10-Q/A 1 a10-qa2123104.txt AMENDMENT NO. 2 QUARTERLY REPORT SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A Amendment No. 2 [Mark One] [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 2004 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____to______ Commission file number: 0-26028 IMAGING DIAGNOSTIC SYSTEMS, INC. (Exact name of registrant as specified in its charter) Florida 22-2671269 ------- ---------- (State of Incorporation) (IRS Employer Ident. No.) 6531 N.W. 18th Court, Plantation, FL 33313 ------------------------------------ ----- (Address of Principal Office) (Zip Code) Registrant's telephone number: (954) 581-9800 Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ X ] No [ ] The number of shares outstanding of each of the issuer's classes of equity as of December 31, 2004: 184,687,532 shares of common stock, no par value. As of December 31, 2004, the issuer had no shares of preferred stock outstanding. IMAGING DIAGNOSTIC SYSTEMS, INC. (A Development Stage Company) EXPLANATORY NOTE Imaging Diagnostic Systems, Inc. (the "Company") is filing this Form 10-Q/A as Amendment No. 2 to our Quarterly Report on Form 10-Q for the period ended December 31, 2004, originally filed with the Securities and Exchange Commission (the "SEC") on February 9, 2005 (the "Original Filing") and Amendment No. 1 originally filed with the SEC on June 7, 2005 to address comments from the staff of the SEC in connection with the staff's review of the Original Filing. We have amended Item 2., "Management's Discussion and Analysis of Financial Condition and Results of Operations", to reflect the net losses applicable to common shareholders since inception through December 31, 2004 and the working capital as of December 31, 2004 & 2003 and June 30, 2004. As a result of this amendment, the certifications pursuant to Section 302 and Section 906 of the Sarbanes-Oxley Act of 2002, filed as exhibits to the Original Filing, have been re-executed and re-filed as of the date of this Form 10-Q/A2. 2 IMAGING DIAGNOSTIC SYSTEMS, INC. (A Development Stage Company) Part I - Financial Information ------------------------------ Item 1. Financial Statements Page Condensed Balance Sheet - December 31, 2004 and June 30, 2004............................... 4 Condensed Statement of Operations - Six months and three months ended December 31, 2004 and 2003, and December 10, 1993(date of inception) to December 31, 2004...................... 5 Condensed Statement of Cash Flows - Six months ended December 31, 2004 and 2003, and December 10, 1993 (date of inception) to December 31, 2004.............................................. 6 Notes to Condensed Financial Statements................................. 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Financial Condition and Results................................... 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk... 15 Item 4. Controls and Procedures 15 Part II - Other Information ---------------------------- Item 1. Legal Proceedings............................................ 16 Item 2. Changes in Securities........................................ 16 Item 3. Defaults Upon Senior Securities.............................. 16 Item 4. Submission of Matters to a Vote of Security Holders ............................................ 16 Item 5. Other Information............................................ 16 Item 6. Exhibits and Reports on Form 8-K............................. 24 Signatures ............................................................. 25 3 IMAGING DIAGNOSTIC SYSTEMS, INC. (A Development Stage Company) Condensed Balance Sheet Assets Dec. 31, 2004 Jun. 30, 2004 ------------ ------------ (Restated)** (Restated)** Current Assets: Unaudited * Cash $ 538,097 $ 554,354 Accounts Receivable 14,011 28,925 Inventory 2,309,930 2,357,864 Prepaid expenses 55,437 64,579 Other current assets 4,291 570 ------------ ------------ Total Current Assets 2,921,766 3,006,292 ------------ ------------ Property and Equipment, net 2,226,943 2,301,095 Other Assets 358,853 375,941 ------------ ------------ $ 5,507,562 $ 5,683,328 ============ ============ Liabilities and Stockholders' Equity Current Liabilities: Accounts Payable and Accrued Expenses $ 1,027,658 $ 1,172,526 Customer Deposits 40,000 40,000 Short term debt 300,407 300,407 ------------ ------------ Total Current Liabilities 1,368,065 1,512,933 ------------ ------------ Stockholders Equity: Common Stock 83,299,091 79,235,712 Additional paid-in capital 1,597,780 1,597,780 Deficit accumulated during development stage (80,757,374) (76,663,097) ------------ ------------ Total stockholders' equity 4,139,497 4,170,395 ------------ ------------ $ 5,507,562 $ 5,683,328 ============ ============ * Condensed from audited financial statements. ** Revision reflects restatements from prior fiscal years. The accompanying notes are an integral part of these condensed financial statements. 4 IMAGING DIAGNOSTIC SYSTEMS, INC. (A Development Stage Company) (Unaudited) Condensed Statement of Operations
Six Months Ended Three Months Ended Since Inception December 31, December 31, (12/10/93) to 2004 2003 2004 2003 Dec. 31, 2004 ---- ---- ---- ---- ------------- (Restated)** Net Sales $ - $ - $ - $ - $ 917,296 Cost of Sales - - - - 363,871 ----------- ---------- ----------- ----------- ------------ Gross Profit - - - - 553,425 ----------- ---------- ----------- ----------- ------------ Operating Expenses: General and administrative 1,493,595 3,106,812 776,583 1,908,368 42,065,539 Research and development 1,439,608 196,307 906,517 111,300 13,136,888 Sales and marketing 586,959 250,203 345,324 191,922 4,030,533 Inventory valuation adjustments 167,368 - 45,132 - 3,402,369 Depreciation and amortization 95,663 83,914 47,831 45,749 2,329,232 Amortization of deferred compensation - - - - 4,064,250 ------------ ------------ ------------ ------------ ------------ 3,783,193 3,637,236 2,121,387 2,257,339 69,028,811 ------------ ------------ ------------ ------------ ------------ Operating Loss (3,783,193) (3,637,236) (2,121,387) (2,257,339) (68,475,386) Gain/Loss on sale of fixed assets - (5,302) - (5,302) 5,585 Interest income 2,937 7,619 1,916 2,513 271,774 Interest expense (314,021) (443,061) (137,463) (130,938) (5,711,587) ------------ ------------ ------------ ------------ ------------ Net Loss (4,094,277) (4,077,980) (2,256,934) (2,391,066) (73,909,614) Dividends on cumulative Pfd. stock: From discount at issuance - - - - (5,402,713) Earned - - - - (1,445,047) ------------ ------------ ------------ ------------ ------------ Net loss applicable to common shareholders $ (4,094,277) $ (4,077,980) $ (2,256,934) $ (2,391,066) $(80,757,374) ============ ============ ============ ============ ============ Net Loss per common share: Basic and Diluted: Net loss per common share $ (0.02) $ (0.02) $ (0.01) $ (0.01) $ (1.04) =========== ============ ============ ============ ========== Weighted avg. no. of common shares 179,994,895 166,116,649 183,133,979 166,943,524 77,615,143 ============ ============ ============ ============ ==========
** Revision reflects restatements from prior fiscal years. The accompanying notes are an intergral part of these condensed financial statements. 5 IMAGING DIAGNOSTIC SYSTEMS, INC. (A Development Stage Company) Condensed Statement of Cash Flows
Six Months Since Inception Ended December 31, (12/10/93) to 2004 2003 Dec. 31, 2004 ------------- ------------- ---------------- (Restated)** Cash provided by (used for) Operations: Net loss $ (4,094,277) $ (4,077,980) $(73,909,614) Changes in assets and liabilities 366,539 376,961 25,461,459 ------------ ------------ ------------ Net cash used by operations (3,727,738) (3,701,019) (48,448,155) ------------ ------------ ------------ Investments Proceeds from the sale of property & equipment - - 29,857 Capital expenditures (4,423) (315,545) (7,209,954) ------------ ------------ ------------ Cash used for investments (4,423) (315,545) (7,180,147) ------------ ------------ ------------ Cash flows from financing activities: Repayment of capital lease obligation - - (50,289) Other financing activities - NET - - 5,835,029 Proceeds from issuance of preferred stock - - 18,039,500 Net proceeds from issuance of common stock 3,715,904 3,667,150 32,342,109 ------------ ------------ ------------ Net cash provided by financing activities 3,715,904 3,667,150 56,166,349 ------------ ------------ ------------ Net increase (decrease) in cash (16,257) (349,414) 538,097 Cash, beginning of period 554,354 1,361,507 - ------------ ------------ ------------ Cash, end of period $ 538,097 $ 1,012,093 $ 538,097 ============ ============ ============
** Revision reflects restatements from prior fiscal years. The accompanying notes are an intergral part of these condensed financial statements. 6 IMAGING DIAGNOSTIC SYSTEMS, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited) NOTE 1 - BASIS OF PRESENTATION We have prepared the accompanying unaudited condensed financial statements of Imaging Diagnostic Systems, Inc. in accordance with generally accepted accounting principles for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In our opinion, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. Operating results for the three and six-month periods ended December 31, 2004 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending June 30, 2005. These condensed financial statements have been prepared in accordance with Financial Accounting Standards No. 7 (FAS 7), Development Stage Enterprises, and should be read in conjunction with our condensed financial statements and related notes included in our Annual Report on Form 10-K filed on September 17, 2004. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires that management make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of expenses incurred during the reporting period. Actual results could differ from those estimates. NOTE 2 - GOING CONCERN Imaging Diagnostic Systems, Inc. (IDSI) is currently a development stage company and our continued existence is dependent upon our ability to resolve our liquidity problems, principally by obtaining additional debt and/or equity financing. IDSI has yet to generate a positive internal cash flow, and until significant sales of our product occur, we are mostly dependent upon debt and equity funding. See Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations". In the event that we are unable to obtain debt or equity financing or we are unable to obtain such financing on terms and conditions acceptable to us, we may have to cease or severely curtail our operations. This would materially impact our ability to continue as a going concern. In the event that we are unable to draw on our private equity line, alternative financing would be required to continue operations. Management has been able to raise the capital necessary to reach this stage of product development and has been able to obtain funding for capital requirements to date. There is no assurance that, if and when FDA marketing clearance is obtained, the CTLM(R) will achieve market acceptance or that we will achieve a profitable level of operations. We have commenced our planned principal operations of the manufacture and sale of our sole product, the CTLM(R), CT Laser Mammography System. We are continuing to appoint distributors and are installing systems under our clinical collaboration program as part of our global commercialization program. We have sold a total of five systems as of December 31, 2004; however, we continue to operate as a development stage enterprise because we have yet to produce significant revenues, we rely on raising capital through our Fourth Private Equity Credit Agreement and we have to create product awareness as a foundation to developing our markets through our existing distributor network and through the appointment of additional distributors and the training of their field service engineers. We would be able to exit FAS 7 Development Stage Enterprise reporting upon having sufficient revenues for two successive quarters such that we would not have to utilize our Fourth Private Equity Credit Agreement for capital to cover our quarterly operating expenses. NOTE 3 - INVENTORY 7 Inventories included in the accompanying condensed balance sheet are stated at the lower of cost or market. The following is a summary of inventories:
December 31, 2004 June 30, 2004 Raw materials consisting of purchased parts, components and supplies $ 1,488,173 $ 1,100,112 Work-in-process including completed units undergoing final inspection and testing $ 38,678 $ 93,869 Finished goods $ 783,079 $ 1,163,883 Total Inventory $ 2,309,930 $ 2,357,864
NOTE 4 - REVENUE RECOGNITION We recognize revenue in accordance with the guidance presented in the SEC's Staff Accounting Bulletin No. 104. We sell our medical imaging products, parts, and services to independent distributors and in certain unrepresented territories directly to end-users. Revenue is recognized when persuasive evidence of a sales arrangement exists, delivery has occurred such that title and risk of loss have passed to the buyer or services have been rendered, the selling price is fixed or determinable, and collectibility is reasonable assured. Unless agreed otherwise, our terms with international distributors provide that title and risk of loss passes F.O.B. origin. NOTE 5 - NEW ACCOUNTING PRONOUNCEMENTS In December 2004, the Financial Accounting Standards Board, or FASB, issued a revision of Financial Accounting Standards No. 123, or SFAS 123(R), which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their values. We expect to calculate the value of share-based payments under SFAS 123(R) on a basis substantially consistent with the fair value approach of SFAS 123. We will adopt SFAS 123(R) effective July 1, 2005. We expect the adoption of SFAS 123R will have an impact on our financial statements; however, we are still evaluating whether the adoption of this standard will be material. In November 2004, the FASB issued SFAS No. 151, "Inventory Costs" ("SFAS 151"), an amendment of ARB No. 43, Chapter 4. SFAS 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not believe adoption of SFAS will have a material effect on its financial position, results of operations or cash flows. NOTE 6 - STOCK BASED COMPENSATION The Company accounts for stock-based compensation issued to its employees using the intrinsic value method. Accordingly, compensation cost for stock options issued is measured as the excess, if any, of the fair value of the Company's common stock at the date of grant over the exercise price of the options. The pro forma net earnings per share amounts as if the fair value method had been used are presented below. For purposes of the following pro forma disclosures, the weighted-average fair value of options has been estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted-average assumptions used for grants for the three and six months ended December 31, 2004, and 2003: no dividend yield; expected volatility of 119%; risk-free interest rate of 4%; and an expected five-year term for options granted. Had the compensation cost been determined based on the fair value at the grant, the Company's net income (loss) and basic and diluted earnings (loss) per share would have been reduced to the pro forma amounts indicated below: 8
Three Months Ended Six Months Ended ------------------ ---------------- December 31 December 31 ----------- ----------- 2004 2003 2004 2003 ---- ---- ---- ---- Net income (loss) - as reported (2,256,394) (2,391,066) (4,094,277) (4,077,980) Less: stock-based employee compensation determined under the Fair value method, net of income tax effect 110,000 195,232 268,511 385,089 ----------- ----------- ----------- ---------- Net income (loss) - pro forma (2,146,394) (2,195,834) (3,825,766) (3,692,891) =========== =========== =========== =========== Basic and Diluted earnings (loss) per share-as reported $ (0.01) $ (0.01) $ (0.02) $ (0.02) Basic and Diluted earnings (loss) per share-pro forma $ (0.01) $ (0.01) $ (0.02) $ (0.02)
9 THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS. ACTUAL RESULTS AND EVENTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED AS A RESULT OF THE RISKS AND UNCERTAINTIES SET FORTH UNDER THE CAPTION "CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING STATEMENTS", IN OUR FORM 10-K FOR THE FISCAL YEAR ENDED JUNE 30, 2004. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Imaging Diagnostic Systems, Inc. is a development stage company, which, since inception, has been engaged in research and development of its Computed Tomography Laser Mammography System (CTLM(R)). The CTLM(R) is a breast-imaging device for the detection of cancer which utilizes laser technology and proprietary computer algorithms to produce three-dimensional tomographic images of the breast. As of the date of this report we have had no substantial revenues from our operations. We have incurred net losses applicable to common shareholders since inception through December 31, 2004 of approximately $80,757,374 after discounts and dividends on preferred stock. We anticipate that losses from operations will continue for at least the next 12 months, primarily due to an anticipated increase in marketing and manufacturing expenses associated with the international commercialization of the CTLM(R), expenses associated with our FDA PMA process, and the costs associated with advanced product development activities. There can be no assurances that we will obtain the PMA, that the CTLM(R) will achieve market acceptance or that sufficient revenues will be generated from sales of the CTLM(R) to allow us to operate profitably. RESULTS OF OPERATIONS There were no revenues for the three and six months ended December 31, 2004. We are in the process of commercializing our operations, and as part of our transition plan to exit from FAS 7 reporting as a development stage enterprise, we have changed the format of our management discussion and analysis of financial condition and results of operations (MD&A) to better disclose and discuss the three most significant categories of expenses, i.e., general and administrative (G&A), research and development (R&D), and sales and marketing (S&M). In our previous filings, the discussion of compensation and related benefits only included salaries, payroll taxes and bonuses for two categories: 1) administrative and engineering and 2) research and development. We expanded the research and development category and are now combining engineering with research and development under our new R&D discussion. We have renamed the administrative and engineering category as general and administrative. We have created an additional category, sales and marketing. Also in our previous discussions, the costs of salaries, payroll taxes and bonuses for sales and marketing were included in administrative and engineering. In addition, we are expanding our discussion of health insurance and worker's compensation insurance so that they fall into one of the three expense categories. We previously included them under insurance costs. GENERAL AND ADMINISTRATIVE (G&A) -------------------------------- General and administrative expenses during the three and six months ended December 31, 2004, were $776,583 and $1,493,595 representing decreases of $1,131,758 or 59% and $1,613,217 or 52%, respectively, for the corresponding periods for 2003. Of the $776,583 and $1,493,595, compensation and related benefits comprised $460,382 (59%) and $922,283 (62%), respectively. The three-month decrease of $1,131,758 was due primarily to a $450,000 one-time settlement expense in the prior year and the reallocation of $260,389 in salaries and payroll taxes, $38,287 in health insurance, $129,841 in travel and subsistence, $112,600 in consulting and $79,352 in professional fees to the appropriate R&D and S&M expense categories. 10 The six-month decrease of $1,613,217 was due primarily to a $450,000 one-time settlement expense in the prior year and the reallocation of $562,921 in salaries and payroll taxes, $68,484 in health insurance, $174,112 in travel and subsistence, $221,390 in consulting and $167,408 in professional fees to the appropriate R&D and S&M expense categories. Other expense items not listed above that are now included in our G&A expense category are: property and casualty insurance; directors' and officers' liability insurance; professional fees associated with our corporate and securities attorneys and independent auditors; maintenance of our current patents; corporate governance expenses; stockholder expenses; utilities; maintenance; telephones; office supplies; and sales and property taxes. These expenses did not have significant changes from the three and six month corresponding periods for 2003. We do not expect a material increase in our general and administrative expenses until we realize a significant increase in revenue from the sale of our product. RESEARCH AND DEVELOPMENT (R&D) ------------------------------ Research and development expenses during the three and six months ended December 31, 2004, were $906,517 and $1,439,608 representing increases of $795,217 or 714% and $1,243,301 or 633%, respectively, for the corresponding periods for 2003. Of the $906,517 and $1,439,608, compensation and related benefits comprised $382,059 (42%) and $739,577 (51%), respectively. The three-month increase of $795,217 was due primarily to clinical expenses increasing by $364,488 as a result of PMA study expenses and the reallocation of $254,111 in salaries and payroll taxes, $36,836 in health insurance, $22,779 in consulting and $52,330 in outside legal services from the G&A expense category. The six-month increase of $1,243,301 was due primarily to clinical expenses increasing by $408,349 as a result of PMA study expenses and the reallocation of $493,684 in salaries and payroll taxes, $75,073 in health insurance, $31,448 in consulting and $109,640 in outside legal services from the G&A expense category. Other expense items not listed above that are now included in our R&D expense category are: costs associated with materials and components we use to make product enhancements to the CTLM(R); materials and components for new product research; professional fees associated with the research and applications for new patents; and the costs associated with the shipping, training, installing and servicing of our clinical collaboration sites. These expenses did not have significant changes from the three and six month corresponding periods for 2003. We expect a significant increase in our R&D expenses because of the costs associated with conducting clinical trials in the United States required for our PMA application. We also expect our consulting expenses and professional fees to increase due to the costs associated with the preparation and submission of our PMA application to the FDA at the conclusion of the U.S. clinical trials. See Item 5. Other Information - "Recent developments, Regulatory Matters". SALES AND MARKETING (S&M) ------------------------- Sales and marketing expenses during the three and six months ended December 31, 2004, were $345,324 and $586,959 representing increases of $153,402 or 80% and $336,756 or 135%, respectively, for the corresponding periods for 2003. Of the $345,324 and $586,959, compensation and related benefits comprised $95,320 (28%) and $157,666 (27%), respectively. The three-month increase of $153,402 was due primarily to the reallocation of $89,508 in salaries and payroll taxes, $5,471 in health insurance and $60,047 in travel and subsistence expenses from the G&A expense category. The six-month increase of $336,756 was due primarily to the reallocation of $146,237 in salaries and payroll taxes, $10,743 in health insurance and $132,760 11 in travel and subsistence expenses from the G&A expense category. Other expense items not listed above that are now included in our S&M expense category are: costs associated with advertising and promotion; trade show expenses; certification expenses; commissions; and product liability insurance. These expenses did not have significant changes from the three and six month corresponding periods for 2003. We expect commissions, advertising and promotion and travel and subsistence costs to increase as we continue to implement our global commercialization program. AGGREGATED OPERATING EXPENSES ----------------------------- In comparing our total operating expenses (G&A, R&D and S&M) in the three and six months ended December 31, 2004 to expenses in the comparable periods in 2003, we had decreases of $183,166 or 8% and $33,160 or 1%, respectively. The overall decrease of $183,166 in the three-month comparative period was the net result of several factors. A significant factor was the recording of a one-time settlement expense of $450,000 associated with the Ladenburg case in 2003. We also had a decrease of $83,139 in overall consulting expenses during this three-month comparative period because we hired a vice president of international sales in September 2004, which eliminated our need for an international marketing consultant; however, we will continue to use other consultants in certain countries to assist our vice president of international sales. A further reduction of consulting fees was a result of the termination of our financial advisor concurrent with the termination of our Third Private Equity Credit Agreement. We had a decrease in advertising and promotion of $30,548 because, after a review of our advertising program, we selected those publications that provided the best exposure to our potential markets. As a cost saving measure we reduced staff at the RSNA 2004 and other trade shows, which resulted in a decrease in travel and subsistence expenses of $42,061.We had a decrease in professional fees of $24,436 primarily due to the settlement of the Ladenburg case in 2003; however, we did have an increase in clinical expenses of $364,488 in connection with our PMA study and an increase of $83,230 in salaries and payroll taxes due to the hiring of new employees. The overall decrease of $33,160 in the six-month comparative period was the net result of several factors. A significant factor was the recording of a one-time settlement expense of $450,000 associated with the Ladenburg case in 2003. We also had a decrease of $156,821 in overall consulting expenses during this six-month comparative period because we hired a vice president of international sales in September 2004, which eliminated our need for an international marketing consultant; however, we will continue to use other consultants in certain countries to assist our vice president of international sales. A further reduction of consulting fees was a result of the termination of our financial advisor concurrent with the termination of our Third Private Equity Credit Agreement. We had a decrease in advertising and promotion of $22,656 because, after a review of our advertising program, we selected those publications that provided the best exposure to our potential markets. We had a decrease in professional fees of $30,482 primarily due to the settlement of the Ladenburg case in 2003. However, we did have an increase in clinical expenses of $408,349 in connection with our PMA study, an increase of $114,001 in salaries and payroll taxes due to the hiring of new employees, an increase in certification expenses of $27,432 due to the cost of a risk analysis study and an increase in stockholder expenses of $59,782 due to an increase in quarterly retainers and workshop days by the Board of Directors. We had a nominal increase of $13,234 in travel and subsistence expenses. We continue to rely on outside consultants and attorneys for our regulatory affairs and expect to incur an increase in consulting expenses and professional fees in the preparation and submission of our PMA application to the FDA. Interest expense during the three and six months ended December 31, 2004, was $137,463 and $314,021 representing an increase of $6,525 or 5% and a decrease of $129,040 or 29% for the corresponding period for 2003. The fluctuations are due primarily to the amount of the draws and the recording of the 7% and 9% discounts on our equity credit line as interest with Charlton Avenue, LLC ("Charlton"). See Item 5. Other Information - "Financing/Equity Line of Credit" 12 BALANCE SHEET DATA Our combined cash and cash equivalents totaled $538,097 as of December 31, 2004. This is a decrease of $16,257 from $554,354 as of June 30, 2004. During the quarter ending December 31, 2004, we received a net of $1,765,396 from the sale of common stock through our private equity agreement with Charlton and the exercise of employee stock options. See - "Financing/Equity Line of Credit" We do not expect to generate a positive internal cash flow for at least the next 12 months due to an anticipated increase in marketing and manufacturing expenses associated with the international commercialization of the CTLM(R), expenses associated with our FDA PMA process, the costs associated with product development activities and the time required for homologations from certain countries. Property and Equipment was valued at $2,226,943 net as of December 31, 2004. The overall decrease of $74,152 from June 30, 2004 is due primarily to depreciation recorded for the first and second quarters. LIQUIDITY AND CAPITAL RESOURCES We are currently a development stage company and our continued existence is dependent upon our ability to resolve our liquidity problems, principally by obtaining additional debt and/or equity financing. We have yet to generate a positive internal cash flow, and until significant sales of our product occur, we are mostly dependent upon debt and equity funding from outside investors. In the event that we are unable to obtain debt or equity financing or are unable to obtain such financing on terms and conditions acceptable to us, we may have to cease or severely curtail our operations. This would materially impact our ability to continue as a going concern. Since inception we have financed our operating and research and product development activities through several Regulation S and Regulation D private placement transactions and with loans from unaffiliated third parties. Net cash used for operating and product development expenses during the six months ending December 31, 2004, was $3,727,738 primarily due to the costs of wages and related benefits, legal and consulting expenses, research and development expenses, clinical expenses, and travel expenses associated with clinical and sales and marketing activities, compared to $3,701,019 in the same six months ending December 31, 2003. At December 31, 2004, we had working capital of $1,553,701 compared to working capital of $2,428,571 at December 31, 2003, and $1,493,359 at June 30, 2004. During the second quarter ending December 31, 2004, we were able to raise a total of $1,762,500 after expenses through the sale of common stock to Charlton. We do not expect to generate an internal cash flow for at least the next 12 months due to the expected costs of commercializing our initial product, the CTLM(R) in the international market and for the expense of continuing our ongoing product development program. We will require additional funds for operating expenses, FDA regulatory processes, manufacturing and marketing programs and to continue our product development program. Accordingly, we plan to utilize the Fourth Private Equity Credit Agreement to raise the funds required prior to the end of fiscal year 2005 in order to continue operations. In the event that we are unable to utilize the Fourth Private Equity Credit Agreement, we would have to raise the additional funds required by either equity or debt financing, including entering into a transaction(s) to privately place equity, either common or preferred stock, or debt securities, or combinations of both; or by placing equity into the public market through an underwritten secondary offering. If additional funds are raised by issuing equity securities, dilution to existing stockholders will result, and future investors may be granted rights superior to those of existing stockholders. Capital expenditures for the six months ending December 31, 2004, were $4,423 as compared to approximately $315,545 for the six months ending December 31, 2003. These expenditures were a direct result of purchases of computer and miscellaneous equipment. We anticipate that the balance of our capital needs for the fiscal year ending June 30, 2005, will be approximately $50,000. There were no other changes in our existing debt agreements other than extensions, and we had no outstanding bank loans as of December 31, 2004. Our fixed commitments, including salaries and fees for current employees and 13 consultants, rent, payments under license agreements and other contractual commitments are substantial and are likely to increase as additional agreements are entered into and additional personnel are retained. We will require substantial additional funds for our product development programs, operating expenses, regulatory processes, and manufacturing and marketing programs. Our future capital requirements will depend on many factors, including the following: 1) The progress of our ongoing product development projects; 2) The time and cost involved in obtaining regulatory approvals; 3) The cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; 4) Competing technological and market developments; 5) Changes and developments in our existing collaborative, licensing and other relationships and the terms of any new collaborative, licensing and other arrangements that we may establish; 6) The development of commercialization activities and arrangements; and 7) The costs associated with compliance to SEC regulations. We now have issued and outstanding 184,687,532 shares of common stock out of 200,000,000 authorized shares. In addition, we have reserved 8,779,017 shares to cover outstanding options (after waivers by some of our executive officers and directors of the reserve requirement for options to purchase 3,800,000 shares held by them which are unvested, unexercisable and/or out of the money). Therefore, given our ongoing need to issue substantial amounts of new shares to raise capital to continue operations under our Fourth Private Equity Credit Agreement with Charlton, we filed a Notice of Special Meeting of Stockholders to be held on February 23, 2005. The Proxy Statement, which was filed on January 4, 2005, seeks to obtain shareholder approval of an amendment to our articles of incorporation approving an increase in our authorized common stock from 200 million to 300 million shares. There can be no assurance that our shareholders will approve such an increase. If they do not, then we will have to seek alternative sources of funding, which may not be available on commercially reasonable terms. Consequently, a failure to obtain such shareholder approval could have a material adverse impact on IDSI. We do not expect to generate a positive internal cash flow for at least 12 months as substantial costs and expenses continue due principally to the international commercialization of the CTLM(R), activities related to our FDA PMA process, and advanced product development activities. We intend to use the Fourth Private Equity Credit Agreement as our principal source of additional capital. There can be no assurance that this financing will continue to be available on acceptable terms. We plan to continue our policy of investing excess funds, if any, in a High Performance Money Market account at Wachovia Bank N.A. Issuance of Stock for Services/Dilutive Impact to Shareholders We have issued and may continue to issue stock for services performed and to be performed by consultants. Since we have generated no revenues to date, our ability to obtain and retain consultants may be dependent on our ability to issue stock for services. From July 1, 1996, to the filing date of this report, we have issued an aggregate of 2,306,500 shares of common stock to consultants, which have been registered on Registration Statements on Form S-8. The aggregate fair market value of the shares was $2,437,151. The issuance of large amounts of common stock for services rendered or to be rendered and the subsequent sale of such shares may depress the price of the common stock. In addition, since each new issuance of common stock dilutes existing shareholders, the issuance of substantial additional shares may effectuate a change in our control. 14 Item 3. Quantitative and Qualitative Disclosures about Market Risk ---------------------------------------------------------- As of the date of this report, we believe that we do not have any material quantitative and qualitative market risks. Item 4. Controls and Procedures ----------------------- We maintain disclosure controls and procedures that are designed to ensure that the information required to be disclosed in the reports that we file under the Securities Exchange Act of 1934 (the "Exchange Act") is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives, and in reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and the Company's Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level. There has been no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting. 15 PART II OTHER INFORMATION Item 1. Legal Proceedings. None Item 2. Changes in Securities. See Item 5. "Other Information" - FINANCING/EQUITY LINE OF CREDIT. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security-Holders. None. Item 5. Other Information. Recent Developments Regulatory Matters In order to sell the CTLM(R) commercially in the United States, we must obtain marketing clearance from the Food and Drug Administration. A PreMarket Approval (PMA) application must be supported by extensive data, including pre-clinical and clinical trial data, as well as extensive literature to prove the safety and effectiveness of the device. Under the Food, Drug, and Cosmetic Act, the FDA has 180 days to review a PMA application, although in certain cases the FDA may increase that time period through requests for additional information or clarification of existing information. In our initial PMA application we followed the guidelines of the "Standardized Shell for Modular Submission" for the FDA approval process. We filed four modules from September 2000 to May 2001, which were accepted, and then filed our PMA application in April 2003. In June 2003 we received notification from FDA that an initial review of our PMA had been conducted and was sufficiently complete to permit a substantive review and was, therefore, suitable for filing. An in-depth evaluation of the safety and effectiveness of the device would be conducted to determine the final approval of the PMA application. We filed a new application with Health Canada in June 2003 because of new clinical data. On June 18, 2003 we received notification from the Medical Device Bureau of Health Canada that our application had been accepted for review. On November 14, 2003 we announced that we received notification from the Medical Device Bureau of Health Canada that our application for a "New Medical Device" license was approved. The license was issued in accordance with the Medical Device Regulations, Section 36. Furthermore, we possess the CAN/CSA ISO 13485-1998 certification, which is an additional regulatory requirement that is evidence of compliance to the quality system of the medical device. In August 2003, we received a letter from the FDA stating that it had completed its review of our PMA. The FDA, in its letter, outlined deficiencies in the PMA application, which must be resolved before the FDA's review could be completed. The FDA stated that until these deficiencies are resolved, the PMA application is not approvable in its current form. The FDA identified measures to make the PMA approvable, and we worked with our FDA counsel and consultants to prepare an 16 amendment to our PMA application to address the deficiencies noted in the letter. In February 2004, we received a warning letter from the FDA specifically regarding the biomonitoring section of an inspection conducted August 13th through August 18th, 2003 at our facility. We submitted our response to this letter to the FDA on February 9, 2004. On March 29, 2004, we announced in an 8-K filing that our responses to the FDA's warning letter regarding the bio-monitoring inspection addressed each of the issues and no further response to the FDA was required at that time. In March 2004, we received an extension of time to respond to the FDA's August 22, 2003 letter regarding our pre-market approval application. In the application we were seeking PreMarket approval from the FDA for this intended use: "The Imaging Diagnostic's Computed Tomography Laser Mammography (CTLM(R)) scanner is intended for use as an adjunct to mammography in patients who have equivocal mammographic findings within ACR BI-RADS categories 3 or 4. In particular, it is not intended for use in cases with clear mammographic or non-mammographic indications for biopsy. This device provides the radiologist with additional information to guide a biopsy recommendation". In September 2004, we announced that our CT Laser Mammography System, CTLM(R), had received Chinese State Food and Drug Administration (SFDA) marketing approval. The People's Republic of China SFDA issued the registration "Certificate for Medical Device". The medical device registration number is 20043241646. On October 15, 2004, we issued a press release of a shareholder letter written by our new CEO, Tim Hansen, detailing the steps he had taken in FDA and other corporate development matters during his first three months as CEO of the Company. In the letter he stated among other things, the following: "the PMA involves a process which has, unfortunately, taken far longer than expected. We have been working on amending the PMA application at the request of the FDA. Our team recommended rephrasing the Computed Tomography Laser Mammography System (CTLM(R)) intended use statement and modifying the patient study protocols. They also recommended adding more clinical cases. Meanwhile the PMA clock was ticking and these well advised changes would have taken more time to complete. Also, as we earlier reported, our PMA amendment and processes were briefly interrupted by a biomonitoring inspection audit of our clinical trials and subsequent warning letter and, although that matter was resolved, the sum of these influences caused serious delays in our filings. These are complex matters, but after conferring with the FDA and our outside consultants, I recently made the decision to simply withdraw our current PMA application and resubmit the entire package in a simpler and more clinically and technically robust filing. Consequently, IDSI will submit a new PMA application with a rephrased intended use statement better supported by our data, the inclusion of new clinical cases to improve the biometrics, and with a new clinical protocol to fully support the adjunctive use of CTLM(R) in clinical mammography settings. The key factor in my decision was the belief that re-filing should not additionally delay our previous schedule. The schedule should remain unchanged because the FDA indicated that Modules 1 through 4 would be `grandfathered' so to speak, and because our clinical case read program will continue in its current form. We are not starting over in any sense of the word. We will, however, submit a fresh and concise PMA application without amendments or extensions. Of course, this approach requires another filing fee but we believe it yields a higher confidence scenario. So, to be very clear, we will submit a new PMA application and there should be no additional delays in our overall schedule. You have all waited patiently for CTLM(R) to become a US market reality, and I would appreciate your continuing support through this next important phase. I am very satisfied with this new approach." In January 2005 we issued a press release of a shareholder letter entitled, "Imaging Diagnostic Systems, Inc. Releases Letter to Shareholders" written by Tim Hansen, CEO. The letter contained a brief status update of the three top priorities stated in Mr. Hansen's initial letter to shareholders released in October 2004. Specific to our PMA activities, the letter stated, "...we are altering course. The clinical study we had analyzed and which we intended to submit to the FDA did not, in our opinion, adequately reflect the capabilities of CTLM(R) as an adjunctive mammography tool. Our clinical cases were collected on CTLM(R) systems dating back to 2001. Since that time IDSI has developed significant improvements in the scanning subsystems, image reconstruction and image display software. We have also improved quality assurance routines to 17 ensure better operator and physician training, and improved image quality control. These enhancements were routinely implemented as they became validated on our international CTLM(R) shipments, but the same changes were not made to the 2001 units in order to maintain our PMA modules in their original forms. We now intend to collect data using our latest systems because we believe the results will yield a stronger study to support our PMA application. Consequently, we will install updated CTLM(R) systems in the US and upgrade several international units to collect data under a new protocol. Our plan will extend the time to actual PMA submission from what we were anticipating in October, but we believe this approach will better support the application." Clinical Collaboration Sites Update CTLM(R) Systems have been installed and patients are being scanned under clinical collaboration agreements with the following hospitals: 1. Schering AG (Three Units) o Robert-Rossle Clinic, University of Muenster and Charite Hospital 2. The University of Vienna, Allgemeines Hospital 3. Humboldt University of Berlin, Charite Hospital 4. The Comprehensive Cancer Centre, Gliwice, Poland 5. Catholic University Hospital, Rome, Italy In September 2004, we announced that we have installed a third CT Laser Mammography System, CTLM(R), as part of Schering AG's Phase 1 clinical study of the fluorescent imaging compound SF64. The third system was installed in the prestigious Charite Hospital in Berlin. We had previously announced that CTLM(R) Systems were installed at the Robert-Rossle Clinic and at the University of Muenster. In November 2004, we announced that the Comprehensive Cancer Centre in Gliwice, Poland signed a clinical collaborative agreement to gather data to expand diagnostic and therapeutic applications of the CT Laser Mammography (CTLM(R)) system. In December 2004, we announced that a CT laser Mammography (CTLM(R)) system was shipped to the Comprehensive Cancer Centre in Gliwice, Poland. A clinical collaboration agreement was previously announced on November 10, 2004. In December 2004, we announced that the Catholic University in Rome, Italy signed a clinical collaboration agreement and that a CT Laser Mammography (CTLM(R)) system had been shipped to their Department of Radiology. This agreement marked the sixth out of eight targeted European sites for our clinical collaboration program. On February 3, 2005, we announced that Charles University Hospital in Prague, Czech Republic has signed a clinical collaborative agreement to gather data and expand the proprietary applications of the CTLM(R). This agreement marked the seventh out of eight targeted European sites for our clinical collaboration program. We are in discussions with other European hospitals and clinics wishing to participate in our clinical collaboration program. The additional collaboration sites will be announced upon the signing of our clinical collaboration agreements. 18 Other Recent Events In September 2004, we announced that Janusz Ostrowski has joined IDSI as Vice President, International Sales. He will be responsible for implementing and managing the distribution network outside of the U.S. Mr. Ostrowski has over 20 years of experience as an imaging equipment industry executive who has spent his career introducing new products and services to global markets. In September 2004, we announced that we signed a multi-year agreement with China Far East International Trading Corporation (CFETC) for the exclusive sale of our CTLM(R) in the People's Republic of China. The new agreement also includes clinical research and collaboration programs and supersedes our previous distribution contract with CFETC. On September 29, 2004 we filed an 8-K report announcing this press release and attached it as an exhibit. In October 2004, we issued a press release entitled "Shareholder Letter from Imaging Diagnostic Systems, Inc." written by our new CEO, Tim Hansen. The letter stated Mr. Hansen's three top priorities: first, get the U.S. FDA Pre Market Approval (PMA) completed; second, launch a global commercialization program; and third, lay out a roadmap to enhance the long-term growth of the Company. On October 18, 2004 we filed an 8-K report announcing this press release and attached it as an exhibit. In November 2004, we announced that we would be an exhibitor at the 36th annual MEDICA 2004 in Dusseldorf, Germany. This internationally renowned medical device conference attracts exhibitors from 67 nations and visitors representing over 100 nations, and we expect to generate leads for future potential sales from the attendees. In December 2004, we announced that EDOMED AS was appointed the exclusive Distributor in the Czech Republic for the CTLM(R). In December 2004, we announced that EDO-MED Sp. Z.o.o. was appointed the exclusive Distributor in Poland for the CTLM(R). In January 2005, we announced that Kurt & Kurt, Inc. was appointed the exclusive Distributor in Turkey for the CTLM(R). In January 2005, we announced the receipt of six international orders for CTLM(R) systems. The orders reflect our new emphasis on global commercialization and recent efforts to strengthen our international distribution network supported by our clinical luminary partnerships. In January 2005, we issued a press release entitled "Imaging Diagnostic Systems, Inc. Releases Letter to Shareholders" written by our CEO, Tim Hansen. The letter gave a brief status update of the three top priorities stated in Mr. Hansen's initial letter to shareholders released in October 2004. On January 27, 2005 we filed an 8-K report announcing this press release and attached it as an exhibit. In January 2005, we announced that we sold a CT Laser Mammography (CTLM(R)) system to our distributor, Biomedical International, Snc. of Rome Italy for installation at the Hospital Civile di Teramo, Teramo, Italy. The CTLM(R) system will be used in the hospital's oncology department. Revenue for the sale will be reported in our third quarter ending March 31, 2005. On February 1, 2005, we announced that we sold a CT Laser Mammography (CTLM(R)) system to our distributor, Abu Dhabi International Medical Services of Abu Dhabi, United Arab Emirates for installation at Al Salama Hospital, Abu Dhabi, U.A.E. Revenue for the sale will be reported in our third quarter ending March 31, 2005. On February 7, 2005, we announced that we sold a CT Laser Mammography (CTLM(R)) system to our distributor, Biomedical International, Snc. of Rome Italy for installation at the Biomedical Mammography Center, Alba Adriatica, Teramo, Italy. Revenue for the sale will be reported in our third quarter ending March 31, 2005. 19 FINANCING/EQUITY LINE OF CREDIT ------------------------------- We will require substantial additional funds for working capital, including operating expenses, clinical testing, regulatory processes and manufacturing and marketing programs and our continuing product development programs. Our capital requirements will depend on numerous factors, including the progress of our product development programs, results of pre-clinical and clinical testing, the time and cost involved in obtaining regulatory approvals, the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights, competing technological and market developments and changes in our existing research, licensing and other relationships and the terms of any new collaborative, licensing and other arrangements that we may establish. Moreover, our fixed commitments, including salaries and fees for current employees and consultants, and other contractual agreements are likely to increase as additional agreements are entered into and additional personnel are retained. On July 17, 2000 we sold to Charlton in a private placement 400 shares of our Series K convertible preferred stock for $4 million. We issued an additional 95 Series K shares to Charlton for $950,000 on November 7, 2000. The total of $4,950,000 was designed to serve as bridge financing pending draws on the Charlton private equity line (described below). We paid Spinneret Financial Systems Ltd. ("Spinneret"), an independent financial consulting firm unaffiliated with the Company and, according to Spinneret and Charlton, unaffiliated with Charlton, $200,000 as a consulting fee for the first tranche of Series K shares and five Series K shares as a consulting fee for the second tranche. We were obligated to pay a 9% dividend on the Series K convertible preferred in cash or common stock at our option semi-annually on June 30 and December 31 of each calendar year or upon the conversion date. Under the Series K Certificate of Designations, we had the option of redeeming the remaining convertible preferred (except for the Spinneret shares) solely through the use of the private equity line by paying cash with the following redemption premiums. Days from closing 0-120 121-180 180 Redemption price As a % of Principal 105% 107.5% 110% In the event that, for whatever reason, we did not redeem the convertible preferred according to the above schedule, the holder had the right to convert the convertible preferred into common stock at a per share price equal to the lower of $1.29 (115% of the closing bid price on the day prior to the initial issuance) or 87.5% of the average of the three lowest closing bid prices (which need not be consecutive) of the 20 consecutive trading days prior to the conversion date. In November 2000, Charlton converted 25 Series K shares plus accrued dividends into 197,349 restricted shares of common stock. In January 2001, Charlton converted $3,950,000 (395 shares) of Series K convertible preferred stock into an aggregate of 4,935,412 common shares and Spinneret converted $50,000 (5 shares) of Series K convertible preferred stock into an aggregate of 63,996 common shares. On December 12, 2000, we registered 5,720,605 common shares underlying the 500 shares of Series K convertible preferred stock. The shares registered included only 58,140 shares underlying the Spinneret Series K preferred so we had to issue 5,856 common shares with a restrictive legend. Those shares were registered in February 2001. Of the remaining 100 shares of Series K preferred stock, 50 shares were converted into 664,659 shares of common stock in April 2001 and 50 shares were redeemed for $550,000 using proceeds from the Charlton private equity line in April 2001. On August 17, 2000, we entered into a $25 million private equity credit agreement with Charlton. On November 29, 2000, prior to any draws under the initial private equity agreement, we terminated that agreement and the initial agreement was replaced by an Amended Private Equity Credit Agreement dated November 30, 2000 (the "Private Equity Agreement"). The Private Equity Agreement committed Charlton to purchase up to $25 million of common stock subject to certain conditions pursuant to Regulation D over the course of a commitment period extending 12 months after the effective date of a registration statement covering the Private Equity Agreement common shares. The timing and amounts of the purchase by the investor were at our sole discretion. We were required to draw down a minimum of $10 million from the credit line over the initial 12-month period. If the minimum amount was not sold, Charlton was entitled to 20 receive a payment equal to 9% of the difference between the $10,000,000 and the amount drawn by us (the "Shortfall Payment"). The purchase price of the shares of common stock was set at 91% of the market price. The market price, as defined in the agreement, was the average of the three lowest closing bid prices of the common stock over the ten day trading period beginning on the put date and ending on the trading day prior to the relevant closing date of the particular tranche. If, subsequent to effectiveness, the registration statement was suspended at any time, we would be obligated to pay liquidated damages of 1.5% of the cost of all common stock then held by the investor for each 15-day period or portion thereof, beginning on the date of the suspension. If such suspension was cured within the first 15 days, the damages would not apply. The only fee associated with the private equity financing was a 5% consulting fee payable to Spinneret. In September 2001 Spinneret proposed to lower the consulting fee to 4% provided that we pay their consulting fee in advance. We reached an agreement and paid them $250,000 out of proceeds from a put. On December 13, 2000 we registered 7,089,685 shares of common stock underlying $10 million out of the $25 million available in the Private Equity Agreement. Because of the decline in our stock price, we did not have sufficient common shares registered to fulfill our obligation under the Private Equity Agreement. To satisfy our obligation to provide registered common shares to cover the $10 million minimum, we registered 9,875,000 additional shares on October 23, 2001. We paid Spinneret an additional $186,235 in consulting fees relating to the Private Equity Agreement from January to September 2001. The principal conditions to our ability to draw under the private equity line were that (i) during the 15 trading days immediately preceding each of the put notice date and the corresponding closing date (11 trading days after the put notice date) the average bid price of our common stock must be at least $.50 and the average daily trading volume must be at least $100,000, (ii) no more than 19.9% of our outstanding common stock (30,598,173 shares as of the date of this report) may be issued under the agreement without shareholder approval if such approval is required by our principal trading market (it is not required by our current market, the OTC Bulletin Board), (iii) the purchase cannot cause Charlton to beneficially own more than 9.9% of our outstanding common stock (according to the information available to us it beneficially owns less than 5% of the common stock as of the date of this report), and (iv) there be no material adverse change in our business or financial condition since our most recent filing with the SEC. The New Private Equity Agreement -------------------------------- Because the average bid price of our common stock fell below the contractually required $.50 during the 15-day period prior to puts and/or put closings from time to time in the period beginning November 15, 2001, Charlton orally agreed to waive the minimum price requirement. Further, because we drew only $5,825,000 of the $10,000,000 minimum by December 13, 2001, Charlton orally agreed to extend the commitment period and thereby waived its right to receive a Shortfall Payment based on our failure to timely draw the $10,000,000 minimum. On May 7, 2002, we and Charlton entered into a written amendment to the Private Equity Agreement as of November 15, 2001, which (i) reduced the minimum stock price requirement from $.50 to $.25, (ii) reduced the minimum average daily trading volume to $50,000, and (iii) extended the commitment period to December 13, 2003. Between November 15, 2001, and April 24, 2002, Charlton accepted two puts totaling $625,000 and 1,410,240 shares despite the relevant average bid price having fallen below $.50. From December 14, 2001, to April 24, 2002, Charlton accepted eight puts totaling $2,600,000 and 5,897,827 shares. Charlton did not accept any puts under the prior Private Equity Agreement after April 24, 2002. Charlton agreed to the waivers sought by us in connection with the prior Private Equity Agreement because of our good working relationship and the mutually beneficial nature of the relationship. During the initial one-year commitment period, we drew only $5,825,000 of the $10,000,000 minimum because we did not require all of the funds and wanted to avoid unnecessary dilution of our shareholders and unnecessary sales of our stock, which could have depressed its market price. Charlton never rejected any of our puts. From January 25, 2001 to April 9, 2002 we drew $8,425,000 and issued 15,015,479 shares to Charlton under the prior Private Equity Agreement. On May 15, 2002, we and Charlton entered into a new private equity agreement which replaced the prior Private Equity Agreement (the "New Private Equity Agreement"). The terms of the New Private Equity Agreement were substantially equivalent to the terms of the prior agreement, except that (i) the commitment period was three years from the effective date of a registration statement 21 covering the New Private Equity Agreement shares, (ii) the minimum amount we had to draw through the end of the commitment period was $2,500,000, (iii) the minimum stock price requirement was reduced to $.20, and (iv) the minimum average trading volume was reduced to $40,000. Since we did not yet have an effective registration statement covering shares to be sold pursuant to the New Private Equity Agreement, in May 2002, Charlton loaned us $350,000 in order to partially cover our short-term working capital needs. This loan was evidenced by a promissory note dated May 29, 2002, due August 1, 2002, and bearing interest at a rate of 2% per month. The loan was secured by a pledge of 1,000,000 shares of our common stock, 500,000 each by our Chief Executive Officer, Linda Grable, and by our Executive Vice President and Chief Financial Officer, Allan Schwartz, and was personally guaranteed by Ms. Grable and Mr. Schwartz. Charlton orally agreed to extend the due date of the note, and we paid it back in full with proceeds of puts under the New Private Equity Agreement between July and December 2002. On May 17, 2002 we filed a registration statement on Form S-2 to register 10,000,000 shares underlying the New Private Equity Agreement, which was declared effective by the SEC on July 24, 2002. We made sales under the New Private Equity Agreement from time to time in order to raise working capital on an "as needed" basis. In total, under the New Private Equity Agreement we drew down $2,076,000 and issued 9,989,319 shares of common stock. The Third Private Equity Credit Agreement ----------------------------------------- On October 29, 2002, we and Charlton entered into a "Third Private Equity Credit Agreement" designed to supplement the prior New Private Equity Agreement. The terms of the Third Private Equity Credit Agreement were substantially equivalent to the terms of the prior agreement, except that (i) the commitment period was three years from the effective date of a registration statement covering the Third Private Equity Credit Agreement shares, (ii) the maximum commitment was $15,000,000, (iii) the minimum amount we had to draw through the end of the commitment period was $2,500,000, (iv) the minimum stock price requirement was reduced to $.10, and (v) the minimum average trading volume in dollars was reduced to $20,000. We made sales under the Third Private Equity Credit Agreement from time to time in order to raise working capital on an "as needed" basis until effectiveness of our registration statement for shares issued under our new Fourth Private Equity Credit Agreement (detailed below). In total, under the Third Private Equity Credit Agreement we drew down $9,705,000 and issued 23,816,276 shares of common stock. The Fourth Private Equity Credit Agreement ------------------------------------------ On January 9, 2004, we and Charlton entered into a new "Fourth Private Equity Credit Agreement" which replaced our prior private equity agreements. The terms of the Fourth Private Equity Credit Agreement are more favorable to us than the terms of the prior Third Private Equity Credit Agreement. The new, more favorable terms are: (i) The put option price is 93% of the three lowest closing bid prices in the ten day trading period beginning on the put date and ending on the trading day prior to the relevant closing date of the particular tranche, while the prior Third Private Equity Credit Agreement provided for 91%, ii) the commitment period is two years from the effective date of a registration statement covering the Fourth Private Equity Credit Agreement shares, while the prior Third Private Equity Credit Agreement was for three years, (iii) the maximum commitment is $15,000,000, (iv) the minimum amount we must draw through the end of the commitment period is $1,000,000, while the prior Third Private Equity Credit Agreement minimum amount was $2,500,000, (v) the minimum stock price requirement is now controlled by us as we have the option of setting a floor price for each put transaction (the previous minimum stock price in the Third Private Equity Credit Agreement was fixed at $.10), (vi) there are no fees associated with the Fourth Private Equity Credit Agreement; the prior private equity agreements required the payment of a 5% consulting fee to Spinneret, which was subsequently lowered to 4% by mutual agreement in September 2001, and (vii) the elimination of the requirement of a minimum average daily trading volume in dollars. The previous requirement in the Third Private Equity Credit Agreement was $20,000. The conditions to our ability to draw under this private equity line, as described above, may materially limit the draws available to us. 22 On January 30, 2004, we filed a registration statement with respect to 5,000,000 shares of our common stock to be issued pursuant to the Fourth Private Equity Credit Agreement. This registration statement became effective March 4, 2004, at which time the Third Private Equity Credit Agreement was terminated and we began drawing under the Fourth Private Equity Credit Agreement. On June 21, 2004 we filed a registration statement with respect to 9,800,000 shares of our common stock to be issued pursuant to the Fourth Private Equity Credit Agreement. This registration statement became effective June 29, 2004. On November 10, 2004 we filed a registration statement with respect to 7,000,000 shares of our common stock to be issued pursuant to the Fourth Private Equity Credit Agreement. This registration statement became effective December 9, 2004. We intend to make sales under the Fourth Private Equity Credit Agreement from time to time in order to raise working capital on an "as needed" basis. We have already drawn in excess of the $1,000,000 minimum but, based on our current assessment of our financing needs, we expect to draw substantially less than the $15,000,000 maximum under the Fourth Private Equity Credit Agreement; however, if those needs change we may draw up to the $15,000,000 maximum. As of the date of this report, under the Fourth Private Equity Credit Agreement we have drawn down $5,922,774 and issued 17,589,813 shares of common stock. As of the date of this report, since January 2001, we have drawn an aggregate of $26,928,774 in gross proceeds from our equity credit lines with Charlton and have issued 66,901,081 shares as a result of those draws. There can be no assurance that adequate financing will be available when needed, or if available, will be available on acceptable terms. Insufficient funds may prevent us from implementing our business plan or may require us to delay, scale back, or eliminate certain of our research and product development programs or to license to third parties rights to commercialize products or technologies that we would otherwise seek to develop ourselves. To the extent that we utilize our Private Equity Credit Agreements, or additional funds are raised by issuing equity securities, especially convertible preferred stock and convertible debentures, dilution to existing shareholders will result and future investors may be granted rights superior to those of existing shareholders. Moreover, substantial dilution may result in a change in our control. 23 Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits 31.1 Certification by Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification by Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification by Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification by Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K A Form 8-K was filed on September 28, 2004, announcing that our CT Laser Mammography System (CTLM(R)) had received Chinese State Food and Drug Administration (SFDA) marketing approval. The Peoples Republic of China SFDA issued the registration "Certificate for Medical Device". The medical device registration number is 20043241646. A Form 8-K was filed on September 29, 2004, announcing that we signed a multi-year agreement with China Far East International Trading Corporation (CFETC) for the exclusive sale of our CT Laser Mammography System (CTLM(R)) in the People's Republic of China. The new agreement also includes clinical research and collaboration programs and supersedes our previous distribution contract with CFETC. A Form 8-K was filed on October 18, 2004 announcing the issuance of a press release entitled, "Shareholder Letter From Imaging Diagnostic Systems, Inc." written by Tim Hansen, CEO. The letter detailed the three top priorities chosen by Mr. Hansen and the Board of Directors. First, get the U.S. FDA Pre Market Approval (PMA) completed; second, launch a global commercialization program; and third, lay out a roadmap to enhance the long-term growth of the Company. A Form 8-K was filed on January 27, 2005 announcing the issuance of a press release entitled, "Imaging Diagnostic Systems, Inc. Releases Letter to Shareholders" written by Tim Hansen, CEO. The letter is a brief status update of the three top priorities stated in Mr. Hansen's initial letter to shareholders released in October 2004. 24 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this amended report on Form 10-Q/A2 to be signed on its behalf by the undersigned thereunto duly authorized. Dated: July 20, 2005 Imaging Diagnostic Systems, Inc. By: /s/ Timothy B. Hansen --------------------- Timothy B. Hansen Chief Executive Officer By: /s/ Allan L. Schwartz --------------------- Allan L. Schwartz, Executive Vice-President and Chief Financial Officer (PRINCIPAL ACCOUNTING OFFICER) 25