    ===========
Issuance of warrants in conjunction with
  debt.......................................  $        --    $    126,164   $    259,106   $    49,621    $        --
                                               ===========    ============   ============   ===========    ===========
Conversion of bridge notes into Series E
  preferred stock............................  $        --    $         --   $  2,000,000   $        --    $        --
                                               ===========    ============   ============   ===========    ===========
Stock issued for asset acquisitions..........  $        --    $         --   $    411,000   $        --    $        --
                                               ===========    ============   ============   ===========    ===========

See accompanying notes.


F-6

DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS
ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

THE COMPANY

Digirad Corporation (the "Company"), a Delaware corporation, designs, develops, manufactures and markets solid-state digital gamma cameras for use in nuclear medicine and provides mobile nuclear medicine imaging services. Nuclear medicine imaging provides unique information about organ function and physiology and can be used for the early detection of many forms of cancer and cardiovascular disease. The Company's portable gamma cameras, which incorporate its proprietary semiconductor detector technology, provide improved images, solid-state reliability, and can be formatted into unique lightweight sizes and shapes. In addition to conventional nuclear medicine applications, the Company's solid-state cameras offer the medical profession imagers that can be used in a variety of new clinical diagnostic imaging applications, which include cost saving applications in the surgical centers, emergency rooms, intensive care units, critical care units and other shared facilities.

BASIS OF PRESENTATION

In 2000, the Company formed two Delaware corporations, Digirad Imaging Solutions, Inc. and its subsidiary Digirad Imaging Systems, Inc., together "DIS", to provide turn-key nuclear cardiology imaging to physicians in their offices on a national basis. DIS is a wholly owned subsidiary of Digirad and was capitalized by contributing certain acquired assets (see Note 2). The accompanying consolidated financial statements include the operations of DIS. Intercompany accounts have been eliminated in consolidation.

INTERIM FINANCIAL DATA

The accompanying consolidated financial statements for the six months ended June 30, 2000 and 2001 are unaudited. The unaudited financial statements have been prepared on the same basis as the audited financial statements and, in the opinion of management, include all adjustments, consisting of only normal recurring adjustments, necessary to state fairly the financial information set forth therein, in accordance with generally accepted accounting principles.

The results of operations for the interim period ended June 30, 2001 are not necessarily indicative of the results which may be reported for any other interim period or for the year ending December 31, 2001.

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and disclosures made in the accompanying notes to the consolidated financial statements. Actual results could differ from those estimates.

PRO FORMA STOCKHOLDERS' EQUITY

If an initial public offering contemplated by this Prospectus is consummated under the terms presently anticipated, all shares of redeemable convertible preferred stock outstanding at June 30, 2001 will automatically convert into 27,129,568 common shares. Unaudited pro forma stockholders' equity at June 30, 2001, as adjusted for the conversion of the redeemable convertible preferred stock is disclosed in the accompanying balance sheet.


F-7

DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS
ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

CASH AND CASH EQUIVALENTS

The Company considers all investments with an original maturity of three months or less when purchased to be cash equivalents. Cash equivalents primarily represent funds invested in money market funds whose cost equals market value.

OTHER ASSETS

Other assets primarily consist of legal, accounting and other costs incurred in connection with a proposed public offering of common stock in the Company. These deferred offering costs total $626,572 and will be charged against the proceeds received in connection with the offering. In the event the offering is unsuccessful, these costs will be charged against the operations of the Company.

CONCENTRATION OF CREDIT RISK

The Company sells its products to customers in the United States and Japan. A relatively small number of customers account for a significant percentage of the Company's revenues. For the year ended December 31, 2000, three product customers accounted for 15.9%, 11.6% and 10.1% of our consolidated revenues. However, for the six months ended June 30, 2001, no product customers accounted for 10% or more of consolidated revenues. No imaging services customers accounted for 10% or more of our consolidated revenues for the year ended December 31, 2000 or the six months ended June 30, 2001. Revenues in 1998 and 1999 were for sales of various pre-commercialization components of the Company's products, licensing and contract research and were not representative of the Company's current products.

A significant percentage of the Company's net imaging services revenue in 2000 and 2001 is derived from governmental agencies, such as Medicare. Management believes that there are minimal credit risks associated with transactions and balances with these governmental agencies. However, there is a potential risk that reimbursement rates can be reduced in the future.

The Company maintains reserves for potential credit losses and contractual allowances, which historically have been within management's estimates.

INVENTORIES

Inventories are stated at the lower of cost or market, cost being determined on a first-in, first-out basis.

PROPERTY AND EQUIPMENT

Depreciation and amortization of property and equipment, including assets recorded under capital leases, is provided using the straight-line method over the shorter of the estimated useful lives of the related assets, which is generally 3 to 10 years, or the lease term if applicable.

INTANGIBLES

Intangibles include acquired customer contracts, a covenant not-to-compete, patents and trademarks and are recorded at cost. Intangibles, except for patents, are amortized over their estimated useful lives, which range from three to five years. Patents are amortized over the lesser of their estimated useful or legal lives (up to 20 years).


F-8

DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS
ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

IMPAIRMENT OF LONG-LIVED ASSETS

The Company follows Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 121, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the projected discounted future net cash flows arising from the assets. SFAS 121 also addresses the accounting for long-lived assets that are expected to be disposed of. To date, no such impairments have been identified.

REVENUE RECOGNITION

The Company recognizes revenue when all four of the following criteria are met:
(i) persuasive evidence that an arrangement exists; (ii) delivery of the products and/or services has occurred; (iii) the selling price is fixed or determinable; and (iv) collectibility is reasonably assured. In addition, the Company complies with SEC Staff Accounting Bulletin No. 101, REVENUE RECOGNITION IN FINANCIAL STATEMENTS ("SAB 101"), which became effective in the fourth quarter of 2000. SAB 101 sets forth guidelines on the timing of revenue recognition based upon factors such as passage of title, installation, payment and customer acceptance.

The Company has two primary sources of revenue which are product sales and imaging services. Product revenues consist of revenues from the sales of gamma cameras and revenues are recognized generally upon shipment and passage of title. Revenue for products that have not previously satisfied customer acceptance requirements or from sales where customer payments are based solely on customer acceptance are recognized upon customer acceptance. The Company also provides installation and training for camera sales. The installation is outsourced to a national service company and training is provided by Company representatives. Neither service is essential to the functionality of the product. Both services are performed shortly after delivery and represent an insignificant cost to the Company. The Company accrues these costs at the time of shipment.

Imaging services revenue is derived from the Company's mobile nuclear imaging services. Revenue related to mobile imaging services is recognized at the time services are performed and collection is reasonably assured. Imaging services revenue is billed on a per procedure or per day basis. The Company is reimbursed for mobile imaging services provided to patients under certain programs administered by governmental agencies and private insurance companies. Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. The Company believes that they are in compliance with all applicable laws and regulations and they are not aware of any pending or threatened investigations involving allegations of potential wrongdoing. Non-compliance can result in significant regulatory action including fines, penalties and exclusion from the Medicare and Medicaid programs.

In 1998, in addition to certain grant revenues, the Company also received $1,250,000 from a collaboration agreement that was terminated in 1999.

STOCK-BASED COMPENSATION

The Company has elected to follow Accounting Principles Board ("APB") Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEEs, and related Interpretations in accounting for its employee stock


F-9

DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS
ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

options. Under APB 25, if the exercise price of the Company's employee stock options is not less than the fair market value of the underlying stock on the date of grant, no compensation expense is recognized. In conjunction with the Company's initial public offering contemplated by this prospectus and other events that occurred in 2000, the Company reviewed its exercise prices and arrived at a revised fair value for certain stock options granted subsequent to June 30, 2000. With respect to the options granted between June 30, 2000 and December 31, 2000 and for the six months ended June 30, 2001, the Company has recorded deferred stock compensation of $800,735 and $1,996,183, respectively, for the difference between the original exercise price per share determined by the Board of Directors and the revised estimate of fair value per share at the respective grant date. The approximate weighted average exercise price and approximate weighted average revised fair value per share for the 798,250 options granted between June 30, 2000 and December 31, 2000 was $0.50 and $1.50, respectively. The approximate weighted average exercise price and approximate weighted average revised fair value per share for the 1,169,200 options granted during the six months ended June 30, 2001 was $1.13 and $2.84, respectively. Deferred stock compensation is recognized and amortized on an accelerated basis in accordance with Financial Accounting Standards Board Interpretation ("FIN") No. 28, ACCOUNTING FOR STOCK APPRECIATION RIGHTS AND OTHER VARIABLE STOCK OPTION OR AWARD PLANs, over the vesting period of the related options, generally four years.

Deferred compensation for stock options and warrants granted to non-employees is recorded at fair value as determined in accordance with SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATIOn, and Emerging Issues Task Force ("EITF")
No. 96-18, ACCOUNTING FOR EQUITY INSTRUMENTS THAT ARE ISSUED TO OTHER THAN EMPLOYEES FOR ACQUIRING OR IN CONJUNCTION WITH SELLING GOODS OR SERVICES. The fair value of the unvested options and warrants is periodically remeasured and the related amortization is adjusted as necessary. Compensation expense related to stock options and warrants to purchase common stock issued to non-employees was $32,272 for the year ended December 31, 2000 and $243,029 for the six months ended June 30, 2001.

WARRANTY COSTS

The Company provides a warranty on certain of its products, generally for periods of up to 12 months and accrues the estimated cost at the time revenue is recorded.

RESEARCH AND DEVELOPMENT

Research and development costs are expensed as incurred.

ADVERTISING COSTS

Advertising costs are expensed as incurred. Total advertising costs for the years ended December 31, 1998, 1999 and 2000 and for the six months ended June 30, 2000 and 2001, were $63,183, $205,500, $133,987, $117,787 and $174,883, respectively.

COMPREHENSIVE INCOME

SFAS No. 130, REPORTING COMPREHENSIVE INCOME, requires that all components of comprehensive income, including net income, be reported in the financial statements in the period in which they are recognized. Comprehensive income is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources, including unrealized gains and losses on investments and foreign currency translation adjustments. The Company's comprehensive loss is the same as the reported net loss for all periods.


F-10

DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS
ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

NET LOSS PER SHARE

The Company calculated net loss per share in accordance with SFAS 128, EARNINGS PER SHARE, and SAB No. 98. Basic earnings per share ("EPS") is calculated by dividing the net income or loss available to common stockholders by the weighted average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted EPS is computed by dividing the net income available to common stockholders by the weighted average number of common shares outstanding for the period and the weighted average number of dilutive common stock equivalents outstanding for the period determined using the treasury-stock method. For purposes of this calculation, common stock subject to repurchase by the Company, convertible preferred stock, options, and warrants are considered to be common stock equivalents and are only included in the calculation of diluted earnings per share when their effect is dilutive. Under the provisions of SAB No. 98, common shares issued for nominal consideration (as defined), if any, would be included in the per share calculations as if they were outstanding for all periods presented. No common shares have been issued for nominal consideration.

Potentially dilutive securities totaling 21,973,776, 21,752,688, 30,412,668 and 33,466,687 for the years ended December 31, 1998, 1999 and 2000 and the six months ended June 30, 2001, respectively, were excluded from historical basic and diluted earnings per share because of their anti-dilutive effect.


F-11

 
DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS
ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

The unaudited pro forma basic and diluted net loss per share calculations assume the conversion of all outstanding shares of preferred stock into common shares using the as-if converted method as of January 1, 2000 or the date of issuance, if later.

                                              YEARS ENDED DECEMBER 31,             SIX MONTHS ENDED JUNE 30,
                                      -----------------------------------------   ----------------------------
                                             1998           1999           2000          2000             2001
--------------------------------------------------------------------------------------------------------------
Numerator:
  Net loss..........................  $(6,191,961)  $(13,192,421)  $(13,476,372)  $(5,691,174)     $(5,845,509)
  Accretion of deferred issuance
    costs on preferred stock........           --             --        (47,347)           --          (56,361)
                                      -----------   ------------   ------------   -----------      -----------
Net loss applicable to common
  stockholders......................  $(6,191,961)  $(13,192,421)  $(13,523,719)  $(5,691,174)     $(5,901,870)
                                      ===========   ============   ============   ===========      ===========
Denominator:
  Weighted average common shares....    3,305,804      3,384,212      3,809,507     3,483,857        4,536,135
  Weighted average unvested common
    shares subject to repurchase....           --         (3,682)       (64,458)      (29,035)        (169,706)
                                      -----------   ------------   ------------   -----------      -----------
Denominator for basic and diluted
  earnings per share................    3,305,804      3,380,530      3,745,049     3,454,822        4,366,429
                                      ===========   ============   ============   ===========      ===========
Basic and diluted net loss per
  share.............................  $     (1.87)  $      (3.90)  $      (3.61)  $     (1.65)     $     (1.35)
                                      ===========   ============   ============   ===========      ===========
Pro forma basic and diluted net loss
  per share.........................                               $      (0.53)                   $     (0.19)
                                                                   ============                    ===========
Shares used above...................                                  3,745,049                      4,366,429
Pro forma adjustment to reflect
  assumed weighted average effect of
  conversion of preferred stock.....                                 21,729,208                     26,069,875
                                                                   ------------                    -----------
Pro forma shares used to compute
  basic and diluted net loss per
  share.............................                                 25,474,257                     30,436,304
                                                                   ============                    ===========


F-12

DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS
ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1999, the FASB issued SFAS No. 137, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES--DEFERRAL OF EFFECTIVE DATE OF FASB STATEMENT NO. 133. SFAS No. 137 defers for one year the effective date of SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which was originally issued in June 1998. SFAS No. 133 now will apply to all fiscal quarters of all fiscal years beginning after June 15, 2000.

SFAS No. 133 requires the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. As of December 31, 2000, the Company did not hold any derivative instruments, or conduct any hedging activities. Therefore there is no anticipated impact to the consolidated financial statements for the adoption of SFAS No. 133.

In June 2001, the FASB issued SFAS No. 141, BUSINESS COMBINATIONS, and SFAS No. 142, GOODWILL AND INTANGIBLE ASSETS. SFAS No. 141 is effective for all business combinations completed after June 30, 2001. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001; however, certain provisions of this Statement apply to goodwill and other intangible assets acquired between July 1, 2001 and the effective date of SFAS No. 142. Major provisions of these Statements and their effective dates for the Company are as follows: (i) all business combinations initiated after June 30, 2001 must use the purchase method of accounting. The pooling of interest method of accounting is prohibited except for transactions initiated before July 1, 2001; (ii) Intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability; (iii) Goodwill and intangible assets with indefinite lives acquired after June 30, 2001, will not be amortized. Effective January 1, 2002, all previously recognized goodwill and intangible assets with indefinite lives will no longer be subject to amortization; (iv) Effective January 1, 2002, goodwill and intangible assets with indefinite lives will be tested for impairment annually and whenever there is an impairment indicator; and (v) all acquired goodwill must be assigned to reporting units for purpose of impairment testing and segment reporting. The Company is currently evaluating the impact that SFAS Nos. 141 and 142 will have on its financial reporting requirements.

2. ASSET ACQUISITIONS

On August 31, 2000, the Company entered into an Asset Purchase Agreement with Florida Cardiology and Nuclear Medicine Group ("FC"), a provider of fixed site and mobile nuclear imaging services that operates in Florida. The Company paid $1,648,000 (including 300,000 shares of common stock valued at $411,000) to acquire the accounts receivables, customer contracts of the mobile nuclear imaging services of FC and a covenant not-to-compete from the seller. The Company utilizes its technology, products, processes and procedures to provide services to the customers acquired. The Company allocated the purchase price to the assets acquired as follows: $101,000 to accounts receivable and


F-13

DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS
ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

$1,547,000 to customer contracts. The cost of the customer contracts is being amortized over five years.

As additional consideration for the purchase of the assets, the Company shall pay to FC a payment based on earnings before interest, income taxes, depreciation and amortization ("EBITDA") during the six months ending August 31, 2001. The payout is payable 50% in cash and 50% in common stock to be issued at the fair value at the date of issuance. In addition, if the Company meets certain revenue collection thresholds during the nine-month period ending one year from the closing of the purchase, the Company will issue 100,000 shares of common stock to FC.

As part of the agreement with FC, the Company entered into a service agreement with FC, whereby FC provided medical billing and collection services. In 2001, the Company replaced FC with another third-party billing and collections service provider.

In November 2000, the Company completed an Asset Purchase Agreement with Nuclear Imaging Systems, Inc. and Cardiovascular Concepts, P.C. (together, "NIS"), a provider of fixed site and mobile nuclear imaging services, which operated in several Mid-Atlantic states. The Company paid $935,000 primarily to acquire NIS's customer contracts. The Company utilizes its technology, products, processes and procedures to provide imaging services to the customers acquired. The Company allocated the purchase price to the assets acquired as follows:
$56,000 to fixed assets, $7,000 to deposits and $872,000 to customer contracts. The cost of the customer contracts is being amortized over five years.

As part of the Asset Purchase Agreement, the Company entered into a medical billing and collection service agreement with Medical Management Concepts, Inc. ("MMC"), a subsidiary of NIS. In 2001 the agreement with MMC was terminated and the Company replaced MMC with another third-party billing and collections service provider.

In addition to the Asset Purchase Agreement, the Company entered into a consulting agreement with the principal shareholder of NIS, whereby the consultant agreed to provide consulting services (as defined) for a period of three years ending on September 29, 2003. As compensation, the consultant could receive up to 150,000 shares of the Company's common stock, based on achieving certain revenue targets; however, as long as the consultant does not breach the non-competition conditions, he will receive a minimum of 100,000 shares of common stock. The fair value of the minimum 100,000 shares of common stock is $172,000 and has been recorded as a covenant not-to-compete on the accompanying balance sheet and amortized over three years.

3. FINANCIAL STATEMENT DETAILS

The composition of certain balance sheet accounts is as follows:

 
ACCOUNTS RECEIVABLE

                                                                    DECEMBER 31,
                                                              -------------------------      JUNE 30,
                                                                     1999          2000          2001
-----------------------------------------------------------------------------------------------------
Accounts receivable.........................................  $       --    $3,093,142    $5,221,011
Less allowance for doubtful accounts........................          --       (39,121)     (233,991)
                                                              ----------    ----------    ----------
                                                              $       --    $3,054,021    $4,987,020
                                                              ==========    ==========    ==========


F-14

 
DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS
ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

INVENTORIES

                                                                   DECEMBER 31,
                                                              -----------------------      JUNE 30,
                                                                   1999          2000          2001
---------------------------------------------------------------------------------------------------
Raw materials...............................................  $266,574    $1,620,999    $2,074,876
Work-in-progress............................................    22,214     2,110,857     4,909,053
Finished goods..............................................        --       144,105       781,481
                                                              --------    ----------    ----------
                                                              $288,788    $3,875,961    $7,765,410
                                                              ========    ==========    ==========

 
PROPERTY AND EQUIPMENT

                                                                    DECEMBER 31,
                                                              -------------------------       JUNE 30,
                                                                     1999          2000           2001
------------------------------------------------------------------------------------------------------
Machinery and equipment.....................................  $ 2,155,228   $ 6,074,846   $ 8,176,057
Furniture and fixtures......................................      212,932       239,505       227,495
Computers and software......................................    1,121,685     1,313,903     1,531,845
Leasehold improvements......................................      773,167       891,757       919,711
Construction in process.....................................      140,451       365,279       425,546
                                                              -----------   -----------   -----------
                                                                4,403,463     8,885,290    11,280,654
Less accumulated depreciation and amortization..............   (2,251,979)   (2,577,323)   (3,370,480)
                                                              -----------   -----------   -----------
                                                              $ 2,151,484   $ 6,307,967   $ 7,910,174
                                                              ===========   ===========   ===========

During 2000 and 2001, the Company entered into a series of financing transactions structured as capital leases. The equipment, consisting of vans equipped with the Company's portable gamma cameras, is used by DIS to provide mobile nuclear imaging services. The terms of these leases generally range from 36 to 63 months. The cost of the equipment was $2,973,636 ($106,899 of accumulated depreciation) at December 31, 2000 and $4,112,650 ($396,939 of accumulated depreciation) at June 30, 2001.

 
INTANGIBLES

                                                                   DECEMBER 31,
                                                              -----------------------      JUNE 30,
                                                                   1999          2000          2001
---------------------------------------------------------------------------------------------------
Acquired customer contracts.................................  $     --    $2,419,000    $2,419,000
Patents and trademarks......................................   421,458       370,335       418,949
Covenant not-to-compete.....................................        --       172,000       172,000
                                                              --------    ----------    ----------
                                                               421,458     2,961,335     3,009,949
Less accumulated amortization...............................    (9,301)     (137,800)     (452,330)
                                                              --------    ----------    ----------
                                                              $412,157    $2,823,535    $2,557,619
                                                              ========    ==========    ==========


F-15

 
DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS
ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

OTHER ACCRUED LIABILITIES

                                                                  DECEMBER 31,
                                                              ---------------------      JUNE 30,
                                                                   1999        2000          2001
-------------------------------------------------------------------------------------------------
Accrued interest............................................  $ 29,817    $154,415    $   91,217
Customer deposits...........................................        --     125,200        11,200
Sales tax payable...........................................     9,675     118,255       183,435
Accrued royalties...........................................        --      96,000       125,500
Accrued offering costs......................................        --          --       337,814
Other accrued liabilities...................................    66,753     431,268       543,803
                                                              --------    --------    ----------
                                                              $106,245    $925,138    $1,292,969
                                                              ========    ========    ==========

4. DEBT

The composition of the Company's debt balance is as follows:

 

                                                                    DECEMBER 31,
                                                              -------------------------       JUNE 30,
                                                                     1999          2000           2001
------------------------------------------------------------------------------------------------------
Lines of credit.............................................  $       --    $   788,348   $ 2,957,023
Loan and security agreement.................................   1,954,650      3,141,960     2,400,314
Capital lease obligations (Note 5)..........................          --      4,152,074     5,480,389
Debt discount...............................................    (119,220)      (203,380)     (147,898)
                                                              ----------    -----------   -----------
                                                               1,835,430      7,879,002    10,689,828
Current portion of debt.....................................    (414,672)    (2,934,580)   (5,613,945)
                                                              ----------    -----------   -----------
Long-term debt, less current portion........................  $1,420,758    $ 4,944,422   $ 5,075,883
                                                              ==========    ===========   ===========

NOTES PAYABLE TO FINANCIAL INSTITUTIONS

In April 2000, the Company entered into a line of credit with a bank for a $2,500,000 revolving line of credit. Borrowings under the line of credit accrue interest at the bank's floating prime rate plus 1% (9.75% at December 31, 2000) and are limited to the available borrowing base (as defined). In July 2001, the line of credit was increased to $4,300,000 and the amended line of credit accrues interest at the bank's floating prime rate plus 2%. The Company is required to make monthly interest payments. The revolving line of credit expires July 31, 2002 with any unpaid balance due upon expiration.

In November 1999, the Company entered into a loan and security agreement to borrow up to $3,000,000. In August 2000, the Company modified its November 1999 loan agreement to borrow an additional $1,000,000. Borrowings under this agreement accrue interest at rates between 13.53% and 14.40%. The Company is required to make monthly payments of $156,273 on principal and interest through November 2002.

During 1999 and 2000, in conjunction with the loan and security agreement (as amended), the Company issued the lender warrants to purchase 294,713 shares of Series E preferred stock at a price of $3.036 per share and valued the warrants at $280,529. The warrants are exercisable immediately. The value of the warrant is recorded as debt discount and is amortized to interest expense on a straight-line basis over the term of the debt. The fair value of the warrants was determined using the Black-Scholes option pricing model with the following assumptions: dividend yield of 0%; expected volatility of 75%; risk-free interest rate of 6%; and a term of three years.


F-16

DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS

ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

In January 2001, the Company entered into a loan and security agreement related to DIS for a revolving line of credit. The Company can draw up to $2,500,000 and an additional $2,500,000 upon approval by the lender's credit committee. The borrowings under the line of credit are limited to 85% of Qualified Account (as defined) and accrue interest at the higher of prime plus 1.25% or 10.25%. The revolving credit line expires in January 2004.

NOTES PAYABLE TO STOCKHOLDERS

The Company has notes payable to stockholders totaling $735,000 that bear interest at 6.35% per year. The notes mature on March 31 of the year immediately following the first year in which the Company generates cash from operations. Since the Company does not expect to generate cash from operations in the year ended December 31, 2001, these notes have been classified as long-term.

Principal maturities on long-term debt, excluding capital lease obligations (see  
Note 5), and notes payable to stockholders are as follows at December 31, 2000:

2001.......................  $1,536,023
2002.......................   1,605,937
                             ----------
                             $3,141,960
                             ==========

The Company's borrowings are generally subject to financial and other restrictive covenants. Substantially all of the Company's assets have been pledged as collateral.

5. LEASE COMMITMENTS

The Company leases its facilities under non-cancelable operating leases which expire through 2002. Rent expense was $303,475, $390,919, $418,470, $199,549, and $346,188 for the years ended December 31, 1998, 1999 and 2000 and the six months ended June 30, 2000 and 2001, respectively.

Annual future minimum lease payments as of December 31, 2000 are as follows:

 

                                                               OPERATING       CAPITAL
                                                                  LEASES        LEASES
--------------------------------------------------------------------------------------
2001........................................................   $351,872    $ 1,240,640
2002........................................................    158,122      1,305,916
2003........................................................     69,375      1,199,575
2004........................................................     28,125        880,552
2005........................................................     24,375        880,552
Thereafter..................................................      4,063             --
                                                               --------    -----------
Total minimum lease payments................................   $635,932      5,507,235
                                                               ========
Less amount representing interest...........................                (1,355,161)
                                                                           -----------
Present value of future minimum capital lease obligations...                 4,152,074
Less amounts due in one year................................                  (721,163)
                                                                           -----------
Long-term portion of capital lease obligations..............               $ 3,430,911
                                                                           ===========


F-17

 
DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS

ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

6. REDEEMABLE CONVERTIBLE PREFERRED STOCK

                                                                   DECEMBER 31, 2000              JUNE 30, 2001
                                                               --------------------------   --------------------------
                                                                               REDEMPTION                   REDEMPTION
                                                                                      AND                          AND
                                                   PRICE PER        NUMBER    LIQUIDATION        NUMBER    LIQUIDATION
DATE ISSUED                               SERIES       SHARE     OF SHARES          VALUE     OF SHARES          VALUE
----------------------------------------------------------------------------------------------------------------------
March 1995............................   A          $  1.00     2,250,000    $ 2,250,000     2,250,000    $ 2,250,000
December 1995.........................   B          $  1.10     2,281,000      2,509,100     2,281,000      2,509,100
August 1997...........................   C          $  1.25     4,800,000      6,000,000     4,800,000      6,000,000
August 1997...........................   D          $2.3073     8,668,140     20,000,000     8,668,140     20,000,000
June 1998.............................   E          $ 3.036       494,071      1,500,000       494,071      1,500,000
March, April, June, November and
  December 2000.......................   E          $ 3.036     6,697,646     20,334,053     6,697,646     20,334,053
January, March and April 2001.........   E          $ 3.036            --             --     1,938,711      5,885,927
                                                               ----------    -----------    ----------    -----------
                                                               25,190,857     52,593,153    27,129,568     58,479,080
                                                               ==========                   ==========
Less: Unamortized deferred issuance
  costs                                                                         (338,411)                    (369,944)
                                                                             -----------                  -----------
                                                                             $52,254,742                  $58,109,136
                                                                             ===========                  ===========

Deferred issuance costs through December 31, 2000 and June 30, 2001 for all series of preferred stock totaled $385,758 and $473,652, respectively, and are being accreted up to the redemption value through July 31, 2004 (the earliest redemption date).

The preferred stock is redeemable on or after July 31, 2004, upon the request of at least 66 2/3% of the holders of preferred stock. The Company shall redeem all outstanding shares of preferred stock by paying in cash its liquidation value plus declared but unpaid dividends. No dividends have been declared through June 30, 2001.

The preferred stock will automatically be converted into shares of common stock upon the closing of a sale of the Company's common stock in a public offering registered under the Securities Act of 1933 which results in aggregate gross proceeds equal to or exceeding $15,000,000 at a price equal to or exceeding $7.50 per share of common stock, or with the approval of holders of at least 75% of the outstanding shares of preferred stock and the approval of 60% of the holders of Series D. Each share of the Series A, B, C, D, and E preferred stock is convertible, at the option of the holder, into one share of the Company's common stock, which has been reserved for issuance upon conversion of the preferred stock, subject to certain antidilution adjustments.

Holders of the Series A, B, C, D, and E preferred stock are entitled to receive dividends, if and when declared by the Board of Directors, at a rate of $0.10, $0.11, $0.125, $0.231, and $0.304 per share per annum, respectively. The holder of each share of preferred stock is entitled to the number of votes equal to the number of shares of common stock into which the preferred stock could be converted. The Company is subject to certain covenants under the agreements that require the vote or written consent by a majority of the then outstanding preferred shares regarding certain changes in the rights and interests of the preferred shares. The shareholders also have certain antidilutive rights.


F-18

DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS

ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

In the event of any liquidation, dissolution or winding up of the Company, the holders of preferred stock are entitled to receive their liquidation value prior and in preference to any distribution of the assets or surplus funds of the Company to the holders of common stock. If, upon the occurrence of such event, the assets and funds distributed among the holders of preferred stock are insufficient to permit full payment, the entire assets and funds of the Company would be distributed among the preferred shareholders in proportion to the product of the liquidation preference of each such share and the number of such shares owned by each such holder.

7. STOCKHOLDERS' EQUITY (DEFICIT)

WARRANTS

During 2000, in conjunction with two consulting agreements, the Company issued two warrants to purchase 10,000 and 500 shares of the Company's common stock at $1.50 and $3.04 per share, respectively. The warrants are exercisable immediately and expire in November 2005. The fair value of the warrants was $5,670.

During the six months ended June 30, 2001, in conjunction with various sales and marketing arrangements, the Company issued warrants to purchase 90,000 shares of the Company's common stock at prices ranging from $1.50 to $3.04 per share. The warrants are exercisable immediately and expire five years from the date of issuance. The fair value of the warrants was $138,300.

In September 2000, in conjunction with convertible bridge note financing the Company issued warrants to purchase up to 65,875 shares of Series E preferred stock at $3.036 per share. The warrants are exercisable immediately and expire the earlier of (i) September 2005 or (ii) the closing of an initial public offering. The fair value of the warrants was $104,741 and was recognized as interest expense in December 2000 due to the conversion of the bridge notes.

During 1999 and 2000, in connection with the Company's loan security agreements, the Company issued 294,713 warrants to purchase Series E preferred stock at a price of $3.036 per share. The fair value of the warrants issued was $126,164 in 1999 and $154,365 in 2000.

All of the warrants above were valued using the Black-Scholes option pricing model with the following assumptions: dividend yield of 0%; expected volatility of 75%; risk-free interest rate of 6%; and a term of three years.

STOCK OPTIONS

In December 1998, the Company's 1997 Stock Option/Stock Issuance Plan was replaced with the 1998 Stock Option/Stock Issuance Plan ("1998 Plan") under which 1,000,000 shares of common stock were reserved for issuance upon exercise of options granted by the Company. Under all stock option plans, the Company is authorized to issue an aggregate of 6,654,860 shares of common stock. Terms of the stock option agreements, including vesting requirements (which is generally four years), are determined by the Board of Directors. Upon grant, the options are exercisable immediately; however any exercised but unvested shares are subject to repurchase by the Company at the original exercise price. Options granted have a term of up to ten years.


F-19

 
DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS
ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

The following table summarizes option activity under the stock option plans:

                                                                            WEIGHTED
                                                                             AVERAGE
                                                                            EXERCISE
                                                                  SHARES       PRICE
------------------------------------------------------------------------------------
Outstanding at December 31, 1997............................   2,506,360    $   0.31
  Granted...................................................   1,248,170    $   0.33
  Cancelled.................................................    (193,079)   $   0.42
  Exercised.................................................     (80,886)   $   0.43
                                                              ----------
Outstanding at December 31, 1998............................   3,480,565    $   0.31
  Granted...................................................     773,500    $   0.35
  Cancelled.................................................  (1,164,991)   $   0.26
  Exercised.................................................     (35,725)   $   0.29
                                                              ----------
Outstanding at December 31, 1999............................   3,053,349    $   0.34
  Granted...................................................   2,574,964    $   0.48
  Cancelled.................................................    (333,754)   $   0.36
  Exercised.................................................    (663,006)   $   0.30
                                                              ----------
Outstanding at December 31, 2000............................   4,631,553    $   0.42
  Granted...................................................   1,230,700    $   1.14
  Cancelled.................................................     (58,209)   $   0.68
  Exercised.................................................    (214,127)   $   0.37
                                                              ----------
Outstanding at June 30, 2001................................   5,589,917    $   0.58
                                                              ==========

As of December 31, 2000 and June 30, 2001, 1,202,190 and 40,264 shares, respectively, were available for future grant.

Following is a further breakdown of the options outstanding as of December 31, 2000:

 

                                                             WEIGHTED                     WEIGHTED
                                            WEIGHTED          AVERAGE                      AVERAGE
                                             AVERAGE   EXERCISE PRICE               EXERCISE PRICE
                             OPTIONS     CONTRACTUAL       OF OPTIONS      VESTED        OF VESTED
EXERCISE PRICE           OUTSTANDING   LIFE IN YEARS      OUTSTANDING     OPTIONS          OPTIONS
--------------------------------------------------------------------------------------------------
    $            0.21        606,995             5.0    $       0.21      579,584    $       0.21
    $            0.25        360,527             7.1    $       0.25      265,919    $       0.25
    $            0.35      2,155,174             8.6    $       0.35      646,971    $       0.35
    $            0.50      1,158,057             9.6    $       0.50       98,984    $       0.50
    $            0.75        300,000             5.2    $       0.75      285,000    $       0.75
    $    3.04 - $3.50         50,800             9.4    $       3.41       50,800    $       3.41
                        ------------    ------------   -------------    ---------   -------------
                           4,631,553             8.1    $       0.42    1,927,258    $       0.44
                        ============    ============   =============    =========   =============

The weighted average fair values of options granted in 1998, 1999, and 2000 were $0.08, $0.07, and $0.59, respectively.

Adjusted pro forma information regarding net loss is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that


F-20

DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS
ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

Statement. The fair value for these options was estimated at the date of grant using the Minimum Value pricing model with the following weighted- average assumptions for 1998, 1999 and 2000: a risk-free interest rates of 5%, 5% and 6%, respectively; a dividend yield of 0%; and a life of the option of five, five and six years, respectively.

For purposes of pro forma disclosures, the estimated fair value of the options is amortized on an accelerated basis in accordance with FIN 28 over the vesting period. The Company's pro forma net loss information is as follows:

 

                                                                      YEARS ENDED DECEMBER 31,
                                                              -----------------------------------------
                                                                     1998           1999           2000
-------------------------------------------------------------------------------------------------------
Pro forma net loss..........................................  $(6,244,166)  $(13,307,042)  $(13,632,212)
Pro forma net loss per share-basic and diluted..............  $     (1.89)  $      (3.94)  $      (3.64)

The pro forma results above are not likely to be representative of the effects of applying SFAS 123 on reported net income or loss for future years.

NOTES RECEIVABLE FROM STOCKHOLDERS

At December 31, 1999 and 2000 and June 30, 2001, the Company had notes receivable from employee stockholders of $4,180, $85,919 and $111,919, respectively. The notes relate to the exercise of common stock options, are full recourse and bear interest at 6% per year. The notes are due on the earlier of
(i) the date on which the employee ceases to be employed by the Company,
(ii) 90 days after an initial public offering of the Company's common stock; or
(iii) May 15, 2010.

 
COMMON SHARES RESERVED FOR ISSUANCE

The following table summarizes common shares reserved for future issuance:

                                                               DECEMBER 31,      JUNE 30,
                                                                       2000          2001
-----------------------------------------------------------------------------------------
Redeemable convertible preferred stock......................     25,190,857    27,129,568
Convertible preferred stock warrants........................        360,588       360,588
Common stock warrants.......................................         10,500       100,500
Common stock options........................................      5,833,743     5,630,181
Commitment to issue common stock (Note 2)...................        150,000       150,000
                                                              -------------   -----------
Total common shares reserved for issuance...................     31,545,688    33,370,837
                                                              =============   ===========

8. INCOME TAXES

As of December 31, 2000, the Company had federal and California income tax net operating loss carryforwards of approximately $39,896,000 and $27,920,000, respectively. The difference between the federal and California tax loss carryforwards is primarily attributable to the 50% limitation in the utilization of California net operating loss carryforwards. The federal tax loss carryforwards will begin expiring in 2006 unless previously utilized. The California tax loss carryforwards will begin to expire in 2002 unless previously utilized. The Company also has federal and California research and development and other credit carryforwards of approximately $1,570,000 and $1,250,000, respectively. The federal research and development and other credit carryforwards begin to expire in 2005 unless previously utilized.


F-21

DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS

ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

The Company's net operating loss and credit carryforwards are subject to an annual limitation on their use as a result of changes in ownership during 1995 and 1997, pursuant to Internal Revenue Code Sections 382 and 383. However, these annual limitations are not expected to have a material affect on the Company's ability to utilize its carryforwards.

Significant components of the Company's deferred tax assets are shown below. A valuation allowance, of which $5,402,000 relates to 2000, has been recognized to offset the deferred tax assets, as realization of such assets is uncertain.

 

                                                                     DECEMBER 31,
                                                              ---------------------------
                                                                      1999           2000
-----------------------------------------------------------------------------------------
Deferred tax assets:
  Capitalized research expense..............................  $  1,517,000   $  1,011,000
  Net operating loss carryforwards..........................    10,535,000     15,569,000
  Research and development and other credits................     1,332,000      2,193,000
  Other, net................................................       536,000        963,000
                                                              ------------   ------------
Total deferred tax assets...................................    13,920,000     19,736,000
Deferred tax liabilities--expensed patents..................       (53,000)      (467,000)
                                                              ------------   ------------
Total net deferred tax assets...............................    13,867,000     19,269,000
Valuation allowance for deferred tax assets.................   (13,867,000)   (19,269,000)
                                                              ------------   ------------
Net deferred tax assets.....................................  $         --   $         --
                                                              ============   ============

9. SEGMENTS

During 2000, the Company commenced commercial operations and realigned its operating structure into two reportable segments, products and imaging services. The Company's new reporting segments have been determined based on the nature of the products and/or services offered to customers or the nature of their function in the organization. The Company evaluates performance and allocates certain costs based on the percentage of sales contributed by each segment. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. In prior years, the Company operated in one reportable segment, which is not comparable to the two


F-22

 
DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS

ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

reportable segments in fiscal 2000 and thereafter. As a result, prior years have been presented as "Other" in the information shown below.

                                                                                           SIX MONTHS ENDED
                                                  YEARS ENDED DECEMBER 31,                     JUNE 30,
                                         ------------------------------------------   ---------------------------
                                                 1998           1999           2000           2000           2001
-----------------------------------------------------------------------------------------------------------------
REVENUES BY SEGMENT:
Products...............................  $        --    $         --   $  5,815,474   $ 1,456,480    $ 9,802,365
Imaging services.......................           --              --      1,259,948            --      4,216,575
Other..................................    1,920,969         283,889             --            --             --
                                         -----------    ------------   ------------   -----------    -----------
  Consolidated revenues................  $ 1,920,969    $    283,889   $  7,075,422   $ 1,456,480    $14,018,940
                                         ===========    ============   ============   ===========    ===========
GROSS PROFIT (LOSS) BY SEGMENT:
Products...............................  $        --    $         --   $ (4,018,877)  $(2,145,323)   $ 3,364,596
Imaging services.......................           --              --        420,652            --        822,212
Other..................................    1,532,797          19,344             --            --             --
                                         -----------    ------------   ------------   -----------    -----------
  Consolidated gross profit (loss).....  $ 1,532,797    $     19,344   $ (3,598,225)  $(2,145,323)   $ 4,186,808
                                         ===========    ============   ============   ===========    ===========
NET LOSS BY SEGMENT:
LOSS FROM OPERATIONS
Products...............................  $        --    $         --   $(12,324,646)  $(5,594,206)   $(3,041,840)
Imaging services.......................           --              --       (614,434)           --     (2,403,010)
Other..................................   (7,049,214)    (13,465,955)            --            --             --
                                         -----------    ------------   ------------   -----------    -----------
  Consolidated loss from operations....   (7,049,214)    (13,465,955)   (12,939,080)   (5,594,206)    (5,444,850)
RECONCILING ITEMS
Interest income........................      903,294         360,476        242,831       123,736        144,732
Interest expense.......................      (46,041)        (86,942)      (780,123)     (220,704)      (545,391)
                                         -----------    ------------   ------------   -----------    -----------
  Consolidated net loss................  $(6,191,961)   $(13,192,421)  $(13,476,372)  $(5,691,174)   $(5,845,509)
                                         ===========    ============   ============   ===========    ===========
DEPRECIATION AND AMORTIZATION BY
  SEGMENT:
Products...............................  $        --    $         --   $    890,763   $   371,141    $   542,249
Imaging services.......................           --              --        257,820            --        638,797
Other..................................      573,030         733,947             --            --             --
                                         -----------    ------------   ------------   -----------    -----------
  Consolidated depreciation and
    amortization.......................  $   573,030    $    733,947   $  1,148,583   $   371,141    $ 1,181,046
                                         ===========    ============   ============   ===========    ===========
IDENTIFIABLE ASSETS BY SEGMENT:
Products...............................  $        --    $         --   $ 16,001,066   $12,489,000    $23,654,270
Imaging services.......................           --              --      7,206,343            --      4,903,042
Other..................................   16,365,039       5,699,304             --            --             --
                                         -----------    ------------   ------------   -----------    -----------
  Consolidated assets..................  $16,365,039    $  5,699,304   $ 23,207,409   $12,489,000    $28,557,312
                                         ===========    ============   ============   ===========    ===========

Sales to a distributor in Japan represented 8.5% and 5.0% of total revenues for the year ended December 31, 2000 and the six months ended June 30, 2001, respectively. The Company did not have any foreign sales for the years ended December 31, 1998 and 1999.


F-23

DIGIRAD CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF JUNE 30, 2001 AND FOR THE SIX MONTHS

ENDED JUNE 30, 2000 AND 2001 IS UNAUDITED)

10. EMPLOYEE RETIREMENT PLAN

The Company has a 401(k) retirement plan (the "Plan"), under which all full-time employees may contribute up to 15% of their annual salary, within limits. The Company may elect to make discretionary contributions upon the approval of the Board of Directors. Through June 30, 2001, the Company had not contributed to the Plan.

11. SUBSEQUENT EVENTS

On August 23, 2001, the Company issued 2,618,462 shares of Series F preferred stock at $3.25 per share for total proceeds of $8,510,002. These holders of the Series F preferred stock are entitled to similar rights and privileges as described in Note 6, except that the price-based antidilution provisions of the Series F preferred stock were modified.

In July 2001, the Company was served with notice that a complaint had been filed by Medical Management Concepts, Inc. in the United States District Court for the Eastern District of Pennsylvania. The complaint alleges, among other things, breach of the terms of a Services Agreement and an Employee Lease Agreement, each dated September 2000 and entered into by and between DIS and MMC. This complaint seeks recovery of damages for approximately $81,000 plus 12.5% of the adjusted estimated net revenue generated from gross sums billed to our mobile nuclear imaging customers from May 1, 2001 to October 31, 2003. The Company believes it has meritorious defenses against this complaint and that its ultimate resolution will not have a material impact on the financial statements.


F-24


[LOGO]

 

Part II

INFORMATION NOT REQUIRED IN PROSPECTUS

 
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The expenses to be paid by the Registrant are as follows. All amounts other than the SEC registration fee, the NASD filing fees and the Nasdaq National Market listing fee are estimates.

                                                                  AMOUNT
                                                                   TO BE
                                                                    PAID
                                                              ----------
SEC registration fee........................................  $
NASD filing fee.............................................
Nasdaq National Market listing fee..........................
Legal fees and expenses.....................................
Accounting fees and expenses................................
Printing and engraving......................................
Blue sky fees and expenses (including legal fees)...........
Transfer agent fees.........................................
Miscellaneous...............................................
    Total...................................................  $
                                                              ==========

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS

Section 145 of the Delaware General Corporation Law permits a corporation to include in its charter documents, and in agreements between the corporation and its directors and officers, provisions expanding the scope of indemnification beyond that specifically provided by the current law.

Article IV of the Registrant's amended and restated certificate of incorporation allows for the indemnification of directors and officers to the fullest extent permissible under Delaware law.

Article VI of the Registrant's bylaws provides for the indemnification of officers, directors and third parties acting on behalf of us if such person acted in good faith and in a manner reasonably believed to be in and not opposed to our best interest, and, with respect to any criminal action or proceeding, the indemnified party had no reason to believe his or her conduct was unlawful.

The Registrant has entered into indemnification agreements with our directors and executive officers, in addition to indemnification provided for in our bylaws, and intends to enter into indemnification agreements with any new directors and executive officers in the future. The indemnification agreements may require the Registrant, among other things, to indemnify our directors and officers against certain liabilities that may arise by reason of their status or service as directors and officers (other than liabilities arising from willful misconduct of a culpable nature), to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified, and to obtain directors' and officers' insurance, if available on reasonable terms. At present, there is no litigation or proceeding pending involving a director, officer or employee of the Registrant regarding which indemnification is sought, nor is the Registrant aware of any threatened litigation that may result in claims for indemnification.

Reference is also made to Section of the Underwriting Agreement, which provides for the indemnification of officers, directors and controlling persons of the Registrant against certain liabilities. The indemnification provision in the Registrant's amended and restated certificate of incorporation, bylaws and the indemnification agreements entered into between the Registrant and each of its


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directors and executive officers may be sufficiently broad to permit indemnification of the Registrant's directors and executive officers for liabilities arising under the Securities Act of 1933.

The Registrant applied for liability insurance for our officers and directors.

Reference is made to the following documents filed as exhibits to this Registration Statement regarding relevant indemnification provisions described above and elsewhere in this prospectus:

 

                                                              EXHIBIT
DOCUMENT                                                      NUMBER
----------------------------------------------------------------------
Form of Underwriting Agreement..............................     1.1
Form of Amended and Restated Certificate of Incorporation to
  be in effect immediately prior to the closing of this
  offering..................................................     3.2
Form of Amended and Restated Bylaws to be in effect
  immediately prior to the closing of this offering.........     3.4
Form of Indemnification Agreement...........................   10.28

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES

(1) On June 23, 1998, the Registrant issued and sold 494,071 shares of its Series E Preferred Stock to Johnson & Johnson Development Corporation for an aggregate purchase price of $1,500,000. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuance was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(2) On October 27, 1999, the Registrant issued warrants to purchase up to 197,628 shares of its Series E Preferred Stock with an exercise price of $3.036 per share to 2 purchasers in connection with a Loan and Security Agreement under which the purchasers agreed to loan the Registrant up to $2,000,000. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(3) On March 15, 2000, the Registrant issued and sold 2,194,797 shares of its Series E Preferred Stock to 10 purchasers for an aggregate purchase price of $6,663,415. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(4) On April 6, 2000, the Registrant issued and sold 1,151,407 shares of its Series E Preferred Stock to 6 purchasers for an aggregate purchase price of $3,495,676. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(5) On May 9, 2000, the Registrant issued warrants to purchase up to 31,208 shares of its Series E Preferred Stock with an exercise price of $3.036 per share to 2 purchasers in connection with a Loan and Security Agreement between the parties in which the purchasers agreed to loan the Registrant up to $2,000,000. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general


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solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(6) On June 9, 2000, the Registrant issued and sold 164,690 shares of its Series E Preferred Stock to Ocean Avenue Investors, LLC--Anacapa Fund I for an aggregate purchase price of $500,000. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuance was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(7) On September 29, 2000, the Registrant issued and sold to 5 purchasers convertible promissory notes in the aggregate principal amount of $2,000,000 that were convertible into shares of the Registrant's Series E Preferred Stock. In consideration for entering into the promissory notes, the Registrant also issued the purchasers warrants to purchase up to 65,875 shares of the Registrant's Series E Preferred Stock at an exercise price of $3.036 per share. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(8) On August 14, 2000, the Registrant issued warrants to purchase up to 65,877 shares of its Series E Preferred Stock with an exercise price of $3.036 per share to 2 purchasers in connection with a Loan and Security Agreement between the parties in which the purchasers agreed to loan the Registrant up to $1,000,000. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(9) On November 10, 2000, the Registrant issued and sold 3,005,595 shares of its Series E Preferred Stock to 10 purchasers for an aggregate purchase price of $9,124,987, which amount reflected the conversion of $2,000,000 of the Registrant's convertible promissory notes into shares of Series E Preferred Stock. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(10) On November 14, 2000, the Registrant issued a warrant to purchase up to 10,000 shares of its Common Stock with an exercise price of $1.50 per share to Cardiovascular Consultants in connection with a consulting relationship. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuance was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(11) On November 14, 2000, the Registrant issued a warrant to purchase up to 500 shares of its Common Stock with an exercise price of $3.04 per share to Robert McKenzie in connection with a consulting relationship. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuance was made without general


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solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(12) On December 8, 2000, the Registrant issued and sold 181,157 shares of its Series E Preferred Stock to 6 purchasers for an aggregate purchase price of $549,993. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(13) On December 14, 2000, the Registrant issued 300,000 shares of its Common Stock to Dr. John F. Kilgore in connection with Dr. Kilgore's entering into a Non-Competition and Non-Disclosure Agreement. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuance was made without general solicitation or advertising. Dr. Kilgore was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(14) On January 4, 2001, the Registrant issued warrants to purchase up to 20,000 shares of its Common Stock with an exercise price of $1.50 per share to 2 purchasers in connection with consulting relationships. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(15) On January 19, 2001, the Registrant issued and sold 683,463 shares of its Series E Preferred Stock to 4 purchasers for an aggregate purchase price of $2,074,994. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(16) On January 26, 2001, the Registrant issued a warrant to purchase up to 20,000 shares of its Common Stock with an exercise price of $2.00 per share to Oklahoma Cardiovascular Associates in connection with a consulting relationship. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuance was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(17) On March 1, 2001, the Registrant issued warrants to purchase up to 10,000 shares of its Common Stock with an exercise price of $3.04 per share to 2 purchasers in connection with consulting relationships. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(18) On March 9, 2001, the Registrant issued and sold 150,362 shares of its Series E Preferred Stock to 3 purchasers for an aggregate purchase price of $456,499. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of


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1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(19) On March 16, 2001, the Registrant issued and sold 296,050 shares of its Series E Preferred Stock to 11 purchasers for an aggregate purchase price of $898,808. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(20) On March 28, 2001, the Registrant issued warrants to purchase up to 20,000 shares of its Common Stock with an exercise price of $3.04 per share to 2 purchasers in connection with consulting relationships. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(21) On April 9, 2001, the Registrant issued and sold 808,836 shares of its Series E Preferred Stock to Merrill Lynch Ventures, LLC for an aggregate purchase price of $2,455,626. The Registrant relied on the exemption provided by
Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuance was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(22) On May 15, 2001, the Registrant issued warrants to purchase up to 20,000 shares of its Common Stock with an exercise price of $3.04 per share to 3 purchasers in connection with consulting relationships. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(23) On July 31, 2001, the Registrant issued a warrant to purchase up to 42,490 shares of its Series E Preferred Stock to Silicon Valley Bank in connection with a Loan and Security Agreement. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuance was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(24) On July 31, 2001, the Registrant issued a warrant to purchase up to 100,000 shares of its Common Stock to McAdams and Whitman Consulting in connection with a Consulting Agreement. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuance was made without general solicitation or advertising. The purchaser was a sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(25) On August 23, 2001, the Registrant issued and sold 2,618,462 shares of its Series F Preferred Stock to 25 purchasers for an aggregate purchase price of $8,510,002. The Registrant relied on the exemption provided by Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The issuances were made without general solicitation or advertising. Each purchaser was a


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PART II

sophisticated investor with access to all relevant information necessary to evaluate the investment and represented to the Registrant that the securities were being acquired for investment;

(26) Prior to January 1, 1998, the Registrant granted options to purchase shares of its Common Stock to various directors, employees and consultants pursuant to its 1995 Stock Option Plan. With respect to all grants of options, each of the issuances were exempt from the registration requirements of the Securities Act of 1933 either by virtue of either (a) Section 4(2) as transactions not involving a public offering, or (b) Rule 701;

(27) From time to time since January 1, 1998, the Registrant has granted options to purchase shares of its Common Stock to various directors, employees and consultants pursuant to its 1997 Stock Option/Stock Issuance Plan. With respect to all grants of options, each of the issuances were exempt from the registration requirements of the Securities Act of 1933 either by virtue of
(a) Section 4(2) as transactions not involving a public offering, or
(b) Rule 701;

(28) From time to time since January 1, 1998, the Registrant has granted options to purchase shares of its Common Stock to various directors, employees and consultants pursuant to its 1998 Stock Option/Stock Issuance Plan. With respect to all grants of options, each of the issuances were exempt from the registration requirements of the Securities Act of 1933 either by virtue of
(a) Section 4(2) as transactions not involving a public offering, or
(b) Rule 701;

(29) As of August 23, 2001, the Registrant has issued and sold, in the aggregate, 393,774 shares of its Common Stock at a per share exercise price of $0.21 to $0.75 to directors, employees and consultants pursuant to their exercise of options to purchase Common Stock issued pursuant under the Registrant's 1995 Stock Option Plan;

(30) As of August 23, 2001, the Registrant has issued and sold, in the aggregate, 127,161 shares of its Common Stock at a per share exercise price of $0.21 to $0.35 to employees and consultants pursuant to their exercise of options to purchase Common Stock issued pursuant under the Registrant's 1997 Stock Option/Stock Issuance Plan; and

(31) As of August 23, 2001, the Registrant has issued and sold, in the aggregate, 518,789 shares of its Common Stock for per share exercise prices ranging from $0.35 to $1.50 to directors, employees and consultants pursuant to their exercise of options to purchase Common Stock issued pursuant under the Registrant's 1998 Stock Option/Stock Issuance Plan.

The recipients of the above-described securities represented their intention to acquire the securities for investment only and not with a view to distribution thereof. Appropriate legends were affixed to the stock certificates issued in such transactions. All recipients had adequate access, through employment or other relationships, to information about the Registrant. No underwriters were involved in the distribution of the above-described securities.


 
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ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) Exhibits

NUMBER                  DESCRIPTION
------------------------------------------------------------------------------------
    1.1*                Form of Underwriting Agreement.
    3.1                 Amended and Restated Certificate of Incorporation.
    3.2*                Form of Amended and Restated Certificate of Incorporation to
                        be in effect immediately prior to the closing of the initial
                        public offering.
    3.3                 Bylaws.
    3.4*                Form of Amended and Restated Bylaws to be in effect
                        immediately prior to the closing of the initial public
                        offering.
    4.1*                Form of Specimen Common Stock Certificate.
    5.1*                Opinion of Brobeck, Phleger & Harrison LLP.
   10.1+                License Agreement by and between Registrant and the Regents
                        of the University of California, dated May 19, 1999, as
                        amended.
   10.2+                Software License Agreement by and between Registrant and
                        Segami Corporation, dated June 16, 1999.
   10.3+                Loan and Security Agreement by and between Registrant and
                        MMC/GATX Partnership No. I, dated October 27, 1999, as
                        amended.
   10.4                 Promissory Note Agreement by and between Registrant and
                        MMC/GATX Partnership No. I, dated November 1, 1999.
   10.5                 Promissory Note Agreement by and between Registrant and
                        MMC/GATX Partnership No. I, dated May 12, 2000, as amended.
   10.6                 Promissory Note Agreement by and between Registrant and
                        MMC/GATX Partnership No. I, dated August 15, 2000, as
                        amended.
   10.7+                Loan and Security Agreement by and between Registrant and
                        Silicon Valley Bank, dated April 1, 2000, as amended.
   10.8*                Loan and Security Agreement by and between Orion Imaging
                        Systems, Inc., Digirad Imaging Systems, Inc. and Heller
                        Healthcare Finance, Inc., dated January 9, 2001.
   10.9*                Master Lease Agreement by and between Registrant and GE
                        Healthcare Financial Services, dated September 26, 2000.
   10.10                Equipment Lease Agreement by and between Registrant and
                        MarCap Corporation, dated October 1, 2000.
   10.11                Lease Agreement by and between Registrant and Judd/King No.
                        1, a California general partnership, dated January 27, 1998,
                        as amended, for the property located at 9350 Trade Place,
                        San Diego, California.
   10.12                Asset Purchase Agreement by and among Digirad Imaging
                        Systems, Inc., Nuclear Imaging Systems, Inc. and
                        Cardiovascular Concepts, P.C., dated September 29, 2000.
   10.13*               Asset Purchase Agreement by and among Registrant, Orion
                        Imaging Systems, Inc., Florida Cardiology and Nuclear
                        Medicine Group, P.A. and Dr. John Kilgore, dated August 31,
                        2000, as amended.
   10.14                Convertible Promissory Note and Warrant Purchase Agreement
                        by and among Registrant and the investors listed on Exhibit
                        A, dated September 29, 2000.
   10.15                Form of Warrant to purchase shares of Series E Preferred
                        Stock by and between Registrant and the investors listed on
                        the attached schedule.
   10.16                Form of Warrant to purchase shares of Common Stock by and
                        between Registrant and the investors listed on the attached
                        schedule.
   10.17+               Fourth Additional Series E Preferred Stock Purchase
                        Agreement by and among Registrant and the investors listed
                        on Schedule 1 thereto, dated November 10, 2000, as amended.


 
II-7

PART II

NUMBER                  DESCRIPTION
------------------------------------------------------------------------------------
   10.18+               Series F Preferred Stock Purchase Agreement by and among
                        Registrant and the investors listed on Schedule 1 thereto,
                        dated August 23, 2001.
   10.19                Amended and Restated Investors' Rights Agreement by and
                        among Registrant and the investors listed on Schedule A
                        thereto, dated August 23, 2001.
   10.20                Amended and Restated Co-Sale Agreement by and among
                        Registrant and the investors listed on Schedule A thereto,
                        dated November 10, 2000.
   10.21                Amended and Restated Series E Voting Agreement by and among
                        Registrant and the investors listed therein, dated November
                        10, 2000.
   10.22                1998 Stock Option/Stock Issuance Plan, as amended.
   10.23                1998 Stock Option/Stock Issuance Plan, Form of Notice of
                        Grant.
   10.24                1998 Stock Option/Stock Issuance Plan, Form of Stock Option
                        Agreement.
   10.25                1998 Stock Option/Stock Issuance Plan, Form of Stock
                        Purchase Agreement.
   10.26*               2001 Stock Incentive Plan.
   10.27*               Form of Indemnification Agreement.
   10.28+               Consulting Agreement dated July 31, 2001.
   10.29+               Service Agreement by and between Registrant and Universal
                        Servicetrends, Inc., dated August 25, 2000.
   10.30                Master Equipment Lease Agreement by and between Registrant
                        and DVI Financial Services, Inc., dated May 24, 2001.
   10.31                Loan Agreement by and between Registrant and Gerald G. Loehr
                        Trust, dated September 1, 1993, as amended.
   10.32                Loan Agreement by and between Registrant and Clinton L.
                        Lingren, dated September 1, 1993, as amended.
   10.33                Loan Agreement by and between Registrant and Jack F. Butler,
                        dated September 1, 1993, as amended.
   10.34*               Form of Warrant to purchase shares of Series E Preferred
                        Stock by and between Registrant and the investors listed on
                        the attached schedule.
   10.35                Warrant to purchase shares of Series E Preferred Stock by
                        and between Registrant and Silicon Valley Bank, dated
                        July 31, 2001.
   10.36+*              Warrant Issuance Agreement, dated July 31, 2001.
   10.37+*              Warrant to purchase shares of Common Stock, dated July 31,
                        2001.
   21.1                 Subsidiaries of Registrant.
   23.1                 Consent of Ernst & Young LLP, Independent Auditors.
   23.2*                Consent of Brobeck, Phleger & Harrison LLP (included in
                        Exhibit 5.1).
   24.1                 Powers of Attorney (included in the Signature Page).


* To be filed by amendment.

+ Certain portions of this Exhibit for which confidential treatment has been requested have been redacted and filed separately with the Securities and Exchange Commission.

(b) Financial Statement Schedules.

SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS AND RESERVES

All other schedules are omitted because they are not applicable or not required or because the required information is shown in the Consolidated Financial Statements of Digirad Corporation or the notes thereto.


II-8

PART II

ITEM 17. UNDERTAKINGS

The undersigned Registrant hereby undertakes to provide to the Underwriter at the closing specified in the Underwriting Agreement, certificates in such denominations and registered in such names as required by the Underwriter to permit prompt delivery to each purchaser.

Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the SEC such indemnification is against public policy as expressed in the Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.

The undersigned Registrant hereby undertakes that:

(1) For purposes of determining any liability under the Securities Act of 1933 the information omitted from the form of prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424 (b)(1) or (4), or 497(h) under the Securities Act of 1933 shall be deemed to be part of this Registration Statement as of the time it was declared effective; and

(2) For the purpose of determining any liability under the Securities Act of 1933 each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.


 
II-9


Signatures

Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized in San Diego, California, on this 5th day of October 2001.

DIGIRAD CORPORATION

By:  /s/ GARY J. G. ATKINSON
     -----------------------------------------
     Name: Gary J. G. Atkinson
     Title: CHIEF FINANCIAL OFFICER

Pursuant to the requirements of the Securities Act of 1933 this Registration Statement has been signed by the following persons in the capacities indicated on October 5, 2001:

 

SIGNATURE                                   TITLE                                 DATE
----------------------------------------------------------------------------------------------------
*
---------------------------------           President, Chief Executive Officer     October 5, 2001
R. Scott Huennekens                           and Director

/s/ GARY J. G. ATKINSON
---------------------------------           Chief Financial Officer (principal     October 5, 2001
Gary J. G. Atkinson                           financial and accounting officer)

---------------------------------           Chairman of the Board of Directors     October 5, 2001
Timothy J. Wollaeger

---------------------------------           Director                               October 5, 2001
R. King Nelson

---------------------------------           Director                               October 5, 2001
Brad Nutter

---------------------------------           Director                               October 5, 2001
Kenneth E. Olson

---------------------------------           Director                               October 5, 2001
Douglas Reed, M.D.

 

*By:           /s/ GARY J. G. ATKINSON
             ----------------------------
                 Gary J. G. Atkinson
                   ATTORNEY IN FACT


 
II-10

SCHEDULE II


DIGIRAD CORPORATION
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES

                                                                             RESERVES FOR
                                                                              EXCESS AND    RESERVES FOR
                                                              RESERVES FOR     OBSOLETE       PRODUCT
                                                                BAD DEBT      INVENTORY       WARRANTY
--------------------------------------------------------------------------------------------------------
Balance at December 31, 1997................................    $    --        $     --     $        --
  Provision.................................................         --              --              --
  Write-offs and recoveries, net............................         --              --              --
                                                                -------        --------     -----------
Balance at December 31, 1998................................         --              --              --
  Provision.................................................         --              --          22,523
  Write-offs and recoveries, net............................         --              --              --
                                                                -------        --------     -----------
Balance at December 31, 1999................................         --              --          22,523
  Provision.................................................     39,121         135,000       2,062,427
  Write-offs and recoveries, net............................         --              --      (1,050,950)
                                                                -------        --------     -----------
Balance at December 31, 2000................................    $39,121        $135,000     $ 1,034,000
                                                                =======        ========     ===========


S-1


Index to exhibits

 

NUMBER                                                                   DESCRIPTION
------------------------------------------------------------------------------------
    1.1*                Form of Underwriting Agreement.
    3.1                 Amended and Restated Certificate of Incorporation.
    3.2*                Form of Amended and Restated Certificate of Incorporation to
                        be in effect immediately prior to the closing of the initial
                        public offering.
    3.3                 Bylaws.
    3.4*                Form of Amended and Restated Bylaws to be in effect
                        immediately prior to the closing of the initial public
                        offering.
    4.1*                Form of Specimen Common Stock Certificate.
    5.1*                Opinion of Brobeck, Phleger & Harrison LLP.
   10.1+                License Agreement by and between Registrant and the Regents
                        of the University of California, dated May 19, 1999, as
                        amended.
   10.2+                Software License Agreement by and between Registrant and
                        Segami Corporation, dated June 16, 1999.
   10.3+                Loan and Security Agreement by and between Registrant and
                        MMC/GATX Partnership No. I, dated October 27, 1999, as
                        amended.
   10.4                 Promissory Note Agreement by and between Registrant and
                        MMC/GATX Partnership No. I, dated November 1, 1999.
   10.5                 Promissory Note Agreement by and between Registrant and
                        MMC/GATX Partnership No. I, dated May 12, 2000, as amended.
   10.6                 Promissory Note Agreement by and between Registrant and
                        MMC/GATX Partnership No. I, dated August 15, 2000, as
                        amended.
   10.7+                Loan and Security Agreement by and between Registrant and
                        Silicon Valley Bank, dated April 1, 2000, as amended.
   10.8*                Loan and Security Agreement by and between Orion Imaging
                        Systems, Inc., Digirad Imaging Systems, Inc. and Heller
                        Healthcare Finance, Inc., dated January 9, 2001.
   10.9*                Master Lease Agreement by and between Registrant and GE
                        Healthcare Financial Services, dated September 26, 2000.
   10.10                Equipment Lease Agreement by and between Registrant and
                        MarCap Corporation, dated October 1, 2000.
   10.11                Lease Agreement by and between Registrant and Judd/King No.
                        1, a California general partnership, dated January 27, 1998,
                        as amended, for the property located at 9350 Trade Place,
                        San Diego, California.
   10.12                Asset Purchase Agreement by and among Digirad Imaging
                        Systems, Inc., Nuclear Imaging Systems, Inc. and
                        Cardiovascular Concepts, P.C., dated September 29, 2000.
   10.13*               Asset Purchase Agreement by and among Registrant, Orion
                        Imaging Systems, Inc., Florida Cardiology and Nuclear
                        Medicine Group, P.A. and Dr. John Kilgore, dated August 31,
                        2000, as amended.
   10.14                Convertible Promissory Note and Warrant Purchase Agreement
                        by and among Registrant and the investors listed on Exhibit
                        A, dated September 29, 2000.
   10.15                Form of Warrant to purchase shares of Series E Preferred
                        Stock by and between Registrant and the investors listed on
                        the attached schedule.
   10.16                Form of Warrant to purchase shares of Common Stock by and
                        between Registrant and the investors listed on the attached
                        schedule.
   10.17+               Fourth Additional Series E Preferred Stock Purchase
                        Agreement by and among Registrant and the investors listed
                        on Schedule 1 thereto, dated November 10, 2000, as amended.
   10.18+               Series F Preferred Stock Purchase Agreement by and among
                        Registrant and the investors listed on Schedule 1 thereto,
                        dated August 23, 2001.
   10.19                Amended and Restated Investors' Rights Agreement by and
                        among Registrant and the investors listed on Schedule A
                        thereto, dated August 23, 2001.


 
INDEX TO EXHIBITS

NUMBER                                                                   DESCRIPTION
------------------------------------------------------------------------------------
   10.20                Amended and Restated Co-Sale Agreement by and among
                        Registrant and the investors listed on Schedule A thereto,
                        dated November 10, 2000.
   10.21                Amended and Restated Series E Voting Agreement by and among
                        Registrant and the investors listed therein, dated November
                        10, 2000.
   10.22                1998 Stock Option/Stock Issuance Plan, as amended.
   10.23                1998 Stock Option/Stock Issuance Plan, Form of Notice of
                        Grant.
   10.24                1998 Stock Option/Stock Issuance Plan, Form of Stock Option
                        Agreement.
   10.25                1998 Stock Option/Stock Issuance Plan, Form of Stock
                        Purchase Agreement.
   10.26*               2001 Stock Incentive Plan.
   10.27*               Form of Indemnification Agreement.
   10.28+               Consulting Agreement dated July 31, 2001.
   10.29+               Service Agreement by and between Registrant and Universal
                        Servicetrends, Inc., dated August 25, 2000.
   10.30                Master Equipment Lease Agreement by and between Registrant
                        and DVI Financial Services, Inc., dated May 24, 2001.
   10.31                Loan Agreement by and between Registrant and Gerald G. Loehr
                        Trust, dated September 1, 1993, as amended.
   10.32                Loan Agreement by and between Registrant and Clinton L.
                        Lingren, dated September 1, 1993, as amended.
   10.33                Loan Agreement by and between Registrant and Jack F. Butler,
                        dated September 1, 1993, as amended.
   10.34*               Form of Warrant to purchase shares of Series E Preferred
                        Stock by and between Registrant and the investors listed on
                        the attached schedule.
   10.35                Warrant to purchase shares of Series E Preferred Stock by
                        and between Registrant and Silicon Valley Bank, dated
                        July 31, 2001.
   10.36+*              Warrant Issuance Agreement, dated July 31, 2001.
   10.37+*              Warrant to purchase shares of Common Stock, dated July 31,
                        2001.
   21.1                 Subsidiaries of Registrant.
   23.1                 Consent of Ernst & Young LLP, Independent Auditors.
   23.2*                Consent of Brobeck, Phleger & Harrison LLP (included in
                        Exhibit 5.1).
   24.1                 Powers of Attorney (included in the Signature Page).


* To be filed by amendment.

+ Certain portions of this Exhibit for which confidential treatment has been requested have been redacted and filed separately with the Securities and Exchange Commission.


   
EXHIBIT 3.1

 

AMENDED AND RESTATED CERTIFICATE OF INCORPORATION

OF

DIGIRAD CORPORATION

Digirad Corporation, a corporation organized and existing under the laws of the state of Delaware, hereby certifies as follows:

1. The name of the corporation is Digirad Corporation. The date the Corporation filed its original Certificate of Incorporation with the Secretary of State was January 2, 1997.

2. This Amended and Restated Certificate of Incorporation restates and amends the provisions of the original Certificate of Incorporation of this Corporation as heretofore in effect and was duly adopted by the Corporation's Board of Directors in accordance with Sections 242 and 245 of the General Corporation Law of the State of Delaware.

3. The text of the Certificate of Incorporation is hereby amended and restated to read as herein set forth in full:

ARTICLE I

The name of the Corporation (hereinafter called "Corporation") is Digirad Corporation.

ARTICLE II

The address of the registered office of the Corporation in the State of Delaware is 30 Old Rudnick Lane, City of Dover, County of Kent 19901, and the name of the registered agent of the Corporation in the State of Delaware at such address is CorpAmerica, Inc.

ARTICLE III

The purpose of this Corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware.

ARTICLE IV

A. CLASSES OF STOCK. This Corporation is authorized to issue two (2) classes of shares, to be designated "Common" and "Preferred" and referred to herein as the "Common Stock" or the "Preferred Stock" respectively. The total number of shares of Common Stock the Corporation is authorized to issue is Forty Two Million Seven Hundred Thirty Eight Thousand Four Hundred Sixty-Two (42,738,462). The par value is $0.001 per share. The total number of shares of Preferred Stock the Corporation is authorized to issue is Thirty Million Three Hundred Twenty One Thousand One Hundred Eight (30,321,108). The par value is $0.001 per share.


The Board of Directors of the Corporation may divide the Preferred Stock into any number of series. The Board of Directors shall fix the designation and number of shares of each such series. The Board of Directors may determine and alter the rights, preferences, privileges and restrictions granted to and imposed upon any wholly unissued series of the Preferred Stock. The Board of Directors (within the limits and restrictions of any resolution adopted by it, originally fixing the number of shares of any series) may increase or decrease the number of shares of any such series after the issue of shares of that series, but not below the number of then outstanding shares of such series.

B. RIGHTS, PREFERENCES, PRIVILEGES AND RESTRICTIONS OF THE SERIES A PREFERRED STOCK, SERIES B PREFERRED STOCK, SERIES C PREFERRED STOCK, SERIES D PREFERRED STOCK, SERIES E PREFERRED STOCK AND SERIES F PREFERRED STOCK.

1. DESIGNATION OF SERIES A PREFERRED STOCK, SERIES B PREFERRED STOCK, SERIES C PREFERRED STOCK, SERIES D PREFERRED STOCK, SERIES E PREFERRED STOCK AND SERIES F PREFERRED STOCK.

Two Million Two Hundred Fifty Thousand (2,250,000) shares of Preferred Stock are designated Series A Preferred Stock (the "Series A Preferred Stock") with the rights, preferences and privileges specified herein. Two Million Two Hundred Eighty One Thousand (2,281,000) shares of Preferred Stock are designated Series B Preferred Stock (the "Series B Preferred Stock") with the rights, preferences and privileges specified herein. Four Million Eight Hundred Thousand (4,800,000) shares of Preferred Stock are designated Series C Preferred Stock (the "Series C Preferred Stock") with the rights, preferences and privileges specified herein. Eight Million Six Hundred Sixty Eight Thousand One Hundred Forty (8,668,140) shares of Preferred Stock are designated Series D Preferred Stock (the "Series D Preferred Stock") with the rights, preferences and privileges specified herein. Nine Million Five Hundred Eighty Three Thousand Five Hundred Six (9,583,506) shares of Preferred Stock are designated Series E Preferred Stock (the "Series E Preferred Stock") with the rights, preferences and privileges specified herein. Two Million Seven Hundred Thirty Eight Thousand Four Hundred Sixty Two (2,738,462) shares of Preferred Stock are designated Series F Preferred Stock (the "Series F Preferred Stock") with the rights, preferences and privileges specified herein. As used in this Article IV, Division B, the term "Preferred Stock" shall refer to the Series A Preferred Stock, the Series B Preferred Stock, the Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock.

2. DIVIDEND PROVISIONS.

The holders of shares of Preferred Stock shall be entitled to receive non-cumulative dividends, out of any assets legally available therefor, prior and in preference to any declaration or payment of any dividend (payable other than in Common Stock of this Corporation) on the Common Stock or any other junior equity security of this Corporation, at the rate of $.10 per share of Series A Preferred Stock, $.11 per share of Series B Preferred Stock, $.125 per share of Series C Preferred Stock, $.23073 per share of Series D Preferred Stock and $.3036 per share of Series E Preferred Stock and $.325 per share of Series F Preferred Stock per annum plus an amount equal to that paid on outstanding shares of Common Stock of this Corporation, whenever funds are legally available therefor, payable quarterly when, as and if

-2-


declared by the Board of Directors and shall be non-cumulative. Dividends, if declared, must be declared and paid with respect to all series of Preferred Stock contemporaneously, and if less than full dividends are declared, the same percentage of the dividend rate will be payable to each series of Preferred Stock.

3. LIQUIDATION PREFERENCE.

(a) In the event of any liquidation, dissolution or winding up of this Corporation, either voluntary or involuntary, the holders of Preferred Stock shall be entitled to receive, prior and in preference to any distribution of any of the assets of this Corporation to the holders of Common Stock or any other junior equity security by reason of their ownership thereof an amount for each share of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock, respectively, held by such holder equal to the sum of (i) $1.00 for each such outstanding share of Series A Preferred Stock (the "Original Series A Issue Price"), (ii) $1.10 for each such outstanding share of Series B Preferred Stock (the "Original Series B Issue Price"), (iii) $1.25 for each such outstanding share of Series C Preferred Stock (the "Original Series C Issue Price"), (iv) $2.3073 for each outstanding share of Series D Preferred Stock (the "Original Series D Issue Price"), (v) $3.036 for each outstanding share of Series E Preferred Stock (the "Original Series E Issue Price"), (vi) $3.25 for each outstanding share of Series F Preferred Stock (the "Original Series F Issue Price") and
(vii) in each case, an amount equal to all declared but unpaid dividends on each such share. If upon the occurrence of such an event the assets and funds thus distributed among the holders of the Preferred Stock shall be insufficient to permit the payment to such holders of the full aforesaid preferential amounts, then the entire assets and funds of this Corporation legally available for distribution shall be distributed, ratably among the holders of the Preferred Stock in proportion to the product of the liquidation preference of each such share and the number of such shares owned by each such holder.

(b) Upon the completion of the distribution required by subsection 3(a) above, if assets remain in the Corporation, the holders of the Common Stock shall receive an amount equal to $.21 per share (adjusted to reflect any subsequent stock splits, stock dividends, or other recapitalizations) for each share of Common Stock held by them. If, upon the occurrence of such event, the assets and funds thus distributed among the holders of the Common Stock shall be insufficient to permit payment to such holders of the full aforesaid preferential amounts, then the entire assets and funds of this Corporation legally available for distribution (after giving effect to the distribution referred to in Section 3(a) hereof) shall be distributed ratably among the holders of the Common Stock in proportion to the amount of such stock owned by each such holder.

(c) After the distributions described in subsections 3(a) and
(b) have been paid, the remaining assets of this Corporation available for distribution to stockholders shall be distributed among the holders of Preferred Stock and Common Stock pro rata based on the number of shares of Common Stock held by each (assuming conversion of all such Preferred Stock).

-3-


4. REDEMPTION.

(a) The outstanding Preferred Stock shall be redeemable as provided in this Section 4. The Series A Redemption Price shall be the total amount equal to $1.00 per share of Series A Preferred Stock to be redeemed together with any declared but unpaid dividends on such shares to the Redemption Date (as such term is hereinafter defined). The Series B Redemption Price shall be the total amount equal to $1.10 per share of Series B Preferred Stock to be redeemed together with any declared but unpaid dividends on such shares to the Redemption Date. The Series C Redemption Price shall be the total amount equal to $1.25 per share of Series C Preferred Stock to be redeemed together with any declared but unpaid dividends on such shares to the Redemption Date. The Series D Redemption Price shall be the total amount equal to $2.3073 per share of Series D Preferred Stock to be redeemed together with any declared but unpaid dividends on such shares to the Redemption Date. The Series E Redemption Price shall be the total amount equal to $3.036 per share of Series E Preferred Stock to be redeemed together with any declared but unpaid dividends on such shares to the Redemption Date. The Series F Redemption Price shall be the total amount equal to $3.25 per share of Series F Preferred Stock to be redeemed together with any declared but unpaid dividends on such shares to the Redemption Date.

(b) On or at any time after July 31, 2004, upon the receipt by this Corporation from the holders of at least 66-2/3% of the then outstanding shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock, voting together as a single class and on an as-converted basis, of a written request for redemption hereunder of their respective shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock (the "Redemption Request"), this Corporation shall, from any source of funds legally available therefor, redeem all of the shares of Preferred Stock by paying in cash therefor a sum equal to the Series A Redemption Price, the Series B Redemption Price, the Series C Redemption Price, the Series D Redemption Price, the Series E Redemption Price and the Series F Redemption Price, respectively.

(c) (i) At least 15, but no more than 30, days prior to the date fixed for any redemption of the Preferred Stock (the "Redemption Date"), which Redemption Date shall be no later than 45 days following the Corporation's receipt of the Redemption Request, this Corporation shall mail written notice, first class postage prepaid, to each holder of record (at the close of business on the business day next preceding the day on which notice is given) of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock to be redeemed at the address last shown on the records of this Corporation for such holder or given by the holder to this Corporation for the purpose of notice or if no such address appears or is given, at the place where the principal executive office of this Corporation is located, notifying such holder of the redemption to be effected, specifying the number of shares to be redeemed from such holder, the Redemption Date, the Series A Redemption Price, the Series B Redemption Price, the Series C Redemption Price, the Series D Redemption Price, the Series E Redemption Price or the Series F Redemption Price, as the case may be, the place at which payment may be obtained and the date on which such holder's Conversion Rights (as hereinafter defined) as to such shares terminate, and calling upon such holder to surrender to this Corporation, in the manner and at the place

-4-


designated, such holder's certificate or certificates representing the shares to be redeemed (the "Redemption Notice"). Except as provided in subsection
4(c)(iii), on or after the Redemption Date, each holder of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock to be redeemed shall surrender to this Corporation the certificate or certificates representing such shares, in the manner and at the place designated in the Redemption Notice, and thereupon the Series A Redemption Price, Series B Redemption Price, Series C Redemption Price, the Series D Redemption Price, the Series E Redemption Price or the Series F Redemption Price, as the case may be, of such shares shall be payable, to the order of the person whose name appears on such certificate or certificates as the owner thereof and each surrendered certificate shall be canceled. In the event less than all the shares represented by any such certificate are redeemed, a new certificate shall be issued representing the unredeemed shares.

(ii) If the funds of the Corporation legally available for redemption of outstanding shares of Preferred Stock on any Redemption Date are insufficient to redeem the total number of shares of Preferred Stock to be redeemed on such date, those funds which are legally available will be used to redeem the maximum possible number of such shares ratably among the holders of (A) first, such shares of Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock to be redeemed, and (B) second, such shares of Series A Preferred Stock to be redeemed. The shares of Preferred Stock not redeemed shall remain outstanding and entitled to all the rights and preferences provided herein. At any time thereafter when additional funds of this Corporation are legally available for the redemption of shares of Preferred Stock, such funds shall immediately be used to redeem the balance of the shares which this Corporation has become obligated to redeem on any Redemption Date but which it has not redeemed.

(iii) From and after the Redemption Date, unless there shall have been a default in payment of the applicable Series A Redemption Price, Series B Redemption Price, Series C Redemption Price, Series D Redemption Price, Series E Redemption Price or Series F Redemption Price, all rights of the holders of such shares as holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock (except the right to receive the Series A Redemption Price, Series B Redemption Price, Series C Redemption Price, Series D Redemption Price, Series E Redemption Price or Series F Redemption Price, without interest, upon surrender of their certificate or certificates) shall cease with respect to such shares, and such shares shall not thereafter be transferred on the books of this Corporation or be deemed to be outstanding for any purpose whatsoever.

(iv) At least three days prior to the Redemption Date, this Corporation shall deposit the Series A Redemption Price, Series B Redemption Price, Series C Redemption Price, Series D Redemption Price, Series E Redemption Price and Series F Redemption Price, of all outstanding shares of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock, designated for redemption in the Redemption Notice, and not yet redeemed or converted, with a bank or trust company having aggregate capital and surplus in excess of $50,000,000, as a trust fund for the benefit of the holders of the shares designated for redemption and not yet redeemed. Simultaneously, this Corporation shall deposit irrevocable instructions

-5-


and authority to such bank or trust company to pay, on and after the Redemption Date or prior thereto, the Series A Redemption Price, Series B Redemption Price, Series C Redemption Price, Series D Redemption Price, Series E Redemption Price and Series F Redemption Price, as the case may be, to the holders thereof upon surrender of their certificates. Any monies deposited by this Corporation pursuant to this subsection 4(c)(iv) for the redemption of shares which are thereafter converted into shares of Common Stock pursuant to Section 5 hereof no later than the close of business on the Redemption Date shall be returned to this Corporation forthwith upon such conversion. The balance of any monies deposited by this Corporation pursuant to this subsection 4(c)(iv) remaining unclaimed at the expiration of two years following the Redemption Date shall thereafter be returned to this Corporation, provided that the stockholder to which such monies would be payable hereunder shall be entitled, upon proof of its ownership of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or Series F Preferred Stock, as the case may be, and payment of any bond requested by this Corporation, to receive such monies but without interest from the Redemption Date.

5. CONVERSION. The holders of Preferred Stock shall have conversion rights as follows (the "Conversion Rights"):

(a) RIGHT TO CONVERT.

(i) Subject to subsection 5(c), each outstanding share of Preferred Stock shall be convertible, at the option of the holder thereof at any time after the date of issuance of such share (and on or prior to the fifth day prior to the Redemption Date, if any, as may have been fixed in any Redemption Notice), at the office of this Corporation or any transfer agent for such series of Preferred Stock, into such number of fully paid and nonassessable shares of Common Stock as is determined by dividing the Original Series A Issue Price, the Original Series B Issue Price, the Original Series C Issue Price, the Original Series D Issue Price, the Original Series E Issue Price and the Original Series F Issue Price, respectively, by the Conversion Price at the time in effect for such series or shares of such series. The initial Conversion Price per share for shares of Preferred Stock shall be the Original Series A Issue Price, the Original Series B Issue Price, the Original Series C Issue Price, the Original Series D Issue Price, the Original Series E Issue Price and the Original Series F Issue Price, respectively, provided, however, that the Conversion Prices for the Series A Preferred Stock, the Series B Preferred Stock, the Series C Preferred Stock, the Series D Preferred Stock, the Series E Preferred Stock and the Series F Preferred Stock shall be subject to adjustment as set forth in subsection 5(c).

(ii) Each outstanding share of Preferred Stock shall automatically be converted into shares of Common Stock at the Conversion Price at the time in effect for such shares immediately upon:

(A) the closing of this Corporation's sale of its Common Stock in a bona fide, firm commitment underwritten public offering registered under the Securities Act of 1933, as amended (the "Securities Act"), which results in aggregate gross offering proceeds to this Corporation of at least $15,000,000, at a public offering price of not less

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than $7.50 per share (adjusted to reflect subsequent stock dividends, stock splits or recapitalizations) (a "Qualifying Public Offering"); or

(B) the approval of (i) holders of at least 75% of the then outstanding shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock, voting together as a single class and on an as-converted basis and (ii) holders of not less than 60% of the Series D Preferred Stock voting as a class, provided, however, that if such approval is in connection with an underwritten offer of securities registered pursuant to the Securities Act, the conversion may be conditioned upon the closing of the sale of securities pursuant to such offering, in which event each outstanding share of Preferred Stock shall not be deemed to have converted until immediately after the closing of such sale of securities.

(b) MECHANICS OF CONVERSION. Before any holder of Preferred Stock shall be entitled to convert the same into shares of Common Stock, such holder shall surrender the certificate or certificates therefor, duly endorsed, at the office of this Corporation or of any transfer agent for such stock, and shall be given written notice by mail postage prepaid, to this Corporation at its principal corporate office, of the election to convert the same and shall state therein the name or names in which the certificate or certificates for shares of Common Stock are to be issued. This Corporation shall, as soon as practicable thereafter, issue and deliver at such office to such holder of Preferred Stock, or to the nominee or nominees of such holder, a certificate or certificates for the number of shares of Common Stock to which such holder shall be entitled as aforesaid. Such conversion shall be deemed to have been made immediately prior to the close of business on the date of such surrender of the shares of such series of Preferred Stock to be converted, and the person or persons entitled to receive the shares of Common Stock issuable upon such conversion shall be treated for all purposes as the record holder or holders of such shares of Common Stock as of such date. If the conversion is in connection with an underwritten offer of securities registered pursuant to the Securities Act, the conversion may, at the option of any holder tendering shares of such series of Preferred Stock for conversion, be conditioned upon the closing with the underwriter of the sale of securities pursuant to such offering, in which event the person(s) entitled to receive the Common Stock issuable upon such conversion of shares of such series of Preferred Stock shall not be deemed to have converted such shares of such series of Preferred Stock until immediately after the closing of such sale of securities.

(c) CONVERSION PRICE ADJUSTMENTS OF THE PREFERRED STOCK. The
Conversion Prices of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock shall be subject to adjustment from time to time as follows:

(i) (A) (1) If this Corporation shall issue any Additional Stock (as defined below) without consideration or for a consideration per share less than the Conversion Price for shares of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock in effect immediately prior to the issuance of such Additional Stock, the new Conversion Price for such shares of such series of Preferred Stock shall be determined by multiplying the Conversion Price

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for such series of Preferred Stock in effect immediately prior to the issuance of Additional Stock by a fraction:

(x) the numerator of which shall be the number of shares of Common Stock outstanding immediately prior to such issuance (for purposes of this calculation only, including the number of shares of Common Stock then issuable upon the conversion of all outstanding shares of Preferred Stock at the Conversion Price for such shares in effect immediately prior to such issuance of Additional Stock) plus the number of shares of Common Stock equivalents which the aggregate consideration received by this Corporation for the shares of such Additional Stock so issued would purchase at the Conversion Price in effect at the time for the shares of the series of Preferred Stock with respect to which the adjustment is being made; and

(y) the denominator of which shall be the number of shares of Common Stock outstanding immediately prior to such issuance (for purposes of this calculation only, including the number of shares of Common Stock then issuable upon the conversion of all outstanding shares of Preferred Stock at the Conversion Price for such shares in effect immediately prior to such issuance of Additional Stock) plus the number of such shares of Additional Stock so issued.

Any series of issuances of Additional Stock consisting of Common Stock or the same series of Preferred Stock, issued at the same price and within a six-month period, shall be treated as one issuance of Additional Stock for the purposes of this calculation.

(2) If this Corporation shall issue, at any time after the date upon which any shares of Series F Preferred Stock were first issued (the "Series F Purchase Date") and on or before December 31, 2001, any Additional Stock (other than shares of Series F Preferred Stock) without consideration or for a consideration per share less than $3.50 (as adjusted to reflect stock dividends, stock splits or recapitalizations), the new Conversion Price for such shares of Series F Preferred Stock shall be adjusted to a price equal to the greater of: (1) the product of 0.925 and the per share price of the Additional Stock, and (2) $3.036.

(3) (x) If this Corporation shall issue, at any time on or after January 1, 2002, any Additional Stock for a consideration per share (a) less than the Conversion Price for such shares of Series F Preferred Stock in effect immediately prior to the issuance of such Additional Stock, and (b) in an amount equal to or greater than $3.036 per share (as adjusted to reflect stock dividends, stock splits or recapitalizations), the new Conversion Price for such shares of Series F Preferred Stock in effect immediately prior to such issuance shall be adjusted to a price equal to the price paid per share for such Additional Stock.

(y) If this Corporation shall issue, any time on or after January 1, 2002, any Additional Stock without consideration or for a consideration less than $3.036 per share (as adjusted to reflect stock dividends, stock splits or recapitalizations) at a time when the applicable Conversion Price for the shares of Series F Preferred Stock is greater than $3.036 per share (as adjusted to reflect stock dividends, stock splits or recapitalizations), the new Conversion Price for such shares of

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Series F Preferred Stock in effect immediately prior to such issuance shall first be adjusted to a price of $3.036 (as adjusted to reflect stock dividends, stock splits or recapitalizations), and then this new Conversion Price of $3.036 (as adjusted to reflect stock dividends, stock splits or recapitalizations) shall be further adjusted by multiplying $3.036 (as adjusted to reflect stock dividends, stock splits or recapitalizations) by a fraction:

(i) the numerator of which shall be the number of shares of Common Stock outstanding immediately prior to such issuance (for purposes of this calculation only, including the number of shares of Common Stock then issuable upon the conversion of all outstanding shares of Preferred Stock at the Conversion Price for such shares in effect immediately prior to such issuance of Additional Stock) plus the number of shares of Common Stock equivalents which the aggregate consideration received by this Corporation for the shares of such Additional Stock so issued would purchase at $3.036 per share (as adjusted to reflect stock dividends, stock splits or recapitalizations); and

(ii) the denominator of which shall be the number of shares of Common Stock outstanding immediately prior to such issuance (for purposes of this calculation only, including the number of shares of Common Stock then issuable upon the conversion of all outstanding shares of Preferred Stock at the Conversion Price for such shares in effect immediately prior to such issuance of Additional Stock) plus the number of such shares of Additional Stock so issued.

(z) If this Corporation shall issue, any time on or after January 1, 2002, any Additional Stock without consideration or for a consideration less than $3.036 per share (as adjusted to reflect stock dividends, stock splits or recapitalizations) and less than the then-applicable Conversion Price for the shares of Series F Preferred Stock, at a time when the applicable Conversion Price for the shares of Series F Preferred Stock is equal to or less than $3.036 per share (as adjusted to reflect stock dividends, stock splits or recapitalizations), the new Conversion Price for the shares of Series F Preferred Stock shall be determined by multiplying the Conversion Price for the Series F Preferred Stock in effect immediately prior to the issuance of such Additional Stock by a fraction:

(i) the numerator of which shall be the number of shares of Common Stock outstanding immediately prior to such issuance (for purposes of this calculation only, including the number of shares of Common Stock then issuable upon the conversion of all outstanding shares of Preferred Stock at the Conversion Price for such shares in effect immediately prior to such issuance of Additional Stock) plus the number of shares of Common Stock equivalents which the aggregate consideration received by this Corporation for the shares of such Additional Stock so issued would purchase at the Conversion Price in effect at the time for the shares of Series F Preferred Stock; and

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(ii) the denominator of which shall be the number of shares of Common Stock outstanding immediately prior to such issuance (for purposes of this calculation only, including the number of shares of Common Stock then issuable upon the conversion of all outstanding shares of Preferred Stock at the Conversion Price for such shares in effect immediately prior to such issuance of Additional Stock) plus the number of such shares of Additional Stock so issued.

Any series of issuances of Additional Stock consisting of Common Stock or the same series of Preferred Stock, issued at the same price and within a six-month period, shall be treated as one issuance of Additional Stock for the purposes of this calculation.

(B) Except for the adjustments required by Section
(c)(i)(A)(2) and Section (c)(i)(A)(3)(x), no adjustment of the Conversion Price for such series of Preferred Stock shall be made in an amount less than one cent per share, provided that any adjustments which are not required to be made by reason of this sentence shall be carried forward and shall be either taken into account in any subsequent adjustment made prior to three years from the date of the event giving rise to the adjustment being carried forward, or shall be made at the end of three years from the date of the event giving rise to the adjustment being carried forward. Except to the limited extent provided for in subsections 5(c)(i)(E)(3) and (c)(i)(E)(4), no adjustment of such Conversion Price for such series of Preferred Stock pursuant to this subsection 5(c)(i) shall have the effect of increasing the Conversion Price for such series of Preferred Stock above the Conversion Price for such series in effect immediately prior to such adjustment.

(C) In the case of the issuance of Common Stock for cash, the consideration shall be deemed to be the amount of cash paid therefor before deducting any reasonable discounts, commissions or other expenses allowed, paid or incurred by this Corporation for any underwriting or otherwise in connection with the issuance and sale thereof.

(D) In the case of the issuance of the Common Stock for a consideration in whole or in part other than cash, the consideration other than cash shall be deemed to be the fair value thereof as determined by the Board of Directors irrespective of any accounting treatment.

(E) In the case of the issuance of options to purchase or rights to subscribe for Common Stock, securities by their terms convertible into or exchangeable for Common Stock or options to purchase or rights to subscribe for such convertible or exchangeable securities (which are not excluded from the definition of Additional Stock), the following provisions shall apply:

(1) The aggregate maximum number of shares of Common Stock deliverable upon exercise of such options to purchase or rights to subscribe for Common Stock shall be deemed to have been issued at the time such options or rights were issued and for a consideration equal to the consideration (determined in the manner provided in subsections 5(c)(i)(C) and (c)(i)(D)), if any, received by the Corporation upon the issuance of

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such options or rights plus the minimum purchase price provided in such options or rights for the Common Stock covered thereby.

(2) The aggregate maximum number of shares of Common Stock deliverable upon conversion of or in exchange for any such convertible or exchangeable securities or upon the exercise of options to purchase or rights to subscribe for such convertible or exchangeable securities and subsequent conversion or exchange thereof shall be deemed to have been issued at the time such securities were issued or such options or rights were issued and for a consideration equal to the consideration, if any, received by this Corporation for any such securities and related options or rights (excluding any cash received on account of accrued interest or accrued dividends), plus the additional consideration, if any, to be received by this Corporation upon the conversion or exchange of such securities or the exercise of any related options or rights (the consideration in each case to be determined in the manner provided in subsections 5(c)(i)(C) and (c)(i)(D)).

(3) In the event of any change in the number of shares of Common Stock deliverable or any increase in the consideration payable to this Corporation upon exercise of such options or rights or upon conversion of or in exchange for such convertible or exchangeable securities, including, but not limited to, a change resulting from the anti-dilution provisions thereof, the Conversion Price of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or Series F Preferred Stock, as the case may be, obtained with respect to the adjustment which was made upon the issuance of such options, rights or securities, and any subsequent adjustments based thereon shall be recomputed to reflect such change, but no further adjustment shall be made for the actual issuance of Common Stock or any payment of such consideration upon the exercise of any such options or rights or the conversion or exchange of such securities; provided, however, that this section shall not have any effect on any conversion of such series of Preferred Stock prior to such change or increase.

(4) Upon the expiration of any such options or rights, the termination of any such rights to convert or exchange or the expiration of any options or rights related to such convertible or exchangeable securities, the Conversion Price of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or Series F Preferred Stock, as the case may be, obtained with respect to the adjustment which was made upon the issuance of such options, rights or securities or options or rights related to such securities, and any subsequent adjustments based thereon, shall be recomputed to reflect the issuance of only the number of shares of Common Stock actually issued upon the exercise of such options or rights upon the conversion or exchange of such securities or upon the exercise of the options or rights related to such securities; provided, however, that this section shall not have any effect on any conversion of such series of Preferred Stock prior to such expiration or termination.

(ii) "Additional Stock" shall mean any shares of Common Stock issued (or deemed to have been issued pursuant to subsection
5(c)(i)(E)) by this Corporation after June 22, 1998, other than:

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(A) Common Stock issued pursuant to a transaction described in subsection 5(c)(iii) hereof; or

(B) 8,154,860 shares of Common Stock, net of repurchases and the cancellation or expiration of options, issued or issuable to employees, directors, consultants or advisors of this Corporation under stock option and restricted stock purchase agreements approved by the Board of Directors commencing as of May 1994, and such other number of shares of Common Stock as may be fixed from time to time by the Board of Directors and approved by a majority of then outstanding Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock, voting as a single class, issued or issuable to employees, directors, consultants or advisors of this Corporation under stock option and restricted stock purchase agreements approved by the Board of Directors; or

(C) Common Stock issued or issuable upon conversion of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock; or

(D) Common Stock issued or issuable in connection with a bona fide business acquisition of or by the Corporation, whether by merger, consolidation, sale of assets, sale or exchange of stock or otherwise upon terms approved by the Board of Directors (including such shares of Common Stock issued or issuable prior to the date hereof); or

(E) Common Stock issued or issuable in connection with services rendered or to be rendered to the Corporation by consultants upon terms approved by the Board of Directors (including such shares of Common Stock issued or issuable prior to the date hereof); or

(F) Common Stock issued or issuable in connection with credit agreements with equipment lessors or commercial lenders upon terms approved by the Board of Directors (including such shares of Common Stock issued or issuable prior to the date hereof); or

(G) any right, option or warrant to acquire any security convertible into the securities excluded from the definition of Additional Stock pursuant to subsections (A) through (F) above (including any such right, option or warrant issued or issuable prior to the date hereof).

(iii) In the event this Corporation should at any time or from time to time after the effective date hereof fix a record date for the effectuation of a split or subdivision of the outstanding shares of Common Stock or the determination of holders of Common Stock entitled to receive a dividend or other distribution payable in additional shares of Common Stock or other securities or rights convertible into, or entitling the holder thereof to receive directly or indirectly, additional shares of Common Stock (hereinafter referred to as

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"Common Stock Equivalents") without payment of any consideration by such holder for the additional shares of Common Stock or the Common Stock Equivalents (including the additional shares of Common Stock issuable upon conversion or exercise thereof), then as of such record date (or the date of such dividend distribution, split or subdivision if no record date is fixed), the Conversion Price for the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or Series F Preferred Stock, as the case may be, shall be appropriately decreased so that the number of shares of Common Stock issuable on conversion of each share of such series shall be increased in proportion to such increase of outstanding shares determined in accordance with subsection 5(c)(i)(E).

(iv) If the number of shares of Common Stock outstanding at any time after the effective date hereof is decreased by a combination of the outstanding shares of Common Stock, then, following the record date of such combination, the Conversion Price for the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or Series F Preferred Stock, as the case may be, shall be appropriately increased so that the number of shares of Common Stock issuable on conversion of each share of such series shall be decreased in proportion to such decrease in outstanding shares.

(d) OTHER DISTRIBUTIONS. In the event this Corporation shall declare a distribution payable in securities of other persons, evidences of indebtedness issued by this Corporation or other persons, assets (excluding cash dividends) or options or rights not referred to in subsection 5(c)(iii), then, in each such case for the purpose of this subsection 5(d), the holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock, shall be entitled to a proportionate share of any such distribution as though they were the holders of the number of shares of Common Stock of this Corporation into which their shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or Series F Preferred Stock, as the case may be, are convertible as of the record date fixed for the determination of the holders of Common Stock of this Corporation entitled to receive such distribution.

(e) RECAPITALIZATIONS. If at any time or from time to time there shall be a recapitalization of the Common Stock (other than a subdivision, combination or merger or sale of assets transaction provided for elsewhere in this Section 5 or Section 6) provision shall be made so that the holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock, shall thereafter be entitled to receive upon conversion of such series of Preferred Stock the number of shares of stock or other securities or property of this Corporation or otherwise, to which a holder of Common Stock deliverable upon conversion would have been entitled on such recapitalization. In any such case, appropriate adjustment shall be made in the application of the provisions of this Section 5 with respect to the rights of the holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock, after the recapitalization to the end that the provisions of this Section 5 (including adjustment of the Conversion Price then in effect and the number of shares purchasable upon conversion of such series of Preferred Stock) shall be applicable after that event as nearly equivalent as may be practicable.

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(f) NO IMPAIRMENT. This Corporation will not, by amendment of its Certificate of Incorporation or through any reorganization, revitalization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by this Corporation, but will at all times in good faith assist in the carrying out of all the provisions of this Section 5 and in the taking of all such action as may be necessary or appropriate in order to protect the Conversion Rights of the holders of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock against impairment.

(g) FRACTIONAL SHARES AND CERTIFICATE AS TO ADJUSTMENTS.

(i) No fractional shares shall be issued upon conversion of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or Series F Preferred Stock, and the number of shares of Common Stock to be issued shall be rounded to the nearest whole share. Whether or not fractional shares are issuable upon such conversion shall be determined on the basis of the total number of shares of such series of Preferred Stock the holder is at the time converting into Common Stock and the number of shares of Common Stock issuable upon such aggregate conversion.

(ii) Upon the occurrence of each adjustment or, readjustment of the Conversion Price of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or Series F Preferred Stock, as the case may be, pursuant to this Section 5, this Corporation, at its expense, shall promptly compute such adjustment or readjustment in accordance with the terms hereof and prepare and furnish to each holder of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock, or instrument convertible into shares of any such series of Preferred Stock, as the case may be, a certificate setting forth such adjustment or readjustment and showing in detail the facts upon which such adjustment or readjustment is based. This Corporation shall, upon the written request furnish or cause to be furnished to such holder a like certificate setting forth (A) such adjustment and readjustment, (B) the Conversion Price at the time in effect, and (C) the number of shares of Common Stock and the amount, if any, of other property which at the time would be received upon the conversion of a share of such series of Preferred Stock.

(h) NOTICES OF RECORD DATE. In the event of any taking by this Corporation of a record of the holders of any class of securities for the purpose of determining the holders thereof who are entitled to receive any dividend (other than a cash dividend) or other distribution, any right to subscribe for, purchase or otherwise acquire any shares of stock of any class or any other securities or property, or to receive any other right, this Corporation shall mail to each holder of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or Series F Preferred Stock at least 20 days prior to the date specified therein, a notice specifying the date on which by such record is to be taken for the purpose of such dividend, distribution or right and the amount and character of such dividend, distribution or right.

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(i) RESERVATION OF COMMON STOCK ISSUABLE UPON CONVERSION. This Corporation shall at all times reserve and keep available out of its authorized but unissued shares of Common Stock solely for the purpose of effecting the conversion of the shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock, such number of its shares of Common Stock as shall from time to time be sufficient to effect the conversion of all authorized shares of such series of Preferred Stock, and if at any time the number of authorized but unissued shares of Common Stock shall not be sufficient to effect the conversion of all then authorized shares of such series of Preferred Stock, in addition to such other remedies as shall be available to the holders of such series of Preferred Stock, this Corporation will take such corporate action as may, in the opinion of its counsel be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purposes.

(j) NOTICES. Any notice required by the provisions of this
Section 5 to be given to the holders of shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock shall be deemed given if deposited in the United States postage prepaid, and addressed to each holder of record at such holder's address appearing on the books of this Corporation.

6. MERGER; CONSOLIDATION.

(a) If at any time after the effective date hereof there is a merger, consolidation or other corporate reorganization in which stockholders of this Corporation immediately prior to such transaction own less than 50% of the voting securities of the surviving or controlling entity immediately after the transaction, or sale of all or substantially all of the assets of this Corporation (hereinafter, an "Acquisition"), then, as a part of such Acquisition, provision shall be made so that the holders of the Series A Preferred Stock, the Series B Preferred Stock, the Series C Preferred Stock, the Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock shall be entitled to receive, prior to any distribution to holders of Common Stock or other junior equity security of the Corporation, the number of shares of stock or other securities or property to be issued to this Corporation or its stockholders resulting from such Acquisition in an amount per share equal to the Original Series A Issue Price, Original Series B Issue Price, Original Series C Issue Price, Original Series D Issue Price, Original Series E Issue Price and Original Series F Issue Price, as applicable, plus a further amount equal to any dividends declared but unpaid on such shares. Subject to the following sentence, the holders of Common Stock shall thereafter be entitled to receive, pro rata, the remainder of the number of shares of stock or other securities or property to be issued to this Corporation or its stockholders resulting from such Acquisition. Notwithstanding anything to the contrary in this Section 6, in the event the aggregate value of stock, securities and other property to be distributed to this Corporation or its stockholders with respect to an Acquisition is less than $5.25 per share (such dollar amount to be appropriately adjusted to reflect any subsequent stock splits, stock dividends or other recapitalizations) of Common Stock outstanding (for purpose of this calculation only, including in the number of shares of Common Stock outstanding the number of shares of Common Stock then issuable upon conversion of all outstanding Preferred Stock), then the stock, securities or other property shall be distributed among the holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, the Series D Preferred Stock, Series E

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Preferred Stock, Series F Preferred Stock and the Common Stock according to the provisions of Section 3 hereof as if such Acquisition were deemed a liquidation.

(b) Any securities to be delivered to the holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, the Series D Preferred Stock, Series E Preferred Stock, Series F Preferred Stock and Common Stock pursuant to subsection 6(a) above shall be valued as follows:

(i) Securities not subject to investment letter or other similar restrictions on free marketability;

(A) If traded on a securities exchange, the value shall be deemed to be the average of the closing prices of the securities on such exchange over the 30-day period ending three days prior to the closing;

(B) If actively traded over-the-counter, the value shall be deemed to be the average of the closing bid or sale prices (whichever are applicable) over the 30-day period ending three days prior to the closing; and

(C) If there is no active public market, the value shall be the fair market value thereof, as mutually determined by the Corporation and the holders of not less than a majority of the then outstanding shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, the Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock.

(ii) The method of valuation of securities subject to investment letter or other restrictions on free marketability shall be to make an appropriate discount from the market value determined as above in subsections 6(b)(i)(A), (B) or (C) to reflect the approximate fair market value thereof, as mutually determined by this Corporation and the holders of a majority of the then outstanding shares of Series A Preferred Stock, Series B Preferred, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock, voting as a single class.

(c) In the event the requirements of subsection 6(a) are not complied with, this Corporation shall forthwith either:

(i) cause such closing to be postponed until such time as the requirements of this Section 6 have been complied with, or

(ii) cancel such transaction, in which event the rights, preferences and privileges of the holders of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock shall revert to and be the same as such rights, preferences and privileges existing immediately prior to the date of the first notice referred to in subsection 6(d) hereof.

(d) This Corporation shall give each holder of record of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or Series F Preferred Stock written notice of such impending transaction

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not later than 20 days prior to the stockholders' meeting called to approve such action, or 20 days prior to the closing of such transaction, whichever is earlier, and shall also notify such holders in writing of the final approval of such transaction. The first of such notices shall describe the material terms and conditions of the impending transaction and the provisions of this Section 6, and this Corporation shall thereafter give such holders prompt notice of any material changes. The transaction shall in no event take place earlier than 20 days after the Corporation has given the first notice provided for herein or earlier than 10 days after the Corporation has given notice of any material changes provided for herein; provided, however, that such periods may be shortened upon the written consent of the holders of a majority of the then outstanding Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock voting as a class.

(e) The provisions of this Section 6 are in addition to the protective provisions of Section 8 hereof.

7. VOTING RIGHTS; DIRECTORS.

(a) The holder of each outstanding share of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock shall have the right to one vote for each share of Common Stock into which such outstanding Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or Series F Preferred Stock could be converted on the record date for the vote or written consent of stockholders. In all cases any fractional share, determined on an aggregate conversion basis, shall be rounded to the nearest whole share. With respect to such vote, such holder shall have full voting rights and powers equal to the voting rights and powers of the holders of Common Stock, and shall be entitled, notwithstanding any provision hereof to notice of any stockholders' meeting in accordance with the bylaws of this Corporation, and shall be entitled to vote, together with holders of Common Stock, with respect to any question upon which holders of Common Stock have the right to vote.

(b) Notwithstanding subsection 7(a), (i) so long as at least fifty percent (50%) of the shares of Series A Preferred Stock and Series B Preferred Stock originally issued remain issued and outstanding, the holders of Series A Preferred Stock and Series B Preferred Stock, voting together as a separate class, shall be entitled to elect one member of the Board of Directors, (ii) so long as at least fifty percent (50%) of the shares of Series C Preferred Stock originally issued remain issued and outstanding, the holders of Series C Preferred Stock, voting as a separate class, shall be entitled to elect one member of the Board of Directors, (iii) so long as at least fifty percent (50%) of the shares of Series D Preferred Stock originally issued remain issued and outstanding, the holders of Series D Preferred Stock, voting as a separate class, shall be entitled to elect one member of the Board of Directors and (iv) so long as at least fifty percent (50%) of the shares of Series E Preferred Stock and Series F Preferred Stock originally issued remain issued and outstanding, the holders of Series E Preferred Stock and Series F Preferred Stock, voting together as a separate class, shall be entitled to elect one member of the Board of Directors. Any additional directors shall be elected by the holders of Preferred Stock and Common Stock, voting together as a single class.

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A vacancy in any directorship elected by the holders of Series A Preferred Stock and Series B Preferred Stock shall be filled only by vote of the holders of Series A Preferred Stock and Series B Preferred Stock, voting together as a separate class; a vacancy in any directorship elected by the holders of Series C Preferred Stock shall be filled only by vote of the holders of Series C Preferred Stock; a vacancy in any directorship elected by the holders of Series D Preferred Stock shall be filled only by a vote of the holders of Series D Preferred Stock; and a vacancy in any directorship elected by the holders of Series E Preferred Stock and Series F Preferred Stock shall be filled only by a vote of the holders of Series E Preferred Stock and Series F Preferred Stock, voting together as a single class. Any vacancy in any other directorship shall be elected by the holders of Preferred Stock and Common Stock, voting together as one class.

This subsection 7(b) shall be void and of no further effect thereafter upon the occurrence of either of the following events:

(i) the closing of a Qualifying Public Offering;

(ii) upon the distribution to the stockholders pursuant to a liquidation as described in Section 3 hereof or an Acquisition as described in Section 6 hereof.

8. PROTECTIVE PROVISIONS.

(a) In addition to any approvals required by law, so long as shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or Series F Preferred Stock are outstanding, this Corporation shall not without first obtaining the approval (by vote or written consent, as provided by law) of the holders of at least a majority of the then outstanding voting power of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock (voting, as one class, in accordance with Section 7):

(i) sell, convey, or otherwise dispose of all or substantially all of its property or business or merge into or consolidate with any other corporation (other than a wholly-owned subsidiary corporation) in which this Corporation is not the surviving corporation or effect any transaction or series of related transactions in which more than fifty percent (50%) of the voting power of this Corporation is disposed of, provided, however, that this restriction shall not apply to any mortgage, deed of trust, pledge or other encumbrance or hypothecation of the Corporation's or any of its subsidiaries' assets for the purpose of securing any contract or obligation; or

(ii) alter or change the rights, preferences, privileges or restrictions of the shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or Series F Preferred Stock; or

(iii) increase the authorized number of shares of Common Stock or Preferred Stock; or

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(iv) create (by reclassification or otherwise) any new class or series of stock having a preference over, or being on a parity with, the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or Series F Preferred Stock with respect to voting, dividends, redemption or conversion or upon liquidation or an Acquisition; or

(v) pay or declare any dividend or make any distribution
(including without limitation by way of redemption, purchase or acquisition) on or with respect to its Common Stock or any other junior equity security other than a dividend in Common Stock of this Corporation; provided, however, that the foregoing shall not prevent this Corporation from (A) repurchasing at cost shares of its Common Stock issued to or held by employees, officers, directors or other persons performing services to this Corporation or its subsidiaries pursuant to agreements providing for such rights of repurchase upon the termination of such services to this Corporation or its subsidiaries, or (B) repurchasing shares of its Common Stock pursuant to any right of first refusal contained in this Corporation's bylaws as of the date hereof; or

(vi) change the authorized number of directors; or

(vii) do any act or thing which would result in taxation of the holders of shares of Preferred Stock under section 305(b) of the Internal Revenue Code of 1986, as amended (or any comparable provision of the Internal Revenue Code as hereafter from time to time amended).

(b) In addition to any approvals required by law, so long as shares of Series C Preferred Stock are outstanding, this Corporation shall not without first obtaining the approval (by vote or written consent, as provided by law) of the holders of at least a majority of the then outstanding voting power of Series C Preferred Stock, voting as a single class:

(i) alter or change the rights, preferences, privileges or restrictions of the shares of Series C Preferred Stock; or

(ii) create (by reclassification or otherwise) any new class or series of stock having a preference over, or being on a parity with, the Series C Preferred Stock with respect to voting, dividends, redemption or conversion or upon liquidation or an Acquisition.

(c) In addition to any approvals required by law, so long as shares of Series D Preferred Stock are outstanding, this Corporation shall not without first obtaining the approval (by vote or written consent, as provided by law) of the holders of at least a majority of the then outstanding voting power of Series D Preferred Stock, voting as a single class:

(i) sell, convey, or otherwise dispose of all or substantially all of its property or business or merge into or consolidate with any other corporation (other than a wholly-owned subsidiary corporation) in which this Corporation is not the surviving corporation or effect any transaction or series of related transactions in which more than fifty percent (50%) of the voting power of this Corporation is disposed of, provided, however, that this restriction shall not apply to any mortgage, deed of trust, pledge or other encumbrance or hypothecation of

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the Corporation's or any of its subsidiaries' assets for the purpose of securing any contract or obligation; or

(ii) alter or change the rights, preferences, privileges or restrictions of the shares of Series D Preferred Stock; or

(iii) increase the authorized number of shares of Series D Preferred Stock; or

(iv) increase the authorized number of directors; or

(v) create (by reclassification or otherwise) any new class or series of stock having a preference over, or being on a parity with, the Series D Preferred Stock with respect to voting, dividends, redemption or conversion or upon liquidation or an Acquisition.

(d) In addition to any approvals required by law, so long as shares of Series E Preferred Stock are outstanding, this Corporation shall not without first obtaining the approval (by vote or written consent, as provided by law) of the holders of at least sixty-six percent (66%) of the then outstanding voting power of Series E Preferred Stock, voting as a single class:

(i) materially or adversely alter or change the rights, preferences or privileges of the shares of Series E Preferred Stock as a separate series in a manner that is dissimilar and disproportionate relative to the manner in which the rights, preferences or privileges of the other series of Preferred Stock are altered, or

(ii) increase the authorized number of shares of Series E Preferred Stock.

(e) In addition to any approvals required by law, so long as shares of Series F Preferred Stock are outstanding, this Corporation shall not without first obtaining the approval (by vote or written consent, as provided by law) of the holders of at least sixty-six and two-thirds percent (66 2/3%) of the then outstanding voting power of Series F Preferred Stock, voting as a single class:

(i) materially or adversely alter or change the rights, preferences or privileges of the shares of Series F Preferred Stock as a separate series in a manner that is dissimilar and disproportionate relative to the manner in which the rights, preferences or privileges of the other series of Preferred Stock are altered, or

(ii) create (by reclassification or otherwise) any new class or series of stock having a preference over the Series F Preferred Stock with respect to voting, dividends, redemption or conversion or upon liquidation or an Acquisition;

(iii) amend Section B. 5(a)(ii)(B)of Article IV hereof; or

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(iv) increase the authorized number of shares of Series F Preferred Stock.

9. STATUS OF REDEEMED OR CONVERTED STOCK. In the event any shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or Series F Preferred Stock shall be redeemed or converted pursuant to Section 4 or 5 hereof the shares so redeemed or converted shall be cancelled and shall not be issuable by this Corporation, and the Certificate of Incorporation of this Corporation shall be appropriately amended to effect the corresponding reduction in this Corporation's authorized capital stock.

10. REPURCHASE OF SHARES. In connection with this Corporation's repurchase at cost of shares of its Common Stock issued to or held by employees, officers, directors or other persons performing services to this Corporation or its subsidiaries pursuant to agreements providing for such rights of repurchase upon the termination of such services to this Corporation or its subsidiaries, or its repurchase of shares of its Common Stock pursuant to any rights of first refusal contained in this Corporation's bylaws as of the date hereof, each holder of Preferred Stock shall be deemed to have waived the application, in whole or in part, of any provisions of the Delaware General Corporation Law or any applicable law of any other state which might limit or prevent or prohibit such repurchases.

C. COMMON STOCK.

1. RELATIVE RIGHTS OF PREFERRED STOCK AND COMMON STOCK. All rights preferences, voting powers, relative, participating optional or other special rights and privileges, and qualifications, limitations, or restrictions of the Common Stock are expressly made subject and subordinate to those that may be fixed with respect to any shares of the Preferred Stock.

2. VOTING RIGHTS. Except as otherwise required by law or this Certificate of Incorporation, each holder of Common Stock shall have one vote in respect of each share of stock held by such holder of record on the books of the Corporation for the election of directors and on all matters submitted to a vote of stockholders of the Corporation.

3. DIVIDENDS. Subject to the preferential rights of the Preferred Stock, the holders of shares of Common Stock shall be entitled to receive, when, as and if declared by the Board of Directors, out of the assets of the Corporation which are by law available therefor, dividends payable either in cash, in property or in shares of capital stock.

4. DISSOLUTION, LIQUIDATION OR WINDING UP. In the event of any dissolution, liquidation or winding up of the affairs of the Corporation, after distribution in full of the preferential amounts, if any, to be distributed to the holders of shares of the Preferred Stock, holders of Common Stock shall be entitled to participate in any distribution of the assets of the Corporation in accordance with Section 3 of Article IV, Division B hereof.

5. NO PREEMPTIVE RIGHTS. The holders of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock, Series F Preferred Stock and Common Stock shall not have any preemptive rights. The

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foregoing shall not, however, prohibit the Corporation from granting contractual rights of first refusal to purchase securities to holders of Preferred Stock.

ARTICLE V

In furtherance and not in limitation of the powers conferred by the laws of the State of Delaware:

A. The Board of Directors of the Corporation is expressly authorized to adopt, amend or repeal the bylaws of the Corporation; provided, however, that the bylaws may only be amended in accordance with the provisions thereof and, provided further that, the authorized number of directors may be changed only with the approval of the holders of at least a majority of the then outstanding shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock (voting as one class) in accordance with Section 7 of Article IV. Division B hereof.

B. Elections of directors need not be by written ballot unless the bylaws of the Corporation shall so provide.

C. The books of the Corporation may be kept at such place within or without the State of Delaware as the bylaws of the Corporation may provide or as may be designated from time to time by the Board of Directors of the Corporation.

ARTICLE VI

A. EXCULPATION.

1. CALIFORNIA. The liability of each and every director of this Corporation for monetary damages shall be eliminated to the fullest extent permissible under California law.

2. DELAWARE. A director of the Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the Delaware General Corporation Law or (iv) for any transaction from which the director derived any improper personal benefit. If the Delaware General Corporation Law is hereafter amended to further reduce or to authorize, with the approval of the Corporation's stockholders, further reductions in the liability of the Corporation's directors for breach of fiduciary duty, then a director of the Corporation shall not be liable for any such breach to the fullest extent permitted by the Delaware General Corporation Law as so amended.

3. CONSISTENCY. In the event of any inconsistency between Sections 1 and 2 of this Division A, the controlling Section, as to any particular issue with regard to any particular matter, shall be the one which provides to the director in question the greatest protection from liability.

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B. INDEMNIFICATION.

1. CALIFORNIA. This Corporation is authorized to indemnify the directors and officers of this Corporation to the fullest extent permissible under California law. Moreover, this Corporation is authorized to provide indemnification of (and advancement of expenses to) agents (as defined in
Section 317 of the California Corporations Code) through bylaw provisions, agreements with agents, vote of stockholders or disinterested directors or otherwise, in excess of the indemnification and advancement otherwise permitted by Section 317 of the California Corporations Code, subject only to applicable limits set forth in Section 204 of the California Corporations Code, with respect to actions for breach of duty to the Corporation and its stockholders.

2. DELAWARE. To the extent permitted by applicable law, this Corporation is also authorized to provide indemnification of (and advancement of expenses to) such agents (and any other persons to which Delaware law permits this Corporation to provide indemnification) through bylaw provisions, agreements with such agents or other persons, vote of stockholders or disinterested directors or otherwise, in excess of the indemnification and advancement otherwise permitted by Section 145 of the Delaware General Corporation Law, subject only to limits created by applicable Delaware law (statutory or non-statutory), with respect to actions for breach of duty to the Corporation, its stockholders and others.

3. CONSISTENCY. In the event of any inconsistency between Sections 1 and 2 of this Division B, the controlling Section, as to any particular issue with regard to any particular matter, shall be the one which authorizes for the benefit of the agent or other person in question the provision of the fullest, promptest, most certain or otherwise most favorable indemnification and/or advancement.

C. EFFECT OF REPEAL OR MODIFICATION. Any repeal or modification of any of the foregoing provisions of this Article VI shall not adversely affect any right or protection of a director, officer, agent or other person existing at the time of, or increase the liability of any director of the Corporation with respect to any acts or omissions of such director occurring prior to, such repeal or modification.

ARTICLE VII

The Corporation shall have perpetual existence.

ARTICLE VIII

The Corporation reserves the right to amend, alter, change or repeal any provision contained in this Certificate of Incorporation, in the manner now or hereafter prescribed by statute, and all rights conferred upon stockholders herein are granted subject to this reservation.

[REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]

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IN WITNESS WHEREOF, this Amended and Restated Certificate of Incorporation has been executed as of this 22nd day of August, 2001.

DIGIRAD CORPORATION


By:      /s/ Scott Huennekens
   -------------------------------------
       Scott Huennekens, President


[SIGNATURE PAGE TO
AMENDED AND RESTATED CERTIFICATE OF INCORPORATION]


   
EXHIBIT 3.3

 

BYLAWS

OF

DIGIRAD CORPORATION

ARTICLE I. - OFFICES

Section 1. REGISTERED OFFICE. The registered office shall be in the City of Dover, County of Kent, State of Delaware.

Section 2. OTHER OFFICES. The Corporation may also have offices at such other places both within and without the State of Delaware as the Board of Directors may from time to time determine or the business of the Corporation may require.

ARTICLE II. - MEETINGS OF STOCKHOLDERS

Section 1. ANNUAL MEETINGS. The annual meeting of the stockholders of the Corporation for the election of directors to succeed those whose terms expire and for the transaction of such other business as may properly come before the meeting shall be held between 30 and 120 days following the end of the fiscal year of the Corporation and at such place as may be determined by the Board of Directors. If the annual meeting of the stockholders be not held as herein prescribed, the election of directors may be held at any meeting thereafter called pursuant to these Bylaws.

Section 2. SPECIAL MEETINGS. Special meetings of the stockholders, for any purpose whatsoever, unless otherwise prescribed by statute, may be called at any time by the Chairman of the Board, the President, or by the Board of Directors, or by one or more stockholders holding not less than ten percent (10%) of the voting power of the Corporation.


Section 3. PLACE. All meetings of the stockholders shall be at any place within or without the State of Delaware designated either by the Board of Directors or by written consent of the holders of a majority of the shares entitled to vote thereat, given either before or after the meeting. In the absence of any such designation, stockholders' meetings shall be held at the principal executive office of the Corporation.

Section 4. NOTICE. Notice of meetings of the stockholders of the Corporation shall be given in writing to each stockholder entitled to vote, either personally or by first-class mail or other means of written communication, charges prepaid, addressed to the stockholder at his address appearing on the books of the Corporation or given by the stockholder to the Corporation for the purpose of notice. Notice of any such meeting of stockholders shall be sent to each stockholder entitled thereto not less than ten (10) nor more than sixty (60) days before the meeting. Said notice shall state the place, date and hour of the meeting and, (i) in the case of special meetings, the general nature of the business to be transacted, and no other business may be transacted, or (ii) in the case of annual meetings, those matters which the Board of Directors, at the time of the mailing of the notice, intends to present for action by the stockholders and (iii) in the case of any meeting at which directors are to be elected, the names of the nominees intended at the time of the mailing of the notice to be presented by management for election.

Section 5. ADJOURNED MEETINGS. Any stockholders' meeting may be adjourned from time to time by the vote of the holders of a majority of the voting shares present at the meeting either in person or by proxy. Notice of any adjourned meeting need not be given unless a meeting is adjourned for thirty
(30) days or more from the date set for the original meeting.

Section 6. QUORUM. The presence in person or by proxy of the persons entitled to vote a majority of the shares entitled to vote at any meeting constitutes a quorum for the transaction of

2


business. The stockholders present at a duly called or held meeting at which a quorum is present may continue to do business until adjournment, notwithstanding the withdrawal of enough stockholders to leave less than a quorum, if any action taken (other than adjournment) is approved by at least a majority of the shares required to constitute a quorum.

In the absence of a quorum, any meeting of stockholders may be adjourned from time to time by the vote of a majority of the shares, the holders of which are either present in person or represented by proxy thereat, but no other business may be transacted, except as provided above.

Section 7. CONSENT TO STOCKHOLDER ACTION. Any action which may be taken at any meeting of stockholders may be taken without a meeting and without prior notice, if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding shares having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted; provided, however, that (i) notice of any stockholder approval without a meeting by less than unanimous written consent shall be given as required by the General Corporation Law of Delaware, and (ii) directors may not be elected by written consent except by unanimous written consent of all shares entitled to vote for the election of directors.

Any written consent may be revoked by a writing received by the Secretary of the Corporation prior to the time that written consents of the number of shares required to authorize the proposed action have been filed with the Secretary.

Section 8. WAIVER OF NOTICE. The transactions of any meeting of stockholders, however called and noticed, and whenever held, shall be as valid as though had at a meeting duly held after regular call and notice, if a quorum be present either in person or by proxy, and if, either before or after the meeting, each of the persons entitled to vote, not present in person or by

3


proxy, signs a written waiver of notice, or a consent to the holding of the meeting, or an approval of the minutes thereof. All such waivers, consents, or approvals shall be filed with the corporate records or made a part of the minutes of the meeting.

Section 9. VOTING. The voting at all meetings of stockholders need not be by ballot, but any qualified stockholder before the voting begins may demand a stock vote whereupon such stock vote shall be taken by ballot, each of which shall state the name of the stockholder voting and the number of shares voted by such stockholder, and if such ballot be cast by a proxy, it shall also state the name of any such proxy.

At any meeting of the stockholders, every stockholder having the right to vote shall be entitled to vote in person, or by proxy appointed in a writing subscribed by such stockholder and bearing a date not more than three years prior to said meeting, unless the writing states that it is irrevocable and satisfies Section 212(e) of the General Corporation Law of Delaware, in which event it is irrevocable for the period specified in said writing and said
Section 212(e).

Section 10. RECORD DATES. In the event the Board of Directors fixes a day for the determination of stockholders of record entitled to vote as provided in Section 1 of Article V of these Bylaws, then, subject to the provisions of the General Corporation Law of Delaware only persons in whose name shares entitled to vote stand on the stock records of the Corporation at the close of business on such day shall be entitled to vote.

If no record date is fixed:

The record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the business day next preceding the day notice is given or, if notice is waived, at the close of business on the business day next preceding the day on which the meeting is held;

4


The record date for determining stockholders entitled to give consent to corporate action in writing without a meeting, when no prior action by the Board of Directors is necessary, shall be the day on which the first written consent is given; and

The record date for determining stockholders for any other purpose shall be at the close of business on the day on which the Board of Directors adopts the resolution relating thereto, or the sixtieth (60th) day prior to the date of such other action, whichever is later.

A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting unless the Board of Directors fixes a new record date for the adjourned meeting, but the Board of Directors shall fix a new record date if the meeting is adjourned for more than thirty (30) days.

Section 11. CUMULATIVE VOTING FOR ELECTION OF DIRECTORS. Provided the candidate's name has been placed in nomination prior to the voting and one or more stockholders has given notice at the meeting prior to the voting of the stockholder's intent to cumulate the stockholder's votes, every stockholder entitled to vote at any election for directors shall have the right to cumulate such stockholder's votes and give one candidate a number of votes equal to the number of directors to be elected multiplied by the number of votes to which the stockholder's shares are normally entitled, or distribute the stockholder's votes on the same principle among as many candidates as the stockholder shall think fit. The candidates receiving the highest number of votes of the shares entitled to be voted for them up to the number of directors to be elected by such shares are elected.

ARTICLE III. - BOARD OF DIRECTORS

Section 1. POWERS. Subject to any limitations in the Certificate of Incorporation or these Bylaws and to any provision of the General Corporation Law of Delaware requiring stockholder

5


authorization or approval for a particular action, the business and affairs of the Corporation shall be managed and all corporate powers shall be exercised by, or under the direction of, the Board of Directors. The Board of Directors may delegate the management of the day-to-day operation of the business of the Corporation to a management company or other person provided that the business and affairs of the Corporation shall be managed and all corporate powers shall be exercised, under the ultimate direction of the Board of Directors.

Section 2. NUMBER, TENURE AND QUALIFICATIONS. The authorized number of directors of the Corporation shall be not less than five (5) nor more than nine
(9), the exact number of directors to be fixed from time to time within such limit by a duly adopted resolution of the Board of Directors or stockholders. The exact number of directors presently authorized shall be six (6) until changed within the limits specified above by a duly adopted resolution of the Board of Directors or stockholders.

Directors shall hold office until the next annual meeting of stockholders and until their respective successors are elected. If any such annual meeting is not held, or the directors are not elected thereat, the directors may be elected at any special meeting of stockholders held for that purpose. Directors need not be stockholders.

Section 3. REGULAR MEETINGS. A regular annual meeting of the Board of Directors shall be held without other notice than this bylaw immediately after, and at the same place as, the annual meeting of stockholders. The Board of Directors may provide for other regular meetings from time to time by resolution.

Section 4. SPECIAL MEETINGS. Special meetings of the Board of Directors may be called at any time by the Chairman of the Board, or the President, or any Vice President, or the Secretary or any two (2) directors. Written notice of the time and place of all special meetings of

6


the Board of Directors shall be delivered personally or by telephone, facsimile or telegraph to each director at least forty-eight (48) hours before the meeting, or sent to each director by first-class mail, postage prepaid, at least four (4) days before the meeting. Such notice need not specify the purpose of the meeting. Notice of any meeting of the Board of Directors need not be given to any director who signs a waiver of notice, whether before or after the meeting, or who attends the meeting without protesting prior thereto, or at its commencement, the lack of notice to such Director.

Section 5. PLACE OF MEETINGS. Meetings of the Board of Directors may be held at any place within or without the State of Delaware, which has been designated in the notice, or if not stated in the notice or there is no notice, the principal executive office of the Corporation or as designated by the resolution duly adopted by the Board of Directors.

Section 6. PARTICIPATION BY TELEPHONE. Members of the Board of Directors may participate in a meeting through use of conference telephone or similar communications equipment, so long as all members participating in such meeting can hear one another.

Section 7. QUORUM. A majority of the directors shall constitute a quorum. In the absence of a quorum, a majority of the directors present may adjourn any meeting to another time and place. If a meeting is adjourned for more than twenty-four (24) hours, notice of any adjournment to another time or place shall be given prior to the time of the reconvened meeting to the directors who were not present at the time of adjournment.

Section 8. ACTION AT MEETING. Every act or decision done or made by a majority of the directors present at a meeting duly held at which a quorum is present is the act of the Board of Directors. A meeting at which a quorum is initially present may continue to transact business

7


notwithstanding the withdrawal of directors, if any action taken is approved by at least a majority of the required quorum for such meeting.

Section 9. WAIVER OF NOTICE. The transactions of any meeting of the Board of Directors, however called and noticed or wherever held, are as valid as though had at a meeting duly held after regular call and notice if a quorum is present and if, either before or after the meeting, each of the directors not present signs a written waiver of notice, a consent to holding the meeting, or an approval of the minutes thereof. All such waivers, consents and approvals shall be filed with the corporate records or made a part of the minutes of the meeting.

Section 10. ACTION WITHOUT MEETING. Any action required or permitted to be taken by the Board of Directors may be taken without a meeting, if all members of the Board individually or collectively consent in writing to such action. Such written consent or consents shall be filed with the minutes of the proceedings of the Board. Such action by written consent shall have the same force and effect as a unanimous vote of such directors.

Section 11. REMOVAL. The Board of Directors may declare vacant the office of a director who has been declared of unsound mind by an order of court or who has been convicted of a felony. Subject to Article IV, Division B,
Section 7(b) of the Corporation's Certificate of Incorporation, the entire Board of Directors or any individual director may be removed from office without cause by a vote of stockholders holding a majority of the outstanding shares entitled to vote at an election of directors; provided, however, that unless the entire Board is removed, no individual director may be removed when the votes cast against removal, or not consenting in writing to such removal, would be sufficient to elect such director if voted cumulatively at an election at which the same total number of votes cast were cast (or, if such

8


action is taken by written consent, all shares entitled to vote were voted) and the entire number of directors authorized at the time of the director's most recent election were then being elected.

Subject to Article IV, Division B, Section 7(b) of the Corporation's Certificate of Incorporation, in the event an office of a director is so declared vacant or in case the Board or any one or more directors be so removed, new directors may be elected at the same meeting.

Section 12. RESIGNATIONS. Any director may resign effective upon giving written notice to the Chairman of the Board, the President, the Secretary or the Board of Directors of the Corporation, unless the notice specifies a later time for the effectiveness of such resignation. If the resignation is effective at a future time, a successor may be elected to take office when the resignation becomes effective.

Section 13. VACANCIES. Except for a vacancy created by the removal of a director, subject to Article IV, Division B, Section 7(b) of the Corporation's Certificate of Incorporation, all vacancies in the Board of Directors, whether caused by resignation, death or otherwise, may be filled by a majority of the remaining directors, though less than a quorum, or by a sole remaining director, and each director so elected shall hold office until his successor is elected at an annual, regular or special meeting of the stockholders. Vacancies created by the removal of a director may be filled only by approval of the stockholders. Subject to Article IV, Division B, Section 7(b) of the Corporation's Certificate of Incorporation, the stockholders may elect a director at any time to fill any vacancy not filled by the directors. Any such election by written consent requires the consent of all of the outstanding shares entitled to vote.

Section 14. COMPENSATION. No stated salary shall be paid directors, as such, for their services, but, by resolution of the Board of Directors, a fixed sum and expenses of attendance, if any, may be allowed for attendance at each regular or special meeting of such Board; provided

9


that nothing herein contained shall be construed to preclude any director from serving the Corporation in any other capacity and receiving compensation therefor. Members of special or standing committees may be allowed like compensation for attending committee meetings.

Section 15. COMMITTEES. The Board of Directors may, by resolution adopted by a majority of the authorized number of directors, designate one or more committees, each consisting of two (2) or more directors, to serve at the pleasure of the Board of Directors. The Board of Directors may designate one or more directors as alternate members of any committee, who may replace any absent member at any meeting of the committee. The appointment of members or alternate members of a committee requires the vote of a majority of the authorized number of directors. Any such committee, to the extent provided in the resolution of the Board of Directors, shall have all the authority of the Board of Directors in the management of the business and affairs of the Corporation, except with respect to (i) the approval of any action requiring stockholders' approval or approval of the outstanding shares, (ii) the filling of vacancies on the Board or any committee, (iii) the fixing of compensation of directors for serving on the Board or a committee, (iv) the adoption, amendment or repeal of bylaws, (v) the amendment or repeal of any resolution of the Board which by its express terms is not so amendable or repealable, (vi) a distribution to stockholders, except at a rate or in a periodic amount or within a price range determined by the Board and (vii) the appointment of other committees of the Board or the members thereof.

ARTICLE IV. - OFFICERS

Section 1. NUMBER AND TERM. The officers of the Corporation shall be a President, a Secretary and a Chief Financial Officer, all of which shall be chosen by the Board of Directors. In addition, the Board of Directors may appoint a Chairman of the Board, one or more Vice

10


Presidents and such other officers as may be deemed expedient for the proper conduct of the business of the Corporation, each of whom shall have such authority and perform such duties as the Board of Directors may from time to time determine. The officers to be appointed by the Board of Directors shall be chosen annually at the regular meeting of the Board of Directors held after the annual meeting of stockholders and shall serve at the pleasure of the Board of Directors. If officers are not chosen at such meeting of the Board of Directors, they shall be chosen as soon thereafter as shall be convenient. Each officer shall hold office until his successor shall have been duly chosen or until his removal or resignation.

Section 2. INABILITY TO ACT. In the case of absence or inability to act of any officer of the Corporation and of any person herein authorized to act in his place, the Board of Directors may from time to time delegate the powers or duties of such officer to any other officer or any director or other person whom it may select.

Section 3. REMOVAL AND RESIGNATION. Any officer chosen by the Board of Directors may be removed at any time, with or without cause, by the affirmative vote of a majority of all the members of the Board of Directors.

Any officer chosen by the Board of Directors may resign at any time by giving written notice of said resignation to the Corporation. Unless a different time is specified therein, such resignation shall be effective upon its receipt by the Chairman of the Board, the President, the Secretary or the Board of Directors.

Section 4. VACANCIES. A vacancy in any office because of any cause may be filled by the Board of Directors for the unexpired portion of the term.

Section 5. CHAIRMAN OF THE BOARD. The Chairman of the Board shall preside at all meetings of the Board.

11


Section 6. PRESIDENT. The President shall be the general manager and chief executive officer of the Corporation, subject to the control of the Board of Directors, and as such shall preside at all meetings of stockholders, shall have general supervision of the affairs of the Corporation, shall sign or countersign or authorize another officer to sign all certificates, contracts, and other instruments of the Corporation as authorized by the Board of Directors, shall make reports to the Board of Directors and stockholders, and shall perform all such other duties as are incident to such office or are properly required by the Board of Directors.

Section 7. VICE PRESIDENT. In the absence of the President, or in the event of such officer's death, disability or refusal to act, the Vice President, or in the event there be more than one Vice President, the Vice Presidents in the order designated at the time of their selection, or in the absence of any such designation, then in the order of their selection, shall perform the duties of President, and when so acting, shall have all the powers and be subject to all restrictions upon the President. Each Vice President shall have such powers and discharge such duties as may be assigned from time to time by the President or by the Board of Directors.

Section 8. SECRETARY. The Secretary shall see that notices for all meetings are given in accordance with the provisions of these Bylaws and as required by law, shall keep minutes of all meetings, shall have charge of the seal and the corporate books, and shall make such reports and perform such other duties as are incident to such office, or as are properly required by the President or by the Board of Directors.

The Assistant Secretary or the Assistant Secretaries, in the order of their seniority, shall, in the absence or disability of the Secretary, or in the event of such officer's refusal to act, perform the duties and exercise the powers and discharge such duties as may be assigned from time to time by the President or by the Board of Directors.

12


Section 9. CHIEF FINANCIAL OFFICER. The Chief Financial Officer may also be designated by the alternate title of "Treasurer." The Chief Financial Officer shall have custody of all moneys and securities of the Corporation and shall keep regular books of account. Such officer shall disburse the funds of the Corporation in payment of the just demands against the Corporation, or as may be ordered by the Board of Directors, taking proper vouchers for such disbursements, and shall render to the Board of Directors from time to time as may be required of such officer, an account of all transactions as Chief Financial Officer and of the financial condition of the Corporation. Such officer shall perform all duties incident to such office or which are properly required by the President or by the Board of Directors.

The Assistant Chief Financial Officer or the Assistant Chief Financial Officers, in the order of their seniority, shall, in the absence or disability of the Chief Financial Officer, or in the event of such officer's refusal to act, perform the duties and exercise the powers of the Chief Financial Officer, and shall have such powers and discharge such duties as may be assigned from time to time by the President or by the Board of Directors.

Section 10. SALARIES. The salaries of the officers shall be fixed from time to time by the Board of Directors and no officer shall be prevented from receiving such salary by reason of the fact that such officer is also a director of the Corporation.

Section 11. OFFICERS HOLDING MORE THAN ONE OFFICE. Any two or more offices may be held by the same person.

ARTICLE V. - MISCELLANEOUS

Section 1. RECORD DATE AND CLOSING OF STOCK BOOKS. The Board of Directors may fix a time in the future as a record date for the determination of the stockholders entitled to notice of and to vote at any meeting of stockholders or entitled to receive payment of any dividend or

13


distribution, or any allotment of rights, or to exercise rights in respect to any other lawful action. The record date so fixed shall not be more than sixty (60) nor less than ten (10) days prior to the date of the meeting or event for the purposes of which it is fixed. When a record date is so fixed, only stockholders of record at the close of business on that date are entitled to notice of and to vote at the meeting or to receive the dividend, distribution, or allotment of rights, or to exercise the rights, as the case may be, notwithstanding any transfer of any shares on the books of the Corporation after the record date.

The Board of Directors may close the books of the Corporation against transfers of shares during the whole or any part of a period of not more than sixty (60) days prior to the date of a stockholders' meeting, the date when the right to any dividend, distribution, or allotment of rights vests, or the effective date of any change, conversion or exchange of shares.

Section 2. CERTIFICATES. Certificates of stock shall be issued in numerical order and each stockholder shall be entitled to a certificate signed in the name of the Corporation by the Chairman of the Board or the President or a Vice President, and the Chief Financial Officer, the Secretary or an Assistant Secretary, certifying to the number of shares owned by such stockholder. Any or all of the signatures on the certificate may be facsimile. Prior to the due presentment for registration of transfer in the stock transfer book of the Corporation, the registered owner shall be treated as the person exclusively entitled to vote, to receive notifications and otherwise to exercise all the rights and powers of an owner, except as expressly provided otherwise by the laws of the State of Delaware.

Section 3. REPRESENTATION OF SHARES IN OTHER CORPORATIONS. Shares of other corporations standing in the name of the Corporation may be voted or represented and all incidents thereto

14


may be exercised on behalf of the Corporation by the Chairman of the Board, the President or any Vice President and the Chief Financial Officer or the Secretary or an Assistant Secretary.

Section 4. FISCAL YEAR. The fiscal year of the Corporation shall be set by the Board of Directors.

Section 5. ANNUAL REPORTS. The Annual Report to stockholders, described in the General Corporation Law of Delaware, is expressly waived and dispensed with.

Section 6. AMENDMENTS. Bylaws may be adopted, amended, or repealed by the vote or the written consent of stockholders entitled to exercise a majority of the voting power of the Corporation. Subject to the right of stockholders to adopt, amend, or repeal bylaws, bylaws may be adopted, amended, or repealed by the Board of Directors, except that a bylaw amendment thereof changing the authorized number of directors may be adopted by the Board of Directors only if these Bylaws permit an indefinite number of directors and the bylaw or amendment thereof adopted by the Board of Directors changes the authorized number of directors within the limits specified in these Bylaws.

ARTICLE VI. - INDEMNIFICATION

Section 1. DELAWARE. The Corporation shall, to the fullest extent authorized under the laws of the State of Delaware, as those laws may be amended and supplemented from time to time, indemnify any director made, or threatened to be made, a party to an action or proceeding, whether criminal, civil, administrative or investigative, by reason of being a director of the Corporation or a predecessor corporation or, at the Corporation's request, a director or officer of another corporation, provided, however, that the Corporation shall indemnify any such agent in connection with a proceeding initiated by such agent only if such proceeding was authorized by the Board of Directors of the Corporation. The indemnification provided for in this Section 1 shall: (i) not be deemed exclusive of any other rights to which those indemnified may be entitled

15


under the Corporation's certificate of incorporation, any bylaw, agreement or vote of stockholders or disinterested directors or otherwise, both as to action in their official capacities and as to action in another capacity while holding such office, (ii) continue as to a person who has ceased to be a director and (iii) inure to the benefit of the heirs, executors and administrators of such a person. The Corporation's obligation to provide indemnification under this Section 1 shall be offset to the extent of any other source of indemnification or any otherwise applicable insurance coverage under a policy maintained by the Corporation or any other person.

Expenses incurred by a director of the Corporation in defending a civil or criminal action, suit or proceeding by reason of the fact that such director is or was a director of the Corporation (or was serving at the Corporation's request as a director or officer of another corporation) shall be paid by the Corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of such director to repay such amount if it shall ultimately be determined that such director is not entitled to be indemnified by the Corporation as authorized by relevant sections of the General Corporation Law of Delaware. Notwithstanding the foregoing, the Corporation shall not be required to advance such expenses to an agent who is a party to an action, suit or proceeding brought by the Corporation and approved by a majority of the Board of Directors of the Corporation which alleges willful misappropriation of corporate assets by such agent, disclosure of confidential information in violation of such agent's fiduciary or contractual obligations to the Corporation or any other willful and deliberate breach in bad faith of such agent's duty to the Corporation or its stockholders.

The foregoing provisions of this Section 1 shall be deemed to be a contract between the Corporation and each director who serves in such capacity at any time while this

16


bylaw is in effect, and any repeal or modification thereof shall not affect any rights or obligations then existing with respect to any state of facts then or theretofore existing or any action, suit or proceeding theretofore or thereafter brought based in whole or in part upon any such state of facts.

The Board of Directors in its discretion shall have power on behalf of the Corporation to indemnify any person, other than a director, made a party to any action, suit or proceeding by reason of the fact that such person, such person's testator or intestate, is or was an officer or employee of the Corporation.

To assure indemnification under this Section 1 of all directors, officers and employees who are determined by the Corporation or otherwise to be or to have been "fiduciaries" of any employee benefit plan of the Corporation which may exist from time to time, Section 145 of the General Corporation Law of Delaware shall, for the purposes of this Section 1, be interpreted as follows: an "other enterprise" shall be deemed to include such an employee benefit plan, including without limitation, any plan of the Corporation which is governed by the Act of Congress entitled "Employee Retirement Income Security Act of 1974," as amended from time to time; the Corporation shall be deemed to have requested a person to serve an employee benefit plan where the performance by such person of his or her duties to the Corporation also imposes duties on, or otherwise involves services by, such person to the plan or participants or beneficiaries of the plan; excise taxes assessed on a person with respect to an employee benefit plan pursuant to such Act of Congress shall be deemed "fines."

Section 2. CALIFORNIA. The Corporation shall indemnify its directors to the fullest extent not prohibited by the California General Corporation Law; provided, however, that the Corporation shall not be required to indemnify any director in connection with any proceeding

17


(or part thereof) initiated by such person or any proceeding by such person against the Corporation or its directors, officers, employees or other agents unless (i) such indemnification is expressly required to be made by law, (ii) the proceeding was authorized by the board of directors of the Corporation or
(iii) such indemnification is provided by the Corporation, in its sole discretion, pursuant to the powers vested in the Corporation under the California General Corporation Law.

The Corporation shall have power to indemnify its officers, employees and other agents as set forth in the California General Corporation Law.

Promptly after receipt of a request for indemnification hereunder (and in any event within ninety (90) days thereof) a reasonable, good faith determination as to whether indemnification of the director is proper under the circumstances because each director has met the applicable standard of care shall be made by: (i) a majority vote of a quorum consisting of directors who are not parties to such proceeding; (ii) if such quorum is not obtainable, by independent legal counsel in a written opinion; or (iii) approval or ratification by the affirmative vote of a majority of the shares of the Corporation represented and voting at a duly held meeting at which a quorum is present (which shares voting affirmatively also constitute at least a majority of the required quorum) or by written consent of a majority of the outstanding shares entitled to vote; where in each case the shares owned by the person to be indemnified shall not be considered entitled to vote thereon.

For purposes of any determination under this bylaw, a director shall be deemed to have acted in good faith and in a manner he or she reasonably believed to be in the best interests of the Corporation and its stockholders, and, with respect to any criminal action or proceeding, to have had no reasonable cause to believe that his or her conduct was unlawful, if his or her action is

18


based on information, opinions, reports and statements, including financial statements and other financial data, in each case prepared or presented by:
(i) one or more officers or employees of the Corporation whom the director believed to be reliable and competent in the matters presented; (ii) counsel, independent accountants or other persons as to matters which the director believed to be within such person's professional competence; and (iii) a committee of the Board upon which such director does not serve, as to matters within such committee's designated authority, which committee the director believes to merit confidence; so long as, in each case, the director acts without knowledge that would cause such reliance to be unwarranted.

The termination of any proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he or she reasonably believed to be in the best interests of the Corporation and its stockholders or that he or she had reasonable cause to believe that his or her conduct was unlawful.

The provisions of the preceding two paragraphs shall not be deemed to be exclusive or to limit in any way the circumstances in which a person may be deemed to have met the applicable standard of conduct set forth by the California General Corporation Law.

The Corporation shall advance, prior to the final disposition of any proceeding, promptly following request therefor, all expenses incurred by any director in connection with such proceeding upon receipt of an undertaking by or on behalf of such person to repay said amounts if it shall be determined ultimately that such person is not entitled to be indemnified under this bylaw or otherwise.

Without the necessity of entering into an express contract, all rights to indemnification and advances to directors under this bylaw shall be deemed to be contractual rights and be

19


effective to the same extent and as if provided for in a contract between the Corporation and the director. Any right to indemnification or advances granted by this bylaw to a director shall be enforceable by or on behalf of the person holding such right in the forum in which the proceeding is or was pending or, if such forum is not available or a determination is made that such forum is not convenient, in any court of competent jurisdiction if (i) the claim for indemnification or advances is denied, in whole or in part, or
(ii) no disposition of such claim is made within ninety (90) days of request therefor. The claimant in such enforcement action, if successful in whole or in part, shall be entitled to be paid also the expense of prosecuting his or her claim. The Corporation shall be entitled to raise as a defense to any such action (other than an action brought to enforce a claim for expenses incurred in connection with any proceeding in advance of its final disposition when the required undertaking has been tendered to the Corporation) that the claimant has not met the standards of conduct that make it permissible under the California General Corporation Law for the Corporation to indemnify the claimant for the amount claimed. Neither the failure of the Corporation (including its board of directors, independent legal counsel or its stockholders) to have made a determination prior to the commencement of such action that indemnification of the claimant is proper in the circumstances because the claimant has met the applicable standard of conduct set forth in the California General Corporation Law, nor an actual determination by the Corporation (including its board of directors, independent legal counsel or its stockholders) that the claimant has not met such applicable standard of conduct, shall be a defense to the action or create a presumption that the claimant has not met the applicable standard of conduct.

To the fullest extent permitted by the Corporation's Certificate of Incorporation and the California General Corporation Law, the rights conferred on any person by this bylaw shall not

20


be exclusive of any other right which such person may have or hereafter acquire under any statute, provision of the Certificate of Incorporation, bylaws, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in his or her official capacity and as to action in another capacity while holding office. The Corporation is specifically authorized to enter into individual contracts with any or all of its directors, officers, employees or agents respecting indemnification and advances, to the fullest extent permitted by the California General Corporation Law and the Corporation's Certificate of Incorporation.

The rights conferred on any person by this bylaw shall continue as to a person who has ceased to be a director and shall inure to the benefit of the heirs, executors and administrators of such a person.

The Corporation, upon approval by the board of directors, may purchase insurance on behalf of any person required or permitted to be indemnified pursuant to this bylaw. The Corporation's obligation to provide indemnification under this Section 2 shall be offset to the extent of any other source of indemnification or any otherwise applicable insurance coverage under a policy maintained by the Corporation or any other person.

Any repeal or modification of this bylaw shall only be prospective and shall not affect the rights under this bylaw in effect at the time of the alleged occurrence of any action or omission to act that is the cause of any proceeding against any agent of the Corporation.

The Corporation shall indemnify the directors and officers of the Corporation who serve at the request of the Corporation as trustees, investment managers or other fiduciaries of employee benefit plans to the fullest extent permitted by the California General Corporation Law.

21


If this bylaw or any portion hereof shall be invalidated on any ground by any court of competent jurisdiction, then the Corporation shall nevertheless indemnify each director to the fullest extent permitted by any applicable portion of this bylaw that shall not have been invalidated, or by any other applicable law.

For the purposes of this bylaw, the following definitions shall apply:

(i) The term "proceeding" shall be broadly construed and shall include, without limitation, the investigation, preparation, prosecution, defense, settlement and appeal of any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative, arbitrative or investigative.

(ii) The term "expenses" shall be broadly construed and shall include, without limitation, court costs, attorneys' fees, witness fees, fines, amounts paid in settlement or judgment and any other costs and expenses of any nature or kind incurred in connection with any proceeding, including expenses of establishing a right to indemnification under this bylaw or any applicable law.

(iii) The term the "Corporation" shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, and employees or agents, so that any person who is or was a director, officer, employee or agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under the provisions of this bylaw with respect to the resulting or surviving corporation

22


as he or she would have with respect to such constituent corporation if its separate existence had continued.

(iv) References to a "director," "officer," "employee," or "agent" of the Corporation shall include, without limitation, situations where such person is serving at the request of the Corporation as a director, officer, employee, trustee or agent of another corporation, partnership, joint venture, trust or other enterprise.

Section 3. INCONSISTENCY. In the event of any inconsistency between
Section 1 and Section 2 of this Article VI, the controlling Section as to any particular issue with regard to any particular matter, shall be the one which authorizes for the benefit of the agent or the other person in question the provision of the fullest, promptest, most certain or otherwise most favorable indemnification and/or advancement.

ARTICLE VII. - RIGHT OF FIRST REFUSAL

Section 1. RIGHT OF FIRST REFUSAL. No stockholder shall sell, assign, pledge, or in any manner transfer any of the shares of common stock of the Corporation or any right or interest therein, whether voluntarily or by operation of law, or by gift or otherwise, except by a transfer which meets the requirements hereinafter set forth in this bylaw:

(a) If the stockholder desires to sell or otherwise transfer any of his shares of common stock, then the stockholder shall first give written notice thereof to the Corporation. The notice shall name the proposed transferee and state the number of shares to be transferred, the proposed consideration, and all other terms and conditions of the proposed transfer.

(b) For thirty (30) days following receipt of such notice, the Corporation shall have the option to purchase all or any portion of the shares specified in the notice at the price and upon the terms set forth in such notice. In the event of a gift, property settlement or other

23


transfer in which the proposed transferee is not paying the full price for the shares, and that is not otherwise exempted from the provisions of this bylaw, the price shall be deemed to be the fair market value of the common stock at such time as determined in good faith by the Board of Directors. In the event the Corporation elects to purchase all or any portion of the shares, it shall give written notice to the transferring stockholder of its election and settlement for said shares shall be made as provided below in paragraph (d).

(c) The Corporation may assign its rights hereunder.

(d) In the event the Corporation and/or its assignee(s) elect to acquire any of the shares of the transferring stockholder as specified in said transferring stockholder's notice, the Secretary of the Corporation shall so notify the transferring stockholder and settlement thereof shall be made in cash within thirty (30) days after the Secretary of the Corporation receives said transferring stockholder's notice; provided that if the terms of payment set forth in said transferring stockholder's notice were other than cash against delivery, the Corporation and/or its assignee(s) shall pay for said shares on the same terms and conditions set forth in said transferring stockholder's notice.

(e) In the event the Corporation and/or its assignees(s) do not elect to acquire all of the shares specified in the transferring stockholder's notice, said transferring stockholder may, within the sixty-day period following the expiration of the option rights granted to the Corporation and/or its assignee(s) herein, transfer the shares specified in said transferring stockholder's notice which were not acquired by the Corporation and/or its assignee(s) as specified in said transferring stockholder's notice. All shares so sold by said transferring stockholder shall continue to be subject to the provisions of this bylaw in the same manner as before said transfer.

24


(f) Anything to the contrary contained herein notwithstanding, the following transactions shall be exempt from the provisions of this bylaw:

A stockholder's transfer of any or all shares of common stock held either during such stockholder's lifetime or on death by will or intestacy to such stockholder's immediate family or to any custodian or trustee for the account of such stockholder or such stockholder's immediate family. "Immediate family" as used herein shall mean spouse, lineal descendant, father, mother, brother or sister of the stockholder making such transfer.

In any such case, the transferee, assignee, or other recipient shall receive and hold such common stock subject to the provisions of this bylaw, and there shall be no further transfer of such stock except in accord with this bylaw.

(g) The provisions of this bylaw may be waived with respect to any transfer either by the Corporation, upon duly authorized action of its Board of Directors, or by the stockholders, upon the express written consent of the owners of a majority of the voting power of the Corporation (excluding the votes represented by those shares to be transferred by the transferring stockholder). This bylaw may be amended or repealed either by a duly authorized action of the Board of Directors or by the stockholders, upon the express written consent of the owners of a majority of the voting power of the Corporation.

(h) Any sale or transfer, or purported sale or transfer, of securities of the Corporation shall be null and void unless the terms, conditions and provisions of this bylaw are strictly observed and followed.

(i) The foregoing right of first refusal shall terminate on either of the following dates, whichever shall first occur:

(i) On May 13, 2004; or

25


(ii) Upon the date securities of the Corporation are first offered to the public pursuant to a registration statement filed with, and declared effective by, the United States Securities and Exchange Commission under the Securities Act of 1933, as amended.

(j) The certificates representing shares of common stock of the Corporation shall bear on their face the following legend so long as the foregoing right of first refusal remains in effect:

"The shares represented by this certificate are subject to a right of first refusal option in favor of the Corporation and/or its assignee(s), as provided in the bylaws of the Corporation."

[REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]

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CERTIFICATE OF SECRETARY

The undersigned, being the Secretary of Digirad Corporation, a Delaware corporation, does hereby certify the foregoing to be the Bylaws of said Corporation, as adopted by the directors of the Corporation and which remain in full force and effect as of the date hereof.

Executed at San Diego, California effective as of January 2, 1997.


     /s/ Craig Andrews
---------------------------
 Craig Andrews, Secretary



   
 
EXHIBIT 10.1

L-99-1261

LICENSE AGREEMENT

FOR

DETECTOR

BETWEEN

DIGIRAD CORPORATION

AND

THE REGENTS OF THE UNIVERSITY OF CALIFORNIA

THROUGH THE

ERNEST ORLANDO LAWRENCE
BERKELEY NATIONAL LABORATORY


                                   L-99-1261

                                TABLE OF CONTENTS

1.   BACKGROUND                                                           1

2.   DEFINITIONS                                                          1

3.   LICENSE GRANT                                                        3

4.   LICENSE ISSUE FEE                                                    4

5.   ROYALTIES AND PAYMENTS                                               4

6    PERFORMANCE REQUIREMENTS                                             6

7    PROGRESS AND ROYALTY REPORTS                                         7

8.   BOOKS AND RECORDS                                                    8

9.   LIFE OF THE AGREEMENT                                                8

10.  TERMINATION BY BERKELEY LAB                                          9

11.  TERMINATION BY DIGIRAD                                               9

12.  DISPOSITION OF LICENSED PRODUCTS                                     9

13.  USE OF NAMES AND TRADEMARKS AND NONDISCLOSURE OF AGREEMENT           9

14.  LIMITED WARRANTY                                                    10

15.  PATENT PROSECUTION AND MAINTENANCE                                  11

16.  PATENT INFRINGEMENT                                                 13

17   WAIVER                                                              13

18.  ASSIGNMENT                                                          13

19.  INDEMNIFICATION                                                     13

20.  LATE PAYMENTS                                                       15


 
L-99-1261

21.  NOTICES                                                             15

22.  U.S.  MANUFACTURE                                                   15

23.  PATENT MARKING                                                      16

24.  GOVERNMENT APPROVAL OR REGISTRATION                                 16

25.  EXPORT CONTROL LAWS                                                 16

26.  FORCE MAJEURE                                                       16

27   MISCELLANEOUS                                                       16


L-99-1261

LICENSE AGREEMENT FOR DETECTOR

This license agreement (the "Agreement") is entered into by The Regents of the University of California ("The Regents"), Department of Energy contract-operators of the Ernest Orlando Lawrence Berkeley National Laboratory, 1 Cyclotron Road, Berkeley, CA 94720, (jointly, "Berkeley Lab"), and Digirad Corporation, ("Digirad") a Delaware corporation, having as its principle place of business, 9350 Trade Place San Diego, California 92126-6330.

1. BACKGROUND

1.1 A certain invention, *** *** (the "Invention"), was made under U.S. Department of Energy contract *** *** at the University of California, Ernest Orlando Lawrence Berkeley National Laboratory by Steven Edward Holland.

1.2 As DOE sponsored development of the Invention, this Agreement and the resulting license are subject to overriding obligations to the federal government pursuant to the provisions of the applicable law or regulations.

1.3 Berkeley Lab wants the Invention developed and used to the fullest extent so that the general public enjoys the benefits of the government-sponsored research.

1.4 Digirad wants to obtain certain rights from Berkeley Lab for the commercial development, manufacture, use, and sale of the Invention.

1.5 Digirad entered into an Option Agreement with Berkeley Lab to license the above referenced invention on June 3, 1998.

1.6 Digirad is a "small business firm" as defined at Section 2 of Public Law 85-536 (15 U.S.C. 632).

Therefore the parties agree as follows:

2. DEFINITIONS

2.1 "Effective Date" means the date of execution by the last signing party.

2.2 "Field of Use" means the development, production and use *** *** ***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

1 of 17


L-99-1261

2.3 "Highly Inflationary Currency" means the currency of any economy with a cumulative inflation rate of *** or more over the most recent *** , as measured by consumer price indices published by the *** ***

2.4 "Licensed Patents" means patent rights to any subject matter claimed in or covered by *** *** *** or any corresponding foreign patent application or patent, for which Digirad has met the requirements of Section 15.2 herein; any division, reexamination, continuation, continuation-in-part (excluding new matter contained and claimed in that continuation-in-part), or of which such application is a successor; any patents issuing on any of the foregoing, and all renewals, reissues and extensions thereof, or other equivalents of a renewal, reissues and extension thereof.

2.5 "Licensed Product" means any product, service or process that employs or is produced by the practice of any invention claimed in Licensed Patents and whose manufacture, use, practice, sale, or lease would constitute, but for the license Berkeley Lab grants to Digirad under this Agreement, an infringement of any claim in Licensed Patents.

2.6 "Selling Price" for the purpose of computing royalties means the price at which Digirad or its sublicensee sells the Licensed Product in an arms-length transaction, less the sum of the following deductions that are customary and actually taken: *** *** *** *** When a Licensed Product is not sold, but is otherwise disposed of, the Selling Price of that Licensed Product for the purposes of computing royalties is *** *** *** When such products are not currently being offered for sale by Digirad, the Selling Price of a Licensed Product otherwise disposed of, for the purpose of computing royalties, is *** *** *** When such products are not currently sold or offered for sale by Digirad or others, then the Selling Price, for the purpose of computing royalties, shall be *** *** For sales of Licensed Products to a Joint Venture or Affiliate (as defined in Paragraphs 2.7 and 2.8 below) that are provided by Digirad to the Joint Venture or Affiliate (directly or indirectly for resale by said Joint Venture or Affiliate) at a reduced price from that customarily charged to an unrelated third party, then the royalty paid to Berkeley Lab will be based on *** *** *** For sales of Licensed Products to a Joint

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

2 of 17


 
L-99-1261

Venture or Affiliate (as defined in Paragraphs 2.7 and 2.8 below) that are provided directly or indirectly by Digirad to the Joint Venture or Affiliate as an end user at a reduced price from that customarily charged to an unrelated third party, then the royalty paid to Berkeley

         Lab will be based on *** ***

2.7      "Affiliate(s)" of a party means                      ***
                                                     ***
                                                     ***
                                                     ***

2.8 "Joint Venture" means any separate entity established pursuant to an agreement between a third party and Digirad to constitute a vehicle for a joint venture, which separate entity purchases, sells or acquires Licensed Products from Digirad at prices substantially different from those at which Digirad would have charged other purchasers that deal at arms length with Digirad. If such separate entity is established, then Berkeley Lab shall collect from Digirad royalties on the Selling Price of Licensed Products by the entity and shall not collect royalties on the Selling Price of Licensed Products by Digirad.

3. LICENSE GRANT

3.1 Subject to the limitations set forth in this Agreement, Berkeley Lab grants to Digirad a nontransferable (subject to Section 18.1), limited (by the terms of Sections 3.2 and 3.7) worldwide exclusive, royalty-bearing license, under Licensed Patents, only in the Field of Use, to develop, make, have made, use, practice, sell, have sold, and lease the Licensed Products.

3.2 Any license under this Agreement is subject to the following: (a) DOE's royalty-free license for federal government practice only, and (b) DOE's option to grant licenses either if reasonable steps to commercialize the Invention are not carried out or in order to meet federal regulations. Digirad shall use best efforts to commercialize Licensed Patents.

3.3 Berkeley Lab also grants to Digirad the right to issue royalty-bearing sublicenses only in the Field of Use to make, use, practice and sell Licensed Products, so long as Digirad has current exclusive rights in the Field of Use.

3.4 Any sublicense Digirad grants must be consistent with all the rights and obligations due Berkeley Lab and the United States Government under this Agreement, including, without limitation, the obligations under
Section 3.2 above.

3.5 Digirad shall provide Berkeley Lab with a copy of each sublicense issued under this Agreement; collect payment of all royalties due Berkeley Lab from sublicensees; and summarize and deliver all reports due Berkeley Lab from sublicensees under Article 7 (PROGRESS AND ROYALTY REPORTS).

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

3 of 17


L-99-1261

3.6 If this Agreement terminates for any reason, *** ***

3.7 Berkeley Lab expressly reserves the right to use the Invention and associated technology for educational and research purposes subject to the limitations of Section 13.2.

4. LICENSE ISSUE FEE

4.1 Digirad shall pay Berkeley Lab a license issue fee of *** *** *** *** *** ***

4.2 This fee is ***

5. ROYALTIES AND PAYMENTS

5.1 Digirad shall pay to Berkeley Lab an earned royalty *** *** of the Selling Price of each Licensed Product Digirad sells.

5.2 Under this Agreement a Licensed Product is considered to be sold when invoiced, or if not invoiced, when delivered to a third party. But when the last patent covering a Licensed Product expires or when the license terminates, any shipment made on or before the day of that expiration or termination that has not been billed out before is considered as sold (and therefore subject to royalty) unless returned to Digirad within *** . Berkeley Lab shall credit royalties that Digirad pays on a Licensed Product that the customer does not accept or returns.

 

5.3      For each sublicense, Digirad shall pay Berkeley Lab  ***
                                            ***
                                            ***
                                            ***
                                            ***
                           ***

5.4 Digirad shall pay to Berkeley Lab by *** of each year the difference between the earned royalties for that calendar year Digirad has already paid to Berkeley Lab and the minimum annual royalty set forth in the following schedule. Berkeley Lab shall credit that minimum annual royalty paid against the earned royalty due and owing for the calendar year in which Digirad made the minimum payment

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CALENDAR YEAR                            MINIMUM ANNUAL ROYALTY
-------------                            ----------------------
    1999                                 $ ***
    2000                                 $ ***
    2001                                 $ ***
    2002 and each year thereafter        $ ***

5.5 Digirad shall send payment for royalties accruing to Berkeley Lab *** together with its royalty report under paragraph 7.4. Digirad shall be entitled to credit *** *** *** ***

5.6 Digirad shall make checks payable to "The Regents of the University of California (Berkeley Lab/L-99-1261.)" Digirad shall pay Berkeley Lab only in United States dollars. If a Licensed Product is sold for moneys other than United States dollars (not including Highly Inflationary Currency), Digirad shall *** *** *** *** If a Licensed Product is sold for a Highly Inflationary Currency,  

         Digirad shall ***
                                                     ***
                                                     ***
                                                     ***
                  ***

5.7      Digirad may not reduce royalties payable by  ***
                                                     ***
                                                     ***
                  ***

5.8 If Digirad cannot promptly remit any royalties for sales in any country where a Licensed Product is sold because of legal restrictions, Digirad may deposit in United States funds royalties due Berkeley Lab to Berkeley Lab's account in a bank or other depository in that country. If Digirad is not permitted to deposit those payments in U.S. funds under the laws of that country, Digirad may deposit those payments in the local currency to Berkeley Lab's account in a bank or other depository in that country.

5.9 If a court of competent jurisdiction and last resort holds invalid any patent or any of the patent claims within Licensed Patent in a final decision from which no appeal has or can be taken, Digirad's obligation to pay royalties based on that patent or claim will cease as of the date of that final decision. Digirad, however, shall pay any royalties that accrued before that decision or that are based on another patent or claim not involved in that decision.

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5.10     Digirad has no duty to pay Berkeley Lab royalties under this Agreement
         on a Licensed Product Digirad sells to the United States Government
         including any United States Government agency. Digirad shall reduce the
         amount charged for a Licensed Product sold to the United States
         Government by an amount equal to the royalty otherwise due Berkeley
         Lab. Such royalty otherwise due Berkeley Lab will count towards the
         minimum annual royalty payments per Section 5.4.

                           6. PERFORMANCE REQUIREMENTS

6.1      Digirad shall proceed with the development, manufacture and sale of
         Licensed Products and shall use diligent commercial efforts to endeavor
         to market them within a reasonable time after the Effective Date in
         quantities sufficient to meet the market demand.

6.2      Digirad shall use diligent commercial efforts to obtain all necessary
         governmental approvals for the manufacture, use and sale of Licensed
         Products.

6.3      Digirad is entitled to exercise prudent and reasonable business
         judgment in meeting its performance requirements under this Agreement.

6.4      If Digirad is unable to perform any of the following, then Berkeley Lab
         may either terminate this Agreement or reduce this limited exclusive
         license to a nonexclusive license:

              6.4.1                  ***
                                     *** or


              6.4.2                  ***
                                     ***
                        ***

It is the understanding of the parties hereto that any termination of the Agreement or reduction of this license to a nonexclusive license as a result of Digirad's failure to meet the specifications of Section
6.4, shall be subject to the *** cure period set forth in Section 10.1 below.

6.5 If Berkeley Lab grants a non-exclusive license to any other party upon royalty rates more favorable than those of this Agreement after reducing this license to a non-exclusive license, then *** *** *** ***

6.6 Digirad and Berkeley Lab by mutual written consent may amend or extend the requirements of Sections 6.4.1-6.4.2 at the written request of Digirad in response to legitimate business reasons.

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7. PROGRESS AND ROYALTY REPORTS

7.1 Beginning June 1, 1999 and *** thereafter, Digirad shall submit to Berkeley Lab a progress report covering Digirad's activities related to the development and testing of all Licensed Products and the obtaining of the governmental approvals necessary for marketing. Digirad shall make these progress reports for each Licensed Product until the first commercial sale of that Licensed Product occurs anywhere in the world.

7.2 The progress reports Digirad submits under Section 7.1 must include, but not be limited to, the following topics:

 

7.2.1    summary of work completed related to the requirements of
         Section 6.4;

7.2.2    key scientific discoveries;

7.2.3    summary of work in progress;

7.2.4    current schedule of anticipated milestones;

7.2.5    market plans for introduction of Licensed Products; and

7.2.6    number of full-time equivalent (FTEs) employees or agents
         working on the development of Licensed Products.

7.3 Digirad shall also report to Berkeley Lab in its immediately subsequent royalty report on the date of first commercial sale of each Licensed Product in the U.S. and in each other country.

7.4 After the first commercial sale of a Licensed Product anywhere in the world, Digirad shall make *** royalty reports to Berkeley Lab on or *** *** Each royalty report must cover the most recently completed *** and must show:

 

7.4.1    the Selling Price of each type of Licensed Product sold by
         Digirad;

7.4.2    the number of each type of Licensed Product sold;

7.4.3    the royalties, in U.S. dollars, payable under this Agreement
         on those sales;

7.4.4    the exchange rates used in calculating the royalty due;

7.4.5    the royalties on government sales that otherwise would have
         been due under Section 5.10; and

7.4.6 for each sublicense, if any:

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7.4.6.1    the sublicensee;

7.4.6.2  the number, description, and aggregate Selling Prices
         of Licensed Products that the sublicensee sold or
         otherwise disposed of;

7.4.6.3  the exchange rates used in calculating the royalties
         due Berkeley Lab from the sublicensee's sales.

7.5 If no sales of Licensed Products have been made during any reporting period, Digirad shall make a statement to this effect.

8. BOOKS AND RECORDS

8.1 Digirad shall keep books and records accurately showing all Licensed Products manufactured, used, or sold under the terms of this Agreement. Digirad shall preserve those books and records for at least *** from the date of the royalty payment to which they pertain and shall open them to inspection by representatives or agents of Berkeley Lab *** *** ***

8.2 Berkeley Lab shall bear the fees and expenses of Berkeley Lab's representatives performing the examination of the books and records. But if the representatives discover an error resulting in a deficiency in royalties of more than *** of the total royalties due for any year, then Digirad shall bear the fees and expenses of these representatives and the difference between the earned royalties and the reported royalties (which shall be subject to the provisions of Article 20 (LATE PAYMENTS)).

9. LIFE OF THE AGREEMENT

9.1 Unless otherwise terminated by operation of law or by acts of the parties in accordance with the terms of this Agreement, this Agreement is in force from the Effective Date and expires concurrently with the last-to-expire Licensed Patent.

9.2 Any termination of this Agreement shall not affect the rights and obligations set forth in the following Articles:

Article 8 Books and Records

Article 12 Disposition of Licensed Products on Hand upon Termination

Article 13 Use of Names and Trademarks and Nondisclosure of Agreement

Article 14 Limited Warranty

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Article 19 Indemnification

Article 25 Export Control Laws

9.3 Termination does not affect in any manner any rights of Berkeley Lab or Digirad arising under this Agreement before the termination.

10. TERMINATION BY BERKELEY LAB

10.1     If Digirad violates or fails to perform any material term of this
         Agreement, then Berkeley Lab may give written notice of such default
         ("Default Notice") to Digirad. If Digirad fails to cure that default
         and provide Berkeley Lab with reasonable evidence of the cure within
         *** of the Default Notice, Berkeley Lab may terminate this Agreement
         and the licenses granted by a second written notice ("Termination
         Notice") to Digirad. If Berkeley Lab sends a Termination Notice to
         Digirad, this Agreement automatically terminates on the effective date
         of the Termination Notice.

                           11. TERMINATION BY DIGIRAD

11.1     Digirad at any time may terminate this Agreement in whole or as to any
         portion of Licensed Patents by giving written notice to Berkeley Lab.
         Digirad's termination of this Agreement will be effective *** after its
         notice. If that termination is without cause within *** years of the
         Effective Date, Digirad shall ***
                                            ***
                  ***

          12. DISPOSITION OF LICENSED PRODUCTS ON HAND UPON TERMINATION

12.1     Within *** of termination of this Agreement for any reason, Digirad
         shall provide Berkeley Lab with a written inventory of all Licensed
         Products in process of manufacture or in stock. Digirad shall make
         diligent efforts to dispose of those Licensed Products within *** of
         termination. The sale of any Licensed Product within *** is subject to
         the terms of this Agreement. Digirad shall cease sales of ***
         *** after termination.

         13. USE OF NAMES AND TRADEMARKS AND NONDISCLOSURE OF AGREEMENT

13.1     In accordance with California Education Code Section 92000, Digirad
         shall not use in advertising, publicity or other promotional activities
         any name, trade name, trademark, or other designation of the University
         of California, nor shall Digirad so use "Berkeley Lab" (including any
         contraction, abbreviation, or simulation of any of the foregoing)
         without

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         Berkeley Lab's prior written consent. As the sole exception to the
         above prohibition, Digirad shall give appropriate credit to the
         inventor(s) and Berkeley Lab at scientific symposia, and in technical
         publications in scientific journals where the licensed technology is
         referenced. Berkeley Lab shall not use in advertising, publicity or
         other promotional activities any name, trade name, or other designation
         of Digirad without its prior written consent except as set forth in
         Section 13.2 below.

13.2     Neither party may disclose the terms or existence of this Agreement to
         a third patty without express written permission of the other party,
         except when required under either the California Public Records Act or
         other applicable law or court order or by Berkeley Lab's contracts with
         the DOE or any other Federal or State entity. Notwithstanding the
         foregoing, Berkeley Lab may disclose the existence of this Agreement
         and the extent of the grant in Article 3, but shall not otherwise
         disclose the terms of this Agreement, except to the DOE.

13.3     The Proprietary Information Exchange Agreement between Digirad and the
         Regents of the University of California as Managers of the Lawrence
         Berkeley National Laboratory, as attached hereto as Exhibit A, shall
         remain in effect through the term outlined in the Proprietary
         Information Exchange Agreement.

                              14. LIMITED WARRANTY

14.1     Berkeley Lab warrants to Digirad that it has the lawful right to grant
         this license.

14.2     Except as set forth above, this license and the associated Invention(s)
         are provided WITHOUT WARRANTY OF MERCHANTABILITY OR FITNESS FOR A
         PARTICULAR PURPOSE OR ANY OTHER WARRANTY, EXPRESS OR IMPLIED. BERKELEY
         LAB MAKES NO REPRESENTATION OR WARRANTY THAT LICENSED PRODUCTS WILL NOT
         INFRINGE ANY PATENT OR OTHER PROPRIETARY RIGHT.

14.3     IN NO EVENT WILL BERKELEY LAB OR DIGIRAD BE LIABLE FOR ANY INCIDENTAL,
         SPECIAL OR CONSEQUENTIAL DAMAGES INCURRED BY THE OTHER PARTY HERETO
         RESULTING FROM EXERCISE OF THIS LICENSE OR THE USE OF THE INVENTION(S)
         OR LICENSED PRODUCTS UNDER THIS AGREEMENT. THIS PROVISION, 14.3, DOES
         NOT APPLY TO INCIDENTAL, SPECIAL OR CONSEQUENTIAL DAMAGES AWARDED IN A
         JUDGEMENT FOR A THIRD PARTY AGAINST A PARTY OR THE PARTIES HERETO.

14.4     Except as set forth above, nothing in this Agreement may be construed
         as:

         14.4.1   a warranty or representation by Berkeley Lab as to the
                  validity or scope of any of Berkeley Lab's rights in Licensed
                  Patents;

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14.4.2   a warranty or representation that anything made, used, sold or
         otherwise disposed of under any license granted in this
         Agreement is or will be free from infringement of patents of
         third parties;

14.4.3   an obligation to bring or prosecute actions or suits against
         third parties for patent infringement, except as specifically
         provided for in Article 16 (Patent Infringement);

14.4.4   a grant by implication, estoppel or otherwise of any license
         or rights under any patents of Berkeley Lab other than
         Licensed Patents, regardless of whether such patents are
         dominant or subordinate to Licensed Patents; or

14.4.5   an obligation to furnish any know-how not provided in Licensed
         Patents.

15. PATENT PROSECUTION AND MAINTENANCE

 

15.1     Berkeley Lab shall diligently maintain the United States patents for
         Licensed Patents (including any future patent rights provided for in
         Section 2.4) using counsel of its choice that is reasonably acceptable
         to Digirad. Berkeley Lab shall bear the cost of pre-paring, filing,
         prosecuting and maintaining any United States patent covered by this
         Agreement.

15.2     Berkeley Lab has filed foreign patent applications corresponding to the
         PCT Application referred to in Section 2.4 (namely US 97/20173) as
         follows:

(a)    European Patent Office (EPO), designating

(i)    ***

(ii)   ***

(iii)  ***

(iv)   ***

(v)    ***

(vi)   ***

(vii)  ***

(viii) ***

(ix) ***

(x) ***

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L-99-1261

(xi) ***

(xii) ***

(b) ***

Berkeley Lab has no obligation to take action to file or prosecute foreign patent applications on behalf of Digirad until the following occurs:

 

         15.2.1   (With the exception of the three countries listed in 15.3
                  below) Digirad makes that request in writing to Berkeley Lab
                  within *** after the Effective Date. The absence of the
                  required notice from Digirad to Berkeley Lab acts as an
                  election not to proceed on protecting foreign rights.

         15.2.2   That notice also identifies the countries Digirad desires.

         15.2.3   Digirad pays Berkeley Lab the foreign license fee as set forth
                  in paragraph 15.4

15.3     Digirad agrees to pay Berkeley Lab *** , upon the day of execution of
         this Agreement, for the foreign patent counterparts to the U.S.
         application for the following countries: ***

15.4     The foreign license fee for each foreign counterpart in addition to
         those listed in Section 15.3 to a United States patent application
         shall be *** for each national filing or for each country designated in
         the PCT filing for entry into the national phase, European Patent
         Convention ("EPC") filing, or similar regional filing.

15.5     Berkeley Lab shall bear the expense of preparing, filing, prosecuting
         and securing all foreign patent applications that Berkeley Lab files at
         Digirad's request (pursuant to 15.2 above). Digirad shall bear the
         expense of ***
                                                     ***
                                                     ***

15.6     Berkeley Lab shall promptly provide Digirad with copies of all relevant
         documentation so that Digirad is informed of the continuing prosecution
         of Licensed Patents and any foreign patent applications Berkeley Lab
         files under Section 15.2. Additionally, Berkeley Lab shall provide
         Digirad a *** *** summarizing the status of the Licensed Patents and
         any foreign patent applications Berkeley Lab files under Section 15.2.
         Digirad shall keep this documentation confidential. Berkeley Lab shall
         use all reasonable efforts to amend any patent application to include
         claims reasonably requested by Digirad to protect the products
         contemplated to be sold under this Agreement.

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16. PATENT INFRINGEMENT

16.1     If either party learns of the substantial infringement of any of
         Licensed Patents, the party shall so inform the other party in writing
         and shall provide the other party with reasonable evidence of the
         infringement. During the period and in a jurisdiction where Digirad has
         exclusive rights under this Agreement, ***
                                                     ***
                                                     ***        Both parties
         shall use their best efforts in cooperation with each other to
         terminate such infringement without litigation.

16.2                                                          ***
                                                              ***
                                                              ***

16.3                                                          ***
                                                              ***
                                                              ***

16.4                                                          ***
                                                              ***
                                                              ***

                                   17. WAIVER

17.1     The waiver of any breach of any term of this Agreement does not waive
         any other breach of that or any other term.

                                 18. ASSIGNMENT

18.1     This Agreement is binding upon and shall inure to the benefit of
         Berkeley Lab, its successors and assigns. Upon written notice to
         Berkeley Lab, Digirad may assign this Agreement to a Digirad wholly
         owned subsidiary or to a purchaser or acquirer of all or substantially
         all of the business or assets of Digirad. Any other attempt by Digirad
         to assign this Agreement is void unless Digirad obtains the prior
         written consent of Berkeley Lab. Berkeley Lab shall not unreasonably
         withhold or delay that consent.

                               19. INDEMNIFICATION

19.1     Digirad shall indemnify, hold harmless and defend Berkeley Lab and the
         U.S. Government and their officers, employees, and agents; the sponsors
         of the research that led to the Invention; and the inventors of the
         patents and patent applications in Licensed Patents against any and all
         claims, suits, losses, damage, costs, fees, and expenses resulting from
         or arising out of exercise of this license or any sublicense. Berkeley
         Lab shall promptly notify Digirad in writing of any claim or suit
         brought against Berkeley Lab in respect of which Berkeley Lab intends
         to invoke the provisions of this Article 19

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         (INDEMNIFICATION).                          ***
                                                     ***
                                                     ***


19.2     Digirad, at its sole expense, shall insure its activities in connection
         with the work under this Agreement and obtain and keep in force
         Comprehensive or Commercial Form General Liability Insurance
         (contractual liability and products liability included) or equivalent
         program of self-insurance with limits as follows:

         19.2.1   Each Occurrence                                     $   ***
         19.2.2   Products/Completed Operations Aggregate             $   ***
         19.2.3   Personal and Advertising Injury                     $   ***
         19.2.4   General Aggregate (commercial form only)            $   ***

19.3     The coverages and limits referred to in this Article 19 do not in any
         way limit the liability of Digirad. Digirad shall furnish Berkeley Lab
         with certificates of insurance, including renewals, evidencing
         compliance with all requirements at least *** prior to the first
         commercial sale, use, practice or distribution of a Licensed Product.

         19.3.1   If such insurance is written on a claims-made form, coverage
                  shall provide for a retroactive date of placement on or before
                  the Effective Date.

         19.3.2   Digirad shall maintain the general liability insurance
                  specified during: (a) the period that the Licensed Product is
                  being commercially distributed or sold (other than for the
                  purpose of obtaining regulatory approvals) by Digirad or by a
                  sublicensee or agent of Digirad, and (b) a reasonable period
                  thereafter, but in no event less than five years.

19.4     The insurance coverage of Section 19.2 must:

         19.4.1   Provide for *** advance written notice to Berkeley Lab of any
                  modification of any such coverage and provide immediate notice
                  of cancellation of such coverage.

         19.4.2   Indicate that DOE and "The Regents of the University of
                  California" are endorsed as additional insureds, but only with
                  respect to the subject matter of this Agreement.

         19.4.3   Include a provision that the coverages are primary and do not
                  participate with, nor are excess over, any valid and
                  collectible insurance or program of self-insurance carried or
                  maintained by Berkeley Lab.

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20. LATE PAYMENTS

20.1     Excepting issues arising from Section 26.1, if Digirad does not make a
         payment to Berkeley Lab when due, Digirad shall pay to Berkeley Lab ***
                                                     ***
                                                     ***
                  ***

                                   21. NOTICES

21.1     Any payment, notice or other communication this Agreement requires or
         permits either party to give must be in writing to the appropriate
         address given below, or to such other address as one party designates
         by written notice to the other party. The parties deem payment, notice
         or other communication to have been properly given and to be effective
         (a) on the date of delivery if delivered in person; (b) on the fourth
         day after mailing if mailed by first-class mail, postage paid; (c) on
         the second day after delivery to an overnight courier service such as
         Federal Express, if sent by such a service; or (d) upon confirmed
         transmission by telecopier. The parties addresses are as follows:

         For payments to Berkeley Lab:       For all other notices to
                                             Berkeley Lab:

         Ernest Orlando Lawrence             Ernest Orlando Lawrence
         Berkeley National Laboratory        Berkeley National Laboratory
         Accounting/Financial Management     Technology Transfer Department
         P.O. Box 528                        Mailstop 90-1070
         Berkeley, California 94701          One Cyclotron Road
         Attention: Licensing Accountant     Berkeley, California 94720
         Fax: 510/486-5995                   Attention: Licensing Manager
         Telephone: 510/486-7113             Fax: 510/486-6457
                                             Telephone: 510/486-6467

         In the case of Digirad:

         Digirad Corporation
         9350 Trade Place
         San Diego, California 92126-6334
         Attention:  President
         Fax:  619-549-7714
         Telephone:  619-578-5300

22. U.S. MANUFACTURE

 

22.1     Digirad shall have Licensed Products produced for sale in the United
         States manufactured substantially in the United States so long as
         Digirad has current exclusive rights in the Field of Use.

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23. PATENT MARKING

23.1     Digirad shall mark all Licensed Products made, used or sold under this
         Agreement, or their containers, in accordance with the applicable
         patent marking laws.

                     24. GOVERNMENT APPROVAL OR REGISTRATION

24.1     If the law of any nation requires that any governmental agency either
         approve or register this Agreement or any associated transaction,
         Digirad shall assume all legal obligations to do so. Digirad shall
         notify Berkeley Lab if it becomes aware that this Agreement is subject
         to a U.S. or foreign government reporting or approval requirement.
         Digirad shall make all necessary filings and pay all costs, including
         fees, penalties, and all other costs associated with such reporting or
         approval process. Berkeley Lab shall fully cooperate with Digirad, to
         the extent it is able to do so within the law and established Berkeley
         Lab policy, to provide documentation and testimony to obtain such
         approval or registration, at Digirad's sole expense.

                             25. EXPORT CONTROL LAWS

25.1     Digirad shall observe all applicable United States and foreign laws and
         regulations with respect to the transfer of Licensed Products and
         related technical data, including, with-out limitation, the
         International Traffic in Arms Regulations (ITAR) and the Export
         Administration Regulations.

                                26. FORCE MAJEURE

26.1     If a party's performance required under this Agreement is rendered
         impossible or unfeasible due to any catastrophes or other major events
         beyond its reasonable control, including, without limitation, the
         following, the parties are excused from performance, war, riot, and
         insurrection; laws, proclamations, edicts, ordinances or regulations;
         strikes, lockouts or other serious labor disputes; and floods, fires,
         explosions, or other natural disasters. When such events abate, the
         parties' respective obligations under this Agreement must resume.

                                27. MISCELLANEOUS

27.1     The headings of the several sections are inserted for convenience of
         reference only and are not intended to be a part of or to affect the
         meaning or interpretation of this Agreement.

27.2     This Agreement is not binding upon the parties until it is signed below
         on behalf of each party.

27.3     No amendment or modification hereof shall be valid or binding upon the
         parties unless made in writing and signed on behalf of each party.

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27.4     This Agreement embodies the entire and final understanding of the
         parties on this subject. It supersedes any previous representations,
         agreements, or understandings, whether oral or written.

27.5     If a court of competent jurisdiction holds any provision of this
         Agreement invalid, illegal or unenforceable in any respect, this
         Agreement must be construed as if that invalid or illegal or
         unenforceable provision is severed from the Agreement, provided,
         however, that the parties shall negotiate in good faith substitute
         enforceable provisions that most nearly effect the parties' intent in
         entering into this Agreement.

27.6     This Agreement must be interpreted under California law without regard
         to principles of conflicts of laws.

Berkeley Lab and Digirad execute this Agreement in duplicate originals through their duly authorized respective officers in one or more counterparts, that taken together, are but one instrument.

THE REGENTS OF THE UNIVERSITY DIGIRAD CORPORATION
OF CALIFORNIA, THROUGH THE
ERNEST ORLANDO LAWRENCE
BERKELEY NATIONAL LABORATORY


By    /S/ PIERMARIA T. ODDONE             By       /S/ SCOTT HUENNEKENS
   -----------------------------             ---------------------------------
                  (signature)                          (signature)

By      PIERMARIA T.  ODDONE              By         SCOTT HUENNEKENS
   ------------------------------            ---------------------------------
            (Please Print)                            (Please Print)

Title    DEPUTY DIRECTOR                  Title    PERS. & COO
      ---------------------------                -----------------------------

Date     MAY 16, 1999                     Date     5-19, 1999
     ----------------------------              -------------------------------


Approved as to form


         /S/ GLENN R. WOODS
----------------------------------------
GLENN R. WOODS
LAWRENCE BERKELEY NATIONAL LABORATORY


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Exhibit A to License Agreement

PROPRIETARY INFORMATION EXCHANGE AGREEMENT

This AGREEMENT made and entered into as of this 23rd day of April 1, 1999 by and between DIGIRAD, a Delaware corporation, whose address is 9350 Trade Place, San Diego, California 92126-6334 and The Regents of the University of California as Managers of the Lawrence Berkeley National Laboratory, whose address is 1 Cyclotron Road, Berkeley, CA 94720.

WHEREAS, the parties hereto are undertaking negotiations towards the development of a license agreement between them, and

WHEREAS, in furtherance of such license, each undersigned party (the "Receiving Party") understands that the other party (the "Disclosing Party") has disclosed or may disclose information relating to the Disclosing Party's business and/or intellectual property (including, without limitation, chemical formulas, computer programs, software, technical drawings, names and expertise of employees and consultants, know-how, formulas processes, ideas, inventions (whether patentable or not), schematics and other technical business, financial, customer and product development plans, forecasts, strategies and information, and any and all information, technical or otherwise related to describing Digirad's ***
*** *** sub-assemblies and related assemblies for use in medical imaging systems and other applications), information which to the extent previously, presently, or subsequently disclosed to the Receiving Party is hereinafter referred to as "Proprietary Information" of the Disclosing Party.

NOW, THEREFORE, in consideration of the parties' discussions and any access the Receiving Party may have to Proprietary Information of the Disclosing Party, the parties agree that any information received by one party from the other shall be governed by the following terms and conditions:

Definition:

"Proprietary Information" shall not include information which:

(a) was rightfully in possession of or known to the Receiving Party prior to receiving it from the Disclosing Party; or

(b) is or becomes part of the public knowledge or literature by acts other than those of the Receiving Party and without fault of the receiving Party; or

(c) was rightfully disclosed to the Receiving Party by a third party provided the Receiving Party complies with restrictions imposed by the third party; or

(d) is transmitted after the expiration of this Agreement; or

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(e) is disclosed by the Receiving Party under a valid order created by a court or government agency, provided that the Receiving Party provides prior written notice to the Disclosing Party of such obligation and the opportunity to oppose such disclosure.

(f) the Receiving Party develops independently, subsequent to receipt of Proprietary Information and for which Receiving Party can demonstrate by written records that independent development occurred without knowledge or use of Proprietary Information.

HANDLING OF PROPRIETARY INFORMATION:

The Receiving Party agrees to (i) hold the Disclosing Party's Proprietary Information in strict confidence as a fiduciary and to take reasonable precautions to protect such Proprietary Information and (ii) handle the Proprietary Information in the same manner that it handles its own proprietary information of like importance, but with at least reasonable degree of care, for a period of five (5) years after the date of disclosure.

LIMITATION ON DISCLOSURE:

The Receiving Party shall not disclose, in whole or in part, such Proprietary Information to any third party without the prior written consent of the Disclosing Party for the period that such information is to be handled as proprietary. The Receiving Party may disclose Proprietary Information only to those of its employees who would require knowledge of such Proprietary Information for the purposes contemplated by this Agreement and who is similarly bound in writing.

LIMITATION OF USE:

The Receiving Party shall make no use, in whole or in part, of any such Proprietary Information other than in furtherance of the purpose of this Agreement without the prior written consent of the Disclosing Party.

If the purpose of the information exchange is the preparation of a proposal to the United States Government, Proprietary Information of either party may be incorporated into the proposal to the United States Government, provided that the proposal document bears the restrictive legend contained in Federal Acquisition Regulation 52.215-12 or a substantially similar successor provision.

TERM:

This Agreement shall expire one (1) year from the date recited in the first paragraph of this Agreement. With the exception of information disclosed in accordance with the provisions of the License Agreement for Detector between Digirad Corporation and the Regents of the University of California through the Ernest Orlando Lawrence Berkeley Laboratory, immediately upon a request by the Disclosing Party at any time (which will be effective if actually received or three days after mailed first class postage prepaid to the Receiving Party's address herein), the Receiving Party will turn over to the Disclosing Party all Proprietary Information of the Disclosing Party and all documents or media containing any such Proprietary Information and any and all copies or extracts thereof. The Receiving Party understands that

2 of 4


nothing herein (i) requires the disclosure of any Proprietary Information of the Disclosing Party, which shall be disclosed if at all solely at the option of the Disclosing Party (in particular, but without limitation, any disclosure is subject to compliance with expert control laws and regulations), or (ii) requires the Disclosing Party to proceed with any proposed transaction or relationship in connection with which Proprietary Information may be disclosed. The party's obligations with respect to Proprietary Information disclosed to it prior to expiration/termination shall survive expiration/termination.

RELATIONSHIP OF PARTIES:

This Agreement is intended to provide only for the handling and protection of Proprietary Information exchanged or disclosed hereunder, and shall not be construed as a Teaming, Joint Venture, Partnership, or other similar arrangement. Specifically, this Agreement shall not be construed in any manner to be an obligation to enter into a contract, nor shall it result in any claim whatsoever for reimbursement of costs.

NO LICENSE:

Neither the execution of this agreement nor the furnishing of any Proprietary Information hereunder shall be construed as granting either expressly, by implication, estoppel or otherwise, any license other than as expressly set forth herein under any invention, patent, copyright, trade secret, mask work right, or any other intellectual property right, now or hereafter owned or controlled by the party furnishing same.

U.S. GOVERNMENT REGULATIONS:

A party receiving Proprietary Information shall comply with all relevant United States Government regulations, including the International Traffic in Arms Regulations and the Export Administration Act.

MISCELLANEOUS:

Each party shall perform its respective obligations hereunder without charge to the other.

Except to the extent permitted by the License Agreement for Detector between Digirad Corporation and the Regents of the University of California through the Ernest Orlando Lawrence Berkeley Laboratory, neither party will refer to this Agreement or use the other party's name in any form of publicity or advertising directly or indirectly, without the prior written consent of the party whose name is proposed for use.

Except as to a sale of the business to which this Agreement relates or transfer of the management of the Ernest Orlando Lawrence Berkley Laboratory, the rights and obligations of each party under this Agreement may not be assigned or transferred to any person, firm or corporation, without the express prior written consent of the other party, which consent will not be unreasonably withheld.

Neither party makes any representations regarding the accuracy, completeness, or freedom from defects of the information disclosed, or with respect to infringement of the rights of others.

3 of 4


The Receiving Party acknowledges and agrees that due to the unique nature of the Disclosing Party's Proprietary Information, there may be no adequate remedy at law for any breach of its obligations hereunder, that any such breach may allow the Receiving Party or third parties to unfairly compete with the Disclosing Party resulting in irreparable harm to the Disclosing Party, and therefore, that upon any such breach or any threat thereof, the Disclosing Party may be entitled to appropriate equitable relief in addition to whatever remedies it might have at law. The Receiving Party will notify the Disclosing Party in writing immediately upon the occurrence of any such unauthorized release or other breach of which it is aware. In the event that any of the provisions of this Agreement shall be held by a court or other tribunal of competent jurisdiction to be illegal, invalid or unenforceable, such provisions shall be limited or eliminated to the minimum extent necessary so that this Agreement shall otherwise remain in full force and effect.

ENTIRE AGREEMENT:

This Agreement represents the entire agreement of the parties pertaining to the subject matter of the Agreement, and supersedes any and all prior oral discussions and/or written correspondence or agreements between the parties with respect thereto.

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed in duplicate original copies by their respective duly authorized representatives.

 

DIGIRAD                                  The Regents of the University of
                                         California Acting as Manager of the
                                         Lawrence Berkeley Laboratory


By:                                      By:
    ------------------------------           -----------------------------

Name:                                    Name:
      ----------------------------             ---------------------------

Title:                                   Title:
       ---------------------------              --------------------------

Date:                                    Date:
      ----------------------------             ---------------------------

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AMENDMENT #1
TO
LICENSE AGREEMENT FOR DETECTOR

This Amendment (the "Amendment"), effective as of the signing date of the last party to sign below, is entered into by The Regents of the University of California ("The Regents"), Department of Energy contract-operators of the Ernest Orlando Lawrence Berkeley National Laboratory ("LBNL"), 1 Cyclotron Road, Berkeley, CA 94720, (jointly, "Berkeley Lab"), and Digirad Corporation ("Digirad"), a Delaware corporation having its principal place of business at 9350 Trade Place, San Diego, CA 92126-6330.

THE PARTIES ENTERED INTO A LICENSE AGREEMENT FOR DETECTOR, REFERENCE NUMBER L-90-1261 (THE "AGREEMENT"), EFFECTIVE DATE OF MAY 19, 1999. THE PARTIES NOW DESIRE TO AMEND THE AGREEMENT BY EXPANDING THE LICENSE TO INCLUDE A NON-EXCLUSIVE FIELD OF USE (AS DEFINED BELOW) PURSUANT TO THE TERMS AND CONDITIONS HEREIN. CAPITALIZED TERMS HEREIN SHALL HAVE THE MEANING AS SET FORTH IN THE AGREEMENT EXCEPT AS OTHERWISE DEFINED IN  
THIS AMENDMENT.

The parties agree as follows:

1. Section 2.2 of the Agreement is hereby deleted in its entirety and replaced with the following:

2.2      "Field of Use" and "Non-Exclusive Field of Use":

         2.2.1    "Field of Use" means the development, production and
                  use of ***
                                                     ***
                                                     ***

         2.2.2    "Non-Exclusive Field of Use" means the development,
                  production and use of ***
                                                     ***
                                                     ***

2. Section 2.4 of the Agreement is hereby deleted in its entirety and replaced with the following:

2.4 "Licensed Patents" means patent rights to any subject matter claimed in or covered by any of the following:

 

2.4.1    US Patent Number ***
                                            ***
                                            ***

2.4.2    Any resulting patent issued in Germany or France
         arising from European Patent Convention Application
         ***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

pg 1

 
                                            ***
                                            ***

2.4.3    Japan Patent Application  ***
                                            ***
                                            ***

2.4.4    with respect to Sections 2.4.1 to 2.4.3, any
         division, reexamination, continuation,
         continuation-in-part (excluding new matter contained
         and claimed in that continuation-in-part), or of
         which such application is a successor; any patents
         issuing on any of the foregoing, and all renewals,
         reissues and extensions thereof, or other equivalents
         of a renewal, reissues, and extensions thereof.

3. Section 3.1 of the Agreement is hereby deleted in its entirety and replaced with the following:

3.1 Subject to the limitations set forth in this Agreement, Berkeley Lab grants to Digirad:

 

3.1.1    a nontransferable (subject to Section 18.1), limited
         (by the terms of Sections 3.2 and 3.7) worldwide
         exclusive, royalty-bearing license, under Licensed
         Patents, only in the Field of Use, to develop, make,
         have made, use, practice, sell, have sold, and lease
         the Licensed Products.

3.1.2    a nontransferable (subject to Section 18.1),
         nonexclusive worldwide, royalty-bearing license,
         under Licensed Patents, only within the Non-Exclusive
         Field of Use, to develop, make, have made, use,
         practice, sell, and lease the Licensed Products.

4. Section 4.1 of the Agreement is hereby deleted in its entirety and replaced with the following:

 

4.1      As consideration for the licenses granted hereunder:

         4.1.1    within the Field of Use, Digirad shall pay Berkeley
                  Lab a license issue fee of ***
                                                     ***
                                                     ***

         4.1.2    within the Non-Exclusive Field of Use, Digirad shall
                  pay Berkeley Lab a license issue fee of ***
                                                     ***
                                                     ***
                           ***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

pg 2

5. Section 5.1 of the Agreement is hereby deleted in its entirety and replaced with the following:

5.1 Digirad shall pay to Berkeley Lab an earned royalty of:

5.1.1 *** of the Selling Price of each Licensed Product Digirad sells within the Field of Use;

5.1.2 *** of the Selling Price of each Licensed Product Digirad sells within the Non-Exclusive Field of Use;

6. Section 5.4 of the Agreement is hereby deleted in its entirety and replaced with the following:

5.4 Digirad shall pay to Berkeley Lab by *** of each year the difference between the earned royalties for that calendar year Digirad has already paid to Berkeley Lab for the Field of Use and Non-Exclusive Field of Use and the minimum annual royalty set forth in the following schedules for the Field of Use and Non-Exclusive Field of Use. Berkeley Lab shall credit that minimum annual royalty paid against the earned royalty due and owing for the calendar year in which Digirad made the minimum payment; provided that the earned royalties and minimum annual royalties for the Field of Use shall be treated separately from and independent of the earned royalties and minimum annual royalties for the Non-Exclusive Field of Use.

 

------------------------------------ ----------------------------------- -------------------------------
           CALENDAR YEAR             MINIMUM ANNUAL ROVALTY FOR FIELD     MINIMUM ANNUAL ROYALTY FOR
                                                   OF USE                  NON-EXCLUSIVE FIELD OF USE
------------------------------------ ----------------------------------- -------------------------------
               1999                                 ***                               N/A
------------------------------------ ----------------------------------- -------------------------------
               2000                                 ***                               N/A
------------------------------------ ----------------------------------- -------------------------------
               2001                                 ***                               ***
------------------------------------ ----------------------------------- -------------------------------
               2002                                 ***                               ***
------------------------------------ ----------------------------------- -------------------------------
               2003                                 ***                               ***
------------------------------------ ----------------------------------- -------------------------------
               2004                                 ***                               ***
------------------------------------ ----------------------------------- -------------------------------
2005 and each year thereafter                       ***                               ***
------------------------------------ ----------------------------------- -------------------------------

7. Sections 6.4 and 6.5 of the Agreement are hereby deleted in their entirety and replaced with the following:

6.4 If Digirad is unable to perform any of the following, then Berkeley Lab may either terminate this Agreement or reduce the limited exclusive license within the Field of Use to a non-exclusive license within the Field of Use:

6.4.1 With regard to the Field of Use:

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

pg 3

 
6.4.1.1          ***
                 ***

6.4.1.2          ***
                 ***

6.4.2 With regard to the Non-Exclusive Field of Use:

 

6.4.2.1                   ***

6.4.2.2                   ***

6.4.2.3                   ***

6.4.2.4                   ***

6.4.2.5                   ***

6.4.2.6                   ***
                          ***

It is the understanding of the parties hereto that any termination of the Agreement or reduction of this license to a non-exclusive license as a result of Digirad's failure to meet the specifications of Section 6.4 shall be subject to the *** day cure period set forth in Section 10.1 below.

6.5 If Berkeley Lab grants a non-exclusive license to any other party within the Field of Use upon royalty rates more favorable than those of this Agreement after reducing the this license within the Field of Use to a non-exclusive license within the Field of Use, then *** *** *** ***

8. The reporting obligations of Section 7 shall apply to both the Field of Use and Non-Exclusive Field of Use, separately and independently. Beginning *** thereafter, Digirad shall submit to Berkeley Lab a progress reports covering Digirad's activities related to the development and testing of all Licensed Products within the Non-Exclusive Field of Use and obtaining of the government approvals necessary for marketing as required pursuant to Section 7.1 ET. SEQ.

9. Section 11.1 of the Agreement is hereby deleted in its entirety and replaced with the following:

11.1 Digirad at any time may terminate this Agreement in whole or as to any portion of Licensed Patents by giving written notice to Berkeley Lab. Digirad's termination

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

pg 4

of this Agreement will be effective *** days after its notice. If that termination pertains to the Field of Use and is  
without cause within *** years of the Effective Date, Digirad
shall ***
                          ***

10. Section 15.2 of the Agreement is hereby deleted in its entirety.

11. Section 15.5 of the Agreement is hereby deleted in its entirety and replaced with the following:

 

15.5                                    ***
                                        ***
                                        ***

12. Section 15.6 of the Agreement is hereby deleted in its entirety and replaced with the following:

15.6 Berkeley Lab shall promptly provide Digirad with copies of all relevant documentation so that Digirad is informed of the continuing prosecution of Licensed Patents. Additionally, upon *** Berkeley Lab shall provide Digirad with a report summarizing the status of the Licensed Patents. Digirad shall keep this documentation confidential. Berkeley Lab shall use all reasonable efforts to amend any patent application to include claims reasonably requested by Digirad to protect the products contemplated to be sold under this Agreement.

13. Digirad acknowledges and agrees that Section 16 applies, other than the first sentence of Section 16.1, only to jurisdictions in which Digirad has exclusive rights under the Agreement. Thus, except for that first sentence of Section 16.1, the entirety of Section 16 will not apply to the Licensed Products insofar as they are within the Non-Exclusive Field of Use.

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

pg 5

14. Except as specifically amended herein, the Agreement is hereby ratified and confirmed.

Berkeley Lab and Digirad execute this Agreement in duplicate originals through their authorized respective officers in one or more counterparts that, taken together, are but one instrument.


THE REGENTS OF THE UNIVERSITY                 DIGIRAD CORPORATION
OF CALIFORNIA, THROUGH THE
ERNEST ORLANDO LAWRENCE
BERKELEY NATIONAL LABORATORY

By   /S/ PIERMARIA ODDONE                     By    /S/ SCOTT HUENNEKENS
  -----------------------------------            ---------------------------
          (Signature)                                    (Signature)

By    PIERMARIA ODDONE                        By    SCOTT HUENNEKENS
  -----------------------------------             --------------------
Title    DEPUTY LABORATORY DIRECTOR           Title    PRESIDENT AND CEO
     --------------------------------                ---------------------
Date    5-24-01                               Date    5-11-01
    ---------------------------------               -----------


Approved as to form


/S/ GLENN R. WOODS
-------------------------------------
GLENN R. WOODS
LAWRENCE BERKELEY NATIONAL LABORATORY


pg 6


   
EXHIBIT 10.2

SOFTWARE LICENSE AGREEMENT

This Software License Agreement ("Agreement") is entered into under seal this 16th day of June, 1999 (the "Effective Date") by and between Segami Corporation, a Maryland corporation having its principal offices at 12624 Golden Oak Drive, Ellicott City MD 21042 ("Segami"), and Digirad Corporation ("Digirad"), a Delaware corporation having its principal offices at 9350 Trade Place. San Diego CA 92126.

Statement of Intention

A. Segami is in the business of the development and sale of software for gamma camera image acquisition, processing and display. Segami's current software is called Mirage

B. Digirad desires to purchase software from Segami for the purpose of gamma camera image acquisition, processing and display which will interface with Digirad's solid state gamma camera.

C. Digirad desires to package the Mirage software and Digirad's hardware for resale as a single product, identifiable only as a Digirad product.

In consideration of the mutual promises and covenants herein contained, the receipt and sufficiency of which are hereby acknowledged, the parties agree under seal as follows:

1. DEFINITIONS. For the purposes of this Agreement, the following terms, when used herein, have the following meaning.

"Base Software"-The existing Mirage software described in EXHIBIT D hereto in object and executable code forms, and all updates, enhancements, revisions, modifications, modules and or sub-modules thereto and all permitted copies, except that Base Software does not include the Interface Development.

"Interface Development"-The new code written and modifications made to the Base Software which will allow use of the Base Software with Digirad's current hardware, in object and executable code forms, and all updates, enhancements, revisions, modifications, modules and or sub-modules thereto and all permitted copies.

"Product" - Digirad's solid state gamma camera bundled together with the Base Software and Interface Development.

2. LICENSE TO DIGIRAD. Subject to all the terms of this Agreement, Segami grants to Digirad a nonexclusive worldwide, fully paid-up license:

(a) to sublicense the Base Software to end-users only in connection with the sale and use of the Products; any such sublicense shall be pursuant to a sublicense agreement for Segami's

Page 1 of 10


benefit that contains applicable similar restrictions and obligations imposed on Digirad hereunder.

(b) to use, adopt, reproduce, display, perform, test, demonstrate and distribute the Base Software as necessary to market, sale and distribute the Products.

(c) sublicense to third parties the distribution rights for the Products and Base Software; any such sublicense shall be pursuant to a sublicense agreement for Segami 's benefit that contains applicable similar restrictions and obligations imposed on Digirad hereunder.

The balance of this Section 2 notwithstanding, the license granted to Digirad shall not include the right to sublicense, sell or distribute the Base Software independently and separate from the Product, with the understanding that Digirad may demonstrate the Base Software or distribute demonstration models of the Base Software, limited in function, for use on systems independent from the Product.

3. USE/LICENSE FEES.

3.1 USE. Segami hereby grants Digirad the right to package and bundle the Base Software with the Product, the Interface Development and Digirad hardware for sale to end-users by Digirad or its subdistributors.

3.2 LICENSE FEES. Digirad shall pay a License Fee (the "License Fee") to Segami, in accordance with the attached Exhibit A, for each copy of the Base Software distributed to any end-user, unless otherwise agreed upon in writing by Segami. Payment of the License Fee shall be made by Digirad and tendered to Segami at the sooner of *** days after customer payment or *** days after customer installation. Digirad will receive a reasonable number of demonstration versions of the Base Software including the dongle keys ("Keys") for using such versions ("Demo Versions") to be used for customer demonstrations and/or Digirad roadshows (not for sale to customers). Segami shall deliver the Demo Versions within *** days upon written request from Digirad.

3.3 AUDIT. Segami shall have the right to audit the books, financial accounts and documents of Digirad *** in each calendar year for which this contract is in force, to verify the number of copies of the Base Software disseminated by Digirad. Segami shall employ an independent Certified Public Accountant at its own cost and expense for such audit. Segami shall give Digirad a minimum of *** days prior written notification of the audit. Digirad shall not unreasonably withhold its cooperation in the audit.

4. INTERFACE DEVELOPMENT.

4.1 DEVELOPMENT. Segami agrees to undertake and complete the code design, programming and testing of the Interface Development. Interface Development shall be in accordance with the specifications on the attached Exhibit B (the "Specifications") and the delivery schedule attached hereto as Exhibit C (the "Delivery Schedule"). Segami shall be

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

Page 2 of 10

responsible for obtaining and maintaining operational status and approvals of the Base Software and Interface Development (and any new versions or improvements thereto) under FDA, CE and other regulatory authorities or agencies. Segami agrees that its conduct in performing its obligations under this Agreement shall conform in all material respects to all applicable laws and regulations of the U.S. and foreign governments (and political subdivisions thereof).

4.2 ACCEPTANCE. Digirad will, by written notice, accept or reject any portion of the Interface Development delivered (individually, the "Deliverable(s)") within *** days after receipt. Failure to give notice of acceptance or rejection within that period will constitute acceptance. Digirad may reject any Deliverable only if the Deliverable fails to meet the Specifications or, at the fault or failing of that Deliverable alone, the Product cannot operate in a commercially reasonable manner. If Digirad properly rejects the Deliverable, Segami will correct the failures properly specified in the rejection notice within *** days of the rejection notice. When it believes that it has made the necessary corrections, Segami will again deliver the Deliverable to Digirad and the acceptance/rejection/correction provisions above shall be reapplied until the Deliverable is accepted; provided, however, that upon the *** or any subsequent rejection or if the corrections are not made within *** days of the initial rejection, Digirad may at its option terminate this Agreement by immediate written notice unless the Deliverable is accepted during the notice period.

5. COMPENSATION FOR INTERFACE DEVELOPMENT. Digirad shall make payments to Segami in accordance with the Delivery Schedule. Each payment will be in U.S. dollars from the United States and will be made no later than *** days from the occurrence of the event specified in the Delivery Schedule for which payment is due.

6. OWNERSHIP RIGHTS. As between the parties Segami shall retain all right title and interest, including all patent, copyright, trade secret, trademark, mask work or other rights, in the Base Software, or any other idea or product conceived or reduced to form by Segami, its agents or assigns as of the Effective Date. Digirad shall have all right, title and interest, in the Interface Development. The parties hereby make any assignments necessary to accomplish the foregoing ownership provisions.

7. SUPPORT/MAINTENANCE.

7.1 SUPPORT. During the term of this Agreement:

(1) Segami shall use its best efforts to respond within *** days after receipt of written notice of verifiable defects, and propose a plan for prompt and effective remedy, and shall provide general guidance concerning the Base Software or Interface Development. Defects shall be reported in writing via electronic mail or facsimile to Segami at the telephone/email numbers provided by Segami to Digirad from time to time.

(2) Segami shall inform Digirad promptly of any changes in the Base Software or delivery schedules.

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

Page 3 of 10

(3) Subject to the other terms and conditions of this Agreement, Segami shall use its reasonable best efforts to promptly fill Digirad's orders for Keys. Promptly following the execution of this Agreement, Segami shall place *** Keys in escrow. If Segami materially fails to provide a sufficient number of Keys to Digirad for delivery of Products to end-users, after *** days written notice to Segami, Digirad shall be entitled to receive from escrow any or all of the Keys. If Segami fails to provide a sufficient number of Keys to Digirad for delivery of Products to end-users, after *** days written notice to Segami, Digirad shall be entitled to a fully executed purchase order from Segami to the Key manufacturer ("Escrow Materials") authorizing the Key manufacturer to provide directly to Digirad those Keys reasonably necessary, in Digirad's sole discretion, for Digirad to sell and install Product. In support of the foregoing and promptly after execution of this Agreement, Segami will place in escrow (pursuant to the terms of an escrow agreement in form mutually acceptable to the parties hereto) the Escrow Materials as they exist at the date of the Agreement. Segami will update the escrow with any new or modified Escrow Materials and Keys promptly as it becomes necessary and will notify Digirad when it does so. *** ***

(4) Segami agrees to provide *** standard training *** for Digirad personnel. *** shall be given at Digirad's main office on a schedule reasonably acceptable to Segami but commencing no later than *** days after Digirad's written request. *** *** ***

(5) Segami shall provide free technical support to Digirad personnel up to *** during the first year, and *** per year after that. This does not include time spent on developments set forth in Section 4 or
Section 7.1(1). Segami shall provide Digirad with all the user's documentation in its possession.

7.2 MAINTENANCE RELEASES. In the exercise of its sole discretion and from time to time, Segami may develop and make available maintenance release for the Base Software at no cost to Digirad. Such maintenance release shall be patches for the purpose of correcting any deficiencies in the Base Software which may become apparent to Digirad and Segami after successful delivery of the Interface Development.

7.3 ENHANCEMENTS/UPGRADES. In the exercise of its sole discretion and from time to time, Segami may develop and make available for sale through Digirad to end-users, and at an additional license fee to Segami, to be negotiated in good faith by the Parties, substantially upgraded versions of the Base Software which incorporate significant functional changes or additions, or substantially improved performance.

8. CONFIDENTIALITY. Each party agrees that all code, inventions algorithms, know-how and ideas and all other business, technical and financial information they obtain from the other are confidential information and property of the disclosing party ("Confidential Information"). Each party shall use Confidential Information of the other party which is disclosed to it only for the purposes of this Agreement and shall not disclose such Confidential

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

Page 4 of 10

Information to-any third party, without the other party's prior written consent, other than to Segami's subcontractors, subdistributors and employees on a need-to-know basis. Each party agrees to take measures to protect the confidentiality of the other party's Confidential Information that, in the aggregate, are no less protective than those measures it uses to protect the confidentiality of its own Confidential Information, but at a minimum, each party shall take reasonable steps to advise their employees, subcontractors and subdistributors of the confidential nature of the Confidential Information and of the prohibitions on copying or revealing such Confidential Information contained herein. The parties each agree to require that the other party's Confidential Information be kept in a reasonably secure location. Notwithstanding anything to the contrary contained in this Agreement neither party shall be obligated to treat as confidential, or otherwise be subject to the restrictions on use, disclosure or treatment contained in this Agreement for any information disclosed by the other party (the "Disclosing party") which: (1) is rightfully known to the recipient prior to its disclosure by the Disclosing Party; (2) is generally known or easily ascertainable by non-parties of ordinary skill in computer process design or programming or in the business of the client; (3) is released by the Disclosing Party to any other person, firm or entity (including governmental agencies or bureaus) without restrictions; (4) is independently developed by the recipient without any reliance on Confidential Information; or (5) is or later becomes publicly available without violation of this Agreement or may be lawfully obtained by a party from a non-party. Neither party will be liable to the other for inadvertent or accidental -disclosure of Confidential Information if the disclosure occurs notwithstanding the party's exercise of the same level of protection and care that such party customarily uses in safeguarding its own confidential information.

Notwithstanding the foregoing, all Confidential Information developed by Segami, including but not limited to the Interface Development, in connection with this Agreement shall be deemed Confidential Information of Digirad disclosed by Digirad to Segami and exceptions (1) and (4) above will not be applicable thereto.

9. EXPORT CONTROL. Each party hereby agrees to comply with all export laws and restrictions and regulations of the Department of Commerce or other United States or foreign agency or authority, and not to export, or allow the export or re-export of any proprietary information or software or any copy or direct product thereof in violation of any such restrictions, laws or regulations.

10. TERMINATION

10.1 TERMINATION BY DIGIRAD. Digirad may terminate this Agreement if Segami is in material breach of, or default under, this Agreement and such breach or default is not cured within *** days after Digirad delivers written notice of such breach or default to Segami.

10.2 TERMINATION BY SEGAMI. Segami may terminate this Agreement if Digirad is in material breach of or default under, this Agreement and such breach or default is not cured within *** days after written notice to Digirad. A material breach of and default

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

Page 5 of 10

under, this Agreement by Digirad shall include, without limitation, the occurrence of the failure of Digirad to pay any License Fee when due.

10.3 SURVIVAL. Sections 5-15 of this Agreement, any accrued rights to payment, any licenses granted in this Agreement that are expressly perpetual and any remedies for breach of this Agreement shall survive termination.

11. LIMITATION OF LIABILITY.

(a) Except under Section 8 and the indemnity provisions of Section 12, neither party nor its affiliates shall, under any circumstances, be liable to the other party or its affiliates for any claim based upon any third party claim or for consequential, incidental, indirect, punitive, exemplary or special damages of any nature whatsoever, or for any damages arising out of or in connection with any malfunctions, delays, loss of data, loss of profit, interruption of service or loss of business or anticipatory profits, even if a party or its affiliates have been apprised of the likelihood of such damages occurring.

(b) *** *** ***

12. INDEMNIFICATION

(a) The parties each agree to indemnify, defend and hold harmless the other from and against any and all amounts, including legal fees and other out-of-pocket expenses, payable under any judgment, verdict, court order or settlement for death or bodily injury or the damage to or loss or destruction of any real or tangible personal property to the extent arising out of the indemnitor's negligence, gross negligence, or willful misconduct in the performance of this Agreement.

(b) Segami agrees to indemnify, defend and hold harmless Digirad, its distributors and end-users from and against any and all amounts, including legal fees and other out-of-pocket expenses, payable under any judgment, verdict, court order or settlement to the extent resulting from any third party allegation that the Base Software or the work performed by Segami under this Agreement infringes such third party's intellectual property rights, including, without limitation, patent, copyright or trade secret. Should Digirad's use of work performed by Segami be determined to have infringed, or if in Segami's and Digirad's reasonable judgment such use is likely to be infringing, *** *** ***

(c) Digirad agrees to indemnify, defend and hold harmless Segami from and against any and all amounts payable under any judgment, verdict, court order or settlement to the extent resulting from any affiliated third party allegation that the work performed by Segami under this Agreement infringes such third party's intellectual property rights to the extent attributable to software, hardware, data, knowledge or services provided by Digirad.

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

Page 6 of 10

(d) The indemnities in this paragraph are contingent upon: (1) the indemnified party promptly notifying the indemnifying party in writing of any claim which may give rise to a claim for indemnification hereunder; (2) the indemnifying party being allowed to control the defense and settlement of such claim; and (3) the indemnified party cooperating with all reasonable requests of the indemnifying party (at the indemnifying party' expense) in defending or settling such claim. The indemnified party shall have the right, at its option and expense, to participate in the defense of any action, suitor proceeding relating to such a claim through a counsel of its own choosing.

13. WARRANTIES. Segami warrants that it has and will obtain agreements with its employees and contractors sufficient to allow it to provide Digirad with the assignments and licenses to intellectual property rights contemplated in this Agreement. Segami also warrants that the Base Software and Interface Development and any part thereof shall meet the Specifications, and perform in a commercially reasonable manner until the later of (i) *** years from the final date of delivery on the Delivery Schedule and (ii) with respect to each product containing the Base Software and/or Interface Development, *** year from the date of installation of such product by Digirad or its distributor to an end-user. If Digirad finds that the Products, or part thereof fail to meet the above warranty, Segami shall, at its option, immediately repair or replace the Base Software and/or Interface Development or part thereof at its costs and expenses without prejudice to any other rights and remedies of Digirad under this Agreement or applicable law. If a Deliverable is rejected, the warranty will extend accordingly from any adjusted final delivery date. Except for
Section 14, notwithstanding anything to the contrary contained in this Agreement, Segami makes no other warranties, express or implied, or whether arising by operation of law, course of performance or dealing, custom, usage in the trade or profession or otherwise including without limitation implied warranties of merchantability and fitness for a particular purpose.

14. MILLENNIUM WARRANTY.

14.1 GENERAL, Other sections of this Agreement notwithstanding, Segami represents and warrants that for a period of four (4) years after the Effective Date, the Base Software and the Interface Development will be able to accurately: (a) process any date-roll event with no adverse impact on the functionality of the software including without limitation, the producing of error(s) or abnormal interruption; (b) process date-data calculations including, without limitation, computation, comparisons, sequencing, sorts and extracts and return and display date-data in a consistent manner regardless of the dates used in such date-data whether before, on, during, or after January 1, 2000; (c) process any date-data computations that can be expected from the software if used for its intended purpose, regardless of the date in time on which the processes are actually performed and regardless of the date-data input, whether before, on, during or after January 1, 2000; (d) exchange date-data related information with other hardware, firmware or software with which it interacts, provided that the interacting hardware, firmware or software is itself capable of exchanging accurate date-data; (e) accept and respond to four-digit year-date input in a manner that resolves any ambiguities as to the century in a defined predetermined and appropriate manner; and (f) store and display date-data in ways that are unambiguous as to the determination of the century. No date-data shall cause such software to

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

Page 7 of 10

perform an abnormally ending routine or function within the processes or generate incorrect values or invalid results. For purposes of the foregoing, a date-rollover event is defined as any transaction between one calendar year and the following calendar year including, without limitation, any time, date and day-of-the-week progressions and any regularly scheduled leap events. Date-data is defined as any data, formula, algorithm, process, input or output, which includes, calculates or represents a date, day or time, a reference to a date, day or time, or a representation of a date, day or time.

14.2 SPECIAL REMEDIES. In the event of any breach of the warranties and covenants contained in this section, provided that such breach is not cured by Segami within *** days following receipt of written notice of such breach, in addition to other rights and remedies that may be available to Digirad under this Agreement, Segami shall be responsible for: (a) any costs of repairing, replacing and/or correcting the affected software; and (b) cover and other similar damages that are incurred by Digirad as a result of Segami's breach of this warranty.

15. MISCELLANEOUS

15.1 BINDING NATURE. This Agreement shall be binding upon and shall inure to the benefit of the parties to this Agreement and their respective successors and permitted assigns. Segami shall not have any right or ability to assign, transfer, or sublicense any obligations or benefit under this Agreement without the written consent of Digirad, except that Segami may assign and transfer this Agreement and its rights and obligations hereunder to any third party who succeeds to substantially all its business or assets.

15.2 ENTIRE AGREEMENT. This Agreement constitutes the entire agreement between the parties and there are no representations, warranties, covenants, or obligations except as set forth in this Agreement. This Agreement supersedes all prior or contemporaneous agreements understandings, negotiations and discussions, written or oral, of the parties to this Agreement, relating to any transaction contemplated by this Agreement.

15.3 SEVERABILITY. Each provision of this Agreement shall be considered separable and if for any reason any provision or provisions in this Agreement are determined to be invalid arid contrary to any existing or future law, that invalidity shall not impair the operation of this Agreement or affect those portions of this Agreement which are valid.

15.4 ARBITRATION. If any dispute or controversy arises among the parties to this Agreement concerning any provision of this Agreement, that dispute or controversy shall be submitted for resolution to a board of arbitration in *** *** *** Such arbitration shall be conducted pursuant to the rules of the American Arbitration Association (the "AAA") or other governing rules and *** *** ***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

Page 8 of 10

15.5 NO AGENCY. This Agreement shall not be deemed to constitute the parties hereto as partners, joint venturers, nor shall either patty hereto be deemed to be an agent of any nature, kind and description whatsoever of the other.

15.6 JURISDICTION AND VENUE. This Agreement shall be governed, enforced, performed and construed in accordance with the laws of the State of *** *** Subject to the provisions of Section 15.4 hereof each of the parties hereto hereby submits to the exclusive jurisdiction of the state and/or federal courts located within the State of *** for any suit, hearing or other legal proceeding of every nature, kind and description whatsoever in the event of any dispute or controversy arising hereunder or relating hereto, or in the event any ruling, finding or other legal determination is required or desired hereunder.

15.7 ATTORNEYS FEES. In the event that legal proceedings are commenced in connection with this Agreement or the transactions contemplated hereby, the party or parties *** *** ***

15.8 AMBIGUITY. The parties acknowledge that each party and its respective counsel have reviewed and revised this Agreement and that the normal rule of construction to the effect that any ambiguities are to be resolved against the drafting party shall not be employed in the interpretation of this Agreement or any amendments or exhibits, or schedules hereto.

15.9 EXHIBITS. The exhibits attached hereto and each certificate, schedule, list summary or other document provided or delivered pursuant to this Agreement or in connection with the transactions contemplated hereby are incorporated herein by this reference and made a part hereof.

15.10 COUNTERPARTS. Provided that all parties hereto execute a copy of this Agreement, this Agreement may be executed in counterparts, each of which shall he deemed an original and all of which together shall constitute one and the same instrument. Executed copies of this Agreement may be delivered by facsimile transmission or other comparable electronic means.

15.11 VOLUNTARY AGREEMENT. The parties hereto represent that they have carefully read the foregoing Agreement, understood its terms, consulted with an attorney of their choice, and voluntarily signed the same as their own free act with the intent to be legally bound thereby. The terms of this Agreement are contractual and not a mere recital.

15.12 FORCE MAJEURE. Neither party shall be liable to the other for its failure to perform any of its obligations under this Agreement during any period in which such performance is delayed due to circumstances beyond its control, including acts of God or public authorities, was and war measures, civil unrest, natural disasters or delays in transportation, delivery or supply.

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

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15.13 NOTICE. All notices under this Agreement shall be in writing and shall be deemed given when personally delivered or three days after being sent prepaid certified or registered United States mail to the address of the party to be noticed as set forth below or such other addresses as such party last provided to the other by notice:

 

Digirad:         Digirad Corporation
                 9350 Trade Place
                 San Diego CA 92126
                 Attn: President and COO

Segami:          Segami Corporation
                 12624 Golden Oak Drive
                 Ellicott City MD 21042
                 Attn: Philippe Briandet Ph.D.

Copy to:         Christopher S. Young, Esq.
                 3440 Ellicott Center Drive
                 Ste. 203
                 Ellicott City MD 21043

IN WITNESS WHEREOF, the parties have caused this Agreement to be duly executed under seal as of the date first above written.

ATTEST: Digirad Corporation


By:      /s/ ILLEGIBLE                       By:     /s/ Scott Huennekens
   -------------------------------              --------------------------------
Title:        Controller           (SEAL)    Title:    President & COO
      ----------------------------                 -----------------------------


Segami Corporation


By:         /s/ ILLEGIBLE       (Secretary)  By:        /s/ ILLEGIBLE
   -------------------------------                ------------------------------
Title:                             (SEAL)    Title:      President
      ----------------------------                 -----------------------------


Page 10 of 10

EXHIBIT A
PRICING SCHEDULE

***
***
***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

A-1

EXHIBIT B

***
***
***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.


Information contained in this document is proprietary to DIGIRAD Corporation and should not be released outside of the company without written permission of the company.

B-1

*** *** ***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.


Information contained in this document is proprietary to DIGIRAD Corporation and should not be released outside of the company without written permission of the company.

B-2

*** *** ***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.


Information contained in this document is proprietary to DIGIRAD Corporation and should not be released outside of the company without written permission of the company.

B-3

*** *** ***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.


Information contained in this document is proprietary to DIGIRAD Corporation and should not be released outside of the company without written permission of the company.

B-4

*** *** ***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.


Information contained in this document is proprietary to DIGIRAD Corporation and should not be released outside of the company without written permission of the company.

B-5

*** *** ***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.


Information contained in this document is proprietary to DIGIRAD Corporation and should not be released outside of the company without written permission of the company.

B-6

*** *** ***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.


Information contained in this document is proprietary to DIGIRAD Corporation and should not be released outside of the company without written permission of the company.

B-7

*** *** ***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.


Information contained in this document is proprietary to DIGIRAD Corporation and should not be released outside of the company without written permission of the company.

B-8

*** *** ***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.


Information contained in this document is proprietary to DIGIRAD Corporation and should not be released outside of the company without written permission of the company.

B-9

*** *** ***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.


Information contained in this document is proprietary to DIGIRAD Corporation and should not be released outside of the company without written permission of the company.

B-10

*** *** ***

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.


Information contained in this document is proprietary to DIGIRAD Corporation and should not be released outside of the company without written permission of the company.

B-11

EXHIBIT C
DELIVERY SCHEDULE

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

C-1

EXHIBIT D
SEGAMI'S BASE SOFTWARE

*** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission.

D-1


   
EXHIBIT 10.3

LOAN AND SECURITY AGREEMENT

Agreement No. __________ Dated as of October 27, 1999

between
MMC/GATX PARTNERSHIP NO. 1

as Lender

and
DIGIRAD CORPORATION
a Delaware corporation
9350 Trade Place
San Diego, CA 92121
as Borrower

 

CREDIT AMOUNT: $3,000,000

Repayment Period:                                36 months

Treasury Note Maturity:                          36 months

Loan Margin:                                     750 basis points

Commitment Termination Dates:                    November 1, 1999 (First Loan)
                                                 June 30, 2000 (Second Loan)

The defined terms and information set forth on this cover page are a part of the LOAN AND SECURITY AGREEMENT, dated as of the date first written above (this "Agreement"), entered into by and between MMC/GATX PARTNERSHIP NO. I ("Lender") and the borrower ("Borrower") set forth above. The terms and conditions of this Agreement agreed to between Lender and Borrower are as follows:


ARTICLE I
INTERPRETATION

1.01 CERTAIN DEFINITIONS. Unless otherwise indicated in this Agreement or any other Operative Document, the following terms, when used in this Agreement or any other Operative Document, shall have the following respective meanings:

"APPLICABLE PREMIUM" shall mean an amount equal to: (i) 4% of the amount being prepaid or accelerated more than twelve (12) months after, but on or before twenty-four (24) months after the first Payment Date, or (ii) 3% of the amount being prepaid or accelerated more than twenty-four (24) months after the first Payment Date; PROVIDED THAT if an Event of Default occurs within twelve (12) months of the first Payment Date (other than an Event of Default specified in Section 9.01 h, i, j, k or l), the Applicable Premium shall be 4% of the amount being prepaid or accelerated.

"BORROWER'S HOME STATE" shall mean California, the state in which Borrower's principal place of business is located.

"BROKER" shall mean Priority Capital.

"BUSINESS DAY" shall mean any day other than a Saturday, Sunday or public holiday under the laws of California or Borrower's Home State or other day on which banking institutions are authorized or obligated to close in California or Borrower's Home State.

"CLAIM" has the meaning given to that term in SECTION 10.03.

"COLLATERAL" has the meaning given to that term in SECTION 5.01.

"COMMITMENT FEE" has the meaning given to that term in SECTION 2.04.

"COMMITMENT TERMINATION DATES" shall mean (a) with respect to the First Loan, November 1, 1999, and (b) with respect to the Second Loan, June 30, 2000, which are the dates specified on the cover page of this Agreement.

"CREDIT AMOUNT" shall mean the maximum aggregate amount of the Loans under this Agreement (if the conditions specified in Schedule 3 are satisfied), which amount is set forth following such term on the cover page of this Agreement.

"DEFAULT" shall mean any event which with the passing of time or the giving of notice or both would become an Event of Default hereunder.

"DEFAULT RATE" shall mean the per annum rate of interest equal to the higher of (i) 18% or (ii) the Prime Rate plus 6%, but such rate shall in no event be more than the highest rate permitted by applicable law.

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"DISCLOSURE SCHEDULE" has the meaning set forth in the definition of the term "Permitted Liens."

"ENVIRONMENTAL LAW" shall mean the Resource Conservation and Recovery Act of 1987, the Comprehensive Environmental Response, Compensation and Liability Act, and any other federal, state or local statute, law, ordinance, code, rule, regulation, order or decree (in each case having the force of law) regulating or imposing liability or standards of conduct concerning any Hazardous Material, as now or at any time hereafter in effect.

"EQUIPMENT" has the meaning given to that term in SECTION 5.01.

"EQUIPMENT COLLATERAL" has the meaning given to that term in SECTION 5.01.

"EQUIPMENT LIST" has the meaning given to that term in SECTION 5.04.

"EQUIPMENT LOANS" has the meaning given to that term in SECTION 2.02.

"EQUITY SECURITIES" of any Person shall mean (a) all common stock, preferred stock, participations, shares, partnership interests or other equity interests in and of such Person (regardless of how designated and whether or not voting or non-voting) and (b) all warrants, options and other rights to acquire any of the foregoing.

"EVENT OF DEFAULT" has the meaning given to that term in SECTION 9.01.

"FUNDING DATE" shall mean a date on which a Loan is made to or on account of Borrower under this Agreement; provided that the Funding Date for the Second Loan shall be on or after March 31, 2000.

"GAAP" shall mean generally accepted accounting principles and practices as in effect in the United States of America from time to time, consistently applied.

"HAZARDOUS MATERIAL" means any hazardous, dangerous or toxic constituent material, pollutant, waste or other substance, whether solid, liquid or gaseous, which is regulated by any federal, state or local governmental authority.

"INDEBTEDNESS" shall mean, with respect to Borrower or any Subsidiary, the aggregate amount of, without duplication, (a) all obligations of such Person for borrowed money, (b) all obligations of such Person evidenced by bonds, debentures, notes or other similar instruments, (c) all obligations of such Person to pay the deferred purchase price of property or services (excluding trade payables aged less than 180 days), (d) all capital lease obligations of such Person, (e) all obligations or liabilities of others secured by a lien on any asset of such Person, whether or not such obligation or liability is assumed, (f) all obligations or liabilities of others guaranteed by such Person; and (g) any other obligations or liabilities which are required by GAAP to be shown as debt on the balance sheet of such Person. Unless otherwise indicated, the term "INDEBTEDNESS" shall include all Indebtedness of Borrower and the Subsidiaries.

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"INTELLECTUAL PROPERTY" shall mean all of Borrower's right, title and interest in and to patents, patent rights (and applications and registrations therefor), trademarks and service marks (and applications and registrations therefor), inventions, copyrights, mask works (and applications and registrations therefor), trade names, trade styles, software and computer programs, trade secrets, methods, processes, know how, drawings, specifications, descriptions, and all memoranda, notes, and records with respect to any research and development, all whether now owned or subsequently acquired or developed by Borrower and whether in tangible or intangible form or contained on magnetic media readable by machine together with all such magnetic media.

"INVESTMENT" shall mean the purchase or acquisition of any capital stock, equity interest, or any obligations or other securities of, or any interest in, any Person, or the extension of any advance, loan, extension of credit or capital contribution to, or any other investment in, any Person.

"LIEN" shall mean any pledge, bailment, lease, mortgage, hypothecation, conditional sales and title retention agreements, charge, claim, encumbrance or other lien in favor of any Person.

"LOAN" means a loan advanced by Lender to Borrower under this Agreement.

"LOAN MARGIN" shall mean the number of basis points set forth following such term on the cover page of this Agreement.

"LOAN RATE" shall mean, with respect to each Loan, the per annum rate of interest (based on a year of twelve 30-day months) equal to the sum of (a) the U.S. Treasury note rate of a term equal to the Treasury Note Maturity as quoted in THE WALL STREET JOURNAL on the date the Note with respect to each Loan is prepared, plus (b) the Loan Margin.

"NOTE" shall mean one of the secured promissory notes of Borrower substantially in the form of EXHIBIT A.

"OBLIGATIONS" has the meaning given to that term in SECTION 5.01.

"OPERATIVE DOCUMENTS" shall mean this Agreement, the Notes and the Warrants and all other documents, instruments and agreements executed and delivered in connection herewith or therewith or in respect of the closing of the transactions contemplated hereby or thereby.

"PAYMENT DATE" has the meaning given to that term in the applicable Note.

"PERMITTED INDEBTEDNESS" shall mean and include:

(a) Indebtedness of Borrower to Lender;

(b) Indebtedness of Borrower secured by Liens permitted under clause (e) of the definition of Permitted Liens;

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(c) Indebtedness arising from the endorsement of instruments in the ordinary course of business;

(d) Indebtedness existing on the date hereof and set forth on the Disclosure Schedule;

(e) Indebtedness consisting of a revolving credit facility in an aggregate principal amount not exceeding the lesser of: (1) $2,500,000, or (2) a borrowing base calculated as a percentage (not exceeding 100%) of qualified accounts receivable plus eligible inventory; and

(f) Subordinated Indebtedness.

"PERMITTED INVESTMENTS" shall mean and include:

(a) Deposits with commercial banks organized under the laws of the United States or a state thereof to the extent such deposits are fully insured by the Federal Deposit Insurance Corporation;

(b) Investments in marketable obligations issued or fully guaranteed by the United States and maturing not more than one (1) year from the date of issuance; and

(c) Investments in open market commercial paper rated at least "Al" or "P1" or higher by a national credit rating agency and maturing not more than one (1) year from the creation thereof.

(d) Investments pursuant to or arising under currency agreements or interest rate agreements entered into in the ordinary course of business;

(e) Investments consisting of deposit accounts of Borrower in which Lender has a perfected security interest; and

(f) Other Investments aggregating not in excess of Two Hundred Fifty Thousand Dollars ($250,000) at any time.

"PERMITTED LIENS" shall mean (a) the Lien created by this Agreement,
(b) Liens for fees, taxes, levies, imposts, duties or other governmental charges of any kind which are not yet delinquent or which are being contested in good faith by appropriate proceedings which suspend the collection thereof (PROVIDED, HOWEVER, that such proceedings do not involve any substantial danger of the sale, forfeiture or loss of any item of equipment and that Borrower has adequately bonded such Lien or reserves sufficient to discharge such Lien have been provided on the books of Borrower), (c) Liens identified on the disclosure schedule attached hereto as SCHEDULE 2 ("DISCLOSURE SCHEDULE"), (d) Liens to secure payment of worker's compensation, employment insurance, old age pensions or other social security obligations of Borrower in the ordinary

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course of business of Borrower, (e) Liens upon any equipment or other personal property acquired by Borrower more than eighteen (18) months after the date hereof to secure (i) the purchase price of such equipment or other personal property or (ii) lease obligations or indebtedness incurred solely for the purpose of financing the acquisition of such equipment or other personal property; PROVIDED that (A) such Liens are confined solely to the equipment or other personal property so acquired and the amount secured does not exceed the acquisition price thereof, and (B) no such Lien shall be created, incurred, assumed or suffered to exist in favor of Borrower's officers, directors or shareholders holding five percent (5%) or more of Borrower's Equity Securities,
(f) carriers', warehousemen's, mechanics', landlords', materialmen's, repairmen's or other similar Liens arising in the ordinary course of business which are not delinquent or remain payable without penalty or which are being contested in good faith and by appropriate proceedings; and (g) non-exclusive licenses of Intellectual Property entered into in the ordinary course of business and non-exclusive licenses or similar arrangements entered into in connection with joint ventures and corporate collaborations; and (h) Liens securing Indebtedness permitted under clause (e) of the definition of Permitted Indebtedness.

"PERSON" shall mean and include an individual, a partnership, a corporation, a business trust, a joint stock company, a limited liability company, an unincorporated association or other entity and any domestic or foreign national, state or local government, any political subdivision thereof, and any department, agency, authority or bureau of any of the foregoing.

"PRIME RATE" shall mean the interest rate per annum specified in the "Money Rates" column of THE WALL STREET JOURNAL, but such rate shall in no event be more than the highest interest rate permitted by applicable law.

"SUBORDINATED INDEBTEDNESS" shall mean Indebtedness subordinated to the Obligations on terms and conditions acceptable to Lender in its sole discretion.

"SUBSIDIARY" shall mean any corporation of which a majority of the outstanding capital stock entitled to vote for the election of directors (otherwise than as the result of a default) is owned by Borrower directly or indirectly through Subsidiaries.

"TERM" shall mean the period from and after the date hereof until the payment or satisfaction in full of all Obligations under this Agreement and the other Operative Documents.

"THIRD PARTY EQUIPMENT" has the meaning given that term in SECTION 5.05.

"TREASURY NOTE MATURITY" shall mean the period of months set forth following such term on the cover page of this Agreement.

"WARRANTS" shall mean separate warrants to be issued at the direction of Lender to purchase securities of Borrower substantially in the form of EXHIBIT B.

1.02. HEADINGS. Headings in this Agreement and each of the other Operative Documents are for convenience of reference only and are not part of the substance hereof or thereof.

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1.03. PLURAL TERMS. All terms defined in this Agreement or any other Operative Document in the singular form shall have comparable meanings when used in the plural form and VICE VERSA.

1.04. CONSTRUCTION. This Agreement is the result of negotiations among, and has been reviewed by, Borrower and Lender and their respective counsel. Accordingly, this Agreement shall be deemed to be the product of all parties hereto, and no ambiguity shall be construed in favor of or against Borrower or Lender.

1.05. ENTIRE AGREEMENT. This Agreement, together with the terms set forth in each of the other Operative Documents, taken together, constitute and, contain the entire agreement of Borrower and Lender and, with regard to their respective subject matters, supersede any and all prior agreements, term sheets, negotiations, correspondence, understandings and communications among the parties, whether written or oral, with respect to their respective subject matters. Borrower acknowledges that it is not relying on any representation or agreement made by Lender or any employee, agent or attorney of Lender, other than the specific agreements set forth in this Agreement and the Operative Documents.

1.06. OTHER INTERPRETIVE PROVISIONS. References in this Agreement to "Articles," "Sections," "Exhibits," "Schedules" and "Annexes" are to articles, sections, exhibits, schedules and annexes herein and hereto unless otherwise indicated. References in this Agreement and each of the other Operative Documents to any document, instrument or agreement shall include (a) all exhibits, schedules, annexes and other attachments thereto, (b) all documents, instruments or agreements issued or executed in replacement thereof, and (c) such document, instrument or agreement, or replacement or predecessor thereto, as amended, modified and supplemented from time to time and in effect at any given time. The words "hereof," "herein" and "hereunder" and words of similar import when used in this Agreement or any other Operative Document shall refer to this Agreement or such other Operative Document, as the case may be, as a whole and not to any particular provision of this Agreement or such other Operative Document, as the case may be. The words "include" and "including" and words of similar import when used in this Agreement or any other Operative Document shall not be construed to be limiting or exclusive. Unless otherwise indicated in this Agreement or any other Operative Document, all accounting terms used in this Agreement or any other Operative Document shall be construed, and all accounting and financial computations hereunder or thereunder shall be computed, in accordance with GAAP.

ARTICLE II
THE CREDIT

2.01. Credit Facility.

(a) THE CREDIT AMOUNT. Subject to the terms and conditions of this Agreement and relying upon the representations and warranties herein set forth as and when made or deemed to be made, Lender agrees to lend to Borrower a maximum of two Loans (respectively, the "First Loan" and the "Second Loan") in an aggregate amount not to exceed the

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Credit Amount. The First Loan shall be in the amount of Two Million Dollars ($2,000,000) and the Second Loan shall be in the amount of One Million Dollars ($1,000,000). The Loans may be prepaid only as set forth in SECTION 2.01(d).

(b) INTEREST RATES. Borrower shall pay interest on the unpaid principal amount of each Loan from the date of such Loan until such Loan is paid in full, at a per annum rate of interest equal to the Loan Rate for such Loan determined in accordance with the definition of Loan Rate. The Loan Rate applicable to a Loan shall not be subject to change in the absence of manifest error. All computations of interest on a Loan shall be based on a year of twelve 30-day months. If Borrower pays interest on a Loan which is determined to be in excess of the then legal maximum rate, then that portion of each interest payment representing an amount in excess of the then legal maximum rate shall be deemed a payment of principal and applied against the principal of such Loan.

(c) PAYMENTS OF PRINCIPAL AND INTEREST. If a Funding Date is not the first day of the month, Borrower shall make an interest only payment on the first Payment Date specified in Lender's Note and thirty-six (36) equal monthly payments of principal plus accrued interest on the outstanding principal amount of such Loan commencing on the first Payment Date as set forth in Lender's Note.

(d) OPTIONAL PREPAYMENT WITH PREMIUM. Borrower may not prepay any Loan within twelve (12) months of its first Payment Date; thereafter, upon ten (10) Business Days' prior written notice to Lender, Borrower may, at its option, at any time, prepay all, and not less than all, of a Loan in full at a prepayment price equal to the principal amount of the Loan, plus interest accrued on the Loan through and including the date of such prepayment, plus a premium on the Loan equal to the Applicable Premium. If an Event of Default occurs and is continuing (other than an Event of Default specified in Section
9.01 h, i, j, k or 1, in which case no Applicable Premium is due and payable), and Lender exercises its right under Section 9.02 to accelerate the Loans or the Loans are automatically accelerated, Borrower expressly agrees that the amount then due and payable shall include the Applicable Premium as of the date of such acceleration.

2.02. USE OF PROCEEDS; THE LOAN AND THE NOTES; DISBURSEMENT.

(a) USE OF PROCEEDS. The proceeds of the Loans shall be used solely for: (1) working capital, or (2) general corporate purposes of Borrower, or (3) purchase of, or reimbursement to Borrower of the acquisition costs of Equipment ("EQUIPMENT LOANS"), or (4) any combination of the foregoing.

(b) THE LOANS AND THE NOTES. The obligation of Borrower to repay the unpaid principal amount of and interest on each Loan shall be evidenced by a Note issued to Lender and Lender is authorized to endorse on a grid annexed to its Note appropriate notations regarding payments made on the Note; PROVIDED, HOWEVER, that the failure to make, or an error in making, any such notation shall not limit or otherwise affect the obligations of Borrower hereunder or thereunder.

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(c) DISBURSEMENT. Lender shall disburse its Loans by wire transfer to Borrower unless otherwise directed in writing by Borrower.

(d) TERMINATION OF COMMITMENT TO LEND. Notwithstanding anything to the contrary in the Operative Documents, Lender's obligations to advance the Loans hereunder shall terminate on the earliest of (i) the occurrence of any Event of Default hereunder and (ii) the respective Commitment Termination Dates.

2.03. OTHER PAYMENT TERMS.

(a) PLACE AND MANNER. Borrower shall make all payments due to Lender in lawful money of the United States, in immediately available funds, at the address for payments and in the manner specified in SECTION 10.05(B).

(b) DATE. Whenever any payment due hereunder shall fall due on a day other than a Business Day, such payment shall be made on the next succeeding Business Day.

(c) DEFAULT RATE. If either (i) any amounts required to be paid by Borrower under this Agreement or the other Operative Documents
(including principal or interest payable on the Loan, any fees or other amounts) remain unpaid after such amounts are due, or (ii) an Event of Default has occurred and is continuing, Borrower shall pay interest on the outstanding principal balance hereunder from the date due or from the date of the Event of Default, as applicable, until such past due amounts are paid in full or until all Events of Defaults are cured, as applicable, at a per annum rate equal to the Default Rate, such rate to change from time to time as the Prime Rate shall change. All computations of such interest at the Default Rate shall be based on a year of 360 days and twelve 30-day months.

(d) FACILITY FEE; COMMITMENT FEE. Upon the execution and delivery of this Agreement, Borrower agrees to pay to Lender a facility fee ("FACILITY FEE") of $25,000 as follows: (i) Borrower has paid a commitment fee in the aggregate amount of $20,000 (the "COMMITMENT FEE"); Twenty Thousand Dollars ($20,000) of the Commitment Fee shall be applied towards the Facility Fee, and (ii) Borrower shall pay to Lender Five Thousand Dollars ($5,000) concurrently with Borrower's execution and delivery of this Agreement. Borrower agrees to pay to Lender within thirty (30) days of invoice Lender's expenses in connection with due diligence or the negotiation, documentation (including without limitation, filing fees related thereto) and funding of the Loans, up to a maximum of Five Thousand Dollars ($5,000); provided that if the First Loan is funded after invoice but before payment, Lender may deduct the invoiced amount from the First Loan proceeds.

ARTICLE III
REPRESENTATIONS AND WARRANTIES

3.01. REPRESENTATIONS AND WARRANTIES. Except as set forth in the Disclosure Schedule, Borrower makes the following representations and warranties to Lender as of the date hereof and again on the Funding Date:

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(a) ORGANIZATION AND QUALIFICATION. Borrower is a corporation duly organized, validly existing and in good standing under the laws of its state of incorporation and is duly qualified to do business in Borrower's Home State. Borrower has no Subsidiaries.

(b) AUTHORITY. Borrower has all necessary corporate power, authority and legal right and has obtained all approvals and consents and has given all notices necessary to execute and deliver this Agreement and the other Operative Documents and to perform the terms hereof and thereof. Borrower has all requisite corporate power and authority to own and operate its properties and to carry on its businesses as now conducted.

(c) CONFLICT WITH OTHER INSTRUMENTS ETC. Neither the execution and delivery of any Operative Document to which Borrower is a panty nor the consummation of the transactions therein contemplated nor compliance with the terms, conditions and provisions thereof will conflict with or result in a breach of any of the terms, conditions or provisions of the charter or the bylaws of Borrower or, to its knowledge, any law or any regulation, order, writ, injunction or decree of any court or governmental instrumentality or any material agreement or instrument to which Borrower is a party or by which it or any of its properties is bound or to which it or any of its properties is subject, or constitute a default thereunder or result in the creation or imposition of any Lien, other than Permitted Liens.

(d) PROPERTIES. Borrower has good and marketable title to the Collateral, free and clear of all Liens, other than Permitted Liens. Borrower has good title and ownership of, or is licensed under, all of Borrower 5 current Intellectual Property, with no known infringement of the rights of others. Borrower has not received any communications alleging that Borrower has violated, or by conducting its business as proposed, would violate any proprietary rights of any other Person. Borrower has no knowledge of any infringement or violation by it of the intellectual property rights of any third party and has no knowledge of any violation or infringement by a third party of any of its Intellectual Property. The Collateral and the Intellectual Property constitute substantially all of the assets and property of Borrower.

(e) AUTHORIZATION, GOVERNMENTAL APPROVALS, ETC. The execution and delivery by Borrower of each Operative Document, the granting of the security interest in the Collateral, the issuance of the Warrants, the issuance of the securities into which the Warrants are exercisable, the issuance of any securities into which the securities issuable upon exercise of the Warrants are convertible, and the performance of the obligations herein and therein contemplated have each been duly authorized by all necessary action on the part of Borrower. No authorization, consent, approval, license or exemption of, and no registration, qualification, designation, declaration or filing with, or notice to, any Person is, was or will be necessary to (i) the valid execution and delivery of any Operative Document to which Borrower is a party, (ii) the performance of Borrower's obligations under any Operative Document, or (iii) the granting of the security interest in the Collateral, except for filings in connection with the perfection of the security interest in any of the Collateral or the issuance of the Warrants. The Operative Documents have been or will be duly executed and delivered and constitute or will constitute legal, valid and binding obligations of Borrower, enforceable in accordance with their respective terms, except as the enforceability thereof may be limited by bankruptcy, insolvency

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or other similar laws of general application relating to or affecting the enforcement of creditors' rights or by general principles of equity.

(f) LITIGATION. There are no actions, suits, proceedings or investigations pending or, to the knowledge of Borrower, threatened against or affecting Borrower, or the business or any property or asset owned by it, before any court or governmental department, agency or instrumentality which, if adversely determined, could reasonably be expected to have a material adverse effect on the financial condition, business or operations of Borrower.

(g) SECURITY INTEREST. Assuming the proper filing of one or more financing statement(s) identifying the Collateral with the proper state and/or local authorities, the security interests in the Collateral granted to Lender pursuant to this Agreement (i) constitute and will continue to constitute first priority security interests (except to the extent any other Permitted Lien may create any priority to Lender's Lien under this Agreement) and (ii) are and will continue to be superior and prior to the rights in the Collateral of all other creditors of Borrower (except to the extent of such Permitted Liens). Except as set forth in the Disclosure Schedule, Borrower does not own any right, title or interest in or to any real property (other than leasehold interests), motor vehicles, promissory notes or other property (excluding Intellectual Property) with respect to which a security interest must be perfected by a method other than the filing of a UCC-1 financing statement.

(h) EXECUTIVE OFFICES. The principal place of business and chief executive office of Borrower, and the office where Borrower will keep all records and files regarding the Collateral, is set forth on the cover page of this Agreement.

(i) SOLVENCY, ETC. Borrower is Solvent (as defined below) and, after the execution and delivery of the Operative Documents and the consummation of the transactions contemplated thereby, Borrower will be Solvent. "SOLVENT" shall mean, with respect to any Person on any date, that on such date
(a) the fair value of the property of such Person is greater than the fair value of the liabilities (including, without limitation, contingent liabilities) of such Person, (b) the present fair saleable value of the assets of such Person is not less than the amount that will be required to pay the probable liability of such Person on its debts as they become absolute and matured, (c) such Person does not intend to, and does not believe that it will, incur debts or liabilities beyond such Person's ability to pay as such debts and liabilities mature and (d) such Person is not engaged in business or a transaction, and is not about to engage in business or a transaction, for which such Person's property would constitute an unreasonably small capital.

(j) CATASTROPHIC EVENTS; LABOR DISPUTES. None of Borrower or its properties is or has been affected by any fire, explosion, accident, strike, lockout or other labor dispute, drought, storm, hail, earthquake, embargo, act of God or other casualty that could reasonably be expected to have a material adverse effect on the financial condition, business or operations of Borrower. There are no disputes presently subject to grievance procedure, arbitration or litigation under any of the collective bargaining agreements, employment contracts or employee welfare or incentive plans to which Borrower is a party, and there are no strikes, lockouts, work stoppages or slowdowns, or, to the acknowledge of Borrower, jurisdictional disputes or organizing activity

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occurring or threatened which could reasonably be expected to have a material adverse effect on the financial condition, business or operations of Borrower.

(k) NO MATERIAL ADVERSE EFFECT. No event has occurred and no condition exists which could reasonably be expected to have a material adverse effect on the financial condition, business or operations of Borrower since December 31, 1998, the date of Borrower's last audited financial statements.

(1) ACCURACY OF INFORMATION FURNISHED. None of the Operative Documents and none of the other certificates, statements or information furnished to Lender by or on behalf of Borrower in connection with the Operative Documents or the transactions contemplated thereby contains or will contain any untrue statement of a material fact or omits or will omit to state a material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. Lender recognizes that all financial projections furnished to Lender by or on behalf of Borrower in connection with the Operative Documents or the transactions contemplated thereby are not to be viewed as facts and that actual results during the period or periods covered by such projections may differ from the projected or forecasted results.

(m) CERTAIN AGREEMENTS OF OFFICERS, EMPLOYEES AND CONSULTANTS.

(i) To the knowledge of Borrower, no officer, employee or consultant of Borrower is, or is now expected to be, in violation of any term of any employment contract, proprietary information agreement, nondisclosure agreement, noncompetition agreement, or any other material contract or agreement or any restrictive covenant relating to the right of any such officer, employee or consultant to be employed by Borrower because of the nature of the business conducted or to be conducted by Borrower or relating to the use of trade secrets or proprietary information of others, and to Borrower's knowledge, the continued employment of Borrower's officers, employees and consultants does not subject Borrower to any material liability for any claim or claims arising out of or in connection with any such contract, agreement, or covenant.

(ii) To the knowledge of Borrower, no officers of Borrower, and no employee or consultant of Borrower whose termination, either individually or in the aggregate, could reasonably be expected to have a material adverse effect on the financial condition, business or operations of Borrower, has any present intention of terminating his or her employment or consulting relationship with Borrower.

ARTICLE IV
REPORTING REQUIREMENTS

4.01. FURNISHING REPORTS. Borrower shall furnish to Lender:

(a) FINANCIAL STATEMENTS. So long as Borrower is not subject to the reporting requirements of Section 12 or Section 15 of the Securities and Exchange Act of 1934, as amended, promptly as they are available, unaudited monthly and audited annual financial

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statements of Borrower and such other financial information as Lender may reasonably request from time to time. From and after such time as Borrower becomes a publicly reporting company, promptly as they are available and in any event: (i) at the time of filing of Borrower's Form 10-K with the Securities and Exchange Commission after the end of each fiscal year of Borrower, the financial statements of Borrower filed with such Form 10-K; and (ii) at the time of filing of Borrower's Form 10-Q with the Securities and Exchange Commission after the end of each of the first three fiscal quarters of Borrower, the financial statements of Borrower filed with such Form 10-Q.

(b) NOTICE OF DEFAULTS. As soon as possible, and in any event within five (5) Business Days after the discovery of a Default or Event of Default provide Lender with an officer's certificate of Borrower setting forth the facts relating to or giving rise to such Default or Event of Default and the action which Borrower proposes to take with respect thereto.

(c) MISCELLANEOUS. Such other information as Lender may reasonably request from time to time.

ARTICLE V
GRANT OF SECURITY INTEREST
GENERAL PROVISIONS CONCERNING SECURITY

5.01. GRANT OF SECURITY INTEREST. Borrower, in order to secure the payment of the principal and interest with respect to the Loans made pursuant to this Agreement, all other sums due under and in respect hereof and of the other Operative Documents, including fees, charges, expenses and attorneys' fees and costs and the performance and observance by Borrower of all other terms, conditions, covenants and agreements herein and in the other Operative Documents (all such amounts and obligations being herein sometimes called the "OBLIGATIONS"), does hereby grant to Lender and its successors and assigns, a security interest in and to the following property (collectively, the "COLLATERAL"): All right, title, interest, claims and demands of Borrower in and to:

(a) All goods and equipment now owned or hereafter acquired, including, without limitation, all laboratory equipment, computer equipment, office equipment, machinery, fixtures, vehicles (including motor vehicles and trailers), and any interest in any of the foregoing, and all attachments, accessories, accessions, replacements, substitutions, additions, and improvements to any of the foregoing, wherever located;

(b) All inventory now owned or hereafter acquired, including, without limitation, all merchandise, raw materials, parts, supplies, packing and shipping materials, work in process and finished products including such inventory as is temporarily out of Borrower's custody or possession or in transit and including any returns upon any accounts or other proceeds, including insurance proceeds, resulting from the sale or disposition of any of the foregoing and any documents of title representing any of the above, and Borrower's books relating to any of the foregoing;

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(c) All contract rights and general intangibles (except to the extent included within the definition of Intellectual Property), now owned or hereafter acquired, including, without limitation, goodwill, license agreements, franchise agreements, blueprints, drawings, purchase orders, customer lists, route lists, infringements, claims, computer programs, computer disks, computer tapes, literature, reports, catalogs, design rights, income tax refunds, payments of insurance and rights to payment of any kind;

(d) All now existing and hereafter arising accounts, contract rights, royalties, license rights and all other forms of obligations owing to Borrower arising out of the sale or lease of goods, the licensing of technology or the rendering of services by Borrower (subject, in each case, to the contractual rights of third parties to require funds received by Borrower to be expended in a particular manner), whether or not earned by performance, and any and all credit insurance, guaranties, and other security therefor, as well as all merchandise returned to or reclaimed by Borrower and Borrower's books relating to any of the foregoing;

(e) All documents, cash, deposit accounts, letters of credit, certificates of deposit, instruments, chattel paper and investment property, including, without limitation, all securities, whether certificated or uncertificated, security entitlements, securities accounts, commodity contracts and commodity accounts, and all financial assets held in any securities account or otherwise, wherever located, now owned or hereafter acquired and Borrowers books relating to the foregoing; and

(f) Any and all claims, rights and interests in any of the above and all substitutions for, additions and accessions to and proceeds thereof, including, without limitation, insurance, condemnation, requisition or similar payments and proceeds of the sale or licensing of Intellectual Property to the extent such proceeds no longer constitute Intellectual Property; but

(g) EXCLUDING, all Intellectual Property; and

(h) Any and all of the following equipment collateral (collectively, "EQUIPMENT COLLATERAL"):

All right, title, interest, claims and demands of Borrower in and to each and every item of equipment, fixtures or personal property, whether now owned or hereafter acquired, together with all substitutions, renewals or replacements of and additions, improvements, accessions, replacement parts and accumulations to any and all of such equipment, fixtures or personal property (collectively, the "EQUIPMENT"), together with all proceeds thereof, including, without limitation, insurance, condemnation, requisition or similar payments, and all proceeds from sales, renewals, releases or other dispositions thereof, which is financed with or is designated as collateral for the Obligations on and after the date of this Agreement by designating such equipment, fixtures and personal property on a UCC financing statement listing Borrower as "debtor" and Lender as "secured party."

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5.02. DURATION OF SECURITY INTEREST. Lender's security interest in the Collateral shall continue until the payment in full and the satisfaction of all Obligations, whereupon such security interest shall terminate. Lender, upon payment in full and the satisfaction of the Obligations, shall execute such further documents and take such further actions as may be necessary to effect the release and/or termination contemplated by this SECTION 5.02, including duly executing and delivering termination statements for filing in all relevant jurisdictions.

5.03. POSSESSION AND LOCATION OF COLLATERAL. The Collateral is and shall remain in the possession of Borrower at Borrower's address stated on the cover page of this Agreement. So long as no Event of Default has occurred and is continuing, Borrower shall remain in full possession, enjoyment and control of the Collateral (except only as may be otherwise required by Lender for perfection of its security interest therein) and to manage, operate and use the same and each part thereof with the rights and franchises appertaining thereto; PROVIDED, HOWEVER, that the possession, enjoyment, control and use of the Collateral shall at all times be subject to the observance and performance of the terms of this Agreement.

5.04. EQUIPMENT COLLATERAL. On or prior to its execution and delivery of this Agreement, Borrower shall provide Lender with a listing, in detail to Lender's satisfaction, of all of Borrower's equipment, fixtures and personal property (collectively, an "Equipment List"), which, at Lender's option, shall be attached as an exhibit to a UCC financing statement filed by Lender naming Borrower as "debtor" and Lender as "secured party." Within thirty days after the end of every quarter after the date hereof, Borrower shall provide Lender with an Equipment List of equipment, fixtures and personal property acquired by Borrower during such quarter (which may exclude Third Party Equipment), and such Equipment List shall, at Lender's option, be attached as an exhibit to a UCC financing statement filed by Lender naming Borrower as "debtor" and Lender as "secured party." Borrower agrees to execute and deliver to Lender any and all such financing statements to Lender.

5.05. LIEN SUBORDINATION. Lender agrees that the Liens granted to it hereunder (except for Liens in Equipment Collateral) shall be subordinate to the Liens granted in connection with Indebtedness permitted by clause (e) of the definition of Permitted Indebtedness. Lender agrees to enter into a subordination agreement with the lender of the Indebtedness permitted by clause
(e) of the definition of Permitted Indebtedness substantially in the form of EXHIBIT D and to negotiate in good faith any changes thereto as long as they are acceptable to Lender. Lender agrees that the Liens granted to it hereunder in Third Party Equipment shall be subordinate to the Liens of future lenders providing equipment financing and equipment lessors for equipment and other personal property acquired by Borrower more than eighteen (18) months after the date hereof ("THIRD PARTY EQUIPMENT"); PROVIDED, that, in the case of equipment financings and leasing such Liens are confined solely to the equipment so financed and the proceeds thereof. Notwithstanding the foregoing, the Obligations hereunder shall not be subordinate in right of payment to any obligations to other lenders, equipment lenders or equipment lessors and Lender's rights and remedies hereunder shall not in any way be subordinate to the rights and remedies of any such lender or equipment lessors. Lender agrees to execute and deliver such agreements and documents as may be reasonably requested by Borrower from time to time which set forth the lien subordination described in this SECTION 5.05 and are reasonably acceptable to Lender. Lender shall have no obligation to execute any agreement or document

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which would impose obligations, restrictions or lien priority on Lender which are less favorable to Lender than those described in this SECTION 5.05.

ARTICLE VI
AFFIRMATIVE COVENANTS

6.01. AFFIRMATIVE COVENANTS.

(a) PAYMENT OF TAXES ETC. Borrower shall pay and discharge all taxes, assessments and governmental charges or levies imposed upon it or upon its income or profits, or upon any properties belonging to it, prior to the date on which penalties attach thereto, and all lawful claims which, if unpaid, might become a Lien upon any of its properties; PROVIDED that there shall be no requirement to pay any such tax, assessment, charge, levy or claim
(i) which is being contested in good faith and by appropriate proceedings or which presents no risk of seizure, forfeiture, levy or other event which could jeopardize any Collateral or (ii) for which payment in full is bonded or reserved in Borrower's financial statements.

(b) INSPECTION RIGHTS. Borrower shall, at any reasonable time and from time to time, permit Lender or any of its agents or representatives to inspect the Collateral, to examine and make copies of and abstracts from the records and books of account of, and visit the properties of, Borrower and to discuss the affairs, finances and accounts of Borrower with any of its officers or directors relating in each case to Lender's capacity as lender and secured party hereunder and with respect to the Collateral.

(c) MAINTENANCE OF EQUIPMENT AND SIMILAR ASSETS. Borrower shall keep and maintain all items of equipment and other similar types of personal property that form any significant portion or portions of the Collateral in good operating condition and repair and shall make all necessary replacements thereof and renewals thereto so that the value and operating efficiency thereof shall at all times be maintained and preserved. Borrower shall not permit any such material item of Collateral to become a fixture to real estate or an accession to other personal property, without the prior written consent of Lender. Borrower shall not permit any such material item of Collateral to be operated or maintained in violation of any applicable law, statute, rule or regulation. With respect to items of leased equipment (to the extent Lender has any security interest in any residual Borrower's interest in such equipment under the lease), Borrower shall keep, maintain, repair, replace and operate such leased equipment in accordance with the terms of the applicable lease.

(d) INSURANCE. Borrower shall, obtain and maintain, at its own expense, insurance of a type and with such limits as are carried by similarly situated companies, including at a minimum:

(i) "All risk" insurance against loss or damage to the Collateral. The coverage limit shall be determined to Lender's reasonable satisfaction. The deductible shall not exceed $25,000. The policy shall name Lender as loss payee with respect to the Equipment, shall not be invalidated by any action of or breach of warranty by Borrower of any provision thereof and waive subrogation against Lender.

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(ii) Commercial general liability insurance (including contractual liability, products liability and completed operations coverages) reasonably satisfactory to Lender. The limit of liability shall be at least $5,000,000 per occurrence. The policy shall be without deductible, except for products liability coverage which may have a deductible up to $25,000. The policy(ies) shall name Lender as an additional insured in the full amount of Borrower's liability coverage limits (or the coverage limits of any successor to Borrower or such successor's parent which is providing coverage), be primary and without contribution as respects any insurance carried by Lender, and contain cross liability and severability of interest clauses.

(iii) Such other insurance against risks of loss and with terms as shall be reasonably required by Lender.

All policies of insurance shall be placed with financially sound, commercial insurers reasonably satisfactory to Lender. All policies of insurance shall provide that Lender shall be given 30 days notice of cancellation of coverage. This notice provision shall be without qualification. On or prior to the first Funding Date and prior to each policy renewal, Borrower shall furnish to Lender certificates of insurance or other evidence satisfactory to Lender that insurance complying with all of the above requirements is in effect.

ARTICLE VII
NEGATIVE COVENANTS

7.01. NEGATIVE COVENANTS. So long as the Obligations remain outstanding, Borrower shall not:

(a) NAME; LOCATION OF CHIEF EXECUTIVE OFFICE AND COLLATERAL. Without thirty (30) days prior written notice to Lender, change its chief executive office or principal place of business or remove or cause to be removed from the location set forth on the cover page hereof or move any Collateral to a location other than that set forth on the cover page hereof.

(b) LIENS ON COLLATERAL. Create, incur, assume or suffer to exist any Lien of any kind upon any Collateral, whether now owned or hereafter acquired, except Permitted Liens.

(c) NEGATIVE PLEDGE REGARDING INTELLECTUAL PROPERTY. Create, incur, assume or suffer to exist any Lien of any kind upon any Intellectual Property, whether now owned or hereafter acquired, except Permitted Liens.

(d) DISPOSITIONS OF COLLATERAL OR INTELLECTUAL PROPERTY. Convey, sell, offer to sell, lease, transfer, exchange or otherwise dispose of (collectively, a "Transfer") all or any part of the Collateral or Intellectual Property to any Person, other than: (i) Transfers of inventory in the ordinary course of business; (ii) Transfers which would constitute Permitted Liens under clause (g) of the definition of Permitted Liens; or (iii) Transfers of worn-out or obsolete equipment.

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(e) DISTRIBUTIONS. (i) Pay any dividends or make any distributions on its Equity Securities; (ii) purchase, redeem, retire, defease or otherwise acquire for value any of its Equity Securities (other than repurchases by cancellation of indebtedness pursuant to the terms of employee stock purchase plans, employee restricted stock agreements or similar arrangements in an aggregate amount not to exceed $100,000); (iii) return any capital to any holder of its Equity Securities as such; (iv) make any distribution of assets, Equity Securities, obligations or securities to any holder of its Equity Securities as such; or (v) set apart any sum for any such purpose; provided, however, that Borrower may pay dividends payable solely in common stock.

(f) MERGERS OR ACQUISITIONS. Merge or consolidate with or into any other Person or acquire all or substantially all of the capital stock or assets of another Person; provided that in the event Borrower requests Lender's consent to such a transaction and Lender does not consent (Lender's decision whether to consent is at Lender's sole discretion), Borrower may prepay the Obligations without any Applicable Premium; provided further, if Lender does consent, the provisions of Section 2.01(d) apply.

(g) TRANSACTIONS WITH AFFILIATES. Enter into any contractual obligation with any affiliate or engage in any other transaction with any affiliate except upon terms at least as favorable to Borrower as an arms-length transaction with unaffiliated Persons.

(h) MAINTENANCE OF ACCOUNTS. Maintain any deposit accounts or accounts holding securities owned by Borrower except (i) accounts located at Silicon Valley Bank, Bank of America and State Street Bank & Trust (Merrill Lynch Premier Institutional Fund), and (ii) other accounts with respect to which Lender takes such action as it deems necessary to obtain a perfected security interest in such account.

(i) INDEBTEDNESS PAYMENTS. (i) Prepay, redeem, purchase, defease or otherwise satisfy in any manner prior to the scheduled repayment thereof any Indebtedness for borrowed money (other than amounts due or permitted to be prepaid under this Loan Agreement or the Notes or under any revolving credit agreement constituting Permitted Indebtedness under clause (e) of the definition of Permitted Indebtedness) or lease obligations, (ii) amend, modify or otherwise change the terms of any Indebtedness for borrowed money or lease obligations so as to accelerate the scheduled repayment thereof or (iii) repay any notes to officers, directors or shareholders. Borrower shall provide a subordination agreement, in the form provided by Lender, between Lender and the following shareholders: Gerald G. Loehr Trust, Jack F. Butler, and Clinton L. Lingren, duly executed by such shareholders within forty-five (45) days after the date of this Agreement.

(j) INDEBTEDNESS. Create, incur, assume or permit to exist any Indebtedness except Permitted Indebtedness.

(k) INVESTMENTS. Make any Investment except for Permitted Investments.

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ARTICLE VIII
CONDITIONS PRECEDENT

8.01. CLOSING. At the time of execution and delivery of this Agreement, Borrower shall have duly executed and/or delivered to Lender the items set forth in PART I OF SCHEDULE 3.

8.02. OTHER CONDITIONS. The obligation of the Lender to make the Loans shall be subject to the execution and/or delivery to such Lender of each of the items set forth in PART I OF SCHEDULE 3 and the satisfaction by Borrower of each condition set forth in PART II OF SCHEDULE 3.

8.03. COVENANT TO DELIVER. Borrower agrees (not as a condition but as a covenant) to deliver to Lender each item required to be delivered to Lender as a condition to a Loan, if the Loan is advanced. Borrower expressly agrees that the extension of any Loan prior to the receipt by Lender of any such item shall not constitute a waiver by Lender of Borrower's obligation to deliver such item.

ARTICLE IX
DEFAULT AND REMEDIES

9.01. EVENTS OF DEFAULT. An "Event of Default" shall mean the occurrence of one or more of the following described events:

(a) Borrower shall (i) default in the payment of principal of or interest on any Loan when the same is due, or (ii) default in the payment of any expense or other amount payable hereunder or thereunder for five (5) days after receipt of written notice from a Lender that the same is due; or

(b) Borrower shall breach any provision of SECTION
6.01(d) or SECTION 7.01; or

(c) Borrower shall default in the performance of any covenant, agreement or obligation (other than a covenant, agreement or obligation referred to in, SECTION 9.01 (a) or SECTION 9.01 (b)) contained in any Operative Document (other than the Warrants) and Borrower shall fail to cure within thirty (30) days after receipt of written notice from Lender any default in the performance of any such covenant, agreement or obligation contained therein; or

(d) Borrower shall have breached the terms of any of the Warrants; or

(e) Any representation or warranty made herein or on the Funding Date by Borrower in any Operative Document, or any certificate or financial statement furnished pursuant to the provisions of any Operative Document, shall prove to have been false or misleading in any material respect as of the time made or furnished; or

(f) Any Operative Document shall in any material respect cease to be, or Borrower shall assert that any Operative Document is not, a legal, valid and binding obligation of Borrower enforceable in accordance with its terms; or

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(g) Defaults shall exist under any agreements of Borrower which consist of the failure to pay any Indebtedness at maturity or which result in a right by such third party or parties, whether or not exercised, to accelerate the maturity of Indebtedness of Borrower in an aggregate amount in excess of One Hundred Thousand Dollars ($100,000) or a material default shall exist under any financing agreement with Lender or any of Lender's affiliates or Lender shall have received a "Blockage Notice" under a subordination agreement with the lender of the Indebtedness permitted under clause (e) of the definition of Permitted Indebtedness; or

(h) A proceeding shall have been instituted in a court of competent jurisdiction seeking a decree or order for relief in respect of Borrower in an involuntary case under any applicable bankruptcy, insolvency or other similar law now or hereafter in effect, or for the appointment of a receiver, liquidator, assignee, custodian, trustee (or similar official) of Borrower or for any substantial part of its property, or for the winding-up or liquidation of its affairs, and such proceeding shall remain undismissed or unstayed and in effect for a period of thirty (30) consecutive days or such court shall enter a decree or order granting the relief sought in such proceeding; or

(i) Borrower shall commence a voluntary case under any applicable bankruptcy, insolvency or other similar law now or hereafter in effect, shall consent to the entry of an order for relief in an involuntary case under any such law, or shall consent to the appointment of or taking possession by a receiver, liquidator, assignee, trustee, custodian (or other similar official) of Borrower or for any substantial part of its property, or shall make a general assignment for the benefit of creditors, or shall fail generally to pay its debts as they become due, or shall take any corporate action in furtherance of any of the foregoing; or

(j) A final judgment or order for the payment of money in excess of One Hundred Thousand Dollars ($100,000) (exclusive of amounts covered by insurance issued by an insurer not an affiliate of Borrower) shall be rendered against Borrower and the same shall remain undischarged for a period of thirty (30) days during which execution shall not be effectively stayed, or any judgment, writ, assessment, warrant of attachment, or execution or similar process shall be issued or levied against a substantial part of the property of Borrower and such judgment, writ, or similar process shall not be released, stayed, vacated or otherwise dismissed within thirty (30) days after issue or levy; or

(k) If there occurs a material adverse change in Borrower's business, or if there is a material impairment of the prospect of repayment of any portion of the Obligations owing to Lender or a material impairment of the value or priority of Lender's security interests in the Collateral; or

(1) If any material portion of Borrower's assets is attached, seized, subjected to writ or distress warrant, or is levied upon, or comes into possession of any trustee, receiver or Person acting in a similar capacity and such attachment, seizure, writ or distress warrant or levy has not been removed, discharged or rescinded within ten (10) days, or if Borrower is enjoined, restrained, or in any way prevented by court order from continuing to conduct all or any material part of its business affairs, or if a judgment or other claim becomes a lien or encumbrance upon any material portion of Borrower's assets, or if a notice of lien, levy, or assessment is filed of

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record with respect to any of Borrower's assets by the United States Government, or any department, agency, or instrumentality thereof, or by any state, county, municipal, or governmental agency, and the same is not paid within ten (10) days after Borrower receives notice thereof, provided that none of the foregoing shall constitute an Event of Default where such action or event is stayed or an adequate bond has been posted pending a good faith contesting by Borrower.

9.02. CONSEQUENCES OF EVENT OF DEFAULT.

(a) If an Event of Default specified under any of CLAUSES
(a) THROUGH (g) OR (j) THROUGH (l) OF SECTION 9.01 shall occur and be continuing, Lender may (i) declare all of the Loans, together with interest thereon, plus the Applicable Premium and all other liabilities of Borrower hereunder and under the other Operative Documents to be immediately due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived, and (ii) terminate any commitment to make the Loans and terminate any commitment to advance money or extend credit to or for the benefit of Borrower pursuant to any other agreement or commitment extended by a Lender to Borrower.

(b) If an Event of Default specified under CLAUSE (h) OR
(i) OF SECTION 9.01 shall occur, then immediately and without notice (i) the Loans, together with interest thereon, plus the Applicable Premium and all other liabilities of Borrower hereunder and under the other Operative Documents shall automatically become due and payable, without presentment, demand, protest or notice of any kind, all of which are hereby expressly waived, and (ii) Lender's commitments hereunder to make the Loans and any other commitment of Lender to Borrower to advance money or extend credit pursuant to any other agreement or commitment shall be terminated.

(c) Borrower expressly agrees that the amount due and payable upon any such acceleration or prepayment of the Loans contrary to the terms hereof shall include a Applicable Premium as of the date of such acceleration or prepayment (except for an Event of Default specified in Section
9.01 h, i, j, k or l).

9.03. RIGHTS REGARDING COLLATERAL. Borrower agrees that when any Event of Default has occurred and is continuing, Lender shall have the rights, options, duties and remedies of a secured party as permitted by law and, in addition to and without limiting the foregoing, Lender may exercise any one or more or all, and in any order, of the remedies herein set forth, including the following:

(a) Lender, personally or by agents or attorneys, shall have the right (subject to compliance with any applicable mandatory legal requirements) to require Borrower to assemble the Collateral and make it available to Lender at a place to be designated by Lender or to take immediate possession of the Collateral, or any portion thereof, and for that purpose may pursue the same wherever it may be found, and may enter any of premises of Borrower, with or without notice, demand, process of law or legal procedure, to the extent permitted by applicable law, and search for, take possession of, remove, keep and store the same, or use and operate or lease the same until sold. In furtherance of Lender's rights hereunder, Borrower hereby grants to

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Lender an irrevocable, non-exclusive license (exercisable without royalty or other payment by Lender) to use, license or sublicense any patent, trademark, trade name, copyright or other Intellectual Property in which Borrower now or hereafter has any right, title or interest together with the right of access to all media in which any of the foregoing may be recorded or stored; provided, however, that such license shall only be exercisable in connection with the disposition of Collateral upon Lender's exercise of its remedies hereunder.

(b) Lender may, if at the time such action may be lawful and always subject to compliance with any mandatory legal requirements, either with or without taking possession and either before or after taking possession, without instituting any legal proceedings whatsoever, having first given notice of such sale by registered or certified mail to Borrower once at least ten (10) days prior to the date of such sale, and having first given any other notice which may be required by law, sell and dispose of the Collateral, or any part thereof, at a private sale or at public auction, to the highest bidder, in one lot as an entirety or in separate lots, and either for cash or on credit and on such terms as Lender may determine, and at any place (whether or not it be the location of the Collateral or any part thereof) designated in the notice referred to above. To the extent permitted by applicable law, any such sale or sales may be adjourned from time to time by announcement at the time and place appointed for such sale or sales, or for any such adjourned sale or sales, without further published notice, and Borrower, Lender or the holder or holders of the Notes, or of any interest therein, may bid and become the purchaser at any such sale.

(c) Lender may proceed to protect and enforce this Agreement and the other Operative Documents by suit or suits or proceedings in equity, at law or in bankruptcy, and whether for the specific performance of any covenant or agreement herein contained or in execution or aid of any power herein granted; or for foreclosure hereunder, or for the appointment of a receiver or receivers for any real property security or any part thereof, or for the recovery of judgment for the Obligations or for the enforcement of any other proper, legal or equitable remedy available under applicable law.

9.04. WAIVER BY BORROWER. Upon the occurrence of an Event of Default, to the extent permitted by law, Borrower covenants that it will not at any time insist upon or plead, or in any manner whatsoever claim or take any benefit or advantage of, any stay or extension law now or at any time hereafter in force, nor claim, take nor insist upon any benefit or advantage of or from any law now or hereafter in force providing for the valuation or appraisement of the Collateral or any part thereof prior to any sale or sales thereof to be made pursuant to any provision herein contained, or to the decree, judgment or order of any court of competent jurisdiction; nor, after such sale or sales, claim or exercise any right under any statute now or hereafter made or enacted by any state or otherwise to redeem the property so sold or any part thereof, and, to the full extent legally permitted, except as to rights expressly provided herein, hereby expressly waives for itself and on behalf of each and every Person, except decree or judgment creditors of Borrower, acquiring any interest in or title to the Collateral or any part thereof subsequent to the date of this Agreement, all benefit and advantage of any such law or laws, and covenants that it will not invoke or utilize any such law or laws or otherwise hinder, delay or impede the execution of any power herein granted and delegated to Lender, but will suffer and permit the execution of every such power as though no such power, law or laws had been made or enacted.

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9.05. EFFECT OF SALE. Any sale, whether under any power of sale available to Lender or by virtue of judicial proceedings, shall operate to divest all right, title, interest, claim and demand whatsoever, either at law or in equity, of Borrower in and to the property sold, and shall be a perpetual bar, both at law and in equity, against Borrower, its successors and assigns, and against any and all persons claiming the property sold or any part thereof under, by or through Borrower, its successors or assigns.

9.06. APPLICATION OF COLLATERAL PROCEEDS. The proceeds and/or avails of the Collateral, or any part thereof, and the proceeds and the avails of any remedy hereunder (as well as any other amounts of any kind held by Lender at the time of, or received by Lender after, the occurrence of an Event of Default hereunder) shall be paid to and applied as follows:

(a) FIRST, to the payment of reasonable costs and expenses, including all amounts expended to preserve the value of the Collateral, of foreclosure or suit, if any, and of such sale and the exercise of any other rights or remedies, and of all proper fees, expenses, liability and advances, including reasonable legal expenses and attorneys' fees, incurred or made hereunder by Lender;

(b) SECOND, to the payment to Lender of the amount then owing or unpaid on the Notes, and in case such proceeds shall be insufficient to pay in full the whole amount so due, owing or unpaid upon the Notes, then FIRST, to the unpaid interest thereon, SECOND, to unpaid principal thereof and third to the remaining balance of the Obligations under the Notes; such application to be made upon presentation of the Notes, and the notation thereon of the payment, if partially paid, or the surrender and cancellation thereof, if fully paid;

(c) THIRD, to the payment of other amounts then payable to Lender under any of the Operative Documents; and

(d) FOURTH, to the payment of the surplus, if any, to Borrower, its successors and assigns, or to whomsoever may be lawfully entitled to receive the same.

9.07. REINSTATEMENT OF RIGHTS. If Lender shall have proceeded to enforce any right under this Agreement or any other Operative Document by foreclosure, sale, entry or otherwise, and such proceedings shall have been discontinued or abandoned for any reason or shall have been determined adversely, then and in every such case (unless otherwise ordered by a court of competent jurisdiction), Lender shall be restored to its former position and rights hereunder with respect to the property subject to the security interest created under this Agreement.

ARTICLE X
MISCELLANEOUS

10.01. MODIFICATIONS, AMENDMENTS OR WAIVERS. The provisions of any Operative Document may be modified, amended or waived only by a written instrument signed by the parties thereto.

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10.02. NO IMPLIED WAIVERS; CUMULATIVE REMEDIES; WRITING REQUIRED. No delay or failure of Lender in exercising any right, power or remedy hereunder shall affect or operate as a waiver thereof; nor shall any single or partial exercise thereof or any abandonment or discontinuance of steps to enforce such a right, power or remedy preclude any further exercise thereof or of any other right, power or remedy. The rights and remedies hereunder of Lender are cumulative and not exclusive of any rights or remedies which it would otherwise have. Any waiver, permit, consent or approval of any kind or character on the part of Lender of any breach or default under this Agreement or any such waiver of any provision or condition of this Agreement must be in writing and shall be effective only in the specified instance and to the extent specifically set forth in such writing.

10.03. EXPENSES; INDEMNIFICATION. Borrower agrees upon demand to pay or reimburse Lender for all liabilities, obligations and out-of-pocket expenses, including reasonable fees and expenses of counsel for Lender, from time to time arising in connection with the enforcement or collection of sums due under the Operative Documents, and in connection with any amendment or modification of the Operative Documents or any "work-out" in connection with the Operative Documents. Borrower shall indemnify, reimburse and hold Lender, each of Lender's partners, and each of their respective successors, assigns, agents, officers, directors, shareholders, servants, agents and employees harmless from and against all liabilities, losses, damages, actions, suits, demands, claims of any kind and nature (including claims relating to environmental discharge, cleanup or compliance), all costs and expenses whatsoever to the extent they may be incurred or suffered by such indemnified party in connection therewith (including reasonable attorneys' fees and expenses), fines, penalties (and other charges of applicable governmental authorities), licensing fees relating to any item of Collateral, damage to or loss of use of property (including consequential or special damages to third parties or damages to Borrower's property), or bodily injury to or death of any person (including any agent or employee of Borrower) (each, a "CLAIM"), directly or indirectly relating to or arising out of the use of the proceeds of the Loans or otherwise, the falsity of any representation or warranty of Borrower or Borrower's failure to comply with the terms of this Agreement or any other Operative Document during the Term. The foregoing indemnity shall cover, without limitation, (i) any Claim in connection with a design or other defect (latent or patent) in any item of equipment included in the Collateral, (ii) any Claim for infringement of any patent, copyright, trademark or other Intellectual Property right, (iii) any Claim resulting from the presence on or under or the escape, seepage, leakage, spillage, discharge, emission or release of any Hazardous Materials on the premises of Borrower, including any Claims asserted or arising under any Environmental Law, or (iv) any Claim for negligence or strict or absolute liability in tort; PROVIDED, HOWEVER, that Borrower shall not indemnify Lender for any liability incurred by Lender as a direct and sole result of Lender's gross negligence or willful misconduct. Such indemnities shall continue in full force and effect, notwithstanding the expiration or termination of this Agreement. Upon Lender's written demand, Borrower shall assume and diligently conduct, at its sole cost and expense, the entire defense of Lender, each of its partners, and each of its respective, agents, employees, directors, officers, shareholders, successors and assigns against any indemnified Claim described in this SECTION 10.03. Borrower shall not settle or compromise any Claim against or involving Lender without first obtaining Lender's written consent thereto, which consent shall not be unreasonably withheld.

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10.04. WAIVERS. NOTWITHSTANDING ANYTHING TO THE CONTRARY CONTAINED IN THIS AGREEMENT OR ANYWHERE ELSE, BORROWER AGREES THAT IT SHALL NOT SEEK FROM LENDER UNDER ANY THEORY OF LIABILITY (INCLUDING ANY THEORY IN TORTS), ANY SPECIAL, INDIRECT, CONSEQUENTIAL OR PUNITIVE DAMAGES.

10.05. NOTICES; PAYMENTS.

(a) All notices and other communications given to or made upon any party hereto in connection with this Agreement shall be in writing (including telexed, telecopied or telegraphic communication) and mailed (by certified or registered mail), telexed, telegraphed, telecopied or delivered to the respective parties, as follows:

Borrower: At the address set forth on the cover page of this Agreement.

Lender: MMC/GATX PARTNERSHIP NO. I
c/o MEIER MITCHELL & COMPANY
4 Orinda Way, Suite 200B
Orinda, California 94563

or in accordance with any subsequent written direction from either party to the other. All such notices and other communications shall, except as otherwise expressly herein provided, be effective when received; or in the case of delivery by messenger or overnight delivery service, when left at the appropriate address.

(b) Unless Lender specify otherwise in writing, all payments shall be made by wire transfer to:

 

GATX Capital Corporation

Bank Name:                Bank of America
Bank Address:             Dallas, Texas 75202
Account No.:              3750878673
ABA Routing No.:          111-000012
Reference:                Digirad Invoice #____________

10.06. TERMINATION. This Agreement shall terminate at the end of the Term; PROVIDED, HOWEVER, that the termination of this Agreement shall not affect any of the rights and remedies of Lender hereunder, it being understood and agreed that all such rights and remedies shall continue in full force and effect until payment of all amounts owed to Lender under or in connection with the Operative Documents, whether on account of principal, interest, fees or otherwise.

10.07. SEVERABILITY. If any provision of any Operative Document is held invalid or unenforceable to any extent or in any application, the remainder of such Operative Document and all other Operative Documents, or the application of such provision to different Persons or circumstances or in different jurisdictions, shall not be affected thereby.

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10.08. SURVIVAL. All representations, warranties, covenants and agreements of Borrower contained herein or made in writing in connection herewith shall survive the execution and delivery of the Operative Documents, the making of the Loans hereunder, the granting of security and the issuance of the Notes.

10.09. RELATIONSHIP OF PARTIES. Borrower and Lender acknowledge, understand and agree that:

(a) The relationship between the Borrower, on the one hand, and Lender, on the other, is, and at all time shall remain solely that of a borrower and lender. Lender shall not under any circumstances be construed to be partners or joint venturers of Borrower or any of its Affiliates; nor shall Lender under any circumstances be deemed to be in a relationship of confidence or trust or a fiduciary relationship with Borrower or any of its Affiliates, or to owe any fiduciary duty to Borrower or any of its Affiliates. Lender does not undertake or assume any responsibility or duty to Borrower or any of its Affiliates to select, review, inspect, supervise, pass judgment upon or otherwise inform the Borrower or any of its Affiliates of any matter in connection with its or their Property, any Collateral held by Lender or the operations of Borrower or any of its Affiliates. Borrower and each of its Affiliates shall rely entirely on their own judgment with respect to such matters, and any review, inspection, supervision, exercise of judgment or supply of information undertaken or assumed by Lender in connection with such matters is solely for the protection of Lender and neither Borrower nor any Affiliate is entitled to rely thereon.

10.10. GOVERNING LAW. This Agreement, the other Operative Documents and the rights and obligations of the parties hereto and thereto shall be governed by and construed and enforced in accordance with the laws of the State of California. Any action to enforce this Agreement against Borrower may be brought in California or, with regard to Collateral, may also be brought wherever such Collateral is located.

10.11. SUCCESSORS AND ASSIGNS. This Agreement and the other Operative Documents shall be binding upon and inure to the benefit of Lender, all future holders of the Notes, Borrower and their respective successors and permitted assigns, except that Borrower may not assign or transfer its rights hereunder or any interest herein without the prior written consent of Lender. Lender may sell to any other financial entity (a "PARTICIPANT") participation interests in Lender's rights under this Agreement and the other Operative Documents; provided that notwithstanding the sale of participations, Lender shall remain solely responsible for the performance of its obligations under this Agreement, Lender shall remain the holder of its Note for all purposes under this Agreement and Borrower shall continue to deal solely and directly with Lender in connection with this Agreement and the other Operative Documents. Lender may disclose the Operative Documents and any other financial or other information relating to Borrower or any Subsidiary to any potential Participant, provided that such Participant agrees to protect the confidentiality of such documents and information using the same measures that it uses to protect its own confidential information.

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10.12. COUNTERPARTS. This Agreement may be executed in any number of counterparts and by different parties hereto on separate counterparts, each of which, when so executed and delivered, shall be an original, but all such counterparts shall together constitute one and the same instrument.

10.13. FURTHER ASSURANCES. Borrower will, at its own expense, from time to time do, execute, acknowledge and deliver all further acts, deeds, conveyances, transfers and assurances, and all financing and continuation statements and similar notices, reasonably necessary or proper for the perfection of the security interest being herein provided for in the Collateral, whether now owned or hereafter acquired.

10.14. POWER OF ATTORNEY IN RESPECT OF THE COLLATERAL. Borrower does hereby irrevocably appoint Lender (which appointment is coupled with an interest), the true and lawful attorney-in-fact of Borrower with full power of substitution, for it and in its name (a) to perform (but Lender shall not be obligated to and shall incur no liability to Borrower or any third party for failure to perform) any act which Borrower is obligated by this Agreement to perform but fails to perform, (b) to ask, demand, collect, receive, receipt for, sue for, compound and give acquittance for any and all rents, issues, profits, avails, distributions, income, payment draws and other sums in which a security interest is granted under SECTION 5.01 with full power to settle, adjust or compromise any claim thereunder as fully as if Lender were Borrower itself, (c) to receive payment of and to endorse the name of Borrower to any items of Collateral (including checks, drafts and other orders for the payment of money) that come into Lender's possession or under Lender's control, (d) to make all demands, consents and waivers, or take any other action with respect to, the Collateral, (e) in Lender's discretion, to file any claim or take any other action or institute proceedings, either in its own name or in the name of Borrower or otherwise, which Lender may reasonably deem necessary or appropriate to protect and preserve the right, title and interest of Lender in and to the Collateral, and (f) to otherwise act with respect thereto as though Lender were the outright owner of the Collateral; PROVIDED, HOWEVER, that the power of attorney herein granted shall be exercisable only upon the occurrence and during the continuation of an Event of Default unless in Lender's reasonable opinion immediate action is necessary to preserve or protect the Collateral. Borrower agrees to reimburse Lender upon demand for all reasonable costs and expenses, including attorneys' fees and expenses, which Lender may incur while acting as Borrower's attorney in fact hereunder, all of which costs and expenses are included within the Obligations.

10.15. CONFIDENTIALITY. All information (other than periodic reports filed by Borrower with the Securities and Exchange Commission) disclosed by Borrower to Lender in writing or through inspection pursuant to this Agreement shall be considered confidential. Lender agrees to use the same degree of care to safeguard and prevent disclosure of such confidential information as Lender uses with its own confidential information, but in any event no less than a reasonable degree of care. Lender shall not disclose such information to any third party (other than Lender's or Lender's partner's attorneys and auditors subject to the same confidentiality obligation set forth herein) and shall use such information only for purposes of evaluation of its investment in Borrower and the exercise of Lender's rights and the enforcement of its remedies under this Agreement and the other Operative Agreements. The obligations of confidentiality shall not apply to any information that (a) was known to the public prior to disclosure by

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Borrower under this Agreement, (b) becomes known to the public through no fault of Lender, (c) is disclosed to Lender by a third party having a legal right to make such disclosure, or (d) is independently developed by Lender.

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IN WITNESS WHEREOF, the parties hereto, by their officers thereunto duly authorized, have executed this Agreement as of the day and year first above written.

DIGIRAD CORPORATION


By:    /s/ Scott Huennekens
   --------------------------------------

Name:  Scott Huennekens
     ------------------------------------


Title: President & CEO

MMC/GATX PARTNERSHIP NO. 1

By: GATX Capital Corporation, as
general partner


By:   /s/ Patricia W. Leicher
   --------------------------------------

Name: Patricia W. Leicher
     ------------------------------------


Title: V.P.


 
SCHEDULES

         1        Funding Certificate
         2        Disclosure Schedule
         3        Conditions Precedent

EXHIBITS

         A        Form of Secured Promissory Note
         B        Form of Warrant
         C        Form of Opinion of Counsel
         D        Form of Subordination Agreement


SCHEDULE 1

FUNDING CERTIFICATE

The undersigned, being the duly elected and acting ____________________ of DIGIRAD CORPORATION, a Delaware corporation ("Borrower"), does hereby certify to the Lender (as defined in the Loan Agreement defined below) in connection with that certain Loan and Security Agreement dated as of October __, 1999, among Borrower and Lender (the "Loan Agreement"; with other capitalized terms used below having the meanings ascribed thereto in the Loan Agreement) that:

1. The representations and warranties made by Borrower in ARTICLE III of the Loan Agreement and in the other Operative Documents are true and correct as of the date hereof.

2. No event or condition has occurred and is continuing that would constitute a Default or an Event of Default under the Loan Agreement or any other Operative Document.

3. Borrower is in compliance with the covenants and requirements contained in ARTICLES IV, V, VI AND VII of the Loan Agreement.

4. All conditions referred to in ARTICLE VIII of the Loan Agreement to the making of the Loan to be made on or about the date hereof have been satisfied.

5. No material adverse change in the general affairs, management, results of operations, condition (financial or otherwise) or prospects of Borrower, whether or not arising from transactions in the ordinary course of business, has occurred.

Dated: _________, 199__

DIGIRAD CORPORATION

By:

Name:

Title:


SCHEDULE 2
DISCLOSURE SCHEDULE

N/A


SCHEDULE 3
CONDITIONS PRECEDENT
PART I:

At the time of execution and delivery of this Agreement, there shall also have been duly executed and delivered to Lender:

(a) The Warrants executed in favor of Lender and Persons specified by Lender which are exercisable for 197,628 shares of Borrower's preferred stock;

(b) A favorable opinion of counsel for Borrower, dated as of the closing date, in the form attached hereto as EXHIBIT C or such other form or forms as Lender may accept;

(c) Copies, certified by the Secretary, Assistant Secretary or Chief Financial Officer of Borrower as of the closing date, of Borrower's charter documents and bylaws and of all documents evidencing corporate action taken by Borrower authorizing the execution, delivery and performance of the Operative Documents to which Borrower is a party, in form and substance satisfactory to Lender and its counsel;

(d) Good standing certificate from Borrower's state of incorporation and the state in which Borrower's principal place of business is located, together with certificates of the applicable governmental authorities that Borrower is in compliance with the franchise tax laws of each such state, each dated as of a recent date;

(e) Evidence of the insurance coverage required by SECTION 6.01(d) of this Agreement;

(f) All necessary consents of shareholders and other third parties with respect to the execution, delivery and performance of this Agreement, the Warrants, the Notes and the other Operative Documents;

(g) Form UCC-1 Financing Statements, duly executed by Borrower, or other documents, and Borrower shall have taken such actions, if any, as Lender shall reasonably determine are necessary or desirable to perfect and protect its security interest in the Collateral;

(h) Notices of Security Interest to Depository Banks in the forms provided by Lender;

(i) A pledged collateral account control agreement, in the form provided by Lender; and

(j) All other documents as Lender shall have reasonably requested.


PART II

On or prior to the Funding Date of the Loans, each of the items set forth in PART I OF THIS SCHEDULE 3 shall have been delivered to such Lender and the following conditions shall have been satisfied or waived by such Lender:

(a) Borrower shall have provided to Lender such documents, instruments and agreements as Lender shall reasonably request to evidence the perfection and priority of the security interests granted to Lender pursuant to ARTICLE V;

(b) No Event of Default or Default shall have occurred and be continuing;

(c) Borrower shall have duly executed and delivered to each Lender a Note in the amount of such Lender's Loan;

(d) In Lender's sole discretion, there shall not have occurred any material adverse change in the general affairs, management, results of operations, condition (financial or otherwise) or prospects of Borrower, whether or not arising from transactions in the ordinary course of business, and there shall not have occurred since the date first written on the cover page of this Agreement any material adverse deviation by Borrower from the business plan of Borrower presented to and not disapproved by Lender;

(e) The representations and warranties contained in this Agreement and the other Operative Documents to which Borrower is a party shall be true and correct in all material respects as if made on such Funding Date;

(f) Each of the Operative Documents remains in full force and effect;

(g) Prior to the funding of the Second Loan, Borrower shall have provided evidence to Lender, satisfactory to Lender, that Borrower has successfully consummated an equity financing or bridge loan or such other financing as Lender deems acceptable with the net proceeds received by Borrower of such financing equaling or exceeding Four Million Dollars ($4,000,000); and

(h) The Funding Date of the Loans shall not be later than the respective Commitment Termination Dates; and the Funding Date of the Second Loan shall not be prior to March 31, 2000.

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EXHIBIT A

SECURED PROMISSORY NOTE

$___________ Dated: [Date]

FOR VALUE RECEIVED, the undersigned, DIGIRAD CORPORATION, a Delaware corporation ("BORROWER"), HEREBY PROMISES TO PAY to the order of MMC/GATX PARTNERSHIP NO. I ("LENDER") the principal amount of _____ Million Dollars ($___000,000) or such lesser amount as shall equal the outstanding principal balance of the Loan made to Borrower by Lender pursuant to the Loan and Security Agreement referred to below (the "LOAN AGREEMENT"), and to pay all other amounts due with respect to the Loan on the dates and in the amounts set forth in the Loan Agreement.

Interest on the principal amount of this Note from the date of this Note shall accrue at the Loan Rate or, if applicable, the Default Rate. The Loan Rate for this Note is ______% per annum based on a year of twelve 30-day months. If the Funding Date of this Loan is not the first day of the month, Borrower shall make a payment of accrued interest on the outstanding principal amount of the Loan on [insert first Payment Date]. Commencing on ________, 199__, and continuing on the first day of each subsequent month (each, a "PAYMENT DATE"), Borrower shall make to Lender thirty-six (36) equal payments of principal plus accrued interest on the then outstanding principal amount in the amount of $_______.

Principal, interest and all other amounts due with respect to the Loan, are payable in lawful money of the United States of America to Lender by wire transfer according to the wire transfer instructions set forth in the Loan Agreement. The principal amount of this Note and the interest rate applicable thereto, and all payments made with respect thereto, shall be recorded by Lender and, prior to any transfer hereof, endorsed on the grid attached hereto which is part of this Note.

This Note is one of the Notes referred to in, and is entitled to the benefits of, the Loan and Security Agreement, dated as of October __, 1999, to which Borrower and Lender are parties. The Loan Agreement, among other things,
(a) provides for the making of a secured Loan to Borrower, and (b) contains provisions for acceleration of the maturity hereof upon the happening of certain stated events.

This Note may be not be prepaid except as set forth in Section 2.01(d) of the Loan Agreement.

This Note and the obligation of Borrower to repay the unpaid principal amount of the Loan, plus the Applicable Premium, interest on the Loan and all other amounts due Lender under the Loan Agreement is secured under the Loan Agreement.

- A-1 -


Presentment for payment, demand, notice of protest and all other demands and notices of any kind in connection with the execution, delivery, performance and enforcement of this Note are hereby waived.

Borrower shall pay all reasonable fees and expenses, including, without limitation, reasonable attorneys' fees and costs, incurred by Lender in the enforcement or attempt to enforce any of Borrower's obligations hereunder not performed when due. This Note shall be governed by, and construed and interpreted in accordance with, the laws of the State of California.

IN WITNESS WHEREOF, Borrower has caused this Note to be duly executed by one of its officers thereunto duly authorized on the date hereof.

DIGIRAD CORPORATION

By:

Name:

Title:

- A-2 -


 
LOAN INTEREST RATE AND PAYMENTS OF PRINCIPAL


                PRINCIPAL                              SCHEDULED
DATE             AMOUNT         INTEREST RATE        PAYMENT AMOUNT        NOTATION BY
----             ------         -------------        --------------        -----------







EXHIBIT B
FORM OF WARRANT

- B-1 -


THIS WARRANT HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED OR ANY STATE SECURITIES LAWS. NO SALE OR DISPOSITION MAY BE EFFECTED WITHOUT (i) EFFECTIVE REGISTRATION STATEMENTS RELATED THERETO, (ii) AN OPINION OF COUNSEL OR OTHER EVIDENCE, REASONABLY SATISFACTORY TO THE COMPANY, THAT SUCH REGISTRATIONS ARE NOT REQUIRED, (iii) RECEIPT OF NO-ACTION LETTERS FROM THE APPROPRIATE GOVERNMENTAL AUTHORITIES, OR (iv) OTHERWISE COMPLYING WITH THE PROVISIONS OF SECTION 7 OF THIS WARRANT.

DIGIRAD CORPORATION

WARRANT TO PURCHASE SHARES
OF SERIES E PREFERRED STOCK

THIS CERTIFIES THAT, for value received, [MEIER MITCHELL & COMPANY/PRIORITY CAPITAL] and its assignees are entitled to subscribe for and purchase [172,925/24,703] shares of the fully paid and nonassessable Series E Preferred Stock (as adjusted pursuant to Section 4 hereof, the "Shares") of DIGIRAD CORPORATION, a Delaware corporation (the "Company"), at the price of $3.036 per share (such price and such other price as shall result, from time to time, from the adjustments specified in Section 4 hereof is herein referred to as the "Warrant Price"), subject to the provisions and upon the terms and conditions hereinafter set forth. As used herein, (a) the term "Series Preferred" shall mean the Company's presently authorized Series E Preferred Stock, and any stock into or for which such Series E Preferred Stock may hereafter be converted or exchanged, and after the automatic conversion of the Series E Preferred Stock to Common Stock shall mean the Company's Common Stock,
(b) the term "Date of Grant" shall mean October __, 1999, and (c) the term "Other Warrants" shall mean any other warrants issued by the Company in connection with the transaction with respect to which this Warrant was issued, the Loan and Security Agreement dated as of October __ 1999 (the "Loan Agreement") between the Company and the lender named therein, and any warrant issued upon transfer or partial exercise of or in lieu of this Warrant. The term "Warrant" as used herein shall be deemed to include Other Warrants unless the context clearly requires otherwise.

If the Company is eligible under the Loan Agreement and requests Lender to fund the Second Loan pursuant to the terms of the Loan Agreement, but Lender elects not to fund the Second Loan, the number of shares of the fully paid and nonassessable Series E Preferred Stock the holder is entitled to subscribe for and purchase as set forth above shall be reduced from [172,925/24,703] to
[115,283/16,469). The terms "Lender" and "Second Loan" shall have the meaning given these capitalized terms in the Loan Agreement.

1. TERM. The purchase right represented by this Warrant is exercisable, in whole or in part, at any time and from time to time from the Date of Grant through the later of (i) seven (7) years after the Date of Grant or (ii) five (5) years after the closing of the Company's initial public offering of its Common Stock ("IPO") effected pursuant to a Registration Statement on Form S-1 (or its successor) filed under the Securities Act of 1933, as amended (the "Act").


2. METHOD OF EXERCISE; PAYMENT; ISSUANCE OF NEW WARRANT. Subject to Section 1 hereof, the purchase right represented by this Warrant may be exercised by the holder hereof, in whole or in part and from time to time, at the election of the holder hereof, by (a) the surrender of this Warrant (with the notice of exercise substantially in the form attached hereto as Exhibit A-1 duly completed and executed) at the principal office of the Company and by the payment to the Company, by certified or bank check, or by wire transfer to an account designated by the Company (a "Wire Transfer") of an amount equal to the then applicable Warrant Price multiplied by the number of Shares then being purchased; (b) if in connection with a registered public offering of the Company's securities, the surrender of this Warrant (with the notice of exercise form attached hereto as Exhibit A-2 duly completed and executed) at the principal office of the Company together with notice of arrangements reasonably satisfactory to the Company for payment to the Company either by certified or bank check or by Wire Transfer from the proceeds of the sale of shares to be sold by the holder in such public offering of an amount equal to the then applicable Warrant Price per share multiplied by the number of Shares then being purchased; or (c) exercise of the "net issuance" right provided for in Section 10.2 hereof. The person or persons in whose name(s) any certificate(s) representing shares of Series Preferred shall be issuable upon exercise of this Warrant shall be deemed to have become the holder(s) of record of, and shall be treated for all purposes as the record holder(s) of, the shares represented thereby (and such shares shall be deemed to have been issued) immediately prior to the close of business on the date or dates upon which this Warrant is exercised. In the event of any exercise of the rights represented by this Warrant, certificates for the shares of stock so purchased shall be delivered to the holder hereof as soon as possible and in any event within thirty (30) days after such exercise and, unless this Warrant has been fully exercised or expired, a new Warrant representing the portion of the Shares, if any, with respect to which this Warrant shall not then have been exercised shall also be issued to the holder hereof as soon as possible and in any event within such thirty-day period; provided, however, at such time as the Company is subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, if requested by the holder of this Warrant, the Company shall cause its transfer agent to deliver the certificate representing Shares issued upon exercise of this Warrant to a broker or other person (as directed by the holder exercising this Warrant) within the time period required to settle any trade made by the holder after exercise of this Warrant.

3. STOCK FULLY PAID; RESERVATION OF SHARES. All Shares that may be issued upon the exercise of the rights represented by this Warrant will, upon issuance pursuant to the terms and conditions herein, be fully paid and nonassessable, and free from all taxes, liens and charges with respect to the issue thereof. During the period within which the rights represented by this Warrant may be exercised, the Company will at all times have authorized, and reserved for the purpose of the issue upon exercise of the purchase rights evidenced by this Warrant, a sufficient number of shares of its Series Preferred to provide for the exercise of the rights represented by this Warrant and a sufficient number of shares of its Common Stock to provide for the conversion of the Series Preferred into Common Stock.

4. ADJUSTMENT OF WARRANT PRICE AND NUMBER OF SHARES. The number and kind of securities purchasable upon the exercise of this Warrant and the Warrant Price shall be subject to adjustment from time to time upon the occurrence of certain events, as follows:

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(a) RECLASSIFICATION OR MERGER. In case of any reclassification or change of securities of the class issuable upon exercise of this Warrant (other than a change in par value, or from par value to no par value, or from no par value to par value, or as a result of a subdivision or combination), or in case of any merger of the Company with or into another corporation (other than a merger with another corporation in which the Company is the acquiring and the surviving corporation and which does not result in any reclassification or change of outstanding securities issuable upon exercise of this Warrant), or in case of any sale of all or substantially all of the assets of the Company, the Company, or such successor or purchasing corporation, as the case maybe, shall duly execute and deliver to the holder of this Warrant a new Warrant (in form and substance satisfactory to the holder of this Warrant), or the Company shall make appropriate provision without the issuance of a new Warrant, so that the holder of this Warrant shall have the right to receive, at a total purchase price not to exceed that payable upon the exercise of the unexercised portion of this Warrant, and in lieu of the shares of Series Preferred theretofore issuable upon exercise of this Warrant, (i) the kind and amount of shares of stock, other securities, money and property receivable upon such reclassification, change, merger or sale by a holder of the number of shares of Series Preferred then purchasable under this Warrant, or (ii) in the case of such a merger or sale in which the consideration paid consists all or in part of assets other than securities of the successor or purchasing corporation, at the option of the Holder of this Warrant, the securities of the successor or purchasing corporation having a value at the time of the transaction equivalent to the valuation of the Series Preferred at the time of the transaction. Any new Warrant shall provide for adjustments that shall be as nearly equivalent as may be practicable to the adjustments provided for in this Section 4. The provisions of this subparagraph (a) shall similarly apply to successive reclassifications, changes, mergers and transfers.

(b) SUBDIVISION OR COMBINATION OF SHARES. If the Company at any time while this Warrant remains outstanding and unexpired shall subdivide or combine its outstanding shares of Series Preferred, the Warrant Price shall be proportionately decreased and the number of Shares issuable hereunder shall be proportionately increased in the case of a subdivision and the Warrant Price shall be proportionately increased and the number of Shares issuable hereunder shall be proportionately decreased in the case of a combination.

(c) STOCK DIVIDENDS AND OTHER DISTRIBUTIONS. If the Company at any time while this Warrant is outstanding and unexpired shall (i) pay a dividend with respect to Series Preferred payable in Series Preferred, then the Warrant Price shall be adjusted, from and after the date of determination of shareholders entitled to receive such dividend or distribution, to that price determined by multiplying the Warrant Price in effect immediately prior to such date of determination by a fraction (A) the numerator of which shall be the total number of shares of Series Preferred outstanding immediately prior to such dividend or distribution, and (B) the denominator of which shall be the total number of shares of Series Preferred outstanding immediately after such dividend or distribution; or (ii) make any other distribution with respect to Series Preferred (except any distribution specifically provided for in Sections 4(a) and 4(b)), then, in each such case, provision shall be made by the Company such that the holder of this Warrant shall receive upon exercise of this Warrant a proportionate share of any such dividend or distribution as though it were the holder of the Series Preferred (or Common Stock issuable upon conversion thereof) as of the record date fixed for the determination of the shareholders of the Company entitled to receive such dividend or distribution.

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(d) ADJUSTMENT OF NUMBER OF SHARES. Upon each adjustment in the Warrant Price, the number of Shares of Series Preferred purchasable hereunder shall be adjusted, to the nearest whole share, to the product obtained by multiplying the number of Shares purchasable immediately prior to such adjustment in the Warrant Price by a fraction, the numerator of which shall be the Warrant Price immediately prior to such adjustment and the denominator of which shall be the Warrant Price immediately thereafter.

(e) ANTIDILUTION RIGHTS. The other antidilution rights applicable to the Shares of Series Preferred purchasable hereunder are set forth in the Company's Certificate of Incorporation, as amended through the Date of Grant, a true and complete copy of which is attached hereto as Exhibit B (the "Charter"). Such antidilution rights shall not be restated, amended, modified or waived in any manner that is adverse to the holder hereof without such holder's prior written consent. The Company shall promptly provide the holder hereof with any restatement, amendment, modification or waiver of the Charter promptly after the same has been made.

5. NOTICE OF ADJUSTMENTS. Whenever the Warrant Price or the number of Shares purchasable hereunder shall be adjusted pursuant to Section 4 hereof, the Company shall make a certificate signed by its chief financial officer setting forth, in reasonable detail, the event requiring the adjustment, the amount of the adjustment, the method by which such adjustment was calculated, and the Warrant Price and the number of Shares purchasable hereunder after giving effect to such adjustment, and shall cause copies of such certificate to be mailed (without regard to Section 13 hereof, by first class mail, postage prepaid) to the holder of this Warrant. In addition, whenever the conversion price or conversion ratio of the Series Preferred shall be adjusted, the Company shall make a certificate signed by its chief financial officer setting forth, in reasonable detail, the event requiring the adjustment, the amount of the adjustment, the method by which such adjustment was calculated, and the conversion price or ratio of the Series Preferred after giving effect to such adjustment, and shall cause copies of such certificate to be mailed (without regard to Section 13 hereof, by first class mail, postage prepaid) to the holder of this Warrant.

6. FRACTIONAL SHARES. No fractional shares of Series Preferred will be issued in connection with any exercise hereunder, but in lieu of such fractional shares the Company shall make a cash payment therefor based on the fair market value of the Series Preferred on the date of exercise as reasonably determined in good faith by the Company's Board of Directors.

7. COMPLIANCE WITH ACT; DISPOSITION OF WARRANT OR SHARES OF SERIES PREFERRED.

(a) COMPLIANCE WITH ACT. The holder of this Warrant, by acceptance hereof, agrees that this Warrant, and the shares of Series Preferred to be issued upon exercise hereof and any Common Stock issued upon conversion thereof are being acquired for investment and that such holder will not offer, sell or otherwise dispose of this Warrant, or any shares of Series Preferred to be issued upon exercise hereof or any Common Stock issued upon conversion thereof except under circumstances which will not result in a violation of the Act or any applicable state securities laws.

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Upon exercise of this Warrant, unless the Shares being acquired are registered under the Act and any applicable state securities laws or an exemption from such registration is available, the holder hereof shall confirm in writing that the shares of Series Preferred so purchased (and any shares of Common Stock issued upon conversion thereof) are being acquired for investment and not with a view toward distribution or resale in violation of the Act and shall confirm such other matters related thereto as may be reasonably requested by the Company. This Warrant and all shares of Series Preferred issued upon exercise of this Warrant and all shares of Common Stock issued upon conversion thereof (unless registered under the Act and any applicable state securities laws) shall be stamped or imprinted with a legend in substantially the following form:

"THE SECURITIES EVIDENCED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE SECURITIES LAWS. NO SALE OR DISPOSITION MAY BE EFFECTED WITHOUT (i) EFFECTIVE REGISTRATION STATEMENTS RELATED THERETO,
(ii) AN OPINION OF COUNSEL OR OTHER EVIDENCE, REASONABLY SATISFACTORY TO THE COMPANY, THAT SUCH REGISTRATIONS ARE NOT REQUIRED, (iii) RECEIPT OF NO-ACTION LETTERS FROM THE APPROPRIATE GOVERNMENTAL AUTHORITIES, OR (iv) OTHERWISE COMPLYING WITH THE PROVISIONS OF SECTION 7 OF THE WARRANT UNDER WHICH THESE SECURITIES WERE ISSUED, DIRECTLY OR INDIRECTLY."

Said legend shall be removed by the Company, upon the request of a holder, at such time as the restrictions on the transfer of the applicable security shall have terminated. In addition, in connection with the issuance of this Warrant, the holder specifically represents to the Company by acceptance of this Warrant as follows:

(1) The holder is aware of the Company's business affairs and financial condition, and has acquired information about the Company sufficient to reach an informed and knowledgeable decision to acquire this Warrant. The holder is acquiring this Warrant for its own account for investment purposes only and not with a view to, or for the resale in connection with, any "distribution" thereof in violation of the Act. By executing this Warrant, the holder further represents as of the Date of Grant that the holder does not have any contract, undertaking, agreement or arrangement with any person to sell, transfer or grant participation to such person or to any third person, with respect to any of the Shares or this Warrant.

(2) The holder is a holder in securities of companies in the development stage and acknowledges that it is able to fend for itself, can bear the economic risk of its holding and has such knowledge ad experience in financial and business matters that it is capable of evaluating the merits and risks of the acquisition of this Warrant and the Shares.

(3) The holder understands that this Warrant has not been registered under the Act in reliance upon a specific exemption therefrom, which exemption depends upon, among other things, the bona fide nature of the holder's investment intent as expressed herein.

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(4) The holder further understands that this Warrant must be held indefinitely unless subsequently registered under the Act and qualified under any applicable state securities laws, or unless exemptions from registration and qualification are otherwise available. The holder is aware of the provisions of Rule 144, promulgated under the Act.

(5) The holder is an "accredited investor" as such term is defined in Rule 501 of Regulation D promulgated under the Act.

(b) DISPOSITION OF WARRANT OR SHARES. With respect to any offer, sale or other disposition of this Warrant or any shares of Series Preferred acquired pursuant to the exercise of this Warrant prior to registration of such Warrant or shares, the holder hereof agrees to give written notice to the Company prior thereto, describing briefly the manner thereof, together with a written opinion of such holder's counsel, or other evidence, if reasonably satisfactory to the Company, to the effect that such offer, sale or other disposition may be effected without registration or qualification (under the Act as then in effect or any federal or state securities law then in effect) of this Warrant or such shares of Series Preferred or Common Stock and indicating whether or not under the Act certificates for this Warrant or such shares of Series Preferred to be sold or otherwise disposed of require any restrictive legend as to applicable restrictions on transferability in order to ensure compliance with such law. Upon receiving such written notice and reasonably satisfactory opinion or other evidence, the Company, as promptly as practicable but no later than fifteen (15) days after receipt of the written notice, shall notify such holder that such holder may sell or otherwise dispose of this Warrant or such shares of Series Preferred or Common Stock, all in accordance with the terms of the notice delivered to the Company. If a determination has been made pursuant to this Section 7(b) that the opinion of counsel for the holder or other evidence is not reasonably satisfactory to the Company, the Company shall so notify the holder promptly with details thereof after such determination has been made. Notwithstanding the foregoing, this Warrant or such shares of Series Preferred or Common Stock may, as to such federal laws, be offered, sold or otherwise disposed of in accordance with Rule 144 or 144A under the Act, provided that the Company shall have been furnished with such information as the Company may reasonably request to provide a reasonable assurance that the provisions of Rule 144 or 144A have been satisfied. Each certificate representing this Warrant or the shares of Series Preferred thus transferred (except a transfer pursuant to Rule 144 or 144A) shall bear a legend as to the applicable restrictions on transferability in order to ensure compliance with such laws, unless in the aforesaid opinion of counsel for the holder, such legend is not required in order to ensure compliance with such laws. The Company may issue stop transfer instructions to its transfer agent in connection with such restrictions.

(c) APPLICABILITY OF RESTRICTIONS. Neither any restrictions of any legend described in this Warrant nor the requirements of
Section 7(b) above shall apply to any transfer of, or grant of a security interest in, this Warrant (or the Series Preferred or Common Stock obtainable upon exercise thereof) or any part hereof (i) to a partner of the holder if the holder is a partnership or to a member of the holder if the holder is a limited liability company, (ii) to a partnership of which the holder is a partner or to a limited liability company of which the holder is a member, or (iii) to any affiliate of the holder if the holder is a corporation; PROVIDED,

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HOWEVER, in any such transfer, if applicable, the transferee shall on the Company's request agree in writing to be bound by the terms of this Warrant as if an original holder hereof.

8. RIGHTS AS SHAREHOLDERS; INFORMATION. No holder of this Warrant, as such, shall be entitled to vote or receive dividends or be deemed the holder of Series Preferred or any other securities of the Company which may at any time be issuable on the exercise hereof for any purpose, nor shall anything contained herein be construed to confer upon the holder of this Warrant, as such, any of the rights of a shareholder of the Company or any right to vote for the election of directors or upon any matter submitted to shareholders at any meeting thereof, or to receive notice of meetings, or to receive dividends or subscription rights or otherwise until this Warrant shall have been exercised and the Shares purchasable upon the exercise hereof shall have become deliverable, as provided herein. Notwithstanding the foregoing, the Company will transmit to the holder of this Warrant such information, documents and reports as are generally distributed to the holders of any class or series of the securities of the Company concurrently with the distribution thereof to the shareholders.

9. MARKET STAND-OFF AGREEMENT. During the time period not to exceed 180 days specified by the Company and an underwriter of securities of the Company, following the effective date of a registration statement of the Company filed under the Act (the "Lock-up"), the holder shall not, to the extent requested by the Company and such underwriter, directly or indirectly sell, offer to sell, contract to sell (including, without limitation, any short sale), grant any option to purchase or otherwise transfer or dispose of (other than to transferees or donees who agree to be similarly bound) any securities of the Company held by it at any time during such period except Common Stock included in such registration; PROVIDED, HOWEVER, that this Section 9 shall be applicable
(a) only to the first such registration statement of the Company pursuant to which Common Stock (or other securities) of the Company are to be sold on its behalf to the public in an underwritten offering, and (b) only if all officers and directors of the Company enter into similar agreements, and (c) such underwriters certify to the holder of this Warrant in writing that (1) they have determined that the holder must be so bound during the Lock-up or it would have a material negative impact on the offering, and (2) all other holders of warrants of the Company have agreed to be similarly restricted. In order to enforce the foregoing covenant, the Company may impose stop-transfer restrictions with respect to the Shares of the holder (and the shares or securities of every person subject to the foregoing restriction) until the end of such period

10. ADDITIONAL RIGHTS.

10.1 ACQUISITION TRANSACTIONS. The Company shall provide the holder of this Warrant with at least twenty (20) days' written notice prior to closing thereof of the terms and conditions of any of the following transactions (to the extent the Company has notice thereof): (i) the sale, lease, exchange, conveyance or other disposition of all or substantially all of the Company's property or business, or (ii) its merger into or consolidation with any other corporation (other than a wholly-owned subsidiary of the Company), or any transaction (including a merger or other reorganization) or series of related transactions, in which more than 50% of the voting power of the Company is disposed of.

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10.2 RIGHT TO CONVERT WARRANT INTO STOCK: NET ISSUANCE.

(a) RIGHT TO CONVERT. In addition to and without limiting the rights of the holder under the terms of this Warrant, the holder shall have the right to convert this Warrant or any portion thereof (the "Conversion Right") into shares of Series Preferred (or Common Stock if the Series Preferred has been automatically converted into Common Stock) as provided in this Section 10.2 at any time or from time to time during the term of this Warrant. Upon exercise of the Conversion Right with respect to a particular number of shares subject to this Warrant (the "Converted Warrant Shares"), the Company shall deliver to the holder (without payment by the holder of any exercise price or any cash or other consideration) that number of shares of fully paid and nonassessable Series Preferred (or Common Stock if the Series Preferred has been automatically converted into Common Stock) as is determined according to the following formula:

X= B - A
 

Y

Where:     X =    the number of shares of Series Preferred (or Common
                  Stock if the Series Preferred has been automatically
                  converted to Common Stock) that shall be issued to
                  holder

           Y =    the fair market value of one share of Series
                  Preferred (or Common Stock if the Series Preferred
                  has been automatically converted to Common Stock)

           A =    the aggregate Warrant Price of the specified number
                  of Converted Warrant Shares immediately prior to the
                  exercise of the Conversion Right (i.e., the number of
                  Converted Warrant Shares multiplied by the Warrant
                  Price)

           B =    the aggregate fair market value of the specified
                  number of Converted Warrant Shares (i.e., the number
                  of Converted Warrant Shares MULTIPLIED BY the fair
                  market value of one Converted Warrant Share)

No fractional shares shall be issuable upon exercise of the Conversion Right, and, if the number of shares to be issued determined in accordance with the foregoing formula is other than a whole number, the Company shall pay to the holder an amount in cash equal to the fair market value of the resulting fractional share on the Conversion Date (as hereinafter defined). For purposes of Section 9 of this Warrant, shares issued pursuant to the Conversion Right shall be treated as if they were issued upon the exercise of this Warrant.

(b) METHOD OF EXERCISE. The Conversion Right may be exercised by the holder by the surrender of this Warrant at the principal office of the Company together with a written statement (which may be in the form of Exhibit A-1 or Exhibit A-2 hereto) specifying that the holder thereby intends to exercise the Conversion Right and indicating the number of shares subject to this Warrant which are being surrendered (referred to in Section 10.2(a) hereof as the Converted Warrant Shares) in exercise of the Conversion Right. Such conversion shall be effective upon receipt by the Company of this Warrant together with the aforesaid written

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statement, or on such later date as is specified therein (the "Conversion Date"), and, at the election of the holder hereof, may be made contingent upon the closing of the sale of the Company's Common Stock to the public in a public offering pursuant to a Registration Statement under the Act (a "Public Offering"). Certificates for the shares issuable upon exercise of the Conversion Right and, if applicable, a new warrant evidencing the balance of the shares remaining subject to this Warrant, shall be issued as of the Conversion Date and shall be delivered to the holder within thirty (30) days following the Conversion Date.

(c) DETERMINATION OF FAIR MARKET VALUE. For purposes of this Section 10.2, "fair market value" of a share of Series Preferred (or Common Stock if the Series Preferred has been automatically converted into Common Stock) as of a particular date (the "Determination Date") shall mean:

(i) If the Conversion Right is exercised in connection with and contingent upon a Public Offering, and if the Company's Registration Statement relating to such Public Offering ("Registration Statement") has been declared effective by the Securities and Exchange Commission, then the initial "Price to Public" specified in the final prospectus with respect to such offering.

(ii) If the Conversion Right is not exercised in connection with and contingent upon a Public Offering, then as follows:

(A) If traded on a securities exchange, the fair market value of the Common Stock shall be deemed to be the average of the closing prices of the Common Stock on such exchange over the 30-day period ending five business days prior to the Determination Date, and the fair market value of the Series Preferred shall be deemed to be such fair market value of the Common Stock multiplied by the number of shares of Common Stock into which each share of Series Preferred is then convertible;

(B) If traded on the Nasdaq Stock Market or other over-the-counter system, the fair market value of the Common Stock shall be deemed to be the average of the closing bid prices of the Common Stock over the 30-day period ending five business days prior to the Determination Date, and the fair market value of the Series Preferred shall be deemed to be such fair market value of the Common Stock multiplied by the number of shares of Common Stock into which each share of Series Preferred is then convertible; and

(C) If there is no public market for the Common Stock, then fair market value shall be determined by the Board of Directors of the Company acting in good faith.

10.3 EXERCISE PRIOR TO EXPIRATION. To the extent this Warrant is not previously exercised as to all of the Shares subject hereto, and if the fair market value of one share of the Series Preferred is greater than the Warrant Price then in effect, this Warrant shall be deemed automatically exercised pursuant to Section 10.2 above (even if not surrendered) immediately before its expiration. For purposes of such automatic exercise, the fair market value of one share of the Series Preferred upon such expiration shall be determined pursuant to Section 10.2(c). To the extent this Warrant or any portion thereof is deemed automatically exercised pursuant to this

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Section 10.3, the Company agrees to promptly notify the holder hereof of the number of Shares, if any, the holder hereof is to receive by reason of such automatic exercise.

11. REPRESENTATIONS AND WARRANTIES. The Company represents and warrants to the holder of this Warrant as follows:

(a) This Warrant has been duly authorized and executed by the Company and is a valid and binding obligation of the Company enforceable in accordance with its terms, subject to laws of general application relating to bankruptcy, insolvency and the relief of debtors and the rules of law or principles at equity governing specific performance, injunctive relief and other equitable remedies;

(b) The Shares have been duly authorized and reserved for issuance by the Company and, when issued in accordance with the terms hereof, will be validly issued, fully paid and non-assessable;

(c) The rights, preferences, privileges and restrictions granted to or imposed upon the Series Preferred and the holders thereof are as set forth in the Charter, and on the Date of Grant, each share of the Series Preferred represented by this Warrant is convertible into one share of Common Stock;

(d) The shares of Common Stock issuable upon conversion of the Shares have been duly authorized and reserved for issuance by the Company and, when issued in accordance with the terms of the Charter will be validly issued, hilly paid and nonassessable;

(e) The execution and delivery of this Warrant are not, and the issuance of the Shares upon exercise of this Warrant in accordance with the terms hereof will not be, inconsistent with the Company's Charter or by-laws, do not and will not contravene any law, governmental rule or regulation, judgment or order applicable to the Company, and do not and will not conflict with or contravene any provision of, or constitute a default under, any indenture, mortgage, contract or other instrument of which the Company is a party or by which it is bound or require the consent or approval of, the giving of notice to, the registration or filing with or the taking of any action in respect of or by, any Federal, state or local government authority or agency or other person, except for the filing of notices pursuant to federal and state securities laws, which filings will be effected by the time required thereby; and

(f) There are no actions, suits, audits, investigations or proceedings pending or, to the knowledge of the Company, threatened against the Company in any court or before any governmental commission, board or authority which, if adversely determined, will have a material adverse effect on the ability of the Company to perform its obligations under this Warrant.

(g) The number of shares of Common Stock of the Company outstanding on the date hereof, on a fully diluted basis (assuming the conversion of all outstanding convertible securities and the exercise of all outstanding options and warrants), does not exceed [________] shares.

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12. MODIFICATION AND WAIVER. This Warrant and any provision hereof may be changed, waived, discharged or terminated only by an instrument in writing signed by the party against which enforcement of the same is sought.

13. NOTICES. Any notice, request, communication or other document required or permitted to be given or delivered to the holder hereof or the Company shall be delivered, or shall be sent by certified or registered mail, postage prepaid, to each such holder at its address as shown on the books of the Company or to the Company at the address indicated therefor on the signature page of this Warrant.

14. BINDING EFFECT ON SUCCESSORS. This Warrant shall be binding upon any corporation succeeding the Company by merger, consolidation or acquisition of all or substantially all of the Company's assets, and all of the obligations of the Company relating to the Series Preferred issuable upon the exercise or conversion of this Warrant shall survive the exercise, conversion and termination of this Warrant and all of the covenants and agreements of the Company shall inure to the benefit of the successors and assigns of the holder hereof.

15. LOST WARRANTS OR STOCK CERTIFICATES. The Company covenants to the holder hereof that, upon receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of this Warrant or any stock certificate and, in the case of any such loss, theft or destruction, upon receipt of an indemnity reasonably satisfactory to the Company, or in the case of any such mutilation upon surrender and cancellation of such Warrant or stock certificate, the Company will make and deliver a new Warrant or stock certificate, of like tenor, in lieu of the lost, stolen, destroyed or mutilated Warrant or stock certificate.

16. DESCRIPTIVE HEADINGS. The descriptive headings of the several paragraphs of this Warrant are inserted for convenience only and do not constitute a part of this Warrant. The language in this Warrant shall be construed as to its fair meaning without regard to which parry drafted this Warrant.

17. GOVERNING LAW. This Warrant shall be construed and enforced in accordance with, and the rights of the parties shall be governed by, the laws of the State of California (without giving effect to principles of conflicts of laws).

18. SURVIVAL OF REPRESENTATIONS, WARRANTIES AND AGREEMENTS. All representations and warranties of the Company and the holder hereof contained herein shall survive the Date of Grant, the exercise or conversion of this Warrant (or any part hereof) or the termination or expiration of rights hereunder. All agreements of the Company and the holder hereof contained herein shall survive indefinitely until, by their respective terms, they are no longer operative.

19. REMEDIES. In case any one or more of the covenants and agreements contained in this Warrant shall have been breached, the holders hereof (in the case of a breach by the Company), or the Company (in the case of a breach by a holder), may proceed to protect and enforce their or its rights either by suit in equity and/or by action at law, including, but not

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limited to, an action for damages as a result of any such breach and/or an action for specific performance of any such covenant or agreement contained in this Warrant.

20. NO IMPAIRMENT OF RIGHTS. The Company will not, by amendment of its Charter or through any other means, avoid or seek to avoid the observance or performance of any of the terms of this Warrant, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the holder of this Warrant against impairment.

21. SEVERABILITY. The invalidity or unenforceability of any provision of this Warrant in any jurisdiction shall not affect the validity or enforceability of such provision in any other jurisdiction, or affect any other provision of this Warrant, which shall remain in full force and effect.

22. RECOVERY OF LITIGATION COSTS. If any legal action or other proceeding is brought for the enforcement of this Warrant, or because of an alleged dispute, breach, default, or misrepresentation in connection with any of the provisions of this Warrant, the successful or prevailing party or parties shall be entitled to recover reasonable attorneys' fees and other costs incurred in that action or proceeding, in addition to any other relief to which it or they may be entitled.

23. ENTIRE AGREEMENT; MODIFICATION. This Warrant constitutes the entire agreement between the parties pertaining to the subject matter contained in it and supersedes all prior and contemporaneous agreements, representations, and undertakings of the parties, whether oral or written, with respect to such subject matter.

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The Company has caused this Warrant to be duly executed and delivered as of the Date of Grant specified above.

DIGIRAD CORPORATION

By

Title

Address: 9350 Trade Place San Diego, CA 92121

MEIER MITCHELL & COMPANY

By

Title

Address: 4 Orinday Way, Suite 200B Orinda, CA 94563

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EXHIBIT A-1

NOTICE OF EXERCISE

To: DIGIRAD CORPORATION (the "Company")

1. The undersigned hereby:

/ / elects to purchase_________ shares of [Series Preferred Stock] [Common Stock] of the Company pursuant to the terms of the attached Warrant, and tenders herewith payment of the purchase price of such shares in full, or

/ / elects to exercise its net issuance rights pursuant to Section 10.2 of the attached Warrant with respect to __________ Shares of [Series Preferred Stock]
[Common Stock].

2. Please issue a certificate or certificates representing _________ shares in the name of the undersigned or in such other name or names as are specified below:



(Name)



(Address)

3. The undersigned represents that the aforesaid shares are being acquired for the account of the undersigned for investment and not with a view to, or for resale in connection with, the distribution thereof and that the undersigned has no present intention of distributing or reselling such shares, all except as in compliance with applicable securities laws.



(Signature)



(Date)


EXHIBIT A-2

NOTICE OF EXERCISE

To: DIGIRAD CORPORATION (the "Company")

1. Contingent upon and effective immediately prior to the closing (the "Closing") of the Company's public offering contemplated by the Registration Statement on Form S___, filed ________, 19___, the undersigned hereby:

/ / elects to purchase __________ shares of [Series Preferred Stock] [Common Stock] of the Company (or such lesser number of shares as may be sold on behalf of the undersigned at the Closing) pursuant to the terms of the attached Warrant, or

/ / elects to exercise its net issuance rights pursuant to Section 10.2 of the attached Warrant with respect to _______ Shares of [Series Preferred Stock] [Common Stock].

2. Please deliver to the custodian for the selling shareholders a stock certificate representing such _________ shares.

3. The undersigned has instructed the custodian for the selling shareholders to deliver to the Company $_______or, if less, the net proceeds due the undersigned from the sale of shares in the aforesaid public offering. If such net proceeds are less than the purchase price for such shares, the undersigned agrees to deliver the difference to the Company prior to the Closing.



(Signature)



(Date)


EXHIBIT B
CHARTER


CERTIFICATE OF AMENDMENT TO
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF DIGIRAD CORPORATION,
a Delaware Corporation

Digirad Corporation, a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware (the "Corporation"),

DOES HEREBY CERTIFY:

FIRST: That resolutions were duly adopted by the Board of Directors of the Corporation setting forth a proposed amendment to the existing Amended and Restated Certificate of Incorporation of the Corporation, and declaring said amendment to be advisable and recommended for approval by the stockholders of the Corporation. The resolutions setting forth the proposed amendment are as follows:

RESOLVED, FURTHER, that Paragraph A and Paragraph B, Section 1 of ARTICLE IV of the Amended and Restated Certificate of Incorporation of this Corporation is hereby amended to read in its entirety as follows:

A. CLASSES OF STOCK. This Corporation is authorized to issue two (2) classes of shares, to be designated "Common" and "Preferred" and referred to herein as the "Common Stock" or the "Preferred Stock" respectively. The total number of shares of Common Stock the Corporation is authorized to issue is Twenty-Seven Million (27,000,000). The par value is $0.001 per share. The total number of shares of Preferred Stock the Corporation is authorized to issue is Eighteen Million Six Hundred Ninety Thousand Eight Hundred Thirty-Nine (18,690,839). The par value is $0.001 per share.

The Board of Directors of the Corporation may divide the Preferred Stock into any number of series. The Board of Directors shall fix the designation and number of shares of each such series. The Board of Directors may determine and alter the rights, preferences, privileges and restrictions granted to and imposed upon any wholly unissued series of the Preferred Stock. The Board of Directors (within the limits and restrictions of any resolution adopted by it, originally fixing the number of shares of any series) may increase or decrease the number of shares of any such series after the issue of shares of that series, but not below the number of then outstanding shares of such series.


B. Rights, Preferences, Privileges and Restrictions of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock.

1. Designation of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock.

Two Million Two Hundred Fifty Thousand (2,250,000) shares of Preferred Stock are designated Series A Preferred Stock (the "Series A Preferred Stock") with the rights, preferences and privileges specified herein. Two Million Two Hundred Eighty-One Thousand (2,281,000) shares of Preferred Stock are designated Series B Preferred Stock (the "Series B Preferred Stock") with the rights, preferences and privileges specified herein. Four Million Eight Hundred Thousand (4,800,000) shares of Preferred Stock are designated Series C Preferred Stock (the "Series C Preferred Stock") with the rights, preferences and privileges specified herein. Eight Million Six Hundred Sixty-Eight Thousand One Hundred Forty (8,668,140) shares of Preferred Stock are designated Series D Preferred Stock (the "Series D Preferred Stock"). Six Hundred Ninety-One Thousand Six Hundred Ninety-Nine (691,699) shares of Preferred Stock are designated Series E Preferred Stock (the "Series E Preferred Stock"). As used in this Article IV, Division B, the term "Preferred Stock" shall refer to the Series A Preferred Stock, the Series B Preferred Stock, the Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock."

SECOND: That, thereafter, the stockholders of said Corporation approved the amended by written consent in accordance with Section 228 of the Delaware General Corporation Law.

THIRD: That said amendment was duly approved in accordance with the provisions of Section 242 of the Delaware General Corporation Law.

FOURTH: That the capital of said Corporation shall not be reduced under or by reason of said amendment.

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IN WITNESS WHEREOF, Digirad Corporation, has caused this certificate to be signed by Scott Huennekens, its President, on this 27th day of October, 1999.


/s/ Scott Huennekens
-----------------------------------------
Scott Huennekens, President


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AMENDED AND RESTATED CERTIFICATE OF INCORPORATION
OF
DIGIRAD CORPORATION

Digirad Corporation, a corporation organized and existing under the laws of the state of Delaware, hereby certifies as follows:

1. The name of the corporation is Digirad Corporation. The date the Corporation filed its original Certificate of Incorporation with the Secretary of State was January 2, 1997.

2. This Amended and Restated Certificate of Incorporation restates and amends the provisions of the original Certificate of Incorporation of this Corporation as heretofore in effect and was duly adopted by the Corporation's Board of Directors in accordance with Sections 241 and 245 of the General Corporation Law of the State of Delaware.

3. The text of the Certificate of Incorporation is hereby amended and restated to read as herein set forth in full:

ARTICLE I

The name of the Corporation (hereinafter called "Corporation") is Digirad Corporation.

ARTICLE II

The address of the registered office of the Corporation in the State of Delaware is 30 Old Rudnick Lane, City of Dover, County of Kent 19901, and the name of the registered agent of the Corporation in the State of Delaware at such address is CorpAmerica, Inc.

ARTICLE III

The purpose of this Corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware.

ARTICLE IV

A. CLASSES OF STOCK. This Corporation is authorized to issue two
(2) classes of shares, to be designated "Common" and "Preferred" and referred to herein as the "Common Stock" or the "Preferred Stock" respectively. The total number of shares of Common Stock the Corporation is authorized to issue is twenty-five million four hundred ninety-four thousand seventy-one (25,494,071). The par value is $0.001 per share. The total number of shares of Preferred Stock the Corporation is authorized to issue is eighteen million four hundred ninety-three thousand two hundred eleven (18,493,211). The par value is $0.001 per share.


The Board of Directors of the Corporation may divide the Preferred Stock into any number of series. The Board of Directors shall fix the designation and number of shares of each such series. The Board of Directors may determine and alter the rights, preferences, privileges and restrictions granted to and imposed upon any wholly unissued series of the Preferred Stock. The Board of Directors (within the limits and restrictions of any resolution adopted by it, originally fixing the number of shares of any series) may increase or decrease the number of shares of any such series after the issue of shares of that series, but not below the number of then outstanding shares of such series.

B. Rights, Preferences, Privileges and Restrictions of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock.

1. Designation of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock.

Two Million Two Hundred Fifty Thousand (2,250,000) shares of Preferred Stock are designated Series A Preferred Stock (the "Series A Preferred Stock") with the rights, preferences and privileges specified herein. Two Million Two Hundred Eighty-One Thousand (2,281,000) shares of Preferred Stock are designated Series B Preferred Stock (the "Series B Preferred Stock") with the rights, preferences and privileges specified herein. Four Million Eight Hundred Thousand (4,800,000) shares of Preferred Stock are designated Series C Preferred Stock (the "Series C Preferred Stock") with the rights, preferences and privileges specified herein. Eight million six hundred sixty-eight thousand one hundred forty (8,668,140) shares of Preferred Stock are designated Series D Preferred Stock (the "Series D Preferred Stock"). Four hundred ninety-four thousand seventy-one (494,071) shares of Preferred Stock are designated Series E Preferred Stock (the "Series E Preferred Stock"). As used in this Article IV, Division B, the term "Preferred Stock" shall refer to the Series A Preferred Stock, the Series B Preferred Stock, the Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock.

2. DIVIDEND PROVISIONS.

The holders of shares of Preferred Stock shall be entitled to receive non-cumulative dividends, out of any assets legally available therefor, prior and in preference to any declaration or payment of any dividend (payable other than in Common Stock of this Corporation) on the Common Stock or any other junior equity security of this Corporation, at the rate of $.10 per share of Series A Preferred Stock, $.11 per share of Series B Preferred Stock, $.125 per share of Series C Preferred Stock, $.23073 per share of Series D Preferred Stock and $.3036 per share of Series E Preferred Stock per annum plus an amount equal to that paid on outstanding shares of Common Stock of this Corporation, whenever funds are legally available therefor, payable quarterly when, as and if declared by the Board of Directors and shall be non-cumulative. Dividends, if declared, must be declared and paid with respect to all series of Preferred Stock contemporaneously, and if less than full dividends are declared, the same percentage of the dividend rate will be payable to each series of Preferred Stock.

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3. LIQUIDATION PREFERENCE.

(a) In the event of any liquidation, dissolution or winding up of this Corporation, either voluntary or involuntary, the holders of Preferred Stock shall be entitled to receive, prior and in preference to any distribution of any of the assets of this Corporation to the holders of Common Stock or any other junior equity security by reason of their ownership thereof an amount for each share of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock, respectively, held by such holder equal to the sum of (i) $1.00 for each such outstanding share of Series A Preferred Stock (the "Original Series A Issue Price"), (ii) $1.10 for each such outstanding share of Series B Preferred Stock (the "Original Series B Issue Price"), (iii) $1.25 for each such outstanding share of Series C Preferred Stock (the "Original Series C Issue Price"), (iv) $2.3073 for each outstanding share of Series D Preferred Stock (the "Original Series D Issue Price"), (v) $3.036 for each outstanding share of Series E Preferred Stock (the "Original Series E Issue Price") and (vi) in each case, an amount equal to all declared but unpaid dividends on each such share. If upon the occurrence of such an event the assets and funds thus distributed among the holders of the Preferred Stock shall be insufficient to permit the payment to such holders of the full aforesaid preferential amounts, then the entire assets and funds of this Corporation legally available for distribution shall be distributed, ratably among the holders of the Preferred Stock in proportion to the product of the liquidation preference of each such share and the number of such shares owned by each such holder.

(b) Upon the completion of the distribution required by subsection 3(a) above, if assets remain in the Corporation, the holders of the Common Stock shall receive an amount equal to $.21 per share (adjusted to reflect any subsequent stock splits, stock dividends, or other recapitalizations) for each share of Common Stock held by them. If, upon the occurrence of such event, the assets and funds thus distributed among the holders of the Common Stock shall be insufficient to permit payment to such holders of the full aforesaid preferential amounts, then the entire assets and funds of this Corporation legally available for distribution (after giving effect to the distribution referred to in Section 3(a) hereof) shall be distributed ratably among the holders of the Common Stock in proportion to the amount of such stock owned by each such holder.

(c) After the distributions described in subsections 3(a) and (b) have been paid, the remaining assets of this Corporation available for distribution to stockholders shall be distributed among the holders of Preferred Stock and Common Stock pro rata based on the number of shares of Common Stock held by each (assuming conversion of all such Preferred Stock).

4. REDEMPTION.

(a) The outstanding Preferred Stock shall be redeemable as provided in this Section 4. The Series A Redemption Price shall be the total amount equal to $1.00 per share of Series A Preferred Stock to be redeemed together with any declared but unpaid dividends on such shares to the Redemption Date (as such term is hereinafter defined). The Series B Redemption Price shall be the total amount equal to $1.10 per share of Series B Preferred Stock to be redeemed together with any declared but unpaid dividends on such shares

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to the Redemption Date. The Series C Redemption Price shall be the total amount equal to $1.25 per share of Series C Preferred Stock to be redeemed together with any declared but unpaid dividends on such shares to the Redemption Date. The Series D Redemption Price shall be the total amount equal to $2.3073 per share of Series D Preferred Stock to be redeemed together with any declared but unpaid dividends on such shares to the Redemption Date. The Series E Redemption Price shall be the total amount equal to $3.036 per share of Series E Preferred Stock to be redeemed together with any declared but unpaid dividends on such shares to the Redemption Date.

(b) On or at any time after July 31, 2004, upon the receipt by this Corporation from the holders of at least 66-2/3% of the then outstanding shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock, voting as a single class, of a written request for redemption hereunder of their respective shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock (the "Redemption Request"), this Corporation shall, from any source of funds legally available therefor, redeem all of the shares of Preferred Stock by paying in cash therefor a sum equal to the Series A Redemption Price, the Series B Redemption Price, the Series C Redemption Price, the Series D Redemption Price and the Series E Redemption Price, respectively.

(c) (i) At least 15, but no more than 30, days prior to the date fixed for any redemption of the Preferred Stock (the "Redemption Date"), which Redemption Date shall be no later than 45 days following the Corporation's receipt of the Redemption Request, written notice shall be mailed, first class postage prepaid, to each holder of record (at the close of business on the business day next preceding the day on which notice is given) of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock to be redeemed at the address last shown on the records of this Corporation for such holder or given by the holder to this Corporation for the purpose of notice or if no such address appears or is given, at the place where the principal executive office of this Corporation is located, notifying such holder of the redemption to be effected, specifying the number of shares to be redeemed from such holder, the Redemption Date, the Series A Redemption Price, the Series B Redemption Price, the Series C Redemption Price, the Series D Redemption Price or the Series E Redemption Price as the case may be, the place at which payment may be obtained and the date on which such holder's Conversion Rights (as hereinafter defined) as to such shares, terminating and calling upon such holder to surrender to this Corporation, in the manner and at the place designated, such holder's certificate or certificates representing the shares to be redeemed (the "Redemption Notice"). Except as provided in subsection 4(c)(iii), on or after the Redemption Date, each holder of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock to be redeemed shall surrender to this Corporation the certificate or certificates representing such shares, in the manner and at the place designated in the Redemption Notice, and thereupon the Series A Redemption Price, Series B Redemption Price, Series C Redemption Price, the Series D Redemption Price or the Series E Redemption Price, as the case may be, of such shares shall be payable, to the order of the person whose name appears on such certificate or certificates as the owner thereof and each surrendered certificate shall be canceled. In the event less than all the shares represented by any such certificate are redeemed, a new certificate shall be issued representing the unredeemed shares.

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(ii) If the funds of the Corporation legally available for redemption of outstanding shares of Preferred Stock on any Redemption Date are insufficient to redeem the total number of shares of Preferred Stock to be redeemed on such date, those funds which are legally available will be used to redeem the maximum possible number of such shares ratably among the holders of (A) first, such shares of Series B, Series C, Series D and Series E Preferred Stock to be redeemed, and (B) second, such shares of Series A Preferred Stock to be redeemed. The shares of Preferred Stock not redeemed shall remain outstanding and entitled to all the rights and preferences provided herein. At any time thereafter when additional funds of this Corporation are legally available for the redemption of shares of Preferred Stock, such funds shall immediately be used to redeem the balance of the shares which this Corporation has become obligated to redeem on any Redemption Date but which it has not redeemed.

(iii) From and after the Redemption Date, unless there shall have been a default in payment of the applicable Series A Redemption Price, Series B Redemption Price, Series C Redemption Price, Series D Redemption Price or the Series E Redemption Price, all rights of the holders of such shares as holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock (except the right to receive the Series A Redemption Price, Series B Redemption Price, Series C Redemption Price, Series D Redemption Price or the Series E Redemption Price, without interest, upon surrender of their certificate or certificates) shall cease with respect to such shares, and such shares shall not thereafter be transferred on the books of this Corporation or be deemed to be outstanding for any purpose whatsoever.

(iv) At least three days prior to the Redemption Date, this Corporation shall deposit the Series A Redemption Price, Series B Redemption Price, Series C Redemption Price, Series D Redemption Price and Series E Redemption Price of all outstanding shares of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock, designated for redemption in the Redemption Notice, and not yet redeemed or converted, with a bank or trust company having aggregate capital and surplus in excess of $50,000,000, as a trust fund for the benefit of the holders of the shares designated for redemption and not yet redeemed. Simultaneously, this Corporation shall deposit irrevocable instructions and authority to such bank or trust company to pay, on and after the Redemption Date or prior thereto, the Series A Redemption Price, Series B Redemption Price, Series C Redemption Price, Series D Redemption Price and Series E Redemption Price, as the case may be, to the holders thereof upon surrender of their certificates. Any monies deposited by this Corporation pursuant to this subsection 4(c)(iv) for the redemption of shares which are thereafter converted into shares of Common Stock pursuant to Section 5 hereof no later than the close of business on the Redemption Date shall be returned to this Corporation forthwith upon such conversion. The balance of any monies deposited by this Corporation pursuant to this subsection 4(c)(iv) remaining unclaimed at the expiration of two years following the Redemption Date shall thereafter be returned to this Corporation, provided that the stockholder to which such monies would be payable hereunder shall be entitled, upon proof of its ownership of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock, as the case may be, and payment of any bond requested by this Corporation, to receive such monies but without interest from the Redemption Date.

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5. CONVERSION. The holders of Preferred Stock shall have conversion rights as follows (the "Conversion Rights"):

(a) RIGHT TO CONVERT.

(i) Subject to subsection 5(c), each outstanding share of Preferred Stock shall be convertible, at the option of the holder thereof at any time after the date of issuance of such share (and on or prior to the fifth day prior to the Redemption Date, if any, as may have been fixed in any Redemption Notice), at the office of this Corporation or any transfer agent for such series of Preferred Stock, into such number of fully paid and nonassessable shares of Common Stock as is determined by dividing the Original Series A Issue Price, the Original Series B Issue Price, the Original Series C Issue Price, the Original Series D Issue Price and the Original Series E Issue Price, respectively, by the Conversion Price at the time in effect for such series or shares of such series. The initial Conversion Price per share for shares of Preferred Stock shall be the Original Series A Issue Price, the Original Series B Issue Price, the Original Series C Issue Price, the Original Series D Issue Price and the Original Series E Issue Price, respectively, provided, however, that the Conversion Prices for the Series A Preferred Stock, the Series B Preferred Stock, the Series C Preferred Stock, the Series D Preferred Stock and the Series E Preferred Stock shall be subject to adjustment as set forth in subsection 5(c).

(ii) Each outstanding share of Preferred Stock shall automatically be converted into shares of Common Stock at the Conversion Price at the time in effect for such shares immediately upon:

(A) the closing of this Corporation's sale of its Common Stock in a bona fide, firm commitment underwritten public offering registered under the Securities Act of 1933, as amended (the "Securities Act"), which results in aggregate gross offering proceeds to this Corporation of at least $15,000,000, at a public offering price of not less than $7.50 per share (adjusted to reflect subsequent stock dividends, stock splits or recapitalizations) (a "Qualifying Public Offering"); or

(B) the approval of (i) holders of at least 75% of the then outstanding shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock, voting together as a single class and (ii) holders of not less than 60% of the Series D Preferred Stock voting as a class.

(b) MECHANICS OF CONVERSION. Before any holder of Preferred Stock shall be entitled to convert the same into shares of Common Stock, such holder shall surrender the certificate or certificates therefor, duly endorsed, at the office of this Corporation or of any transfer agent for such stock, and shall be given written notice by mail postage prepaid, to this Corporation at its principal corporate office, of the election to convert the same and shall state therein the name or names in which the certificate or certificates for shares of Common Stock are to be issued. This Corporation shall, as soon as practicable thereafter, issue and deliver at such office to such holder of Preferred Stock, or to the nominee or nominees of such holder, a certificate or certificates for the number of shares of Common Stock to which such holder shall be entitled as aforesaid. Such conversion shall be deemed to have been made immediately prior to the close of business on the date of such surrender of the shares of such series of Preferred

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Stock to be converted, and the person or persons entitled to receive the shares of Common Stock issuable upon such conversion shall be treated for all purposes as the record holder or holders of such shares of Common Stock as of such date. If the conversion is in connection with an underwritten offer of securities registered pursuant to the Securities Act, the conversion may, at the option of any holder tendering shares of such series of Preferred Stock for conversion, be conditioned upon the closing with the underwriter of the sale of securities pursuant to such offering, in which event the person(s) entitled to receive the Common Stock issuable upon such conversion of shares of such series of Preferred Stock shall not be deemed to have converted such shares of such series of Preferred Stock until immediately prior to the closing of such sale of securities.

(c) CONVERSION PRICE ADJUSTMENTS OF THE
PREFERRED STOCK. The Conversion Prices of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock shall be subject to adjustment from time to time as follows:

(i) (A) If this Corporation shall issue any Additional Stock (as defined below) without consideration or for a consideration per share less than the Conversion Price for shares of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock in effect immediately prior to the issuance of such Additional Stock, the new Conversion Price for such shares of such series of Preferred Stock shall be determined by multiplying the Conversion Price for such series of Preferred Stock in effect immediately prior to the issuance of Additional Stock by a fraction:

(x) the numerator of which shall be the number of shares of Common Stock outstanding immediately prior to such issuance (for purposes of this calculation only, including the number of shares of Common Stock then issuable upon the conversion of all outstanding shares of Preferred Stock at the Conversion Price for such shares in effect immediately prior to such issuance of Additional Stock) plus the number of shares of Common Stock equivalents which the aggregate consideration received by this Corporation for the shares of such Additional Stock so issued would purchase at the Conversion Price in effect at the time for the shares of the series of Preferred Stock with respect to which the adjustment is being made; and

(y) the denominator of which shall be the number of shares of Common Stock outstanding immediately prior to such issuance (for purposes of this calculation only, including the number of shares of Common Stock then issuable upon the conversion of all outstanding shares of Preferred Stock at the Conversion Price for such shares in effect immediately prior to such issuance of Additional Stock) plus the number of such shares of Additional Stock so issued.

Any series of issuances of Additional Stock consisting of Common Stock or the same series of Preferred Stock, issued at the same price and within a six-month period, shall be treated as one issuance of Additional Stock for the purposes of this calculation.

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(B) No adjustment of the Conversion Price for such series of Preferred Stock shall be made in an amount less than one cent per share, provided that any adjustments which are not required to be made by reason of this sentence shall be carried forward and shall be either taken into account in any subsequent adjustment made prior to three years from the date of the event giving rise to the adjustment being carried forward, or shall be made at the end of three years from the date of the event giving rise to the adjustment being carried forward. Except to the limited extent provided for in subsections 5(c)(i)(E)(3) and (c)(i)(E)(4), no adjustment of such Conversion Price for such series of Preferred Stock pursuant to this subsection 5(c)(i) shall have the effect of increasing the Conversion Price for such series of Preferred Stock above the Conversion Price for such series in effect immediately prior to such adjustment.

(C) In the case of the issuance of Common Stock for cash, the consideration shall be deemed to be the amount of cash paid therefor before deducting any reasonable discounts, commissions or other expenses allowed, paid or incurred by this Corporation for any underwriting or otherwise in connection with the issuance and sale thereof.

(D) In the case of the issuance of the Common Stock for a consideration in whole or in part other than cash, the consideration other than cash shall be deemed to be the fair value thereof as determined by the Board of Directors irrespective of any accounting treatment.

(E) In the case of the issuance of options to purchase or rights to subscribe for Common Stock, securities by their terms convertible into or exchangeable for Common Stock or options to purchase or rights to subscribe for such convertible or exchangeable securities (which are not excluded from the definition of Additional Stock), the following provisions shall apply:

(1) The aggregate maximum number of shares of Common Stock deliverable upon exercise of such options to purchase or rights to subscribe for Common Stock shall be deemed to have been issued at the time such options or rights were issued and for a consideration equal to the consideration (determined in the manner provided in subsections 5(c)(i)(C) and (c)(i)(D)), if any, received by the Corporation upon the issuance of such options or rights plus the minimum purchase price provided in such options or rights for the Common Stock covered thereby.

(2) The aggregate maximum number of shares of Common Stock deliverable upon conversion of or in exchange for any such convertible or exchangeable securities or upon the exercise of options to purchase or rights to subscribe for such convertible or exchangeable securities and subsequent conversion or exchange thereof shall be deemed to have been issued at the time such securities were issued or such options or rights were issued and for a consideration equal to the consideration, if any, received by this Corporation for any such securities and related options or rights (excluding any cash received on account of accrued interest or accrued dividends), plus the additional consideration, if any, to be received by this Corporation upon the conversion or exchange of such securities or the exercise of any related options or rights (the consideration in each case to be determined in the manner provided in subsections 5(c)(i)(C) and
(c)(i)(D)).

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(3) In the event of any change in the number of shares of Common Stock deliverable or any increase in the consideration payable to this Corporation upon exercise of such options or rights or upon conversion of or in exchange for such convertible or exchangeable securities, including, but not limited to, a change resulting from the anti-dilution provisions thereof, the Conversion Price of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock, as the case may be, obtained with respect to the adjustment which was made upon the issuance of such options, rights or securities, and any subsequent adjustments based thereon shall be recomputed to reflect such change, but no further adjustment shall be made for the actual issuance of Common Stock or any payment of such consideration upon the exercise of any such options or rights or the conversion or exchange of such securities; provided, however, that this section shall not have any effect on any conversion of such series of Preferred Stock prior to such change or increase.

(4) Upon the expiration of any such options or rights, the termination of any such rights to convert or exchange or the expiration of any options or rights related to such convertible or exchangeable securities, the Conversion Price of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock, as the case may be, obtained with respect to the adjustment which was made upon the issuance of such options, rights or securities or options or rights related to such securities, and any subsequent adjustments based thereon, shall be recomputed to reflect the issuance of only the number of shares of Common Stock actually issued upon the exercise of such options or rights upon the conversion or exchange of such securities or upon the exercise of the options or rights related to such securities; provided, however, that this section shall not have any effect on any conversion of such series of Preferred Stock prior to such expiration or termination.

(ii) "Additional Stock" shall mean any shares of Common Stock issued (or deemed to have been issued pursuant to subsection 5(c)(i)(e)) by this Corporation after June 22, 1998, other than:

(A) Common Stock issued pursuant to a transaction described in subsection 5(c)(iii) hereof, or

(B) 3,454,860 shares of Common Stock, net of repurchases and the cancellation or expiration of options, issued or issuable to employees, directors, consultants or advisors of this Corporation under stock option and restricted stock purchase agreements approved by the Board of Directors commencing as of May 1994, and such other number of shares of Common Stock as may be fixed from time to time by the Board of Directors and approved by a majority of then outstanding Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock, voting as a single class, issued or issuable to employees, directors, consultants or advisors of this Corporation under stock option and restricted stock purchase agreements approved by the Board of Directors, or

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(C) Common Stock issued or issuable upon conversion of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock.

(iii) In the event this Corporation should at any time or from time to time after the effective date hereof fix a record date for the effectuation of a split or subdivision of the outstanding shares of Common Stock or the determination of holders of Common Stock entitled to receive a dividend or other distribution payable in additional shares of Common Stock or other securities or rights convertible into, or entitling the holder thereof to receive directly or indirectly, additional shares of Common Stock (hereinafter referred to as "Common Stock Equivalents") without payment of any consideration by such holder for the additional shares of Common Stock or the Common Stock Equivalents (including the additional shares of Common Stock issuable upon conversion or exercise thereof), then as of such record date (or the date of such dividend distribution, split or subdivision if no record date is fixed), the Conversion Price for the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock, as the case may be, shall be appropriately decreased so that the number of shares of Common Stock issuable on conversion of each share of such series shall be increased in proportion to such increase of outstanding shares determined in accordance with subsection 5(c)(i)(E).

(iv) If the number of shares of Common Stock outstanding at any time after the effective date hereof is decreased by a combination of the outstanding shares of Common Stock, then, following the record date of such combination, the Conversion Price for the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock, as the case may be, shall be appropriately increased so that the number of shares of Common Stock issuable on conversion of each share of such series shall be decreased in proportion to such decrease in outstanding shares.

(d) OTHER DISTRIBUTIONS. In the event this Corporation shall declare a distribution payable in securities of other persons, evidences of indebtedness issued by this Corporation or other persons, assets (excluding cash dividends) or options or rights not referred to in subsection 5(c)(iii), then, in each such case for the purpose of this subsection 5(d), the holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock, shall be entitled to a proportionate share of any such distribution as though they were the holders of the number of shares of Common Stock of this Corporation into which their shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock, as the case may be, are convertible as of the record date fixed for the determination of the holders of Common Stock of this Corporation entitled to receive such distribution.

(e) RECAPITALIZATIONS. If at any time or from time to time there shall be a recapitalization of the Common Stock (other than a subdivision, combination or merger or sale of assets transaction provided for elsewhere in this Section 5 or Section 6) provision shall be made so that the holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock, shall thereafter be entitled to receive upon conversion of such series of Preferred Stock the number of shares of stock or other securities or property of this Corporation or otherwise, to which a holder of

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Common Stock deliverable upon conversion would have been entitled on such recapitalization. In any such case, appropriate adjustment shall be made in the application of the provisions of this Section 5 with respect to the rights of the holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock, after the recapitalization to the end that the provisions of this
Section 5 (including adjustment of the Conversion Price then in effect and the number of shares purchasable upon conversion of such series of Preferred Stock) shall be applicable after that event as nearly equivalent as may be practicable.

(f) NO IMPAIRMENT. This Corporation will not, by amendment of its Certificate of Incorporation or through any reorganization, revitalization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by this Corporation, but will at all times in good faith assist in the carrying out of all the provisions of this Section 5 and in the taking of all such action as may be necessary or appropriate in order to protect the Conversion Rights of the holders of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock against impairment.

(g) FRACTIONAL SHARES AND CERTIFICATE AS TO ADJUSTMENTS.

(i) No fractional shares shall be issued upon conversion of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock, and the number of shares of Common Stock to be issued shall be rounded to the nearest whole share. Whether or not fractional shares are issuable upon such conversion shall be determined on the basis of the total number of shares of such series of Preferred Stock the holder is at the time converting into Common Stock and the number of shares of Common Stock issuable upon such aggregate conversion.

(ii) Upon the occurrence of each adjustment or, readjustment of the Conversion Price of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock, as the case may be, pursuant to this
Section 5, this Corporation, at its expense, shall promptly compute such adjustment or readjustment in accordance with the terms hereof and prepare and furnish to each holder of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock, or instrument convertible into shares of any such series of Preferred Stock, as the case may be, a certificate setting forth such adjustment or readjustment and showing in detail the facts upon which such adjustment or readjustment is based. This Corporation shall, upon the written request furnish or cause to be furnished to such holder a like certificate setting forth (A) such adjustment and readjustment, (B) the Conversion Price at the time in effect, and (C) the number of shares of Common Stock and the amount, if any, of other property which at the time would be received upon the conversion of a share of such series of Preferred Stock.

(h) NOTICES OF RECORD DATE. In the event of any taking by this Corporation of a record of the holders of any class of securities for the purpose of determining the holders thereof who are entitled to receive any dividend (other than a cash dividend) or other

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distribution, any right to subscribe for, purchase or otherwise acquire any shares of stock of any class or any other securities or property, or to receive any other right, this Corporation shall mail to each holder of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock at least 20 days prior to the date specified therein, a notice specifying the date on which by such record is to be taken for the purpose of such dividend, distribution or right and the amount and character of such dividend, distribution or right.

(i) RESERVATION OF COMMON STOCK ISSUABLE UPON CONVERSION. This Corporation shall at all times reserve and keep available out of its authorized but unissued shares of Common Stock solely for the purpose of effecting the conversion of the shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock, such number of its shares of Common Stock as shall from time to time be sufficient to effect the conversion of all authorized shares of such series of Preferred Stock, and if at any time the number of authorized but unissued shares of Common Stock shall not be sufficient to effect the conversion of all then authorized shares of such series of Preferred Stock, in addition to such other remedies as shall be available to the holders of such series of Preferred Stock, this Corporation will take such corporate action as may, in the opinion of its counsel be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purposes.

(j) NOTICES. Any notice required by the provisions of this Section 5 to be given to the holders of shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock shall be deemed given if deposited in the United States postage prepaid, and addressed to each holder of record at such holder's address appearing on the books of this Corporation.

6. MERGER; CONSOLIDATION.

(a) If at any time after the effective date hereof there is a merger, consolidation or other corporate reorganization in which stockholders of this Corporation immediately prior to such transaction own less than 50% of the voting securities of the surviving or controlling entity immediately after the transaction, or sale of all or substantially all of the assets of this Corporation (hereinafter, an "Acquisition"), then, as a part of such Acquisition, provision shall be made so that the holders of the Series A Preferred Stock, the Series B Preferred Stock, the Series C Preferred Stock, the Series D Preferred Stock and Series E Preferred Stock shall be entitled to receive, prior to any distribution to holders of Common Stock or other junior equity security of the Corporation, the number of shares of stock or other securities or property to be issued to this Corporation or its stockholders resulting from such Acquisition in an amount per share equal to the Original Series A Issue Price, Original Series B Issue Price, Original Series C Issue Price, Original Series D Issue Price and Original Series E Issue Price, as applicable, plus a further amount equal to any dividends declared but unpaid on such shares. Subject to the following sentence, the holders of Common Stock shall thereafter be entitled to receive, pro rata, the remainder of the number of shares of stock or other securities or property to be issued to this Corporation or its stockholders resulting from such Acquisition. Notwithstanding anything to the contrary in this Section 6, in the event the aggregate value of stock, securities and other property to be distributed to this Corporation or its stockholders with

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respect to an Acquisition is less than $5.25 per share (such dollar amount to be appropriately adjusted to reflect any subsequent stock splits, stock dividends or other recapitalizations) of Common Stock outstanding (for purpose of this calculation only, including in the number of shares of Common Stock outstanding the number of shares of Common Stock then issuable upon conversion of all outstanding Preferred Stock), then the stock, securities or other property shall be distributed among the holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, the Series D Preferred Stock, Series E Preferred Stock and the Common Stock according to the provisions of Section 3 hereof as if such Acquisition were deemed a liquidation.

(b) Any securities to be delivered to the holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, the Series D Preferred Stock, Series E Preferred Stock and Common Stock pursuant to subsection 6(a) above shall be valued as follows:

(i) Securities not subject to investment letter or other similar restrictions on free marketability;

(A) If traded on a securities exchange, the value shall be deemed to be the average of the closing prices of the securities on such exchange over the 30-day period ending three days prior to the closing;

(B) If actively traded over-the-counter, the value shall be deemed to be the average of the closing bid or sale prices (whichever are applicable) over the 30-day period ending three days prior to the closing; and

(C) If there is no active public market, the value shall be the fair market value thereof, as mutually determined by the Corporation and the holders of not less than a majority of the then outstanding shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, the Series D Preferred Stock and Series E Preferred Stock.

(ii) The method of valuation of securities subject to investment letter or other restrictions on free marketability shall be to make an appropriate discount from the market value determined as above in subsections 6(b)(i)(A), (B) or (C) to reflect the approximate fair market value thereof, as mutually determined by this Corporation and the holders of a majority of the then outstanding shares of Series A Preferred Stock, Series B Preferred, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock, voting as a single class.

(c) In the event the requirements of subsection 6(a) are not complied with, this Corporation shall forthwith either:

(i) cause such closing to be postponed until such time as the requirements of this Section 6 have been complied with, or

(ii) cancel such transaction, in which event the rights, preferences and privileges of the holders of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock shall revert to and be the same as such rights, preferences and privileges existing immediately prior to the date of the first notice referred to in subsection 6(d) hereof.

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(d) This Corporation shall give each holder of record of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock written notice of such impending transaction not later than 20 days prior to the stockholders' meeting called to approve such action, or 20 days prior to the closing of such transaction, whichever is earlier, and shall also notify such holders in writing of the final approval of such transaction. The first of such notices shall describe the material terms and conditions of the impending transaction and the provisions of this Section 6, and this Corporation shall thereafter give such holders prompt notice of any material changes. The transaction shall in no event take place earlier than 20 days after the Corporation has given the first notice provided for herein or earlier than 10 days after the Corporation has given notice of any material changes provided for herein; provided, however, that such periods may be shortened upon the written consent of the holders of a majority of the then outstanding Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock voting as a class.

(e) The provisions of this Section 6 are in addition to the protective provisions of Section 8 hereof.

7. VOTING RIGHTS; DIRECTORS.

(a) The holder of each outstanding share of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock shall have the right to one vote for each share of Common Stock into which such outstanding Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock could be converted on the record date for the vote or written consent of stockholders. In all cases any fractional share, determined on an aggregate conversion basis, shall be rounded to the nearest whole share. With respect to such vote, such holder shall have full voting rights and powers equal to the voting rights and powers of the holders of Common Stock, and shall be entitled, notwithstanding any provision hereof to notice of any stockholders' meeting in accordance with the bylaws of this Corporation, and shall be entitled to vote, together with holders of Common Stock, with respect to any question upon which holders of Common Stock have the right to vote.

(b) Notwithstanding subsection 7(a), (i) so long as at least fifty percent (50%) of the shares of Series A Preferred Stock and Series B Preferred Stock originally issued remain issued and outstanding, the holders of Series A Preferred Stock and Series B Preferred Stock, voting together as a separate class, shall be entitled to elect one member of the Board of Directors, (ii) so long as at least fifty percent (50%) of the shares of Series C Preferred Stock originally issued remain issued and outstanding, the holders of Series C Preferred Stock, voting as a separate class, shall be entitled to elect one member of the Board of Directors, and (iii) so long as at least fifty percent (50%) of the shares of Series D Preferred Stock originally issued remain issued and outstanding, the holders of Series D Preferred Stock, voting as a separate class, shall be entitled to elect either one or two members of the Board of Directors, as set forth in that certain Amended and Restated Voting Agreement between the Corporation and its stockholders dated on or about August 8, 1997. Any additional directors shall be elected by the holders of Preferred Stock and Common Stock, voting together as one class. In the case of any vacancy in the office of a director elected by the holders of the Series A Preferred Stock and

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Series B Preferred Stock, the Series C Preferred Stock or the Series D Preferred Stock pursuant to this subsection 7(b), the holders of a majority of the then voting power of the Series A Preferred Stock and Series B Preferred Stock, the Series C Preferred Stock or the Series D Preferred Stock, as applicable, shall, within sixty (60) days of such vacancy, elect a successor to hold office for the unexpired term of the director whose place shall be vacant. In the case of a vacancy in the office of any other director, the successor of that director shall be elected within sixty (60) days of such vacancy to hold office for the unexpired term of the director whose place shall be vacant, and such successor director shall be elected by the holders of Preferred Stock and Common Stock, voting together as one class. Any director who shall have been so elected may be removed during the aforesaid term of office, whether with or without cause, only by the affirmative vote of the holders of a majority of the voting power of the Series of Preferred Stock which first elected him. This subsection 7(b) shall be void and of no further effect thereafter upon the occurrence of either of the following events:

(i) the closing of a Qualifying Public Offering;

(ii) upon the distribution to the stockholders pursuant to Section 3 or Section 6 hereof of the net proceeds of the sale of all or substantially all the assets of the Corporation.

8. PROTECTIVE PROVISIONS.

(a) In addition to any approvals required by law, so long as shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock are outstanding, this Corporation shall not without first obtaining the approval (by vote or written consent, as provided by law) of the holders of at least a majority of the then outstanding voting power of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock (voting, as one class, in accordance with Section 7):

(i) sell, convey, or otherwise dispose of all or substantially all of its property or business or merge into or consolidate with any other corporation (other than a wholly-owned subsidiary corporation) in which this Corporation is not the surviving corporation or effect any transaction or series of related transactions in which more than fifty percent (50%) of the voting power of this Corporation is disposed of, provided, however, that this restriction shall not apply to any mortgage, deed of trust, pledge or other encumbrance or hypothecation of the Corporation's or any of its subsidiaries' assets for the purpose of securing any contract or obligation; or

(ii) alter or change the rights, preferences, privileges or restrictions of the shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock; or

(iii) increase the authorized number of shares of Common Stock or Preferred Stock; or

(iv) create (by reclassification or otherwise) any new class or series of stock having a preference over, or being on a parity with, the Series A Preferred Stock,

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Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock with respect to voting, dividends, redemption or conversion or upon liquidation; or

(v) pay or declare any dividend on its Common Stock or any other junior equity security other than a dividend in Common Stock of this Corporation; or

(vi) change the authorized number of directors; or

(vii) do any act or thing which would result in taxation of the holders of shares of Preferred Stock under section
305(b) of the Internal Revenue Code of 1986, as amended (or any comparable provision of the Internal Revenue Code as hereafter from time to time amended).

(b) In addition to any approvals required by law, so long as shares of Series C Preferred Stock are outstanding, this Corporation shall not without first obtaining the approval (by vote or written consent, as provided by law) of the holders of at least a majority of the then outstanding voting power of and Series C Preferred Stock voting as a single class:

(i) alter or change the rights, preferences, privileges or restrictions of the shares of Series C Preferred Stock; or

(ii) create (by reclassification or otherwise) any new class or series of stock having a preference over, or being on a parity with, the Series C Preferred Stock with respect to voting, dividends, redemption or conversion or upon liquidation.

(c) In addition to any approvals required by law, so long as shares of Series D Preferred Stock are outstanding, this Corporation shall not without first obtaining the approval (by vote or written consent, as provided by law) of the holders of at least a majority of the then outstanding voting power of and Series D Preferred Stock voting as a single class:

(i) sell, convey, or otherwise dispose of all or substantially all of its property or business or merge into or consolidate with any other corporation (other than a wholly-owned subsidiary corporation) in which this Corporation is not the surviving corporation or effect any transaction or series of related transactions in which more than fifty percent (50%) of the voting power of this Corporation is disposed of, provided, however, that this restriction shall not apply to any mortgage, deed of trust, pledge or other encumbrance or hypothecation of the Corporation's or any of its subsidiaries' assets for the purpose of securing any contract or obligation; or

(ii) alter or change the rights, preferences, privileges or restrictions of the shares of Series D Preferred Stock; or

(iii) increase the authorized number of shares of Series D Preferred Stock; or

(iv) increase the authorized number of directors; or

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(v) create (by reclassification or otherwise) any new class or series of stock having a preference over, or being on a parity with, the Series D Preferred Stock with respect to voting, dividends, redemption or conversion or upon liquidation.

(d) In addition to any approvals required by law, so long as shares of Series E Preferred Stock are outstanding, this Corporation shall not without first obtaining the approval (by vote or written consent, as provided by law) of the holders of at least a majority of the then outstanding voting power of and Series E Preferred Stock voting as a single class:

(i) materially or adversely alter or change the rights, preferences or privileges of the shares of Series E Preferred Stock as a separate series in a manner that is dissimilar and disproportionate relative to the manner in which the rights, preferences or privileges of the other series of Preferred Stock are altered, or

(ii) increase the authorized number of shares of Series E Preferred Stock.

9. STATUS OF REDEEMED OR CONVERTED STOCK. In the event any shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Series E Preferred Stock shall be redeemed or converted pursuant to Section 4 or 5 hereof the shares so redeemed or converted shall be cancelled and shall not be issuable by this Corporation, and the Certificate of Incorporation of this Corporation shall be appropriately amended to effect the corresponding reduction in this Corporation's authorized capital stock.

10. REPURCHASE OF SHARES. In connection with repurchases by this Corporation of its Common Stock pursuant to agreements with certain of the holders thereof approved by this Corporation's Board of Directors, each holder of Preferred Stock shall be deemed to have waived the application, in whole or in part, of any provisions of the Delaware General Corporation Law or any applicable law of any other state which might limit or prevent or prohibit such repurchases.

C. COMMON STOCK.

1. RELATIVE RIGHTS OF PREFERRED STOCK AND COMMON STOCK. All rights preferences, voting powers, relative, participating optional or other special rights and privileges, and qualifications, limitations, or restrictions of the Common Stock are expressly made subject and subordinate to those that may be fixed with respect to any shares of the Preferred Stock.

2. VOTING RIGHTS. Except as otherwise required by law or this Certificate of Incorporation, each holder of Common Stock shall have one vote in respect of each share of stock held by such holder of record on the books of the Corporation for the election of directors and on all matters submitted to a vote of stockholders of the Corporation.

3. DIVIDENDS. Subject to the preferential rights of the Preferred Stock, the holders of shares of Common Stock shall be entitled to receive, when, as and if declared by the Board of Directors, out of the assets of the Corporation which are by law available therefor, dividends payable either in cash, in property or in shares of capital stock.

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4. DISSOLUTION, LIQUIDATION OR WINDING UP. In the event of any dissolution, liquidation or winding up of the affairs of the Corporation, after distribution in full of the preferential amounts, if any, to be distributed to the holders of shares of the Preferred Stock, holders of Common Stock shall be entitled to participate in any distribution of the assets of the Corporation in accordance with Section 3 of Article IV, Division B hereof.

5. NO PREEMPTIVE RIGHTS. The holders of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock and Common Stock shall not have any preemptive rights. The foregoing shall not, however, prohibit the Corporation from granting contractual rights of first refusal to purchase securities to holders of Preferred Stock.

ARTICLE V

In furtherance and not in limitation of the powers conferred by the laws of the State of Delaware:

A. The Board of Directors of the Corporation is expressly authorized to adopt, amend or repeal the bylaws of the Corporation; provided, however, that the bylaws may only be amended in accordance with the provisions thereof and, provided further that, the authorized number of directors may be changed only with the approval of the holders of at least a majority of the then outstanding shares of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock (voting as one class) in accordance with Section 7 of Article IV Division B.

B. Elections of directors need not be by written ballot unless the bylaws of the Corporation shall so provide.

C. The books of the Corporation may be kept at such place within or without the State of Delaware as the bylaws of the Corporation may provide or as may be designated from time to time by the Board of Directors of the Corporation.

ARTICLE VI

A. EXCULPATION.

1. CALIFORNIA. The liability of each and every director of this Corporation for monetary damages shall be eliminated to the fullest extent permissible under California law.

2. DELAWARE. A director of the Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to the Corporation or its stockholders,
(ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the Delaware General Corporation Law or (iv) for any transaction from which the director derived any improper personal benefit. If the Delaware General Corporation Law is hereafter amended to further

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reduce or to authorize, with the approval of the Corporation's stockholders, further reductions in the liability of the Corporation's directors for breach of fiduciary duty, then a director of the Corporation shall not be liable for any such breach to the fullest extent permitted by the Delaware General Corporation Law as so amended.

3. CONSISTENCY. In the event of any inconsistency between Sections 1 and 2 of this Division A, the controlling Section, as to any particular issue with regard to any particular matter, shall be the one which provides to the director in question the greatest protection from liability.

B. INDEMNIFICATION.

1. CALIFORNIA. This Corporation is authorized to indemnify the directors and officers of this Corporation to the fullest extent permissible under California law. Moreover, this Corporation is authorized to provide indemnification of (and advancement of expenses to) agents (as defined in Section 317 of the California Corporations Code) through bylaw provisions, agreements with agents, vote of stockholders or disinterested directors or otherwise, in excess of the indemnification and advancement otherwise permitted by Section 317 of the California Corporations Code, subject only to applicable limits set forth in Section 204 of the California Corporations Code, with respect to actions for breach of duty to the Corporation and its stockholders.

2. DELAWARE. To the extent permitted by applicable law, this Corporation is also authorized to provide indemnification of (and advancement of expenses to) such agents (and any other persons to which Delaware law permits this Corporation to provide indemnification) through bylaw provisions, agreements with such agents or other persons, vote of stockholders or disinterested directors or otherwise, in excess of the indemnification and advancement otherwise permitted by Section 145 of the Delaware General Corporation Law, subject only to limits created by applicable Delaware law (statutory or non-statutory), with respect to actions for breach of duty to the Corporation, its stockholders and others.

3. CONSISTENCY. In the event of any inconsistency between Sections 1 and 2 of this Division B, the controlling Section, as to any particular issue with regard to any particular matter, shall be the one which authorizes for the benefit of the agent or other person in question the provision of the fullest, promptest, most certain or otherwise most favorable indemnification and/or advancement.

C. EFFECT OF REPEAL OR MODIFICATION. Any repeal or modification of any of the foregoing provisions of this Article VI shall not adversely affect any right or protection of a director, officer, agent or other person existing at the time of, or increase the liability of any director of the Corporation with respect to any acts or omissions of such director occurring prior to, such repeal or modification.

ARTICLE VII

The Corporation shall have perpetual existence.

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ARTICLE VIII

The Corporation reserves the right to amend, alter, change or repeal any provision contained in this Certificate of Incorporation, in the manner now or hereafter prescribed by statute, and all rights conferred upon stockholders herein are granted subject to this reservation.

[REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]

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IN WITNESS WHEREOF, this Amended and Restated Certificate of Incorporation has been executed as of this 22nd day of June 1998.

DIGIRAD CORPORATION


By:      /s/ Karen A. Klause
    -------------------------------------
       Karen A. Klause, President


[SIGNATURE PAGE TO
RESTATED CERTIFICATE OF INCORPORATION]

EXHIBIT C

FORM OF OPINION OF COUNSEL

[Date]

MMC/GATX PARTNERSHIP NO. I
c/o GATX Capital Corporation, Agent
Four Embarcadero Center
Suite 2200
San Francisco, California 94111

Ladies and Gentlemen:

We have acted as counsel for Digirad Corporation (the "Borrower") in connection with (i) the execution of the Loan and Security Agreement of even date herewith (the "Loan Agreement") between Borrower and MMC/GATX PARTNERSHIP NO. I ("Lender"), (ii) the issuance of warrants to purchase Borrower's Series E Preferred Stock (the "Warrants") and (iii) the transactions contemplated thereby. This opinion is being rendered to you pursuant to Section 8.01 of the Loan Agreement. Capitalized terms not otherwise defined in this opinion have the meaning given them in the Loan Agreement.

In connection with this opinion and our representation, we have examined originals, or copies certified or otherwise identified to our satisfaction, of the following:

(i) The Loan Agreement;

(ii) The Warrants;

(iii) The Note dated as of [Date];

(iv) The Restated Articles of Incorporation and the Bylaws of Borrower, each as in effect on the date hereof;

(v) The certificate of an officer of Borrower as to certain factual matters ("Officer Certificate");

(vi) Certificates issued by the Secretary of State of the State of
[state of incorporation] dated ____________________ 199__, certifying the good standing of Borrower;

(vii) Such other documents, records, and certificates as we have deemed necessary or appropriate as a basis for the opinions hereafter expressed.


The Loan Agreement, the Note and the Warrants are hereinafter referred to as the "Transaction Documents."

In such examinations we have assumed the genuineness of all signatures, the authenticity of all documents submitted to us as originals and the conformity to originals of all documents submitted to us as certified, facsimile, telecopied or photostatic copies thereof. As to certain matters of fact material to our opinion, we have relied upon the Officer Certificate and upon your representations in the Transaction Documents.

As used in this opinion, the expression "to the best of our knowledge," means the actual present knowledge or belief of those attorneys in our firm who have or who are currently representing Borrower. We have not undertaken any independent investigation to determine the existence or nonexistence of other facts, and no inference as to our knowledge of the existence or nonexistence of other facts should be drawn from the fact of this firm's representation of Borrower in connection with the Transaction Documents.

Based upon and subject to the foregoing and subject to the qualifications contained herein, we are of the opinion that:

(a) Borrower is a corporation duly organized, validly existing and in good standing under the laws of the State of [state of incorporation].

(b) Borrower has the requisite corporate power and authority to execute, deliver and perform the Transaction Documents and to issue the Warrants. All action on the part of Borrower, its directors and its shareholders necessary for the authorization, execution, delivery and performance of the Transaction Documents, has been taken. The Transaction Documents have been duly executed and delivered by an authorized officer of Borrower.

(c) The execution, delivery and performance of the Transaction Documents do not conflict with or violate any provision of Borrower's Restated Articles of Incorporation or Bylaws or of applicable law.

(d) The Transaction Documents constitute legal, valid and binding obligations of Borrower, enforceable in accordance with their respective terms. To our knowledge, no filing need be made with any governmental authority with respect to the Transaction Documents in connection with an exemption from state usury laws or in connection with any other matter. [usury may be excepted]

(e) The shares of Series E Preferred Stock issuable upon exercise of the Warrants have been duly authorized and reserved for issuance upon such exercise, and when issued in accordance with the terms of the Warrants, will be duly authorized, validly issued, fully paid and non-assessable.

(f) The shares of Common Stock issuable upon conversion of the Series E Preferred Stock into which the Warrants are convertible, have been duly authorized and reserved for


issuance, when so issued in accordance with the terms of Borrower's Restated Articles of Incorporation, will be duly authorized, validly issued, fully paid and non-assessable.

The opinions set forth above are subject to the following additional qualifications, assumptions, limitations and exceptions:

(A) The effect of bankruptcy, insolvency, reorganization, fraudulent conveyance, moratorium and other similar laws relating to or affecting the rights and remedies of creditors generally.

(B) Limitations imposed by general equitable principles upon the specific enforceability of any of the provisions of the Transaction Documents and upon the availability of injunctive relief or other equitable remedies.

(C) We express no opinion as to the enforceability of any choice of law provision in the documents.

(D) We express no opinion as to the compliance or noncompliance with applicable antifraud statutes under the rules and regulations of state and federal securities laws concerning the issuance of the Warrant.

(E) We express no opinion herein concerning any law other than the law of the State of California, [the General Corporation Law of the State of Delaware] and the federal laws of the United States of America.

This opinion is furnished to you solely for your benefit and may not be relied upon by any other person (other than assignees of any of your rights) without our prior written consent, which consent shall not be unreasonably withheld or delayed.

Very truly yours,


EXHIBIT D

FORM OF SUBORDINATION AGREEMENT

This Subordination Agreement (this "AGREEMENT") is made as of this _____ day of _______ 1999, by and between _________ Bank ("SENIOR CREDITOR") having its principal place of business at ________________________________________________, and MMC/GATX Partnership No. I, a California general partnership, having its principal place of business at Four Embarcadero Center, Suite 2200, San Francisco, California 94111 ("CREDITOR").

RECITALS

A. Digirad Corporation ("BORROWER") has a _______________________ Dollars ($___________) revolving line of credit from Senior Creditor which is or may be from time to time secured by assets and property of Borrower, pursuant to the [Loan and Security Agreement, dated as of _________ 1999], between Borrower and Senior Creditor (as the same may from time to time be amended, modified, supplemented, restated or replaced, the "SENIOR LOAN AGREEMENT") and the other documents executed in connection therewith (together with the Senior Loan Agreement, the "SENIOR CREDIT DOCUMENTS").

B. Creditor has extended or will extend loans in the aggregate original principal amount of Three Million and 00/100 Dollars ($3,000,000.00) as evidenced by one or more Secured Promissory Notes (and as the same may from time to time be amended, modified, supplemented, extended, renewed, restated or replaced, the "SUBORDINATED NOTES") made by Borrower in favor of Creditor. Borrower's obligations to Creditor evidenced by the Subordinated Notes are secured by the personal property collateral granted by the Borrower to Creditor pursuant to a Loan and Security Agreement dated as of October __ 1999 (as the same may from time to time be amended, modified, supplemented or restated, the "SUBORDINATED SECURITY AGREEMENT").

(a) Pursuant to the terms and conditions of this Agreement, Creditor is willing to subordinate: (i) all of Borrower's indebtedness and obligations to Creditor, whether presently existing or arising in the future under or relating to the Subordinated Security Agreement and Subordinated Notes (collectively, the "SUBORDINATED DEBT") to Borrower's indebtedness and obligations to Senior Creditor in a principal amount not to exceed the lesser of: (1) a borrowing base calculated as a percentage (not exceeding 100%) of qualified accounts receivable plus eligible inventory, or (2) $2,500,000.00 (the "SENIOR PRINCIPAL AMOUNT"), plus interest thereon at the standard rate (and not the default rate) set forth in the Senior Credit Documents (including all interest accruing after the commencement by or against Borrower of a bankruptcy, reorganization or similar proceeding), plus, without limitation, the cost of collecting such obligations (including attorneys' fees) (collectively, the "SENIOR DEBT"); and (ii) all of Creditor's security interests in Borrower's property (other than Financed Equipment) (the "COLLATERAL") to all of Senior Creditor's security interests in Borrower's property. Notwithstanding anything to the contrary contained in the definition of "Subordinated Debt", there shall be expressly excluded from such definition any warrant(s) to purchase securities of Borrower executed by Borrower in favor of Creditor or its assignee ("WARRANTS") and all rights of the holder thereunder.


For purposes of this Agreement, the term "Financed Equipment" shall mean all right, title, interest, claims and demands of Borrower in and to each and every item of equipment, fixtures or personal property, whether now owned or hereafter acquired, together with all substitutions, renewals or replacements of and additions, improvements, accessions, replacement parts and accumulations to any and all of such equipment, fixtures or personal property, together with all proceeds thereof, including, without limitation, insurance, condemnation, requisition or similar payments, and all proceeds from sales, renewals, releases or other dispositions thereof, which is financed with or is designated as collateral for Borrower's obligations to Creditor under, and on and after the date of, the Subordinated Security Agreement by the designation of such equipment, fixtures and personal property on a UCC financing statement listing Borrower as "debtor" and Creditor as "secured party."

NOW, THEREFORE, THE PARTIES AGREE AS FOLLOWS:

1. Notwithstanding the respective dates of attachment or perfection of the security interest of Creditor and the security interest of Senior Creditor: (i) the security interest of Creditor in the property of Borrower (other than Financed Equipment), shall at all times be subordinate to the security interest of Senior Creditor; provided, that if the security interest of Senior Creditor in certain assets or property of Borrower is not valid or perfected then the lien subordination set forth in this Section 1 shall not be effective with respect to such assets or property of Borrower, and (ii) all security interests now or hereafter acquired by Creditor in Financed Equipment shall at all times be prior and superior to any security interests now held or hereafter acquired by Senior Creditor in the Financed Equipment. Creditor shall turn over to Senior Creditor any payments received from the sale, liquidation, other disposition or exercise of remedies with respect to any property of Borrower (other than Financed Equipment). Senior Creditor shall turn over to Creditor any payments or proceeds received from the sale, liquidation, other disposition or exercise of remedies with respect to the Financed Equipment.

2. Nothing herein shall be deemed to subordinate, waive or restrict the performance of the obligations arising under the Warrants or subordinate any interest in stock issuable upon exercise of the Warrants or subordinate any interest in the Financed Equipment. Nothing herein shall be deemed to restrict or prevent Borrower from making any payment to Creditor under the Subordinated Debt.

3. If the Senior Creditor delivers to Creditor a written notice (a "BLOCKAGE NOTICE") which states a specific default has occurred under the Senior Credit Documents and continues to exist after the giving of any required notice and the expiration of any applicable grace or cure period, then during any Blockage Period (as defined below), Creditor shall not exercise any remedy with respect to the Collateral, or commence, or cause to be commenced or prosecuted, or participate in any administrative, legal or equitable action against Borrower. As used herein, "Blockage Period" means a period of time beginning on the date a Blockage Notice is delivered to Creditor and terminating on the earlier of: (1) 60 days thereafter, or (2) Senior Creditor's written consent to such termination, or (3) when Senior Creditor has commenced a judicial proceeding or non-judicial actions to collect or enforce the Senior Debt or a case or proceeding by or against Borrower is commenced under the federal Bankruptcy Code or any other insolvency law. After the termination of any Blockage Period pursuant to the terms hereof


and until Creditor's receipt of a subsequent Blockage Notice from Senior Creditor, Creditor may exercise any remedy with respect to the Collateral and the Subordinated Debt, or commence, or cause to be commenced or prosecuted, or participate in any administrative, legal or equitable action against Borrower. Senior Creditor shall not collect, take possession of, foreclose upon, or exercise any rights or remedies with respect to the Financed Equipment, judicially or nonjudicially, or attempt to do any of the foregoing, without the prior written consent of Creditor, which shall be a matter of Creditor's sole discretion.

4. (a) Upon an event of default under the Subordinated Security Agreement, a sale or disposition of any of the Financed Equipment whether or not approved by Creditor, the bankruptcy or insolvency of Borrower, or Creditor's exercise of remedies against Borrower (a "Release Event"), Senior Creditor's security interests in the Financed Equipment shall be automatically terminated without further deed or act. The proceeds of any Financed Equipment so sold or disposed of shall be applied, after the deduction of any and all costs relating to such sale or disposition (including attorneys' fees, advertising costs and auctioneer's fees) to any and all indebtedness evidenced by the Subordinated Security Agreement in such order as Creditor may, in its discretion, determine, and only if all obligations owed to Creditor by Borrower under the Subordinated Security Agreement have been paid in full, then to all or any part of the present or future indebtedness, liabilities, guaranties or other obligations of Borrower to Senior Creditor in such order as Senior Creditor may, in its discretion, determine.

(b) Senior Creditor agrees to execute and deliver to Creditor, promptly upon Creditor's request, appropriate UCC termination statements or partial releases with respect to any Financed Equipment on or after a Release Event; although Senior Creditor acknowledges that its security interests in the Financed Equipment would be released in any event pursuant to Section (a).

(c) Senior Creditor hereby irrevocably appoints Creditor as Senior Creditor's attorney-in-fact, and grants to Creditor a power of attorney with full power of substitution, in the name of Senior Creditor, for the use and benefit of Creditor, without notice to Senior Creditor, on or after a Release Event to execute and file UCC termination statements or partial releases with respect to any Financed Equipment; although Senior Creditor acknowledges that its security interests in the Financed Equipment would be released in any event pursuant to Section (a).

(d) Senior Creditor acknowledges and agrees that Creditor has no fiduciary, agent, bailee or duty to Senior Creditor with regard to the Financed Equipment. Senior Creditor acknowledges and agrees that Creditor has no obligations to Senior Creditor as a junior lienholder except only those obligations specifically assumed by Creditor under this Agreement and Senior Creditor waives any other junior lienholder rights, claims and defenses. Senior Creditor shall not resist or take any action to prevent Creditor from exercising any remedies with respect to the Financed Equipment and Senior Creditor shall turn over to Creditor any Financed Equipment coming into Senior Creditor's possession or custody. Except as provided in this Agreement, at any time and from time to time, without notice to Senior Creditor, Creditor may take such actions with respect to the Subordinated Security Agreement and the Financed Equipment as Creditor, in its sole discretion, may deem appropriate, including, without


limitation, terminating advances to Borrower, increasing the principal amount of the Subordinated Notes, extending the time of payment, increasing applicable interest rates, renewing, compromising or otherwise amending the terms of any documents affecting the Subordinated Notes, the Subordinated Security Agreement, and the Financed Equipment, and enforcing or failing to enforce any rights against Borrower or any other person. Senior Creditor waives the benefits, if any, of any statutory or common law rule that may permit a subordinating creditor to assert any defenses of a surety, guarantor or junior lienholder, or that may give the subordinating creditor the right to require a senior creditor to marshal assets, give notice or maximize value, and Senior Creditor agrees that it shall not assert any such defenses, claims or rights.

4. At any time and from time to time, without notice to Creditor, Senior Creditor may take such actions with respect to the Senior Debt as Senior Creditor, in its sole discretion, may deem appropriate, including, without limitation, terminating advances to Borrower, increasing the principal amount in an amount not to exceed the Senior Principal Amount, extending the time of payment, increasing applicable interest rates, renewing, compromising or otherwise amending the terms of any documents affecting the Senior Debt and any collateral securing the Senior Debt, and enforcing or failing to enforce any rights against Borrower or any other person, but in no event shall the principal amount be increased in an amount exceeding the Senior Principal Amount. Creditor waives the benefits, if any, of any statutory or common law rule that may permit a subordinating creditor to assert any defenses of a surety or guarantor, or that may give the subordinating creditor the right to require a senior creditor to marshal assets, and Creditor agrees that it shall not assert any such defenses or rights inconsistent with the provisions of this Agreement.

5. In the event of Borrower's insolvency, reorganization or any case or proceeding under any bankruptcy or insolvency law or laws relating to the relief of debtors, these provisions shall remain in full force and effect. This Agreement shall remain effective until the earlier of: (i) Borrower no longer owes any amounts under the Senior Credit Documents, or (ii) Creditor has received payment of all amounts owed Creditor under the Subordinated Notes and the Subordinated Security Agreements.

6. This Agreement shall bind any successors or assignees of the parties. This Agreement is solely for the benefit of Creditor and Senior Creditor and not for the benefit of Borrower or any other party.

7. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original and all of which together shall constitute one instrument. This Agreement shall become effective only when it shall have been executed by Creditor and Senior Creditor (provided, however, in no event shall this Agreement become effective until signed by an officer of Senior Creditor in California).

8. This Agreement shall be governed by and construed in accordance with the laws of the State of California without giving effect to conflicts of law principles. Creditor and Senior Creditor submit to the exclusive jurisdiction of the state and federal courts located in the Northern District of California. CREDITOR AND SENIOR CREDITOR WAIVE THEIR


RESPECTIVE RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF THIS AGREEMENT OR ANY OF THE TRANSACTIONS CONTEMPLATED HEREIN.

9. This Agreement represents the entire agreement with respect to the subject matter hereof, and supersedes all prior negotiations, agreements and commitments. Creditor is not relying on any representations by Senior Creditor or Borrower in entering into this Agreement, and Creditor has kept and will continue to keep itself fully apprised of the financial and other condition of Borrower. Senior Creditor is not relying on any representations by Creditor or Borrower in entering into this Agreement or the Senior Credit Documents, and Senior Creditor has kept and will continue to keep itself fully apprised of the financial and other condition of Borrower. This Agreement may be amended only by written instrument signed by Creditor and Senior Creditor.

10. In the event of any legal action to enforce the rights of a party under this Agreement, the party prevailing in such action shall be entitled, in addition to such other relief as may be granted, all reasonable costs and expenses, including reasonable attorneys' fees, incurred in such action.

11. Promptly upon an event of default under the Subordinated Security Agreement and the Subordinated Notes, Creditor shall endeavor to provide Senior Creditor with written notice of such default, but Creditor's failure to do so shall not result in any breach of this Agreement or affect the rights of the parties hereto.


IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the date first above written.

 

"SENIOR CREDITOR"                          "CREDITOR"

_____________ BANK                         MMC/GATX PARTNERSHIP NO.  1,

                                           BY:  GATX CAPITAL CORPORATION,
                                                ITS GENERAL PARTNER

By:                                        By:
    --------------------------------          ---------------------------------

Title:                                     Title:
      ------------------------------             ------------------------------

THE UNDERSIGNED APPROVES OF THE TERMS OF THIS AGREEMENT.

"BORROWER"

DIGIRAD CORPORATION

By:

Title:


FIRST AMENDMENT
TO
LOAN AND SECURITY AGREEMENT

This FIRST AMENDMENT TO LOAN AND SECURITY AGREEMENT ("First Amendment"), dated as of August 14, 2000, is entered into by and between DIGIRAD CORPORATION, a Delaware corporation ("Borrower"), and MMC/GATX PARTNERSHIP NO. 1, a California general partnership ("Lender").

RECITALS

A. Borrower and Lender are parties to a Loan and Security Agreement, dated as of October 27, 1999 (the "Loan Agreement") pursuant to which Lender has financed certain equipment.

B. Borrower has now requested that the amount of funding available under the Loan Agreement be increased by $1,000,000. Lender is willing to amend the Loan Agreement upon the terms and conditions set forth herein.

AGREEMENT

NOW, THEREFORE, in consideration of the above recitals and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, Borrower and Lender hereby agree as follows:

1. DEFINITIONS; INTERPRETATION. Unless otherwise defined herein, all capitalized terms used herein and defined in the Loan Agreement shall have the respective meanings given to those terms in the Loan Agreement. Other rules of construction set forth in the Loan Agreement, to the extent not inconsistent with this First Amendment, apply to this First Amendment and are hereby incorporated by reference.

2. AMENDMENTS TO LOAN AGREEMENT.

(a) The cover page of the Loan Agreement shall be amended to read in its entirety as set forth in Exhibit A to this First Amendment.

(b) Section 1.01 of the Loan Agreement shall be amended to add the following defined terms in appropriate alphabetical order:

"CREDIT AMOUNT" shall mean, as it applies to the Facility A Loans or the Facility B Loan, respectively, the maximum aggregate amount of the Loans under this Agreement (if the conditions specified in Schedule 3 are satisfied), which amount is set forth following such term on the cover page of this Agreement.

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"FACILITY A LOANS" shall mean Loans made on the terms set forth under the heading Facility A on the cover page of this Agreement.

"FACILITY B LOAN" shall mean the Loan made on the terms set forth under the heading Facility B on the cover page of this Agreement.

"LOAN" means each advance of credit by Lender to Borrower under this Agreement. Each reference to a Loan shall be deemed to refer to a Facility A Loan or a Facility B Loan and the respective terms thereof as is specified on the cover page of this Agreement.

(c) The definition of Applicable Premium in
Section 1.01 of the Loan Agreement shall be changed to read as follows:

"APPLICABLE PREMIUM" shall mean

for Facility A Loans, an amount equal to: (i) 4% of the amount being prepaid or accelerated more than twelve (12) months after, but on or before twenty-four (24) months after the first Payment Date, or (ii) 3% of the amount being prepaid or accelerated more than twenty-four (24) months after the first Payment Date; PROVIDED THAT if an Event of Default occurs within twelve (12) months of the first Payment Date (other than an Event of Default specified in
Section 9.01 h, i, j, k or 1), the Applicable Premium shall be 4% of the amount being prepaid or accelerated.

for the Facility B Loan, an amount equal to: (i) 2% of the amount being prepaid or accelerated more than twelve (l2) months after, but on or before twenty-four (24) months after the first Payment Date, or (ii) 1.5% of the amount being prepaid or accelerated more than twenty-four (24) months after the first Payment Date; PROVIDED THAT if an Event of Default occurs within twelve (12) months of the first Payment Date (other than an Event of Default specified in Section 9.01 h, i, j, k or 1), the Applicable Premium shall be 2% of the amount being prepaid or accelerated.

(d) Section 2.01(a) of the Agreement will be changed to read as follows:

(a) THE CREDIT AMOUNT. Subject to the terms and conditions of this Agreement and relying upon the representations and warranties herein set forth as and when made or deemed to be made, Lender agrees to lend to Borrower a maximum of two Facility A Loans (respectively, the "First Loan" and the "Second Loan") in an aggregate amount not to exceed the Credit Amount and one Facility B Loan in the amount of One Million Dollars ($1,000,000). The First Loan shall be in the amount of Two Million Dollars ($2,000,000) and the Second Loan shall be in the amount of One Million Dollars ($1,000,000). The Loans may be prepaid only as set forth in SECTION 2.01(d).

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(e) Section 2.01(d) of the Agreement will be changed to read as follows:

(d) OPTIONAL PREPAYMENT WITH PREMIUM. Borrower may not prepay any Loan within twelve (12) months of its first Payment Date; thereafter, upon ten (10) Business Days' prior written notice to Lender, Borrower may, at its option, at any time, prepay all, and not less than all, of a Loan in full at a prepayment price equal to the principal amount of the Loan, plus interest accrued on the Loan through and including the date of such prepayment, plus a premium on the Loan equal to the Applicable Premium. If an Event of Default occurs and is continuing (other than an Event of Default specified in Section 9.01 h, i, j, k or 1, in which case no Applicable Premium is due and payable), and Lender exercises its right under Section 9.02 to accelerate the Loans or the Loans are automatically accelerated, Borrower expressly agrees that the amount then due and payable shall include the Applicable Premium as of the date of such acceleration. In the event that Borrower and the lender of the Indebtedness permitted by clause (e) of the definition of Permitted Indebtedness request Lender's agreement that there be an increase in the amount of such Indebtedness and Lender does not consent (which consent shall be at Lender's sole discretion), Borrower shall be permitted to prepay all Indebtedness hereunder without payment of any Applicable Premium.

(f) The following representation and warranty of Borrower is added to Section 3.01 as Section 3.01(n):

(n) INTELLECTUAL PROPERTY. Any registrations or application of Borrower's Intellectual Property with the US Patent and Trademark Office or the US Copyright Office are listed in the Exhibit C to this Agreement.

(g) Section 5.01 of the Agreement will be changed to read as follows:

5.01 GRANT OF SECURITY INTEREST. Borrower, in order to secure the payment of the principal and interest with respect to the Loans made pursuant to this Agreement, all other sums due under and in respect hereof and of the other Operative Documents, including fees, charges, expenses and attorneys' fees and costs and the performance and observance by Borrower of all other terms, conditions, covenants and agreements herein and in the other Operative Documents (all such amounts and obligations being herein sometimes called the "OBLIGATIONS"), does hereby grant to Lender and its successors and assigns, a security interest in and to the following property (collectively, the "COLLATERAL"): All right, title, interest, claims and demands of Borrower in and to:

(a) All goods and equipment now owned or hereafter acquired, including, without limitation, all laboratory equipment, computer equipment, office equipment, machinery, fixtures, vehicles (including motor vehicles and trailers), and any interest in any of the foregoing, and all attachments, accessories, accessions, replacements, substitutions, additions, and improvements to any of the foregoing, wherever located;

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(b) All inventory now owned or hereafter acquired, including, without limitation, all merchandise, raw materials, parts, supplies, packing and shipping materials, work in process and finished products including such inventory as is temporarily out of Borrower's custody or possession or in transit and including any returns upon any accounts or other proceeds, including insurance proceeds, resulting from the sale or disposition of any of the foregoing and any documents of title representing any of the above, and Borrower's books relating to any of the foregoing;

(c) All contract rights and general intangibles (including Intellectual Property), now owned or hereafter acquired, including, without limitation, goodwill, license agreements, franchise agreements, blueprints, drawings, purchase orders, customer lists, route lists, infringements, claims, computer programs, computer disks, computer tapes, literature, reports, catalogs, design rights, income tax refunds, payments of insurance and rights to payment of any kind;

(d) All now existing and hereafter arising accounts, contract rights, royalties, license rights and all other forms of obligations owing to Borrower arising out of the sale or lease of goods, the licensing of technology or the rendering of services by Borrower (subject, in each case, to the contractual rights of third parties to require funds received by Borrower to be expended in a particular manner), whether or not earned by performance, and any and all credit insurance, guaranties, and other security therefor, as well as all merchandise returned to or reclaimed by Borrower and Borrower's books relating to any of the foregoing;

(e) All documents, cash, deposit accounts, letters of credit, certificates of deposit, instruments, chattel paper and investment property, including, without limitation, all securities, whether certificated or uncertificated, security entitlements, securities accounts, commodity contracts and commodity accounts, and all financial assets held in any securities account or otherwise, wherever located, now owned or hereafter acquired and Borrower's books relating to the foregoing; and

(f) Any and all claims, rights and interests in any of the above and all substitutions for, additions and accessions to and proceeds thereof, including, without limitation, insurance, condemnation, requisition or similar payments and proceeds of the sale or licensing of Intellectual Property.

(g) Any and all of the following equipment collateral (collectively, "EQUIPMENT COLLATERAL"):

All right, title, interest, claims and demands of Borrower in and to each and every item of equipment, fixtures or personal property, whether now owned or hereafter acquired, together with all substitutions, renewals or replacements of and additions, improvements, accessions, replacement parts and accumulations to any and all of such equipment, fixtures or personal property (collectively, the "EQUIPMENT"), together with all proceeds thereof,

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including, without limitation, insurance, condemnation, requisition or similar payments, and all proceeds from sales, renewals, releases or other dispositions thereof, which is financed with or is designated as collateral for the Obligations on and after the date of this Agreement by designating such equipment, fixtures and personal property on a UCC financing statement listing Borrower as "debtor" and Lender as "secured party."

(h) Sections 5.04 and
5.05 of the Agreement shall be changed to read as follows:

5.04 EQUIPMENT COLLATERAL. On or prior to its execution and delivery of this Agreement, Borrower shall provide Lender with a listing, in detail to Lender's satisfaction, of all of Borrower's equipment, fixtures and personal property (collectively, an "Equipment List"), which, at Lender's option, shall be attached as an exhibit to a UCC financing statement filed by Lender naming Borrower as "debtor" and Lender as "secured party." Within thirty days after the end of every quarter after the date hereof, Borrower shall provide Lender with an Equipment List of equipment, fixtures and personal property acquired by Borrower during such quarter through and including April 27, 2001, and such Equipment List shall, at Lender's option, be attached as an exhibit to a UCC financing statement filed by Lender naming Borrower as "debtor" and Lender as "secured party." Borrower agrees to execute and deliver to Lender any and all such financing statements to Lender. Borrower's equipment, fixtures and personal property acquired after April 27, 2001 may become Third Party Equipment.

5.05 LIEN SUBORDINATION. Lender agrees that the Liens granted to it hereunder (except for Liens in Equipment Collateral) shall be subordinate to the Liens granted in connection with Indebtedness permitted by clause (e) of the definition of Permitted Indebtedness. Lender agrees to enter into a subordination agreement with the lender of the Indebtedness permitted by clause (e) of the definition of Permitted Indebtedness substantially in the form of EXHIBIT D and to negotiate in good faith any changes thereto as long as they are acceptable to Lender. Lender agrees that the Liens granted to it hereunder in Third Party Equipment shall be subordinate to the Liens of future lenders providing equipment financing and equipment lessors for equipment and other personal property acquired by Borrower after April 27, 2001 ("THIRD PARTY EQUIPMENT"); PROVIDED, that, in the case of equipment financings and leasing such Liens are confined solely to the equipment so financed and the proceeds thereof. Notwithstanding the foregoing, the Obligations hereunder shall not be subordinate in right of payment to any obligations to other lenders, equipment lenders or equipment lessors and Lender's rights and remedies hereunder shall not in any way be subordinate to the rights and remedies of any such lender or equipment lessors. Lender agrees to execute and deliver such agreements and documents as may be reasonably requested by Borrower from time to time which set forth the lien subordination described in this SECTION
5.05 and are reasonably acceptable to Lender. Lender shall have no obligation to execute any agreement or document which would impose obligations, restrictions or lien priority on Lender which are less favorable to Lender than those described in this SECTION 5.05.

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(i) New Section 5.06 and
5.07 shall be added to the Agreement, which read as follows:

5.06 INTELLECTUAL PROPERTY.
(a) Within 30 days of the date of this Agreement, Borrower shall register or cause to be registered with the United States Copyright Office any software (material to the business of Borrower) developed or acquired by Borrower in connection with any product developed or acquired for sale or licensing. (b) While any Obligations remain outstanding, Borrower shall register or cause to be registered with the United States Copyright Office (i) any software (material to the business of Borrower) developed or acquired by Borrower hereafter from time to time in connection with any product developed or acquired for sale or licensing and (ii) any major revisions or upgrades to any software that has previously been registered with the United States Copyright Office. Borrower shall file for registration within 30 days from the development or acquisition of such software, major revision or upgrade.
(c) If Borrower has or will federally register any Intellectual Property with the United States Copyright Office or the United States Patent and Trademark Office, then Borrower shall execute and deliver to Lender, for filing with the United States Copyright Office or the United States Patent and Trademark Office, as the case may be, a grant of security interest in such Intellectual Property, in form acceptable to Lender, within 30 days of the date Borrower registers such Intellectual Property. (d) If, on or before December 31, 2000, Borrower raises at least Fifteen Million Dollars ($15,000,000) in the next equity round, and no Default or Event of Default shall exist at such time, then Lender agrees to release its security interest in Intellectual Property.

5.07 NIS AND FLORIDA ACQUISITIONS; COPELCO EQUIPMENT FINANCING. Notwithstanding anything to the contrary herein, Lender consents to Borrower entering into a $3,250,000 credit facility with Copelco or another lender to finance 10 cameras and associated chairs and vehicle, and such equipment may be Third Party Equipment hereunder. In addition, Lender consents to Borrower's acquisition of (i) the mobile business of Nuclear Imaging Systems ("NIS") for the payment to NIS of $750,000 and up to 200,000 shares of Borrower's common stock, (ii) the fixed business of NIS on substantially the same terms as set forth in Exhibit D to this First Amendment, and (iii) the mobile business of Florida Cardiology and Nuclear Medicine Group ("FCNM") for the payment to FCNM of $1,000,000 and up to 400,000 shares of Borrower's common stock; provided, however, prior to Borrower forming any new Subsidiary to hold such assets, Borrower shall provide to Lender documentation to Lender's satisfaction, including without limitation, subsidiary guaranties, to ensure Lender's perfected security interest in such assets, subject only to Permitted Liens.

(j) A new Section 6.01(e) shall be added to the Agreement which reads as follows:

(e) EQUITY INVESTMENT. Borrower shall permit Lender, at Lender's option, to purchase in Borrower's next round of equity financing up to $500,000 of the securities sold in such financing at the same price and on the same terms as paid and received by the lead investor of the equity financing. Borrower agrees that it shall notify each Lender promptly upon the execution by Borrower of a term sheet or letter of intent setting forth the

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terms and conditions of such financing and in any event within five (5) days of such execution. This right of purchase may be assigned by a Lender to its Affiliates.

3. AMENDMENT FACILITY FEE; DEPOSIT. Upon the funding of the Facility B Loan, Borrower agrees to pay to Lender a facility fee ("AMENDMENT FACILITY FEE") of $8,333. Borrower has paid Lender a good faith deposit of $10,000 (the "Deposit"). The Deposit, less Lender's costs and expenses (including in-house counsel fees of $2,500) in an aggregate amount not to exceed $5,000, shall be applied towards the Amendment Facility Fee.

4. CONDITION TO EFFECTIVENESS. The effectiveness of this Amendment is conditioned upon the delivery by Borrower to Lender of the following:

(a) A certificate of the Secretary or the Assistant Secretary of Borrower, in form and substance satisfactory to Lender, certifying the adoption of resolutions of the Board of Directors of Borrower approving this First Amendment and the transactions contemplated hereby (including the issuance of the Warrants described in Section 4(b) and
4(c) below).

(b) A Warrant in the form of Exhibit B hereto.

(c) A Warrant in the form of Exhibit B hereto, except for a total of 8,235 shares executed and delivered to Priority Capital.

(d) This First Amendment duly executed by Borrower.

5. EFFECT OF FIRST AMENDMENT. On and after the date hereof, each reference to the Loan Agreement in the Loan Agreement or in any other document shall mean the Loan Agreement as amended by this First Amendment. The execution, delivery and effectiveness of this First Ame